美评2014年第1期

China-USA Business Review Volume 13, Number 1, January 2014 (Serial Number 127)

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China-USA Business Review Volume 13, Number 1, January 2014 (Serial Number 127)

Contents Economics Adoption of International Financial Reporting Standards Has Enhanced Chinese Company Transparency

1

Jing Lin, João Neiva de Figueiredo, A. J. Stagliano Creative Destruction as Economic Pattern of Europe’s Small-Scale Audiovisual Media Markets and Minority-Language Film Industries

12

Margarita Ledo-Andión, Antí a López-Gómez, Enrique Castelló-Mayo Creative Batik Motif Design Based on Local Cultural Art and Natural Environments

20

Timbul Raharjo, Toyibah Kusumawati, Suryo Tri Widodo Industrial Risk Management: Modeling From the Explosion of the 19/01/04 Complex of Liquefied Natural Gas, Skikda (GL1 / K)

38

Hanya KHERCHI MEDJDEN, Khadidja SADI

Management Substance vs. Form in Shareholder Financing: How Does This Affect the Corporate Interest?

47

Ferruccio Maria Sbarbaro, Andrea Sacco Ginevri University Systems in Europe: A Multi-Dimensional Efficiency Comparison Michael Steiner, Andreas Niederl, Michael Ploder

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China-USA Business Review, ISSN 1537-1514 January 2014, Vol. 13, No. 1, 1-11

DAVID PUBLISHING

Adoption of International Financial Reporting Standards Has Enhanced Chinese Company Transparency Jing Lin, João Neiva de Figueiredo, A. J. Stagliano Saint Joseph’s University, Philadelphia, PA, USA 

The research reported here shows that China’s recent adoption of Accounting Standards for Business Enterprises (ASBE) has increased the quality of Chinese financial reporting. With China’s decade of World Trade Organization (WTO) membership marked by dazzling economic growth, it is useful to reflect on how financial reporting itself can assist in the country’s future progress. Critical to the success of ensuring strength for this burgeoning economy is attraction of foreign investment capital. As China’s internal consumption grows, cross-border economic linkages will increase and require new investment inflows for further infrastructural and macroeconomic development. Only a reliable, trusted, and transparent financial reporting framework can ensure credibility in the world market for scarce capital resources. Evidence from this study covering six years for more than 1,200 publicly traded Chinese firms points to enhanced quality of financial reporting. This is an important empirical finding that demonstrates the benefits of adopting global financial reporting standards. China, which still relies heavily on governmental planning, has recognized the need for more transparency in financial market operations. Superior company reporting and enhanced quality of reported earnings numbers significantly contribute to greater domestic and foreign investor confidence in Chinese institutions.

Keywords: accounting standards, Accounting Standards for Business Enterprises (ASBE), earnings quality, International Financial Reporting Standards (IFRS), income smoothing

Introduction This paper reports on an assessment of the quality of the financial reporting made by Chinese companies.

Motivation for the empirical examination comes from the recent mandatory implementation of a new set of Chinese accounting guidelines, the Accounting Standards for Business Enterprises (ASBE). Although ASBE are indigenous domestic standards, they are considered to be substantially equivalent to the worldwide benchmark International Financial Reporting Standards (IFRS) that have been developed by the International Accounting Standards Board (IASB). As the second largest economy in the world, China’s recent move to bring its national accounting standards closer in line with IFRS is indicative of a continuous effort to further convergence with the global financial reporting framework.

ASBE was issued in February 2006 by China’s Ministry of Finance (MOF); it was set for implementation Jing Lin, Ph.D., Associate Professor of Accounting, Erivan K. Haub School of Business, Saint Joseph’s University.

João Neiva de Figueiredo, Ph.D., Associate Professor of Management, Erivan K. Haub School of Business, Saint Joseph’s University.

A. J. Stagliano, Ph.D., Professor of Accounting, Erivan K. Haub School of Business, Saint Joseph’s University.

Correspondence concerning this article should be addressed to A. J. Stagliano, 5600 City Avenue, Philadelphia, PA, USA 19131-1395. E-mail: astaglia@sju.edu.

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by all Chinese publicly traded companies beginning on January 1, 2007. Over the past two decades, the MOF now has prescribed a series of four different accounting regulations in 1992, 1998, 2001, and 2006 (Peng & van der Laan Smith, 2010). Each of these pronouncements is emblematic of significant progress toward convergence with international standards. By promulgating ASBE, the MOF declared that China was entering a new era of globalization in its financial reporting practices (Ding & Su, 2008).

The goal of the IASB is to develop a single set of high quality accounting standards for worldwide application in financial reporting. Given the increasingly important role that China plays in the world market, this research explores whether the adoption of ASBE, an IFRS-based standard, has resulted in an improvement in financial reporting by Chinese companies. The main focus in this paper is on the quality of earnings reported by publicly traded firms.

To measure earnings quality, three indicators are adopted: (1) smoothing of earnings; (2) earnings being managed toward a positive target amount; and (3) timeliness of loss recognition. The data are taken from companies reported in the Chinese Securities Market and Accounting Research (CSMAR) files for the period from 2004 to 2009. A total of 1,220 unique firms that have financial data across all seven years (including 2003 as the base year) are identified for the final analysis. By design, an equal number of firm-year observations (3,660) were created in the pre- and post-ASBE study periods of 2004 to 2006 and 2007 to 2009, respectively.

The empirical results indicate more fluctuations in net income subsequent to the time when ASBE was implemented. The variability of net income relative to the variability of cash flows also is higher in the post-ASBE period; this outcome suggests reduced earnings smoothing activities following the adoption of IFRS-based accounting standards. Companies seem more likely to manage earnings toward a positive target in the post-adoption period. At the same time, firms tend to engage in more timely loss recognition after ASBE became effective. Taken together, the findings suggest an increase in earnings quality associated with the adoption of IFRS-convergent accounting standards in China.

In the next section, the relevant literature is viewed. The testable hypotheses and research design are given in the third section. The sample and results are described in the fourth section. The fifth section concludes the paper with an analysis of the results along with a discussion of their usefulness in the context of China’s emergence as a world economic power.

Background Literature The primary objective espoused by the IASB is establishment of a single robust set of high quality global accounting and reporting standards. To that end, this body has worked over the years with many national standard-setting groups to bring about convergence. Currently, more than 100 countries either permit or require IFRS for public companies. Additional nations are expected to transition to IFRS over the next few years.

Since the idea of a uniform framework of accounting and reported emerged more than 40 years ago, the concept has generated a great deal of academic (and financial-press) literature.

One particularly interesting stream of research has centered on the initial impact of IFRS adoption. Daske, Hail, Leuz, and Verdi (2008) examined the economic consequences of mandatory IFRS reporting in 26 countries. They analyzed the effects on financial-instrument market liquidity, firms’ cost of capital, and Tobin’s q, documenting an increase in market liquidity around the time of the IFRS introduction, a reduction in firms’ cost of capital, and an increase in equity valuations. They discovered, inter alia, that the capital-market benefits occur only in countries where firms have incentives to be transparent and when legal enforcement is

ADOPTION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS

3

strong—thereby underscoring the importance of understanding firms’ managers’ reporting incentives and countries’ enforcement regimes in assessing the quality aspect of financial reporting.

Focusing on accounting quality, Barth, Landsman, and Lang (2008) studied the adoption of International Accounting Standards (IAS), the international principles framework that preceded IFRS, in 21 countries. They measured accounting quality on three dimensions: earnings management, loss recognition, and value relevance of accounting amounts. They found that firms applying IAS generally showed less earnings management, more timely loss recognition, and higher value relevance of accounting amounts than do like firms that adhered to different domestic standards alone. They suggested that an improvement in accounting quality was documented in the post-adoption period.

Chen, Tang, Jiang, and Lin (2010) investigated the 2005 mandatory adoption of IFRS by 15 member states in the European Union (EU). Comparing the accounting quality of publicly listed companies before and after full adoption of IFRS, the authors found higher post-adoption accounting quality for many indicators—less earnings management toward a target, reduced absolute magnitude of discretionary accruals, and higher accruals quality. However, there also was evidence that firms engaged in more income smoothing activities and recognized large losses in a less timely manner after the transition to IFRS. Overall, they attributed the quality improvement to adoption of IFRS rather than potential changes in managerial incentives, institutional features of capital markets, or the general business environment. In another study that examined the value relevance of IFRS adoption in the EU, Armstrong, Barth, Jagolinzer, and Riedl (2010) identified 16 events leading to the formal adoption and document a number of positive market reactions to these. Their results suggest that investors expect information quality benefits from IFRS adoption.

Researchers also have examined IFRS adoption impacts in various individual country settings. For example, Jeanjean and Stolowy (2008) concentrated their analysis on three IFRS first-time adopter countries: Australia, France, and the United Kingdom (UK). They found that the pervasiveness of earnings management did not decline after the introduction of IFRS. In fact, they observed an increase in earnings management among French companies. Their conclusion was that the “switch” to IFRS did not convincingly result in an overall improvement in terms of earnings quality. Horton and Serafeim (2010) focused their study on the UK in an attempt to determine whether disclosure of IFRS reconciliation adjustments for previously published UK GAAP (Generally Accepted Accounting Principles) statements had information content. Looking at six adjustment areas most directly affected by the IFRS requirements, they concluded that these reconciliation adjustments had measurable incremental value relevance when compared to the UK GAAP numbers.

Several excellent studies have been conducted on IAS/IFRS adoption in Germany. For instance, Hung and Subramanyam (2007) investigated the financial statement impacts of changing to IAS for the years from 1998 to 2002. Although they uncovered no evidence that book value and income were more value relevant under IAS than under German GAAP (HGB), IAS income exhibited greater conditional conservatism than the HGB-reported income did; this outcome was consistent with the fair-value orientation of IAS versus the typical income-smoothing orientation of HGB. In another study of German firms (years from 2002 to 2006), Paananen and Lin (2009) concluded that accounting quality did not improve, but actually declined over the period studied.

Empirical studies conducted to have date focused almost exclusively on companies in developed countries.

These have produced mixed results on the question of changes in reporting quality (C. Liu, Yao, Hu, & L. Liu 2011). As additional developing countries endorse IFRS, interest in the effect on companies in these locations

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ADOPTION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS

has grown. Ball, Robin, and Wu (2003) examined the quality of financial reporting of four common-law countries in East Asia: Hong Kong, Malaysia, Singapore, and Thailand. Interestingly, their analysis showed that firms’ earnings did not exhibit higher quality than that evidenced in code-law countries. Their findings underscore the importance of examining managers’ incentives at the same time that questions about accounting standards application are studied.

Turning to China, the subject of the new research described here, an early study by Echer and Healy (2000) compared the usefulness of statements prepared under IAS with those that followed Chinese domestic standards for the period 1993 to1997. No evidence was found that information was more useful when prepared under IAS. According to the authors, this outcome can be attributed to an absence of effective controls and financial infrastructure in China. Chen, Sun, and Wang (2002) focused on a major 1998 convergence effort by the Chinese government, issuance of “Accounting Regulation for Listed Companies” that sought to harmonize Chinese GAAP with IAS. Their results suggest that the gap between Chinese-standards and IAS-measured earnings continued to exist after the new regulations were implemented. The study’s authors attribute this lack of improvement to inadequate supporting infrastructure, manifested principally by excessive earnings management and low quality auditing.

More recently, certain studies have examined the quality of financial reporting more closely than the earlier papers cited above. Zhou, Xiong, and Ganguli (2009) investigated whether Chinese firms that adopted IAS had higher earnings quality by comparing voluntary IAS adopters and non-adopters from 1994 to 2000.

They discovered that adopting firms were less likely to smooth earnings, that their tolerance for reporting losses was not lower than non-IAS adopters, and that their recognition of losses was not timelier.

Similar in some ways to the study reported on below, Liu et al. (2011) examined the impact of ASBE on Chinese companies for the period from 2005 to 2008. They provide limited evidence of reduced earnings management and higher value relevance of accounting data for 2007 and 2008, the post-ASBE years, suggesting an overall increase of accounting quality. This study encompasses a significantly larger company sample, makes use of a different database (CSMAR), includes more industries, has a longer testing window, and takes into account both a company’s share type (A or B) and its listing exchange. In several ways, this new study is complementary to and a natural extension of Lin, Neiva de Figueiredo, and Stagliano (2012), as it broadens the scope of that study, tests additional hypotheses, and provides further confirmatory evidence for several of the previously offered findings.

The significant amount and breadth of literature described above demonstrate the high level of interest regarding IFRS adoption around the world. This new study contributes to the growing body of literature by focusing on one important economy as it takes significant steps toward full convergence with global financial reporting guidelines.

Hypotheses and Research Design With respect to the matter of accounting quality, the mixed findings—alluded to earlier—resulting from studying different countries over various time periods, suggest that no directional prediction be made in the statement of hypotheses. On the one hand, ASBE made fundamental changes to the previously applied Chinese accounting standards. Thus, it is possible to expect improvement in earnings quality to result from implementation. On the other hand, though, China is very different from many of those countries studied in terms of both historical development and economic philosophy. The lack of effective controls and enforcement

ADOPTION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS

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mechanisms easily can lead to little or no alteration in managers’ reporting behavior. Therefore, it is prudent to state a simplified general hypothesis that mandatory adoption of ASBE impacted Chinese firms’ earnings quality without suggesting that either improvement occurred or quality diminished.

Three commonly used measures were adopted to proxy for earnings quality: earnings smoothing, managing earnings toward a positive target, and the likelihood of recognizing losses in a timely manner.

The three hypotheses that will be tested are stated as follows: H1: Mandatory adoption of ASBE affected Chinese firms’ earnings smoothing.

H2: Mandatory adoption of ASBE affected the likelihood of Chinese firms managing earnings toward a positive target.

H3: Mandatory adoption of ASBE affected the likelihood of Chinese firms recognizing losses in a timely manner.

In this study, similar to a large number of prior examinations of the phenomenon, earnings smoothing (H1) is measured in three ways. The first measure is the variability of the change in annual net income (NI). Each firm’s change in net income from the immediately preceding year is regressed on a set of control variables (see equation (1)). The variance of residuals from the regression serves as a proxy for earnings smoothing activities.

If firms smooth earnings, relatively small fluctuations in net income from one year to the next are expected to be observed. The control variables are size, growth, equity issuance, debt issuance, leverage, asset turnover, and operating cash flows; all of these factors have been identified in prior research as contributing to earnings volatility. Also firms’ listing location, type of shares issued, and industry group are included as control variables.

NIit = α0 + α1SIZEit + α2GROWTHit + α3EISSUEit + α4DISSUEit + α5LEVit + α6TURNit + α7OCFit + α8EXCHit + α9DUALit + α10BSHRit + α11-16INDit + εit

(1)

where: SIZE = the natural logarithm of year-end total assets; GROWTH = percentage change in sales; EISSUE = percentage change in common stock outstanding; DISSUE = percentage change in total liabilities; LEV = year-end total liabilities divided by year-end total shareholders’ equity; TURN= sales divided by year-end total assets; OCF = net cash flow from operating activities divided by year-end total assets; EXCH = an indicator variable that equals one if the company is listed on the Shenzhen Stock Exchange, and zero if the listing is on the Shanghai Stock Exchange; DUAL = an indicator variable that equals one if the company issues two types of shares (A and B), and zero if a firm issues only one type (either A or B); BSHR = an indicator variable that equals one if only B shares are issued, and zero otherwise; IND = dummy variables for industry fixed effects, based on the CSMAR classifications.

The second measure for income smoothing assessment is the ratio of the variability of the change in net income (NI) to the variability of the change in operating cash flows (OCF). The variance of the residuals from the regression of OCF on the control variables represents the variability of OCF. If firms manage earnings through accruals, the variability of NI should be lower than that of OCF, a low ratio suggests

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earnings smoothing. Similar to equation (1), the variability of OCF is obtained from this model: OCFit = α0 + α1SIZEit + α2GROWTHit + α3EISSUEit + α4DISSUEit + α5LEVit + α6TURNit + α7OCFit + α8EXCHit + α9DUALit + α10BSHRit + α11-16INDit + εit (2) The final measure of earnings management is the Spearman coefficient of partial correlation between the residuals of accruals and the residuals of operating cash flows. Accruals (ACC) are computed as net income minus operating cash flows. A more negative correlation between cash flows and accruals indicates earnings management since firms can use accruals to smooth the variability in earnings. Separate regressions of cash flows (equation (3)) and accruals (equation (4)) are computed on the set of control variables—excluding the cash flow one. The Spearman correlation coefficient is based on the residuals from these two regressions.

OCFit = α0 + α1SIZEit + α2GROWTHit + α3EISSUEit + α4DISSUEit + α5LEVit + α6TURNit + α7EXCHit + α8DUALit + α9BSHRit + α10-15INDit + εit (3) ACCit = α0 + α1SIZEit + α2GROWTHit + α3EISSUEit + α4DISSUEit + α5LEVit + α6TURNit + α7EXCHit + α8DUALit + α9BSHRit + α10-15INDit + εit (4) To assess whether ASBE affects a firm’s likelihood of managing income toward a positive target (this addresses H2), previous studies are followed in defining NI, scaled by total assets, as small positive (SPOS) if it falls within the range of 0 and 0.01. Thus, SPOS is a dummy variable that takes the value of one if scaled NI lies in the interval 0 and 0.01 and zero otherwise. A logit model is applied to regress SPOS on an indicator variable, POST, which equals one if the observation is in the post-ASBE period and zero otherwise (equation (5)). The usual control variables also are included in this model.

SPOSit = α0 + α1POSTit + α2SIZEit + α3GROWTHit + α4EISSUEit + α5DISSUEit + α6LEVit + α7TURNit + α8OCFit + α9EXCHit + α10DUALit + α11BSHRit + α12-17INDit + εit (5) To measure the likelihood, for the third hypothesis, of firms reporting losses in a timely manner, NI, scaled by total assets, is defined as large negative (LNEG) if it is smaller than -0.20. LNEG is a dummy variable that takes the value of one if scaled NI is less than -0.20 and zero otherwise. Again, a logit model is employed to regress LNEG on an indicator variable, POST, which equals one if the observation is in the post-ASBE period and zero otherwise (equation (6)). The usual control variables again are included.

LNEGit = α0 + α1POSTit + α2SIZEit + α3GROWTHit + α4EISSUEit + α5DISSUEit + α6LEVit + α7TURNit + α8OCFit + α9EXCHit + α10DUALit + α11BSHRit + α12-17INDit + εit (6)

Company Sample and Results The sample firms are taken from the CSMAR database. Since 2007 is the year that ASBE became effective, the years from 2004 to 2006 were designated as the pre-ASBE period and 2007 to 2009 as the post-ASBE period. Because the number of companies publicly traded is increasing over the years under study, the coverage of CSMAR grows. To ensure that the same firms before and after the event are compared, companies that were publicly traded in year 2003 are used as the base sample for the purpose of computing changes into 2004. Another requirement to assure that the study sample remains intact is that the firms selected must have all needed financial variables in CSMAR from 2003 to 2009.

As shown in Table 1, on December 31, 2003, CSMAR included 1,334 firms traded on either the Shenzhen Stock Exchange (SZSE) or the Shanghai Stock Exchange (SHSE). In this population grouping, 86 companies issued both A and B shares (these are “dual-listed” firms). Since CSMAR “double counts” this type of firm by including the same set of financials twice, one of the two identical data entries for each of the 86 companies

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was excluded in the analysis. Furthermore, 28 firms (two of which were dual-listed) were found to have some missing data elements that were needed in the models. To make certain that consistent model estimation occurred over the six-year study period, all 28 of these firms were removed from the analysis. The final sample consists of 1,220 companies. There are 3,660 firm-year observations in each of the pre-ASBE and post-ASBE periods.

Table 1 Descriptive Statistics Relating to Sample Firms: Sample Selection

Initial number of firms as of 12/31/2003 Less: Firms with A & B dual listing (same data) Less: Firms with missing financial data Final sample: Number of firms Total number of firm-year observations

2004 1,334 -86 -28 1,220

Pre-ASBE 2005 2006 1,334 1,334 -86 -86 -28 -28 1,220 1,220 3,660

Post-ASBE 2008 2009 1,334 1,334 -86 -86 -28 -28 1,220 1,220 3,660

2007 1,334 -86 -28 1,220

In this final sample, 84 firms are dual-listed; they account for 6.89 percent of the firms studied. Nearly all of the sample firms, a total of 1,114 (91.31 percent), issue only A shares. The remaining 22 firms (1.80 percent) issue B shares solely. As for the listing location, the Shenzhen Stock Exchange has 472 of the sample companies (38.69 percent) and the Shanghai Stock Exchange has the other 748 (61.31 percent). Table 2 shows the detailed breakdown of share types and listing locations.

Table 2 Descriptive Statistics Relating to Sample Firms: Breakdown of Share Type and Listing Location

A and B shares B shares only A shares only Total Percentage

Shenzhen Stock Exchange

Shanghai Stock Exchange

Total

Percentage

41 12 419 472 38.69%

43 10 95 748 61.31%

84 22 1,114 1,220 100.00%

6.89% 1.80% 91.31% 100.00%

Table 3 Descriptive Statistics Relating to Sample Firms: Breakdown of Sample Companies by Industrial Classification CSMAR classification Finance Public utility Properties Conglomerates Industrials Commerce Total

CSMAR code 0001 0002 0003 0004 0005 0006

Number of firms 14 103 70 212 715 106 1,220

Percentage 1.15% 8.44% 5.74% 17.38% 58.61% 8.69% 100.00%

Based on CSMAR’s definition, a company can be categorized into one of six industry groups: finance, public utility, properties, conglomerates, industrials, and commerce. As shown in Table 3, the industrials group has the largest number of firms (715) and accounts for 58.61 percent of the sample; the finance group, the smallest classification studied, has only 14 companies (1.15 percent).

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ADOPTION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS Table 4 reports descriptive statistics for the regression model test and control variables.

Table 4 Descriptive Statistics for Variables Used in the Analyses

Test Variables ∆NI ∆OCF ACC OCF SPOS LNEG Control Variables SIZE GROWTH EISSUE DISSUE LEV TURN EXCH DUAL BSHR Notes. *, **,

***

Pre-ASBE (N = 3,660) Mean Median

Std. Dev.

Post-ASBE (N = 3,660) Mean Median

0.0054 0.0096 -0.0434 0.0535 0.1656 0.0352

0.0027 0.0088 -0.0334 0.0522 0.0000 0.0000

0.0994 0.1000 0.1007 0.0808 0.3717 0.1844

0.0087 0.0075 -0.0271 0.0528 0.1303 0.0279

21.3037 0.2133 0.0925 0.2047 1.3516 0.6620 0.3869 0.0689 0.0180

21.2399 0.1518 0.0000 0.1022 1.0782 0.5375 0.0000 0.0000 0.0000

1.0344 0.5036 0.2252 0.4930 1.0465 0.5000 0.4871 0.2532 0.1331

21.6285 0.2234 0.1201 0.2510 1.4156 0.6876 0.3869 0.0689 0.0180

***

*** *

***

*** *** ** **

Std. Dev.

