Inspire - Issue 1

LOUGHBOROUGH UNIVERSITY SCHOOL OF BUSINESS AND ECONOMICS BI-ANNUAL MAGAZINE //

ISSUE 1 // WINTER 2010

An insider’s account of the days leading up to:

THE ICELANDIC BANKING CRISIS THE FUTURE OF BANKING P8 THE RISE OF THE EAST P12 MEET THE DEAN P18

www.lboro.ac.uk/sbe

41782 D&P Nov 10

LOUGHBOROUGH UNIVERSITY SCHOOL OF BUSINESS AND ECONOMICS BI-ANNUAL MAGAZINE

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Angus Laing

Editor: Ondine Barry Assistant Editor: Karen Roxborough Designer: Ian Jepson Photographer: Phil Wilson

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.elcome to the first edition of Inspire, our .biannual magazine, marking the launch of .the new School of Business and Economics at Loughborough. Comprising the Business School, the Department of Economics and the Professional and Management Development Centre, the establishment of the School of Business and Economics is a significant milestone in Loughborough University developing a world-leading presence in the field of business and economics research and education.

– build clusters of research excellence that sit at the intersection of contemporary intellectual debate and the challenges confronting business and policy communities;

Built on foundations of world-class research, educational excellence and practical relevance, and anchored within one of the UK’s leading universities, the new School is set to extend its influence and reach in academic and business spheres at a critical time for the UK and other Western economies.

One of the attractions for me of taking up the post of Dean of Business and Economics at Loughborough this March was these very characteristics. In the aftermath of the banking crisis, there has been significant media attention on the role of academia in shaping policy and practice in the business world. Much of that attention has been critical, arguing that there is a disconnect between the worlds of academic research and business practice.

That the School of Business and Economics has excellent foundations is evident from the performance of the constituent parts of the School across the major league tables and our multiple accreditations. Among the most significant recent accolades and indicators of the strength of the new School are: – NSS 2010 – ranked 4th for Management Studies and joint 5th for Accounting – The Sunday Times’ University Guide 2011 – ranked joint 2nd in Management and 2nd for Finance and Accounting – The Independent’s Complete University Guide 2011 – ranked 7th for Accounting and Finance and 6th for Business Studies – The Times’ 2011 Good University Guide – ranked 5th for Accounting and Finance and 5th for Business Studies There is no question that we are operating in challenging times, but any successful school must constantly adapt and innovate to remain at the cutting edge of research and teaching. To be a genuine leader in ideas and practice requires that we continually reflect on our activities and bring new offerings to the market. This is particularly pertinent in the face of the challenging and rapidly changing international environment within which we operate.

– become genuinely international in our orientation and operations.

For me, the DNA of the School and University, revolve around the themes of: – relevance – the relevance of our education to the worlds of practice – application – the application of our research and to real contexts – engagement – the engagement of our staff with non-academic communities

That is not the case with Loughborough. As is evident from the articles in this edition of Inspire, and those highlighted in our new research brochure, Insight (which can be found online at www.lboro.ac.uk/sbe), it is clear that the research conducted in the School is of immediate relevance to the world of policy and practice.

The challenge for all of us in the School is to ensure that as we build for the future, the underlying characteristics are central to our reorganisation of the School. It is the commitment to the distinctiveness of our DNA that will enable us to achieve our aspirations.

In the longer term, our strategic repositioning will see significant changes in the relationship between universities and the broader community, in particular with the business community and with our graduates. Within this context I look forward to working in varying ways with many of you to take the new School forward, to capitalise on our excellence and build a School with international reach, impact and recognition.

Sincerely Yours,

However, opportunities abound for the innovative and the entrepreneurial in such challenging times. The ‘age of austerity’ in public funding in particular marks a significant break from the recent past and requires that we fundamentally rethink the way we operate.

Specifically, we as a School need to: – be innovative in our approaches to the delivery of programmes and respond to the opportunities;

Angus Laing Dean, School of Business and Economics Loughborough University

LOUGHBOROUGH UNIVERSITY SCHOOL OF BUSINESS AND ECONOMICS BI-ANNUAL MAGAZINE

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The 7th October 2008 is a day that will forever remain in memory of Business School alum Mark Sismey–Durrant, and that of many others, for a long time. For that day began with the FSA informing Mark that the retail deposits of the Heritable Bank, which he ran, were being transferred to a special treasury vehicle and that the bank was being placed into administration. It was also on that day that the Icesave deposits operation that he was also responsible for was suspended with the parent company, Landsbanki, being placed under the Icelandic equivalent of Chapter 11.

This article looks back at the days leading up to the Icelandic banking crisis as experienced by Mark, giving us a clear insight into what eventually happened and the lessons learned. His experience spans the time between 2002 and 2008 when he was Chief Executive of Heritable Bank, a 133-year-old Scottish bank based in London which had been acquired by Landsbanki in 2000.

An insider’s account of the days leading up to:

THE ICELANDIC BANKING CRISIS

by Mark Sismey-Durrant

With a population of around 310,000, Iceland’s inhabitants are often viewed as an industrious nation, comprising entrepreneurial and optimistic people who are self reliant, independent and, at times, stubborn. The country is home to the world’s smallest free-floating currency, the Icelandic Krona, and its political system reflects the world’s first parliamentary democracy, where its population are more used to coalition politics than the UK. Their increasingly liberal economics policy post 2000 led to banking privatisation in 2003 and the introduction of a beneficial (and inflationary) 18% tax regime in 2004. Through much of the period 2002 to 2008, the Central Bank of Iceland (CBI) had almost no external debt, but consequently, it also held virtually no foreign currency reserves. This was to prove important in the events that unfolded.

Iceland’s banking system was extensive for a country of its size with three major banks, Landsbanki, Islandbanki and Kaupthing, dominating the market. There were also a number of smaller savings banks that existed in a saturated market with overseas expansion the only option for growth. Prior experience in these areas was limited where previous operations were nothing of the scale or operational intensity seen in other European banks.

The final crucial ingredient to the saga was the emergence in Iceland of a small elite group of entrepreneurs – movers and shakers in Icelandic business who gained controlling stakes in the major banks and ended up borrowing huge amounts from them. Significantly, these oligarchs ran their businesses like aggressive private equity companies, leading Mickey Clarke on BBC Radio 5 Live in 2006 to describe Iceland as “like one giant hedge fund”.

Throughout 2003-04, the Icelandic banks and businesses were driven by these risk-tolerant entrepreneurs to compete aggressively domestically and abroad, reinforcing a national desire for recognition.

This was then combined with an international banking community eager and willing to support them with abundant leverage.

“IT IS CLEAR WHEN THE SIZE OF THE FINANCIAL SYSTEM OF A COUNTRY IS, FOR INSTANCE, THREEFOLD ITS GDP, THE COMPETENT AUTHORITIES HAVE THE POTENTIAL TO SET RULES FOR THE FINANCIAL SYSTEM TO COMPLY WITH AND ENSURE COMPLIANCE WITH THEM. HOWEVER, WHEN THE SIZE IS NINE TIMES GDP, THE ROLES ARE REVERSED. IT APPEARED THAT THE PARLIAMENT AND GOVERNMENT LACKED BOTH THE POWER AND COURAGE TO SET REASONABLE LIMITS TO THE FINANCIAL SYSTEM.”

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THE ICELANDIC BANKING CRISIS The Truth Commission Report, carried out by the Icelandic Government after the banking crisis, concluded that with hindsight, at this point the Icelandic Banks were already in difficulty, even if this did not manifest in their financial results which showed strong growth, profits and asset quality at the time.

