Perspectives Summer 2014 by Gies College of Business

Perspectives

HEADS OR TAILS? WILL BITCOIN BE A WINNER OR A LOSER?

Summer 2014

College of Business at the University of Illinois at Urbana-Champaign

[ CONTENTS ]

f you’ve had the opportunity to visit BIF during the week, you know that it’s a vibrant environment where students, faculty, and staff gather. Some are tackling assignments, reading email, or sharing opinions; others are conducting research, working on group projects, or enjoying engaging conversation. The activity in BIF represents the many voices in the College of Business and the ongoing dialogue that is at the heart of cultivating an atmosphere of academic inquiry. Each issue of Perspectives provides a glimpse into that dialogue and features a variety of those voices. In this issue, for instance, you’ll read what faculty have to say about timely business topics. You’ll meet alumni who are leaving their imprint on industry and on the College as well. You’ll read what undergraduate and graduate students think about subjects as diverse as Bitcoin and subsistence marketplaces. And on this page, you’ll hear from alumni who appreciate the opportunity to listen to these voices and add their own. It’s how we all contribute to the dialogue that creates a healthy business climate. We look forward to continuing the conversation. Sincerely,

Larry DeBrock Josef and Margot Lakonishok Endowed Dean

Perspectives

SUMMER 2014

College of Business at the University of Illinois at Urbana-Champaign

[ YOUR] PERSPECTIVE

DERIVATIVE DANGER

HEADS OR TAILS? WILL BITCOIN BE A WINNER OR A LOSER?

ON THE COVER What are the odds that Bitcoin will become a viable currency? Charles Kahn, the Fred S. Bailey Memorial Chair of Finance, demonstrates that it may well be a toss up.

I read with great interest the article “Gambling on the Future” in your recent issue of Perspectives. In the first paragraph, it points out that the author, Professor Abdel-khalik, came across a GAO report in 1994 on “Derivatives,” which convinced him that unregulated derivatives represented a major threat to the financial system. I signed that report as Comptroller General of the United States and head of GAO and also testified before both the Senate and House Banking Committees. I liked the article as it explained the continued danger of derivatives and how the holding of trillions of dollars of derivatives are concentrated in our four largest banks. I send you and the College my very best wishes for continued success. Chuck Bowsher ’53 ACCY Editor’s Note: For those interested in reading more about the GAO report, its warnings about derivatives, and how the financial press covered the report’s release, Bowsher suggests an article in the Columbia Journalism Review. Visit www.cjr.org and type in “derivatives echo chamber” in the search box.

IN-DEPTH 2 10

Heads or Tails? Will Bitcoin be a winner or a loser as an alternative currency?

Ahead of the Pack? The controversy over high-frequency trading continues to heat up.

Is Cash Really King?

Stopping the Fraud Spiral

Why are ﬁrms stashing more cash and what does this strategy mean?

Researchers examine what strategies are most eﬀective in controlling fraud.

Global Reach Experts gather to make a diﬀerence in subsistence marketplaces.

DEAN Larry DeBrock MANAGING EDITOR Mary Kay Dailey EDITOR Cathy Lockman

MORE TO KNOW ABOUT PTO Your Spring 2014 article on the benefits of a paid sick leave policy really hit home. Our company, Roadrunner Pharmacy, adopted a Paid Time Off (PTO) policy beginning this fiscal year after extensive review. We believe that the combination of an employee’s time off for sick leave and vacation time into one program is the best of both worlds. Since PTO is an “all-purpose” time off policy for eligible employees, they can use this time off for personal business, extended bereavement leave, and any other appropriate reason that an employee needs to be absent from work. After an employee’s probation period has ended, he/she earns PTO days, which can also be converted to hours as the situation warrants. As a CPA/CGMA, there was an interesting transition that was required to comply with the GAAP rules on accounting for compensated absences. But overall, I know that our PTO program is a much better method of treating our employees equitably. Really appreciate receiving Perspectives. Although I am of the College of Commerce generation, it is great to know our university’s College of Business continues to pride itself on quality research and effective communication! John Zatarski ’76 MAS We welcome your perspective, too. Send your comments or suggestions for future articles to our managing editor, Mary Kay Dailey, at mkdailey@illinois.edu.

CONTRIBUTING WRITERS Tom Hanlon Cathy Lockman Doug McInnis

SHORT TAKES

PHOTOGRAPHER Thompson • McClellan Photography PROOFREADER Cristy Gillespie DESIGNER Pat Mayer

Perspectives has been named a Circle of Excellence Bronze Award winner by the Council for Advancement and Support of Education and an Award of Excellence winner by the University & College Designers Association. www.business.illinois.edu

SUMMER 2014

[ MY ] PERSPECTIVE

Words from the Ys

What the Tech?

60-Second Proﬁle

Taking our Qs

Reality Check

Legacy

The Reason Why

Parting Shot

The University of Illinois at Urbana-Champaign is an equal opportunity, affirmative action institution. Printed on recycled paper with soybean ink.

[ COVER STORY ]

“Is it a currency, a payment system, or is it a commodity?” Michael Shaw

WILL BITCOIN BE A WINNER OR A LOSER?

ver since you dropped your first quarters into a piggybank or deposited the dollar bills from your babysitting job into a bank account, you’ve understood that cash is a valuable commodity. You know the denomination of each piece of U.S. currency. Maybe you can even recite whose likeness appears on each bill and can tell where your coins are minted.

an IOU as payment because you would know he’s good for it. And those IOUs could be traded among individuals, in which case, the IOUs could constitute a currency.” Its intangible quality, its unknown—or even negative—reputation, and its complicated technology make Bitcoin seem more than a bit nebulous to the general public. But will that mean that the virtual currency won’t catch on? After all, not everyone uses U.S. currency for reputable purposes and few people really understand how the Internet or cell phones work, but it doesn’t stop millions of us from using all three every day.

THE COIN FLIP Bitcoin made its debut in 2009 and has since soared in value. If you had invested $1,000 in the virtual currency a few years ago when they were worth less than $1 apiece, you would have been a millionaire by late 2013 when they topped out at over $1,200 apiece. Of course, there’s volatility with such an investment as well. Prices in the past year have varied widely from the $1,200 this past winter to $430 in the spring and everywhere in between. But not everyone who is interested in Bitcoin is looking at it as an investment. Many are more focused on the cyber currency’s ability to change the way the world does business. It is the most popular of the more than 200 virtual currencies that now exist, racking up more than 60,000 transactions a day world-

wide, according to firms that track virtual currencies. “I think this is the real deal—it’s revolutionary,” says Richard Porter, who follows Bitcoin as an economist at the Federal Reserve Bank of Chicago. “This digital thing has opened the door to currency that isn’t issued by the state. If Bitcoin succeeds, it could become a currency (for everyday use).” Bitcoin’s allure stems from longsought breakthroughs in cryptography that enable Bitcoin and other virtual currencies to securely send payments between two parties without a costly third-party middleman, such as a credit card, PayPal, or a bank wire service. For that reason, Bitcoin is very cheap to use. But despite that potential, there’s a lot about Bitcoin that makes people nervous. It is, in effect, a financial system that runs parallel to those of the developed world. Bitcoin func-

tions as a global currency that isn’t backed or controlled by any government and it isn’t subject to the monetary policy of the Federal Reserve or any other central bank. “It’s going to be hard to tax and somewhat hard to regulate,” says Porter. Then there’s the fact that the currency has proved volatile. After peaking at roughly $1,200 apiece, Bitcoin’s value fell by more than half. China’s decision to shutter the country’s Bitcoin operations pulled more than 1.3 billion potential users out of the system. Last year, federal agents busted Silk Road, which trafficked in drugs and took payments through difficult-to-unravel Bitcoin transactions. Attorney General Eric Holder has since told the House Judiciary Committee that Bitcoin could be used to conceal illegal activity. A worse blow came when the Mt. Gox Bitcoin exchange in Tokyo an-

Perspectives SUMMER 2014

HEADS OR TAILS?