0.0050 0.0041 -0.0232 0.0494 0.0000 0.0000

***

21.5726 0.1013 0.0000 0.0916 1.1068 0.5754 0.0000 0.0000 0.0000

***

***

*** *

*** ***

*

0.1185 0.1095 0.1159 0.0904 0.3367 0.1646 1.2535 0.8022 0.2886 0.7675 1.1160 0.5164 0.4871 0.2532 0.1331

Significantly different between two groups at the 10%, 5%, and 1% levels, respectively (two-tailed tests). NI is

the change in annual net income scaled by year-end total assets; OCF is the change in operating cash flows scaled by year-end total assets; ACC stands for accruals and is the difference between net income and operating cash flows, scaled by year-end total assets; OCF is the annual net cash flow from operating activities scaled by year-end assets; SPOS is a dummy variable that equals 1 if scaled net income is between 0 and 0.01, otherwise it takes the value 0; LNEG is a binomial-indicator test variable with value 1 when scaled NI is less than -0.20 and 0 otherwise; SIZE is the natural logarithm of year-end total assets; GROWTH is the percentage change in sales; EISSUE is the percentage change in common stock; DISSUE is the percentage change in total liabilities; LEV stands for leverage and equals year-end total liabilities divided by total year-end shareholders’ equity; TURN stands for total asset turnover and equals sales divided by year-end total assets; EXCH is an indicator variable that equals one if a firm is listed on Shenzhen Stock Exchange and zero if it is traded on the Shanghai Stock Exchange; DUAL is an indicator variable that equals one if a firm issues both A and B shares and zero otherwise; BSHR is an indicator variable that equals one if a firm issues only B shares and zero otherwise.

With this very large sample tested, there is an expectation that extreme values will be observed. All continuous variables were winsorized at the one percent and 99 percent levels. The average change of net income in the post-ASBE period is higher than that in the pre-ASBE period. This same pattern persists for the median comparison. Both differences are statistically significant. This provides univariate support for H1 that the variability of net income has changed (in this case, increased) after implementation of ASBE. On the contrary, the change in operating cash flows is lower in the post-ASBE period, although the differences in both means and medians are not statistically significant. Accruals (i.e., the difference between net income and operating cash flows) tend to be more negative in the years before firms adopted ASBE, suggesting that firms had bigger accrual amounts and had more accrual items to record prior to ASBE.

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On average, there are fewer instances of small positive earnings after the implementation of ASBE; the difference between the two periods is significant both in means and medians. This outcome provides univariate support for H2 that the pattern of firms managing earnings toward a positive target has changed after ASBE became effective. Similarly, for reporting large negative income, the number of firm-year observations is smaller in the post-ASBE period, lending univariate support to H3 that the way that companies recognize losses appears to differ between the two test periods.

Regarding the control variables, although the same set of companies was used, in the post-ASBE period the firms tend to be slightly larger in size, issue more equity and debt, and have greater financial leverage and total asset turnover. On the other hand, the operating cash flows (these are used in certain of the regression models as a control variable) are fairly comparable between the two periods.

The comparisons of the earnings quality before and after the implementation of ASBE are presented in Table 5.

Table 5 Earnings Quality Analysis Outcomes Pre-ASBE (N = 3,660) Post-ASBE (N = 3,660) Variability of ∆NI 0.0092 0.0136*** Variability of ∆NI over ∆OCF 1.5857## 2.2274 Correlation of ACC and OCF -0.5938 -0.6226 Small Positive NI (SPOS) 0.3039+++ Large Negative NI (LNEG) 0.3581++ *** Notes.

Significantly different between two groups at the 1% level (two-tailed tests); ++, +++ Significantly different from zero at the 5% and 1% levels, respectively (two-tailed tests); ## Significantly less than two at the 5% level (one-tailed tests).

The first three items measure the earnings smoothing activities (H1). As indicated by the test item NI, the variance of the residuals from equation (1) in the pre-ASBE period is 0.0092, significantly lower than 0.0136, the variance in the post-ASBE period. Since a lower variance is indicative of income smoothing, companies appear to engage in fewer earnings smoothing activities in the post-adoption period.

Consistent with the first measure, the ratio of the variance of change in net income to the variance of change in cash flows is lower before the ASBE implementation (1.5857) than it is in the post-ASBE period (2.2274).

Furthermore, the ratio of 1.5857 is significantly smaller than 2. Although no statistical test can determine whether the difference in the ratios is significant or not, in this case the ratio changes from significantly less than 2 to larger than 2 between the periods, suggesting that the difference in earnings variability is not caused merely by the difference in cash flow variability. This finding is in line with the first one above.

The final measure is the correlation between accruals and operating cash flows, which should have a negative sign. The correlation in post-ASBE period is -0.6226, slightly more negative than that in pre-ASBE period of -0.5938. Though a more negative correlation indicates earnings management, the difference is not statistically different at even the 10 percent level. This finding suggests that the correlation between accruals and operating cash flows remains fairly consistent before and after the adoption of ASBE. Next, the focus can turn to the likelihood of firms managing earnings toward a positive target (H2). Table 5 reports the coefficient of POST from the logit regression, where POST equals one if the observation is from the post-ASBE period. The positive and highly significant coefficient (0.3039) suggests that it is more likely for firms to report small positive earnings after ASBE was implemented than before. This is in contrast to the

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descriptive statistic reported in Table 4 where SPOS has a smaller average (i.e., fewer incidents of small positive earnings) in the post-ASBE period. Nevertheless, the evidence suggests that the probability of firms reporting small positive income has changed after ASBE became effective.

Lastly, there is a reporting on whether a difference in the timeliness of firms recognizing losses between the two test periods (H3) has been found. Similar to the previous test, a logit model to regress POST on LNEG, a dummy variable for large negative net income, and the set of control variables is used. As presented in Table 5, the coefficient of POST is positive and statistically significant (0.3581). This indicates that firms report negative incomes in a timelier manner after the implementation of ASBE.

Discussion and Conclusion The question for examination is whether the 2007 mandatory adoption of the IFRS-based accounting standards in China had an impact on the quality of firms’ reporting of earnings. Following previous studies, earnings quality is measured on three aspects: earnings smoothing, earnings being managed toward a positive target, and timeliness of firms recognizing losses. To conduct the comparison, three years before and three years after ASBE implementation were chosen for the test period. A final sample of 1,220 companies was obtained from CSMAR, giving 3,660 firm-year observations in each of the comparison periods.

From this testing, evidence was found for less earnings smoothing in the post-adoption period.

Specifically, the variability of change in net income declines in the three years after ASBE became mandatory.

This pattern continues to hold even after taking into account the variability of change in operating cash flows.

Although the difference in correlation between accruals and operating cash flows turns out to be insignificant, the overall findings point to the fact that net income exhibits a higher variability from one period to the other after the adoption of ASBE; this suggests that less earnings smoothing activity occurred in the post-adoption period. Coincidentally, there is a finding that companies tend to manage their earnings toward a positive target in the post-ASBE period. Firms are more likely to recognize losses in a timely manner after the new accounting standards became effective, indicating an improvement in earnings quality.

As discussed in the background literature review section above, this study significantly expands Lin et al.

(2012). It is also related to Liu et al. (2011) who examined the impact of ASBE adoption on Chinese firms in the period of 2005 to 2008. That research is extended here in two very substantial ways: by including a larger number of firms and testing over a longer period of time. The results here are in line with their findings and provide additional support for the positive impact that IFRS-based standards have concerning firms’ financial reporting quality.

Several limitations for this study are readily acknowledged. First, information for some control variables, such as each sample firm’s auditor and its percentage of closely-held shares, which normally are included in regression models that seek to shed light on earnings quality has not been considered at all in the instant study.

To accommodate this, some data source other than CSMAR would have to be accessed. Second, 2007 is the year that compliance with ASBE became mandatory. Data from that year may be noisy as firms adjusted to the new reporting regime. As time goes by and more annual data become available, additional tests over a longer period must be undertaken to confirm the findings given above. Despite these limitations, this is one of very few studies to examine the impact of mandatory adoption of IFRS-based accounting standards in China, an important developing economy. It adds to the ongoing discussion concerning the costs and benefits of IFRS implementation around the globe.

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References Armstrong, C. S., Barth, M. E., Jagolinzer, A. D., & Riedl, E. J. (2010). Market reaction to the adoption of IFRS in Europe. The Accounting Review, 85, 31-61.

Ball, R., Robin, A., & Wu, J. S. (2003). Incentives versus standards: Properties of accounting income in four East Asian countries.

Journal of Accounting and Economics, 36, 235-270.

Barth, M. E., Landsman, W. R., & Lang, M. H. (2008). International accounting standards and accounting quality. Journal of Accounting Research, 46, 467-498.

Chen, H., Tang, Q., Jiang, Y., & Lin, Z. (2010). The role of international financial reporting standards in accounting quality: Evidence from the European Union. Journal of International Financial Management & Accounting, 21, 220-278.

Chen, S., Sun, Z., & Wang, Y. (2002). Evidence from China on whether a harmonized accounting standard harmonizes accounting practices. Accounting Horizons, 16, 183-197.

Daske, H., Hail, L., Leuz, C., & Verdi, R. (2008). Mandatory IFRS reporting around the world: Early evidence on the economic consequences. Journal of Accounting Research, 46, 1085-1142.

Deloitte. (2006). Comparison of IFRS and new Chinese accounting standards. New York: Deloitte.

Ding, Y., & Su, X. (2008). Implementation of IFRS in a regulated market. Journal of Accounting and Public Policy, 27, 474-479.

Echer, E., & Healy, P. M. (2000). The role of international accounting standards in transitional economies: A study of the People’s Republic of China. Retrieved from http://papers.ssrn.com/paper.taf?abstract_id=233598 Horton, J., & Serafeim, G. (2010). Market reaction to and valuation of IFRS reconciliation adjustments: First evidence from the UK. Review of Accounting Studies, 15, 725-751.

Hung, M., & Subramanyam, K. R. (2007). Financial statement effects of adopting international accounting standards: The case of Germany. Review of Accounting Studies, 12, 623-657.

Jeanjean, T., & Stolowy, H. (2008). Do accounting standards matter? An exploratory analysis of earnings management before and after IFRS adoption. Journal of Accounting and Public Policy, 27, 480-494.

Lin, J., Neiva de Figueiredo, J., & Stagliano, A. J. (2012). The impact of IFRS adoption on earnings quality of Chinese firms.

Journal of Accounting and Finance, 26, 3-11.

Liu, C., Yao, L. J., Hu, N., & Liu, L. (2011). The impact of IFRS on accounting quality in a regulated market: An empirical study of China. Journal of Accounting, Auditing & Finance, 26, 659-676.

Paananen, M., & Lin, H. (2009). The development of accounting quality of IAS and IFRS over time: The case of Germany.

Journal of International Accounting Research, 8, 31-55.

Peng, S., & van der Laan Smith, J. (2010). Chinese GAAP and IFRS: An analysis of the convergence process. Journal of International Accounting, Auditing and Taxation, 19, 16-34.

Zhou, H., Xiong, Y., & Ganguli, G. (2009). Does the adoption of international financial reporting standards restrain earnings management? Evidence from an emerging market. Academy of Accounting and Financial Studies Journal, 13, 43-56.

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China-USA Business Review, ISSN 1537-1514 January 2014, Vol. 13, No. 1, 12-19

DAVID PUBLISHING

Creative Destruction as Economic Pattern of Europe’s Small-Scale Audiovisual Media Markets and Minority-Language Film Industries Margarita Ledo-Andión, Antía López-Gómez, Enrique Castelló-Mayo University of Santiago de Compostela, Galicia, Spain 

The small cinematography model as well as its incorporation into creation of the European digital space emerges as a paradigm of the creative destruction phenomenon in the way that Sombart spoke about and, afterwards, Schumpeter disseminated it seven decades ago. Working from this perspective, the University of Santiago de Compostela (USC)’ audiovisual research group has been looking for the barriers the small cinema in original version must overcome and has even tested some of its findings in different geopolitical areas such as Lusophony, Latin America, or Europe. The European case, which has been currently worked on within the Europe Creative Program 2014-2020, recognized the explicit contribution of the national cinemas to the cultural and linguistic diversity as brand image of the current Europe, promoting spaces of exchange that overcome its endemic problems of fragmentation and visibility. Our theoretical frame of reference responds to the thematic complexity of a symbolic materialization of the contemporary culture such as the cinema, though without forgetting its economic aspects and the implementation of the current public policies. In this way, based on the theory of the authors such as Morley (2007) and his concept “Average, Identity & Technology”, our methodological suggestion brings together empirical aspects of the reception studies with the poll of axiological values shared. At the same time, it analyzes the role of the intellectuals and experts in the construction and dissemination of the intercultural exchange according to the postulates of Schlesinger (1991). In regard to the methodology implemented, it is necessary to highlight that GEA’s studies contemplate a synergistic analysis of multiple types of the sampling of data and information management from online multiplatform surveys, viewed of samples, discussion forums, etc.. Our registered system combines two types of software: a data platform chain management system (CMS) with the predictive analysis software (PASW) Statistics 19. As main conclusions, it would be advocated for the small and pluralistic European film industries to become an exponent of a cultural fusion to the detriment of the European cinema, as a whole, which would be the exponent of the cinema of standards.

Keywords: audio-visual policy, minority-language film, cultural industries, European identity and diversity, Europe Creative Program, small-scale audiovisual Margarita Ledo-Andión, Ph.D., Full Professor at Department of Communication Sciences, University of Santiago Compostela.

Antía López-Gómez, Ph.D., Associate Professor at Department of Communication Sciences, University of Santiago Compostela.

Enrique Castelló-Mayo, Ph.D., Associate Professor at Department of Communication Sciences, University of Santiago Compostela.

Correspondence concerning this article should be addressed to Margarita Ledo-Andión, Facultade de Ciencias Comunicación (Campus Norte), 15.782 (Santiago de Compostela), Spain. E-mail: margarita.ledo@usc.es.

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Introduction The expansion of innovation and its practical consequences towards the conceptual field as well as the introduction of the notion of creative destruction in the way of thinking about the meaning and function of certain objects have led us to question the appropriateness of the development model promoted by the EU 2020 Agenda in relation to the film industry: a cumulative model with hegemonic pretentions. This paper will advocate the possibility of replacing this model with one that is based on the rights of the diversity of cultures to free expression, creation, access, and interaction. It will examine the role of the small-scale minority-language film industries as exponents of the European diversity policies and as part of the economy of culture, based on the case study of the Welsh, Finnish, and Galician cinemas.

This paper proposes that the process of creative destruction can take place in the European audiovisual industry to favor the organization of small-scale film industries. This idea guides the research study currently developed by the multidisciplinary Audiovisual Studies Group (Grupo de Estudos Audiovisuais) directed by professor Margarita Ledo Andión from the University of Santiago de Compostela (Galicia): Hacia el espacio digital europeo. El papel de las cinematografías pequeñas en versión original (Towards the European digital space. The role of the small-scale minority-language film industries). The Audiovisual Studies Group has a long trajectory researching issues related to identity and has incorporated researchers from Europe and Latin America in recent years to become more international.

Research Variables and Objectives This paper presents the first results of the aforementioned study, which examines the so-called Digital Agenda for Europe. A Europe 2020 Initiative (Retrieved from http://ec.europa.eu/digital-agenda/en/scoreboard) is still in the making. The research variables and objectives of this examination are: 

The identification of the actions aimed at improving the visibility and accessibility of small-scale

minority-language non-hegemonic film industries in the European digital space, as it is being outlined in the framework of the aforementioned Digital Agenda; 

The identification of: (1) The barriers are currently preventing the consolidation of the original-version

minority-language film industry as one of the main exponents, or even the protagonist, of the policies included in the Digital Agenda for the promotion and preservation of (cultural) diversity in Europe, and (2) The exponents used by the European Commission (EC) to promote and preserve cultural diversity; 

Identification, in consequence, of the way in which the policies of the EC treats the small-scale film

industries in view of the new digital technological territory.

This paper will address the abovementioned three objectives, beginning with the latest position adopted towards original version films (OVF) in the European media legislation, and the paper will develop these three issues, starting with the third issue related to the most recent Community position.

The Widespread of the Original Versions in the Current European Audio-Visual Context In this regard, in June 2011 the Education, Audiovisual and Culture Executive Agency (EACEA) published the final report Etude—Study on the use of Subtitling: The potential of subtitling to encourage foreign language learning and improve the mastery of foreign languages (sur l’utilisation du sous-titrage. Le potentiel du sous-titrage pour encourager l’apprentissage et améliorer la maîtrise des langues.

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EACEA/2009/01). This report reflects the interest that the EC has shown since 2003 in the development of multilingualism. This interest has been translated in the promotion of language learning among European citizens to develop a multilingual economy, and it has been with this, rather pragmatic, notion that the linguistic diversity has been promoted in the EC discourse.

Let’s say it: The linguistic diversity is an indisputable reality in Europe, and the EC must operate with it. It should be noted, in any case, that it is not so much a question of the relative prevalence of the monolingualism or the linguistic homogeneity, but rather the idea of how the multilingualism is a necessary condition for mutual understanding both in the European and global economic context. On the contrary, the very concept raised by the European authorities is a controlled and limited multilingualism, and exactly tailored to the demands of Europe where the diversity is therefore a right, but it is a right that should not be institutionalized.

Along this line of thought, and prior to the development of the aforementioned report, in September 2008 the EC published a communication with a very suggestive title: Multilingualism: an asset for Europe and a shared commitment. In this communication the EC praises the benefits that the investment in language training can bring to citizens, enterprises and the European society as a whole. It is in this context where the audiovisual sector is presented as facilitator of the informal learning of languages.

The study’s report published by the EACEA in 2011 is a follow up to this communication and proposes the development of a study aimed at identifying the potentialities of subtitling OVF to stimulate learning and improve the teaching of foreign languages, which highlights the pedagogical, instrumental, and functional aspects of multilingualism and the cultural industries. From our perspective, however, multilingualism should have been linked to its capacity to produce and transmit difference.

This one-year study started to be developed in May 2010 and covered 33 countries: the 27 EU member countries, three countries members of the European Economic Area–Iceland, Norway and Liechtenstein, as well as Switzerland, Croatia, and Turkey. One of the nine objectives established in this study is very relevant to the objectives of our work: to identify the barriers to the use of subtitling and to determine whether subtitling plays a major role in the building of a language-friendly environment in Europe.

In this aspect, our interest centres on location of the inequality gaps, which massively call into questioning the democratic nature of the impossible European delirium: It would thus have the existence of a plurality of cultures with a mutual and harmonious connection, insofar as they are subordinate to superior cultures, in the economic and political common interest.

As the study’s report points out, in Europe three main practices are used to translate foreign audiovisual work—films, documentaries, fiction, and animation—into the national language, here is important to note that the report assumes that there is a single national language—subtitling, dubbing, and voice-over. Apart from these practices, there is self-description intended for blind or sight-impaired viewers and subtitling for the deaf or hearing-impaired. Language translation practices vary from country to country and even within the same country depending on the features of the broadcast medium—film or television, and the target audience—general public, cinema-enthusiast public, young people, and people with accessibility problems.

The report offers a map of the language transfer practices in cinema and television across countries. This map has allowed us to distinguish between subtitling countries, dubbing countries, voice-over countries, and mixed-practices countries. Subtitling is the most widespread language transfer practice in Europe, since it was used in 28 countries but not in Spain.

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Critical Analysis of the Dominant Discourse on Audiovisual Translation Our research focuses on this fact, on the margins of the report, on the identification of the relationship between the four types of language transfer practices and the small-scale minority-language nationalities, whose languages are sometimes recognized as co-official and whose film industries demand the right to keep their integrity and particularly their linguistic integrity, that is, the right to not be dubbed and to use the language of their cultural territory—as much as the official language of the State of which they are parts—to translate films produced somewhere else in other languages.

This is the case of the Spanish Autonomous Community of Galicia, who has its own official language and whose film industry is located in a broader context, the Spanish State, where dubbing is the dominant practice, for both European and Americans films. Of all the European box-office release films in 2009, 53% were exclusively released in a dubbed version and 29% in both versions—dubbed and subtitled—(EACEA, 2011).

The share of American films exclusively released in a dubbed version was even greater with 69% (EACEA, 2011). A second feature of the Spanish cinema industry is that it is dominated by American films.

However, the study of the EACEA dismisses the specific conditions of language transfer practices in the multilingual environment of the Spanish State, as it only mentions the case of Catalonia, whose Cinema Law, approved by the Autonomous Parliament of Catalonia on 30 June 2010, establishes that foreign films released to box offices must have the same percentage of prints dubbed in Catalan as in Spanish. With this measure, the government of Catalonia, undoubtedly, aims to put the Catalan and Spanish languages at the same levels in all the social areas, but is not against the policy of dubbing, which is in itself a regressive policy with respect to the survival and preservation of the multilingual environments.

The study concludes that in all countries audiences predominantly prefer the audiovisual translation mode they are used to, i.e., the preference depends on the tradition of the country. However, it should be remarked that the population of each country is not homogeneous and that, as it is well known, the heterogeneity of the audiences has been exploited by the cultural industries at least since the 1990s and particularly now when the content distribution platforms have become greatly diversified. The study, however, only differentiates preferences between urban and rural inhabitants, people with and without university studies, foreign-language speakers and people who only speak the mother tongue. The methodological simplification leads us to think that the study consciously conceals the reality, plurality and heterogeneity of the European space (Retrieved from https://www.estudosaudiovisuais.org).

Regarding the conclusions of the report, the most important in general terms are as follows (EACEA, 2011).  There is a complex correlation between subtitling and the knowledge of other languages—and for this reason the pedagogical issue does not seem to justify the determination to expand subtitling to the detriment of dubbing. There is no negative correlation between the dubbing tradition and the knowledge of foreign languages: The population of the countries where dubbing is the dominant practice speaking languages in addition to the mother tongue, although do not speak more foreign languages than the people from countries where subtitling is more common;  On the one hand, in countries with a tradition of subtitling, the majority of respondents stated that their foreign language proficiency level (particularly in English) was very similar to that of their mother-tongue, i.e., a level of four or five on a scale of five. On the other hand, in countries with a tradition of dubbing, the majority of

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respondents evaluated their foreign language proficiency level at three on a scale of five. Here is important to note that, from our perspective, multilingualism is not the same as speaking just another foreign language used in most films in Europe;  The last striking conclusion is that the majorities of the European population trust on the educational potential of subtitling (71.8%, particularly among the youngest population between 12 and 25 years of age) and are willing to watch films in their original language with subtitles if these are broadcast by television channels.

Our conclusion is that content in their original version and with subtitles (as a means of pedagogical support) should be promoted but just as much as: (1) the incorporation in the EC of audiovisual content produced by small-scale film companies to achieve real multilingualism; (2) the provision of good distribution infrastructure; and (3) the taste/commitment to watch cinema as a diverse cultural form. All of this would counteract the fact that the cinemas in practically the majority of European countries are dominated by English-language and American productions.

The Status of the Small-Scale Film Industries in the EC’s Audiovisual Policy The following section focuses on identifying, now that the Digital Agenda has been established: (1) Which are the current factors that prevent the small-scale film industries that are part of the European socio-cultural and industrial sectors from becoming the protagonist actors in the promotion and preservation of diversity; and (2) which are the actors that have been considered as valid exponents in this new project.