Over this same period, Mark took Heritable Bank on a path of diversification and growth. In 2002 Heritable Bank had a solitary business line financing £80m of UK residential property development in full, funded by the parent company, Landsbanki. Over the ensuing period the bank commenced a number of speciality finance businesses in mortgages, asset finance and professional finance and ultimately grew the bank’s asset base to £1.3bn by 2008, with the accompaniment of strong and steady profit growth.

Importantly, the Heritable Bank’s business model was to raise retail and wholesale deposits, so that by the time the squeeze on funding arrived in 2006, Heritable had become self reliant for its funding.

This in turn led to the suggestion that Heritable could manage a UK deposit raising business into Landsbanki’s London branch on behalf of the parent company. This would be both in terms of wholesale deposits from local authorities and universities and through the launch of an outsourced online retail savings business that became Icesave. This was all supported by Landbanki’s still-strong Moody’s rating.

From this point the expansion of the Icelandic banks comprised a multifaceted drive. This included the acquisition of banking opportunities across Europe, the seeking of enhanced geographic presence across the world and a strong desire for asset growth. At the time their continued and strengthening efforts were paying off. Their were GDP increased from 100% to 923% between 2004 and 2007.

The EUSD supported the notion that deposits could be raised anywhere in Europe and could support assets held elsewhere. Local regulatory restrictions on retail deposits would normally prevent this happening on any scale. However, the UK FSA granted a global liquidity concession to Landsbanki, which facilitated this until it was surrendered in spring 2008.

What followed was a significant growth in retail deposit funding – Icesave launched in the UK in October 2006, reaching £4.8bn by December 2007 and subsequently launched in the Netherlands in April 2008.

This rapid expansion was only made possible by a strong supply of international funding. Between 2003 and 2006 the banks succeeded in raising long-term bond finance from € 6bn to € 51bn, raising the finance from international banks on the back of a strong Icelandic country rating, which was supplied to the banks on the assumption of central bank support for the banking system. However, bonds outstanding rose during this time. The bankers assumed that provided they kept raising capital to support their growth, funding would be provided.

In January 2008 things appeared reasonably well despite the market impact from Northern Rock’s failure, with rising deposits and the highly regarded success of Icesave helping demonstrate capacity to meet the refinancing obligations, particularly for Landsbanki.

However, in February 2008, Landsbanki’s Icelandic competitor, Kaupthing, launched a new savings initiative, Edge, aggressively within the UK. It was at this point that the spotlight fell on the adequacy of deposit protection arrangements, which were at the time split between the partially funded Icelandic (1%) and UK schemes.

This over-reliance on wholesale funding would prove to be a major issue for the banks. Danske Bank issued a report in 2006 that questioned the viability of the business model and a looming debt overhang between 2008 and 2009, causing credit ratings to come under pressure. For a time, the Icelandic banks succeeded in raising more expensive finance in the short-term US Collateralised Debt Obligation (CDO) market, but this served only to amplify the refinancing risk and exposed them to a critical running market commentary through their Credit Default Spread (CDS) spread pricing.

Within a week of launching, Kaupthing switched deposits to its UK subsidiary, KSF. Landsbanki, with its online savings account business, Icesave, already established, faced a bigger challenge. A significant outflow by value occurred from Icesave in response to the media focus on deposit protection and the need for savers to spread their money around. Despite few Icesave accounts being closed and many new ones opened as savers redistributed smaller balances around the market, the outflow raised regulatory alarm bells for the first time.

In the event, the position stabilised and, indeed, Icesave restored growth to its deposit base by October 2008. The account base moved from all easy access to over half being less liquid fixed rate bonds and ISAs. During 2008 the account base for Icesave grew from 130,000 to 330,000. Despite this marketing success, it was clear that fears over deposit protection, stoked by Northern Rock, were now a pressing issue.

What ensued between March and October 2008 was an increasingly frantic series of negotiations between Landsbanki and the home regulatory authority (FME) to engineer the transfer of Icesave deposits into Heritable and thereby remove the Icelandic link for deposit protection and regulation. That this failed to happen in this period despite the efforts of everyone involved can only really be put down to a mixture of politics, cultural misunderstanding and, ultimately, slow progress resulting in increasingly entrenched positions. The result was that the UK authorities found themselves as host regulator with limited powers for enforcement.

When Lehman failed in late September 2008, it became too late to resolve the Icesave situation, and the UK Tripartite authorities decided to act under special Northern Rock legislation. The Truth Commission is particularly strident in its view that Iceland’s most senior ministers, the Governors of the CBI and the Head of FME, were all guilty of negligence in this respect – they allowed the banks to grow in an unconstrained manner to 2006 and they failed to protect Icelandic interests by facilitating the subsidiarisation of Icesave in 2008 with disastrous consequences for the Icelandic nation.

The boom-and-bust cycle which led to the collapse of the Icelandic banking system, and which threatened the national Icelandic economy, was a mirror of global trends to October 2008. The Icelandic banks had outgrown Iceland’s ability to support them, particularly as the CBI has failed to even try to strengthen foreign currency reserves until it was too late. This was all the more shocking given that the CBI had a grasp of the extent of the potential crisis six months before it broke, yet appears to have achieved nothing in this time.

The outcome for the people of Iceland is that they still have to deal with the legacy of Icesave in terms of deposit compensation obligations for the UK and the Netherlands. The price for ordinary Icelanders for the failings of a small number of business leaders has been profoundly high. However, this must be met to enable Iceland to resume its place as a member of the international community and, ultimately, enable its EU accession.

Fundamentally, the lessons in Iceland have been confronted and learned – the frankness and transparency of the Truth Commission report has made certain of that. A government has fallen on the issue and a previously passive nation has taken to the streets of Reykjavik to ensure their voices are heard. The fundamental strength of their economy based on their natural resource, demographic structure and highly educated workforce will ensure their ultimate recovery, but it will take a very long time.

A personal reflection

by Mark Sismey Durrant “For me, personally, I have learned many lessons from the experience. One of which is in an unfolding crisis you must think clearly and only respond to what you can control and influence. There is no point in worrying about what has happened – nothing can change past events.

But also, you have to expect the unthinkable in running your business and plan for the worst stresses imaginable, testing its resilience against these. The best time to do this is when your business is at its best – there is no alchemy in business, and the good times will never last forever.

“I shall be wary in future of a business like Landsbanki with two Group CEOs and a lack of open management communication processes. However, against all of this, ultimately you cannot be prepared for everything that might happen. In our case, Heritable remained the accepted solution to the Icesave problem right up until the final hours before the failure of Landsbanki – I didn’t expect as a British bank that we would be placed into administration when Landsbanki failed.”

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DAVID LLEWELLYN Interview by Ondine Barry

WHAT NOW FOR THE BANKS? TALKING FINANCIAL SYSTEMS WITH DAVID LLEWELLYN The Professor of Money and Banking here at Loughborough and at the Vienna University of Economics and Business, David Llewellyn has been at the forefront of research and policy for several decades. With an impressive CV, including being currently on the Academic Board of the International Centre for Financial Regulation in London and a Council member and former President of the European Money and Finance Forum (a network association of bankers, central bankers, financial practitioners and academics), David is actually very approachable, inviting animated discussions on banking and financial regulation.

We caught up with him recently and asked for his assessment of the recent economic crisis…

David Llewellyn: “What will be very interesting over the next 10 years will be an exciting development in economics partly as a result of the economic crisis. A lot of the traditional paradigms and assumptions will need to be re-thought as it is evidently clear that they did not yield us insights as to what might have caused the crisis.

“In terms of financial regulations, there are two things that regulation is designed to do.

