DO TRANSACTIONAL, TRANSFORMATIONAL AND SPIRITUAL LEADERSHIP STYLES DISTINCT

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ABSTARCTING AND INDEXING SERVICES

EBSCO (Business Source Complete)
ii
JANUARY 2011. VOLUME 2. NUMBER 1
CONTENTS
RESIDENTIAL DEMAND FOR ELECTRICITY IN DASMARINAS, CAVITE, PHILIPPINES

Willington O. Onuh, PhD., Alice T. Valerio, PhD. and Ananias Permalino, Jr., MBA. 1
A STRATEGIC FRAMEWORK FOR VALUE ENHANCING ENTERPRISE RISK MANAGEMENT

Lai Fong Woon, Noor Azlinna Azizan and M. Fazilah Abdul Samad 23
A PRELIMINARY STUDY OF TOP SMEs IN MALAYSIA: KEY SUCCESS FACTOR VS

GOVERNMENT SUPPORT PROGRAM
Daisy Kee Mui Hung, Azura Abdullah Effendi, Lilis Suriety Abdul Talib
and Noor Afiza Binti Abdul Rani 48
ANALYSIS OF INCOME AND EXPENDITURE OF HOUSEHOLDS IN THE EAST COAST

OF PENINSULAR MALAYSIA
Noorhaslinda Kulub Abd. Rashid, Aslina Nasir, Nik Hashim Nik Mustapha
and Nik Fuad Kamil 59
DO TRANSACTIONAL, TRANSFORMATIONAL AND SPIRITUAL LEADERSHIP STYLES

DISTINCT? : A CONCEPTUAL INSIGHT
Zaini Jamaludin, Nik Mutasim Nik Ab. Rahman, Zafir Khan Muhammad Makhbul
and Fazli Idris 73
CAN THE MODEL OF THE RIBA-FREE ISLAMIC COMMERCIAL BANK PROVIDE A NEW
PARADIGM FOR THE FUTURE OF GLOBAL BANKING?: A THEORETICAL REVIEW
Nico P. Swartz 86
OKUN’S LAW IN MALAYSIA: AN AUTOREGRESSIVE DISTRIBUTED LAG (ARDL)

APPROACH WITH HODRICK-PRESCOTT (HP) FILTER
Ngoo Yee Tingi and Loi Siew Lingii 95
THE EFFECT OF OWNER’S GENDER AND AGE TO FIRM PERFORMANCE: A REVIEW

ON MALAYSIAN PUBLIC LISTED FAMILY BUSINESSES
Noor Afza Amran 104
iii
1
RESIDENTIAL DEMAND FOR ELECTRICITY IN DASMARINAS, CAVITE, PHILIPPINES