In general terms, the EU authorities acknowledge the technological revolution whereby the convergence between Internet and the traditional sources of information and cultural content have modified the consumption habits of the people, who as they relate to each other, consume contents produced by all kinds of providers. In view of the changes circumstances, the task of the EC and the Council will be the positioning the European creative industries in the 21st century. Three specific fields will be concentrated on:  A regulatory framework: In particular the Audiovisual Media Services Directive (AVMSD), aimed at creating a single European market for all types of media (EC, 2007a); the European recommendations on the protection of children and minors (Retrieved from http://ec.europa.eu/avpolicy/reg/minors/rec/index_en.htm); and recommendations on the film heritage (Retrieved from http://ec.europa.eu/avpolicy/reg/cinema/index_en.htm);  Funding programs as the MEDIA (Retrieved from http://ec.europa.eu/culture/media/index_en.htm) program: The European Fund provides a long-term financial framework complementing national and other sources of finance;  Measures destined to promote distribution of distributing online content and media pluralism, respectively;  Measures aimed at defending Europe’s cultural interests at the heart of the World Trade Organization.

Although the following steps do not exhaust the field of information to be analyzed, in July 2011, the EC published the Green Paper on the online distribution of audiovisual works in the European Union (EU): opportunities and challenges towards a single market, an initiative of M. Michel Barnier (Single Market Commissioner), Neelie Kroes (Vice-President for the Digital Agenda), and Androulla Vassiliou (Commissioner for Education, Culture, Multilingualism and Youth). This paper was intended to become the basis for the debate to decide whether it was necessary or not to adapt and how the regulatory framework allowed companies in the sector to develop new operation models in order to allow content creators to find new distribution channels, and to allow consumers to benefit from better access to contents across Europe.

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However, the paper focuses on the European Television (TV) market, which is the protagonist of the audiovisual industry and the second most important market in the world, just after the USA. In fact, in 2010 the European TV market represented around 29% of the total market (EC, 2011). Given these conditions, the EC established that one of the main objectives of the digital single market is to contribute to the development of major European actors in the global audiovisual sector. Thus, the single market should serve as a trampoline for large companies in particular to take over the global market. Disappointingly, in this international and globalizing project of the EU the small-scale film industries are not stimulated to strengthen their areas of influence, or at least not as much as the major media groups.

Another concrete action that arises in the context of the Digital Agenda is the constitution and implementation of the High Level Group on Media Freedom and Pluralism, which is responsible for the report titled A Free and Pluralistic Media to Sustain European Democracy. As the title suggests, this last report addresses precisely the role that the media can play to sustain of European democracy, through the guaranteeing of the freedom of expression and pluralism.

The report includes a chapter titled Diversity, which is very relevant for our research study because it acknowledges the diversity of the European media landscape, which according to the High Level Group is based on the historical, cultural, political, and economic specificities, and also the diversity of the media intervention policies in the EU Member States. Thus, the enlarged role attributed to the EC is to ensure diversity—this notion is closely linked to the idea of political democracy, which takes specific form in the plurality of opinions and in its representation in the media, as well as what the principles referred to should be applied to different regulatory mechanisms in each country through the development of different political cultures.

In addition, the Digital Agenda includes a staff working paper on media pluralism aimed at promoting media pluralism in the member states. This paper includes a section on Internal and external pluralism, which highlights the need to examine not only the external pluralism, related to media ownership rules, but also the internal pluralism, which is considered to be essential for small markets. The working paper particularly refers to the audiovisual field, where a regulated market, internal pluralism, should be developed, so that content diversity can be stimulated and monitored by imposing programs requirements and obligations in the law or licenses or even by imposing structural obligations such as the composition of management bodies or bodies responsible for the selection of programs or contents.

Consequently, the fundamental point having in mind here is: Europe has made enormous economic progress, thanks to the single market, but nothing or next to nothing has been done in the field of its cultural pluralism. In that regard, the concept of pluralism can only be understood as a tacit agreement between the economic system (capitalism) and the political system (liberal democracy): a common understanding that seems to sustain the EU’s institutional framework.

Europe 2020 Program and the International Dimension of Audiovisual Policy Finally, in order to conclude our analysis of the Digital Agenda, it is important to mention that the section titled The International dimension of audiovisual policy (Retrieved from http://ec.europa.eu/digital-agenda/en/international-dimension-audiovisual-policy) addresses all the aspects related to the Creative Europe Program (Retrieved from http://ec.europa.eu/culture/creative-europe/) developed by the EC on 23 November, 2011, to support the European cultural and creative sectors, from 2014 to 2020.

Basically, the programme proposes, first of all, that its implementation is justified by Europe’s need to invest

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more in the cultural and creative industries, since they contribute significantly to economic growth, employment, innovation, and social cohesion. Here it is important to note the aspects with which the cultural and creative sectors are related in the political discourse of the EU. Based on this statement, the EC indicates that the program is aimed at safeguarding and promoting the cultural and linguistic diversity, and strengthening the competitiveness of the cultural and creative sectors, by taking advantage of the conditions of the digitisation and economic globalisation era. The objective is, thus (1) to enable the sectors to reach their full potential by seizing the opportunities of the digital age and globalisation so that they can contribute to the general objectives of the Europe 2020 program: sustainable growth, employment, and social cohesion; (2) to provide new international perspectives, markets, and audiences; and (3) to build on the success of the previous MEDIA and culture programs.

Now it is important to establish that the peculiarity of creative Europe is the fact that it is an enhanced funding program that will simultaneously:  Support artists and cultural professionals to develop their skills and to work outside their national borders;  Provide more funding for transnational cultural activities organised between EU and non-EU countries;  Support the audiovisual and culture sectors of the EU with schemes tailored to their specific needs;  It will facilitate the access to private funding through guarantees which can generate more than € 1 billion in loans and will seek to strengthen banking expertise in the cultural and creative industries.

The EC’s framework Creative Europe Program will be accomplished through the development of guidance and practical tools benefiting 300,000 artists and cultural professionals in their respective countries. Also, more than 1,000 European films will benefit from a specific support for cinema distribution, in Europe and beyond, in both ordinary distribution services and in digital networks. Finally, the program specifies that around 2,500 European movie theatres will be helped to ensure a public display on at least 50% of European movies.

Because there can be no doubt about the EC intention in order to further the distribution process, to ensure that European contents are indeed available worldwide, as well as its intention to increase the number of European small market players with a sufficient overall presence in global market. Our question is whether these conditions of incorporation to that global circulation model is the only way to promote cultural diversity, that is, by incorporating it to the conditions of global connectivity in which the Digital Agenda translates.

By Way of Conclusion: Towards an Assumption of Creative Destruction Economic Principle After the previous analysis, now it is time to address the central issue proposed by this paper: Creative Destruction. As it is widely known, in the 1990s Joseph Alois Schumpeter (1883-1950) played a major part in an economic debate: Political economist of Austrian origin, Schumpeter’s name has been closely associated with the creative destruction process.

At that time, such a concept was used to describe the process whereby Information Communication Technology (ICT) replaced the previous technological solutions and gave way to new approaches. The creative destruction idea, as is well known, also is at the heart of the economic cycles theories (H. Reinert & E. S. Reinert, 2006). Thus, in the capitalist economic evolution, the choice is between creating and destroying or preserving. The first option ensures the survival of the system in renovated conditions, while the second leads to decadence.

This would be a similar approach to a biological model: “the life desire for self-betterment” is further

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spurred by competition, or continues as it does, in a slow continual decline. This is based on Schumpeter’s identification of the periodic industrial mutation processes that constantly transform the economic structure by continuously destroying the previous economic orders and creating new elements. This process of creative destruction is the essential fact about capitalism (Schumpeter, 2009; Sombart, 2001).

It is Schumpeter’s notion on which the central proposal of our research is based: the proclamation of the end of the model of integration of the particular (in the case of our subject matter: the small-scale film industries that operate in Europe) into the global (that European-style market, global showcase of an infinity of content through a virtual or digital artery that extends across the whole planet). This is the objective of the approach of the cultural industries, and ultimately of culture itself, as an abundant, inexhaustible, and flexible cultural fusion.

As Schumpeter himself pointed out, the capitalist machine was always a mass-production machine, which meant that was also a mass-production machine for the masses. The author places before us the illustrative example of Queen Elizabeth and her silk stockings: Capitalist perspective would not produce more silk stockings for Queens, but makes them accessible to a large number of factory girls (Schumpeter, 2009).

By contrast, and because the old logic of this audiovisual industry needs to be renewed, the paper proposes the possibility, or at least the contemplation, of a fragmentary survival model, i.e., a model for the audiovisual industries that coexist in an integral manner but not necessarily in a integrated way in their differential condition, subsisting not at the same level but above the large-scale film industries. In conclusion, the paper advocates for the small and pluralistic European film industries to become an exponent of a cultural fusion to the detriment of the European cinema, as a whole, which would be the exponent of the cinema of standards.

References European Commission (EC). (2007a). Audiovisual media services directive (AVMSD). Official Journal of the European Union, 18(12), 27-45.

European Commission (EC).

(2007b).

Staff working paper on media pluralism.

Retrieved from http://ec.europa.eu/information_society/media_taskforce/doc/pluralism/media_pluralism_swp_en.pdf European Commission (EC). (2008). Multilingualism: An asset for Europe and a shared commitment. Retrieved from http://ec.europa.eu/languages/news/20080918-commission-communication-on-multilingualism_en.htm European Commission (EC). (2011). Green paper on the online distribution of audiovisual works in the European Union: Opportunities and challenges towards a single market.

Retrieved from http://ec.europa.eu/internal_market/consultations/2011/audiovisual_en.htm Education, Audiovisual and Culture Executive Agency (EACEA). (2011). Study on the use of subtitling: The potential of subtitling to encourage foreign language learning and improve the mastery of foreign languages. Retrieved from http://eacea.ec.europa.eu/llp/studies/study_on_the_use_of_subtitling_en.php Morley, D. (2007). Modernity and technology: The geography of the new. New York: Routledge.

Reinert, H., & Reinert, E. S. (2006). Creative destruction in economics: Nietzsche, Sombart, Schumpeter. In J. G. Backhaus, & W. Drechsler (Eds.), Friedrich Nietzsche: Economy, and society. New York: Springer.

Schlesinger, P. (1991). Media, state and nation: Political violence and collective identities. London: Sage.

Schumpeter, J. A. (2009). Can capitalism survive? Creative destruction and the future of the global economy. New York: Harper Collins Publishers.

Sombart, W. (2001). Economic life in the modern age. New Brunswick, N.J., and London: Transaction Publishers.

Vike-Freiberga, V., Däubler-Gmelin, H., Hammersley, B., & Poiares Pessoa Maduro, L. M. (2013). A free and pluralistic media to sustain European democracy.

Retrieved from http://ec.europa.eu/information_society/media_taskforce/doc/pluralism/hlg/hlg_final_report.pdf

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China-USA Business Review, ISSN 1537-1514 January 2014, Vol. 13, No. 1, 20-37

DAVID

PUBLISHING

Creative Batik Motif Design Based on Local Cultural Art and Natural Environments Timbul Raharjo, Toyibah Kusumawati, Suryo Tri Widodo Indonesian Institute of the Arts Yogyakarta, Yogyakarta, Indonesia ď€

Local arts, culture, and natural environment of Indonesia had their own uniqueness. They might be explored to help and to develop batik industry in Indonesia, especially in motif aspect. It was necessary to help craftsmen to create new and innovative batik products. The study was conducted as an effort to motivate batik craftsmen in developing batik industry through production of creative and unique batik motives. First study question: What are artistic motives of local arts and culture of natural environment of Yogyakarta and Central Java able to give distinct and characteristically local styles? Second was how to create creative batik inspired by local arts and natural environment. It has identified arts that have potentials to give inspiration of new motives, including Borobudur temple, Prambanan temple, Sewu temple, leather puppets (Wayang) and keris. Also, it has identified environments such as Merapi Mountain, Code River, Parantritis Beach, Sewu Mountain, Menoreh Hill, Solo River, and Grojogan Sewu waterfall. Ten designers and five batik industries were involved in materializing the batik motives in addition to lectures and students. Exploration method was used here that examined motif forms, analysis and creation of alternative sketches, selection, creation of designs and prototypes, and finally evaluation. The results were 159 batik prototypes of local arts and culture motives. It was concluded that the craftsmen needed new designs of local characters of Indonesia that have been created in the study. Also, it has managed to create new names of unique, creative, and innovative batik motives based on the local arts, culture, and also natural environment. They were ready to apply in the production of the batik for commercial purpose.

Keywords: creative, innovative, local arts, local culture, local natural environment

Outcome Predictions Batik was one of the kinds of industry in Java. The industry has long been popular and developing up to the present. The well-known batik industrial areas of Java among others were Yogyakarta and Solo. There were many people of the areas who worked as batik industrial craftsmen/entrepreneurs. However, not all of the craftsmen and the entrepreneurs in the batik industry managed to develop their business. The causal factors among others were the limitation in the ability of the entrepreneurs in the batik industry to develop and to create more innovative batik products, while consumers were increasingly critical in selecting the batik products they want to buy. Consequently, it required them to keep pace with the demand of their consumers.

Timbul Raharjo, DR., Drs., M.Hum, Chairman of Art Management Master Study Program, Postgraduate Program of Indonesian Institute of the Arts Yogyakarta.

Toyibah Kusumawati, S.Sn., M.Sn, Department of Crafts, Faculty of Fine Arts, Indonesian Institute of the Arts Yogyakarta.

Suryo Tri Widodo, S.Sn., M.Hum, Department of Crafts, Faculty of Fine Arts, Indonesian Institute of the Arts Yogyakarta.

Correspondence concerning this article should be addressed to Timbul Raharjo, Tirto Rt. 06, Kasongan, Bangunjiwo, Kasihan, Bantul, Yogyakarta, 55184, Indonesia. E-mail: timbulksg@yahoo.com.

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Considering the condition described above, it was necessary to help the batik industrial society by developing strategies in developing the industry so that they were able to satisfy market tastes and to compete globally. One of the strategies was to make creative efforts, especially in developing batik motives/designs that were unique, creative, and innovative based on local cultural arts and natural environment elements.

There were many cultural heritages in Yogyakarta and Solo such as Borobudur temple, Prambanan temple, Sewu temple, wayang, and keris representing valuable cultural heritages of forefathers that had interesting structures, forms and beautiful ornaments. Additionally, the areas also had beautiful natural environment. The cultural arts and the environement had huge potential to serve as inspiring source of new creative batik motives.

Therefore, it was expected that unique, creative, and innovative batik motives would be created and became superior products that gained consumer’s acceptance.

The objectives of the study were:  To create new, unique, creative, and innovative batik motives based on local cultural arts and natural environment;  To improve the quality and the productivity of batik industry by diversifying the products and by creating innovative designs to satisfy market tastes;  To help batik industrial society in the areas of Yogyakarta, Solo, and the surrounding areas, especially those with difficulties in developing their business because of their limited ability in developing and creating innovative designs of batik product;  To motivate the entrepreneurs in batik industry, to reactivate, and to increase the production of creative industry of batik handicrafts.

The uses of the study were:  The entrepreneurs in the batik industry of Yogyakarta, Solo areas, and the surrounding areas, especially those with difficulties in developing their business and in accessing knowledge, skills, and experiences in the area of designs and batik;  The entrepreneurs in the batik industry could adopt or develop the batik motives and designs resulting from the study in producing batik products.  Natural environment would be well-preserved because the study put the priority on the use of natural dyestuffs.

Study Method The study used cultural and artistic aspects as inspiring source in creating batik motives, including Borobudur temple, Prambanan temple, Sewu temple, keris, and wayang of Solo style. Additionally, it also used natural environment of Yogyakarta and Solo to enrich the diversity and the beauty of the resulting motives. The proposed results of the study would be different from those of prior studies though they used the same idea source, which was Prambanan temple. It was planned that the study would be organized in three months with the following design of activities: (1) The collection of the data of temples, wayang and keris was carried out through literature study and interview. All of the resulting data were then analyzed and used as the basis in creating batik design/motives; (2) The creation of batik motives includes following activities:  creating alternative sketches;  selecting sketches;

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creating batik designs/motives;  evaluating batik designs/motives.

(3) The materialization of batik products based on the created designs followed by the evaluation of the materialized products; (4) The exhibition of the results of the study; (5) The socialization of the results of the study to the craftsmen of the batik in Yogyakarta, Solo, and the surrounding areas and to the institution concerned, including Department of Industry and National Craft Council, and so on; (6) The training of creating batik designs and products for the craftsmen of batik in Yogyakarta, Solo, and the surrounding areas.

Once the activities of the study have been in completion, it was expected that the resulting motives were used and even considered as the reference for further development by the craftsmen in the batik industry. 

The Definition of Temple, Keris, Wayang, and Natural Environment Temple The term candi, meaning temple, came from candika that was one of the names of Durga goddess as the goddess of death (Soekmono, 1973). Therefore, the temple was often related to the means of enthronement of a king. The term candi in Indonesian referred to an ancient religious building of Hindu-Buddha civilization (Dumarcay, 2007). It was used as the sacred place to worship gods and goddesses or to venerate Buddha.

Actually, it was not only used as religious place, but also as non-religious one. It was evidenced in many archeological sites from classic Indonesian Hindu-Buddha epoch that served the function of palace, bathing place, gateway, and so on. All of the ancient building might also be referred to as temple.

Others suggested that temples were replicas of gods’ living place, which was Mahameru Mountain.

Therefore, the architecture of the temples was ornamented with various kinds of carvings and relieves resembling the natural condition of Mahameru Mountain (Supriatna, 2011). The temples and the message sent through their architecture along with their sculptures were inseparable of their spiritual content, creative power, and the skills of the creators. The existing interpretation of the temple only referred to the building inheritance of Hindu-Buddha epoch in Indonesian archipelago, including Malaysia. The temple referred to historic buildings of Hindu-Buddha all over the world, including Cambodia, Myanmar, Thailand, Laos, Vietnam, Sri Lanka, India, and Nepal (Retrieved from id.wikipedia.org/wiki/candi).

Keris Based on the vocabulary of Javanese, the name keris came from the syllable Keris derived from the word kekeran and the syllable ris derived from the word aris. The kekeran meant fence, hindrance, warning, and control. The word aris meant calm, slow, and fine (Koesni, 2003). Meanwhile, others interpreted the word keris as sinangker karono aris, meaning that there was a secret in the object, which was noble values of a creative work symbolizing life order and theological understanding. In other words, it had noble meaning of Javanese philosophy. It also symbolized the sharpness with which human being must think that the resulting thoughts were useful for people at large (Retrieved from http://www.tabloidpamor.com/berita-237-pamor-keris-dan-kultur-budayanya.html). There was in Javanese stratification in the usage of the language and the word keris belonged to the stratum ngoko that was used in the

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socialization of individuals of equal social status and its finer usage was dhuwung that belonged to the stratum krama, while the higher stratum was krama inggil and it was called in the stratum curiga (Koesni, 2003).

The whole keris had following parts: ukiran or carvings of its lower part, wilahan or its blade, warangka or its sheath, and pendhok or the cover of the warangka. Actually, what was referred to as the keris was only its blade and in its development the whole parts that constituted the cultural object were called keris (Hamzuri, 1988).

Wayang The term wayang might be analyzed from some point of views. In Kamus Umum Bahasa Indonesia (1976) it was defined as figures made of leather, wood, and other materials and imitated human beings. It was played in a puppet shadow play (Poerwadarminto, 1976). It also meant shadow (ayang-ayang) because its shadow was seen on a screen (kelir) describing people’s behavior in the past in the imagination of the creator. It was clearly observed in the visualization of the puppet that fitted the behavior of certain characters (Sagio, 1991).

It was further described by Pigeaud who defined the wayang as: (1) performed puppets; and (2) the performance performed in various forms and contained certain teachings accompanied by gamelan ensemble.

The term wayang came from Javanese word that meant shadow. Therefore, the wayang was more likely to be defined as the performance of leather puppet shadow play. Especially, wayang purwa played the stories of Mahabarata, Ramayana, and Kresnayana as the most favorite stories in Java. The wayang purwa was made of leather and widely known as wayang kulit purwa, leather puppets (Kusumawati, 2011).

Natural Environment The term nature might be understood in its broader meaning as found in the words world, physical world, or material world referring to the phenomena of physical world and also life in general. Natural scale stretched from sub-atom to cosmos. However, it might be considered as coming from English, which was “nature” coming from Greek natura that meant essential quality, innate disposition, and literally meant birth (Harper, 2006). The natura was the Greek translation of physis originally related to innate characteristics of plants, animals, and other figures in the world (Naddaf, 2006).

In various usages of the concept, the term nature was often used to refer to geology and wild life. It might generally refer to various living plants and animals, and in certain cases it also referred to certain kinds of objects and how they changed such as weather and geological aspects of earth and also materials and energies that constituted them. It also related to environment or natural environment or wild animals, stones, forests, beaches, and in general things that have not substantially changed by human beings or survived with minor human interference.

Definition of Batik, Motif, and Batik Pattern Etymologically, the term bathik came from Javanese with the suffix tik that meant “tiny”. It was also the case of the term ambatik (Javanese) or anyerat (writing or drawing something small and complicated) that meant painting on plain cloth using wax (malam) and canting, which was a painting tool made manually (Soedarso, 1998). There were those suggesting that the term bathik written in the form of batik or the Javanese letter tha was written using ta. The batik might be interpreted following jarwa dhosok, which became ngembat titik or rambataning titik-titik, creeping propagation of dots. In Javanese culture, the batik might be understood

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using equivalent without any further explanation. The verb membatik, creating batik, was understood as long sequence of processes of painting a motif till finished piece (babaran) (Honggopuro, 2002). In other words, it started from designing and then creating pattern and waxing, dying and finishing that were referred to as pelorodan, which meant removing the wax from the cloth so that the motif was materialized on the cloth.

The main roles of the batik were as clothing material, while the form was adjusted to its function. It served as the clothing material, while keprabon clothing symbolized magnificence and the nobility of a king, as the clothing worn in the ritual of passage and also pasowanan. It was used in the forms of long clothes (bebed/tapih), kampuh (dodot), semekan (kemben), selendang or shawl, head scarf (dhestar), and sarong (Suyanto, 2002).

Ornamental styles or motives represented basic form that served as the point of departure in creating ornaments. It was also the case of the ornamental style and the motives applied to batik media. The motives were then arranged in a way that they formed patterns (Dalidjo, 1983). The ornamental styles or the motives became essential for a pattern once the motives have been arranged into a pattern (Gustami, 1980).

The motives were usually created on the basis of natural forms such as plants, human beings, animals, inanimate objects (e.g., mountains, clouds, and buildings) and so on. Furthermore, they could also describe or express someone’s experience or artist’s esthetic experience. They might be taken from various referential sources, which were: (1) plants, animals, human beings, mountains, water, clouds, sun, moon, stars, and so on; (2) symbols or god attributes or those in power in the forms of weapons, thrones, letter arrangement, and so on; (3) the forms of human imaginary forms such as kinara-kinari, ganesha, kala-makana, and so on; and (4) geometric forms such as circles, triangles, squares, and so on (Dalidjo, 1983).

