lien tran thi hong and holloway - 2014 - developments in corporate governance - the case of vietnam

Therefore, a thorough investigation into the corporate governance policies and practices of listed companies in the country should be of interest to different stakeholders, such as inter

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CORPORATE OWNERSHIP & CONTROL

Volume 11, Issue 3, 2014, Continued - 2

Tran Thi Hong Lien, David A Holloway

Helan Ramya Gamage, Ananda Wickramasinghe

DIVIDEND TAX, DIVIDEND PAYMENTS AND SHARE VALUES: A SOUTH AFRICAN

Me Stéfani Coetzee, Johannes de Wet

Pravina D Oodith, Sanjana Brijball Parumasur

Surjit Tinaikar, Kun Yu

Wei Wang

DEVELOPMENTS IN CORPORATE GOVERNANCE: THE CASE

Keywords: Corporate Governance, Public Companies, Government, International Institutions,

Corporate governance has come a long way in both

developed and developing nations in the past three

decades (Solomon, 2007; Tricker, 2012) A series of

spectacular corporate failures across the globe in that

period of time has acted as a catalyst for the

establishment of a range of enquiries across different

nations that have crafted recommendations to develop

sets of principles, guidelines and codes to help

construct a ‘best practice model’ of corporate

governance (Clarke, 2007; Dallas, 2004a; Hamilton &

Mickletwait, 2006; OECD, 2004; Psaros, 2009;

Solomon, 2007; Tricker, 2012) The major part of

this work on a best practice model has occurred in the

Western developed nations The question that

remains unanswered is whether such a model is

capable of being imported without major change into

other regions of the world and used by developing

nations in their own evolving corporate governance

frameworks

This paper investigates the situation in Vietnam

and argues that a ‘one size fits all’ model is not

necessarily the best approach for this developing

nation We argue that there are key features and

cultural contexts in the country that need to be taken

into account when promoting appropriate corporate

governance policies and practices in the corporate

sector In the end, we also acknowledge that

performance and behaviour in the corporate governance field cannot be legislated for and needs to

be nurtured and encouraged across the country Vietnam provides effective case studies to assess to what extent Western developed corporate governance codes and practices are relevant to this vibrant, regional nation state

This paper consists of several parts The first, deals with the background literature of corporate governance internationally and then corporate governance developments in Vietnam The next section highlights and analyses the history of corporate governance and the emergence of joint stock companies in the country The following part focuses on three key elements (government, international institutions and the nature of business) that have emerged as central to the Vietnamese corporate governance context Then a discussion section deepens the analysis and features a case of serious fraud that raises serious questions about the embedding of effective and ethical behaviours in the corporate governance arena The final part concludes that Vietnam still has a longer journey to undertake effective corporate governance reform and to embed acceptable ethical behaviours in public companies

2 Literature Review

2.1 Corporate Governance

Corporate governance literature has identified a range

of different issues and perspectives There are several

theories about the corporate governance phenomenon

including agency, transaction costs economics,

stewardship, resource dependency, stakeholder,

managerial hegemony and class hegemony They

encompass different dimensions such as the role of

corporate governance in organisations and the role

and purpose of boards, theoretical origin, unit of

analysis, focal dimension, details about board activity,

level of empirical support and they also identify a

range of limitations about the appropriate application

of theory (Clarke, 2007)

There is an acceptance that agency theory is the

most prevalent theoretical lens used in corporate

governance research (Bebchuk, Cohen, & Ferrell,

2009; Claessens & Fan, 2003; Clarke, 2007; Mallin,

2013; Monks & Minow, 2004; Psaros, 2009;

Solomon, 2007; Tricker, 2012) Utilising this

theoretical insight, corporate governance issues and

concerns emerge because of the inappropriate

relationship that exists between the principal and the

agent The principals are considered to be the

shareholders (owners) and board of directors; whilst

the agents are members of senior management The

theory argues that the agents have their own personal

goals that are not the same as, or aligned with, those

of the principals, so they do not always act to advance

the interests of the principals In other words, the

agents act primarily to advance their own

self-interests

When this relationship imbalance occurs,

shareholders, corporation and economies can suffer

financially from illegal and/or unethical events such

as fraudulent accounting, insider trading,

unauthorized transactions and ultimately corporate

failures, as demonstrated by the Barings and Enron

scandals (Gourevitch & Shinn, 2005; Hogan, 1997;

Tricker, 2012) Avoidance of these negative

consequences requires that the principals/shareholders

need to exercise control over senior management

through a range of mechanisms; one of which is

effective corporate governance

Corporate governance issues emerge because of

the separation between ownership and management

(Gourevitch & Shinn, 2005; Solomon, 2007; Swan,

2000; Tricker, 2012) This separation can be traced

back to the formation of joint stock companies in the

17th century Increasing concentration of economic

power into ever larger corporations was accompanied

by a dispersion of ownership; individual shareholders

gave the power to blockholders and senior managers

who took daily charge of corporate operations (Berle

& Means, 1933) Berle and Means (1933) also

predicted that corporations would become dominant

institutions like nation states and religions

Controllers (managers) of corporations must balance the interests of the community, not just those of the owners or the controllers In other words, corporations need to take into account owners, management, employees and a range of other stakeholder groups This concept and argument led to the emergence

of the “Multi-stakeholders” theory of corporate governance “Corporate governance is defined as the system of checks and balances, both internal and external to companies, which ensures that companies discharge their accountability to all their stakeholders and act in a socially responsible way in all areas of their business activities” (Solomon, 2007, p 14) The Organization for Economic Co-operation and Development (OECD) and the World Bank, two active promoters of good corporate governance practices on a global scale, have identified a list of these stakeholder groups that include management, the board of directors, controlling shareholders, minority shareholders and other stakeholders such as creditors, financial institutions, employees, trade unions, public interest groups and general society Corporate governance processes and activities need to take into account the relationships between these diverse parties as they are affected by the very same structures and processes that impact the direction and control of companies (The World Bank, 2006) Whilst agency theory has equivocal empirical evidence and has been heavily critiqued, multi-stakeholder theory has received solid support in the literature (Zahra & Pearce quoted by Clark, 2007, p 28)

Taking a further step, some researchers advocate using a mix of theories for empirical investigation “A multitheoric approach to corporate governance is essential for recognising the many mechanisms and structures that might reasonably enhance organizational functioning” (Daily, Dalton & Cannella quoted by Clark, 2007, p 26)

Serious corporate governance concerns and scandals have emerged during the past three decades Corporate governance issues came to the fore after a series of spectacular corporate failures and scandals in leading corporations such as Barings (UK), Allied Irish Bank (Irland), Enron (US), WorldCom (US), Tyco (US), Marconi (UK), Swissair (Switzerland), Royal Ahold (Netherlands), and Parmalat (Italy) Several elements had been attributed as the root causes for the scandals such as corporate overexpansion; over dominant CEOs; greed, hubris and desire for power; failure of internal controls, and ineffective boards (Hamilton & Mickletwait, 2006) Fraudulent accounting techniques were often used to conceal serious financial and governance problems Poor external auditing practices also allowed problems to remain hidden and prominent rating agencies also failed to provide early warning of troubles ahead (Hamilton & Mickletwait, 2006) As a result there emerged a demand for serious reform of corporate governance principles and practices A

series of enquiries and government initiatives

identified that the solution should be at the macro

level by constructing best practice codes of corporate

governance

In as much as companies are “social

institutions”, their impacts on societies and economies

are so significant that corporate governance problems

attract the attention and intervention of governments

in resolving these concerns There has been a

proliferation of corporate governance codes and

policy documents, voluntary or mandatory, both at the

national and supra-national levels (Solomon, 2007)

At least 96 nations have developed what they deemed

to be appropriate corporate governance codes (ecgi,

2013)

The United Kingdom is generally acknowledged

as a world leader in corporate governance reform, as a

result of a growing stakeholder interest in corporate

governance issues within the boardroom, the

institutional investment community and the

Government (Solomon, 2007, p 49) The most

prominent countries in the reform movement, besides

the United Kingdom, are the United States, Japan,

Switzerland, South Africa and Korea, and most of the

extant literature has focused on these developments

However, other countries such as Russia, China, India

and Brazil have also emerged as new locations for

corporate governance research and reform (Claessens

& Fan, 2003; Monks & Minow, 2004; OECD, 2001,

2011; Shleifer & Vishny, 1997; Solomon, 2007;

Tricker, 2012)

Different reform approaches emphasize different

aspects of corporate governance codes and practices

The focus is on ensuring a sound basis for an effective

corporate governance framework, enhancing the

rights of shareholders and key ownership functions,

the equitable treatment of shareholders, the role of

stakeholders, disclosure and transparency, as well as

the responsibilities of the board (OECD, 2004)

Tricker (2012) identified six areas for improvement,

including clarification of the board role, the board’s

access to information and understanding of the

organisation, enhancing good relations between

boards and management, effective board oversight of

company strategy, appropriate management

development, and succession and risk management A

narrower focus considers only shareholders and

ownership, directors and monitoring, management

and performance (Monks & Minow, 2004) Padgett

(2012), however, argues that corporate governance

reform should focus on issues to do with ownership,

the board of directors, stakeholders, remuneration, the

market for corporate control, regulation, and

communication and disclosure Mallin (2013) also

includes institutional investors in shareholder and

stakeholder perspectives

Corporate governance does matter and there is

no “one size fits all” concept A holistic approach that

incorporates multiple explanatory factors and

stakeholder groups would be a reform process that

can deliver an effective solution in the longer term (Dallas & Patel, 2004), p 13)

2.2 Corporate governance – Country Assessement

Corporate governance alternative systems are classified as Anglo-Saxon, Germanic, Latin and Japanese with acknowledged differences in their orientation, representative countries, prevailing concept of the firm, the board system, main stakeholders that exert influence on managerial decision-making, importance of stock and bond markets, market for corporate control, ownership concentration, compensation based on performance and the time horizon of economic relationships (Clarke, 2007) Researchers generally agree that the main categories of corporate governance in the world consist of models from the Anglo-America, Continental Europe, Asia Pacific, emerging markets and transition economies (Clarke, 2007; Dallas, 2004a; Lou, 2007; Psaros, 2009; Solomon, 2007; Tricker, 2012)

Different countries start their corporate governance reforms in different ways Many governance reformers have cited the Cadbury Report

1992 in the United Kingdom as a key development in the modern literature on corporate governance This code, and the development of the U.K Combined Code which was to follow, was formulated as a response to several visible U.K corporate failures of the late 1980s and early 1990s (Dallas & Patel, 2004) Similarly, regulatory reforms in the United States following the corporate failures in that country were

an effort to stabilise the financial markets

In Europe, several countries’ corporate governance codes and other efforts were inspired by the code in the UK and US (Clarke, 2007) “At the beginning probably there was a sense of simply matching the regulation of close economic neighbours

by developing similar codes, however over time it is likely that the engagement in the codes became more real” (Clarke, 2007, p 175-176)

In Asian countries:

“a range of external agencies have an interest in sustaining the reform process including the IMF, World Bank, and Asian Development Bank, and they have all engaged in major initiatives to facilitate and support the reform process Moreover, international investors will not be sumpathetic to economies that are not consistently raising their standards of corporate governance” (Clarke, 2007, p 207-208)

In addition as Dallas argued:

“Country factors can play important, even determining, roles in setting the environment for corporate governance practice at the individual company level Attitudes toward corporate governance can vary from country to country Diverse country forces – legal, political, historical, cultural – come together to shape ownership structures,

stakeholder priorities, and fundamental attitudes

toward the role of the firm in the economy” (2004a, p

138)

Currently there are two major frameworks in

use: one incorporates rules based approach and the

second uses a principles-based approach In addition,

the main areas of focus are market infrastructure,

legal infrastructure, regulatory infrastructure and

information infrastructure (Dallas, 2004b) Also, there

are the two analytical processes of modeling and

clinical/interactive approaches (Dallas, 2004b)

Finally, there are varying country perspectives

and drivers in relation to corporate governance

initiatives such as Standard and Poor’s Sovereign

Credit Ratings, World Bank’s Rule of Law

Regulatory Indicators and Transparency

International’s Corruption Perceptions Index (Dallas,

2004a) The Organisation for Economic Co-Operation

and Development (OECD) is a major player in the

area of country assessment with a system of national

reports, regional roundables (Asia, Eurosia, Latin

America, Middle East and North Africa and South

Africa) The assessment is also based on the main

aspects of legal and regulatory system and economic

conditions

2.3 Corporate Governance in Vietnam

Vietnam is still an under-researched location in the

literature on corporate governance For example, the

book, Corporate Governance and Accountability

(Solomon, 2007), provides an analysis and overview

of corporate governance developments in 36 countries

around the world, including not only developed

countries but also developing or transition countries

such as Poland, Thailand, Indonesia and Hungary

Vietnam is, however, not included

A similar omission occurs in some of the more

highly cited papers on corporate governance, such as

Shleifer and Vishny (1997) and Porta et al (1998)

For instance, in "A Survey of Corporate Governance",

the authors investigated corporate governance through

a major review of published studies mainly from the

United States, United Kingdom, Japan, Sweden and

Russia; they felt it “unfortunate” that there is little

research from the rest of the world (Shleifer &

Vishny, 1997); and, of course, there were no studies

about Vietnamese corporate governance In “Law and

Finance”, the authors used a sample including

non-financial listed companies from 49 countries in

Europe, North and South America, Africa, Asia and

Australia; there were no socialist or transition

economies (Porta, Lopez‐de‐Silanes, Shleifer, &

Vishny, 1998); obviously, again, Vietnam was not

included

In some studies focusing on the Asia-Pacific

region, such as "Corporate Governance in Asia: A

Survey" (Claessens & Fan, 2003) and “Corporate

Governance in Asia: A Comparative Perspective

(OECD, 2001), the authors discussed and analyzed

Vietnam’s neighboring countries such as China, Japan, Thailand, Malaysia, Singapore, Korea and Indonesia but not Vietnam itself In addition, since

2006, the OECD has published a series of reports on corporate governance in the region (OECD, 2011), in which Vietnam is more frequently mentioned as a participant in the surveys The reports show progress

in the region based on six main corporate governance principles recommended by the OECD; however, there are no major studies of corporate governance in Vietnam