Willington O. Onuh, PhD
De La Salle University-Dasmarinas
Alice T. Valerio, PhD

De la Salle University-Dasmarinas
Ananias Permalino, Jr., MBA

Meralco-Cavite
ABSTRACT
Recent unstable oil prices and continuing concerns of global warming have reignited interest in
understanding the demand for residential electricity consumption by households. Given the declining
tariff block that characterizes electricity demand, understanding households’ responsiveness to electricity
price changes can help both utility companies and policymakers predict future energy needs and design
appropriate policy responses to future conservation needs.
This study identifies the factors affecting the demand for electricity of 403 households in the province of
Cavite, Philippines. It also calculates appliance specific price and income elasticity’s of their electricity
demand. The reciprocal least square estimation and probity model were employed.
The findings show that number of TVs, number of fans, floor area, number of bedrooms, member of
household not working, gross income, and refrigerator size increase electricity consumption. On the
other hand, number of households and electricity consumption practices tend to reduce electricity
consumption. Overall, household price elasticity of demand for electricity is low. Evidently, appliance
specific price elasticity’s differ across appliance portfolio. These differences reflect both the mean
monthly consumption of the appliance and the coefficient of the appliance price used in the point
elasticity computation. Overall, household income elasticity with respect to electricity demand is low and
positive. This implies low responsiveness of residential electricity demand with respect to changes in
income. Additionally, lower income households have greater elastic demand for electricity than higher
income level households.
Keywords: Residential demand for electricity, electricity consumption, tariff block, appliance
portfolio, price elasticity of electricity demand.
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1.0 INTRODUCTION
The residential sector heavily relies on electricity as the most convenient form of household energy
source. During the past few decades, electricity consumption in the Philippines has grown faster than
any other fuel. The growth rate of per capita household electricity consumption in the Philippines has
exceeded the growth rate of per capita income. While the Philippine per capita electricity consumption
has been lower relative to other Asian countries (United Nations Economic and Social Commission for
2
Asia and the Pacific [UNESCAP], 2001) the national demand for electricity is at an all-time high. Rapid
population growth and an expanding digital economy will drive electricity demand even higher within
the next 25 years. Meeting this demand will be a challenge for the Philippine electric companies
requiring them to make major investments in power plants, as well as the transmission and distribution
systems used to deliver electricity where it is needed.
Differences in energy consumption between urban and rural households are more distinct with
electricity. Electricity consumption by households in the National Capital Region and other urban areas
has increased by an average of 27.8 per cent whereas consumption of electricity in rural areas continued
to stagnate (UNESCAP, 2001). Electricity consumption in the Philippines grew by 10.6 percent in 2003,
then by a lower 3.2 percent in 2004, and then by an even lower 2.5 percent in 2005. In 2006 electricity
consumption grew by only 1.1 percent. In general, it is residential and commercial users who hold a
bigger share of total consumption. The thing is, residential and commercial consumers have peak hours
when their demand for electricity is strong (Freedom from Debt Coalition, 2008).
The Philippine electricity consumption shows a consistent trend over the years. Annual growth rate is
four percent for Luzon and six percent for Visayas and Mindanao. However, during the past five years,
the demand for electricity of residential sector has been noticed. Electricity consumption of residential
consumers is greater than that of commercial and industrial sectors. Based on the Philippine Power
Statistics report of Department of Energy (DOE), commercial sector is the lowest consumer among the
three sectors (DOE, 2008). From 1986 to 2001, industrial sector is the highest consumer of electricity.
However, in 2001 up to 2005, the highest demand for electricity has been shifted to residential sector. In
2006, the electricity consumption of residential sector in Luzon was 28 percent while that of commercial
and industrial were 26 percent and 25 percent, respectively. Industrial sector got the highest share in
both Visayas and Mindanao. Overall, the electricity consumption for both residential and industrial
sector has a slight difference in 2006.
In 2005, Manila Electric Company (Meralco) has about 3.9 million residential customers. During the
same year, Cavite has 515,707 residential customers (Meralco, 2008). This is about 13 per cent of the
total residential customers within the service area of Meralco, most of the customers being served are
in Metro Manila. In Cavite, however, the electricity consumption of residential customers was 868,178
MWh. Dasmariñas, being its biggest municipality in terms of population, has 109,040 residential
customers with an electricity consumption of 162,306 MWh. This is about 21 per cent of the total
residential customers and about 18.7 per cent of the total electricity consumption in Cavite.
Much has been written about the determinants of demand for electricity in developing and developed
countries (eg. Holtedahl & Joutz, 2000; Ubogu, 2002; Reiss & White, 2002; Lin, 2003; Department of