Creating a motif was drawing basic object or idea of new forms. The forms were then processed into new forms that were beautiful, of flat impression and did not have any of their original characteristics of the source of the idea. It was necessary in creating an ornamental style to undergo transforming process of the realistic original forms into new and unrealistic forms, which were artistic and ornamental in nature that fitted ornamental elements. An ornament must have decorative characteristic and the decorative forms could be created by deforming and stylizing the original objects. Deforming meant transforming existing form of an object into new form without removing the original characteristics, while stylizing meant transforming the existing form into more flexible one (Sutanto, 1984). Furthermore, it was described that the ornamental style of the batik was generally in the forms of: (1) stylization, which was enrichment and the transformation of form into more stylistic without abandoning its original characteristics; (2) distortion, which was the transformation of a form for the purpose of accentuating certain elements of an object; and (3) decorative, which was simplifying a form regardless of perspectives and three dimensional aspect (Riyanto, 1993).

In creating a new motif without abandoning the original characteristics of an object, the object must be thoroughly studied. The resulting motives were then arranged into a pattern of motives. The pattern of the batik was arranged in various ways, which were among others regularly repeating it on a drawing area divided into ordered areas. The methods to repeat a motif were: (1) unidirectional repetition; (2) reversed repetition; (3) rotated repetition; and (4) free or variable repetition (Suryahadi, 1998).

A batik pattern was made of two main elements, which were primary motif, filling motif (isen-isen).

Primary ornamental style was the one that became the main element of a batik motif. A motif was an ornament applied on the background of the pattern as the filling elements or balancer that the pattern got its harmony. The isen-isen was an ornament that filled the main parts of a motif.

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The Sources Inspiration of Batik Motif Design Creation Borobudur Tempel Borobudur temple was situated in Borobudur village of Borobudur sub-district of Magelang district of Central Java province. The geographic environment surrounding the temple was mountainous areas of Merapi and Merbabu mountains in east, Sindoro and Sumbing mountains in north, and Menoreh in south and it was situated between Progo and Elo rivers.

The temple was built in nine layers of terrace and a single main stupa on its top. The layers of terrace consisted of six terraces of square form and three terraced of circle form. The three lower layers were referred to as kamadhatu, rupadhatu and arupadhatu so that technically it had lower part, middle part, and upper part. It had ascending stairs in its main four directions with the main gait situated in the east. The building materials of the temple came from the rivers in the surrounding areas with the total volume of about 55,000 m3 (Balai Konservasi Peninggalan Borobudur, 2011). Observed from above, it was of square form with its center of a circle on which the stupa was situated.

The lower part that was referred to as kamadhatu consisted of undag wall and open verandah and behind it was the real foot of the temple. The rupadhatu terrace of the body of the temple consisted of paths one, two, three and four. Ornamental style of antefixes was found on the wall of the terrace and water ducts were found on each of the outer corners. The lower wall and the upper wall were connected by floor line. Meanwhile, right above the floor line and behind the antefixes was balustrades along with their feet, body and head, except the path one.

The arupadhatu or the head of the temple consisted of shelf (batur) levels one, two, three and the central stupa. The three walls were straight or level without any foot profile and the head did not have any relief. There were small stupas on the shelves in which were Buddha statues. There were 72 small stupas distributed in three respective levels of the temples, consisting of 36 statues, 24 statues, and 16 statues. The stupa of the upper part of the temple consisted of three profiles. The feet had a characteristic of padma profile, the body had the charachterisic of genta profile, while the head had the characteristic of harmika and yasthi profile (Tukidjan, 2008).

There were many ornaments found on the walls of the temple such as the ornamental styles of leaves and spiraling plants. The ornamental styles were found on the panels flanking the narrative relieves on the main walls situated in the paths one, two, three, and four (Kismayanti, 2013). Additionally, there were also reliefs telling stories such as karmawibangga, lalitavistara, jataka, avadana, and gandawyuha.

Prambanan Temple Prambanan temple was the biggest Hindu temple situated in Prambanan area of the Special District of Yogyakarta. It consisted of 240 temples that were classified into three yards. Each of the yards was separated by surrounding fences with gates in its four directions. There were 16 temples in the first yard, including main temple and three wahana temples, two flanking (apit) temples and four pathok temples and also four corner temples.

The main temple consisted of Brahma temple situated in south area, Siva temple in central area, and Visnu temple in north area. Each of the temples faced eastward. The wahana temple was the vehicle temple (asana) of the three gods of trimurti, which were Angsa temple as the vehidle of god Brahma, Nandi temple as the vehicle of god Siva, and Garuda temple as the vehicle of god Visnu. The three temples were situated in front of the

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main temple and faced westward. The flanking (apit) temple was the one that flanked three main temples and the wahana temples, consisting of north and south flanking temples. The pathok temple was situated in each of the yard corners and kelir temple was situated in each of the entrance gate. There were 224 perwara temples in the second yard and there was not any temple found in the third yard. However, excavation was conducted and found some foundation structure that was expected to be the one of monks living areas.

The Prambanan temple had luxurious ornamental patterns and its architecture was grandiosely soaring.

The ornaments might be classified into flora, fauna and divine creatures and also kala-makara. The floral ornaments consisted of spiraling plants, circle-shape of flowers, patched papers, and lotuses. The fauna ornaments included goose, dogs, chickens, squirrels, crocodiles, eagles, elephants, fishes, tigers, lizards, cockatoo, scorpions, frogs, monkeys, donkeys, rabbits, snails, crow, crabs, horses, pigeon, parrot, deer, ox, rats, lions, and snakes, while the ornaments of divine creatures included kinara-kinari. Additionally, the temple also had well-known ornamental styles of batik that were referred to as nitik, sida mukti, pinggiran, and semen.

Another well-known ornamental style of the temple was Prambanen ornamental style and it was not found in any other temple. It was one of the special ornaments of the temple. It had three niches containing sitting lions between two kalpataru trees and other complementary ornaments. One of the complementary ornaments was umbrella and birds on the kalpataru trees and also the divine creatures kinara-kinari under the trees in addition to peacocks, goats, antelopes, rabbits, chickens, gooses, and so on. The complex of the temples contained relieves telling the stories of Ramayana, Kresnayana, dancers, and music players, Ghana, Brahma as resi, Visnuas monk, and so on.

Sewu Temple Sewu temple was situated about a kilometer north east of the group of Prambanan temple. It consisted of 249 buildings consisting of a main temple, eight flanking temples, and 240 perwara temples. It was expected that it used to have three yards and each of the yards was separated by surrounding fences. The main temple was situated in the first yard surrounded by fences of 85 cm of height. The main temple had central chamber and four displaying cahmbers and each of the chambers had its respective entrance gate. The east entrance gate served as the main entrance gate into central chamber and hence it was concluded that the temple faced eastward.

There was a series of relieves depicting the ornamental style of purnakalsa or flower vase in addition to lion statues in each of the meeting corners of the feet and the structure of stairs. Also, there was a relief in the outer side of the stairs whose ends were in the form of makara. The relief depicted a demon kalpawrksa and a flower vase in the form of sankha. Various ornaments were also found in the body of the temple, which were among others: (1) kala makara in front of their doors; (2) a relief of a sitting god in the position vajrasana whose head was surrounded by fire or siracakra as the symbol of goodness and it was situated below kala; (3) the relieves depicting some dancers and small drum players were also found on the outer wall of the balustrade; and (4) ghana representing divine creature was depicted as dwarf and it was found in the corners of the temple.

The ornaments of the top of the temple were among others pilasters, niches, artefixes decorated by god statues and ornamental plants (Kusen, 1992).

Additionally, the main temple of the Sewu temple had the ornaments of medallions, flowers and spiraling plants, patched papers, and so on. The ornaments of flowers and jewelries/perls and shawls/ribbons were the characteristics of the Sewu temple.

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Keris of Solo Style Keris of Yogyakarta and Surakarta styles emerged after Giyanti treaty in 1755. The division of Mataram in Java into Yogyakarta and Surakarta was based on the treaty. The two kingdoms developed differently, especially in the kingdom protected rules. However, they might be considered as following the same pattern (Kusumawati, 2011). The kingdom of Surakarta represented the continuation of Kartasura kingdom because it was ruled by a king. Surakarta also had the right to own tangguh of the keris itself. The kingdom developed independently as a result of the presence of cultural shift. The innovation caused the change in the form of the keris of Kartasura tangguh into Surakarta tangguh (Harsrinuksmo, 2004).

The keris of Surakarta style represented the continuation of the keris of Kartasura tangguh that the keris was created in the period of Surakarta palace since the period of Paku Buwono III in 1721.

In general, the keris of Surakarta era used fine iron with pamor pattern, the pamor material was excessive, the body of the keris resembled the fingers of cassava leaves, always used ada-ada, gula milir, and pekakan that the tip of the keris resembled a tail/the buttock of hair louse, used big pesi and meteorit pamor was used because it required facial manifestation (Harsrinuksmo, 2004).

The form of Javanese keris of Solo style experienced significant changes in Majapahit era into its latest form. The carvings of the kerist of Majapahit era presented the forms of ascetics with bowing position. The form is up to the present time clearly observed in the forms of the statues that have been stylized and lost its statue characteristics and the bowing figure remained. If there were ornamental variations, the typical formed would not disappear.

In general, there were two forms of warangka or sheath of Solo style, which were ladrang and gayaman.

The ladrang consisted of angkup, lata, janggut, gandhek, godhong (resembled leave), gandar, ri, and cangkring.

Gayaman (gandhon) was almost of the same parts as the ladrang, but there was not any angkup, godhong, and gandhek (Retrieved from id.wikipedia.org/wiki/keris). The warangka of Surakarta style was usually referred to as wanda of Surakarta Hadiningrat with wide form and various and luxurious pattern. The form of godhongan was wide, luxurious, and of various pattern. The handle had arched carvings and widened in its head, while the lower part of wadah or the sheath of the sharp blade of the keris was also wide (Buanadjaya, 1997).

Purwa Leather Puppet of Solo Style In general, purwa leather puppet of Solo type was of static impression, especially the purwa leather puppets, had slim physical form but had valuable distinct beauty if it was played in a leather puppet shadow play because the puppeteer could easily play and control the wooden puppets so that the puppeteer affairs of Surakarta style was more likely to be dominant. Concerning with the form aspect the leather puppets also developed and even the shift of the tradition into new creation. In the glorious era of Surakarta Kingdom leather puppets of huge dimension have even been created and named Kyai Kadung (Sagio, 1991).

The typical characteristic of the leather puppets of Solo style was found in the part called praba, which was the ornaments used by knights and it was of big dimension and resembled wings symbolizing life light or highly regarded figures. The carvings of Soly style were more compact and used red and blue colors that gave complicated impression. Kelat bahu of hand and leg ornaments were simpler and short. The part ulur-ulur or the ornament of chest resembling the stretching rope that was carved in a way that it became was very interesting, the separation of the protruding part on the right and left sides that separated by fine flowers without any significant protruding part between the rope and the stem of the flower.

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Gunungan puppet of Solo style had the picture of a straight and widening gate adjacent to the edge part of the gunungan puppet, which was rather thick. The giant leather puppets were in general described as slimmer so that it was easier to play them. The clothings worn by the knight characters and the king generally used parang rusak batik as sandhangan at the same time served as the sign that they were great knights though there were also some knights that did not wear the clothings made of the batik parang rusak (Soekatno, 1992).

Merapi Mountain Merapi Mountain represented the only one situated in the Special District of Yogyakarta, which was approximately 30 km north of Yogyakarta City. The mountain was situated in four districts, including Central Java territory and the territory of the Special District of Yogyakarta, which were Sleman district, Magelang district, Boyolali district, and Klaten district. It was 2,911 above sea level with the declivity of its upper area of 30o and formed steep hill. Its crater was surrounded by old Merapi rocks in north and east that its lava vault was directed to Krasak stream, Putih stream, and Blongkeng stream. It had high erosion rate as a result of its topographic condition and high rainfall.

Code River Code River was a river that splitted Yogyakarta City. The river bank of Code River represented green area of the city and had the potential to develop as tourist object. The river could be used as tourist attraction or new magnet of river tourism that could be integrated as cultural art tourism, tourism environment, and culinary tourism. All of them were packed in an interesting river panorama.

The Core area had some interesting sites. One of them was the area of the home of Jogja artists that was by the Public Works of the province in 2000. There were many young people enjoyed the evening time of the beauty of the scenery of the river and its environment. Big trees, bamboo clusters, and the character of the beautiful landscape in other hand were growing in big number and there were some springs (Fajriyanto, 2010).

Parangtritis Parangtritis beach was situated in Parangtritis village of Kretek sub-district of Bantul district of the Special District of Yogyakarta. Natural potentials were supported tourism in Parangtritis and became the characteristics of the tourism object, which was sloped with huge sand area. It was also supported by open and clean sea scenery without any hindrance of islands and camphor unanimous areas stretching from north (Penyusunan Rencana Induk Wisata, 1997).

The area of Parangtritis was the one with very interesting natural tourism potentials. A blend of natural elements of ocean, beach, land, and mountains in an area that was relative wide though it was able to create typical atmosphere. Natural atmosphere that rapidly changed to the north direction presented an interesting sequence of view changes from beach to mountainous areas.

Sewu Mountain Karst was mountainous areas of camphor stones with unique landscape as a result of the erosion of the stone by water. The formation of the karst lasted for hundreds of years and resulted in invisible streams, vertical wells, springs, complex underground water systems, and caves (Nuryanti, 2006).

Sewu Mountain was one of the karst areas of Java Island. The carst area of Sewu Mountain geographically stretched in the southern area of Java from Central Java to East Java. Administratively, the karst of Sewu Mountain was situated in the Special District of Yogyakarta, precisely the district of Gunung Kidul and some

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areas of Bantul district. The topography of the karst of Gunung Kidul was situated in the south areas of Gunung Kidul, including 10 sub-districts with the total karst areas of 82,637 hectares or 55% of the territory of the district (Wahyuningsih, 2009).

There were two kinds of karst, which were endokarst and exsokarst. The potential of the endokarst of the mountain was classified into two, which were cave group and underground stream group with their respective characteristic attraction related to their morphology, morphometry, genesa, and panorama. The potential of the ecokarst of the mountain was particularly classified into three, which were beach object, karst hills, and karst valley. The karst spread was observed in the phenomena of exokarst were esthetically very interesting and unique.

The phenomena of the endokarst began to be popular for the people, especially karst caves with esthetic values of their ornaments such as stalagtit and stalagmite and other ornamental forms of flowstone (Worosuprojo, 2006).

The phenomena of superficial karst spread became the characteristics of the mountain which was the forms of conical karst that amounted to 40,000 objects. The superior karst object in the mountainous areas was represented by the segment of Mulo in which there were various forms and dimensions of the karst resulting from the erosion process of karstification. The karst segment was considered to be representative of the existing karst system in the district because of the big number, the variety of its landscape, including dolina, uvala, polje, dried valley, karst spring and lakes, and the natural phenomena under the surface of the caves.

The beaches of the district belonged to the karst of the mountain stretching from Ngobaran in west of Saptosari subdistrict to Sadeng beach in the east of Girisubo sub-district. In general, the morphology of the karst in the mountain was of the form of bay with sandy beach and steep mountain sides (Worosuprojo, 2006).

Menoreh Hill Menoreh hill or mountain was a mountainous area stretching from northwest area of Kulonprogo district to the eastern area of Purworejo district and part of Magelang district, representing the natural boarder of the three districts. The mountainous area resulted from coral and not volcanic materials, stretching from Begelenarea to the north and reached the west area of Magelang City. The mountainous areas of Menoreh were well-known as the basis of the struggle of Diponegoro Prince and his followers in Java war that lasted for five years (1825-1830) against Dutch colonizer (Retrieved from id.wikipedia.org/wiki/ pegunungan_menoreh).

Bengawan Solo River The term bengawan in Javanese means big river. Bengawan Solo River was the longest one in Java with two upper streams coming from south mountainous area of Wonogiri and Ponorogo and ended in an orifice in Gresik. In the past, the river was called Wuluyu, Wulayu, and Semangi (Semangy in Dutch literature) of 17th century. Its length was about 548.53 km and flowed through two provinces, which were Central Java and East Java. It flowed through three districts, which were Wonogiri, representing the main upper stream in the catching area of Gajah Mungkur, Karanganyar, Ponorogo (the main upper stream of Madium catching area), Boyolali, Sragen, and Klaten. The central administrative areas included Sukoharjo, Solo, Ngawi, Madiun, Magetan, Blora, and Cepu. The lower stream administrative areas included Bojonegoro, Tuban, Lamongan, and Gresik.

Sewu Waterfall Sewu waterfall represented one of the tourism objects in Tawangmangu village of Tawangmangu sub-district of Karanganyar district of Central Java province. It was a beautiful waterfall with typical mountainous atmosphere and became the main tourist object of the areas. It might be reached by walking the

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footpath that has been hardened and neatly arranged of some hundreds meters.

The tourist object had the potential of natural resource of flora, including various species of plants such as pine, kaliandra, dammar, and casuarinas trees. Additionally, there were also fauna natural resources such as birds.

The Resulting Batik Motif Designs Figures 1-12 show the batik motif inspired by temple, puppet, and the natural environment and so on.

Figure 1. The batik motif inspired by Borobudur Temple.

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Figure 2. The batik motif inspired by Prambanan Temple.

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Figure 3. The batik motif inspired by Sewu Temple.

Figure 4. The batik motif inspired by keris of solo style.

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Figure 5. The batik motif inspired by leather puppets of solo style.

Figure 6. The batik motif inspired by Merapi Mountain.

Figure 7. The batik motif inspired by Code River.

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Figure 8. The batik motif inspired by Parangtritis Beach.

Figure 9. The batik motif inspired by Gunung Sewu Mountain.

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Figure 10. The batik motif inspired by Menoreh Hill.

Figure 11. The batik motif inspired by Bengawan Solo River.

Figure 12. The batik motif inspired by Grojogan Sewu Waterfall.

Conclusions The study was the implementation of the creativity in creating batik designs inspired by local cultural arts and natural environment of Yogyakarta, Solo, and so on. It was necessary to explore the local cultural arts as an effort to preserve the cultural identify of Indonesia. The local cultural arts of Yogyakarta and the surrounding areas included Borobudur temple, Prambanan temple, and Sewu temple, while the natural environment included Merapi Mountain, Code River, Parangtritis beach, Sewu Mountain, and Menoreh hill. The local cultural arts of Solo and the surrounding areas included keris and leather puppets, while the natural environment included Bengawan Solo River and Grojogan Sewu waterfall. The objects inspired the creation of new and creative batik motives.

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Temples, keris, and leather puppets were proven to be very interesting elements that enabled further and inexhaustible exploration. The elements included forms, structure, and artistic styles. The data of the expressed manifestations included whole forms and the forms of the parts of the temples, the keris and the leather puppets, and their ornamental styles.

The new and creative batik motives were created based on photographs, image data, or other documentation that were subsequently focused on certain data and alternative sketches were made. The sketches were then selected and the designs were made. There were two methods in the creation of the new batik motives, which were manual (directly drawn using hands) and computer-aided drawing.

There were 159 batik motives resulting from the study that functioned as long cloth and clothing materials.

All of the batik motives were in the batik patterns with defined scale that it would be easier to materialize them on cloth. They were arranged in various methods such as regular repetition, horizontal arrangement, vertical arrangement, diagonal arrangement (i.e., oblique lines), half-step, and full step shifting.

References Borobudur Heritage Conservation. (2011). Borobudur: Overview (Candi Borobudur Selayang Pandang). Magelang: Conservation Agency of Central Java.

Buanadjaya, B. S. (1997). Kris weapon: Historical value-metaphysical (Keris Pusaka: Nilai Historis-Metafisik). Solo: CV. Aneka.

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Dumarcay, J. (2007). Candi Sewu and Buddhist architecture of central Java (Candi Sewu dan Arsitektur Bangunan Agama Buddha di Jawa Tengah). Jakarta: Kepustakaan Populer Gramedia.

Fajriyanto. (2010). Alternative tourism river plate code, Yogyakarta: Save remaining RTH (Wisata Alternatif Bantaran Sungai Code, Yogyakarta: Menyelamatkan RTH yang Tersisa). Paper Workshop Nasional. Yogyakarta: Eco river City Yogyakarta.

Gustami, S. P. (1980). Ornaments Indonesian art (Nukilan Seni Ornamen Indonesia). Yogyakarta: Sekolah Tinggi Seni Rupa Indonesia “ASRI”.

Hamzuri. (1988). Keris. Jakarta: Publising by Djambatan Harsrinuksmo. (2004). Encyclopedia Kris. Jakarta: Gramedia.

Honggopuro, K. R. T. K. (2002). Batik as clothing in the order and guidance (Bathik sebagai Busana dalam Tatanan dan Tuntunan). Surakarta: Yayasan Peduli Karaton Surakarta Hadiningrat Publishing.

Kismayanti, C. (2013). Variations reliefs plants in Borobudur (Variasi relief Sulur Daun pada Candi Borobudur). Retrieved from http://lontar.ui.ac.id/opac/themes/libri2/detail.jsp?id=20159705&lokasi=lokal Koesni. (2003). Knowledge about Kris (Pakem Pengetahuan Tentang Keris). Semarang: Aneka Ilmu.

Kusen. (1992). Repairing Sewu temple: Preservation projects/utilization of historical and archeological artifact (Purna Pugar Candi Sewu: Bagian Proyek Pelestarian/Pemanfaatan Peninggalan Sejarah dan Purbakala). Yogyakarta: Balai Konservasi Jawa Tengah.

Kusumawati, T. (2011). Typical new creations Batik Yogyakarta: Temple, puppet, and Kris as source of ideas (Motif Batik Kreasi Baru Khas Yogyakarta: Candi, Wayang, dan Keris sebagai Sumber Ide). Yogyakarta: Leutikaprio.

Naddaf, G. (2006). The Greek concept of nature. Albany: SUNY Press.

Nuryanti, W. P. (2006). “Karst” through tourism. Workshop on Tourism Development of Sewu Mountain in Central Java and Gombong’s Karst Area, Yogyakarta.

Penyusunan Rencana Induk. (1997). Sleman region tourism development: Region craft (Pengembangan Pariwisata Kawasan Kaliurang Sleman: Kawasan Kerajinan). Yogyakarta: Department of Tourism, Postal and Telecommunications Director General Tourism Development Project, DIY. Poerwadarminto, W. J. S. (1976). Indonesian language common dictionary (Kamus Umum Bahasa Indonesia). Jakarta: Balai Pustaka.

Riyanto, D. (1993). The process of Batik and Batik printing (Proses Batik: Batik Tulis, Batik Cap, Batik Printing). Solo: CV. Aneka.

Sagio. (1991). Puppet genre Yogyakarta: Morphology, inlay, decoration and manufacturing technique (Wayang Kulit Gagrak

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Yogyakarta: Morfologi, Tatahan, Sunggingan dan Teknik Pembuatannya). Jakarta: Haji Masagung.

Soedarso, S. (1998). Indonesian Batik painting: Classical to contemporary (Seni Lukis Batik Indonesia: Batik Klasik Sampai Kontemporer). Yogyakarta: Taman Budaya Propinsi Daerah Istimewa Yogyakarta.