Even if your preferred method of payment is a credit card, you know and trust the feeling of coins in your pocket and crisp dollar bills in your wallet. But tangible currencies aren’t the only ones making their way into the revenue stream these days. Virtual currencies are gaining widespread notoriety, even if they aren’t widely understood. And Bitcoin is one of the most popular. What is it? Well, look at what it’s not. For starters, Bitcoin is not an actual coin you can hold in your hand. In fact, the image you see of it on these pages is more of a logo—a representation created so that the public will identify Bitcoin as money even if exists only in cyberspace and not in your pocket. It’s also not a currency that’s backed by the government. But does it have to be in order to work? “In principle the answer to that question is no,” says Charles Kahn, the Fred S. Bailey Memorial Chair of Finance and an expert on payment systems and their regulation. “Currency is, in effect, an IOU. What you need for a currency to work is reputation.” Because the U.S. dollar has a global reputation, people around the world accept it. But, as Kahn explains, “If you had a powerful, respected individual, someone who has wealth and a strong reputation, someone like Warren Buffet, for instance, that person could just write

IN THE NEWS Bitcoin was created in 2009 with little fanfare. However, in the first six months of 2014, it has been a major newsmaker.

Mt. Gox, once the biggest Bitcoin exchange, discloses losses of $470 million. The exchange blamed technical issues that paved the way for fraudulent withdrawals.

The IRS rules Bitcoin is property, not currency, and is subject to capital gains taxes. The decision creates a potential tax paperwork nightmare for Bitcoin users.

Attorney General Eric Holder warns that Bitcoin and other crypto currencies could aid in money laundering and other criminal enterprises.

Robocoin, manufacturer of Bitcoin ATMs, announces plans to ship another 50 units before summer. Japan gets its first Bitcoin ATM.

Merchants along Lee Road in Cleveland Heights, Ohio, designate their street the first U.S. Bitcoin Blvd., a move designed to promote the area as tech savvy.

Bloomberg discloses plans to list Bitcoin on its data terminals, a decision that could give Bitcoin an added measure of acceptance in U.S. finance.

Venture capital investments in Bitcoin surge to nearly $65 million in the first quarter. That compares to just over $74 million for all of 2013.

The Federal Elections Commission unanimously rules that politicians can accept small Bitcoin donations. But campaigns must convert bitcoins into U.S. dollars before spending them, the commission says.

Dish Network, the satellite TV provider with more than 14 million U.S. subscribers, says it will allow its customers to pay their bills with Bitcoin.

The Securities and Exchange Commission reiterates that all issuers selling securities to the public must comply with the registrations of the securities laws, including issuers who seek to raise funds using Bitcoin.

Sources: Reuters, The Wall Street Journal, The New York Times, Bloomberg, Coinreport.net, The Plain Dealer, Time, International Business Times, The Washington Post, Politico, and Forbes.

ACCEPTANCE BIT BY BIT Still, Bitcoin supporters have plunged ahead, building a support system to speed Bitcoin acceptance. While few merchants now take them, the number is growing by the week. For instance, you can now buy a sandwich at one Subway franchise in Allentown, Pennsylvania, or book a ride into space on Richard Branson’s Virgin Galactic. It was also recently announced that Bloomberg will list Bitcoin on its data terminals, furthering its legitimacy. And in the fall, un-

“Currency is, in effect, an IOU. What you need for a currency to work is reputation.” Charles Kahn

dergraduates at MIT will receive $100 in the virtual currency as part of the MIT Bitcoin Project, which is “aimed at creating an ecosystem for digital currencies at MIT.” A tiny but growing Bitcoin ATM network is also helping to grease the wheels. Put your dollars in those ATMs and they will credit bitcoins to your cyberspace bank account known as a wallet. Bitcoin ATMs can be found in Tokyo, Halifax, Sydney, and even Austin, Texas, and the number is expected to grow rapidly.

You can also purchase bitcoins from Bitcoin exchanges, from friends, or from other third parties. And you can get them by accepting Bitcoin as payment for goods or services. Once bitcoins are in your account, you can spend them using your computer or cell phone. But one of Bitcoin’s biggest attractions may be users’ ability to send bitcoins from one party to another for little or no charge. That is likely to appeal to people who work in a foreign country and transmit much of

their income to families back home. They now pay up to 14 percent of that amount in various service fees, according to World Bank data. That data also shows that migrant workers sent $414 billion back to their home countries in 2013, so Bitcoin has the potential to shift $40 billion or more from financial services firms to the migrants and their families. Bitcoin may also appeal to countries that don’t have adequate banking networks or the other elements of a sophisticated financial system— parts of Africa, for instance. It may find a mass audience in the underdeveloped world even if nations with highly developed financial systems choose to spurn it. This could help Bitcoin slip into major economies through the back door. “You could imagine it taking hold in those countries,” says Kahn. “From there, it could spread here. If Bitcoin has a base elsewhere, then developed countries would have to acknowledge it. If several countries in Africa become advocates for Bitcoin, then it’s harder for other countries to say, ‘Oh well, this is just illegal activity.’”

TECH CHECK Typically, technological progress and its fallout follow an evolutionary path where one thing leads to another. Shaw, professor of business

administration and an expert in ecommerce, believes that the transformation of the music business provides an example that could have implications for digital currency. It started when Napster made it easy for friends to share music using the Internet, he explains. But Napster ran into charges of copyright infringement from the music business, which wasn’t getting paid when music was shared. Eventually, Napster was shut down by court order (though it later re-emerged in a new, legal format). Despite its legal issues, “Napster showed the need to digitize music, instead of using the CD as the medium,” Shaw says. “Apple seized on the concept and pioneered online music sales through iTunes.” As a result of that shift, music lovers could buy music one song at a time and Apple made money. But CD sales, once a cash cow for recording companies, plummeted. Stores that sold CDs closed in droves. Shaw says Bitcoin represents a similar evolution by changing the way we pay for things. “You have services that had been dominated by banks and credit card companies. But Bitcoin has shown it can perform the same functions in a more convenient way,” Shaw says. “We

had credit cards, then PayPal. Now we have Bitcoin.” There is a versatility to the Bitcoin technology that is getting attention, too. “Virtual currencies seem to have a pretty sound footing,” says Vishal Sachdev, lecturer in business administration. “More and more venture capital is going into this technology. It seems to have enough different use cases—beyond just paying for products online—to ensure that it will stick around. One interesting use case is having Bitcoin be a transit currency for an exchange of traditional currencies. So you would convert USD to Bitcoin and then Bitcoin to EURO and then save on transaction costs of going through traditional exchange mechanisms.” Kahn agrees, to a point. “Bitcoin is a really clever technology,” he says. “It allows for all sorts of possible uses that are really intriguing. For example, you could build systems that keep track of ownership of assets.” It could even be used to send digital signatures or digital securities, Bitcoin backers say. “But Bitcoin as a payment system is a toy,” says Kahn. “China has already said Bitcoin won’t be part of its payment system. And ultimately, central banks across the world won’t stand for it if Bitcoin gets big enough.” Cathy Lockman Doug McInnis

•

TWO BITS, FOUR BITS, SIX BITS, A DOLLAR ALL FOR BITCOIN STAND UP AND HOLLER

ne of Bitcoin’s biggest champions is Silicon Valley entrepreneur and Illinois graduate Marc Andreessen ‘94 ENG. His venture capital firm, Andreessen Horowitz, had pumped nearly $50 million into Bitcoin startups as of January. Earlier this year, Andreessen made the case for Bitcoin in a New York Times opinion piece. “Bitcoin is the first practical solution to a longstanding problem in computer science called the Byzantine Generals Problem,” he wrote. “To quote from the original paper defining the B.G.P.: ‘(Imagine) a group of generals of the Byzantine army camped with their troops around an enemy city. Communicating only by messenger, the generals must agree upon a common battle plan. However, one or more of them may be traitors who will try to confuse the others. The problem is to find an algorithm to ensure that the loyal generals will reach agreement.’” In other words, says Andreessen, it’s about “how to establish trust between otherwise unrelated parties over an untrusted network like the Internet.” The technology underlying Bitcoin does that, and Andreessen believes the implications will be revolutionary. As of today, for example, parts of the world that lack modern payment systems “are excluded from products and services that we in the West take for granted. Bitcoin, as a global payment system anyone can use anywhere at any time, can be a powerful catalyst to extend the benefits of the modern economic system to everyone on the planet.”