First is to reduce the probability that banks fail. Second, to reduce the costs when they do fail. My view is that because of financial innovation, bankers will always find a way around regulation. Building a strategy of new rules to stop banks failing just won’t work.

It never has in the past. And in fact, a lot of people are arguing that one of the major causes of the last crisis was how the banks responded to the then-regulation.

“So I believe we’re going down the wrong road if we think new regulation is the answer.

What I think instead we ought to be doing is devising mechanisms to reduce the cost when banks do fail. Because they will fail. The one thing that you can be absolutely certain of is that there will be another financial crisis sooner or later.”

So can we reduce the cost of failure?

How will banks change in order to survive?

DL: “One of the things that can be done is for the supervisors at the FSA (or its successor) to intervene long before a bank gets into real trouble – what we term as ‘early intervention’. Secondly, be prepared to close a bank before it becomes insolvent (quite controversial). And thirdly, require banks to have ‘living wills’, whereby they are required to state in advance what they will do when certain bad things happen to them. Above all, we must ensure that the tax-payer is not required to incur the costs of rescuing banks.

DL: “I think the role that banks play in the financial system will become smaller. Why? Because they became too big – they overexpanded, and that was one of the elements of the crisis. Second, the cost of banking will rise. The days of so-called “free banking” (which, in any case, is a myth) are numbered.

“Let us suppose that we could reduce the costs of banks failing to zero (which we can’t of course). In which case, we could be relaxed about whether banks failed or not, in which case there would be no need for detailed regulation. On the other hand, if the costs of bank failure were always very high, then we wouldn’t want banks to fail and would therefore need more extensive and intensive regulation.

My point is that there is a trade-off between the two: lowering the probability of bank failures and minimising the costs of failures.

“One of my research papers at the moment is on the idea of that trade off. If we can reduce the costs of failure then we don’t need to be too regulatory, which I think would be a good thing as I’m sceptical about how much regulation can achieve.”

How do you think the regulators will deal with the issue?

DL: “One of the first things the current Coalition Government did was to transfer the FSA’s main function to the Bank of England, a process that will take a few years. If you take the FSA as it currently stands, it’s the most powerful regulator in the world, perhaps too big. And the new split that will take place will transfer the consumer protection function into a new consumer protection agency, which I think is better. Perhaps I am biased because, when I was a Public Interest Director on the Board of the Personal Investment Authority, that was precisely our responsibility. I believe strongly in having a dedicated agency responsible for consumer protection, which is desparately needed in the area of finance.”

So what about crisis management?

DL: “The issue of crisis management is a pivotal one: How do you actually manage crises when they occur? I’ve done consultancy work with regulatory agencies around the world, and my argument has always been that when things are running normally, it doesn’t matter who regulates it. The real test is which model is best at handling a crisis, and the regulators didn’t do a great job the last time!”

“IT’S ONLY A QUESTION OF TIME BEFORE MANCHESTER UNITED GETS A BANKING LICENSE.”

“Third, I think the banks are going to become more risk adverse.

Banks have been under-pricing risk for so long, and it’s one of the reasons they got into trouble. We will get a more realistic risk pricing into rates of interest. I think we will also see a more traditional model of banking reinstated. There will also be more non-bank competitors – we’re already seeing it with Tesco developing their financial services. Indeed, one of the fastest-expanding retail banks in Sweden is Ikea... It’s only a question of time before Manchester United gets a banking license.

“So I think that banks will face more competition in some of their markets. On a technical level, there will be much less leverage – much less debt relative to equity, because banks will be required to hold more equity in capital. So I think slower growth and more expensive banking will emerge.”

Do you think the days of serious investment power are gone?

DL: “I suspect so. I think it was all part and parcel of the euphoria that developed at that time, which in turn was one of the factors leading to the banking crisis.

“The structure of the world economy will change massively. I think we still underestimate the change that is happening with the centre of the world’s economic gravity shifting to the East. Have you ever been to Toys ’R Us? I challenge you to go there and find any toy that is not made in China. The centre of gravity is shifting, and it’s going to be a big challenge for the traditional economies, which will have to adapt in three key ways: 1) they will need to develop niches; 2) they will move into supplying high-tech specialised components to the new industrialised countries; and 3) they will have to become more service orientated. I think the challenge is going to be big, very big indeed.”

LOUGHBOROUGH UNIVERSITY SCHOOL OF BUSINESS AND ECONOMICS BI-ANNUAL MAGAZINE

10 DAVID LLEWELYN

AMON CHIZEMA

Interview by Ondine Barry

Interview by Ondine Barry

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Do you think we’ll see a double-dip recession?

“HAVE YOU EVER BEEN TO TOYS ’R US? I CHALLENGE YOU TO FIND ANY TOY NOT MADE IN CHINA.”

DL: “No, I don’t. I think we’ll be in a period of slow growth for a few years, but I don’t envisage going back into recession.

“Make no mistake, though: the economic environment has changed and is set to change further. Free university education, free dental care, affordable housing, earnings-related pensions: they will go, indeed some have already gone. And also the demographic factors have changed: the number of pensioners is going up and up, and the number of workers relative to that is going down. In addition, you have a smaller number of people paying real resources to support the non-working population.

“It will be a very different environment for our graduates, but it’s a very exciting area of business, and I think it’s set to become even more exciting. Banking and finance will undoubtedly change, and there will be a lot of challenges in this industry over the next few years, but there will also be new opportunities and new types of careers that will develop in response. It is, in fact, a very good time to be in this field.”

Dr David Llewellyn is Professor of Money and Banking at Loughborough University, Honorary Visiting Professor at CASS Business School in London and Visiting Professor at the Vienna University of Economics and Business Administration. He is Consultant Economist to ICAP plc and has recently been working with several central banks on aspects of the global financial crisis. His recent research includes a project at the Centre for European Studies in Brussels on the economics and role of European cooperative banks.

Although announcing his ‘retirement’ this year, David will thankfully continue to lecture and conduct research into financial systems and crises and resolution strategies. He can be contacted at D.T.Llewellyn@lboro.ac.uk

Direct Link to Our Teaching Dr Regina Frank, lecturer of the final year Strategy in Banking module, lends her international investment banking expertise and her passion for applied research to her teaching of BSc in Banking, Finance and Management finalists.

Past dissertations centred around two main topics: mergers and acquisitions of financial institutions and the internationalisation strategy of banks. Examples ranged from the merger of Mitsubishi-Tokyo FG with UFJ Bank and the partial acquisition of Lehman Brothers by Nomura, to the internationalisation strategies of Bank of China, Citigroup, Unicredit and Santander. The quality of the projects was such that Barry Howcroft, Professor in Retail Banking and Deputy Dean of the School, recommended the top three to be published.

Says Regina: “The high quality of the output is testament to the hard work of our students, their insights gained during their placement year, as well as the exceptional maturity with which they approach final-year projects”.

A FAST TRACK

TO SUCCESS Amon Chizema, Senior Lecturer in International Business and Strategy and Programme Director of the BSc in International Business, has been living in the UK for eight years. Originally from Zimbabwe, Amon has previously spent time working in industry and teaching in both Africa and the UK. In June 2004, Amon joined the Business School and enrolled on the PhD programme with (now Emeritus) Professor Trevor Buck as his Supervisor. Amon submitted his thesis in record time – just two-anda-half years.

Your career has progressed so quickly…

“What made me become successful, completing my PhD so quickly, was that I was very fortunate to work with the right people, and also because I was very focused,” says Amon. “When my first child was born in 2004, I realised that if I was more focused I would use my time more effectively. I also realised that I had been underutilising my potential. You just decide it is the right time sometimes.”