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Semarang: Aneka Ilmu.

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Structuring Plan Buildings: Recent Area Reef Tawangmangu District. (1993). Central Java Province Building Section Central Java Setup Project in cooperation with PT. Candra Kirana Total Design: Fourth Report (Final Report). Surakarta: Department of Public Works, Karanganyar regency, and the Department of Tourism, Post and Telecommunications.

Supriatna, N. (2011). History (Sejarah). Yogyakarta: PT. Grafindo Media Pratama.

Suryahadi, A. A. K. (1998). Drawing patterns by Motif. Directorate of vocational education (Menggambar Pola dengan Motif.

Direktorat Pendidikan Menengah Kejuruan). Jakarta: Departemen Pendidikan dan Kebudayaan.

Sutanto. (1984). Ornaments knowledge (Pengetahuan Ornamen). Jakarta: Ministry of Education and Culture.

Suyanto, A. N. (2002). History of Batik Yogyakarta (Sejarah Batik Yogyakarta). Yogyakarta: Publishing by Rumah Penerbitan Merapi.

Tukidjan. (2008). Study architecture pattern & dimension Lorong 1 Borobudur Temple (Kajian Arsitektur Pola & Dimensi Lorong 1 Candi Borobudur). Yogyakarta: Balai Konservasi Peninggalan Borobudur.

Wahyuningsih, H. (2009). Referral Karst area spatial planning approach through the principles of ecotourism (Arahan Perencanaan Tata Ruang Kawasan Karst melalui Pendekatan Prinsip Ekowisata). Tesis Program Pascasarjana Fakultas Teknik Universitas Gadjah Mada Yogyakarta.

Worosuprojo, S. (2006). Tourism Development in Karst Gombong-Mount Sewu By the Provincial Government of Central Java, Yogyakarta and East Java. Area Tourism Development Workshop Gombong and Gunung Sewu Karst, Ministry of Culture and Tourism, In collaboration with the Provincial Government of Yogyakarta, Central Java and East Java.

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China-USA Business Review, ISSN 1537-1514 January 2014, Vol. 13, No. 1, 38-46

DAVID

PUBLISHING

Industrial Risk Management: Modeling From the Explosion of the 19/01/04 Complex of Liquefied Natural Gas, Skikda (GL1 / K) Hanya KHERCHI MEDJDEN, Khadidja SADI ENSSEA, Algiers, Algeria 

After several incidents or accidents, the most serious case being the one who struck the complex Skikda liquefied natural gas (GL1 / K) on January 19, 2004, the group Sonatrach sensitive to the incident has taken further steps along the lines of prevention safe knowing that the business risk is an integral part of the business industry and it is about health, safety, and environmental protection. These factors will be taken into account in the process of management and decision making at all levels. This study tries to find the causal factors of the explosion of 19 January 2004 (GL1 / K) and to develop a fault tree and assess the risks arising from these factors, why our research is based on interviews: at first, with an industrial safety engineer (Health, Safety, and Environment (HSE) Department, General Direction of Sonatrach), an executive director of insurance, a department head of insurance, an insurance consultant, a department head of downstream activity and two financial executives; secondly, a poll at the general direction with insurance adjusters and engineers in industrial safety; and finally a report may visit the complex which has been made (the report) 15 days before the explosion. The cause-effect diagram is used which is a cause-effect method both upwards (search for causes of failure) and down (search for consequences of failure) that can not only identify risks system and the detailed analysis, but also can describe the form of a single graph, both the normal operation of a system. The default trees developed show that all the risks assessed are located in areas: acceptable, undesirable, and intolerable, which requires the development of an action plan providing control measures at all sensitive points.

Keywords: industrial risk, probability of default, failure tree

Introduction The danger is defined as a situation which, in itself, a power to cause damage to people and property, otherwise the danger is the situation or condition that threatens the physical integrity of persons. There is a danger or nuisance when a material, a product, a procedure, and an organization are able to cause immediate damage or delayed.

There are many definitions of risk. According to the definition found in Webster’s, it is written: “Danger Hanya KHERCHI MEDJDEN, Doctor in Statistics and Applied Economics, Lecturer, High School of Statistics and Applied Economics, ENSSEA. Khadidja SADI, Doctor in Statistics and Applied Economics, Lecturer, High School of Statistics and Applied Economics, ENSSEA. Correspondence concerning this article should be addressed to Hanya KHERCHI MEDJDEN, 32 rue Ahmed Boumazouza El Madania Alger Algeria. E-mail: kherchi.hanya@enssea.dz.

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any more or less predictable”, and it is written in the Littre “Too bad more or less any foreseeable event against the occurrence of which it is ensured, the made to expose them to danger, in the hope of getting a perk”.

According to the statistical risk, it is considered as the combination of issues subject to a hazard, that is to say, the confrontation a probability of an event by the vulnerability of the wider environment. So this paper notes: (1) The hazard is the likelihood or probability of the occurrence of a phenomenon or event; (2) The issue or vulnerability—three types of issues can be distinguished:  The human issues: It is individuals directly or indirectly exposed to the consequences of the accident. They can be found in a public place, at home, at their place of work, etc.. The risk can range from minor injuries to death. The type of accident affects the type of injury;  Economic issues: A major industrial accident may alter the economic tool of an area. Businesses, roads, or railway adjacent to the site of the accident may be destroyed or severely damaged. In this case, the economic consequences can be disastrous;  Environmental issues: A major industrial accident can have significant impacts on ecosystems. You can watch the destruction of fauna and flora, but the consequences of an accident may also have an impact on health (for example, pollution of groundwater).

All human activity, even trivial, may cause undesirable consequences: excess food and beverages (cancers, cardiovascular disease), smoking and breathing polluted air (cancers, cardiovascular diseases), housework (falls), and dangerous sports (injury, death).

Zero risk which does not exist is a risk that can be reduced, without ever being canceled. For example, a minimal risk, because the probability (P) of the event in question is very small, but the consequences would be incalculable, is the impact of the earth with an asteroid large enough to cause this that it is called a nuclear winter.

Risk Perception and Evaluation It should be noted that the counterparty risk is always a benefit, it is the case of voluntary risk that is to say, the selected risks, to which the salary will be adjusted to the dangers incurred, by the example as the case of journalists sent to cover events in areas affected by military operations. This is also the case of involuntary risks which is to say the risk of damage, but in this case, who withdraws the benefit is not necessarily the one liable as areas invaded by pollution due to cement plants, the key risk here and the surrounding population are benefited employees of the plant.

Actual Risk, Perceived Risk The real risk is the risk assessed by data already known (risk = hazard × issues).

Perceived risk is the risk as perceived by the public in general little able to estimate the importance of lack of information or technical knowledge. A simple example is the natural apprehension that there may be riding in a plane.

Major Risk The major risk is called when the phenomenon is widespread and vulnerabilities. Risk is also called major when during an event of natural or technological monitoring impact on people, property, and the environment, the public may lose confidence in the political and economic powers.

Generally the major risk is characterized by many victims, a significant cost of damage, impacts on the environment and the economy.

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Industrial Risk Industrial risk is a major risk. The term “business risk” is the likelihood of a specific effect occurring within a specified period or in specified circumstances, due to a major accident event related to loss of control of an industrial activity. These effects may have implications for site personnel, surrounding communities, buildings, and the environment.

On the other way, industrial risk is an accidental event such as a gas emission, fire, or explosion of major character, which occurs on an industrial site and causing immediate and serious consequences for neighboring populations, property, or environment. All activities requiring large amounts of energy or products are concerned, that in case of malfunction, the emanation of these energies or products have consequences beyond the confines of the factory. Depending on the mode of action on human and relevant products, industrial risks are divided into three categories:  Risk of fire or thermal hazard;  Risk of explosion;  Risk toxic.

Industrial Risk Assessment There are several methods for assessing industrial risk among them: The analysis of failure modes, effects, and criticality of their Failure Mode and Effects Analysis (FMEA) is an analytical approach and probabilistic down which aims to analyze in a systematic and preventive system failures or a technical device whose consequences can affect its reliability and maintainability.

It uses two different and complementary analyzes:  A qualitative analysis of failure modes, their causes and their effects;  A quantitative analysis of the severity of consequences and the likelihood of failure modes and their impact on the reliability and maintainability of the system considered.

The FMEA, general conduct in the design phase of the system or sub-system can also be used during operation to trigger remedial actions to perform.

It can be applied both to a product or a modification (FMEA-product), as a process or method of production, manufacturing, quality control (process-FMEA) or only means of production (FMEA Middle-production).

The preliminary risk analysis (PRA). The PRA is an approach to top-down analysis and deterministic designed by the United States (U.S.) Army in the 1960s. It aims to highlight the main risks likely to be encountered in the design of new systems.

This method generally carried from the beginning of the system design at a global level, however, can be made throughout the design, even when operating studied in order to make updates or perform further analysis.

It can quickly highlight the main risk situations and without wanting to go into too much detail, a system can serve as the basis for the subsequent production of more detailed analyzes.

The cause-effect diagram. The diagram or graph is a cause-effect method both upwards (search for causes of failure) and down (search for consequences of failure) that can not only identify risks system and the detailed analysis, but also can describe the form of a single graph, both the normal operation of a system.

This method is very useful for identifying when the design or operation, the risks of systems consist of a sequence of actions relatively predictable.

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It is thus a valuable aid for the identification of scenarios constituting the predominant risks.

Markov chains. Markov chains are stochastic, which are tools modeling aimed to analyze and assess the reliability or availability of a system as a whole (the graphs used then being significantly different).

They describe chains of events analytically and graphically the behavior of dynamic systems (transition from one state to another state) and calculate the characteristics and conditions of the cruising speed when is reached.

The Monte-Carlo. The Monte-Carlo (stochastic) is the technique of simulation random universe that leads to very detailed analyzes of complex systems.

It can be used not only to simulate the behavior (operation and malfunction) systems subject to various risks and for which it is difficult to obtain sufficiently reliable information, but can also be used for project scheduling problems to perform quantitative analysis of certain risk components, namely, the impact of the variability of the duration or cost of project tasks.

Performing a simulation by the Monte-Carlo method, on the one hand, requires well studied model of the system (in the form of a graph, a tree, and a network etc.) and on the other hand, is based on the drawing of random numbers, that is to say random number following a certain probability distribution.

It generally requires the use of a simulation tool with a random number generator and a battery of probability laws which can cover most situations.

Petri nets. Petri nets (stochastic) are a specific application of the Monte-Carlo method, invented in 1962 to describe the system behavior automated manufacturing, they are now used in many areas to improve the dependability of complex systems, they used to model and simulate dynamically (taking into account the time factor) the evaluation of a system to represent graphs by changing the various successive states of the system studied.

Hazard Identification of Complex Gl1 / K Fire and Explosion Complex GL1 / K has two distinct major areas:  The first area is dedicated to the process units 10, 20, 30, and 40 as well as utility and storage;  The second area relates to Units five and six, and the associated storage.

The distance between these two areas is about 700 meters and it can be considered that the risk of destruction from one zone to another is relatively low. Regarding the distance between the process units, the average is 24 meters. This distance is to consider, in the event of a major incident on train liquefaction as likely to cause serious damage to nearby facilities.

Risks Surrounding On the east side of units five and six, there are complex petrochemical facilities of national petrochemical company. The risk of explosion due to the storage of ethylene and ethane is not excluded. In addition, he noted the absence of the nearby airport complex.

Environment The enviroment which includes the following parts:  Climates: The average summer temperatures are between 28 °C and 32 °C. In winter they are between 10 °C and 0° C. The average humidity is 54% in winter and 76% in summer.

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Precipitation: The average rainfall is about 400 mm of water per year especially during the winter months;  Wind: The predominance of winds is North-West/North-East. Wind speed may exceed 50 km/h;  Earthquake: The region is considered as an active seismic zone;  Flooding: It should be noted that there is no river or near to river, that an accident in the complex could cause a risk of flooding. 

Evaluation of Explosion of 19 January 2004 (GL1 / K) On 19 January, 2004, a strong explosion occurred at 18:40 at the complex natural gas liquefaction Skikda (GL1 / K).

The Units 40, 30, 20, and 10 of the six units of liquefaction, that include GL1 / K complex, were heavily damaged and subjected to an intense fire.

The Power Plant SONELGAZ terraced Complex LNG was triggered as a result of the shock wave of the explosion.

It is unfortunate that this incident was the cause of 23 deaths and 74 wounded evacuated to the hospital in Skikda which 42 have left after receiving the necessary care and five have been sent to hospital Annaba.

This study tries to find the causal factors of the explosion of 19 January 2004 (GL1/K) to develop a fault tree and assess the risks arising from these factors, why our research is based on interviews with: (1) Interviews with:  An industrial safety engineer (HSE Department, General Direction of Sonatrach);  An executive director of insurance (Department of Insurance, Branch Sonatrach);  A department head of insurance (Department of Insurance, Branch Sonatrach);  Insurance consultant (Department of Insurance, Branch Sonatrach);  Department head of downstream activity (Department downstream Branch Sonatrach);  Two financial executives (Department of Insurance, Branch Sonatrach).

(2) A poll is at the general direction with insurance adjusters and engineers in industrial safety; (3) A report may visit the complex, which has been made (the report) fifteen days before the explosion.

The Tree of Default: Two random events occur exclusively or inclusively. So the logical operator “OR” indicates that the event occurs independently if any events are based and the logical operator “AND” indicates that the event occurs only if the basic events exist simultaneously.

The disaster of 19 January 2004 was due to two assumptions: Hypothesis 1: A main problem—a fire or explosion.

Fire: The main causes of the fire are due to faulty heating appliances, careless smokers, wiring damage, and undetermined causes; Explosions: either a type scenario Unconfined Vapor Cloud Explosions (UVCE), or type scenario Boiling Liquid Expanding Vapor Explosion (BLEVE): (1) UVCE: It is an ignition source and a gas leak (simultaneously).  Ignition source: This is defective heating equipment or careless smokers or wiring damaged or undetermined causes;  Gas leak: poor reservoir quality problem or maintenance of the equipment or poor quality equipment or an

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appliance or amortized or depreciated pipe maintenance problem of a pipe.

(2) BLEVE: It is a human problem, or an organizational problem, or a technical problem.

The human problem is being lack of training or lack of vigilance or premeditated destruction;  Organizational problem: either emergency procedure or system of work or work permit or updated documentation or procedure or work instruction or wrong interpretation of terms of internal organization;  Technical problem: It is a device problem or an issue or a problem tank boiler or pipe problem;  Problem of device: maintenance, quality, overload device, or amortized;  Tank problem: quality, overload, or environment;  Boiler problem: overloading, maintenance, or leaking steam;  Pipe problem: maintenance is depreciated.

Hypothesis 2: The problem and the response team firefighters.

This is a problem response team or at firefighters.  Response team: lack of training, insufficient equipment, experience, or team died;  Firefighters: lack of training, not enough equipment, or shortage.

Probability of Basic Events The estimated probabilities of basic events can be calculated from: Databases that was nonexistent at Sonatrach; Tests whenever possible, however it was impossible because regulations do not allow Sonatrach.

Expert judgment: In this step the company organizes a council of all experts and engineers of all levels, who believes his own probabilities.

Finally the following assumptions are set: (1) These probabilities are arbitrary; (2) n = 43 (since there are 43 basic events); 43

(3) The sum of probabilities equal to 1:

 P  1; i

1

(4) Probability > 0023 : high probability; Probability < 0023 : low probability. where: 0.0023 = 1/43.

Necessary formulas for estimating probabilities of intermediate events and disasters (dreaded) are: BLEVE: To calculate the probability of the event through BLEVE, it must calculate the probabilities of intermediate events that make up the BLEVE namely:  Human is : Human (lack of training) OR (lack of alertness) OR (premeditated destruction).

P (Human) = P (lack of training) + P (Complacency) + P (premeditated Destruction).  Organizational is: Organizational Plan (internal organization) OR (work system) OR (Mal interpretation set) OR (How to work) OR (Updated documentation) OR (Emergency Procedure) OR (Work Permit).

P (Organizational) = P (Plan internal organization) + P (work system) + P (Mal interpretation set) + P

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(Procedure for work) + P (Updated documentation) + P (Procedure emergency) + P (Work Permit).  Technical is: (Camera) OR (Reservoir) OR (boiler) OR (Pipe) P (Technique) = P (Camera) + P (tank) + P (boiler) + P (Pipe) BLEVE = (Human) OR (Organizational) OR (Technical)

Results BLEVE: The probability that the cause of a BLEVE scenario is: P (human problem) = 0.023; P (Organizational) = 0.133; P (Technical) = 0.302, which is the highest probability; P (BLEVE) = 0.023 + 0.133 + 0.302 = 0.458.

And P (technical problem) = P (device problem) + P (reservoir problem) + P (boiler problem) + P (pipe problem): P (device problem) = 0.14; P (reservoir problem) = 0.027; P (boiler problem) = 0.03; P (pipe problem) = 0.1.

So a technical problem is most likely that it is the cause of a BLEVE scenario, and a device is more likely to cause a technical problem.

UVCE: The operator UVCE logic is “AND” so the two probabilities causing the problem cannot be compared: P (Ignition source) = 0.11300; P (Gas leak) = 0.16500; P (UVCE) = 0.11300 × 0.16500 = 0.018605.  E explosion: It is noted that the probability of a BLEVE (0.458) is greater than that of UVCE (0.018605), and then a BLEVE scenario is most likely to explode. But that UVCE probability is not zero cannot be eliminated.  Fire: The probability of fire is (0.06). If this is compared with the probability of explosion (0.476645), then it can be said that the phenomenon is a blast, but as the probability of fire is not zero, there is always a possibility that the phenomenon is a fire.  Response team and firefighters: The probability of response team is (0.0907) and firefighters are (0.107), then the problem was probably a firefighter’s problem response team, without eliminating the intervention team.

Disaster of January 19, 2004 Events It is noted that the logical operator is “AND”, so the two cases cannot be compared, but the probability is equal to (0.11), that is to say, the possibility, that the causes of the disaster are those which have been found in our research, is (11/100).

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INDUSTRIAL RISK MANAGEMENT

The matrix evaluation risks: Greater likelihood of intervening events is the “Technology” (BLEVE). To construct the intervals is divided by five (there are five levels of probabilities) (see Table 1).

Table1 Intervals of Probabilities for Risk Assessment Intervals of probabilities [0 to 0.0604] [0.0604 to 0.1208] [0.1208 to 0.1812] [0.1812 to 0.2416] [0.2416 to 0.302]

   

Risk assessment Extremely unlikely Unlikely Possible Probable Inevitable

There are four types of gravity (see Table 2). The gravity depends on the damage caused: Slight; Moderate; Grave; Disastrous.

Risk = Probability  gravity

Table 2 Matrix of Risk Evaluation Probability Gravity Inevitable Probable Possible Unlikely Extremely unlikely

Slate

Moderate

Grave

Disastrous

5 4 3 2 1

10 8 6 4 2

15 12 9 6 3

20 16 12 8 4

We can now evaluate the risks by source of danger as indicated in Table 3.

Table 3 Risk Evaluation of the Explosion January 19, 2004 Sources of danger Consequence Lack of training-Lack of vigilance-Premeditated destruction Human (BLEVE) Internal organizational plan-Work system-Wrong interpretation of set pointOrganizational Working procedure-Last updated from the documentation-Emergency (BLEVE) procedure-Work permit Maintenance unit-Quality appliance-Overload device-Unit cushioningTechnique Quality tank-Environment-Overload tank-Overload boiler-Leak steam(BLEVE) Maintenance boiler-Maintenance Pipe-Pipe cushioning Devices of heating systems-Undetermined causes-carelessness of smokers- Source ignition Electrical installation (UVCE) Quality of the reservoir-Maintenance of the machine-Quality of device-Unit Gas leak depreciated-Pipe amortized-Maintenance pipe (UVCE) Devices of heating systems-Carelessness of smokers-Undetermined causesFire Electrical installation Not enough material-Lack of experience-Team died-Lack of training Response team Lack of training-Not enough material-Lack of experience Firefighters

Probability 0.023 1

Gravity 4

Risk 4

0.133

2

3

9

0.302

5

4

20

0.113

2

4

8

0.165

3

4

12

0.06

1

3

3

0.031 0.085

1 2

2 2

3 4

46

INDUSTRIAL RISK MANAGEMENT

Conclusions This paper discusses the risk assessment of a complex gas activity, where the acceptable risk can develop instantly an intolerable risk. An amount for each area of risk cannot be given. The disaster has cost a total loss of 452 million U.S. dollars (32,544 million dinars Algeria).

For sources of danger “Human” (lack of training, lack of vigilance, premeditated destruction) that result in a BLEVE scenario, the risk equals four representing an acceptable risk. For sources of danger “Organizational” which resulted in a BLEVE scenario, the risk equals nine representing a risk adverse. Regarding the sources of danger “Technology” (BLEVE consequence), the risk is 20, which represents an intolerable risk. Regarding the sources of danger “Ignition source”, the risk is equal to eight, so risks adverse. For sources of danger “gas leak” (result UVCE), the risk is equal to 12, people are in the area of undesirable risk. For sources of danger which have resulted in a fire, the risk is equal to three which are positioned in the acceptable risk. For sources of danger have a problem with team intervention, the risk is equal to eight (undesirable risk). For sources of danger having a problem with firefighters, the risk is equal to six (acceptable).

It is noted that all the risks assessed are located in areas: acceptable, undesirable, intolerable, which requires the development of an action plan providing control measures at all sensitive points.

References Courtot, H. (1998). La gestion des risques dans les projets. Retrieved from http://www.economica.net/ European Comity commission. (2003a). Directive 1999/92/CE du Parlement Européen et du Conseil concernant les prescriptions minimales visant à améliorer la protection en matière de sécurité et de santé des travailleurs susceptibles d'être exposés au risque d'atmosphères explosives (pp. 0057-0064). Journal officiel No. L 023, Bruxelles.

European Comity commission. (2003b). Guide de bonne pratique à caractère non Contraignant. Bruxelles Commission Européenne DG Emploi, Affaires Sociales et égalité des Chances Unité D4.

French Institute of Environnement. (2005). La perception sociale des risques naturels. Données d l’environnement, No. 99, IFEN. Ministry of Ecology an Sustainable Development. (2003). Guide juridique de la prévention des risques majeurs. Collection Prévention des risques naturels. MEDD, France.

National Institute of Industrial Environment and Risks. (1999). Guide des méthodes d’évaluation des effets d’une explosion de gaz à l’air libre. Direction des Risques Accidentels Unité thématique Phénoménologie, INERIS. National Institute of Industrial Environnement and Risks. (2001). Emission accidentelle d’une substance chimique dans l’atmosphère. INERIS National Institute of Research and Security. (1998). Prévention du risque chimique. INRS Paris.

National Institute of Research and Security. (2001). Maîtrise des risques prévention et principe de précaution. INRS, Paris.

National Institute of Research and Security. (2001). Prévention des risques d’incendie et d’explosion de poussières de farine lors du stockage. INRS Paris.

Nationale Institute of Research and Security. (1981). Prévention et lutte contre le feu. INRS 1981.