•

Perspectives SUMMER 2014

nounced it lost 850,000 bitcoins valued at $400 million in a hacking attack. Some 200,000 bitcoins were later recovered, but the exchange failed and has filed for bankruptcy in the United States and Japan. Bitcoin suffered yet another setback when the Internal Revenue Service declared that Bitcoin was property, subject to capital gains and losses that will complicate the taxes of Bitcoin users. The ruling highlights the multifaceted nature of Bitcoin. “Is it a currency, a payment system, or is it a commodity?” asks Michael Shaw, the Leonard C. and Mary Lou Hoeft Chair of Information Systems. “If it’s a commodity and I receive bitcoins, then when I exchange it for cash I’ll be taxed if I make money on it.”

Doug McInnis

[WORDS FROM THE Ys ]

Do you think Bitcoin is a viable currency?

about Bitcoin? A visit to BIF provided us with information on whether today’s students are comfortable with the alternative currency and what they think it means for their future and the future of business. Here are Words from the Ys.

“

I think there is a place for alternative currencies in the future, but it likely won’t be Bitcoin. I think the electronic currency that will be successful will have to have a much broader acceptability than Bitcoin currently does. It will have to be something that you can use at places you visit frequently, like Starbucks. Because of those limitations and how complex it is to mine Bitcoin, I don’t use it, but if those problems are solved by another alternative currency, I think it could be something that catches on with people who are comfortable with technology.

”

Heesang Yeo Senior in Accountancy Louisville, Kentucky

“

As an accounting major, my first concern about an alternative currency like Bitcoin revolves around its legitimacy. I’m much more comfortable with a currency that is tangible, that I can hold in my hand, and that actually has the backing of the government rather than being created anonymously. Plus, there are a lot of unknowns surrounding Bitcoin. That doesn’t mean it won’t be around in the future, or that there won’t be other alternative currencies that do take off, I just think they’ll need to be much more user-friendly, more easily understood, and much less suspect if they’re going to be popular with consumers and business.

”

Laura Foltz Sophomore in Accountancy Wheaton, Illinois

“

I have a friend in Ghana who trades Bitcoin, but to me, it’s a concept that raises a lot more questions than answers. If I’m going to invest my hard-earned money, I need to know that the investment has a market structure, that it is legal, and that there is someone responsible for overseeing how it’s used and traded. We know that there are risks to all investments, but with Bitcoin there is no regulation to provide a framework for understanding its uses. Plus, there’s no place to go if you have issues with it. To me, there’s also a big question about the currency’s legitimacy when the person who created it is in hiding. But I do think that people who are early adopters, in general, may be more likely to use and invest in Bitcoin because they’re more comfortable with the technology.

”

Rose Dodd MBA Student Accra, Ghana

As part of my Investment Management class this year, a team of us managed a market-timing hedge fund strategy. There were members of the group who wanted to invest in Bitcoin because they felt it had strong upside potential. I didn’t support that strategy, though, because Bitcoin didn’t seem like a good investment. I don’t see it as a sustainable currency. It doesn’t have the structure to support its value or legitimacy. For instance, it isn’t backed by a government or tied to a gold standard. But the majority ruled, and our group invested in it. We came away with a loss on Bitcoin.

“

risk averse, so a digital currency Bitcoin is an interesting phenomAlthough I haven’t mined Bitcoin “likeI’mBitcoin “enon. “myself, that is not regulated or As the world’s largest virtual I know others who have

Harout Sahakian MBA Student Los Angeles, California

Leah Dinh Master’s Student in Accountancy Ho Chi Minh City, Vietnam

”

monitored in any way is not something that I’m likely to use. And from an investment standpoint, Bitcoin has wide fluctuations in value, which adds even more risk. I think the fact there are so many intricacies to it that we don’t know about or understand, including its taxability, causes most people to be skeptical and to see Bitcoin as having the potential to have a negative impact on the overall economy rather than a positive one. I think I’ll stick with cash and credit cards for most of my purchases and PayPal for online buying.

”

currency market, it has had a lot of media attention—both good and bad. It has many promising features, such as quick settlement, low transaction costs, and efficiency. On the other hand, it has been marred by a number of problems: high volatility, threat of regulation, risk of cornering, an algorithm that can be gamed, etc. The biggest problem, though, is that many people do not understand what it is. One oftencited criticism is that it enables a lot of illegal activity. While Bitcoin activities can be anonymous, it is important to note that every transaction is recorded in its history. As such, it is possible to trace any past transaction. Cash, on the other hand, does not give us this ability. Regardless, I prefer Litecoin.

”

Richard Crowley PhD Student in Accountancy Naperville, Illinois

gotten involved in this currency for arbitrage purposes. The potential for substantial profit makes it an intriguing and maybe even a promising investment opportunity. But like all such opportunities, you first have to have the money to invest. With Bitcoin, you also have to have the time to mine and monitor the currency. And then there’s the risk factor. With so many rumors swirling around about this currency as well as the recent bankruptcy of the Mt. Gox Bitcoin exchange, you have to be willing to assume a lot of risk.

”

Joven Wu Master’s Student in Finance Hangzhou, China

Perspectives SUMMER 2014

How does Generation Y feel

[ Technology ]

Q A

“When you pay with bitcoins, every transaction is logged by the ‘blockchain.’ It basically operates like an audit trail of how much Bitcoin was spent by which purchaser and accepted by which vendor. The blockchain is Bitcoin’s answer to transaction transparency and security.”

What the Tech?

Vishal Sachdev

Who created Bitcoin? Actually, nobody knows except the person or persons who created it. The original speciﬁcations for Bitcoin were published on a cryptography mailing list in 2009 by Satoshi nakamoto, a pseudonym for one or more persons whose identity has never been revealed.

Q Who owns the Bitcoin Network? There is no one owner. everyone can participate in the network. Q

How many bitcoins are there? Today, there are fewer than 13 million. The system is set so the number of bitcoins will grow to no more than 21 million in all. There are no provisions to expand it. Keep in mind that a bitcoin can be split into “satoshis,” and

one bitcoin equals 100 million satoshis. So the tradable currency units eventually will amount to 2.1 billion satoshis.

Q How do new bitcoins enter the system? They must be “mined” through solving computer algorithms, which requires putting significant computing power to work. As more bitcoins are mined, the process of mining them becomes more difficult. This prevents new bitcoins from flooding the system. As the supply is limited, the price per bitcoin tends to rise over time as more and more people use them. The higher price makes it worthwhile for bitcoin miners to do the increasingly arduous work of mining them. Individuals often sign up into a cooperative system to pool their computing power to mine the bitcoins and share in the proceeds of the mining operation.

Do I have to be a “miner” to obtain bitcoins? no. you can also purchase and sell bitcoins through online Bitcoin exchanges; you can accept bitcoins as a payment for goods or services; and you can trade traditional currencies for bitcoins.

How can I buy bitcoins? First, you need a Bitcoin “wallet,” which is basically an app that you can download on your phone or computer. If you choose to purchase bitcoins through an exchange, you register with the exchange, enter your bank account information, and convert currency into bitcoins. To learn more about the exchanges, you can visit www.howtobuybitcoins.info.

How do I make purchases with bitcoins? Most Bitcoin transactions are online. you use your Bitcoin wallet to create and enter an “address” for the recipient of the payment, enter the amount of bitcoins required, and press “Send.” The

Bitcoin network receives the transaction. It is veriﬁed by the miners, and then the transfer of bitcoins is made to the recipient’s address.