Amon went on to win the Michael Z Brooke prize of the Academy of International Business (AIB) for the best doctoral paper, and published a paper in International Business Review with Trevor, both of which helped expedite his completion. He was promoted to Lecturer in February 2007, and in October 2009 he was promoted to Senior Lecturer. Now the Programme Director for the BSc in International Business, Amon’s research focuses on corporate governance.

What was it that drew you to corporate governance research?

“In terms of my background, I’m a qualified Chartered Secretary (ICSA). Generally, Chartered Secretaries are lawyers – they advise directors in terms of strategy and legal compliance, etc. Having qualified, I developed an interest in corporate governance from the perspective of law and finance. I wanted to pursue that area, and once I was introduced to Trevor, it was a perfect fit.”

And your specific focus?

“Initially, I wanted to study Asian and African stock markets. But I switched my focus to comparative governance, studying the diffusion of corporate governance practices across countries – an aspect of international business.

“A recent paper is on Korean corporate governance – I was approached by an academic in Korea who wanted to work with me, and I said yes, provided we change the focus of the paper.”

Before they knew it, they had published a paper in one of the leading journals in business and management: “Because of that success, we’ve submitted a follow-up paper to another good journal, so it’s been very useful”.

Amon’s work has appeared in the Journal of Management Studies, Journal of World Business and Corporate Governance: An International Review. Part of this work was funded by a research grant he won from the Nuffield Foundation.

What are you working on currently?

“I am currently working on three projects: One with Katsu Shinozawa on Japanese corporate governance and firms’ adoption of the committee system. The second is on the empowerment of shareholders – out of a call for papers from Wharton Business School on the recent economic crisis. This paper was accepted for presentation at Wharton’s annual conference and it is being considered for inclusion in Corporate Governance: An International Review.

“The third project is also based on the recent financial crisis, looking at the separation of the chairperson and the CEO in companies, the so-called ‘relational distance’, with regard to effectiveness in the job.”

In addition to his research and teaching commitments, Amon is also supervising a student from the British University of Egypt – the first student to come through the programme to Loughborough. Amon is happy to supervise doctoral research on any topic of corporate governance using agency, signalling or institutional theory as an analytical lens.

In terms of other professional activities, Amon has presented and chaired sessions at major international conferences such as AIB, Academy of Management (AoM) and Society for the Advancement of Socio-Economics (SASE). He’s also been involved with the African Development Bank in Tunisia, a division of the World Bank, working for them as a consultant.

Dr Amon Chizema is Senior Lecturer in International Business and Strategy and Programme Director of International Business. Email A.Chizema@lboro.ac.uk

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WHAT DOES THE ECONOMIC RISE OF CHINA AND INDIA MEAN FOR BRITAIN? by Ben Ferrett The resurgence of “Chindia” is one of the biggest economic stories of our time. Their recent recovery, following the implementation of the comprehensive economic reform programmes, has led to a growth in real income per head, outshining not only the UK but also many other industrialised countries. From 1990 to 2008, real income per head grew by 4.7% a year on average in India, and by 9% in China, whereas in the UK this figure was at 2.4%.

The key question for many academic economists, and the nation as a whole, is: What truly does this mean for Britain?

Benefits for Britain may come in the form of increases in the real national income as economists have predicted that international trade, such as with China and India, increases the real national incomes of all trading partners. International trade in itself creates benefits by decoupling production and consumption. It allows countries to specialise in the production of the goods that their resource endowments make them most suited to producing.

In the long term it is expected that developing countries will export labour-intensive and lowskill products to the world market, whereas developed countries will tend to export goods whose production requires significant inputs of skilled labour, technology and capital.

However, there are downsides to trade integration. In particular, the gains from trade can be very unevenly distributed. Because international trade creates gains through economic restructuring, some industries will expand and others shrink. An example of this can be seen in the contrast within Western countries between middle-class consumers, who are able to enjoy cheap Chinese electronics imports, and assembly line workers whose firms are at the hard end of that import competition.

Economics does confirm these intuitions where types of labour that are heavily used in import-competing sectors will lose out from trade integration, while those whose main employment is in expanding export sectors will benefit. Drawing the threads together, Britain, as a developed country, should export high-tech goods in exchange for low-skill imports – low-skilled workers will lose out in this process compared to their skilled counterparts.

Empirical evidence also tells us that there is no doubt that the skill premium, usually measured as the ratio of graduate to nongraduate earnings, has risen sharply in developed countries since the early 1970s.

Traditionally, economists have tended to doubt the importance of globalisation in this

process. The usual culprit was technological change: changes in production processes, such as computerisation, that led firms to switch their labour demands towards highskilled workers.

More recently it is the surge in imports from developing countries like China that has led to a reassessment of the importance to labour market outcomes of trade flows. The usefulness of the trade/technology distinction has also been questioned.

The policy challenge for Britain, and other developed countries, is to ensure that they should gain all the benefits from globalisation without destroying the overall economic gain. For this reason, the vast majority of economists would oppose policies of tariffs and protectionism. The price of such policies – the squandering of the gains from trade – is just too great.

You may ask why take distribution of income seriously? Developments in the world economy are no one’s fault, so it seems unfair that low-skilled workers in countries such as India and China, who are already relatively deprived, should be singled out to bear the costs. Moreover, hard-headed politics also suggests that distribution matters.

Nothing in economic theory says that the winners from trade integration must be in a majority. If the losers are sufficiently numerous, a protectionist backlash will threaten to destroy the gains from trade.

The lesson is clear: to put policies of free trade on a firm footing, we need to ensure that the benefits are widely shared.

To misquote the reformers of Eastern European communism, the task for Britain and other developed countries must be to build capitalism with a human face. Education and training policies should become lifelong, and they should be geared towards enabling labour market entrants and displaced workers to take advantage of job opportunities in growing sectors. At the same time, in-work benefits, like the tax credits system, should be used to top up the market earnings of adversely affected workers.

Of course, these policies need to be carefully co-ordinated: one creates an incentive to move jobs, the other to stay. However, the broad outlines to follow are clear.

Dr Ben Ferrett is Lecturer in Economics.

His research and teaching is in the field of globalisation.

Email B.E.Ferrett@lboro.ac.uk.

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QUANTUM

MECHANICS AND THE

STOCK MARKET

by Ian Davidson and Mark Tippett

In 1954 Max Born was awarded the Nobel Prize for Physics for the statistical interpretation he had given to the Schrödinger wave equation in quantum mechanics. By any measure, Born was a member of a remarkable family. His father was an anatomist and embryologist of some distinction. Born’s wife, Hedwig Ehrenberg, also came from a family of scholars and industrialists. His youngest child, Gustav Victor Rudolf Born, is an Emeritus Professor at King’s College London. Born’s eldest child, Irene, married Brinley Newton-John who was the officer responsible for taking the Deputy Leader of the Nazi Party, Rudolph Hess, into custody when his aeroplane crash landed in Scotland in 1941. Brinley NewtonJohn and his family subsequently emigrated to Australia where he worked first as Professor of German in the University of Melbourne and later as Vice-Principal in the University of Newcastle in New South Wales.

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17

QUANTUM MECHANICS AND THE STOCK MARKET

As an interesting aside, It was Mark Tippett’s privilege to study as an undergraduate in the University of Newcastle where, he can confirm, that Brinley Newton-John was unquestionably the most popular Vice-Principal amongst the students in any university he has been associated with. Newton-John was a remarkable man (although his popularity was aided, Tippett suspects, by the fact that his daughter is Olivia Newton-John, perhaps best known for her role in Grease).