SONATRACH. (2005). Santé, sécurité, environnement et développement durable Bulletin mensuel édité par la Cellule Communication Activité Aval. No. 1 juillet, SONATRACH.

D

China-USA Business Review, ISSN 1537-1514 January 2014, Vol. 13, No. 1, 47-59

DAVID PUBLISHING

Substance vs. Form in Shareholder Financing: How Does This Affect the Corporate Interest?* Ferruccio Maria Sbarbaro Link Campus University, Rome, Italy

Andrea Sacco Ginevri Cattolica University, Rome, Italy  This article analyzes the “substance versus form” contrast in the context of shareholders’ financing, exploring how it simultaneously affects both the corporate creditors’ protections and the long-term growth of the company. In particular, the paper describes the role of shareholders’ financing in the corporation capitalization and its qualification under the current “substance versus form” debate; then it illustrates the substantial approach commonly taken by the case law and explores the effects of the above mentioned debate on the corporate creditors’ protections; finally, the paper examines the impact of this practice on the governance side. This article argues that, in a context where substance should govern over form, the most acceptable standards of review should be those that refuse a mechanical application of the formal factors and privilege a comprehensive approach that can lead to a common sense evaluation of the facts and circumstances surrounding a transaction. In other words, the so-called “substantial factors” should certainly be helpful in reaching such a common sense understanding of the transaction since they may show the objective intent of the parties. In short, judicial tools that legitimate and expand the recharacterization of debt to equity are advisable devices because at the same time (1) they strengthen the (actual) corporate creditors’ protections; and (2) they foster a long-term growth of the company which benefiting from a conversion of its financial resources into equity (i.e., perpetual capital), may pursue a business strategy more focused on a sustainable and careful development of the enterprise.

Keywords: corporate governance, corporate interest, corporate creditors, shareholders’ financing, long-term view, substance vs. form, recharacterization, equity subordination

Introduction This article analyzes the “substance versus form” contrast in the context of shareholders’ financing, exploring how it simultaneously affects both the corporate creditors’ protections and the long-term growth of the company.

In particular, section two—Does substance govern over form in shareholder financing?—briefly describes the role of shareholders’ financing in the corporation capitalization and its qualification under the current *

This article has been drafted as follows: Sections 2 and 4 by Ferruccio Maria Sbarbaro and Sections 3 and 5 by Andrea Sacco Ginevri. Sections 1 and 6 have been jointly drafted by the Authors.

Ferruccio Maria Sbarbaro, Adjunct Professor of Comparative Law, Link Campus University.

Andrea Sacco Ginevri, Adjunct Professor of Corporate Law, Cattolica University.

Correspondence concerning this article should be addressed to Ferruccio Maria Sbarbaro, via E.Duse n. 37, Rome, 00197, Italy.

E-mail: f.sbarbaro@unilink.it.

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SUBSTANCE VS. FORM IN SHAREHOLDER FINANCING

“substance versus form” debate. Section three—The Substantial Approach in the Case Law illustrates the substantial approach commonly taken by the case law. Section four—How an “equity view” of shareholder financing protects corporate creditors?—explores the effects of the above mentioned debate on the corporate creditors’ protections while section five—How an “equity view” of shareholder financing fosters a long-term growth of the company?—examines the impact of this practice on the governance side.

Does Substance Govern Over Form in Shareholder Financing?

The nature, purpose, and condition of shareholders’ loans to a corporation are relevant elements that do affect company’s capitalization and the interests of both non-lending shareholders and outside creditors.

In fact, in limited liability firms, there is a substantial risk that shareholders wishing to finance the corporation prefer to contribute through debt instead of equity, on a loan basis, in order to formally acquire a reimbursement priority over other shareholders and keep their contribution safe from capital exposure.

In this context, the impact of a reimbursement obligation on the above interests gets even more sensitive when a corporation approaches the “zone of insolvency” and the contrast between equity holders and creditors degenerates into a dispute, with bankruptcy courts coming into play.

When such issues arise, the analysis of company’s capitalization requires an interplay between substance and form, in order to effectively identify whose contributions are located on the “positive side” of an asset distribution, company liquidation or winding-up situation.

Therefore, bankruptcy courts have a general authority to rule that a claim against the trustee, or debtor in possession, should not be considered as an actual debt claim but rather as an equity interest1. The result of such a ruling, named “recharacterization”, is that the claim is subordinated to all the debt claims of (other) creditors and is treated pari passu (with an equal step) with the claims of the equity holders.

This judicial device differs from another, similar instrument used by bankruptcy courts, namely, the “equitable subordination”, which is used to subordinate an actually existing debt claim to those of other creditors, because of some inequitable conduct engaged into by the subordinated creditor, and only to the extent necessary to remedy to the inequitable conduct2.

Even though courts themselves have shown a degree of uncertainty in determining whether certain claims had to be recharacterized or equitably subordinated (Nozemack, 1999)3, these two mechanisms come into play at different stages and serve different and distinct purposes. The former is used to determine whether a purported debt claim actually exists (or should rather be considered as an equity interest), while the latter establishes a reimbursement hierarchy among different actual creditors and therefore may only be considered when a claim is recognized as being an existing debt claim.

On the other hand, recharacterization does not require any finding of inequitable conduct on behalf of the “lender” and exclusively involves the determination by a court that a transaction which the parties have 1

It is worth noting that a minority of the bankruptcy courts does not recognize the authority to provide such a relief. See e.g., In re Outboard Marine Corp., 50 Collier Bankr. Cas. 2d (MB) 931, 2003 WL 21697357 (N.D. Ill. 2003); In re AutoStyle Plastics, Inc., 269 F.3d 726, 748, 45 U.C.C. Rep. Serv. 2d 964, 2001 FED App. 0378P (6th Cir. 2001). In re Cold Harbor Associates, L.P., 204 B.R. 904, 915, 30 Bankr. Ct. Dec. (CRR) 336, 37 Collier Bankr. Cas. 2d (MB) 753 (Bankr. E.D. Va. 1997), all cited in 2004 Annual Survey of Bankruptcy Law, Sprayregen, Friedland, Brighton, Bianca, Recharacterization of Debt to Equity: An Overview, Update, and Practical Guide to an Evolving Doctrine.

2 In re AutoStyle Plastics, Inc., 269 F.3d 726, 747, 45 U.C.C. Rep. Serv. 2d 964, 2001 FED App. 0378P (6th Cir. 2001). See also 2004 Annual Survey of Bankruptcy Law, cit.

3 See also In re AutoStyle Plastics, Inc., 269 F.3d 726, 748, 45 U.C.C. Rep. Serv. 2d 964, 2001 FED App. 0378P (6th Cir. 2001).

SUBSTANCE VS. FORM IN SHAREHOLDER FINANCING

49

characterized as debt should be actually treated as an equity contribution 4 . Of course, if a claim is recharacterized, equitable subordination never comes into play5.

Despite the differences between these two devices and their different areas of application, whatever approach to the interpretation of shareholder financing must focus on certain factors, with the purpose of preventing the semblance of the contractual obligation to take over the substance of the financial contribution to the corporation. These factors may be listed as follows: (1) the formalities of the alleged loan agreement; (2) the financial situation of the company and how the parties actually treated the advance; and (3) the relationship between the creditor and the debtor (Nozemack, 1999).

The first group includes those elements that may be referred to as the “formal factors”, that can prima facie (on the first appearance) indicating whether the transaction respects the formalities of proper debt transaction, like: (1) the name given by the parties to the instruments, if any, evidencing indebtedness; (2) the presence of a fixed maturity date and schedule of payments; (3) the presence of an interest rate and interest payment; (4) the security, if any, provided by the borrower; (5) the extent to which the claims were subordinated to those of outside creditors; and (6) the presence of a sinking fund to provide repayments.

The second group includes a number of substantial factors, like: (1) adequacy of the capitalization of the company; (2) the sources used for the repayments; (3) the extent to which advances were used to acquire capital assets; and (4) the corporation ability to obtain outside financing.

The third group could be either restricted to a sole substantial factor, namely, (1) the identity of interest between the creditor and stockholder, or extended to include two more elements; (2) the ratio of shareholder loans to capital; and (3) the amount or degree of shareholder control6.

With regard to the formal factors it should be doubted why they should be used in determining whether a claim is debt or equity and what function these factors serve. Moving from a presumption that the parties acted in good faith, the formal factors may be seen as a tool used in order to determine the actual intent of the parties with respect to their agreement. One could argue that, if the parties called the relevant instruments with names evidencing a debt transaction, provided for collaterals to secure the repayments and so on, they actually wanted to conclude a debt transaction and, therefore, the court should not consider it as equity.

However, a more pragmatic approach suggests that the formal factors have very little effectiveness, if any, in discovering the actual intent of the parties. To the contrary, if courts relied too much on them, it would become relatively easy for sophisticated parties to obviate the court’s scrutiny. This could be done by simply executing a “loan” agreement which provides for: (1) a fixed (but illusory) maturity date; (2) a fixed interest rate (payment for which can be deferred until the maturity date); and (3) the granting of securities for the advance. The unsecured creditors would then be left with the difficult task of uncovering a “smoking gun” that demonstrates that the true intent of the parties was different. The inevitable result would be that recharacterization claims would almost always be rejected, if ever brought to courts.

Therefore, a decisive relevance must be recognized, in this context, to certain substantial factors. For 4

See 2004 Annual Survey of Bankruptcy Law, cit.

LLBL 6.03A, 2010 WL 3878862; In re Georgetown Bldg. Associates, Ltd. Partnership, 240 B.R. 124, 137, 35 Bankr. Ct. Dec. (CRR) 95, 42 Collier Bankr. Cas. 2d (MB) 1946, 42 U.C.C. Rep. Serv. 2d 1050 (Bankr. D. D. C. 1999). See also 2004 Annual Survey of Bankruptcy Law, cit.

6 These factors have been elaborated by the court of In re Outboard Marine Corp., 50 Collier Bankr. Cas. 2d (MB) 931, 2003 WL 21697357 (N.D. Ill. 2003) and derived from In re Hyperion Enterprises, Inc., 158 B.R. 555, 29 Collier Bankr. Cas. 2d (MB) 1281, 24 U.C.C. Rep. Serv. 2d 670 (D.R.I. 1993).

5

50

SUBSTANCE VS. FORM IN SHAREHOLDER FINANCING

instance, in order to characterize a claim as an equity interest, it is necessary to find an identity of interest between the creditor and the stockholder: It would be unreasonable to think that an external lender, simply because it has provided money to a struggling company, actually intended to realize an equity contribution into such company.

However, the insider status of the lender alone would have little meaning, if it is not put in connection with the overall relationship between lender(s) and borrower. For instance, if shareholders advance money to the corporation in proportion to their respective equity interests, this evidence standing alone is a relevant suggestion that, with the loan, the parties actually intended to conceal an equity contribution7. Conversely, if there is a disproportionate ratio between the lender’s equity interest in the corporation and the loan, there could be evidence of bona fide (real or done honestly) debt8.

Moreover, if the amount of control exercised by the lender on the corporation is increased as a result of the transaction9, or more generally, any time a lender obtains the right to control the company’s operations (Nozemack, 1999), there should be a reasonable ground to characterize the transaction as equity contribution.

The intent of the parties may also be inferred by the analysis of the way they expect the borrower to use the advances and of the way they expect such advances to be repaid. As to the first issue, a proof of bona fide indebtedness can be identified where the advances are used to meet the daily operating needs of the corporation, rather than to purchase capital assets10. However, in these same circumstances, it cannot be excluded that the debtor was in need of working capital and that, therefore, the parties’ intent was to provide an equity contribution11.

As to the issue of the source of repayment, the general rule is that if the expectation of repayment depends solely on the success of the borrower’s business, the transaction has the appearance of a capital contribution12.

The reason for this rule is clear: If the capital provided is treated by the parties as “risk capital”, then the “lender” cannot escape the inherent consequences of business ownership by labeling its investment as “loan”.

Thus, as (1) the intent of the parties represents the main—if not the only—element that characterize the transaction as debt or equity; and (2) the purpose of the financing shareholder may be identified only through an investigation of the “substantial factors”, the interplay between substance and form should definitely favor the former.

The Substantial Approach in the Case Law The major difficulty in determining a clear standard of approach to shareholders’ contributions is probably due to the fact that courts employ many different standards of review, without clear indications about what elements—or group of elements—should have prominent relevance. On the contrary, courts say that all the factors taken into account must be weighted as a unique group, so that none of them should be decisive. The characterization of such transactions requires a fact intensive analysis and courts usually prefer to have a 7

In re Cold Harbor, 204 B.R. at 919.

AutoStyle Plastics, Inc., 269 F.3d 726, 751.

9 See Estate of Mixon, 464 F.2d 394, 406 (5th Cir. 1972) (noting that when debtor grants creditor participation in management as result of advances, management participation is evidence of capital contribution by creditor); Cold Harbor, 204 B.R. at 917 (observing that one characteristic of equity contribution is participation in management), both cited in 2004 Annual Survey of Bankruptcy Law, cit., at 711.

10 AutoStyle Plastics, Inc., 269 F.3d 726, 752 (citing Roth Steel Tube, 800 F.2d 625, 632).

11 Matter of Transystems, Inc., 569 F.2d 1364, 1370 (5th Cir. 1978).

12 AutoStyle Plastics, Inc., 269 F.3d 726, 751 (citing Roth Steel Tube, 800 F.2d 625, 631).

8

SUBSTANCE VS. FORM IN SHAREHOLDER FINANCING

51

case-by-case approach, rather than developing a rigid doctrine to be applied to all cases. Even if such a flexible approach seems appropriate in this context, its inevitable result is uncertainty: Insiders willing to provide cash to a struggling corporation are left without clear indications as to whether their advance will be characterized as equity or debt.

In general, it can be observed that U.S. courts believe in the predominance of substance over form in the context of shareholder financing.

The 3rd U.S. Circuit Court of Appeals, in the opinion of In re Submicron Systems Corporation13 citing a dictum of the U.S. Supreme Court in Pepper v. Litton, held that the bankruptcy court’s ability to recharacterize purported debt as equity, just like its ability to equitably subordinate debt, is grounded in its equitable authority “to ensure that substance does not give way to form and that technical considerations do not prevent substantial justice from being done”14.

A close examination of how a formal approach can lead to an unfair result can be found in the opinion given in AutoStyle Plastic, precisely in the part where the court analyzes the presence of a fixed interest rate and interest payments15. The court says that the agreement provided ab initio (from the beginning) for both an interest rate and interest payment. The parties subsequently agreed to defer interest payments. However, according to the court, this factor is not indicative of equity but, at best, it cuts both ways, since the deferral of interest payment indicates the possibility that during the course of the transaction the defendants eventually never expected to get repaid and converted their debt to equity. Still, it does not change the fact that, initially at least, there was a fixed rate and interest payments, “indicating that the transaction was originally intended to be debt, not equity”16. Thus, according to the court, (1) the original intent of the parties may be inferred by an analysis of the formal factors; and (2) even if the parties eventually acted inconsistently with the intentions stated in the transaction documents, this simply means that they changed their mind during the course of the transaction. However, the court, relying on In re Cold Harbor, stated that such change in the intent of the parties should not be taken into account because “recharacterization applies to transactions that were equity contributions ab initio”17.

Conversely, the court of Submicron System held that the determinative inquiry in classifying advances as debt or equity is the intent of the parties “as it existed at the time of the transaction”18. In this case, the court (which included now Supreme Court Justice Alito) refused to apply a multi-factor tests and, rather, focused more generally on the intent of the parties. The court stated that the multi-factor tests undoubtedly include pertinent factors, but they devolve to an overreaching inquiry: The characterization as debt or equity is a court’s attempt to discern whether the parties “called an instrument one thing when in fact they intended it as something else”. Then the court goes on saying that the intent of the parties may be inferred, among other things, also “from what they say in their contracts”19. However, thereafter the court adds that “form is no doubt a factor, but in the end it is no more than an indicator of what the parties actually intended and acted on”. In the same opinion, the court also recognizes that no mechanistic scorecard suffices and that answers lie in facts that 13 14 15 16 17 18 19

432 F.3d 448, 455-56 (3d Cir. 2006).

308 U.S. 295, 305, 60 S.Ct. 238, 84 L.Ed. 281 (1939), emphasis added.

AutoStyle Plastics, Inc., 269 F.3d 726, 751.

AutoStyle Plastics, Inc., 269 F.3d 726, 751, emphasis added.

AutoStyle Plastics, Inc., 269 F.3d 726, 751, emphasis added.

432 F.3d 448, 457 (3rd Cir. 2006).

In re Submicron System Corporation, 432 F.3d 448, 456 (3rd Cir. 2006).

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SUBSTANCE VS. FORM IN SHAREHOLDER FINANCING

confer context case-by-case. It is worth to underline that the other two elements mentioned by the court as indicators of the parties’ intent are: (1) what the parties do through their actions; and (2) the economic reality of the surrounding circumstances, which indeed appear to be more powerful tools than a mere review of the formalities set up by the parties.

Consistently, the court of In re Phase-I Molecular Toxicology was persuaded that the transaction was a loan and not an equity contribution, inter alia (among other things), by the fact that the intended repayment was expected to be received from the sale of assets and, therefore, was not entirely dependent on the future success of the debtor’s business20.

As discussed above, the two groups of substantial factors elaborated in AutoStyle Plastic and in Outboard Marine include the following elements: (1) the financial situation of the company and how the parties actually treated the advance, including: the adequacy or inadequacy of capitalization; the sources used for the repayments; the extent to which advances were used to acquire capital assets; and the corporation ability to obtain outside financing; and (2) the relationship between the creditor and the debtor, including: identity of interest between the creditor and stockholder; the ratio of shareholder loans to capital; and the amount or degree of shareholder control.

In AutoStyle Plastic the court applied an 11-factor test derived from a tax case, Roth Steel Tube, in which the issue was recharacterization of tax claims21.

Such substantial factors can be used by courts for determining the real intent of the parties in connection with a given transaction and are the most commonly accepted elements used by courts to evaluate whether a debt claim should be recharacterized to equity.

Some courts, following the approach indicated by Submicron System, are starting to refuse the application of a multi-factor test, while privileging a case-by-case approach that can lead to a common sense evaluation of the facts and circumstances surrounding a transaction22. However, as can be seen from above, such common sense approach will not differ too much, and probably cannot prescind from, an analysis of at least some of the substantial factors, in particular (1) what the parties do through their actions; and (2) the economic reality of the surrounding circumstances23.

An increased focus on the substantial elements of the transaction is clearly shown by the Courts of Appeal for the Eleventh and Fifth Circuits in some tax cases24. In these cases, the courts employed a 13-factor test, very similar to the so called “AutoStyle Plastic test”, with the significant difference that they mentioned the “intent of the parties” as a distinct and additional factor with respect to the formal ones. In particular, in Estate of Mixton, the court draws a distinction between the subjective and objective intent of the parties25. According to the court, the parties’ intent to create either a debt or equity relationship is the ultimate issue to be determined.

However, the court goes on, notwithstanding their subjective belief, the parties may objectively manifest their intent through their actions, also taking into account the economic reality in which they acted. Therefore, the crucial point of this issue is understanding whether the subjective intent of the parties, as expressed in the 20

In re Phase-I Molecular Toxicology, 287 B.R. 571, 577, 49 Collier Bankr. Cas. 2d (MB) 1375 (Bankr. D. N.M. 2002).

Roth Steel Tube Co. v. C.I.R., 800 F.2d 625, 86-2 U.S. Tax Cas. (CCH) ¶ 9676, 58 A.F.T.R.2d 86-5808 (6th Cir. 1986).

22 Radnor, 353 B.R. 820, 838; 2006 Bankr. LEXIS 3699, 36.

23 432 F.3d 448, 457 (3rd Cir. 2006).

24 Stinnett’s Pontiac Serv., Inc. v. Comm’r, 730 F.2d 634, 638 (11th Cir.1984) (citing Estate of Mixon v. United States, 464 F.2d 394, 402 (5th Cir.1972)) both cited in Submicron System.

25 Estate of Mixon v. United States, cit., 407.

21

SUBSTANCE VS. FORM IN SHAREHOLDER FINANCING

53

corporate documentation, should be disregarded in characterizing the transaction. The answer of the court to this question is that there is a well-recognized principle in all areas of the law: That a subjective intent on the part of an actor will not alter the relationship or duties created by an otherwise objectively indicated intent. This approach clearly recalls a substantial way of thinking of shareholder financing characterization, indicating that the substantial factors should have prominent importance in order to infer the (objective) intent of the parties26.

In other words, the actual behavior of the parties, in connection with the economic reality in which they acted, can say more about their intent than the facial appearance of the transaction. This is what the court implies when, citing Tyler v. Tomlinson27, it says that law requires that creditorship has genuine existentiality and that “This requires more than a declaration of intention to create an indebtedness and more than the existence of corporate paper encrusted with the appropriate nomenclature captions”28.

In the same line of reasoning, in Stinnett’s Pontiac the court, recalling somehow the wording of the Supreme Court in Pepper v. Litton, says that to hold that the subjective intent of the parties should prevail over their objective intent would be to ignore the plain facts and to elevate form over substance29.

Thus, if—as suggested above—the formal factors should not be considered in order to determine the intent of the parties, what is their proper role in the context of shareholder financing characterization? Should courts continue to take into account these elements?

A possible answer to these questions might be that, due to the scarce effectiveness these factors have in understanding the real nature of a transaction, courts should give them a more limited consideration.

In particular, the suggestion is that these factors should be treated as “negative” factors, meaning that their presence should be generally seen as a (very weak) indication of a debt transaction, but only if the analysis of the substantive aspects of the transaction points to the same conclusion; conversely, their absence should be seen—of course always in the light of the other factors—as a strong indication of an equity contribution, especially (or maybe even exclusively) in the context of a transaction between sophisticated parties, which would very unlikely enter into a real debt transaction without the proper transaction documentation and adequate guarantees in place.

This seems particularly evident, for example, thinking about elements such as: (1) the name given by the parties to the instruments, if any, evidencing indebtedness; (2) the presence of a fixed maturity date and schedule of payments; (3) the presence of an interest rate and interest payment; (4) the security provided by the borrower; or (5) the presence/absence of a sinking fund.

How an “Equity View” of Shareholder Financing Protects Corporate Creditors?

The consequences of a predominance of substance over form in case law may touch the positions of different classes of stakeholders and therefore, considering the combination and the bi-lateral effects of inside and outside corporate governance elements and controls, affect the balance of the heterogeneous interests wheeling around the corporation.

In fact, from a corporate governance point of view it may be possible to determine whether a potential 26

This issue will be discussed in further detail below. This essay suggests that some of the substantial elements should also be taken into account in determining the level of dangerousness of the transaction with respect to the rights of outside bona fide creditors.

27 Tyler v. Tomlinson, 414 F.2d at 850.

28 Estate of Mixon v. United States, cit., 407.

29 Stinnett’s Pontiac, cit., at 639 (citing Tyler v. Tomlinson, cit., at 850).

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effect of such a ruling on a company’s “inside” corporate governance (shareholders-directors relationships and controls) could generate a benefit also for outside creditors and other stakeholders. A starting point could be set as follows: The equity capital of a company may be regarded as a minimal and basic protection granted (among others) to: (1) trade creditors (in general, unsophisticated third parties that decide to deal with a company but cannot or do not want to provide independently for more intensive tools (Lutter, 2006)); and/or (2) involuntary creditors of the company (e.g., holders of a credit deriving from a damage claim).