What has led to this outcome and gap in the literature? Most of the leading international studies are based on previous studies published in leading journals, conferences, books and reports; these publications have not been extended into the Vietnamese context Therefore, a thorough investigation into the corporate governance policies and practices of listed companies in the country should be of interest to different stakeholders, such as international academics, policy makers, and investors and an effective contribution to closing this gap

In 2006, the World Bank issued a Report on the Observance of Standards and Codes (ROSC) – Corporate Governance Country Assessment on Vietnam The corprorate governance frameworks were benchmarked against the OECD Principles of Corporate Governance: the main areas for focus included ensuring the basis for an effective corporate governance framework, the rights of shareholders and key ownership functions, the equitable treatment of shareholders, the role of stakeholders in corporate governance, disclosure and transparency and the responsibilities of the board The report analysed four keys issues relating to investor protection, disclosure, enforcement and company oversight and the boad The report also made several policy recommendations (The World Bank, 2006)

3 Analytical Overview of the Development

of Corporate Governance in Vietnam

On a narrow scope, corporate governance issues relate mainly to public companies The definition of a public company is enshrined in Article 25, section 1, Law on Securities (Quốc hội khóa 11, 2006) :

A public company means a shareholding company which belongs to one of the following three categories:

(a) A company which has made a public offer

of shares;

(b) A company which has shares listed on the Stock Exchange or a Securities Trading Centre; (c) A company which has shares owned by at least one hundred (100) investors excluding professional securities investors, and which has paid-

up charter capital of ten (10) billion Vietnamese dong1

3.1 Securities Markets Development

One critical feature of joint stock companies is that

their shares can be transferred freely between

different parties This enables the number of

shareholders to range from three to an unlimited

number When the number surpasses the threshold of

100, a company is a designated as a public company

Traditionally, Vietnamese do business and trade

with people they know personally; personal

relationships are considered a requirement for

ensuring credibility and trust among parties When

capital source funding from this group is not

sufficient for a particular business, company owners

and managers then look for investment funds from

outsiders These outsiders are also looking for

credible partners in which to invest The two parties

then agree on a mechanism for ensuring credibility

other than the usual personal relationship Securities

markets with prescribed financial functions of listing,

public offering, and share auction are such a

mechanism since this mechanism is backed by the

Government In fact, both of the securities exchanges

in Vietnam are one-member limited liabilities

companies with 100% State ownership with the

government represented by the Ministry of Finance

(Hochiminh Stock Exchange, 2013)

The first securities exchange of Vietnam was

opened in Ho Chi Minh City in 2000; the second one

was in Hanoi and came into operation in 2005 A

central over-the-counter exchange system (UPCoM)

was also opened in 2009 under the management of

Hanoi Stock Exchange The Law on Securities was

passed and promulgated by government in June 2006

and subsequently amended in November 2010 This

provided the legal and enhanced framework for

securities markets in general and markets for public

companies in particular

At the start, there were only two companies

listed on the Hochiminh Stock Exchange By April

2013, there were 702 listed companies on both

exchanges, accounting for 55% of all the public

companies in Vietnam This is evidence of the

exchanges’ influence on the development and growth

of public companies across the country

Enterprises (SOEs) and the Formation of

Public Companies in Vietnam

The transformation of state-owned enterprises into

joint stock companies in Vietnam was conducted via

several careful steps including “test” (1990), “trial”

(1992) then equitization (in other words,

privatization) on a large scope (1996-1998) (Chính

phủ, 1996; Chủ tịch Hội đồng bộ trưởng, 1992; Hội

đồng bộ trưởng, 1990)

From 1998 to 2007, equitization was conducted

on large scale (Chính phủ, 1998, 2002, 2004)

Conditions were lowered to allow legal entities and

natural persons to have rights to buy shares All small and medium enterprises in industries that the Government did not need to keep under 100% government ownership were part of the equitization scheme However, the biggest corporations were not

on the list In 2007, big corporations with 100% state ownership were then put on the equitization scheme considerations (Chính phủ, 2007, 2011) Some of the big ones that were sucessfully equitized and listed are Vietcombank, Military Bank and Vietinbank There are many other large entities that are expected to be part of large IPO offerings in the future, such as Vinaphone, Mobiphone, Vietnam Airlines, BIDV and Agribank

In 2012, the Prime Minister approved a scheme for re-structuring state-owned enterprises and corporations in the period up to 2015 with an important focus on classifying them into sub-categories in which the Government maintains either 100%, 75%, 65% and 50% ownership (Thủ tướng Chính phủ, 2012) The equitizations program should have been finished in 2010 However, the equitization process has slowed down because of the large scale and complexity of the remaining corporations The scale of the new scheme is such that one cannot expect the equitization/privatisation process to be completed before 2020

The equitization schemes have transformed a significant number of SOEs into joint stock companies including public companies Thirty companies form the VN30 indice baskets of the Hanoi Stock Exchange and the Hochiminh Stock Exchange

as at April 2013, with each basket containing 16 companies that used to be state-owned enterprises that were privatised VN30 indices are calculated based on the 30 top shares in terms of market values which accounts for about 80% of total market value and 60%

of total trading value (Sở giao dịch chứng khoán thành phố Hồ Chí Minh, 2013)

In addition, most of the listed companies outside the VN30 baskets were also formed as part of the equitization process This development provides evidence of the crucial nature of the contribution of equitization schemes in helping to establish a robust group of public companies in Vietnam

3.3 Typical Features of Corporate Governance of Public Companies in Vietnam

As part of this development phase, the evolution of corporate governance in the public sphere in Vietnam highlights three key features that are analysed in the following sub-sections

Leading Role of the Government

The government of the day is the prime initiator when

it comes to making laws that embedded key corporate governance principles and practices Governments

around the world carry out this key role through the

enactment of laws and through court processes that

ensure a central role in creating principles and codes

for corporate governance in all nations (Gourevitch &

Shinn, 2005) If the private “bonding mechanism” is

effective, then the role of politics and laws are less

important; if, however, this mechanism is not

effective then solutions to such a problem require the

enactment of effective laws (Gourevitch & Shinn,

2005)

In the 20-year development of public companies

in Vietnam, the government opened the way for the

creation of joint stock companies, and also supplied

the markets with the very first public and listed

companies and created the biggest public companies

through the privatisation of SOEs The government

has also created the framework, and principles for

corporate governance and guided the markets to

conform with these codes

The establishment of a corporate governance

framework has achieved significant progress in a

medium time frame In 2006, the “legal framework

and institutional foundation for capital market in

Vietnam is in its initial development” (World Bank,

2006, p 1) The legal framework for corporate

governance is regulated by the Law on Enterprises

enacted in 2005, the Model Charter 2002 and the Law

on Securities 2006 Vietnam has had to confront

major challenges in enforcing laws, enhancing

institutions for administration, compulsory law

enforcement, and market development as well as

promoting good corporate governance

In 2012, six years after the previous comment,

institutional framework for effective corporate

governance has been issued In fact, administrative

agencies have implemented active measures for the

last years in issuing appropriate documents on

enhancing corporate governance In 2010, Laws on

Credit Institutions was approved After Circula

09/20102, a new circular on information declaration

was approved in April 2012 (Circular 52/2012 by

Ministry of Finance), and Guidlines on corporate

governance was issued in July 2012 All of these legal

documents expose new challenges to companies in

Vietnam with poor corporate governance quality

(IFC, 2012, p 23) (Tổ chức Tài chính Quốc tế (IFC),

2012), 23)

Recognizing the importance of the government

in corporate governance in Vietnam, the International

Finance Corporation (IFC) warned that “The

government must be “a pioneer” in promoting good

corporate governance practice At least, the

government needs to approve its representatives in

companies with major part of state ownership,

requires those companies to implement good

corporate governance” (IFC, 2012, p 24) In

addition, “shareholders, especially state shareholders,

need to more actively participate in corporate

2 Circular regulates information disclosure on sercurities

markets by the Ministry of Finance

governance issues” (IFC, 2012, p 25) Three years of Corporate Governance Scorecard reports reveal that corporate governance in Vietnam has been implemented in a top-down way, relying on legal framework and penalty measures (IFC, 2012, p 23) The government can influence corporate governance practices in public companies in two major ways, either by establishing an appropriate institutional framework for these public companies or

by directly participating in corporate governance as a key shareholder within these companies A recent survey concluded that state ownership had a negligible impact on corporate governance scores and practices by comparison with foreign shareholders This finding also identified that the government held a controlling ownership interest (50% or over) in 31%

of all the companies surveyed (IFC, 2012, p 20) The government plays a crucial role in the macro political environment; changes in the political environment and interactions among key stakeholders occur continuously and they can affect corporate governance For example, the extension of pension funds (especially of Pillar 2 – Corporate funds, and Pillar 3 – Savings and investment of employees) acts

as a direct driver for enhancing employee participation in corporate governance (Gourevitch & Shinn, 2005, p 23) These major stakeholders and shareholders include: financial institutions, banks, other firms; family or ethnic networks; and state ownership (Gourevitch & Shinn, 2005, p 5)

In the context of Vietnam, the government’s key role as a major shareholder in a range of public companies and its attention to employees’ benefits which is expressed through the participation of the trade union in corporate activities (a key feature of a socialist society) work relatively harmoniously In addition, corporate managers are selected through the influence of key stakeholders especially the government Therefore, in many public companies, a coalition exists that is similar to a corporatist compromise coalition3 A similar situation occurs in those public companies without significant levels of state ownership As a result, majority shareholders prevail and minority shareholder protection is weak The average score of “Equitable treatment of shareholders” has continuously decreased in the IFC’s Corporate Governance Scorecards in consecutive years from 2009 (65.1), 2010 (61.0) through to 2011 (57.8) (IFC, 2012, p 13)

In addition, pension savings of employees are almost all via social insurance funds that are mostly contributed to by the companies, a minor part by the employees and then the funds are managed by the Government This is considered Pillar 1 amongst the three pillars of the pension system Corporate pension

funds do not exist and private investment by

employees is low because of low wage rates

Employees do not usually have direct input into the

investment activities of the current

government-managing pension funds, so they do not have

incentives to participate in the corporate governance

of public companies

Clearly, the impact and the influence of the

political system over corporate governance of public

companies in Vietnam are highly visible and

pervasive To sum up, the participation of the

government in corporate governance policies and

practices is substantial; however, the outcome is only

positive in the area of the governance framework

While playing the role of a major shareholder, the

government has not generated more positive

outcomes in the Corporate Governance Scorecard

results compared to the private sector, and especially

in respect to those companies with foreign ownership

levels

Active Participation of International Institutions

Corporate governance frameworks have evolved and

developed around the world via a process of

dissemination from one country to another Until the

first half of the 2000s the “main propellants of

thoughts and practices in corporate governance come

from the United States Institutional investors from

U.S influenced corporate governance practices in

other countries where they invested in and required

U.S governance principles The number of research

and publications on corporate governance from

United States were bigger than that from the rest of

the world” (Tricker, 2012, p 474) Together with the

development and the emergence of other economies

such as the BRIC (Brazil, Russia, India and China)

and the Middle East countries, and diminishing

importance and attractiveness of capital flows from

United States, initiatives in corporate governance

frameworks have emerged in other countries This

started with the influential Cadbury report in 1992

investigating financial aspects of corporate

governance in United Kingdom, followed by OECD

and World Bank’s principles (not through legislation)

of corporate governance, and best practice models for

corporate governance in family businesses in Asia

(Tricker, 2012)

International financial institutions (International

Monetary Fund (IMF), Bank for International

Settlement (BIS) and OECD) have a special interest

in promoting good corporate governance; they act as

intermediaries connecting good corporate governance

with major shareholders and external investors,

especially international investors Development

organizations such as the World Bank and the OECD

are interested in enhancing the protection of minority

shareholders in order to develop stronger and more

effective capital markets; with the resulting market

development, in its turn, promoting national and

regional economic growth The IMF and BIS have a vital interest in the reduction of ethical problems in financial corporations (Gourevitch & Shinn, 2005) In other words, these institutions are pioneers in the opening of national markets, establishing a level playing field favourable for national and international investors This disseminating mechanism has been well demonstrated in outcomes that had been embedded in Vietnam The World Bank and IFC are the two institutions with the most credible activities in promoting the establishment of effective corporate governance practices in public companies in Vietnam From 1999 to 2013, the World Bank had financed Vietnam through the establishment of 26 technical support projects that included components focusing on corporate governance with a total total value of US$1,652,780,000 These projects focused

on major issues such as renovating the management

of state-owned enterprises, restructuring the banking system, educating directors of boards about good corporate governance as well as projects aimed at alleviating poverty (World Bank, 2013).(Ngân hàng thế giới, 2013)

In 2006, the World Bank published a report on corporate governance in Vietnam, Report on the Observance of Standards and Codes (ROSC) – Corporate Governance Country Assessment – Vietnam 2006 This is considered to be the first document that has introduced the definition of modern corporate governance into Vietnam, and evaluated the observance of corporate governance codes and standards based on OECD principles This report analyses the corporate governance framework in Vietnam, including components of relevant laws and regulations, supervisory and compulsory behaviour mechanisms and markets, especially the securities markets The report highlighted major issues, summarized the context of observance and compliance with OECD corporate governance principles and recommended additional points for further improvement (World Bank, 2006) Since this report, the term “corporate governance” has been disseminated widely from policy consultants to researchers and business people throughout Vietnam (Ngân hàng thế giới, 2006)