Q Why not just use a credit card for online transactions? For sellers, the answer is easy. you avoid paying the 2 to 3 percent fees that credit card companies charge vendors for each transaction. For both parties, there are also security advantages to using Bitcoin rather than credit cards. When you pay with bitcoins, every transaction is logged by the “blockchain.” It basically operates like an audit trail of how much Bitcoin was spent by which purchaser and accepted by which vendor. The blockchain is Bitcoin’s answer to transaction transparency and security. So another potential beneﬁt is that by using Bitcoin vendors and buyers can avoid the fallout that occurs when credit card systems are breached and account holders’ numbers are hacked.

How can you have a global currency system with only 21 million units? As more people use bitcoins, the value of each bitcoin increases. So the total market cap for Bitcoin— that is the amount available to spend—increases.

But if bitcoins get too expensive, how can anyone aﬀord to buy them? Bitcoins are inﬁnitely divisible into sub units. The smallest units may be just fractions of a penny. So you can buy just part of a bitcoin. And you can use just part of a bitcoin to pay for goods and services.

Q What can you do with small units of bitcoin, say if it is worth less than $1? Actually, a lot. For instance, you could support a favorite blogger with small bitcoin payments. In fact, some bloggers are already asking for bitcoin contributions. one included the phrase, “We accept tips.” he had collected about $60.

Q But aren’t bloggers or anyone else who accepts Bitcoin at risk from currency ﬂuctuations? yes. For that reason, you might want to convert them into another currency quickly, if you don’t have the appetite for risk.

Q Why haven’t other people created virtual currencies? Actually, they have created several. They’re all based on variations of the original protocol for Bitcoin. each one of them tries to address something that Bitcoin does not. For example, some allow for faster transactions.

•

Perspectives SUMMER 2014

In this column, Perspectives asks a faculty expert to shed light on a timely technology topic. For our cover story on Bitcoin, we talked with Vishal Sachdev, director of the Illinois MakerLab and lecturer in business administration. He shares his insights on the most frequently asked questions about this alternative currency.

[ HIGH FINANCE ]

THE HIGH-FREQUENCY TRADING RACE IS ON

t’s been a few decades since highfrequency trading companies began using computer black boxes to transact thousands of trades per second. In 1998, the first transatlantic cable, between New York and London, allowed data to travel roundtrip in 64 milliseconds. In 2009 and 2010, crews between New Jersey and Chicago blasted holes in mountainsides and tunneled under riverbeds to lay 827 miles of fiber-optic cable that can transfer financial data from the two endpoints in 13 milliseconds. (Wall Street banks paid $28 million for this venture.) Still not fast enough. The race goes on. It is called the “race to zero,” as companies attempt to whittle away at the difference between the speed of their orders and the speed of light. It’s all in the name of beating other traders to the punch and, ultimately, of reaping the financial rewards that milliseconds, or even nanoseconds, deliver. And so, in the past few years, new weapons that are even faster than cable have been added to the high-frequency trading (HFT) arsenal: laser beams and microwaves.

THE NEED FOR SPEED “Cable is no longer state of the art,” says Mao Ye, assistant professor of finance. “Now it’s microwave towers. We have already passed the point of how much speed is beneficial to the market. We are fighting for nanoseconds now. I don’t think speed competition at this level creates any social benefit.” But apparently there are private benefits for the companies who are investing millions—or even billions —of dollars into gaining a few nanoseconds on their competitors. For example, a new fiber link between London and Tokyo, used primarily by stock traders, has a price tag of $1.5 billion. Those nanoseconds, after all, can translate into millions of dollars for trading companies. Highfrequency traders can learn when big buy orders are being placed and insert their own orders ahead of it. That maneuver gains the trader a penny or so on each share that’s being traded. “Minimum price increment is one cent for low-price stocks,” Ye says. “It doesn’t sound like much, but if you trade at a very high frequency you can make a lot of money.”

Perspectives SUMMER 2014

Ahead of the Pack?

FINANCIAL STRATEGY

Is Cash Really King? Ye has focused his research on HFT, sharing his ﬁndings in the fall of 2012 with the U.S. Senate Subcommittee on Securities, Insurance and Investment. His early research led him to think that HFT needed more regulation, that it was a runaway train bound to crash—as in the famed Flash Crash of May 6, 2010, when the market dropped nearly 1,000 points in 20 minutes. But his views have changed. “Previously, I was focused on solving the problems associated with HFT through the use of regulation, for instance, through policy proposals like minimum resting time or a cancellation tax or something similar. But I’ve come to realize that market failure can actually come from the regulation.” Ye believes many of the negative views of high-frequency traders are politicized. “Not all high-frequency traders are bad,” he says. “Maybe some of them are. But you need to look at the system, not the traders. It might be the system you designed that has the problems. I think regulation causes the problems.” So how can we resolve the issues with HFT? “We need to understand the relationship between existing regula-

“We need to understand the relationship between existing regulations and highfrequency trading before we make any policy.” Mao Ye

tions and high-frequency trading before we make any policy,” says Ye. “If we don’t know how the existing regulation relates to high-frequency trading, we can make policies that can make the market even worse. If you don’t understand the relationship, sometimes when you try to ﬁx problems, you create other problems. And the problems you create are maybe bigger than the problems you solved.”

THE DEBATE GOES ON The controversy over high-frequency trading continues to heat up. The Justice Department and the Securities and Exchange Commission are investigating HFT, and a lawsuit has been ﬁled against the CME, owner of the Chicago Mercantile Exchange and the Chicago Board of Trade, alleging that the world’s largest futures market allows highfrequency traders an advance peek

at price and market data before other market participants see the data. In addition, Flash Boys: A Wall Street Revolt, by Michael Lewis has stirred the debate on the values and ethics of HFT. At one point in his book, Ye says, Lewis espouses the view that the U.S. stock market is rigged. “My view is slightly diﬀerent from Lewis’s,” he says. “I’m more neutral.” What Ye is not neutral on is the idea of going to ﬁve-cent increments in trading for some small-cap stocks. There has been some call for that in recent months. “I was shocked by that idea,” Ye says. “Many are saying it would create more jobs. But what it really would do is further encourage the competition for speed.” Ye recommends a move in the opposite direction. By quoting stock prices in increments of less than a penny, he says, much of the highfrequency trading could be competed away. He notes that the current one-cent tick size acts as a price constraint on low-priced stocks, and speed is how you break the tie. With increments of less than a penny, there would be less need for speed. Tom Hanlon

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Perspectives SUMMER 2014

TO REGULATE OR DEREGULATE?

orporations are growing flush with cash. And it’s not just the largest ones that are stashing it. In fact, smaller firms actually hold the highest percentage of their assets in cash. They also have the most to win—and lose—as they implement strategies for accumulating and spending cash.

“ In 1998, the percentage of assets held in cash hovered around 3 percent. Recently, it reached the unprecedented level of 12 percent. Research shows that for small companies the number has climbed even higher, reaching as high as 35 percent.”

WHO’S FLUSH WITH CASH? 25 ISSUERS WITH THE LARGEST CASH HOLDINGS AS OF 2013

Heitor Almeida

Company “There has been a significant increase in firms’ cash balances in the last 15 years,” says Heitor Almeida, the Stanley C. and Joan J. Golder Chair in Corporate Finance. “In 1998, the percentage of assets held in cash hovered around 3 percent. Recently, it reached the unprecedented level of 12 percent. Research shows that for small companies the number has climbed even higher, reaching as high as 35 percent.” Why are firms stashing more cash and what does this strategy mean for companies, investors, and the economy? “Cash certainly can be king for innovative firms,” says Almeida. “You need to have cash to conduct strong R&D operations. Technology and pharmaceutical firms often hold more cash for this reason. Cash certainly can be king for small, risky, innovative firms especially in periods of high economy-wide volatility because such firms are much more sensitive to market fluctuations. Riskier companies also tend to hold more cash in case they can’t raise external funding. The liq-

uidity gives them a degree of financial flexibility.” And while liquidity is a good thing, not all cash is created equal. Passive cash is one source. It comes from operational cash flows. Active cash, which you raise through issuing debt or borrowing, is another. Almeida says that much of the cash on company balance sheets today is passive. Strong profits combined with cutbacks in spending, hiring, and other expenses are responsible for this passive-cash-rich environment. So while making money and saving it can be a good strategy, Almeida says that passive cash is the kind that can burn a hole in your pocket—and that can have some negative consequences. “It’s the free cash flow problem we talk about in finance,” he says. “While most companies generally take good care of their cash, there can be a lot of pressure for companies who have passive cash to spend it.” Governments may want to see companies spend their money to stimulate the economy. Institutional investors may want to have cash re-

turned to them in the form of dividends or share repurchases. “Those pressures can lead to undisciplined spending and poor investment decisions,” he says. “While cash provides financial flexibility, that has to be tempered with discipline.”