Many legal systems, especially those of European civil law countries, set forth specific rules on the constitution of the corporate capital and its minimum amount, which vary depending on the kind of corporate entity and on the industry in which the latter is involved (i.e., the minimum amount of capitalization increases according to the presumed magnitude of the activities carried out and the inherent amount of risk with respect to third parties). The adoption of rules on minimum capitalization is perhaps more justified in civil law systems, where judges prefer to enforce relatively bright-line rules, rather than develop standards for the protection of corporate creditors, such as fiduciary duties, piercing the veil, fraudulent conveyance, equitable subordination, recharacterization, and other instruments developed in common law jurisdictions (Lutter, 2006, p. 653).

The balance points between the advantage of limited liability and a fair use of the corporate entity vary from one to the other legal system, but all western legal systems share the same ultimate goal: preventing shareholders from avoiding the responsibilities and risks related to entrepreneurial activities by unfairly manipulating the corporate instruments to their advantage (Dooley, 1992; Enriques, 2003; Hopt, Kanda, Roe, Wymeersch, & Prigge, 1998; Visentini, 1998; Cheffins, 1992; Hopt, 2010; 2011).

Bankruptcy courts constantly see the undercapitalization of the borrowing company as an index of a suspicious transaction, whereas, from a doctrinal point of view, undercapitalization may be divided into two categories: “nominal” and “material” undercapitalization. A corporation is “nominally undercapitalized”, even though it actually has sufficient financial means to pursue its corporate purpose and to face its obligations towards outside creditors, such financial means are mainly provided by the shareholders as debt capital, rather than as “risk capital” (i.e., equity, which is instead provided to an insufficient extent). Conversely, a corporation is “materially undercapitalized” when both equity and “debt” contributions are insufficient, with the result that the corporation is unable to face its obligations as they become due (Portale, 1991).

As specified above, the event that triggers the possibility to bring a claim for recharacterization of debt to equity is the initiation of a bankruptcy proceeding, meaning that the corporation, at a certain moment in its life, became “materially undercapitalized”. However, when bankruptcy courts analyze the capitalization of a corporation in order to understand whether it is adequate or inadequate to prevent it to fall in the “zone of insolvency”, they implicitly refer to the concept of “nominal undercapitalization” (Sbarbaro, 2012), which is generally seen as a strong evidence of an equity contribution.

For example, the court of In re Cold Harbor stated that the issue of undercapitalization is particularly important when the corporation is started by the shareholders with a minimal amount of capital, who then make a large loan of money to the newly formed corporation30. Also, in Pepper v. Litton, the U.S. Supreme Court stated that so-called loans or advances by a dominant or controlling shareholder will be subordinated to claims of other creditors, and thus treated as capital contributions, where the paid-in capital is purely nominal, the 30

In re Cold Harbor, 204 B.R. at 917.

SUBSTANCE VS. FORM IN SHAREHOLDER FINANCING

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capital necessary for the scope and magnitude of the operations of the company being furnished by the stockholders as a loan31.

According to the Supreme Court, shareholders should not be allowed to manipulate the corporate device in order to avail themselves of privileges normally permitted to outside creditors, so that a transaction shall be characterized as equity if there was an ongoing situation of nominal undercapitalization before the relevant transaction was carried out, without the burden to prove that the borrower was materially undercapitalized.

Slightly differently, the court of Diasonics, Inc. v. Ingall stated that capitalization is inadequate, in the opinion of a skilled financial analyst, it would definitely be insufficient to support a business of the size and nature of the bankrupt in light of the circumstances existing at the time the bankrupt was capitalized32. Such a definition of inadequate capitalization recalls the same policy reasons underlying the rules on minimum corporate capital of civil law systems: The higher is the risk for third parties in connection with the activities carried out by the corporation, the higher must be the capitalization.

The efforts to protect outside creditors have been brought to extreme consequences by some courts, in particular, the court of Diasonics33 —which held that shareholder loans shall be characterized as equity contribution in one of two circumstances: (1) where the plaintiff proves initial undercapitalization; or (2) where the plaintiff proves that the loans were made when no other disinterested lender would have extended credit34.

These two circumstances are not cumulative and therefore it is sufficient that only one of them is proven by the plaintiff, at least in the 11th Circuit35; furthermore, from a literal reading of the opinion, it seems sufficient that a corporation was initially undercapitalized in order to characterize as capital contribution any shareholder financing. However, this approach reveals several criticalities, as underlined by the following example.

A corporation is started with insufficient capital but, during the course of its life, is adequately capitalized with equity contributions by stockholders. After several years, during which the corporation entered in dealing with third parties and regularly met its obligations, the corporation begins to suffer overwhelming losses due to deteriorated market conditions. In such a situation, an insider would probably be the only entity willing to extend credit to the corporation. In this case, the application of a strict Diasonics test would certainly lead to the recharacterization of any shareholder loan to an equity contribution. In particular, a per se (in itself) application of the second factor mentioned above would prevent any shareholder or insider from ever loaning money to a company experiencing distress36.

As seen from above, a formal interpretation of the test developed by the 11th Circuits could lead to undesirable results, proving once again that substance shall govern over form in order to prevent shareholders from manipulating the corporate devices avoiding the consequences of business ownership.

31

Pepper v. Litton, cit. at 309-310.

Diasonics, Inc. v. Ingall, 121 B.R. 626, at 631 (citing In re Multiponics, 622 F.2d 709, 717 (5th Cir. 1980)).

33 Diasonics, Inc. v. Ingall, 121 B.R. 626, at 631.

34 In re N&D Properties, Inc., 799 F.2d 726 (11th Cir. 1986).

35 See also In re N & D Properties, Inc., 799 F.2d 726, 733, 15 Bankr. Ct. Dec. (CRR) 254, 15 Collier Bankr. Cas. 2d (MB) 726 (11th Cir. 1986) (Shareholder loans may be deemed capital contributions in one of two circumstances: where the trustee proves initial undercapitalization or where the trustee proves that the loans were made when no other disinterested lender would have extended credit); Matter of Herby’s Foods, Inc., 2 F.3d 128, 132, 24 Bankr. Ct. Dec. (CRR) 1116, 29 Collier Bankr. Cas. 2d (MB) 1375, Bankr. L. Rep. (CCH) ¶ 75446 (5th Cir. 1993) (If an insider makes a loan to an undercapitalized corporation, the combination of undercapitalization and the insider loan may allow the bankruptcy court to recharacterize the loan as a capital contribution); Matter of Fabricators, Inc., 926 F.2d 1458, 1469, 21 Bankr. Ct. Dec. (CRR) 809, 24 Collier Bankr. Cas. 2d (MB) 1489, Bankr. L. Rep. (CCH) ¶ 73875 (5th Cir. 1991) (When an insider makes a loan to an undercapitalized corporation, a court may recast the loans as contributions to capital).

36 2004 Annual Survey of Bankruptcy Law, cit.

32

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Therefore, those bankruptcy courts which rely on substantive factors in order to determine the actual intent of the parties better protect the interests of both non-financing shareholders and outside creditors, suggesting that this standard of review would be the most suitable.

Moreover, the role of the substantial factors should not be limited to this, because the courts have often relied on these factors also in order to determine the degree of dangerousness of a transaction with respect to the outside bona fide creditors of the company, showing an even more “defensive” effect of the substantial approach to shareholder financing, which could work as an ex ante (before the event) protection for every stakeholder.

How an “Equity View” of Shareholder Financing Fosters a Long-Term Growth of the Company?

From a “global” corporate governance perspective, legal devices that help to increase the capital adequacy of the corporations, as long as they are not driven by a formal approach, seem to stimulate better corporate governance by helping management and directors to act with a long-term focus. This also means—as introduced above—that a “two-tier benefit” could reach the outside creditors of the corporation: On the one hand, a device such as recharacterization directly protects the corporation’s capitalization; on the other hand, long-term corporate strategies, focusing on the corporation’s stability and development process (Gilson, 1996; Easterbrook & Fischel, 1991), provide an indirect protection for outside creditors and for the qualified interests of the stakeholders in general (Freeman, 2010; Freeman & Evan, 1988).

Of course, it is difficult to find the right balance between the legitimate reasons of creditors and the equally legitimate interest of shareholders of keeping the corporation alive and protecting their initial equity interest. As said, the Diasonics test is probably overreaching, given that its second prong actually prohibits any insider loan to undercapitalized entities. On the other hand, it seems reasonable to hold that if a company was undercapitalized both at the beginning of its life and at the time of the transaction, shareholders should not be allowed to have their claim repaid before, or pari passu (with an equal step) with, outside creditors. As a matter of fact the majority of courts, consistently with the above considerations, does not believe that undercapitalization must be present only at the beginning of the life of the corporation. This is evident, for example, in AutoStyle Plastic, where the court pointed out that capitalization is not to be assessed only at the moment of initial capitalization, but also at the time when the advance was made.

Therefore, enduring undercapitalization is one of the most important elements to be considered by courts, even though this element is not per se sufficient to characterize a purported debt claim as equity. Interestingly, the Fourth Circuit noted that a claimant’s insider status and a debtor’s undercapitalization alone will normally be insufficient to support the recharacterization of a claim, suggesting that in many cases, an insider will be the only party willing to make a loan to a struggling business, and recharacterization should not be used to discourage good-faith loans37.

In AtlanticRancher, the court tried to put in relation the financial failure of the debtor with its “chronic undercapitalization”, focusing on whether or not undercapitalization was the most important cause of the debtor’s financial failure38.

37

28-2 ABIJ 42, 42-43, citing In re Official Committee of Unsecured Creditors for Dormer Aviation (N. Am.) Inc., 453 F.3d 225, 234 (4th Cir. 2006).

38 In re AtlanticRancher, Inc., 279 B.R. 411, 436 (Bankr. D. Mass. 2002).

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According to this approach, one could argue that, if the company is deliberately kept by shareholders in a chronic condition of undercapitalization (even only nominal), when such shareholders decide—in order to remedy to a contingent situation of material undercapitalization—to extend a loan to the company, they should not be allowed to the protections of genuine creditorship if the corporation then actually goes bankrupt. Again, form would prevail over substance and compress the corporate interest.

An additional element that courts often take into consideration is whether the loan had the character of an arm’s length transaction and, in particular, whether bankruptcy was actually evitable when the loan has been extended to the debtor. In particular, the court of Trimble held that at the time of the loan no financial institution would have been willing to extend credit, because the business was a “hopelessly insolvent corporate structure”39.

One of the policy reasons why insider loans should not be discouraged is that they may be the only means to keep a distressed corporation alive, but it is also true that, if the overall circumstances suggest ex ante that the corporation will soon become insolvent, the insider should not be encouraged to extend a useless loan to such a corporation. Timing also matters in such a situation: One of the elements that could be considered in order to determine whether the insider-lender was aware (or ought to be aware) of the inevitability of bankruptcy could be the closeness of the transaction to the actual beginning of the bankruptcy proceeding. Even if it would be risky to give too much relevance to such a temporal factor (substance should win over form also in this context), it seems certainly reasonable to think that a shareholder loan extended on the verge of bankruptcy should be subject to careful judicial scrutiny.

Here come again the basic policy questions underlying the “equity view”: Should shareholder loans to distressed companies be permitted or prohibited? Do transactions of this kind impair the rights of outside bona fide creditors40? Does the characterization of shareholder financing influence the corporate governance of the company?

The basic answer that should be given to these questions is that shareholder loans to a company facing liquidity crisis should not be per se prohibited. As discussed above, if a shareholder loan is the only way to keep the corporation alive and avoid bankruptcy, it seems excessive to think that shareholders should not be permitted to finance corporation.

If the corporation is facing material undercapitalization, a cash contribution by an insider can be beneficial also to pre-existing outside unsecured creditors. In fact, cash streams going into the company, would normally be used to meet the debtor’s obligations toward outside creditors as they become due and, therefore, would be somehow “distributed” to them. Such an argument could be used to justify the permissibility of shareholder loans in the above mentioned situation as happened in AutoStyle Plastic, where it has been stated that the use of advances to meet the daily operating needs of the corporation, rather than to purchase capital assets, is indicative of bona fide indebtedness41.

In the light of above, this ruling assumes a new significance: Besides the aim of determining the parties’ intent, such factor may also be used in order to evaluate whether the transaction is beneficial or detrimental to 39

In re Trimble Co., 479 F.2d 103, 118 (3d Cir. 1973).

Furthermore, assuming that in certain circumstances shareholders are the only subjects willing to provide cash to a struggling corporation, how should the legitimate purpose of keeping the corporation alive be balanced with the rights of outside bona fide creditors?

41 AutoStyle Plastics, Inc., 269 F.3d 726, 752 (citing Roth Steel Tube, 800 F.2d 625, 632).

40

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pre-existing outside creditors. In any case, without such transaction, the company would remain “materially undercapitalized”, and therefore, outside unsecured creditors would normally not be able to recover the whole amount of their respective credits from a bankruptcy proceeding.

Although this argument seems acceptable from the pre-existing creditors’ point of view, it could be pointed out that, after the shareholder loan is extended to the company, it will not be materially undercapitalized anymore, but would then become nominally undercapitalized. Such corporation will then continue to deal with pre-existing creditors accumulating new indebtedness (e.g., trade creditors will probably continue to provide goods or services to the corporation) and probably will also enter into some kind of relationship with new voluntary creditors (e.g., new suppliers) or even with involuntary creditors (e.g., someone who is damaged by the corporation). In this case, the post-transaction creditors will be dealing with a nominally undercapitalized company and, in case of insolvency of the latter, they will concur pari passu with the insider-lender for the satisfaction of their credit. It would be also realistic to assume that insider-lenders would usually secure their credit with a lien over (some of) the assets of the corporation, so that the post-transaction outside creditors will also be deprived of the value of such assets as a source for the repayment of their credit.

These risks for outside creditors are not merely theoretical and it must be borne in mind that, if a recharacterization claim has been brought before a court, it means that the debtor eventually became insolvent and that there is an actual ongoing bankruptcy proceeding. In these circumstances, it is hard to argument that the shareholder loan was beneficial to post-transaction outside unsecured creditors, especially those who became creditors of the corporation in a period of time close to the beginning of the bankruptcy proceeding.

In a time where corporate governance systems around the world are converging towards the long-term growth of the companies, the above mentioned conclusions generally have a consistent impact on corporate governance.

If corporate managers’ obsession with short-term shareholder wealth maximization has, in many instances, diverted their attention from the efficient operation of their companies, in order to make the company profitable in the long run, corporations need to invest capital in the long-term endeavours, which often have a significant time lag between the time of investment and the eventual returns (Sacco Ginevri, 2011) .

Therefore, assuming that companies should be managed with a long-term view, whenever equity prevails over debt (and substance over form), corporate managers could pursue the creation and preservation of the sustainable economic long-term growth of their company, because the interest represented by the stock is generally of unlimited duration42—so allowing directors to invest in long-term strategies—while short loan duration is generally preferred by lenders to limit the danger to debtholders of wealth transfers to equity-holders resulting from investment and dividend decisions (Klein, Coffee, & Partonoy, 2010).

A third “contrast” could then be observed in the context of shareholder financing characterization: After “debt vs. equity” and “substance vs. form”, “short term vs. long term” should also acquire importance as a legitimacy standard for both shareholder loans and corporate governance strategies.

Conclusions In a context where substance should govern over form, the most acceptable standards of review should be those that refuse a mechanical application of the multi-factor tests and privilege a comprehensive approach that 42

In other words, there is usually no initially agreed-upon point in time when a common shareholder becomes entitled to demand the return of his or her initial contribution or some other amount.

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can lead to a common sense evaluation of the facts and circumstances surrounding a transaction43.

In other words, the so-called “substantial factors” should certainly be helpful in reaching such a common sense understanding of the transaction since they may show the objective intent of the parties.

In short, judicial tools that legitimate and expand the recharacterization of debt to equity are advisable devices because at the same time (1) they strengthen the (actual) corporate creditors’ protections; and (2) they foster a long-term growth of the company which—benefiting from a conversion of its financial resources into equity (i.e., perpetual capital)—may pursue a business strategy more focused on a sustainable and careful development of the enterprise.

References Cheffins, B. (1992). The history of corporate governance. ECGI Law Working Paper No. 184/2012.

Dooley, M. P. (1992). Two models of corporate governance. Business Lawyer, 47, 461-465.

Easterbrook, F. H., & Fischel, D. R. (1991). The economic structure of corporate law. Cambridge, M.A.: Harvard University Press.

Enriques, L. (2003). Corporate governance codes, corporate law and proprietorships: Some preliminary thoughts (Codici di corporate governance, diritto societario e assetti proprietari: alcuni aspetti preliminari). Banca Impr. Soc., 1, 97.

Freeman, R. E. (2010). Strategic management: A stakeholder approach. Cambridge, UK: Cambridge University Press.

Freeman, R. E., & Evan, W. (1988). A stakeholder theory of modern corporation: The Kantian capitalism. Englewood Cliffs, N.J.: Prentice Hall.

Gilson, R. J. (1996). Corporate governance and economic efficiency: When do institutions matter. Washington University Law Quarterly, 74(2), 327-345.

Hopt, K. (2010). Comparative corporate governance: The state of the art and international regulation. ECGI Law Working Paper No. 170/2011.

Hopt, K. (2011). Corporate governance of banks after the financial crisis. ECGI Law Working Paper No. 181/2011.

Hopt, K. J., Kanda, H., Roe, M. J., Wymeersch, E., & Prigge, S. (1998). Comparative corporate governance—The state of art and emerging research. New York: Oxford University Press.

Klein, W. A., Coffee, J. C., & Partonoy, Jr. F. (2010). Business organization and finance (p. 282). New York: Foundation Press.

Lutter, M. (2006). Das Kapital der Aktiengesellschaft in Europa. Berlin: De Gruyter.

Nozemack, M. (1999). Making sense out of bankruptcy courts’ recharacterization of claims: Why not use §510(c) equitable subordination?. Retrieved from http://scholarlycommons.law.wlu.edu/wlulr/vol56/iss2/8 Portale, G. B. (1991). Share capital and undercapitalized joint stock company (Capitale sociale e società per azioni sottocapitalizzata). Rivista delle società, 1, 29-30.

Sacco Ginevri, A. (2011). The rise of long-term minority shareholders’ rights in publicly held corporations and its effect on corporate governance. European Business Organization Law Review: EBOR, 12(4), 587-619.

Sbarbaro, F. M. (2012). The solvency test in the U.S. legal system (Il solvency test nell’ordinamento statunitense). Comparative Civil Law, 11, 1-20.

Visentini, G. (1998). Compatibility and competition between European and American corporate governance: Which model of capitalism?. BROOK. J. INT’L L., 3, 836-837.

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Radnor, 353 B.R. 820, 838; 2006 Bankr. LEXIS 3699, 36.

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China-USA Business Review, ISSN 1537-1514 January 2014, Vol. 13, No. 1, 60-71

DAVID

PUBLISHING

University Systems in Europe: A Multi-Dimensional Efficiency Comparison Michael Steiner University of Graz, Graz, Austria

Andreas Niederl, Michael Ploder JOANNEUM RESEARCH Forschungsgesellschaft mbH, Graz, Austria

The paper undertakes an examination of university systems of selected European countries from the perspective of the Austrian higher education system. The challenge of implementing higher institutional autonomy, accountability, and controllability in the Austrian higher education system is discussed with respect to recent experience in selected national university systems in Europe. Two major challenges were identified, first, the high diversity of the Austrian university system, and second, the implementation of considerable reorganization in a comparatively short period and under conditions of relatively high uncertainty. Data envelopment analysis (DEA) was used to compare the performance of universities of five European countries and to take account of the multidimensionality of both input and output. The technical efficiency of these universities was then calculated. In contrast to analysis employing only one output dimension, the technical efficiency of individual universities using the new measure was found to be very high. Country averages only differ marginally.

Keywords: university systems in Europe, comparative university performance, multidimensionality, data envelopment analysis (DEA), technical efficiency of universities

Higher Education Systems and Institutions: Challenges and Strategies  Changing expectations with respect to the link between a knowledge driven economy and economic growth have significantly altered the demands placed on higher education institutions (HEIs) and have kicked off a phase of rapid changes.

Such changes concern new patterns of knowledge production, the demand for greater interaction with national innovation systems and the service function of higher education, as well as related questions of scientific capacity and infrastructure.

The role of HEIs in educational systems is also a focus of debate, e.g., the ongoing “massification” of higher education and its increasing internationalization. Questions concerning the availability of public funds have also gained significance throughout the last few decades.

Michael Steiner, DDr., Professor, Department of Economics, University of Graz.

Andreas Niederl, Mag., POLICIES—Centre for Economic and Innovation Research, JOANNEUM RESEARCH Forschungsgesellschaft.

Michael Ploder, Mag., POLICIES—Centre for Economic and Innovation Research, JOANNEUM RESEARCH Forschungsgesellschaft.

Correspondence concerning this article should be addressed to Michael Steiner, Department of Economics, University of Graz, Universitätsstraße 15, 8010 Graz, Austria. E-mail: michael.steiner@uni-graz.at.

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Despite the very different historical backgrounds, traditions, and institutional varieties existing across Europe, higher education policies and the repertoire of policy instruments have begun to converge across the continent.

Common trends now emerging include changes in government funding, with increasing importance being given to competitive funding (IPTS, 2008). National governments are trying to decouple HEIs from traditional cameralistic models and to provide a framework for increasing institutional autonomy on one hand, and for greater accountability and reliance on performance agreements on the other. The last decade showed that the traditional linear model of knowledge production and the emphasis on the “science push effect” in creating innovations are no longer suitable as a theoretical and strategic framework in modern science and technology policies. As a consequence, pro-active fostering of collaboration with business and so-called “third mission” projects have gained significantly importance.

Other relevant trends include increasing differentiation in higher education systems in terms of a mass-education vs. a research approach, together with the promotion of centers of excellence focusing on top-level thematic strengths.

The academic world has changed significantly throughout the last few decades and has become increasingly output and performance-oriented. Both national governments and HEIs have realized the need for concrete measures to increase the attractiveness of academic careers.

Concrete strategies for HEIs in Europe comprise (Jongbloed et al., 2006):  Achieving focus and mass by rationalizing research activity (selectivity, critical mass, profiling);  The creation of “centers of excellence” as a result of university rationalization and profiling policies. Such centers often function as inter-disciplinary institutes;  Using financial/budgetary instruments as a means of attaining research goals and enhancing quality;  Strengthening the steering capacity of the university’s central management (e.g., by adjusting the internal planning, budgeting and control cycle);  The setting up of a support facility (or office) to help researchers apply for funds or commercialize their research findings;  Decentralization (devolving responsibility and making departments more autonomous when it comes to their management and resourcing) as a means to increasing research performance and research income;  Employing human resource management (HRM) as an instrument in helping institutions achieve the right composition of academic staff. For instance, vocational HEIs may encourage staff to engage more in research as this also helps improve teaching;  Improving research training (Doctor of Philosophy (Ph.D.) track; graduate schools);  Engaging in linkages with the outside world (region, industry, small and medium enterprises(SME)).