Energy, Philippines, 2001; Khanna & Rao, 2009; and ishi & Joutz, 2009). These studies differed only in
the specification of price variable; time period covered (whether short-run or long-run); sector included
(whether commercial or residential); performance outcomes of economic policies affecting the
electricity sector, including institutional reforms such as privatization and regulation; and the proxy
variables used for urbanization to indicate economic development. Other works attempted to include
other variables such as environmental variables and price of electricity-consuming equipment
(Francisco,1988) while others considered the stock of electrical equipment and rate of utilization (DOE,
Philippines, 2001).
The effectiveness of pricing policy is dependent on how responsive the consumers are on changes of
electricity prices. Intuitively, households may adjust their electricity consumption based on prices,
3
income, and how efficient their electrical appliances are. The objectives of this paper are to identify the
factors affecting residential demand for electricity; determine the responsiveness of residential demand
for electricity to changes in electricity prices and income; and calculate the marginal effects for a
portfolio of residential appliances.
The estimation of consistent and stable price and income elasticity estimates is important. The study will
benefit the electric utilities, the residential consumers, and government planners and private investors
who need to be well informed regarding privatization programs in restructuring the industry. Electric
utilities will have a relevant basis in explaining to consumers their electricity consumption behavior and
possibly suggest how to efficiently use their appliances and conserve electricity. In effect, if consumers
are well informed on their electricity consumption, the country as whole will benefit in terms of
optimizing the resources. This study may also be used as a reference in designing a rate structure and
forecasting of energy sales. Moreover,ith proper and effective communication channels, residential
consumers will be informed on how to efficiently use their appliances and conserve electricity. In effect,
if consumers are well informed on their electricity consumption, the country as whole will benefit in
terms of optimizing the resources.
2.0 LITERATURE REVIEW
In the past years, a number of studies on electricity demand has been documented and published. It
has been one of the interests of economists and environmentalists across nations. According to
Holtedahl and Joutz (2000), the short-run and long-run residential electricity consumption in Taiwan are
affected by the price of electricity, household disposable income, population growth, and degree of
urbanization. Urbanization, as a measure of economic development, was used to capture economic
development characteristics and electricity-using capital stocks not explained by income. Urbanization
implies greater access to electricity. The study did not include weather variables. In the estimation of
residential electricity demand in Seoul, family size, size of house, household income, and dummy for a
plasma television and air conditioner have a positive effect on residential electricity demand (Yoo, Lee,
& Kwak, 2007). However, the price of electricity has a negative relation with residential electricity
demand.
Ubogu (2002), however, in his analysis of the Nigerian electricity demand found that average price of
electricity, though rightly signed, was found to be insignificant. The findings showed that per capital
income, previous level of electricity consumption and urbanization are the most significant explanatory
variables for the residential sector's electricity consumption. As regards the commercial sector, the
significant explanatory variables were previous level of electricity consumption, income, average price of
electricity and urbanization.
Mayer and Horowitz (2003) analyzed the demand for electricity and its relationship with the price of
electricity using monthly consumption statistics of a community of owner-occupied, almost identical
townhouses. A simple statistical model was used to split the cooling season demand for electricity into
air-conditioner demand and the demand for lights and appliances. The noncooling portion of the
demand decreased, but otherwise increased each year. It was found that, although the marginal price
has doubled, these changes in price have had little effect on demand.
Reiss and White (2002) used a sample of California households and variation in electricity demand in
both the short run and long run. Tariff design was considered to have energy conservation, raise
additional revenues for utilities, and minimize expenditure changes in lower-income households. In the
4
short-run, electricity demand is a factor of utilization of existing appliance stock, while in the long-run,
changes utilization behavior and changes in stock of electric appliance are the significant variables.
However, the study focused only on short-run effect because of limitations in the data and difficulty in
the appliance replacement decisions. Appliances were categorized as space heating, water heating, air
conditioning, refrigeration, pools, and other appliance. The effect of seasonal use of electricity and
weather were not considered in the study.
Lin (2003) estimated the electricity demand in China by including GDP, price of electricity, population,
structural changes, and efficiency improvement in the model. The study revealed that electricity
demand is negatively related to changes in infrastructures and efficiency improvement. The weather
condition was not integrated in the model because of difficulty in assessing its effect on electricity