WHAT STRATEGY RULES? So what’s the best strategy to achieve both flexibility and discipline? Almeida suggests that companies pay out profits through regular dividends, if possible, rather than retaining them. In 2013, nearly $300 billion was returned to investors in the form of dividends, but that’s out of a U.S. corporate cash hoard of $1.25 trillion. His optimal liquidity policy recommendations also include funding your cash externally rather than building it from retained earnings—that is, using active cash rather than passive. Precautionary borrowing, where you issue long-term securities and hold the proceeds as cash, is one active-cash strategy. “By raising large amounts of capital and saving it as cash, a company can shelter the

value of innovation from market fluctuations,” says Almeida. Establishing credit lines is another active-cash strategy, but in the United States it’s an option reserved mostly for large companies. “Credit lines act as liquidity insurance where the company pays a fee in exchange for an option to borrow in the future if they need to,” says Almeida. “Such credit lines can obviate the need for precautionary borrowing.” If you decide on the precautionary borrowing route, Almeida suggests that you develop a strategy ahead of time for managing your long-term debt, one that allows you to take advantage of windows of opportunity to raise the funds and also avoid maturity walls. The world of private equity provides an example of how an optimal cash policy like the one recommended by Almeida works. “It is well known that private equity targets carry a significant amount of debt, and private equity firms aggressively use dividend recapitalizations to return excess cash to investors, and they also appear to

carry a significant amount of cash after a buyout,” says Almeida. “Private equity firms are also known for their special ability to renegotiate maturing debt and avoid financial distress.”

ACTIVE CASH TAKES THE CROWN What kind of mistakes are you more likely to make when you use passive cash? Almeida points to research that shows that companies that use passive cash for acquisitions are more likely to destroy shareholder value than companies rich with active cash. “This could be because when you have to go out and get the cash you might be more careful about how you use it than if you have just been accumulating it,” he says. “Or maybe it’s because you have banks and investors more closely monitoring the money when it is borrowed. Active cash seems to force companies to think harder about their decisions.” Another area where companies that employ active-cash strategies

fare better is in stock repurchasing decisions. “Companies rich with passive cash do not generate higher returns when repurchasing stock,” explains Almeida. “That’s likely because their market timing is poor. For instance, they repurchase when the stock price is high. It may also be that active cash may serve as a form of discipline that actually improves their repurchase decisions.” So when it comes to cash, who wears the crown? Discipline and flexibility rule, says Almeida. “You need the flexibility that cash provides. By choosing to use active cash rather than passive cash, you just may buy the discipline you need to make good, solid decisions. Though these strategies can be more costly in the short run, the use of active cash actually leads to fewer spending mistakes, which saves money in the long term.” Cathy Lockman

•

Microsoft Corp. Google Inc.

Cash and short-term investments (in millions $) $83,944 58,717

Verizon

54,129

Cisco Systems Inc.

47,065

Apple Inc.

40,711

Oracle Corp.

36,974

Pfizer Inc.

32,498

Johnson & Johnson

29,206

General Motors Co.

27,919

Ford Motor Co.

25,116

The Coca-Cola Co.

20,268

Intel Corp.

20,087

Amgen Inc.

19,401

Merck & Co. Inc.

17,486

Chevron Corp.

16,516

Hewlett-Packard Co.

16,165

Boeing Co.

15,225

General Electric Co.

14,005

Medtronic Inc.

13,667

Chrysler Group LLC

13,344

Amazon.com Inc.

12,447

IBM Corp.

11,066

EMC Corp.

10,664

AbbieVie Inc.

9,895

DISH Network Corp.

9,739

Source: StandardandPoors.com

[ 60-SECOND PROFILE ]

240 F INANCE

The number of appearances David Sinow made on WILL AM-580, the University’s public radio station, as a regular guest commentator on wealth management issues for their live call-in show

A DJUNCT P ROFESSOR

48 The number of times David has been named to the University’s List of Excellent Teachers in his 24-year teaching career; he also received the Provost’s Award for Excellence in 2010 as outstanding clinical professor and was named a Top 20 U.S. Business Professor in 2006 by Businessweek

162 The number of miles from the University of Illinois to Dixon, Illinois, where David grew up; when President Ronald Reagan, also a Dixon resident, returned to his hometown in 1982, he autographed a copy of David’s dissertation on international relations and law as a favor to David’s father, Sidney, who had worked on the restoration effort of the Reagan boyhood home

51 The measurement in inches of the biggest muskie this fisherman has caught; David and his wife, Carole, who he says “can outfish him any day of the week,” enjoy angling from their canoe in the backwaters of northern Wisconsin and Canada

10 The number of positions he has held on major charitable foundation boards and financial boards during the last 15 years

9 The number of years he proudly served as a member of the Board of Education for the Mahomet-Seymour school district, just west of Champaign-Urbana

7 20 The number of insurance and reinsurance companies from around the world that have participated with the College’s Office of Risk Management and Insurance Research; David is one of the founders of ORMIR and has served as executive director since its establishment 10 years ago

11 The number of University of Illinois degrees in the Sinow family: David has four— a bachelor’s, master’s, and PhD in political science and a JD; wife Carole has a bachelor’s degree; daughters Renee and Megan and father Sidney are all Illini as well, each of them earning bachelor’s and master’s degrees from the University

David has a front-row seat for fishing while his wife, Carole, a five-time U.S. marathon canoe champion, does the paddling.

Perspectives SUMMER 2014

The number of University of Illinois student start-ups David has counseled or invested in during the past 5 years, including businesses that focus on Internet retailing, real estate computer apps, international legal outsourcing, and even hair extensions

[LEADErShIP]

Name: Chirantan “CJ” Desai Current position: President, Emerging Technology Products Division, EMC Corporation Previous positions: Executive Vice President, Information Management, Symantec Corporation; Vice President, Pivotal Corporation; Director of Products, Oracle Corporation University of Illinois degrees: MBA ’95; Master of Computer Science ’95 In September 2013, CJ Desai was named president of EMC’s newest division, Emerging Technology Products. This spring he visited the College of Business to share his story and expertise with our MBA students. Here he takes our questions about his career path, the opportunities and challenges of emerging technologies in the IT storage industry, and his vision for success.

What is it about the EMC opportunity that excites you most? DESAI: EMC created my division when I joined the company. This division is focused on disruptive technologies, that is, innovations that create a new market and eventually replace earlier technologies. I am excited about the commitment that EMC has made to address the changing IT landscape through such innovation, which may or may not be aligned with the company’s core businesses. EMC reported $23.22 billion in revenues in 2013 and is very focused on helping customers as they take advantage of existing and disruptive technologies. What do you consider the biggest challenge in your industry? DESAI: The IT storage industry is going through a major transformation. Flash media is disrupting disk storage, software-deﬁned storage models are emerging, and the cost to store data continues to drop while performance demands

are increasing. Flash storage provides an order-of-magnitudebetter performance than hard disk drives, which reduces latency and increases throughput. This enables the most demanding and missioncritical applications, such as financial trading systems and transactional databases, to run at a blazing speed. I think we all need to be prepared to redefine storage yet again. We need to get ready for hyper convergence, which will offer the flexibility to deliver storage and computing as one in a time-to-value curve as never seen before. What is a product that EMC has recently introduced that can help transform business for customers? DESAI: Late last year, EMC announced the general availability of our XtremIO All-Flash Array. This is a huge milestone, not just for EMC, but also for the future of the virtualized datacenter. Silicon Valley is abuzz these days with web-oriented companies that can

rapidly prototype their products and make constant changes in real-time as they get feedback from customers. Enterprise storage, on the other hand, must be stable and trustworthy as a platform that a business can operate reliably on for years. It’s a challenging problem to tackle, and start-ups pursuing this market often make critical mistakes. XtremIO can address this problem because of its architecture. EMC’s XtremIO team spent a lot of time thinking about the problems companies were experiencing and architected the foundation of the XtremIO array as the solution, long before they even started writing the code. random I/O performance is certainly one of those problems, but so are scale out, cost, environmental impact, improving the ability to handle dynamic virtual machine cloning, dealing with VMotion operations, and addressing all of these during high-volume production hours. XtremeIO is a real diﬀerence maker.