Despite the existence of a common set of challenges and strategies in higher education systems at a European level, the relevant financial and regulatory frameworks are still shaped within a national context and thus considerable differences still exist across national higher education systems.

In order to make a useful comparison of different HEIs and to learn from the experience of those in other countries, it is essential that specific national contexts be taken into account.

This paper discusses the historic background and current challenges faced by European higher education systems from an Austrian perspective. The aim of the paper therefore—based on recent contributions concerning changes in selected national higher education systems and on the discussion of relevant, comparable

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statistical data—is to gain greater insight into the feasibility of a performance-driven approach in steering higher education systems and to assess related pre-conditions for such a change in Austria. Starting with the historical background and recent changes in the higher education system in Austria, the paper presents selected national cases in order to illustrate the complexity, multidimensionality, and respective temporal horizons as the higher education systems move towards becoming competitive, more flexible, but controllable entities exhibiting greater institutional autonomy and accountability.

The last section of the paper attempts to quantify the technical efficiency of universities. The database used include information on different inputs and outputs, and by means of data envelopment analysis (DEA), the efficiency of selected universities in five countries is compared.

The Development of the Austrian University System The Austrian academic system has a very long tradition. The first university was established in 1365, and up to 1993, public universities (for both scientific and arts programs) were the only HEIs available in Austria.

From a structural point of view, the higher education system remained very static despite the high increases in student numbers beginning in the 1970s. In the past 15 years, however, the higher education system has changed dramatically and the number of institutions increased from 19 in 1993 to 69 in 2009. This was mainly due to the establishment of various and new types of HEIs (e.g., The Institute of Science and Technology (I.S.T.) Austria, private universities, Universities of Applied Science, University for Further Education Krems, University colleges of teacher education) and to the establishment of three distinct public medical universities (which emerged from former positions as faculties of large general universities).

The Austrian higher education system is characterized by small and medium sized universities, high diversity, and a relatively high degree of specialization at several institutions.

The following paragraphs provide a short introduction to the five major types of institutions in the Austrian higher education sector:  Public universities remain the dominant form of institution in the higher education system in Austria. Up to 2004 two main types of universities could be distinguished within the Austrian public university sector—“science universities” and “colleges of arts and music” (nowadays called “universities for the arts”).

Even in recent decades, the influence of Humboldt’s initial vision concerning the role of universities in public life remained strong, and the university landscape in Austria faced relatively little pressure to change. However, towards the end of the last millennium several developments finally set the ball rolling. The Universities Act 2002 created a common legal basis for science and arts universities by eliminating the legal distinction between the two types. The act gained full power on January 1st, 2004 and also changed the status of public universities to that of full legal bodies under public law (Kottmann, 2008);  A feature of the Austrian science university sector is its diversity. This is also a result of the Universities Act 2002. The sector now includes three autonomous medical universities, one university of veterinary medicine, one university of economics and business administration, two universities of technology, one university of mining, and one university of natural resources. In addition, universities for applied life sciences and “general” science universities can also be distinguished. The University for Further Education Krems is a public university of a special kind, having its own legal basis, as established by the Danube University Krems Act 1994. It is a corporation under public law with far-reaching powers of self-administration, serves the goal of providing post-graduate training and further training, and only offers non-regular study programs. The

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relatively high diversity of the Austrian public university landscape is thus a major challenge with respect to the establishment of a system of performance-oriented coordination and pro-active structural change in the higher education system;  Private universities are very common in other European countries but were non-existent in Austria until quite recently. The University Accreditation Act 1999 paved the way for the establishment of private universities in Austria. The first private university was accredited in 2000 by the Accreditation Council. Today 12 private universities exist in Austria. However, Austrian private universities only cover a relatively small part of the student population. Some of the private universities also receive strong support from regional governments;  Universities of Applied Sciences (UASs) are relatively new in the Austrian higher education system. The first program started in the academic year 1994/1995. This new type of tertiary education provided an alternative to existing university studies in Austria and was based on the Fachhochschule Studies Act 1993 (Kottmann, 2008). UASs offer degree programs at university level and serve the needs of those seeking vocational training with a scientific basis or practical orientation. They also have a mandate for applied research. A considerable share of study programs offered by UASs consists of part-time professional development programs. twenty UASs now exist in Austria;  A large part of the programs offered by colleges for medico-technical occupations and by colleges for midwifery (on level International Standard Classification of Education (ISCED) 5B) has already been incorporated in UASs programs. However, this is still an ongoing process as there is no legal obligation to shift.

UASs provide bachelor and master degrees, but they do not have the right to award doctorates or PhDs. Nevertheless graduates of University of Applied Sciences master programs (or pre-Bologna-diploma programs) are allowed to pursue doctoral studies at a university (sometimes additional requirements have to be fulfilled before they may enter university doctoral programs);  University colleges of teacher education represent a new type of higher education institution resulting from the upgrading of existing educational structures. They started operating in the study year 2007/08. The Federal Act on the Organization of University Colleges of Teacher Education 2005 called for the transfer of the training of compulsory school teachers as well as of the continuing and in-service training of all teachers from the former teacher training colleges (ISCED 5B) to the new university colleges of teacher education (ISCED 5A). The shift from ISCED level 5B to 5A means that the previous vocational nature of the training has been upgraded and that completion of the program now results in the award of a bachelor degree (Bachelor of Education). In Austria, there are nine public, and five private university colleges of teacher education;  The I.S.T. Austria, located in Klosterneuburg (close to Vienna), is a relatively recent establishment. It is a post-graduate academic institution, with an emphasis on basic research in scientific fields such as life sciences, physics, mathematics, chemistry, computer science, and multidisciplinary areas. The institution is committed to becoming a world-class research centre, and aims at providing an international, state-of-the-art environment for approximately 500 scientists and doctoral students by 2016. The legal basis for the institute is the Federal Law on the Establishment of the I.S.T. 2006.

In addition to the HEIs described above, several schools of theology also exist. These are run by the church and are mainly responsible for the education of priests and those working within the realm of church affairs. They will not be considered in this paper.

Hence, in contrast to conditions prevailing in the recent past, it can now be said that Austria has a highly

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diversified higher education system that is characterized not only by several different types of higher education institution but also by considerable differences within a specific type.

In addition to this massive increase in the diversity and number of HEIs, the nature of governance at public universities, which still represent the majority of students and are the most important research actors, has also changed radically in recent years. A move from direct control by the public authorities to complete autonomy was introduced in 2004. The major aim of this shift was to improve the public universities’ research profile (IPTS, 2008). The direction and steering of public universities are now based on performance agreements. This is intended to allow universities to focus on specific areas of interest, but also to ensure that synergies are exploited. So far, the level of differentiation prevailing within the university sector with regard to status, prestige and the role of research remain relatively low.

The establishment of Universities of Applied Science and of private universities also gave federal regions in Austria the opportunity to take a more active role in higher education policy. Governments in regions lacking a public university have become very active in supporting the establishment of Universities of Applied Science (and to a lesser extent private universities).

The functions of the different types of HEIs vary considerably. However, there are numerous areas of overlap. For example, Universities of Applied Science are undertaking a particular effort to increase their research activities and thus become more similar to traditional universities.

A Comparison of Developments in Austria to Developments in Other Selected Countries The developments presented for Austria in the previous section lie in stark contrast to those found in other European countries. Outside Austria, a major long-range effort has often been undertaken not to increase but to reduce the number of HEIs, e.g., via the merging of various HEIs as in Denmark or Finland. Based on selected national cases, the following paragraphs show how these developments have been part of a long-term strategy which is still ongoing.

The Case of the Netherlands—Towards Institutional Autonomy, Market Orientation, and Accountability The higher education system of the Netherlands is composed of 14 public universities, 40 “hogescholen” (these are comparable to Universities of Applied Science in Austria, but started in the Netherlands in the mid-1960s), and five private universities.

While in many countries higher education reform only began in the last decade, in the Netherlands reforms started in the beginning of the 1980s.

Beginning in the 1980s the view of the role of government in the higher education system changed.

Universities were granted more autonomy and the government was meant to steer or guide from a distance (from government to governance). At that time the sector of universities of applied science (hogescholen) was consolidated: Mergers took place that reduced the number of universities of applied science from 375 in 1983 to 40 in 2009 (Westerheijden, de Boer, & Enders, 2009).

In the decades since the 1980s substantial reforms have continued to take place in the Netherlands. Several waves of reforms, all with a common objective, have been implemented. Such reforms have been primarily dedicated to creating more institutional autonomy, greater market orientation, and enhanced accountability.

While overall these forms can be considered successful, they did take a considerable amount of time. The respective roles of stakeholders in the higher education system have been changed significantly. The government is now considered as a “market engineer”, universities as entrepreneurs, and students as customers

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(Enders et al., 2006). Reforms are still taking place, and frequently they are first tested on a small scale.

Apart from the different time frame involved in the Netherlands, the consolidation of the universities of applied science also offers an interesting contrast to developments in Austria. In addition, closer cooperation between traditional universities and universities of applied science is also being discussed. In fact one university of applied science has already merged with a university (the Free University Amsterdam and the “hogeschol” in Zwolle, Windesheim).

Switzerland—Successful Change Against a Background of Strong Federal and Regional Interests in a Highly Diversified Academic System The Swiss higher education system consists of two Federal Institutes of Technology, 10 cantonal universities, eight UASs, and 14 teacher training institutions. The UASs were established from 1995 to 1997 on the basis of the existing professional schools. They represent roughly one third of students and 50% of 1st year enrolments.

Apart from the Federal Institutes of Technology in Zurich and Lausanne, the governance of HEIs in Switzerland is organized at the cantonal level. Hence, great differences exist in legal status, rules, etc., and governance tends to be very complex. Irrespective of these differences, the funding of universities has become increasingly competitive in almost all cantons (Lepori, 2007).

Due to the fact that for the most part responsibility for higher education governance is in the hands of the cantons, overall national coordination proves very challenging since in effect it has to be based on various bottom-up initiatives and on achieving consensus. Although this implies that the reforms implemented thus far have tended to be of a gradual nature, they have nonetheless had a substantial impact. The strong local stakeholder interests within the system mean that mechanisms for change remain bottom-up in character.

(Lepori & Fumasoli, 2009).

The Swiss higher education system is unique in terms of governance structure, although it is possible to discern similarities to the Austrian system in that due to the growing engagement of federal regions in Austria, governance is also becoming increasingly complex.

Owing to the excellent performance of the Swiss higher education system pressure for reform was never very high, and, as indicated above, any improvements that were made, were normally driven by bottom-up processes.

Italy—Long Ranging Change in a Highly Differentiated “University” System The Italian higher education system consists of approximately 100 public and private universities, more than 100 Institutions for Arts and Music and a few universities specialised in postgraduate studies only. The universities represent the vast majority of students, however.

In line with other European countries, reforms have been implemented in Italy over the past 20 years in order to increase university autonomy and to initiate change in university curricula.

Over the last 15 years specific changes have been carried out in university regulation which basically dates back to the system based on the Gentile reform of 1923. Study programs and the allocation of responsibilities in university management have been redrawn, and there has been a progressive and wide transfer of responsibilities from the central government to the individual universities. The overall legal autonomy of universities has increased, as has their autonomy with respect to funding, teaching, and the recruitment of university teaching staff (Reale & Poti, 2009).

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Finland—Radical Change Borne by Considerable Bottom-up Dynamics The Finnish higher education system is binary: It consists of roughly 20 universities and 30 polytechnics.

The polytechnics were established in the 1990s in order to deal with increasing student numbers. In addition, there is also a National Defence University and a Police College. Compared to other HEIs, the latter two institutions differ considerably in terms of governance and functions and will thus not be considered in this paper.

University autonomy was increased in 1997, and modifications to governance have continued ever since.

Full autonomy has only been possible since 2010 (the implementation process will be finalised in 2012). Other changes in the past decade have included the establishment of a graduate school system. This has led to a considerable increase in the number of doctorates (Aarrevaara, Dobson, & Elander, 2009).

In Finland higher education policy is discussed mainly within the context of innovation policy, and currently, several university mergers are taking place or are under discussion. The aim of the merger process is to decrease the number of universities to 15 (Aarrevaara et al., 2009).

In addition to mergers, various institutes are in the process of relocation or of becoming integrated into other institutes. Such changes are normally the result of years of discussion and fine-tuning and are frequently driven by bottom-up initiatives.

The Finnish higher education system is similar to the Austrian system. However, changes in governance have been implemented over a much longer time period. It seems that this longer time frame has made it easier to take bottom-up initiatives into account.

Comparing Performance—Possible Approaches in the Face of Different Academic Systems and Institutions Compared to other Western European countries, changes in the Austrian higher education system appear to have been relatively slow in coming. It was only after the 1990s that structural change or changes in governance started to gain speed and become more comprehensive. However, a drawback remains in that the changes implemented so far, may also be partly responsible for the challenges that remain in steering the overall system. Such challenges are also more severe than they need be due to the relatively high diversity of Austrian higher education (particularly universities). This not only makes direct comparisons within Austria relatively difficult, it also tends to hinder comparison of Austrian HEIs with those of other countries. Any meaningful comparison of educational performance in the tertiary sector thus requires the development of a suitable methodology.

Multi-dimensionality of Input and Output University activities may be considered multi-dimensional since they encompass both the generation and dissemination of knowledge using several avenues, i.e., research, teaching, and the so-called “third mission”, including interaction with economic and social sectors. Thus, to be worthwhile, any overall comparison of university systems needs to take account of the diverse nature of the various activities. This represents a considerable challenge. The quality of the different university inputs and outputs is far from being homogenous, making direct comparison extremely difficult. In addition, the time periods needed before the various outputs become observable may not be definable. A further problem resides in the fact that no generally acceptable weightings are available with respect to the numerous activities, i.e., the relative importance of teaching, research, co-operation with agents in the external economy, etc. remain unclear (Dundar & Lewis, 1998;

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Bonaccorsi, Daraio, & Lepori, 2007).

This rules out the use of an assessment based on a simple weighted sum of the various outputs (such as number of publications, graduates, patents etc.) since it does not allow for the multi-dimensionality of the various activities to be simultaneously taken into account. Simple statistical ratios, e.g., the number of publications per researcher, etc. are also inadequate for purposes of overall comparison since they fail to take account of complementarities, substitution effects, and joint production among outputs (Bonaccorsi & Daraio, 2003).

However, more advanced statistical techniques are available, which are capable of coping with the above problems. The use of such techniques means that input and output behaviour of very diverse bodies may be adequately compared. One relevant method, DEA, is described below.

Methods and Data DEA is a highly flexible statistical method enabling simultaneous consideration of very diverse inputs and outputs. It is thus applicable in the context of university comparison where factors exhibiting a high degree of heterogeneity and non-determinability are common. To be more specific, DEA may be used to calculate the technical efficiency of university productivity, i.e., how much more output may be obtained from the use of a given set of inputs (or the obverse, how a certain output might be achievable using fewer inputs). Although attempting an assessment of university performance on the basis of technical efficiency is likely to appear highly suspect to many observers, one has to remember that there is nevertheless a great deal of consensus concerning the need to avoid inefficiencies or waste of public resources in times of general scarcity.

Date envelopment analysis allows for the simultaneous consideration of diverse inputs and outputs without requiring any (implicit or explicit) prior knowledge concerning factor interrelationships. The method is used to calculate the technical efficiency of a specific unit, in our case a university, with respect to a hypothetical input-output efficiency frontier. The technical efficiency is the relative input-output correlation compared to the best institution in the group under consideration, the highest efficiency score is one. The frontier is drawn up with respect to units of comparison suitable for the entity under observation. It is thus clearly important that the basis for comparison contains institutions which are truly comparable. Given the present relatively high level of diversity within the higher education system, attempting such a comparative analysis at the Austrian level is unlikely to be very fruitful. To be useful, any such overall assessment requires a much broader basis for comparison (even though this also means that a certain amount of detail will have to be sacrificed owing to the more limited comparability of international data).

The origins of DEA can be traced back to the work of Farrell (1957) and its first applications to Charnes, Cooper, and Rhodes (1978) and F채re, Grosskopf, and Lovell (1985). The technique is often employed by industrial engineers when undertaking productivity analysis. DEA efficiency units always need to be interpreted with respect to the relevant units of comparison, and represent relative, not absolute values.

Confidence intervals for DEA units, developed on the basis of the work by Simar and Wilson (1998; 2000), may be employed to help interpret the explanatory power of the efficiency values derived. Using such work as a starting point, an input-oriented DEA analysis was carried out (under the assumption of variable returns to scale) in an attempt at an international comparison of the Austrian university system.

The availability of suitable data is a key point in carrying out any DEA. As part of the European project Advanced Quantitative Methods for the Evaluation of the Performance of Public Sector Research

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(AQUAMETH) under the Network of Excellence PRIME, a harmonised database was developed on HEIs in 12 countries. Ideally, all inputs and outputs arising as part of university activities (which are subject to university control or direction) should be considered in the analysis. In practice, however, owing to the diverse nature of the university activities and data available under AQUAMETH, which is not realistic. Nevertheless, as a considerable share of university activity is dedicated to research and/or teaching, at least these two dimensions need to be taken account of in any attempt on overall assessment and comparison. University employees represent the most important resource in teaching and research activity. However, as it could clearly be seen in previous sections, such activities may vary considerably depending on the scientific discipline in question. This makes it necessary to distinguish between the various scientific or academic objectives of university staff.

Considerable differences also exist with respect to the funding and resources needed across research and teaching activities. On the basis of such considerations and given the nature of the international comparative data, the following indicators were chosen for use in attempting an overall comparison of Austrian and non-Austrian universities (see Table 1).

Table 1 Indicators Used in International Comparison Outputs (3), Inputs (7) Output 1 Output 2 Output 3 Input 1 Input 2 Input 3 Input 4 Input 5 Input 6 Input 7

Indicator No. of graduates (“diploma” and/ or master’s program) No. of doctorates (including PhDs) ISI-Publications Financial resources (in Euros) No. of academic staff employed in engineering and technical sciences, agriculture and forestry, veterinary medicine No. of academic staff employed in human medicine No. of academic staff employed in natural sciences No. of academic staff employed in social sciences No. of academic staff employed in other scientific fields No. of non-academic staff

Note. Source: Based on AQUAMETH database 4.2.

The model specifications chosen allowed for an overall assessment of Austrian university performance and its international comparison, and took account of the diverse nature of structural and resource factors. The specifications chosen also mean that only five (those described in section three above) of the 12 university systems available in AQUAMETH could be used in the comparison calculated. Various gaps and incomparabilities in data and university systems (e.g., the relatively high significance of bachelor programs in Great Britain) rule out a more comprehensive approach. Furthermore, the scheme used for allocation of academic staff is not capable of taking proper account of those employed in Austrian universities of arts. These universities are thus not considered in the analysis. This means that the comparison of Austrian university technical efficiencies is based on a dataset comprising 133 universities from Switzerland, Holland, Italy, Finland, and Austria.

Results A comparison of university systems from Switzerland, Holland, Italy, Finland, and Austria, taking both structural and resource differences into account, shows that most of the institutions observed, come out very well in terms of the relationship between inputs employed and output achieved in teaching and research, i.e.,

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they appear to attain a very high level in terms of technical efficiency with respect to these two fields of activity.

The average values obtained for the universities observed do not differ from each other to any significant extent.

Figure 1 shows that once the necessary structural adjustments are taken into consideration, differences between Austrian universities are very small (as is also the case for Holland). In contrast, university systems in Switzerland, Italy, and Finland exhibit a far larger proportion of institutions achieving below average levels of technical efficiency in teaching and research.

Figure 1. National differences in university technical efficiencies for teaching and research (DEA-VRS).

On taking the different inputs and outputs simultaneously into account, and given the large differences among universities, it is interesting to find that the technical efficiency of individual universities in the set considered is in general very high. Country averages also only differ marginally. This is in stark contrast to pictures that arise when only single dimensions are taken into account (e.g., research measured in terms of publications). This highlights how important it is to take the multidimensionality of HEIs into account.

Hence a truly comparative, comprehensive assessment of individual academic institutions: • should not be limited to analysis of individual dimensions alone, e.g., research only; • must take differences in scientific orientation and availability of resources into consideration; • must be able to do justice to the complexity of the correlations between the various inputs and outputs; • must be flexible enough to address the differences in these correlations between individual universities.

Conclusions and Further Challenges The Austrian higher education system is characterized by a very long tradition of small and medium sized universities, high diversity, and a relatively high degree of specialization among several institutions. The higher education system in Austria long remained very static from a structural point of view despite the high increases

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in student numbers, beginning in the 1970s. Even in more recent decades, the influence of Humboldtâ&#x20AC;&#x2122;s initial vision concerning the role of universities in public life remained strong, and the university landscape in Austria faced relatively little pressure to change.

However, during the last decade, the higher education system has been increasingly confronted with demands for institutional change. Higher education policy and institutions need to rise to the new challenges and establish the more robust mechanisms, greater accountability, and comprehensive databases required for the more efficient steering of the higher education system. This is all the more relevant given the relatively high heterogeneity of the Austrian system (direct university comparisons are thus difficult). A database and adequate methods of structural analysis and performance measurement have to consider multiple dimensions. As argued above, multidimensional analyses allow for a much better comparison of selected universities across countries.

Using DEA, it proved possible to take a number of different outputs (graduates, publications etc.) and inputs (financial resources, academic staff by field, etc.), i.e., a number of different structural settings into account.

Interestinglyâ&#x20AC;&#x201D;and surprisingly (given the very different institutional backgrounds examined)â&#x20AC;&#x201D;the technical efficiency of the individual universities considered was found to be quite high. Values for country averages also showed only small deviations from each other.

The approach described above means that universities with similar financial resources, academic staff, research specializations etc. can be compared in terms of their output, and hence, their technical efficiency with respect to inputs and outputs can also be assessed. Thus, inadequate or misleading one-dimensional comparisons, for example, those based on the number of publications only (e.g., used to compare Harvard with small universities), whereby differences in inputs are totally neglected, can now be avoided.

However, despite the use of technical and statistical instruments in providing a more valuable basis for the introduction of greater flexibility and accountability in a diversified higher education system, such as that found in Austria, existing institutional reality throw up several more challenges.

Two major challenges were identified. First, the relatively high diversity of the Austrian higher education systems seems to act to prevent the development of a more uniform system of coordination and steering. It also seems to hinder the comprehensive redeployment of resources. Second, there is a need to accomplish considerable reorganization in a comparatively short period of time, and to do this under conditions of high uncertainty.

The national cases discussed above serve to provide an interesting starting point when considering further development of the higher education system, particularly concerning questions relating to endogenous dynamics. Bottom-up stimulation in itself is inadequate. For several higher education systems, it seems to be essential that more long-term and incremental processes are undertaken in order to avoid the irritations caused by what is often erratic top-down intervention.

While higher education policy has long been a matter of national policy, broad discussion of higher education system reforms on a European level is slowly emerging, but still wanting. At the moment initial steps are being undertaken to create a common understanding of the heterogeneous landscape of higher education in Europe and, as a consequence, to develop more comparable and refined databases at the institutional level.

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