Following the initiatives of the World Bank, the IFC – a member of the World Bank Group, is implementing the “Vietnam Corporate Governance Project” According to the IFC, this project aims to improve overall corporate governance practices in Vietnam via a specific range of activities such as: consulting corporations, institutional investors and banks about the implementation of good corporate governance practices; working with related state agencies in improving the legal framework for corporate governance; enhancing capability for corporate governance training and education organizations; and, improving society’s understanding

of the importance of corporate governance The project has published a series of reports and books on

corporate governance such as the corporate

governance scorecard (2010-2012), OECD corporate

governance principles (2004), and a manual for board

directors (2010) These empirical research outcomes

and essential corporate governance knowledge needs

to be widely disseminated to all interested parties

Passiveness of Businesses

How have businesses responsed to these ranges of

activities and promotion of good corporate

governance by the government and the international

institutions? The analysis in the first section of the

three key features has demonstrated the degree of

activity by the government in establishing and

continuously improving the institutional system for

corporate governance However, from the perspective

of business, there has been little progressive change,

except for some minor cases (IFC, 2012) In 2012, the

100 biggest listed companies on the two exchanges of

Vietnam showed a decrease in corporate governance

score results referred to earlier in this paper; only one

conclusion can be be drawn from this The companies

themselves have not fulfilled their duties in

developing a quality investment market in Vietnam

(IFC, 2012)

Jay Lorsch (cited by Tricker, 2012, p 21-22)

discovered that the most current corporate collapses

were due mostly to the increasing complexity of the

companies and this situation could only be solved by

improvement in the role and functions of the boards

of directors, not by direct intervention by government

Boards should develop appropriate structures,

processes and practices Muth and Donalson (cited by

Tricker, 2012, p 62) recognized that a board with

executive members operated better than a board that

merely ‘ticked the boxes’ with respect to best practice

corporate governance principles in using independent

board members This discovery goes against accepted

ideas of good corporate governance; however, there is

support for Lorsch’s argument that it is the effective

performance of the board of directors itself, not the

government that can improve and deliver effective

corporate governance

All companies need a charter that forms the

foundation for companies corporate governance

regime; however, many board members and

committee members have never even read the charter

(Tricker, 2012) This situation also occurs in Vietnam;

where almost all listed and unlisted companies have

implemented the model charter for joint stock

companies issued by the Ministry of Finance (Hải &

Liên, 2012), with only minor modification for

individual company details and industry This appears

to mean that shareholders also do not consider the

charter important for protecting their benefits

There may be two reasons behind this outcome

The first is that the shareholders may want to rely on

external mechanisms such as the government to

protect their benefits; the second is that they may

choose to exit by selling off their shareholding instead

of voicing their concerns when they recognize the companies are not performing effectively In both cases, the shareholders do not invest resources in the development of private contracts such as the charter

In reality, the second choice is popular in Vietnam because of a traditional viewpoint that until you get compensation, you have suffered more than that4 The government should pay special attention to this if they want to enhance good corporate governance; people need a solution to the problem that shareholders do not trust official bonding mechanisms, both private and governmental

4 Discussion

Despite the efforts detailed above, the corporate governance performance of companies in Vietnam in general, and public companies in particular, are at the medium quality level on several scales In a two-phase survey, Hai & Lien (2012) found that the quality of corporate governance of companies listed

on the Hanoi Stock Exchange in 2010 was at the medium level (25.73/51) on the Gov-Score scale, meeting the minimum requirements of promulgated regulations and that there were only minor instances

of progressive practices and improvement This conclusion matches the results of the IFC’s

“Corporate Governance Scorecared Report 2011” which was based on 2010 data

The report had calculated that the average corporate governance score of all surveyed companies was 44.7%, slightly higher than the score of 43.9% in

2009 (IFC, 2011) In general, the companies had made some improvement, such that there was no companies with a low score below 20%, the minimum score in 2010 was 29.3% (IFC, 2011) However, this level of improvement was not maintained through to

2011 According to the currently accepted standards

on good corporate governance practices, the score should be in a range from 65% to 74%; however none

of the companies surveyed in Vietnam recorded such

a score (IFC, 2012) In 2010, 80% of the companies scored from 40% to 59%; whilst in 2011, this percentage had reduced to 73% and there were more companies registered as scoring from 10% to 29% compared to the 2010 results (IFC, 2012) Even among the top 25 companies by market value, the average corporate governance score was only 46.5%, which was only slightly higher than the overall average of 42.5% (IFC, 2012) These results substantiate Hai & Lien’s conclusion that there was

no difference in the corporate governance of companies listed in Hanoi Stock Exchange in 2010, with scores ranging from 24 to 28 (on a 51 point scale) Analysis of a 2011 survey of 107 public companies (either listed or unlisted) based on the Gov-Score criteria shows that the quality of corporate

4

An old saying in Vietnam

governance in public companies in Vietnam has only

shown a minor improvement and there is no

significant differences among corporate groups even

though they differ in scale and their listing on separate

exchanges The 2011 Gov-Score was 24.6/51, slightly

lower than the score 25.7 in 2010 (Hải & Liên, 2013)

The Anglo-Saxon corporate governance model

and system has been developed specifically for a

market based system with diffused equity ownership,

strong minority protection and disclosure, and strong

company law enforcement European continental

countries have corporate relationships based around

bank finance and with business networks at the center

Asian countries, on the other hand, utilised a

corporate governance approach that is personal

relationship based, with high levels of family control

and a business networks perspective (Clarke, 2007)

Vietnam is closer to the Asia model with some minor

differences

In Asian countries, researchers call for stronger

government intervention because they have seen the

failure of voluntary efforts and lack of effective action

by business itself They also call for a stronger

supervisoring role by banks However, in Vietnam,

the reliance on banks for such purposes can also be

suspect The following section identifies a serious

problem in one of Vietnam’s main banks and is an

exemplar of the difficulties in Vietnam for embedding

effective and good corporate governance practices in

large companies

Fraud and the Forging of Documents at Vietinbank

Vietinbank was the only Vietnamese enterprise listed

in the Top 2000 world's largest enterprises by Forbes Magazine in 2012 In 2012, the total assets of the bank was 503.5 billion Vietnam Dong, with owners equity of 33.6 billion and a charter capital of 26.2 billion (Vietinbank, 2013) State ownership, represented by the State Bank of Vietnam, accounts for 89% of the total ownership interests in the bank

In 2013, the charter capital was raised to 37.2 billion, with 35.5% of the outstanding shares listed on the Hochiminh Stock Exchange

In the first month of 2014, observers in Vietnam became aware that an ex-official of Vietinbank, Nhu – the former manager of risk management division of a Vietinbank branch in Hochiminh City, had been convicted of illegally appropriating assets, forgery and defrauding personal clients and other banks of about 4,000 billion Vietnam dong (equivalent to US$200m) She had started by borrowing millions of dollars in 2007 from financial institutions and individuals with extremely high interest rates around 1% to 3% per day to finance her real estate deals When she was unable to repay these loans, she started

to forge documents to withdraw money from Vietinbank accounts Nhu carried out this fraudulent borrowing for more than a year, and all the transactions were between Vietinbank and other banks and individuals and conducted in Vietinbank premises She claimed to be raising funds on the bank's behalf

Figure1 Money flow in Vietinbank Scandal 2014

From March 2010 to September 2011, Nhu used

similar fraudulent techniques to withdraw money

from the accounts of nine companies, three banks and

three individuals with a total value of nearly 4,000 billion Vietnam Dong The banks included Navibank,

Maritime Bank and the Asia Commercial Bank

(ACB)

From May 2010 to November 2011, ACB had

entrusted 19 staff members to make trust investment

contracts with Vietinbank with a total value of

VND719 million All those contracts were supposedly

entitled to interest rates higher than the ceiling rate

(14 percent) set by the State Bank of Vietnam by

3.8% to 4.5% annually In the same way, the

Maritime bank had also entrusted with Vietinbank

2,500 billion, Navibank 1,500 million and Tienphong

Bank 1,860 billion In the final count, ACB had lost

lost 716 million, and Navibank 200 billion in this

fraud

After individual clients had deposited money

into their Vietinbank accounts, Nhu then forged

clients’ signatures and stamps to make saving books

under the clients’ name Then, she used those saving

books as collateral to acquire loans from Vietinbank

and other banks (such as the Vietnam Internationa

Bank – VIB) When Vietinbank discovered that all the

loan documents were forged, Vietinbank still

withdrew money from the collateralized saving books

to compensate for the loans it had made

At first, Vietinbank rejected any obligations to

the clients who had lost significant funds by arguing

that all the trust investment contracts with Vietinbank

were forged and all the money had not been put into

the bank’s financial records, and all the transactions

were not in Vietinbank premises However, under

pressure from the individual victims and

organizations, the bank declared that it would be

responsibe for honouring the legal contracts in this

case Lawyers acting for the individual and corporate

victims submitted bank statements to the court as

evidence that all the money had already been put into

Vietinbank system and was reflected in the bank’s

accounts

Ultimately Nhu was found guilty and was

sentenced to life imprisonment However what has

angered people is the decision of the prosecutors to

clear Vietinbank of any liability This fraudulent

scandal reflects badly on both micro and macro

corporate governance issues in Vietinbank and other

banks and Vietnam in general The bank’s board of

directors had failed to prevent the management

implementing a deposit and saving policy that

supplied interest rates higher than the legal ceiling

rate In addition to failing to audit and detect

weaknesses in the transaction system and procedures,

the failure put the bank at a high risk of capital loss

In fact, ACB and Navibank did lose a large amount of

funds in this case

There had been illegal transactions not only

between individuals and respective banks, but also

between banks with other banks This helped to

unearth a significant failure of the legal interbank

transaction system in meeting banks’ capital demand

and a corresponding failure of policies In addition,

auditors, both private and state, had carried out

several audits on the bank during the time of this major fraudulent activity, but they failed to discover anything amiss

This case of fraud has certainly highlighted that there are still major concerns and difficulties with corporate governance practices and processes across the corporate sector in Vietnam There is still a lot of work to do to embed best practice and effective corporate governance models that are capable of working as required in the Vietnamese context

Conclusion

Corporate governance frameworks are still evolving

in both developed and developing nations The common approach is not to take a legislative path to ensure effective reform, rather the process has been one of developing principles, guidelines and codes that effectively construct a ‘best practice model’ of corporate governance However, it is also clear that a

‘one size fits all’ model is not applicable across the globe There is a clear need to construct corporate governance frameworks that are situationally contextual and appropriate to different regions and nation states In particular, the notion that a Western developed corporate governance model can be imported without change into the ASEAN region is problematic

This paper has highlighted a range of issues that has confronted decision-makers, government and other major stakeholders in Vietnam when attempting

to construct an appropriate corporate governance regime that will be appropriate for this developing nation The details of the fraudulent case in the Vietinbank highlight a key point in the corporate governance debate Ultimately, the approach required

is to enhance and promote effective performance and behaviour amongst board directors to help deliver effective and good corporate governance without utilising a big legislative stick as a threat

The underlying reality of corporate governance practices in Vietnam is that the quality of corporate governance is below international standards and is only currently at a medium level of quality The Vietnamese government has actively developed an enhanced and more complete corporate governance framework, and international institutions in the country have actively supported these developments, but the passive attitude and nature of the companies themselves is slowing down the embedding of improved corporate governance practices The roots

of this problematic situation are located, fistly in the civil-law-originated legal system used in Vietnam, and also the existence of an institutional system that over-prioritizes the role of the government in the economy, and finally, a socio-economic environment with opportunities that allow for unprofessional business practices to prosper Such features weaken economic incentives created by contemporary policies and make it difficult for companies to practice good

corporate governance Vietnam still has a long way to

go in the field of corporate governance

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IDIOSYNCRASIES OF TAKING RISK: A CASE OF A

Given the self-evident that nature of complexity, irrationality and uncertainty in this context, a sophisticated exploration of entrepreneurial social reality of risk taking and management requires the fundamental philosophy of subjectivism and therefore this study adopts qualitative inductive case study methods in a sample of Sri Lankan entrepreneurs The study found that entrepreneurs do indeed use their social and cultural understanding to a great extent in their decision making

Keywords: Entrepreneurial Risk, South-Asian Entrepreneurialism, Socio-Cultural Impact On

Entrepreneurship, Uncertainty, Rational Risk Taking Model

* Senior Lecturer in Entrepreneurship, James Cook University, Singapore

Email: helan.gamage@jcu.edu.au

**Senior Lecturer in Strategy and International Business, Sydney Business School, University of Wollongong

Email: ananda@uow.edu.au

1 Context

Entrepreneurial risk as a fundamental element of most

entrepreneurial decision making, it has been appeared

from the time when the word ‘entrepreneurship’

originated from the French verb entre-prende5 in

Europe in the 1100s Risk-taking has been persistently

associated with entrepreneurship ever since 1848

when Mill proposed that the bearing of risk was what

differentiated entrepreneurs from managers (Carland

et al 1984) and this is still the case (Stevenson 1999;

Gamage 2004) Risk taking behaviour of the

entrepreneur has been observed by economists

(Knight 1921; Schumpeter 1936) and psychologists

(McClelland 1961) All these conventional theories ,

models and ideologies of entrepreneurship embrace

that risk can be calculated and moderated through

knowledge and the process of rational

decision-making (Haley &Stumpf 1989; Miner et al 1994)

Most of theoretical and practical reasons promote for

generating greater knowledge about the effect of

situational and personal characteristics on

decision-making under risk (Blais and Weber, 2001) Even

though the effects of risk, risk perceptions, and risk

propensities of entrepreneurs on entrepreneurial

5 'Entre’ stand for 'between' and 'prendre' being for ' to take’

or ‘to undertake’ (Bolton et al 2000)

choices have not been explicitly examined in empirical research (Forlani and Mullins, 2000) Sitkin and Pablo (1992) in their model of risk behaviour argue that the available research on risk taking have been focused on a single determinant of risk behaviour, which can yield contradictory empirical findings and produce inaccurate conclusions about determinants of risk behaviour There is a gap

in our knowledge about the link between risk taking, risk propensity, and risk perception in the context of social, cultural and political and risk (Gamage 2004), which required entrepreneur's social wisdom to manage risk in a context sensitive approach In this paper, socio-cultural values are of particular relevance

to understanding entrepreneurial risk in the South Asia as a social phenomenon The philosophy of empowering entrepreneurs in Sri Lanka is largely based on the theories and models that have arisen, predominantly, from western paradigm and are largely based on rational scientific approaches to analysis, which are not directly appropriate to the cultural perspectives necessary for entrepreneurship in South Asian countries