How would you describe your leadership style? DESAI: I spend a lot of time on hiring team members to ensure that I have a very talented team. My top priority is to establish a team that has a strong dynamic built on collaboration, trust, and talent, and I work relentlessly to develop that atmosphere and working relationship. I communicate often and try to be as transparent as possible so that my team understands the business and situational context. Listening is a particularly important part of my role as well. I pay close attention to what my team is telling me, and I am always learning something from them. In addition, I always seek input from experts while making a decision and spend time teaching my team how to make decisions. What do you look for when choosing members of your team? DESAI: Talent is key in this business, so I look ﬁrst at what they have already accomplished and then assess whether I think

there is potential for them to do even more in the future. The diversity of their work experience is also very important because I’m building a strong team that can be ready to handle a wide range of new challenges. Then I spend time drilling down to assess their work ethic and attitude. Each of my team members brings diﬀerent talents and strengths, but I’m looking for all of them to have the same dedication to hard work, collaboration, and results.

What leaders have inﬂuenced you the most in your career? DESAI: I have been very inﬂuenced and inspired by the leadership qualities of Jack Welch and Colin Powell.

What was a pivotal decision in your career? DESAI: Early on in my career, I worked on a technology product that challenged the conventional products and business models. It was a very high-risk project that did not succeed at the end, but the lessons I learned from it were pivotal to my career. Often, successes don’t teach you as much as risks and even failure.

What is the biggest motivator in your work? DESAI: I am most motivated by focusing on business results. That means doing all I can to position my product to be best in its class, to grow its market share, and to be #1 in the industry in which it competes.

What’s your go-to strategy when faced with a difficult decision? DESAI: My first step is almost always to go to my team and listen to everyone’s opinion and then make the difficult decision with the team’s help.

Perspectives SUMMER 2014

TAKING OUR Qs

[ REALITY CHECK ]

Time is Money

The Effects

The Reality

arlier this year, AOL announced a change to their 401(k) plan. Instead of making an employer match every pay period, the company was moving to a lump-sum, end-of year contribution. After a week of negative publicity surrounding the announcement and the reasoning behind it, AOL leadership reversed their decision, returning to the every-pay-period match. AOL is the latest employer to consider the lump-sum option as a way to contain costs while still providing this important

hat does a change like this mean for employees? According to Scott Weisbenner, professor of finance, “When viewed in isolation, a match paid one time at the end of the year as opposed to continuous payments over the course of the year means a loss in potential returns and in contributions for those who change jobs. But you have to put that change into perspective. The fact that companies provide a match, and some a very generous one, is certainly a big benefit for employees and a big cost for employers.” A study by Vanguard calculates that such a move by companies could reduce 401(k) wealth by 8 percent. That’s based on a model that assumes 7 job changes over a 40-year career (numbers that are backed up by Department of Labor statistics) and the loss of an employer match with each resignation.

benefit to employees. IBM adopted an end-of-year match in 2012

“Those hurt most by a lump-sum payment are likely to be

and, despite some public pressure, has maintained the new policy.

employees who change jobs more frequently,” says Weisbenner,

Less than 10 percent of employers have implemented

a James F. Towey Faculty Fellow. “But in the big picture, this is a

the so-called last-day rule, which in many cases also requires

change that is more palatable to employees than reducing the

employees to be on the payroll on the day that the match is made.

amount of the match. Plus, other changes in the 401(k) landscape

If the employee leaves before that date, they forfeit the employer

have actually added benefits overall, which means a stronger

match. The practice may not be widespread, but it is getting

program for employees and higher costs for employers. There are

attention.

trade-offs that may need to be made to counter those costs, and this may be one of them.” What are some of those additional benefits and costs? Automatic enrollment and immediate eligibility are the biggest. By enrolling all employees right away and not requiring a year of work before matching begins, the companies are increasing participation rates and, thereby, increasing an employee’s 401(k) bottom line. “In general, 401(k) plans are getting more inclusive through adoption of policies like auto enrollment,” says Weisbenner. “This move to lump-sum payments might be a sign of a slight pull back, but from a worker’s perspective, high expense ratios on the mutual funds in their 401(k) plans could have a more negative Any chance the government would step in to force corporations to match on a pay-period basis? Weisbenner says it’s hard

Scott Weisbenner, a James F. Towey Faculty Fellow, weighs in on the impact of the move by some employers to change the timing of their 401(k) matching contributions.

to predict but that such a move could result in unintended consequences, like companies eliminating their match altogether. “A more useful strategy would be to see what firms make this move and what it means for their employees before jumping in and legislating change.”

• Cathy Lockman

Perspectives SUMMER 2014

effect on their portfolios than this change.”

[ LEGACY ] n 1922, Green Street was fairly quiet. The Model T had only been available for just over a decade, so there was no traffic congestion. In fact, the first parking meter wouldn’t even be invented for another 13 years. The 9,500 students on campus could get lunch or a soda at the Mosi-Over, get their portrait taken at the Duncan Studio, stop by the Green Street Tea Pot, visit a dentist, or just take a leisurely stroll. Today’s Green Street is much busier, of course. With more than 44,000 students, dozens of restaurants, stores, banks, and ATMs, and all the busses and cars making their way through campustown, it’s a lively, and often congested, place. This spring a group of six students from the College of Business, the College of Engineering, and the College of Fine and Applied Arts envisioned a calmer, safer, more efficient Green Street. As part of a project for Engineering 333: Creativity, Innovation, and Vision, the students presented a plan that would redesign the area of Green Street from Wright to Fourth Streets as a pedestrian mall with no through traffic. The group believes the change would create a more welcoming atmosphere for students and visitors, provide a safer environment for pedestrians and bikers, and allow for more green space on Green. For merchants, that could mean outdoor seating options and other economic benefits that could result from using the open space for concerts or other events that would bring pedestrians to the area. The idea, the students say, is to make that stretch of Green Street less chaotic by eliminating the parking and traffic issues and to provide a more inviting campustown corridor. Although there is no official plan to make such changes to Green Street, the project has gained some traction on social media and generated some interest in the community. Such ideas are just part of the innovative thinking that goes on in our Business classes on Sixth Street and in classrooms all over campus. Cathy Lockman

Perspectives SUMMER 2014

MORE GREEN ON GREEN STREET?

[ ETHICS ]

Stopping the Fraud Spiral

•

“This work is part economics, part human behavior.” Jon Davis

ables. The use of ABM confers an additional advantage: It allows us to gain insights into fraud even when data in organizations are censored.” Davis explains that when you’re making assumptions about individual behavior, it’s important to take a straightforward approach and create a simple model. “This work is

part economics, part human behavior. If you get too complicated, you don’t understand what’s happening,” he says.