But getting back to the study in hand, Max Born took his PhD in 1909 from the University of Göttingen and subsequently held a number of academic posts in Europe. However, he returned to the University of Göttingen in 1921 where he was appointed as Foundation Director of the new Institute of Theoretical Physics in the University. Here, Born formulated the now-standard interpretation of the Schrödinger wave equation as providing the probability amplitude of a given quantum state. The probability distribution itself is obtained by squaring the probability amplitude for the given state. Indeed, Born and several of the most eminent scientists of his day (including Niels Bohr) argued that Born’s interpretation of the Schrödinger wave equation has wider application, and they subsequently applied it with some success to the connection between consciousness and the brain, to the problem of free will in human decision making and also to the physiological properties of biological organisms.

Now, in idle conversation a year or so ago, Professor Ian Davidson, former Director of the Business School at Loughborough University, suggested that as it is often argued that stock market prices exhibit wave-like properties, then perhaps Born’s interpretation of the Schrödinger wave equation might provide a good model for the way stock market prices evolve over time.

Davidson and Tippett then collected daily rates of return for the 31 components of the Financial Times’ London Stock Exchange (FTSE) All Share Index over the period from 1994 until 2007 and used the given data to estimate wave functions for each component of the FTSE Index. Much to their surprise, the quantum tunneling model they had derived using the Schrödinger wave equation was strongly compatible with the returns of all but one of the 31 components of the Index. Moreover, the probability distributions obtained from squaring the Schrödinger wave equation for each of the 31 components of the Index were significantly different from the normal distribution upon which financial analysis has conventionally been based.

One can obtain further insights into the differences between the conventional returns distributions on which financial analysis is based, and those implied by the quantum tunneling model briefly summarised above, by considering the Schrödinger wave equation for the Oil & Gas Producers component of the FTSE All Share Index. The Schrödinger wave equation is estimated using the daily returns on the Oil & Gas Producers component of the Index for the period from 1994 until 2007:

Schrödinger Wave Function for the Oil & Gas Producers Component of the FTSE All Share Index Estimated from Daily Returns Covering the Period 1994-2007.

Moreover, the flatter of the two distributions is the normal distribution implied by the mean and standard deviation of the returns on the Oil & Gas Producers component of the FTSE All Share Index. Davidson and Tippett’s analysis shows that whilst the more peaked probability distribution implied by the quantum tunneling model provides a very good description of the way returns on the Oil & Gas Producers component evolved over the period studied, the normal distribution conventionally used in financial analysis is incompatible with the same returns.

And nor is this an isolated occurrence. The same conclusion applies to all but one of the 31 components of the same Index, and is also the same when applied to the Food Producers Component of the FTSE All Share Index.

Tippett took Davidson’s suggestion to heart and derived a quantum ‘tunneling’ model under which the instantaneous return on a given stock evolves as a particle moving in a square potential well, but in such a way that there is an “irregular” probability that the particle will periodically tunnel into the well’s retaining walls before being reflected back into the cavity defining the well.

“STOCK MARKET PRICES EXHIBIT WAVE-LIKE PROPERTIES.”

Probability Distribution for the Oil & Gas Producers Component of the FTSE All Share Index Estimated from Daily Returns Covering the Period 1994-2007.

The returns are all stated on an annualised basis − for example, an annual rate of return of 1.46 or 146 per cent is equivalent to a return of 1.46365 = 0.004 or about two fifths of one per cent per day. Moreover, all returns in the above graph have been “centred” by subtracting the average annual return of 9.3275 per cent on the Oil & Gas Producers component over the period from 1994 until 2007. Now, one can square the above wave function and thereby obtain the probability distribution associated with the daily centred return on the Oil & Gas component of the FTSE All Share Index. This is the more peaked of the two distributions given in the following graph on the next page.

Again, Davidson and Tippett’s analysis shows that whilst the more peaked probability distribution implied by the Schrödinger wave equation provides a very good description of the way returns on the Food Producers component FT All Share Index has evolved over the period from 1994 until 2007, the normal distribution is incompatible with the same returns.

These results have important implications in several areas. The Basel Accords, for example, are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision, and many of the world’s advanced industrialised countries have signed up to them. The Accords describe minimum standards of capital adequacy based on the three major components of risk faced by banks: credit risk, operational risk and market risk. Conventional practice implements these risk measures on the assumption that asset returns evolve in terms of a normal distribution. Yet the overwhelming weight of empirical evidence is that the normal distribution is a generally poor descriptor of asset returns. Capital adequacy measures, which assume returns evolve in terms of a normal distribution, must therefore be problematic.

“THE OVERWHELMING WEIGHT OF EMPIRICAL EVIDENCE IS THAT THE NORMAL DISTRIBUTION IS A POOR DESCRIPTOR OF ASSET RETURNS.”

Then there is the pervasive assumption in financial analysis that risk can be adequately measured by the variance (that is, the volatility) associated with a given probability distribution. Here it is important to emphasise that the normal distribution has the unique property that all higher moments have a strict functional relationship with the variance. Hence, once the variance is known then the risk measures implied by the higher moments (e.g., skewness, kurtosis, etc.) can be easily determined. Unfortunately, this is not the case for other distributions (such as those that arise from the Schrödinger wave equation), and so when asset returns are not compatible with the normal distribution, the variance will not be the all-encompassing risk measure it is generally assumed to be by financial practitioners.

This has particularly important implications for hedging procedures and the valuation of derivative securities (such as options and futures contracts), which tend to be based on the assumption that the variance provides an all-encompassing measure of risk.

The mathematical foundations of much contemporary finance theory and practice are to be found in the “old” quantum theory developed between 1900 and around 1920. In a classic paper published in 1905, Albert Einstein showed that the normal distribution both permeates and is a natural consequence of much of the old quantum theory. Against this, the “new” quantum theory developed by Niels Bohr, Max Born, Werner Heisenberg and Erwin Schrödinger from 1925 onwards and on which the Schrödinger wave equation is based, encompasses a much broader class of probability distributions.

Moreover, the empirical evidence suggests that these more general probability distributions show much greater compatibility with asset returns than the normal distribution on which financial analysis has conventionally been based. Yet, surprisingly, there have been relatively few applications in financial analysis of the probability distributions that arise out of the new quantum theory.

Dr Mark Tippett is Professor Emeritus of Accounting and Finance. Dr Ian Davidson is a Visiting Professor. Mark is happy to be contacted at M.Tippett@lboro.ac.uk

LOUGHBOROUGH UNIVERSITY SCHOOL OF BUSINESS AND ECONOMICS BI-ANNUAL MAGAZINE

18 ANGUS LAING Interview by Ondine Barry

AT THE HELM WITH

ANGUS LAING Joining Loughborough in March 2010, Professor Angus Laing’s tenure here as the new Dean of Business and Economics may not be even a year old, but his quick grasp of what makes Loughborough tick and enthusiastic appreciation of why Loughborough and the School are such fantastic places to be right now are reminiscent of a seasoned professional.

There is an overpowering sense of optimism at the creative challenges that lie ahead in the halls here – but let us hear from Angus about what his thoughts have been during this testing time.

Let us start at the beginning…

What brought you to Loughborough?

Angus Laing: “My first academic job was at the University of Aberdeen, during which time I did my PhD. It was very much an apprenticeship. After nine years there, I came to the conclusion I should probably move, and so went to the OU [Open University], taking the position of Beneficial Bank Chair in Marketing.

“If the first nine years were formative, the next four years at OU were transformational, giving me a completely different perspective on how business and management education can be delivered.

“I moved to the University of Glasgow to become Head of the Business School. It was, again, a very useful learning experience, operating at a different level, a more senior level, while attempting to keep up a very active research agenda with large ESRC and National Institute for Health Research projects.