2 Critics on the Mainstream Perspectives

of Entrepreneurial Risk

From the 13th century onwards permissible free

competition emerged in western society (Gay 1923

cited in Aitken 1965) and this developed further with

the growth of international trade Large-scale

enterprises in industrialisation involved risk bearing,

capital accumulation, and psychological and

organising abilities to approach and enhance unknown

international markets The pioneers of

entrepreneurship, the classical economists Richard

Cantillan (1734), Adam Smith (1805), J.B.Say (1834),

and J.S Mill (1848)focussed on the normal flow of

economic activitiesunder conditions of rational

individuals with ideal information in new, unknown

states of economy According to Schumpeter (1936)

the entrepreneur is in a position to carry out new

economic combinations while Hirschman (1958)

emphasizes their importance in mobilizing resources

This market-exchange economy required

psychological and material resources to organise

large-scale, mass production effectively and

rationally These terms referred to functions and

qualities which were an exciting and unknown

experience taken at one's own risk (Greenfield

&Strickon 1981).In this institutional process

entrepreneurship has been defined as a factor of

production that carries risk and uncertainty in the

process of organising other factors of production

(Cole 1949).These conventional western ideologies

havegiven emphasis to the process of rational

decision-making in calculating and moderating risk

factor in relation to the process of organising factors

of production in market-exchange economy

Enhancement of entrepreneurial performance

has been seen historically as possible through the

extensive acceptance of western ideologies

Therefore, the influence of the west on ideas and

practices in non-western countries has been strong

(Sinha 1999) The rational risk moderation process

has been utilised in entrepreneurship development

programs in the South Asia (Sinha 1999; Gamage

2004) however, the aim of economic and industrial

development through application of western

ideologies has not remained unchallenged in

developing countries (Hofstede 1994; Kao et al 1999;

Wickramasinghe & Hopper 2000; Gamage 2004)

This issue has been examined from different

perspectives These include an examination of the

validity and transferability of knowledge (Leonard

1985; Sexton 1987), the utility and impact of such

knowledge ( Kao et al 1999; Sinha 1999) and cultural

diversity (Hofstede 1980; 1984; 1994; Nanayakkara

1999; Adler 1997; Kao et al 1999;Ratnasiri 1999;

Wickramasinghe & Hopper 2000) If culture supplies

the initial social conditions under which

entrepreneurial practices emerge, then the behaviors

and practices that constitute current notions of

entrepreneurship should be expected to fit the values

of the cultures that generated and shaped the phenomenon(Mehdi and Ali 2009).From these perspectives, management and work activities in an enterprise depend critically on socio-cultural values

practices,therefore,without considering the complexity of indigenous society and culture, which hinders attempts to understand entrepreneurial risk

3 Exclusiveness of the Sri Lankan cultural Setting and Entrepreneurial Culture

Socio-Sri Lankan culture demonstrates various complex and unique behavioural patterns It has had its own civilization for millennia, although from the 12th century it was subjected to several invasions The last and the most dominant colonization was by the British who ruled from 1796 until 1948 The British influence caused significant changes to the original socio-cultural setting (De Silva 1981; Mowlana 1994; Jayawardena 2000) British colonialism was central to the economic, political, and cultural construction of modern Sri Lanka The imposed British administrative, religious, judicial and education systems retain their influence (De Silva et al 1973;

De Silva 1981) In particular the total education and training system has been influenced in terms of objectives, design, content, and methods by the west (Ruberu 1962; Nanayakkara 1999a)

Sri Lanka received its independence in 1948, and now embraces Asian, Western and other cultural influences After independence, Sri Lankan society blended traditional culture with European social structure (Ludowyk 1966; Jayawardena 2000) Sri Lankan entrepreneurial culture can be said to have evolved through two different routes One can be traced to the origins of Sri Lankan civilisation and the other to the western influence, originating from the Industrial Revolution, and imposed through colonisation which systematically destroyed the indigenous feudal system Entrepreneurship literature available in Sri Lanka either by way of imports or local production, is almost exclusively western in origin and character (Nanayakkara 1999a) or has influenced academic and professional systems Similarly, the personnel involved in bilateral and multilateral assistance programmes have also spread western ideology through training programmes It is clear that western knowledge in Sri Lanka is influential However, observations from India show the heart and the mind of such a system often do not work together and this conflict is apparent (Khare 1999)

4 The Research Approach and Design: Holism and Qualitative Methodology

The dynamic interaction between the social context of entrepreneurial activities (including risk) and the

complexity of the South Asian culture invites an

alternative approach to understand its entrepreneurial

risk The emerging research philosophy outlined

above built on a set of beliefs and feelings about the

world (ontology) and how it should be understood

(epistemology) and studied (methodology) (Denzin&

Lincoln 2000) The exploratory nature of this

culture-based research embraced the fundamental philosophy

of subjectivism Hence this paper attempts to

understand and document whether entrepreneurial risk

in South Asia is critically dependent on social values

and indigenous business practices

The exploratory nature of this culture-based

research embraced the fundamental philosophy of

subjectivism A qualitative research methodology and

inductive holistic case study approach including

grounded theory analysis were selected to explore

people’s experiences and behaviour This paper

analyse entrepreneurial risk factor in the Asian

entrepreneurs through a case study approach that

focussed on ten entrepreneurs who started up

home-based businesses and which have grown to become

significant in Sri Lankan society This allowed

context sensitive theoretical understanding of

entrepreneurial risk taking reality in Sri Lanka to

emerge Hence, this study used purposive sampling to

select informative case studies

The study sought to understand the subjective

realism rather than to impose objective rationalism

(Mason 1996) Therefore, the researcher did not have preconceived beliefs in exploring social realities Interpreting and understanding the meanings of social reality through close interaction with the knower and the known (Denzin& Lincoln 2000) required active interaction between the researcher and the individual

or community experiencing the phenomenon

The inductive and holistic study of human experience required qualitative methodology to explore the inward and outward interactions of entrepreneurial experience Using a qualitative case study approach, the problems of questionnaire-based scientific studies (cf Perera 1990; Turner 1993; Chetty 1996; Gummesson 2000; Wickramasinghe & Hopper 2000; Gamage et al 2003a; b) could be overcome These problems include: a reliance upon the logic of sampling for statistical generalisation by testing hypotheses derived from predetermined theory; belief in an objective reality ascertainable through a ‘falsification process’; and an erroneous belief that ‘scientific’ methods enable researchers to

be objective and neutral recorders of events (Wickramasinghe & Hopper 2000)

In this study, timeframes of the case study subjects were between 13 and 41 years Therefore, these entrepreneurs had up to 41 years of experience

of the phenomenon (see Table 1) The long period of experience in business revealed how entrepreneurial activity changes over time

Table 1 Age of the businesses selected in this thesis

Ten entrepreneurs were interviewed and all these

businesses were based in Western Province in Sri

Lanka This study is longitudinal and first round of

interviews conducted in 2002 and second round of

same study conducted in 2012

Using detailed stories of small rich informative

case studies enabled the researcher to gain a relatively

complete picture (Eisenhardt 1989a) of the range of

entrepreneurial experiences This study applied a

grounded theory technique of constructive thematic

generation to provide a language to describe the

findings (Strauss & Corbin 1990) Themes emerging

from the empirical data required further iterative

processes to explore the foundation value sets (social

meanings) underpinning particular actions The

foundation value sets discovered were interpretations

of socio-cultural realities in the context, based on

understanding how entrepreneurial behaviours fit in

the society and culture The literature about the

historical origins of religions and politics also

contributed to understanding the deep-rooted reality

of behavioural patterns and actions within society

This led to insights into entrepreneurial performance

in Sri Lanka

The amount of data generated by qualitative methods was extremely large Organizing and analysing the data could have appeared to be an impossible task (Patton 2002) The data analysis software tool, ‘Nvivo, Qualitative Data Software’ was used to manage data efficiently throughout the course

of the research project (Silverman 2001; Patton 2002) Credibility and reliability of data were achieved through data triangulation (Denzin 1989; Yin 1994; Silverman 2001) Multiple sources of information were sought, and the interview scripts were presented back to participants for verification

The research output was described using words and illustration rather than numbers (Penrose 1990; Miles &Huberman 1994) This style of analytical presentation of output in terms of storytelling has attracted a number of management and entrepreneurship researchers (e.g Turner 1993; Chetty 1996; Gummesson 2000; Greenhalgh 2000; Workman 2001) The research methodology and methods went beyond those previously employed

within the culture and entrepreneurship area in Sri

Lanka, to capture insights of entrepreneurship in the

Sri Lankan context

5 Empirical Evidence: Uniqueness of Sri

Lankan Culture and Entrepreneurial Risk

In this exploratory study it has been found that with

the socio-cultural environment in Sri Lanka, the

contextual reality of managing risk challenges the

underlying assumptions of rational risk management

processes.In cultures that are different from the west,

as in Sri Lanka, conventional theories of rational risk

taking process are inconsistent with the national and

the local cultures For example, Sri Lankan businesses

try to preserve their paternalistic system, and

emphasise socially boundedrelations, and rightness,

trust, loyalty and collectivism (Nanayakkara 1999a;

Gamage 2004) These are the pillars of the Sri Lankan

cultural system In this context, five main themes

have emerged in entrepreneurial decision making

onrisk taking These themes involved:

5.1 Entrepreneurial risks shape from

socially driven uncertainties

The data suggest that social uncertainties in Sri Lanka

are critical in influencing entrepreneurial risk

Evidence is provided by thecases; all were

emphasised that "we are making business decisionsin

the dark environmentdue to political instability, lack

of reliable information and violence of youth

organisations".Periodic promises given by politicians

about reducing power-cuts had disrupted

entrepreneurial activity as they were not realistic

promises These situations influenced to close down

their business activities andalso profitable

international business lines Some cases indicated that

as a result of these circumstances, international

customers have approached other country suppliers

One of the entrepreneurs expressed his

disappointment:

How can we predict our business? More than

three to four months continuous power limitations (at

least two hours in daytime and another two or three

hours evening or night) have occurred each year in the

last six years Productivity and achieving targets have

been affected Furthermore, unrealistic promises

given by politicians about ending power-cuts have

disrupted entrepreneurial operational activity

Social uncertainties had been transformed into

different forms of risk in entrepreneurial activity For

example, risks in decision-making on production,

continuation of business activities and exporting

products in time, and approval and smooth production

processes resulted from social, political and

economic instability, which has turned the

entrepreneurial environment into a more uncertain

realm More than 20 years of continuous ethnic civil

war and youth unrest due to poverty, unemployment

and imbalances in income distribution have led to the uncertain socio-political milieu Moreover, changing weather conditions in the last few years resulted in disruptions to the hydroelectric power system which was unable to cope with the increasing usage of electricity by household, commercial and industrial sectors Most entrepreneurs get used to such uncertainty because they see no other alternative as they are uncontrollable and unpredictable and could not be seen them throughthe rational process of forecasting and moderating risk

5.2 Generating Risk: the social disorder matters

Most entrepreneurial challenges were derived from the disorder of the social system in Sri Lanka The case exemplified a lethargic social system where things just do not move efficiently, is it in banks or government departments, creating delays, time-consuming practices, and the need for political and personal favours or conversely, knocks to business activity Time management is a top concern of entrepreneurial success as they have to use their time more efficiently Several entrepreneurs expressed their disappointment on the time factor; higher waiting period for getting things done Entrepreneurs' experiences in several respects:

Within the last two months three times, tax department people came to the company and asked for the same bundle of files and they took all those files and brought them back Three times office people traced files and replaced files Taking time of the workers directly affected to the productivity and achieving production targets

The Bank asked us to come several times to discuss our loan Every day they told us something and discouraged us This was the initial experience of getting a loan to start my business

Another entrepreneur’s experience on discrimination on issuing bank loan at the setting up stage of the business:

For a Rs 500,000 bank loan, bank requested securities for the loan Finally two guarantors were found but one higher officer in the bank has refused to approve the loan by saying that, who is giving a loan for this kind of man ThelBehethkaraya who produces traditional oil treatments (this has a very sarcastic meaning) Again loan was rejected

Afterwards entrepreneur had to arguewith the Chairman of the Bank to show him the rules and regulations that indicate ‘no bank facilities are available for oil treatment businessmen' The reality

is, there was no such regulation in the process of issuing loans but personal subjectivity/biases were involved in making decision on loan to grant or not This has created stress, uncertainty and risk not

in business aspect but also health aspect of the entrepreneur In the absence of an adequate legal framework, informal constraints play a large role in

the society In Sri Lanka, political influence especially

often greatly helped in getting permission to access

resources and enters local and international markets

This was evident in Cases, the entrepreneur’s political

relational power was used to handle threats to the

existence of their businesses.In the political context of

Sri Lanka, government authorities and politicians

often acquire power by which they override some

rules and create situations that are governed not by

rules but by the power of particular individuals These

discretionary and personalised favours generated

entrepreneurial risks on the one hand or eliminated on

the other The entrepreneur, who operates in such an

environment of frequent social disturbances and

constraints derived from inadequate social, political

and legal structures, is unable to readily manage risk

through rational planning (Nanayakkara&Ranasinghe

1984; Nanayakkara 1999a; Gamage 2004)

Entrepreneurial risks associated with time,

favourations, biases, stress, disappointment, changing

promises and letting entrepreneurs down could not be

even calculated and moderated through the rational

process of entrepreneur risk

The data also suggest that dishonesty and

bureaucracy of most government authorities was a

formidable challenge to entrepreneurial activity This

was supported by the statement of entrepreneurs

" Everything needs follow up actions If we

wait until they do it, it will not happen We have to

push them to get things done by government

authorities"

Because the political and public system and

organisations often did not incorporate commitment,

honesty and respect, the opportunity existed for

opportunists to set up monitors and controls as

necessary requirements from the social system

Evidence from one of the entrepreneurs who had

experience on influence of multinational companies

"Some multinational companies wanted me

eliminated from the market … They never allowed

me to use the Sri Lankan name for my product I

thought, my product is a Sri Lankan product, why

can’t I use a Sri Lanka name for it So without

approval I had to stop my business for two years

Multinational companies have distracted

indigenous entrepreneurial activities

Another case highlighted that bribery was

demanded in order to continue the order for the

product

'While I was producing the order one officer

asked for a bribe and I thought, why should I give a

bribe to sell my product? I refused to give a bribe

Then suddenly they stopped my production while I

was continuing my production process My business

totally collapsed.'