STRATEGIES THAT WORK Through their research, Davis and Pesch found four strategies that worked to control fraud:

Launching programs to root out the offenders and fire them. This strategy could reduce existing fraud to near zero, the researchers reported, but in the long-term, it wouldn’t stop an occasional outbreak of widespread fraud. • Creating grass-roots programs to instill an anti-fraud ethic in employees. The goal is to “inoculate” employees so that they will reject overtures from coworkers to join fraudulent schemes. “The key is that word gets around that fraud is unacceptable,” says Davis. • Hiring top managers who think fraud is wrong. • Reducing the opportunity for individuals to commit fraud. “All of these worked to some extent,” says Pesch. “But the two that reduced fraud the most were ethical training and firing. However, these two didn’t work equally well in all cases.” Ethical training worked best in corporations where employees have the ability to influence one another, she says. “If it’s an organization where employees are not especially susceptible to social influ-

ence, ethical training wasn’t particularly effective. In those organizations, detection and firing worked best.” Both ethical training programs and detection efforts require companies to invest manpower to save money in the long run. It takes fraud investigators to uncover offenders and staff time to instill an anti-fraud ethic in the rank and file. The latter is “a heavy lift,” says Davis. “You have to go out and change a lot of people’s ideas of what’s acceptable and what’s not. It’s not just a code of ethics. That’s just window dressing for organizations. This is about influencing individuals within organizations.”

INOCULATING AGAINST OUTBREAKS Past studies have suggested that fraud is a fact of life, omnipresent in corporations around the world. The trick is to keep it from spiking, and that’s where the work of Davis and Pesch comes in. “We looked at when fraud becomes widespread,” says Pesch. “Then we focused on what controls we can put in place to stop that spike.”

“The two [strategies] that reduced fraud the most were ethical training and firing.” Heather Pesch

When fraud escalates it can undermine a company. Thefts of equipment, padded expense accounts, and embezzlement erode profitability from within. Worldwide, such losses have been estimated at more than $3.5 trillion, equal to about five percent of revenues on average. That significantly erodes profit margins.

When the fraud is committed by the corporation itself, it invites negative publicity, regulatory action, lawsuits, criminal prosecutions, and large fines and judgments. Examples of fraud by corporations include price fixing, paying bribes to get business, and cooking the books to deceive investors. Enron, for instance, pre-

sented a facade of solid profitability when in fact it was going broke. “There was a culture at Enron among a group of people that viewed certain things as acceptable,” says Davis. In many ways, the researchers’ findings mirror what we experience growing up. If lots of kids use drugs, then it’s hard for other kids to resist peer pressure to use drugs as well. Conversely, if most kids think drugs are bad, then drug use is less likely to spread. “Peers are really important in terms of influencing behavior,” says Davis. Corporations work the same way, the researchers found, which is why ethical training was so effective. Davis likens ethical training to disease inoculation programs. “If you inoculate enough people, you don’t get outbreaks of disease.” Similarly, if you convince enough employees that fraud is wrong, you don’t get outbreaks of fraud, he says. This approach has a secondary benefit—it creates an environment where whistle blowing is more likely to occur. This helps weed out bad apples, says Pesch. “Whistle blowing is the most likely way that fraud will be uncovered.” • Doug McInnis

Perspectives SUMMER 2014

orporate fraud comes in two flavors. In the first, employees bite the hand that feeds them. In the second, the business itself engages in unethical behavior. Now a new study from the College of Business says that a multifaceted strategy can do much to keep both types of fraud from spiraling out of control. The research, conducted by Jon Davis, R.C. Evans Endowed Chair in Business, and Heather Pesch, assistant professor of accountancy, was published in the journal Accounting, Organizations and Society. To conduct the research, Davis and Pesch used agent-based modeling, a computer-generated analysis that models human behavior. The technique, which is relatively new in accounting studies, provides researchers with a view of the bigger picture based on small-scale interactions. Pesch says ABM “is well suited to address questions involving organizational outcomes, such as a culture of fraud, resulting from the interactions between individuals within an organization and organizational vari-

[THE MAIN EVENT ]

Global Reach MAKING A DIFFERENCE IN SUBSISTENCE MARKETPLACES

“The idea of being able to use business to improve the lives of people who are living in the world’s harshest conditions is a challenge that I find really attractive and rewarding.” Seth Faber

R. Venkatesan knows all about living in subsistence. Growing up, he shared a 200-square-foot room with his family of six. They had no electricity for 15 years, shared a toilet with 10 other families, and struggled daily for food. He had no shoes or sandals. What Venkat learned growing up informs his work as an expert in subsistence marketplace literacy. In fact, he has written a book on the topic. According to his coauthor, Madhu Viswanathan, the Diane and Steven N. Miller Endowed Professor of Business Administration, Venkat is “a pioneer in enabling marketplace literacy among lowliterate, low-income individuals in India.”

Perspectives SUMMER 2014

Srini Venugopal, Esi Elliot, Seth Faber, and Madhu Viswanathan were among the presenters and participants at the Fifth Subsistence Marketplaces Conference.

“There’s a purpose to academics, and it’s not just to do research and teach. It’s about actually making a difference in the lives of consumers around the world.” Esi Elliot

GIVING BACK Seth Faber, MBA ’13, traveled to India to conduct field research as part of the Sustainable Marketplaces Lab course he took under Viswanathan. A conference panelist this year, he echoes Elliot’s sentiment about creating value for consumers. “The business efforts focusing on subsistence marketplaces have this incredibly unique challenge of being both profitable and having a positive impact,” he says. “The idea of being able to use business to improve the lives of people who are living in the world’s harshest conditions is a challenge that I find really attractive and rewarding.” Having that positive impact can often be translated as “giving back” —which is a major theme of all of these conferences. “One thing I’ve learned from Madhu is how to give back,” says Faber. “He’s from the Chennai area, and he’s been able to give so much back to that area, and do it through his current work on the other side of the world. He sets the bar high for

giving back and for ensuring that his work outlives his own life. That’s true success. He redefined how I view success.” Faber adds that consumers in subsistence markets think differently. Their constraints have caused them “to be quite innovative and resourceful; they are able to do more with less.” And that has an impact on product manufacturers, Faber says. “We have to be better at meeting the demands of these markets. Their resources are limited, but their needs are high, so as product manufacturers we have to be innovative in improving the benefit-to-price ratio of our offerings.” Faber’s research project in India was for Wahl Clipper Corporation. The company hired Faber after he graduated to help Wahl continue its efforts at the subsistence level. “I’m trying to champion ideas and efforts that involve inclusive business and reverse innovation and working on strategy as to how we can implement those ideas profitably at the subsistence level,” he says.

Another thing that Faber and the other participants in the conference have learned is that you can’t approach a subsistence marketplace as you would any other marketplace. “When companies look at the income levels and wealth present in subsistence markets, they immediately think of how to lower price,” Faber explains. “Yes, price is important, and I believe there’s a limit to how high price can be, but equally important is value. I’ve learned that consumers in subsistence markets want more than a low price; they want a degree of quality, they want service, and sometimes they even want certain product features.”

MAKING THINGS HAPPEN Viswanathan, who initiated the first subsistence marketplaces conference in 2006 and has been the driving force behind all five conferences to date, says the uniqueness of the conferences is their bottom-up approach. “Many people have looked at business and poverty,” he says. “But we have created a space where we take this bottom-up approach, and we challenge ourselves on what we mean by the micro-level understanding of that bottom level, whether it is how people feel or how they think, and so on.” The biggest takeaway, he adds, is having participants “change the way

they think, and that applies to all of us in terms of pushing us out of our comfort zones and then maybe envisioning different pathways in terms of our research and our teaching and our social initiatives. So that is the biggest takeaway, to really make people think and hopefully act as well after that.” Elliot agrees. As a former head of the microenterprises division in a financial services firm in Ghana, she

A PhD student working with Viswanathan, Venugopal grew up in India and saw poverty all around him. As a result, he developed a passion around entrepreneurship and poverty. He has been involved in the last three conferences and says that the conference has been instrumental in choosing his career pathway. “I found in the conference and the broader community a nurturing en-

“This conference has never been about one small area within a single discipline. For every person who does research, we want a practitioner who can give us insights from their experience.” Madhu Viswanathan finds that the subsistence marketplaces conference deepens her understanding of how to unleash and create resources to reduce worldwide poverty. “We make things happen by getting involved,” she says. “The world will not get any better if we just let it be. We have to make things happen, and that’s what the subsistence marketplaces conference is doing—making things happen, not just watching things happen.” Srini Venugopal, MBA ’11, is someone who makes things happen.

vironment to not just present my work, but to engage with others— scholars and role models who pursued this pathway and made a success of it,” he says. Venugopal notes a distinction of the subsistence marketplaces conferences. “Research in the business schools has largely ignored the marketplace activity and experience of people who live in poverty,” he says. “The subsistence marketplaces conference was one of the first to provide a home for scholars within business schools to conduct research

ENTREPRENEURIAL VIBRANCY “It’s funny that I had to come all the way to Champaign to find a nurturing environment for my passion,” says Srini Venugopal, who grew up in India. “I’ve always been fascinated by the entrepreneurial vibrancy in these subsistence marketplaces. It’s common to see people living in poverty engaging in entrepreneurial activities to make their lives better.” Venugopal, a PhD student in the College, is conducting research on entrepreneurship in the context of poverty. He points out that poverty is a subjective experience—“the experience of a female immigrant in the United States would be different from that of a local Caucasian male, for example”—and notes that ingenuity runs high among subsistence entrepreneurs. For example, female Haitian immigrants in Miami have started “home restaurants”—making meals for single Haitian migrant workers who can get a meal for about two dollars in the home, and then go. “There’s a lot of creative and entrepreneurial activity on the part of the poor to make their circumstances better,” Venugopal says.