“There are three things during my time at Glasgow that I’m most proud of achieving: One was taking what was a very traditional academic department and forging a set of innovative partnerships with organisations – commercial and professional – to deliver innovative and exciting programmes.

The second was in developing international partnerships – taking the University out of Glasgow – and establishing collaborative programmes with universities in China, India and Colombia. And the third was securing AACSB accreditation, a process which I am re-familiarising myself with at Loughborough!

“The move to Loughborough reflects the recognition of what gives me a real buzz – creating an environment where other academics can flourish and where we can provide genuinely life-changing educational experiences for students at undergraduate and postgraduate levels.

“Regarding what brought me to Loughborough specifically, however, is its engagement with industry. Loughborough has a great density of networks with the business community, and if there’s one thing I want to achieve it is consolidating those networks to strengthen our research and teaching activities, and in turn league table performance. I’m particularly enthusiastic about things like the placement scheme. This type of activity gives a distinctive dimension to our taught programmes. This close industry connection of our programmes is the very DNA of Loughborough. We must develop them; we must extend them.”

In terms of becoming the School’s first Dean, do you have any specific goals?

AL: “The short-term goal has of course been the opportunity to bring together two distinctive and very capable academic units – Economics and Business – into one integrated School. They’ve both had considerable success in recent years in different ways. The excitement is in being able to develop both further into leading players internationally in their respective fields.

“The more medium-term goal is building on a wonderfully strong reputation we have in the UK. Given the capabilities and strengths we have, great opportunities lie before us to build the SBE into the hub of a network of international partnerships with other leading universities so that we can deliver genuinely global education and genuinely global research.”

“LOUGHBOROUGH HAS A GREAT DENSITY OF NETWORKS WITH THE BUSINESS COMMUNITY.”

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20 ANGUS LAING Interview by Ondine Barry

What do you see as your biggest challenges?

AL: “The one thing that all UK universities are facing is the changes that are going to come in funding arrangements, the inevitability of reduction in government funding, the associated increase in student fee levels and the emergence of increasingly consumerist students. This changes our environment, it changes the expectations of students and it’s going to challenge us to revisit the way we deliver business and economics education.

“And I think that is immensely exciting. I believe that at a university like Loughborough, where we have outstanding undergraduate programmes and excellent financial management over the past decade, we are in a strong position going forward. We are in a position to seize opportunities, to determine the shape of our own future.

Other universities will not be in such a fortunate position.”

What in your mind constitutes a good business education?

AL: “What I think constitutes a good business education is in achieving a balance between the theoretical and conceptual understanding, which is vitally necessary to allow prospective managers to be reflective and critically creative in their thinking, and at the same time providing practice-based skills and expertise to enable these prospective managers to actually do things. At the same time we want to prepare our graduates for their career, not just their first job.

“Now, obviously there’s going to be a difference between business education at an undergraduate level and at a post-experience level. So for undergraduate students, the biggest challenge is to provide them with what is sometimes referred to as a ‘practice pitch’ – an opportunity to ‘take out’ their knowledge and expertise and employ them in practice. As I’ve said already, one of Loughborough’s hallmarks is the compulsory placement year for our undergraduate business students. That makes such a difference in terms of bridging the gap between theory and practice. And it’s that interaction between the two that is absolutely central in allowing them to develop their skills as prospective managers.

“It’s rather different on the MBA side where you are dealing with practising professionals who have experience with business and managerial functions. There it’s not so much providing a practice pitch as giving them lenses to look at the world in a critical manner, to understand why certain things happen. It’s about providing conceptual frameworks to enable them to understand the challenges they face and formulate responses that reflect leading-edge practice. It’s that that stretches their minds and enables them to look at problems in a new, strategic way.”

“WE WANT TO PREPARE OUR GRADUATES FOR THEIR CAREER, NOT JUST THEIR FIRST JOB.” How can and should businesses engage with universities and, specifically, with Loughborough?

AL: “Given my views on what makes a good business education, clearly there is a need for close engagement.

But how exactly you engage with the business community is a continually evolving issue, reflecting ongoing changes in our operations.

“At Loughborough, we have a cohort of staff who can engage with business audiences. Among our academics who are top-end researchers, I would argue that we have a proportion that is higher than in the majority of business schools who engage effectively with the various communities of practice they are interested in influencing.

“I’m looking to the business community to engage with the School around a range of our key activities: with executive education programmes that are highly relevant and highly rigorous, with graduates who are better equipped with the skills required for going into employment than is the case for the majority of business schools in the UK, with research that addresses critical contemporary issues.”

What do you think is the future of MBAs? AL: “The MBA has had a huge amount of bad press lately.

In my opinion, what makes an MBA a success is the extent to which these quantitative skills and financial management techniques are balanced by a broader understanding of what it is to be an effective manager, an effective leader, what are often labelled as the ‘soft skills’. An MBA programme should produce managers who are critical thinkers and creative problem solvers, who can deliver vision that offers value to a range of stakeholders and who have an understanding of the social and ethical context within which they operate.

“I believe the MBA has a definite future. It continues to address an importance need for both organisations and developing managers. Equally, the MBA will need to continue to evolve, as it has done, to remain current and relevant in the globalised, information-rich world in which we operate. For Loughborough, I would argue that developing and running a full-time MBA programme is an extremely exciting opportunity given that we will be entering the market late and, drawing on the distinctive skills of Loughborough, creating a clearly differentiated offering. Watch this space.”

How important is an international strategy for business schools?

AL: “Universities will need to become genuinely international.

Business schools are arguably at the forefront of universities’ international development. It’ll be interesting to see the configuration they’ll take, because while business is global, management nevertheless is very often culturally anchored; consumption is typically culturally anchored. The issues that businesses face have a strong regional and, indeed, local dimension to them.

“In terms of new developments, we’re going to see far more in the way of international partnerships. At Loughborough we are identifying a number of key markets where we would want to operate, developing partnerships with universities of similar standing to us whom we will work with in the design, development and delivery not only of taught programmes, but also of research projects that address issues on a crossnational basis.”

Do you think the recent economic crisis will affect the SBE? AL: “Yes, inevitably, and in a multitude of ways. Companies facing severe financial difficulties are going to be clawing back especially in the SME sector on management development training activities, on putting managers and executives through programmes. So we’ve seen a certain – thankfully, limited – impact, but it is an impact nonetheless.

“We will be addressing some big issues as well in light of the crisis: Can we justify what we do as a business school? What do our products actually deliver? Are they suitable, are they fit for purpose? Those are issues we have to wrestle with in conjunction with the organisations we work with in respect of, for example, development programmes and placements.

“Also, the impact on government finances of the crisis is going to profoundly influence us. The changes, as I’ve

“A SUCCESSFUL MBA PROGRAMME PRODUCES MANAGERS WHO ARE CRITICAL THINKERS AND UNDERSTAND THE SOCIAL AND ETHICAL CONTEXT WITHIN WHICH THEY OPERATE – MANAGERS WHO CAN DELIVER VISION THAT OFFERS VALUE TO A RANGE OF STAKEHOLDERS.”

mentioned already, are going to move us in a direction I suspect of a much more consumerist undergraduate student body. This is not necessarily a bad thing, but it will force us to review fairly fundamentally many of our assumptions about the way we operate.

“We will have to look at more diverse sources of funding, for research, for students. We are already looking at ways in which we can engage with our alumni in terms of developing their relationship with the School, making alumni feel much more part of an on-going community.”

And finally, do you have any advice for our graduates?

AL: “Follow your passion! Be true to yourself. Recognise what it is that you’ve really enjoyed, that you’ve valued and found stimulating. Be bold. Be prepared to grasp the opportunities that arise in times of crisis. And never, ever be afraid of change.”