In these cases, the entrepreneur’s high social

morality increased his exposure torisk within such

disorder of the social context

The following statements indicate another social

disorder that is the lack of implementation of proper

customer protection in the legal system and unethical behaviour of some business groups in the society Entrepreneurs are willing to take challenges and risk related to the business activities but they believe that socially driven unethical and illegal influences are very challenging and create big risk for entrepreneurial activities

'One competitor made the same product and used a similar type brand name Anyway, customers complained about our products We had to find this unhealthy competitor and we found his production system was totally outside hygiene requirements The lack of implementation of proper customer protection

in the legal system is a big risk for entrepreneurs' 'One very popular product suddenly was rejected

by the customers The whole production was stopped and the raw materials were examined by sending them

to another country Then we realised some fraud was happening to our imported raw materials It could not

be traced at the quality control as that chemical was activated in a couple of days So we had a big loss; however, those are some experiences and business is difficult in such an unethical environment Otherwise business is a challenge that can be taken'

Organisational corruption and political influences are prevalent As a result, unethical transactions and actions are usual in day-to-day social life Most cases provided evidence that in their entrepreneurial journey, the entrepreneur’s personal and political relations, respectability and also willingness to give bribes were forceful The legal and social security system is still need to be improved in Sri Lanka in order to avoid unnecessary risk for the entrepreneurs

The following cases were exposed that businesses were frequently influenced by the actions

of government organizations

Six months after increasing my workers’ salary, the government announced a general salary increase and asked all private companies to follow the same rule So if we do not follow the general rule workers make problems Fortunately, I could afford that because the Dollar exchange was positive at that time Socially driven risks were more harmful and more powerful than market driven risk in entrepreneurial activity.This uncertainty and risk in the Asian context has been studied by Hofstede (1980), he asserted that uncertainty is rooted in culture and reinforced through basic institutions such

as family, school, and the state Business uncertainty and risk initiation were therefore often critical, and social and cultural, and could not be separated, as business is a part of society

6 Being Inquisitive About Others: Perceptions and Management of Risks

In Sri Lankan society and culture, people are concerned and inquisitive about others’ behaviour and performance and this builds negative or positive

attitudes to which they react This includes jealousy,

frustration, resentment, anger and personal politics, all

of which potentially operate against the entrepreneur’s

wellbeing and piliganeema (SP) These confrontations

were understood as either politically motivated (often

resulting from opportunistic political forces) or due to

human emotions

The data suggest a range of perceptions on

entrepreneurial risk taking behaviour within the social

cultural context Some risks were seen as personal and

are kept covert; others were seen as social and

collective, and made overt, were managed

collectively

6.1 Failures as Social Confrontation and

Accepted as a Personal Risk

The data shows that most failures and social

confrontations were kept at a personal level The

following statements provide evidence:

When my product was suddenly refused by the

Department … I met a minister several times …but he

was deaf to me I went to Japan but nobody knew the

reason …when I came back I saw unsold production

was stocked in the factory What I did without telling

my workers was to remove it all to my house at night

As a leader I should maintain my respect and try not

to create a feeling of my incompetence among

workers

Once our product was upset due to fraud

happening to our imported raw materials We had a

big loss It is very unethical in business perspective

However, we (certain Directors) kept this incident a

secret I know they (who did the fraud) wanted to

eliminate our social and business dignity

Socially unethical challenges such as creating

frauds against the entrepreneur because of anger and

jealousy were often taken personally and therefore

entrepreneurs tried to manage them individually It

was assumed that personal challenges are aimed at the

piliganeema (SP) of the entrepreneur; in turn

entrepreneurial dignity would be damaged by the loss

of confidence of workers, buyers, suppliers,

supportive organisations and society For example, if

subordinates’ confidence, respect and loyalty were

lost, work commitment seemed to disappear from

workers

The entrepreneurs interviewed seemed to

perceive the necessity to take into account both

personal and business risks (Osborne 1995) and also

social and psychological risk (Gasse 1982; Ray 1986)

which had been identified as typically involved in an

entrepreneur's risk-taking According to the data, in

Sri Lanka, the entrepreneur felt shame (embraced

social concerns and feelings) in relation to a particular

fault or error According to Bradshaw (1988)6, with

shame, there are painful feelings of alienation,

6

With guilt, the response is a desire for atonement, to make

amends, to correct a mistake, or heal a hurt (Bradshaw 1988:

Healing the shame that binds you)

doubt, loneliness, isolation, perfectionism, inferiority, helplessness and hopelessness Entrepreneurs were ashamed to show their powerlessness (especially those who held some power and dignity) and they kept social confrontation covert to protect their SP with a motivation of securing workers’ and other stakeholders’ confidence, loyalty and commitment This was different from guilt which is determined by objective criteria (Kaufman 1996) in an individualistic context (Bradshaw 1988)

6.2 Collectivist or What? Business Challenges as Shared Risks

The following cases best illustrate shared risks Through my experience (both failure and success) I know what to do in the operation of the business and the market I use my experience with my workforce’s capabilities to face these challenges I can give my knowledge but workers are important in carrying them out So I shared my vision, business challenges and internal issues with my employees to face them I always remind them if we take risk together we can easily win Then we will be better off

I told my workers, this is yours If you are committed to grow this business, there are no problems for us to face business challenges and to grow We have to work together to win business challenges

Ethically driven business challenges such as healthy business competition were accepted collectively in Sri Lanka Both management and the workforce were encouraged by collective obligations

to face business risks Verbally and visually, the entrepreneur always moralized collective norms by experientially creating a collective risk-taking culture and displaying posters on the strength of togetherness Observations revealed that, in several challenging situations, most entrepreneurs addressed their subordinates very colloquially The expressions: Umbala (you), Kollani(boys), Putha (son), Duwa (daughter), Daruwo(child),Nubala(you) and Lamai (child), represent closeness, togetherness and familiarity.Thesewordsgive a different sense of relationships Putha, Duwa, DaruwoNubala and Lamaiindicate familial (parent and child) relationships, love and caring; Kollani and Nubalaalwaysrepresent a feeling of an advisory relationship between an adult and a young person; and Umbala and Nubalashow friendship In general, people in Sri Lanka show strong friendliness and closeness by using specific colloquial words in conversation with friendly facial expressions

The system had a built-in resistance to individualism Familial emotions had been built up, developing a real sense of belonging to the entrepreneur or to the company in which caring, obligation and taking risks together operated between

subordinates and superiors through paternalistic

approaches7

We understood that there was no specific

demarcation between social confrontations and

business challenges The entrepreneur in Case Six

considered business fraud against his product as a

social confrontation The entrepreneur in Case Five

considered the business fraud of another business

producing a similar product with a similar brand name

as a business challenge This provides evidence that

entrepreneurial risk was perceived and interpreted

subjectively within an individual context

6.3 This Is How We Manage Risk:

Conceptualisation Skill

The data indicate that loyalty and respect from

supportive authorities were derived from

entrepreneurial reputation, professionalism, and trust

As a result, personal favours were highly possible

Interviewed had with third parties revealed that:

We (fruit sellers at the Nugegodapola) always

give him (the entrepreneur) our fruits We do not

allow our new people to sell to others first If we want

we can sell our fruits very easily to hotels and

retailers for higher prices, but we never do it We can

still remember how kind he was to us in the very early

stages of our business If we ask for personal help, he

never says ‘No’ Sometimes, he helps us financially

We take money from him in advance until fruits are

supplied He helps our urgent situations like funerals

He is really a gentleman (Some fruit suppliers to the

business)

We encourage customers to buy “(name of the

company)” products because this Mudalali (the owner

of the business) gives remarkable service to the

society He is also very concerned about us He looks

after us He wants us to grow We appreciate his

caring for us and the country (Some retailers in the

business)

According to Case below, the entrepreneur

appeared to take an unnecessary risk by not doing

sufficient research or analysis before acting

I do not know anything about theories of

planning; I don’t do any market research or formal

systematic analysis before acting

However, this was not the reality The data

suggest that his key skills in managing risk were

based on a social capacity for value judgements The

following case evident more on this social and value

judgment on entrepreneurial decision making

I learned everything by painful experience in this

society, their behaviour (good and bad), political

situations, I have a good vision towards the future of

this business and alternatives though we do not have

more business information These come from my

7 Paternalism’ or ‘paternalistic approach’ in this study is used

to signify caring and obligations which operate between

subordinates and superiors

painfulexperience Experience is not really the business techniques but about people and society It is difficult me to explain but my social insight give me wisdom, vision and directions These cannot be put into a written document I cannot give my experience

to anybody, even for my son They have to earn such painful experience by their own and learn

The entrepreneur often processed myriad bits of information available to him and conceptualised several alternatives, in depth, through his social wisdom before he acted The only market-related factor of any importance was personal knowledge of the market The entrepreneurs’ previous experience of failures had expanded their wisdom; giving them confidence they had the skills to avoid failure in future Social knowledge and the insights gained through painful social experience emerged from most case studies relating to risk management and future planning

Risk management through value bases and conceptual skill were best illustrated in worker recruitment policy For examples:

When I recruit my workers I am so concerned about their family background That means, the poor village type, and humble

I specially recruit the poor, disadvantaged group

of people to work There are many reasons a) If we help them they are very grateful and they do not want

to leave the company b) We have higher officers who were promoted from the very lower level and they are also from such family background If I take high-class people then it creates internal unbalance and problems among workers c) High class people have several opportunities in the society and they try to leave the company more often

Entrepreneurs preferred workers who are loyal and reliable rather than technically qualified This basically deviates from seeking work efficiency and higher productivity in the process of human resource management Entrepreneurs were found to have set a priority forwork harmony on the basis of social wisdom In general, workers in Sri Lanka display strong collective behaviour in demanding rights An issue related to one worker affects all workers’ productivity through strikes or ‘work to rule’ until the particular worker’s problem is resolved Sometimes this issue leads to union actions and continues for months, potentially causing the total business to collapse This requires the entrepreneur to consider the workers’ social behaviours and contrasts with a problem such as technical know-how, which could be handled through on- the-job training or external training The ability to conceptualise possible social challenges allows him to deal with risk through social value judgments

6.4 Luck and Karma in Risk Tolerance

Behaviour: Religion Matters

Religious faith in Sri Lanka leads to ‘Luck’ and

‘Karma’ Casesillustratethis effect:

Buddhism believes in a systematic mental

culture To the question of how to eradicate problems,

the answer given by the Buddha is 'when a wise man,

established well in morality (sila) has developed his

mind and understanding (panna) which has been

developed by moral and intellectual investigation

rather than fixed by rational and economic figures I

always work according to Buddhist concept of sila

and panna in relation to business activities This

Buddhist guidance is the precaution of my business

risk

The entrepreneur understood that Buddhism

teaches the way to penetrate to the root of the problem

(similar to the western analytical approach) and find

out the main cause of it within the social moral

context (different context from western countries)

Individuals were guided by their religious norms to

become more skilled in managing human life and to

promote more satisfactory living

Suddenly my Sri Lankan buyer refused my

product … My friend in Japan was able to help me

He is the first man in Japan going out of the country

to buy such products So I believe we should have

luck also when doing business

While …one officer asked for bribery and…my

business collapsed, that is my karma… The garment

industry has been introduced in Sri Lanka on a very

large scale And also imports of printing ink have

been limited This was my luck to come back to my

business I believe in karma, as I am a Buddhist

Some have got every human organ without

imperfection, but some people are born with several

problems, that is our karma So I have to maintain

behaving in such a way as to get good karma

It was a big threat of multinational products like

Coca Cola for us I had a very hard time selling our

natural fruit drinks Some small boutique traders

chased me when I brought my product However, our

luck came Fortunately, television media came to Sri

Lanka and fresh fruits and health care programmes

were broadcasted It was a new media and people

were so interested to try to follow what it showed

This made a big impact for our business So I believe

we need to have luck also

Lack of information and unforeseen conditions

led to unavoidable uncertainties In such situations

where the entrepreneur had no power over exterior

influences he resorted to religious faith The

entrepreneur was persuaded with luck and karma

Religious faith and values rooted in religious morality

were part of the social behaviours and provided

satisfactory compromises between unexpected failure

and success

In Buddhist values every material thing that

exists is impermanent But the good and bad points

collected in life (Karma) are carried forward to the next life Therefore, every living being has the results

of its own past karma to work out, and any interference with his situation will not be anything more than a temporary alleviation of the suffering it is bound to endure (Pickering 1995) The impact of uncertainties was neutralised in terms of karmaand luck Therefore, any impact of uncertainties had been taken as tolerable The majority of Sri Lankan entrepreneurs (86.6%) believe in Karma (Buddhdasa 1995) Entrepreneurs did not see uncertainty as something to be avoided or moderated in any particular rational model but to be expected and tolerated through social and religious faith and morals This is the key difference from western thinking on risk management

All four main components of entrepreneurial risk management described here: risk initiation, perceptions of risk, risk management and such tolerance indicated that business uncertainty was mainly derived from social, political and cultural settings The business stakeholders and socially and politically influential actors, government authorities, their spouses, relations and friends were all involved (formally or informally) in the risk handling process

in terms of creating personal favours This is supported by studies of business risk in the Asian context by Hofstede (1980) who asserts that strategies for coping with uncertainty are rooted in culture and reinforced through basic institutions such as family, school, and the state This does not mean that markets are not subject to risk, but that business risks in Sri Lanka were largely socially derived, were powerful, and demand widely developed conceptual skills for effective management

7 Irrationality of Entrepreneurial Risk

Entrepreneurial Paradigm

In the western models, entrepreneurial risk can be managed through knowledge of and entrepreneurial alertness to markets (Kirzner 1973; High 1986) and the process of rational decision-making Classical economist Knight’s (1921) classification of entrepreneurial risk includes perfect knowledge, risk and uncertainty Schumpeter (1936) asserts entrepreneurial risk-taking behaviour in innovative economic activities which implies risk taking in a rather uncertain condition of novelty Research supports the idea that firms that innovate and are proactive also tend to take larger risks (Miller 1983; Covin 1989; 1991)