“[Subsistence marketplaces] deserve to be studied as marketplaces in their own right. Most of the people in the world are exchanging in this way; it’s been going on for ages.” Madhu Viswanathan

Perspectives SUMMER 2014

For 13 years, Venkat has worked with Viswanathan’s Marketplace Literacy Project. “He has led multiple research projects, designed and facilitated numerous student immersion trips to India, and helped create video-based lessons on marketplace literacy,” Viswanathan says. Earlier this summer, Venkat shared that knowledge and experience with others as a presenter at the Fifth Subsistence Marketplaces Conference held in Urbana-Champaign and sponsored by the College of Business. Viswanathan says Venkat personifies what this conference is about: giving back, helping out, empowering. Making a real difference in people’s lives. Not just a theoretical difference. “There’s a purpose to academics, and it’s not just to do research and teach,” says Esi Elliot, assistant professor of marketing at Suffolk University, who was attending her third subsistence marketplaces conference. “It’s about actually making a difference in the lives of consumers around the world.” She adds that while profit is the name of the game for marketers, through the ideas shared at the conferences, “marketers are not just making profit, but creating value around the world for consumers.”

[ THE REASON WHY ]

PRESCRIPTION FOR SUCCESS

SMART STRATEGY Brown ’90 ACCY was named CFO of Perrigo in July 2006. Since that time, company revenues have nearly quadrupled, earnings have grown five-fold, and employment has grown 57 percent (to nearly 10,000 employees). Perrigo has acquired 17 other companies, and they now have more than a 70 percent share of the over-the-counter generic drug market in the United States.

What’s the secret to Perrigo’s success? “We do what we know how to do and we do it well; provide the highest-quality products, great customer service, invest in innovation, and be smart in what/how we spend,” says Brown. “It’s hard to compete with us because of our relative cost-effectiveness and efficiency— we produce over 48 billion tablets a year.” If Perrigo is a well-kept secret, Brown isn’t—at least within her industry. She was named the #1 CFO on the sell-side in pharmaceuticals for 2014 by Institutional Investor (who ranked her #3 in both 2011 and 2012). The media conglomerate also recognized her for “Top Investor Relations by a CFO—Mid Cap” in 2012. But her favorite award is being ranked #21 on The Wall Street Journal’s 2012 list of Best CFOs. Brown is quick to deflect praise onto her team. “I’m the face of the finance function,” she says, “but the team that we built over the years can stand up to absolutely anyone on that one-to-twenty list.” She has always had a keen eye for opportunity, is a master strategist and exceptional leader, and knows when to go with her gut—all great attributes for a CFO of a fast-growing company.

OPPORTUNITY KNOCKS Brown knows how to recognize and seize opportunities, starting with her decision to attend Illinois in the late 1980s. “I didn’t know, at eighteen, what I wanted to do, but Illinois was attractive to me because I knew it would provide me a lot of options.

I was a very practical person, even as a teenager.” She spent nine years with Ernst & Young and six with Whirlpool. “With both companies, I was an expat as well as a U.S. employee,” she says. She spent 10 years in Europe, learning German and Italian along the way (“learning foreign languages teaches you humility because you are now the least eloquent person in the room by miles!”), and meeting her eventual husband, an ex-pat himself who still works for Whirlpool. Brown and her husband had been back in the United States for about 18 months when opportunity knocked again—or, rather, called. “I got a call from a company in Michigan I’d never heard of: Perrigo,” she says. “I told them no. They said let’s do lunch. So I said fine, I’ll take lunch.” She came away impressed with Perrigo’s business model and its “fun, Midwestern, down-to-earth, nonbraggadocio approach.” It didn’t hurt that the sitting CFO told her he was going to retire soon and he wanted her to succeed him. “I liked who they were as people, I liked their DNA, I really liked the energy of my soon-to-be boss, so I joined, and the rest is history.” And so the Midwestern girl— born and raised in Dolton, Illinois— who had lived for 10 years in Europe, came back to her roots, hit the ground running (she immediately flew to Israel to be part of a negotiation there), and hasn’t stopped since.

SEEING THE BIG PICTURE In June 2011, Brown received a call from Michigan Congressman Dave Camp’s office, asking her if she’d like to testify before the Committee on Ways and Means on how business tax reform can encourage job creation. She leapt at the opportunity because she has strong feelings about the tax policies that put U.S. businesses at relative disadvantage with foreign companies. “I spoke on behalf of Perrigo about how passionate we felt about continuing to grow and invest in the U.S. and abroad and pointed out the idiosyncrasies that discourage such investments. I viewed it as my civic duty to have this dialogue,” she says. “I get to go to Washington regularly, but this was exciting because we were asked to have a direct voice in these serious discussions and debates.” It is no less exciting for Brown to show up for work in Allegan, or wherever her travels for Perrigo take her. “I love my job,” she says. “With our tremendous growth, that means every day is different. We spend a lot of time looking forward—my team works to skate where the puck is going, versus where it is.” As busy as Brown is, she is making time for the university that acted as the springboard for her career. She recently returned to Illinois and spoke to an international finance class about cross-border deals, and she hopes to return again. She particularly wants to encourage students to consider ex-pat jobs: “Try it, because when you’re 22, you don’t have a lot to lose,” she says. It certainly worked for her. Tom Hanlon

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WHAT Has been recognized across the industry for her work, including numerous recognitions from Institutional Investor as well as being named to The Wall Street Journal’s list of Best CFOs WHERE Allegan, Michigan WHEN Graduated from the College in 1990; spent nine years with Ernst & Young and six years with Whirlpool; joined Perrigo in 2006 WHY Testified before Congress because of her conviction that current U.S. tax policies put American businesses at a disadvantage with foreign companies

Perspectives SUMMER 2014

errigo is one of the most successful companies you’ve never heard of. Its U.S. headquarters is tucked away in tiny Allegan, Michigan—not far from the shores of Lake Michigan, but light years from anything beyond a 20-second traffic jam. Yet it does all right for itself, developing, manufacturing, and distributing more than 1,000 over-thecounter and generic prescription pharmaceuticals as well as many other healthcare products. And it’s gone from a $900 million run rate in 2004 to about a $4 billion run rate today. Perrigo’s reach is broad, deep, and essentially invisible because its products are labeled with contracting retailers’ names. How broad and how deep? Well, every second of every day, over 1,600 Perrigo products are being consumed. It has what it believes to be the fourth-largest pharmaceutical manufacturing footprint in the world. And Judy Gawlik Brown has played a critical role in enlarging that footprint.

WHO Judy Gawlik Brown, Executive Vice President and Chief Financial Officer, Perrigo Company plc

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PARTING SHOT

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What are you carrying? During the poverty simulation exercise at the recent Subsistence Marketplaces Conference hosted by the College of Business, this attendee carried a baby. It signified his role as a child in a family of four as they navigated the requirements of service providers while balancing the realities of daily life. It was a powerful way to address the challenges of those carrying the burden of poverty.