Professor Angus Laing is Dean of Business and Economics at Loughborough University. His research interests focus on the consumption and delivery of professional services in contemporary societies, complemented by an extensive range of management development and consultancy work in both the public and private sectors.

If you would like to discuss his research or any of the opportunities that are available at the School, email A.W.Laing@lboro.ac.uk

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THE ART OF

BEHAVIOURAL FINANCE

by William Forbes

It has been estimated that the total support given to US and European banks since the start of the financial crisis now tops $14 trillion dollars. If “Wall Street got drunk” as former President Bush claimed, we as taxpayers and users of public sector services are certainly picking up the bar tab.

All this seems a world away from the equilibrium pricing models of standard Finance classes taught at Loughborough – and, indeed, any major business school in the US or UK. So what went wrong?

In response, I’ve developed a new optional module in the Business School which tries to explore some of the standard models of decision making we have. It does so by drawing upon studies by psychologists of how we actually do make financial decisions – as opposed to how economic theory says we should make them.

Behavioural Finance brings three major insights: 1. Human intuition is fragile – basic investment principles aren’t studied by everyone who makes investments. That’s why they’re biased and fall in predictable patterns. This demands new theory – a major spur to developing the Behavioural Finance module.

We have to consider decision processes if we want to know how decisions are made in finance: How did this choice come about? In this, financial choices are analogous to medical choices, consumer choices and structured other choices.

2.

3. People’s personal beliefs are relevant in finance. Decision- making processes are already studied in medicine and in the airline industry in order to improve their procedures and quality of services. Traditional financial economics puts emphasis on the ‘homo-economicus’ (fully rational reasoning), and it is important that we study decision making in finance because this rationality isn’t always the case in real life.

Part of the contribution of behavioural finance is a Catholicism of methodological approach which standard finance typically eschews.

So the behavioural perspective is often distinguished more by how it is done than by what is studied. This Catholicism of research method is ideal for research problems requiring an interdisciplinary approach.

Since much of the motivation for teaching finance in a business school context is to harness the benefits of interdisciplinary work, we might expect finance academics working in business schools and their alumni to particularly value the behavioural approach.

Behavioural Finance is informed by three strands of psychological traditions. These are: n Cognitive and behavioural psychology. Here the focus is upon

how our minds undertake the requisite calculations required to maximise wealth. Much of the Nobel Prize-winning work of Daniel Kahneman (often in association with the late Amos Tversky) took this form.

n Emotional or Freudian financial decision making. This relates

to the emotional intensity of trading, where the focus is on decision making being more than a strictly calculative process.

Assets can fulfil deeper emotional needs and therefore trading can induce a dramatic adverse response.

n Social psychology. This recognises the need to find acceptance

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HAS THE CLIMATE CHANGE DEBATE RUN OUT OF STEAM?

by Tom Weyman-Jones In the aftermath of the financial crisis of 2007-2008, you could be forgiven for thinking that climate change has been pushed off the UK’s political and economic agenda. In this article, Tom WeymanJones explains how the climate change debate rages on.

Global governments continue with their efforts towards allocating energy use and carbon emission reduction through various initiatives.

Commitment to the policy directions set out by Lord Stern in his bestselling Blueprint for a Safer Planet (Vintage, 2010) has also helped the move towards dealing with the issues for the UK government and others around the world. However these efforts are not without their problems.

not fully acknowledge areas of uncertainty.

There are also many unanswered questions about how to tackle the problem. If tradable permit schemes such as the European Union Emissions Trading Scheme (EU-ETS) do prove impossible to implement, then one alternative is to switch to a carbon tax. While this has attractions for governments faced with massive public deficits, it is regressive and at the levels indicated earlier up to 100 per tonne of carbon will have a real impact on the living standards of the poorest segment of society.

My new module focuses on how the insights from these fields can help us reform finance theory, especially asset-pricing theories, the subject of which forms the core of our teaching. The module content heavily draws upon the teachers’ new textbook Behavioural Finance, published by John Wiley in September 2009.

The European Union Emissions Trading Scheme (EU-ETS), a major pillar of the EU climate policy, was originally viewed as a major step in fostering a credible international policy in its design of a tradable carbon permits scheme for which high energy-using EU industries had to subscribe. The scheme has been marred by the decisions of national governments to inflate the allocations of permits, and currently the price of carbon permits is around 15-16 per tonne of carbon. In contrast, using evidence from the McKinsey Company on marginal carbon abatement costs, it appears that a target range of around 50-100 per tonne of carbon would be needed to meet the targets advocated by Lord Stern.

Dr William Forbes is Professor of Accounting and Finance and Co-ordinator of the Business School Research Seminar Series. He teaches on financial accounting, valuation and financial statement analysis, and his research focuses on market-based accounting and valuation with a particular focus on the new-economy. He can be contacted via W.Forbes@lboro.ac.uk

The Inter-governmental Panel on Climate Change (IPPC) is also recovering from press criticism of claims about the near-term impact of climate change on glacier melting, and, along with a debate on its future leadership, it is attempting to re-position itself as an evaluating body for the scientific evidence, rather than one that advocates particular policy directions.

This subsidy is surprisingly high: the typical UK household buys electricity from its supplier at a price somewhere between 15 and 20 pence per kiloWatthour, but the FIT on offer since April 2010 pays households who generate their own electricity between 27 and 43 pence per kiloWatthour depending on whether they use wind or solar power.

The scientific evidence itself was also called into question by the failure of many of the environmental experts involved to be completely transparent in making their data accessible, although many critics now accept that this was the result of naivety rather than deception.

Evidently, the climate change debate is still passionate and likely to become more intense over the near future. Idealistically, it should be conducted on a more mature level as participants step back from entrenched ideological positions and allow the science and the economics to speak.

and even encouragement of our acts. Certainly rejection by our professional peers can be painful and potentially costly in career terms. We may prefer to ‘fail conventionally’ rather than expose ourselves to the social isolation nonconformity can bring.

“IF ‘WALL STREET GOT DRUNK’, WE ARE CERTAINLY PICKING UP THE BAR TAB.”

One notable re-positioning occurs in a new publication by The Royal Society: Climate Change: a summary of the science (September 2010).

This concentrates on the causes, not the more politically controversial impact of climate change, and, in the words of Pallab Ghosh, Science correspondent, BBC News, the guide has been updated partly as a result of complaints by 43 of the Royal Society’s members who were concerned that the tone of its previous guide was too strident and did

A favourite policy device is for government to pick an industrial champion and provide subsidies to support it. This is happening in the UK where the industrial champion is renewable energy and the subsidy strategy provides a feed-in-tariff (FIT) which requires that energy suppliers make regular payments to householders and communities who generate their own electricity from renewable or low-carbon sources such as solar panels and wind turbines.

Dr Tom Weyman-Jones is Professor of Industrial Economics. His research focus is in the field of efficiency and productivity analysis. Email T.G.Weyman-jones@lboro.ac.uk.

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THE QUIET REVOLUTION:

THE SHARING OF ‘BACK-OFFICE’ SERVICES

by Ian Herbert and Will Seal

As an alternative approach to either traditional head office centralisation (where each business unit has its own service department) or third-party outsourcing, the Shared Service Organisation (SSO) model aggregates business support services in a new quasi-autonomous organisational form. By re-locating in specialised sites, and by incorporating characteristics from business divisions, head office and outsourcing, the SSO combines a marketstyle, customer-centred outlook with in-house management direction and control (see diagram below).