The neo-Austrian school believes entrepreneurial riskinteracts with the internal situation

of the business and with the economic, political and social circumstances surrounding the business (Cole 1949) The Harvard School considers the human factor in the production system as well as sensitivity

to environmental characteristics that affect

decision-making

McClelland’s (1953; 1961) psychological theory

also discusses business uncertainty and certainty

based on availability of reliable information to the

entrepreneur He argues that risk involvement is

essential in undertaking a venture and such risk can be

moderated through logical analysis of information

Furthermore, in his theory of n Ach, a large

incongruity between an entrepreneur’s aspirations and

end results leads to avoidancemotives (McClelland

1953) as far as personal achievement is concerned

From this, if business risks are defined in terms

of economic and psychological connotations, business

risk is focused by (the western paradigm) only on a

firm or an individual entrepreneur However, business

uncertainty and risk are often socially and culturally

interpreted and cannot be separated, as business is a

part of society The country’s social conditions and

cultural values provide the ingredients for critical

risks for the entrepreneur and lead to a definition of

entrepreneurial uncertainty as ‘socially-derived

doubts’ As a result, different issues emerged in

entrepreneurial activity and were identified as

entrepreneurial risk factors

Risk calculated by predicting and forecasting

economic effects was insignificant in the context of

possible social challenges in Sri Lanka This

challenges Kirzner’s (1973;1979) and High’s (1986) arguments of risk management through knowledge of markets and entrepreneurial market alertness In Sri Lanka, entrepreneurial risk management was both defined by and managed in a social context rather than an objective cognitive context Whether the entrepreneurs want to moderate, tolerate or avoid risk was rooted in their values and beliefs system Conceptualisation of business risk was subjective and antithetical to the psychological theory (McClelland 1961) and to moderating risk and risk-avoidance (Miner et al 1994) through rational approaches The market mechanism in risk management therefore worked loosely in Sri Lanka (Gamage et al 2003a) Deep understanding from the findings led to a guiding model for business risktaking and management in Sri Lankan (Figure 1), which discriminates between the social and business implications of business risk This indicates that the entrepreneur needs to build a wider risk- management circle through value base in response to entrepreneurial risk This involves conceptualisation skills not limited only to analytical skills and approaches Therefore, risk management requires the entrepreneurs’ social wisdom to screen social risks rather than simple knowledge creation of market alertness

Figure 1 Entrepreneurial risks and the risk management circle

Source: Develop by the researcher

Conclusion

Socio-cultural values and beliefs, which direct social

being, influence entrepreneurial risk behaviour in Sri

Lanka Sri Lankan businesses cannot survive by

merely following entrepreneurial orthodoxy within the western paradigm, which does not lead to appropriate practices because conflicts and challenges are palpable In this research work found that in the South Asian cultural context social wisdom and value

judgment is prominent and essential in understanding,

tolerating and managing uncertainty and risk which

are driven from socially and culturally Sri Lanka

should not imitate a western system with its own

shortcomings Sri Lanka should develop its own

strengths in entrepreneurship development It needs to

understand how cultural values and practices are

reflected in the unique organisation of business

Finally this study revealed that

Socio-cultural-relativism in entrepreneurship’, may be more

appropriate to understand entrepreneurial reality in its

context

The authors propose that the entrepreneurial risk

may be explained by recognizing the fact that

entrepreneurs use experience-derived knowledge

including socio-cultural and politico-economic

intuition and wisdom to a problem, which is likely to

lead them to perceive multiple risks in a given

decision situation

These findings provide a new perspective for

understanding how entrepreneurs deal with the

unjustifiable amount of risk associated with the

complexity of indigenous society and culture in the

South Asian context, which challenges the western

ideologies and practices of entrepreneurial risk This

context sensitive understanding sheds some light

especially for policy makers, trainers and educational

institutions to develop more integrated and context

sensitive entrepreneurship development policies and

training and educational programs

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DIVIDEND TAX, DIVIDEND PAYMENTS AND SHARE VALUES: A SOUTH AFRICAN PERSPECTIVE

Me Stéfani Coetzee*, Johannes de Wet**

Abstract

The study investigates the impact of changes in dividend taxes on dividend payment policies and in turn, the impact of dividend payments on share prices An event study approach is used to analyse the share price movements before, on and after dividend announcement dates The results for companies

of which the dividend paid resulted in an increase in the dividend payout ratio were that share prices responded positively to the announcement on the announcement date and for the few days thereafter The findings again underline the paradoxical nature of dividends and although a better understanding

of the impact of dividends on South African companies was gained, the dividend puzzle remains largely unsolved

Keywords: Agency Theory, Clientele Effect, Dividend Puzzle, Dividend Tax (DT), Secondary Tax on

Companies (STC), Shareholder Value, Signalling Theory

* Office 3 – 21, Department of Financial Management, EMS – Building, University of Pretoria, Pretoria, South Africa Tel: 012 – 420 4926

Recent dividend tax reforms in South Africa and

internationally have again intensified the focus on the

impact of taxation on dividend payment policies and

in turn, the effect of dividends on share prices The

picture that emerges after a review of the literature in

the next section is far from coherent since there are

numerous theories on the importance of dividends,

some of which are directly opposed to each other

Among many other influencing factors, a discrepancy

between the rate of tax on dividends and the capital

gains tax rate has a direct bearing on the preference or

the lack thereof on the part of shareholders for cash

dividends and therefore, dividend announcements

may have an impact on share prices that is not entirely

predictable

If the current view that the main financial aim of

a business enterprise should be to enhance and

maximize shareholder wealth is still valid, then it

stands to reason that dividend policies should be

structured towards the fulfilment of this aim, all other

things being equal This study investigates the

existing theories regarding the payment of cash

dividends and then proceeds with empirical tests based on South African companies listed on the JSE

An event study approach was used to analyse the impact of dividend announcements on the share prices

to dividend announcements irrespective of whether the announcement resulted in an increase or decrease

of the company’s payout ratio Contrary to the expectation, for companies that announced dividends resulting in increases in payout ratios, share prices reacted positively on and after the announcement date For companies that announced dividends resulting in decreases in payout ratios, share prices also reacted positively around the announcement date This latter finding is in line with what was anticipated

2 Literature Review

2.1 A global perspective of recent

research

On 1 April 2012 Secondary Tax on Companies (STC)

of 10%, levied on South African companies, was

replaced with a Dividend Tax (DT) of 15% levied on

beneficial shareholders In the greater global context

the South African dividend tax adjustment did not

occur in isolation; on the contrary, it follows in the

wake of international capital market taxation reforms

These changes in taxation legislation sparked renewed

interest in the debate regarding the impact of dividend

taxes Wang and Guo (2011:199) reported that a

number of countries focused on dividend tax reforms

in recent years However, the direction of the

adjustments was contradictory as some countries like

Germany and Britain increased their dividend tax rate

while others like the United States and China have

reduced it

Alstadsaeter and Fjaerli (2009:596) conducted

research based on Norwegian companies for the

period 1999 to 2006 They found that after the

introduction of a dividend tax in 2006, there was a

sharp drop in dividends accompanied by a dramatic

decrease in debt ratios The dividend payments and

capital structure of companies proved to be very

sensitive to the changes in the taxation of the

shareholders

Wang and Guo (2011:208) researched the

impact of a dividend tax cut in 2005 in China and

found that it resulted in companies increasing their

dividends In a study based on Indian listed

companies, Ganguli (2011:132) asserted that dividend

tax adjustments provided unique opportunities to

investigate share price reaction to changes in dividend

payouts His research focused on the introduction of a

dividend tax in India and found that, contrary to

expectations, increased dividend payments lead to

increased share values in spite of the fact that higher

dividends lead to higher dividend tax

Jabbour and Liu (2004:73) studied the impact of

the 2003 divided tax cuts in the United States of

America (USA) on dividend policy and found that the

more profitable the company, the better the chance

that a higher dividend would be paid due to a lower

dividend tax rate Brown, Lliang and Weisbenner

(2007:1963) also investigated the (temporary) 2003

dividend tax cut in the USA and found evidence that

companies were much more likely to increase

dividends after the tax cut if the top executives owned

a larger proportion of the issued shares

Amromin, Harrison and Sharpe (2008:625)

tested the hypothesis that the dividend tax cut in May

2003 in the USA would boost share prices and

thereby lower the cost of capital Their findings

presented little evidence that the news of the tax cut

had an impact on share values in the share market as a

whole They did find positive abnormal returns for high-dividend yield shares, while low-dividend shares actually decreased in value

In the American Tax Foundation Special Report (2010), it is documented that before the dividend tax reduction of 2003, double taxation and high tax percentages made the USA unattractive as an investment destination It was argued that the double taxation discouraged capital formation, encouraged debt financing and discouraged corporate investment and dividend payouts The top individual tax rate on dividends and on capital gains was dropped to 15% and this move brought some welcome relief by reducing the double tax on corporate profits However, the lowered rates brought only temporary respite because they were set to expire at the end of

2010 with the capital gains tax rate increasing to 20% and the rate on dividends increasing to 39.6%

2.2 Miller and Modigliani and the clientele effect

In order to get a better grasp of the link between dividend tax, dividend policy and share values, it is necessary to go back to 1961 when Miller and Modigliani (1961) postulated that under perfect capital market conditions with no transaction costs and no taxes, dividends would be irrelevant and would not affect the value of a company Unfortunately, a world with no taxes does not exist and shareholders receiving dividends are required to pay tax on the dividend income in most countries The alternative to paying a dividend is the re-investment of profits which theoretically is capitalised into the share price, resulting in taxable capital gains when the shares are sold As a secondary, but related comment it is noted that dividend taxes and capital gains tax both constitute double taxation because profits are already taxed at normal corporate tax rates and then taxed again as a dividend tax upon distribution or as a capital gain upon realisation of the shares Consequently, it is evident that the tax rates and unique requirements of countries regarding the taxation of dividends and capital gains are very relevant to the dividend payment decision

Miller and Modigliani (1961) also came up with the clientele effect which assumes each company has

a body of shareholders which finds its dividend policy optimal This means that a change in the dividend policy might cause a change in clientele and this could be costly Elton and Gruber (1970:73) provided evidence, based on a sample of American companies, supporting Miller and Modigliani’s clientele effect and indicated that a change in dividend policy could cause a costly change in shareholder wealth They also found that shareholders in higher tax brackets show a preference for capital gains over dividend income, compared to those in lower tax brackets who

do not

Elton and Gruber (1970) also found that, in line

with the expectation that dividend taxes make

dividends worth less than capital gains, share prices

dropped by less than the full amount of the dividend

on ex-dividend days According to Eades, Hess and

Kim (1984) dividend tax is not the sole cause of this

anomaly found by Elton and Gruber (1970) Eades et

al (1984) provided evidence that the ex-dividend day

price decrease for share dividends (called scrip

dividends in South Africa and stock dividends in the

USA) was also less than the amount of the dividend in

spite of the fact that the receipt of share dividends are

tax-exempt in the hands of the shareholders

2.3 The link between dividend tax,

dividend payouts and shareholder value

Fama and French (1998:841) started their study with

the hypothesis that value is negatively related to

dividends and positively related to debt Their results

showed the opposite, namely that there is a positive

relation between dividends and company value and

that dividends apparently contain information about

profitability that is not conveyed by reported earnings

or other accounting indicators

Harris and Kemsley (1999:275) and Harris,

Hubbard and Kemsley (2001:569) used a sample of

American companies for the period 1975 to 1994 and

studied the impact of dividend taxes on company

valuation They stated the premise that in the USA

retained earnings are subject to dividend tax when

distributed versus contributed equity capital that can

be paid back to shareholders without attracting tax, as

an initial point of reference Furthermore, it was

inferred that retained earnings should be valued

(lower) on an after-tax basis; compared to contributed

capital, which should be valued on a before-tax basis

The conclusions were that overall company value and

the relative valuation weights investors attribute to

retained earnings, contributed equity and current

earnings were all affected significantly by dividend

taxes

In a study based on American companies over

the period 1989 to 1998, Dhaliwal, Li and Trezevant

(2003:176) used the term ‘tax penalty’ to refer to the

scenario where dividend income in the hands of

individual taxpayers is taxed at a higher effective rate

than capital gains income Their results indicated that

a dividend tax penalty is incorporated into the return

of a company’s ordinary shares and that the

company’s dividend policy and ownership structure

have an impact on the size of the dividend tax penalty

Yang and Chang (2004:55) indicated how the

difference in the way that income from dividends,

interest and capital gains are taxed in the hands of the

recipient presents opportunities for shareholders and

company management to devise permissible strategies

to maximise tax savings by shifting gains and losses

between them By implication, these strategies impact

the dividend policies of companies and affirm the

dynamic interaction between dividend taxes, capital gains taxes, dividend payouts, capital structure and company value

The literature reviewed so far seem to indicate that, internationally, companies persist with dividend payments in spite of strong arguments that the re-investment of profits would be preferable from most investors’ point of view and therefore enhances shareholder value Further investigation into this phenomenon brought to light the roles played by the concept called ‘the dividend puzzle’, signalling theory and the agency theory of dividends, which are discussed in the ensuing section

2.4 Dividend puzzle, signalling theory and agency theory

Black (1976) postulated that the dividend puzzle and signalling theory present two counter-arguments The dividend puzzle theory states that if dividends are taxed at a higher rate in the hands of the shareholders than the tax on capital gains, companies should limit

or not pay the dividend because it would be preferable for shareholders to rather make their own dividends

by selling shares when it suits them The benefits of this approach would be paying less tax and having the flexibility to choose the time when shares are sold to

create the home-made dividend

Signalling theory, on the other hand, argues that

in spite of the higher tax cost when the dividend is paid, the dividend provides valuable information about the company’s future prospects, thereby removing information asymmetry between managers and shareholders In a follow-up study Black (1986) stated that the positive correlation of share prices with dividends simply meant that ‘investors care about dividends directly’