This article shines a light on how shared services are quietly changing businesses across the spectrum. Consultants claim that the SSO can reduce the cost of support service provision with the additional benefit that both control and knowledge remain located within the hierarchy of the firm. As SSOs are often linked to other organisational changes, such as the introduction of Enterprise Resource Planning (ERP) systems, advocates argue that the SSO offers the critical mass the chance to reengineer and standardise business processes using the best technology.

Shared Service Organisation Structure

Head Office

Business unit 1

Business unit 2

Business unit 3

Operating units

Operating units

Operating units

Shared service centre

Work practices then continue to be challenged because the performance of the SSO can be market tested through benchmarking with other SSOs. Furthermore, collegial relationships between business units and the SSO ensure that service outputs remain aligned with changing business needs. Thus, the SSO should achieve the ‘best of both worlds’: market competition and management control.

According to management consultants, the benefits make the case for the SSOs compelling. Yet academic research suggests a more mixed verdict. Janssen and Joha (2006) found that in a public service in the Netherlands several primary motives for the SSO model, such as cost reduction, access to higher skills, reduction of complexity, higher service levels and so on, were not achieved (although some unanticipated benefits, such as sharing best practice and better security, were realised serendipitously). Our research suggests that the motives for sharing services and the benefits expected, to say nothing of the benefits actually achieved, vary significantly between organisations.

Whilst the common theme is to reduce non-core headcount and cost, there are differences in approach. Some SSOs see their primary mission as providing better business support services so that the talents of expensive front-line workers are optimised. Such thinking is in contrast to viewing the ‘back-office’ as simply another overhead burden to be cut. But, whichever route is taken, for most case organisations in our study, the real benefit is that the SSO brings a new visibility and transparency to costs that were previously hidden within divisions.

“THE REAL BENEFIT IS THAT THE SSO BRINGS A TRANSPARENCY TO COSTS THAT WERE PREVIOUSLY HIDDEN WITHIN DIVISIONS.”

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THE QUIET REVOLUTION: THE SHARING OF ‘BACK-OFFICE’ SERVICES Monetary savings have been identified in three key areas through this research: – Savings based on the reduction of headcount and relocation, – Savings achieved post migration through business process

re-engineering (BPR) and an ethos of continuous improvement and cost reduction, and – Savings achieved through benchmarking and sharing best practice with other SSOs.

Additionally, the common processes and information protocols of the SSO enable top management to have a line-of-sight into divisional businesses based on ‘one source of the truth’. Through changing times and business contexts the primary concern for the large multidivisional corporation is how to co-ordinate a collection of segmented operations into a cohesive strategic form, and at the same time control individual divisions to ensure that the overall plan is achieved.

Standardisation through the SSO enables more direct understanding and comparison of individual divisions, with less opportunity for political posturing based on asymmetric information. Indeed, for those organisations keen to reconfigure themselves as the orchestrators of a virtual supply-chain, the systems and processes of the SSO provides a key element in what is called ‘enterprise architecture’.

Thus far, the SSO has generally stayed below the ‘radar’ of both the press and academia. Actual migration of activities from divisions, and hence headline job losses, tends to be gradual and thus goes largely unnoticed, along with subsequent fallout from process redesign and role de-skilling. Furthermore, the sharing of services tends to start small, with those ‘Cinderella’ tasks that are less contentious politically and operationally, such as payroll, banking, estate management, etc.

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The shared service model has captured the imagination of a wide variety of organisations in both the private and public sectors and there would appear to have significant implications for the future shape of the professional functions. Especially in developed economies such as the UK and US, as workers are forced to compete on price and performance in the global knowledge economy. As well, there will likely be impacts for individuals, professional bodies, organisations, geo-economic policy and even business schools.

On a positive note, it would appear that the UK has something of a lead in shared service design and management. The next phase of development will see an expansion of the range of activities being shared, especially in terms of higher-level activities, such as providing advice to management and the design of corporate policy. The development of shared services across all parts of the public sector is likely to be a massive project in the next few years.

Further information and resources can be found on the project website at www.shared-services-research.com

Ian Herbert is Lecturer in Accounting and Financial Management. He teaches accounting and financial management and his research focuses on the evolving role of the finance function and the impact of shared services on the design of the multidivisional company and the implications for professional workers.

Dr Will Seal is Professor of Management Accounting with research interests in accounting for hotels and hospitality, supply chains, management accounting, management control and corporate governance.

If you work in a shared service environment, Ian would be interested to hear from you: I.P.Herbert@lboro.ac.uk

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But, whilst the timescale of change might be slower, the SSO movement is similar to business process outsourcing in that it encourages management to dismantle traditional function silos and at the same time to adopt a more global outlook. Support activities, once streamlined and commoditised, can potentially be sourced from across the globe, or at least benchmarked against world’s best standards and prices. Taken together, lots of small evolutionary changes in the hitherto ‘peripheral’ back-office could see a more revolutionary reappraisal of the design of the multi-divisional form.

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“THIS WAS A VERY INTENSIVE AND EARNEST PROCESS. THE STAFF WERE ALL INCREDIBLY OPEN AND HONEST ABOUT THEIR COMMUNICATION PROCESSES, WHICH WAS ESSENTIAL IN ORDER TO HELP POSITIVELY INFLUENCE THEIR COMMUNICATIONS.”

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VISUALISING THE SHOP FLOOR by Ondine Barry and Nicola Bateman Nicola Bateman’s research on visual management (VM) problems within organisations’ communication boards is inherently an operations management issue surrounding graphic design. How does one best communicate production processes and analyses within an area or several areas of a company effectively and efficiently?

For Swedish security systems manufacturer Assa Abloy, Nicola was brought in to look at their shop floor communication boards, primarily to help address issues of effectiveness and efficiency with regard to the design and layout of the boards and, ultimately, to help improve their internal communications.

“This was a very intensive and earnest process,” Nicola said.

“The staff were all incredibly open and honest about their communication processes and how they used the boards, which was essential to me in my research as I needed to know exactly what they needed to get from the boards in order to help positively influence their communications.”

She conducted her research at Assa Abloy over two years, producing detailed feedback on how best to design and lay out their boards, which she says (with obvious satisfaction), the company incorporated immediately into many different areas of their business.

The boards were the company’s main communication tool for their security lock production cells, and as such, were vital for communicating status reports and production analysis updates to the staff. At-a-glance knowledge was something that the company was hoping to achieve via the boards but were not fully realising. Hence Nicola’s involvement.

From her research work at Assa Abloy, Nicola went on to the SMMT Industry Forum, which runs hands-on improvement workshops for many different types of companies. She has enhanced their approach to VM to incorporate the findings from Assa Abloy. This means the research will be applied on a much wider scale and can be disseminated to many companies.

Nicola met with Assa Abloy’s team members and sat in on meetings wherein the boards were used and discussed by the staff. These meetings were facilitated by an engineer from the Automotive Trade Association SMMT Industry Forum. Nicola modified the standard Industry Forum approach and input VM principles through which to look at the boards’ efficacy:

Nicola’s research has been delivered at a number of conferences and organisations and has been well received in a wide range of industries, demonstrating the need for teams to effectively communicate in sectors as diverse as healthcare and high technology research and development.

1. Using the right graphical tool 2. Sparing use of colour 3. Avoiding excessive use of borders and boxes 4. Utilising board layout that is reflective of the flow and structure of the information

Dr Nicola Bateman is Senior Lecturer in Operations Management. Her main research is on the development and use of effective communication in both public and private sectors. She can be reached at N.A.Bateman@lboro.ac.uk

School of Business and Economics Loughborough University Leicestershire LE11 3TU UK T: +44 (0)1509 222701

www.lboro.ac.uk/sbe