John and Williams (1985) and Bernheim and Wantz (1995) produced evidence in support of signalling theory by concluding that it is the higher tax on dividends which makes dividends informative about the companies’ future values Amihud and Murgia (1997) investigated the validity of the signalling models applied to German companies Unlike the USA, dividends of German companies were actually taxed at a lower rate than capital gains

at the time and the study set out to determine whether dividends still conveyed information about future value under these conditions The findings were that dividend changes in Germany impacted share prices

in the same way as in the USA, indicating that dividend payments contain information that can be explained by factors other than the dividend tax

‘premium’

Roseff (1982) and Jensen (1986) interpreted dividends in the context of agency theory which denotes managers as agents of shareholders and shareholders as the principals in a relationship with conflicting interests The cash pay-out of dividends reduces the power of managers by decreasing the free

cash flow resources under their control When new

capital needs to be raised to finance investments, it is

more likely that management will be subjected to the

monitoring and discipline of the lenders and the

capital market The dividend paid also serves as a

deterrent for extravagant expenses and

empire-building by managers Dividend payments therefore

reduce agency costs

Pinkowitz, Stultz and Williamson (2006) undertook a

study on the agency theory implications of dividends

and corporate governance They included companies

from different countries in the study The results

suggested that the relationship between dividends and

company value is weaker in countries with better

corporate governance and therefore support the

agency theory

2.5 Dividend tax and dividend policy in

South Africa

Before 1993, dividends received in South Africa were

taxed in the hands of individual taxpayers and not at

company level Companies receiving dividends were

exempt from this dividend tax According to Williams

(1997:83) individual taxpayers were allowed a

deduction for dividends received ranging from 33.3%

to 100% of the dividend, depending on their other

taxable income Just before the replacement of this

personal dividend tax regime with STC in 1993, most

taxpayers had to include two thirds of the dividend

received as part of the total taxable income to be taxed

at personal marginal tax rates

In 1993, STC was introduced at a rate of 15%

levied against the company paying the dividend and

not the shareholder receiving it There was a

simultaneous drop in the normal corporate tax rate at

the time from 48% to 40% Koch, Schoeman and Van

Tonder (2005:194) and De Wet and Das (2008)

commented that the motivation for the dramatic

adjustment was ‘to encourage investment

opportunities’ and to boost job creation along with

increased capital investment, which would be

effected, according to SAICA (2009:12), by

encouraging companies to adopt modest dividend

distribution policies Joseph (2012:17) noted that the

introduction of STC was meant to ensure continuing

investment in the South African market, despite the

fact that, at the time, the economy was unstable due to

political changes

Ellis (2008) researched the impact of the

introduction of STC on dividend payments of South

African companies and found that there was no

negative effect as the dividends of companies in the

sample just continued to increase Correia Flynn,

Wormald and Uliana (2007:16-21), however,

indicated that the composition of dividends changed

dramatically since 1993 as companies used

substantially greater amounts of scrip dividends

(shares) instead of cash dividends to limit the liability

for STC Following the introduction of STC in 1993,

the STC rate was raised and reduced on different occasions while the corporate tax rate generally declined The STC rate was reduced from 12.5% to 10% on 1 October 2007 as part of the first phase of the Dividend Tax implementation process (Joseph, 2012:17) and the corporate tax rate at this time was (and still is) 28%

The introduction of the new Dividends Tax (DT) had already been announced by the then Minister of Finance, Trevor Manuel, in his Budget Speech of

2007 (Passmore, 2012:36), although STC remained in place until 31 March 2012 The minister indicated that the secondary tax system (STC) which allows tax to

be collected from a few thousand companies instead

of millions of shareholders, would be replaced in order to enhance the transparency and equity of the tax system (Manuel, 2007)

The main objectives, supplied by the South African Revenue Service (SARS, 2012), for the change to the new dividend tax withholding system, were to align South Africa with the international norm

of taxing the recipient of a dividend and not the company that issues the dividend, and to make South Africa a more attractive international investment destination, as previously foreign investors had viewed South Africa as having a higher corporate tax rate than other international investment areas Troskie (2008/9:35) believes that the new dividend withholding tax system will make the South African company tax rate more competitive, and that it should reduce uncertainty for foreign investors, as the system will be familiar to them, which, according to Mazansky (2009) will hopefully make South Africa a more attractive foreign investment destination Initially, the Dividend Tax was to be phased in

at a 10% rate (similar to the existing STC rate), with the effective date for the completion of the conversion

to the new tax system set for the end of 2008 However, the implementation thereof was delayed, according to Mollagee (2013:21) and Fin24 (2010), mainly due to the renegotiation of international double tax treaties

According to SAICA (2009: 12) the second phase of the STC reform entails the replacement of STC with a tax that is levied at a shareholder level In his 2012 Budget Speech the current Minister of Finance, Pravin Gordhan, announced that the Dividend Tax would take effect as of 1 April 2012, but at a rate of 15%, and not 10% as had been previously announced (Gordhan, 2012)

The reasons for the increase in the rate appear unclear, as the minister merely mentioned ‘equity reasons’ Different interpretations were therefore given to his statement by analysts, including that the increase would be used to compensate SARS for the substantial ‘losses’ it would suffer as a result of certain groups being exempt from dividend tax (Wealthwisemag, 2012) and that the increase was an attempt to address the apparent mismatch in the way

that income from interest, dividends and capital gains

are taxed (Planting, 2012)

The beneficial shareholders that will be exempt

from dividend tax include all South African

companies, public benefit organisations, all tiers of

government and semi-government institutions,

pension, provident, retirement annuity and other

similar funds, environmental rehabilitation trusts,

medical aid schemes and the first R200 000 of the

total dividend paid to shareholders in

micro-businesses during a particular year of assessment

(Joseph, 2012:17 and Troskie, 2008/9:35)

The new Dividend Tax system would initially

have allowed, for a period of five years, the offsetting

of STC credits against dividends paid, provided that

the company paying the dividend had notified the

recipient of the dividends of the amount by which the

dividends reduced the STC credit of said company

(Ellary, 2012:34) However, the minister of Finance

in his 2012 budget speech also reduced the initial five

year transition period in respect of STC credits to

three years, due to the delayed implementation of the

Dividends Tax regime (McFadden, 2012) and as the

proposed increase of the rate from 10% to 15% meant

that any available STC credit was likely to be used up

more quickly (Planting, 2012)

The offsetting of an STC credit against possible

dividends would mean that the dividend in question

would not be taxed during that particular year, which

would increase dividends in the hands of investors

during this three year period It furthermore implies

that for as long as the STC credits last, companies are

more likely to pay out more substantial dividends to

investors during this time

It should also be noted that Passmore (2012:36)

and Mollagee (2013:20) addressed the fact that the

new Dividend Tax will add a significant

administrative burden on the companies which have

to withhold the dividend taxes This could potentially

act as a disincentive to paying dividends To this

extent, Brandt (2012) advises companies to consider

amending their dividend policies in order to ease the

burden of the implementation of the new dividend

withholding tax system

However, at the same time, companies are

informed that, although they are under no obligation

to increase their dividend policy to ensure that their

shareholders are in a similar position as they would

have been under the old STC system; this matter

should be borne in mind for future dividend decisions

Companies may be very confused about the

contradictory advice, and it should be interesting to

see what the effect of the dividend tax system will be

once the implementation period and STC offsetting

period has passed

3 Objective of the Study and Hypotheses

Under the STC dividend tax regime in South Africa

the perception existed that the total corporate tax

burden locally was heavier than in other foreign countries and as a consequence, it had a negative impact on the attractiveness of South Africa as an investment destination The replacement of STC with Dividend Tax in 2012 aligned South Africa with most other countries where dividends are taxed in the hands

of the receiver and not at company level In commentaries by Momentum Investments (2012) and PKF Chartered Accountants (2012) it is stated explicitly that Dividend Tax was implemented to encourage investment into the country

Purely from a company perspective, the relief of the obligation to pay STC meant less total corporate tax and the possibility of greater (inbound) foreign investment However, from an individual investor’s point of view, the 15% Dividend Tax may lead to a preference for capital growth rather than dividends and therefore may inhibit the payment of dividends The current maximum effective capital gains tax rate

in South Africa is 13.3%, making profit re-investment

a slightly better option than receiving a dividend The increase of the dividend tax rate from 10%

as STC to 15% as Dividend Tax may be construed as

a discouragement to pay dividends and an incentive for re-investment The fiscal intent may be that greater re-investment of profits may lead to more future profits and in turn, more tax for the state and job creation From an investor’s view, less dividends and more re-investment of profits, combined with the availability of projects with potential positive net present values (NPVs), could lead to higher share prices There was some support for this argument in a study based on listed South African companies by Nell, Hamman and Smit (2001) who found that companies that decreased dividends showed growth in earnings in the following years

However, this perspective is somewhat contrary

to findings by Arnott and Asness (2003:84) that provided emphatic evidence that low payout ratios precede low earnings growth Incentivizing higher retention rates is also in conflict with the signalling theory and agency theory, which both support the notion that the payment of a dividend has value and therefore may lead to an increase in the share price and company value

The objective of this study is therefore to investigate the impact of dividend announcements on the share price of companies, against the background

of recent government tax legislation, the signalling theory and agency theory There are therefore two hypotheses, the first being that higher dividend payouts lead to lower company value:

H1 = Higher dividend payouts lead to lower company value

The second hypothesis is related and complementary to the first, namely that lower dividend payouts lead to higher company value:

H2 = Lower dividend payouts lead to

higher company value

It should be noted that both hypotheses are in

line with fiscal intent, but contrary to the signalling

and agency theories

4 Data and Descriptive Statistics

Companies listed on the JSE were used for the

empirical tests and the top 100 companies in terms of

ordinary share market capitalization were included in

the initial sample Only the companies that paid cash

dividends during the period 1 January 2008 to 31 December 2012 were retained for the purposes of the analysis and data regarding dividends paid (DIV), earnings after tax (EAT), market capitalization (MV), dividend announcement dates and daily share prices were gathered McGregor BFA was used as the source for the data and the final size of the sample for which complete information could be extracted was 68 companies The total cash dividends, earnings, market capitalisation, dividend payout and dividend yield for the sample companies for each year from 2008 to

2012 are provided in Table 1

Table 1 Total dividends, earnings, market capitalisation, dividend payout % and dividend yield % per year from

Table 1 indicates that the total dividends paid by

the sample companies dropped from 2009 to 2010,

but then again showed an upward trend in 2011 and

2012 Total earnings dropped significantly from 2008

to 2009, perhaps as a result of the economic crisis, but

then grew strongly in 2010 and 2011, after which a

drop-off occurred again in 2012 Total market

capitalisations dropped from 2008 to 2009 and then

showed steady growth each year until 2012 Dividend

payout ratios reached a high of 52.32% in 2009,

dropped significantly in the next two years and then recovered to 48.56% in 2012 Dividend yields also peaked in 2009, dropped by a large margin in 2010 and then increased gradually to 4.49% in 2012 Table

2 contains the descriptive statistics of changes in dividends, earnings and payout ratios, as well as companies that increased their payout ratios and those that decreased it

Table 2 Descriptive statistics

∆DIV PAYOUT (%) = (Dividendt/ EATt / Dividendt-1/EATt-1 -1)*100

The descriptive statistics in Table 2 are based on

the average of the changes in dividends, earnings and

payout ratios for each company in the sample Large

increases or decreases in dividends, earnings or

payout ratios by individual companies produced

outliers which distorted the averages However, no

effort was made to remove these on the grounds that

the main purpose of calculating these changes was to

identify the companies that increased their payout

ratios and those that decreased it The research methodology is described in the next section

5 Research Methodology

An event study approach as described by MacKinlay (1997:14-16) was used as methodology and specifically the constant mean return model The model is used to investigate abnormal daily share returns around the final dividend declaration date,

which is denoted as the event date, or day 0 Similar

to a study based on Indian companies by Ganguli

(2011:134), an event window of 11 days was used,

including the 5 days before the dividend

announcement day, the announcement day itself and

the 5 days thereafter The estimation window was set

at 150 days, ranging from day -155 to day -6 All the

calculations described below were done separately for the two groups, namely the companies that increased dividend payouts and those that decreased it

For each day in the event window, as well as in the estimation window, daily returns were determined using the following formula:

Rit = (Pit - Pit-1) / Pit-1

Where Pit = Closing share price on a given day

Pit-1 =Closing share price on the previous day;

prices are adjusted for share splits, bonus share issues,

rights issues and share buybacks

The constant mean return model requires the determination of the expected return during the

estimation period, which is the mean daily return:

Finally, the cumulative average abnormal return

(CAAR) is determined for each day in the event

window and the results are tabulated and plotted on a

graph for analysis and interpretation

6 Results and Discussion

The AARs and CAARs during the event window for

each year from 2008 to 2012 for companies that

increased their dividend payout ratios are presented in

Table 3, while the same information for companies

that decreased their dividend payout ratios is given in Table 4 The tables are followed by the graphs depicting the movement in the AARs and CAARs during the 11-day estimation period Figure 1 shows the data for companies that increased their dividend payout ratios and Figure 2 the data for those companies that had decreases in their dividend payout ratios

Table 3 Share price reaction to dividend payout increases

Figure 1 Graphical presentation of share market reaction to dividend payout increases

Table 3 and the graph-lines in Figure 1 reveal

that for companies that increased their dividend

payout ratios there was very little market reaction

before the dividend declaration announcement day

On the announcement day and on each of the next

five days, the market price reacted positively,

indicating that the market perceived the increased

dividend payout ratios as good news This is in spite

of the higher tax that the dividends would attract relative to capital gains tax and it is contrary to the first hypothesis that higher dividend payouts would result in lower company values The first hypothesis

is therefore rejected

Table 4 Share price reaction to dividend payout decreases

AAR (%)CAAR (%)

-1,000-0,5000,0000,5001,0001,5002,000

AAR (%)CAAR (%)

Table 4 and the graph-lines in Figure 2 show that

for companies that announced dividends resulting in

lower payout ratios, the market price also reacted

positively, indicating that the market also interpreted

the announcement of dividend payments resulting in

lower payout ratios as good news Positive share price

returns were reported in anticipation two days prior to

the dividend announcement date and the positive

returns continued each day for each of the following

seven days until the fifth day after the dividend

announcement

The slight drop in the positive returns two days

after the announcement date can be ascribed to an

expected correction in the share price after continuous

increases in the preceding four days These findings

for companies that had decreases in dividend payout

ratios are in line with the second hypothesis that

decreases in dividends would lead to increased share

values in the presence of dividend taxes which are

higher than the rate of capital gains tax The second

hypothesis is therefore accepted

One would have expected the findings for the

two groups of companies to move in tandem, i.e

higher payouts and lower values for the one group

combined with lower payouts and higher values for

the other or alternatively higher payouts and higher

values for the one group combined with lower

payouts and lower values for the other The

contradiction in the findings for the two groups of

companies is somewhat perplexing as the findings for

the companies with increased dividend payouts lend

support to the signalling and agency theories, while

the results for the companies with decreased payouts

re-affirm the dividend puzzle theory of Black (1976)

The CAAR of 1.669% for companies that

decreased their payouts was slightly higher than the

CAAR of 1.214% of companies that increased their

payouts and consequently one might argue that on the

balance, the net effect for the total sample of JSE

companies was that the markets reacted more

positively to decreases in dividend payouts compared

to the reaction to increases in the same

Conclusions

Numerous studies have been done locally and

internationally to determine the impact of dividend

payments on share values To date, no local study has

endeavoured to gauge the impact of dividend

announcements and payout ratios on share values

during an event window using daily share price

information Changes in the legislation on dividend

taxes, like the change from STC to a dividend

withholding tax system in South Africa in 2012,

accompanied by an increase in the rate from 10% to

15%, create the opportunity to investigate how

different tax implications affect dividend policies and

how dividends affect share prices This study first

explores the theoretical landscape related to the

impact of dividends on share prices and then uses the

event study approach to compare the results of price movements during an event window with those during

an estimation window

The results of the study are mixed and in a sense constitute a ‘hung jury’ It was found that the markets reacted positively to dividend announcements that resulted to higher dividend payout ratios as well as those that resulted in lower payout ratios The positive movements of share prices around the dividend announcement dates also, against the backdrop of the imperfections and tax dispensation of the local financial markets, render the irrelevance theory of Miller and Modigliani (1961) invalid for South African JSE listed companies

The first hypothesis stating that higher dividend payouts would result in lower share values was rejected on the grounds that the findings report share price increases after announcements of increased dividend payouts These results support the signalling theory that postulates that dividends have information value which is greater than the higher tax cost related

to it, relative to capital gains tax The results are also

in line with the agency theory which argues that dividend payments have value because it limits the free cash flow at the disposal of managers

Given the findings that led to the rejection of the first hypothesis, one would have expected that the second hypothesis would also be rejected Surprisingly, for companies of which the dividend announcements resulted in decreases in dividend payout ratios, share prices also reacted positively and even more so than for the group of companies that had increases in their payout ratios These findings represent support for the dividend puzzle theory of Black (1976) which states that it is preferable to not pay dividends when the tax on the dividends outweigh the capital gains tax rate

Based on these outcomes it could be debated whether there is perhaps an inconsistency or an overly optimistic bias in the South African share market which manifests in announcements of dividends resulting in both increases and decreases in dividend payouts positively impacting share prices Furthermore, significant movements in the international markets, causing extreme volatility on the JSE, may have coincided with the event windows

in the research period and consequently may have masked the impact of the dividend announcements The findings therefore do not send a clear signal

in terms of how South African investors have interpreted changes in dividend payments in recent times of changing taxes on dividends The ramifications of dividend policy changes on share prices therefore still remain somewhat of a mystery It

is suggested that the underlying causes of this phenomenon as well as the impact of the new dividend withholding tax system in South Africa on company dividend policies and share values from

2012 onwards, be explored in further studies

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BEING ON TOP OF YOUR GAME AT THE BOTTOM OF THE

a lucrative market in the South African context From the paper, it is evident that the BOP proposition, if effectively implemented, has the potential to reduce poverty in South Africa and increase the profits of MNCs It then reviewed Prahalad’s twelve Principles of Innovation and strategically divided these into six differentiation and six low-cost strategies The paper concludes by articulating creative strategies (based on Prahalad’s 12 principles of innovation) for active participation and competitive advantage at the bottom of the pyramid, which are vividly presented in a model for strategic partners especially multinational corporations (MNCs) to adopt when expanding their scale of operations to incorporate the BOP market

Keywords: Bottom of the Pyramid, Global Poverty, Poverty in South Africa, Differentiation

Strategies, Low-Cost Strategies

*School of Management, IT and Governance, Faculty of Management Studies, University of KwaZulu-Natal (Westville campus), Private Bag X54001, Durban, 4000

In the year 2000, 192 member countries of the United

Nations committed themselves to achieving 8 United

Nations Millennium Development Goals, the first of

which is the eradication of extreme poverty and

hunger This millennium declaration was an

unprecedented expression of solidarity in which 192

countries (both rich and poor) pledged to make every

plausible endeavour to promote human development

and halve poverty by 2015 This mammoth task had

raised the question about whether or not the efforts of

government, non-governmental organisations

(NGOs), aid agencies and the Corporate Social

Responsibility (CSR) initiatives of organisations in

the private sector were going to be commensurate in

ameliorating the plight of approximately 4 billion

people who are economically at the bottom of the

pyramid (BOP) (Prahalad, 2005)

Prahalad, an internationally acclaimed business

philosopher and strategist, promulgated in his book

entitled, The Fortune at the Bottom of the Pyramid:

Eradicating Poverty through Profits, an alternative

approach to poverty reduction which involves a joint collaborative effort by government, NGOs, large domestic firms, multinational corporations (MNCs) as well as the poverty stricken citizens themselves in order to alleviate poverty and generate profits for the businesses that serve the needs of BOP consumers Prahalad and Hart (2002) advocated that MNCs have the necessary financial and physical resources, infrastructure, knowledge, expertise, experience and capabilities to:

 redesign their existing business models to suit the BOP markets;

 create innovative and low-cost product and service offerings that will improve lifestyles, nutrition and well-being of BOP consumers and

 articulate business strategies that will not only be conducive to reaping profits but also form the basis for establishing a competitive advantage and growing market share at the bottom of the pyramid

Like any unorthodox proposition, Prahalad’s

BOP perspective has morphed into a contentious issue

in which its merits and effective implementation have

been supported or questioned by business strategists,

academics and sagacious scholars An insight into the

criticisms of the BOP proposition falls outside the

jurisdiction of this paper Recent literature and

success stories pertaining to the BOP proposition does

however suggest that this market can be harnessed by

profit-seeking organisations in order to generate

profits for themselves by establishing a relationship of

trust with BOP consumers and shifting the focus from

the highest possible profit margins to the highest

possible volume of sales (Anderson & Billou, 2007;

Pitta, Guesalaga & Marshall, 2008; Prahalad & Hart,

2002; Sridharan & Viswanathan, 2008;

Subrahmanyan & Gomez-Arias, 2008; Tripathi & De,

2007) The underlying rationale in servicing the needs

of the BOP consumers is for MNCs to reduce the

per-unit cost of products through the effects of economies

of scale, set modest profit margins in order to render

their products affordable and industriously increase

their volume of sales by tapping into previously

‘unreachable’ markets by employing creative market

development and distribution strategies

2 The Purpose of the Article

This article purports to analyse the viability of

Prahalad’s BOP proposition within the South Africa

context, assess how prevailing strategies need to be

altered in order for MNCs to profitably serve the

needs of the BOP consumers in South Africa and to

articulate creative strategies (based on Prahalad’s 12

principles of innovation) to form a model for active

participation and competitive advantage at the bottom

of the pyramid

Before delving into the theoretical framework of

the BOP proposition, an understanding of what and

who constitutes the BOP market is necessary together

with a background into the current state of poverty in

both, the international as well as South African

arenas

3 Global Poverty

An elementary definition of poverty is that, it is a

state in which there is a lack of adequate resources to

meet a specified quantum of basic requirements for

survival It is often defined as material or

multidimensional (such as, income, health, education,

security) deprivation However, such a simplistic

conceptualisation of poverty runs the risk of the poor

being perceived as victims of unfortunate

circumstances instead of conscious actors struggling

to improve their conditions (Engberg-Persen &

Ravnborg, 2010)

There are three basic approaches to estimating

poverty lines, namely, an absolute, a relative and a

subjective approach, each of which views poverty and

the appropriate quantification thereof, differently According to Statistics South Africa (2007), an absolute poverty line is calculated with reference to a fixed basket of goods and this fixed monetary value is only updated to take into account inflation and does not take cognisance of shifts in the average standard

of living in society It is the minimum standard, under which an individual would not be able to ‘make ends meet’ and is the absolute minimum income or expense necessary to meet basic needs (Araar, Bibi, Duclos & Younger, 2010) Oosthuizen (2007) defines

a relative poverty line as the one that takes society’s characteristics into consideration and endeavors to identify those individuals whose standards of living are unacceptably low relative to the rest of society Such a poverty line begins to measure the ability of the households or individuals to engage adequately in their society and is defined as a proportion of the mean or median income of that society, and is thus, defined in relation to a social norm (Araar et al., 2010) The subjective approach to measuring poverty relies on the individuals’ opinions of what constitutes the minimum income that is required by the household in order to sustain itself A tremendous amount of controversy exists on whether the absolute, relative or subjective approach is the best estimate for

a poverty threshold (International Development Research Centre, undated) and very often the choice

is not clear-cut (Oosthuizen, 2007)

Prahalad and Hart (2002) used a four-tiered world economic pyramid to represent the global distribution of wealth and the capacity to generate income (Figure 1)

As depicted in the pyramid (Figure 1), Tier 1 comprises the wealthy, affluent middle- and upper-income consumers from developed countries and a small proportion of rich elite consumers from the developing world who have substantial opportunities

to generate high levels of income Tiers 2 and 3 comprises individuals whose annual per capita income (based on purchasing power parity in American dollars) is between $1 500 and $20 000 Jaiswal (2007, p 6) defines purchasing power parity (PPP) as the ‘concept that is used to equalize the purchasing power of different currencies in their respective countries for a given amount of goods and services’ According to London (2007), purchasing power parity is a measure that equates the price of a basket of identically traded products and services across countries, thereby providing a standardised comparison of real prices Tier 4 represents the largest proportion of approximately 4 billion people in the pyramid who earn less than $1 500 per annum, based

on purchasing power parity in American dollars and this tier has been identified as the bottom of the pyramid

Figure 1 The Economic Pyramid

Prahalad, C.K & Hart, L.H., (2002), ‘The Fortune at the Bottom of the Pyramid’, Strategy+Business, Available at http://www.cs.berkeley.edu/~brewer/ ict4b/Fortune-BoP.pdf p 4.

London (2007) uses the term ‘base of the

pyramid’ as opposed to ‘bottom of the pyramid’ to

describe the consumers in Tier 4 but albeit a slight

variation in the term, this tier is representative of the

poor at the base of the global socio-economic ladder

who transact primarily in an informal market

economy In a collaborative global study by the

World Resources Institute (WRI) and the

International Finance Corporation (IFC), it was found

that the highest prevalence of BOP consumers reside

in rural villages, urban slums and shanty towns across

Africa, Asia, Eastern Europe, Latin America and the Caribbean (London, 2007) These BOP markets are challenging to reach from a distribution, credit provision and communication point of view and educational levels of these consumers are low to non-existent (Prahalad and Hart, 2002)

In August 2008, the World Bank had revised its estimates of global poverty to what it believes to be a more accurate reflection of poverty today (Figure 2)

Figure 2 Percent of People in the World at Differenct Poverty Levels, 2005

World Bank Development Indicators, (2008), ‘Percentage of people in the world at different poverty levels, 2005’, Available

at at http://www.globalissues.org/ article/4/poverty-around-the-world#WorldBanksPovertyEstimatesRevised p 6.

Using a new threshold for extreme poverty of

$1.25 per day, the World Bank concluded that there

were 1.4 billion people (approximately 22 percent),

out of the global population of 6.46 billion people,

living in extreme poverty in 2005 (Figure 2) (World

Bank Development Indicators, 2008) Many

developing countries today have poverty lines at $2

and $2.50 Statistics from Figure 2 reveal that 2.6

billion people (approximately 40 percent) live below

$2 per day and almost half of the global population

(3.14 billion people) survives on less than $2.50 per day (World Bank Development Indicators, 2008) According to the United Nations Millennium Development Goals Report (2011), the proportion of people living on less than $1.25 per day has decreased from 1990 to 2005 in most of the developing regions with the highest prevalence of BOP consumers (Figure 3)

Figure 3 Percentage of People living on less than $1,25 per day, 1990 and 2005

Adapted from United Nations Millennium Development Goals Report, (2011), ‘Proportion of people living on less than $1.25 a day, 1990 and 2005 (Percentage)’, Available at - http://www.un.org/millenniumgoals/pdf/(2011_E)%20MDG%20Report%202011_Book%20LR.pdf p

6

From Figure 3 it is evident that the sharpest

reduction in poverty between 1990 and 2005 was

found in Eastern Asia (from 60 percent in 1990 to 16

percent in 2005) The Caucasus & Central & Western

Asian regions however recorded increases in the

proportion of people living on less than $1.25 per day

Developing countries on aggregate have experienced

a reduction in the number of people living on less

than $1.25 daily from approximately 1.8 billion in

1990 to 1.4 billion in 2005 and the World Bank’s new

poverty projection for 2015 expects a further decrease

to approximately 900 million people (United Nations

Millennium Development Goals Report, 2011)

4 The Current Extent of Poverty in South Africa

South Africa was one of the signatories to the United Nations Millennium Declaration but a commitment to reducing poverty in the country started well before the international millennium targets were set in the form

of the Reconstruction and Development Programme which set out to meet the basic needs that were incorporated into the formulation of the democratic government’s policy framework from 1994 (Statistics South Africa, 2007) The South African Institute of Race Relations Survey (2010/2011) reveals statistics which indicate that progress is being made towards poverty reduction in South Africa, but at a straggler’s pace (Figure 4)