consumption. Structural changes such as construction of buildings, homes, and other infrastructures
were considered as significant factors to contribute to the electricity consumption of the country.
However, structural changes like new homes and commercial establishment were not considered. The
study concluded that the GDP, energy prices, and structural changes are significant determinants in the
short-term electricity consumption.
In the Philippines, the demand for electricity was estimated using the short-run and long-run models
(Department of Energy, 2001). The short-run residential demand for electricity model was based on the
demand for electricity-usage appliances while the long-run considered the variation of stock of
appliances. In the short-run model, electricity consumption is a function of stock of electrical equipment
and the rate of utilization. Moreover, the rate of utilization depends on the household size, price of
electricity, household budget, and household class (urban or rural). It was found that the residential
demand for electricity is a function of household budget per capita, price of electricity, household size,
household class (urban or rural), entrepreneurial activities, electrical appliances, and interaction
between price of electricity and the electrical appliance. The long-run demand for electricity of
residential consumers depends on the changes or variation of the electrical appliances. The electricity
consumption is a function of income, price of electricity, prices of competing fuels, and household
characteristics. The empirical model is represented by the average household electricity consumption,
average household expenditure per capita (adjusted for provincial price differences), average price of
electricity, percent of households located in urban areas, and percentage of households with
refrigerators.
Francisco (1988) also tried to include other variables such as own price variables, income, price of
substitutes for electricity, price of electricity-consuming equipment, and environmental variables to
explain the demand for electricity in the Philippines. The price considers the block pricing and the
demand charge applied to the consumption of electricity. His paper focused on the demand elasticities
of the Philippines concentrating the franchise area of Manila Electric Company (Meralco). The segments
include residential, commercial, and industrial customers. For the demand model of residential
customers, the problem in block pricing was mentioned. The price of liquefied petroleum gas (LPG),
price of firewood, and level of employment were found to be insignificant factor. The price of LPG was a
good substitute for electricity for commercial and industrial customers, but not for residential
customers. Firewood was not a significant substitute for all customer class. The price of electricity-
consuming appliances like the flat iron and refrigerators has small effects on the demand for electricity
of residential customers while the price of air conditioners has a significant effect.
The Energy Information Administration (1998) revealed that in the US, the principal determinants of
short-term demand variations in the residential sector are weather factors, although a significant trend
5
in consumption per household persists in raising demand from year to year. For weather, nonzero
parameter values for heating degree-days or cooling degree-days are allowed only during the season in
which particular weather impacts are meaningful for the aggregate data. Thus, heating degree-days
affects residential demand only from October through April. This technique is designed to improve the
credibility of the separate estimates of heating and cooling degree-day effects on electricity demand,
which might otherwise be confounded due to a close (negative) correlation between aggregate cooling
and heating degree-days. In addition, growth in the total number of households in the US adds
proportionately to electricity demand, other things being equal.
Meralco (2006) employed an econometric model to forecast residential energy sales. The residential
energy sales used by Meralco from 1991 to 2005 varied over time. In 1991, an electricity sale is a
function of Personal Consumption Expenditure per capita (PCE/n), number of customers, and the price
of electricity. From 1992 to 1997, the model was a function of Gross National Product per capita
(GNP/n), price of electricity, number of customers, and percent system loss plus an autoregressive
variable. In 1998, the autoregressive variable was removed from the model. In 2005, percent LOSS was
dropped from the model and other variable was considered. Notwithstanding these changes in
variables, residential electricity consumption is positively affected by GNP per capita and total number
of customers.
Khanna and Rao (2009), likewise, quantified the determinants of electricity demand and supply
efficiency in developing countries. They postulated the causal relationship between electricity
consumption and economic growth, price and income elasticities of demand, and the barriers to
adoption of energy-efficient equipment. They also examined the performance outcomes of economic
policies affecting the electricity sector, including institutional reforms such as privatization and
regulation. Results showed that electricity demand is driven by GDP, prices, income, the level and
characteristics of economic activity/urbanization, and seasonal factors. The magnitude of their effects
differs across countries, time periods, and studies even for the same country.
Several studies also attempted to measure the change in electricity demand due to a change in price
and model and forecast short-term and long-term peak half-hourly demand (Fan & Hyndman, 2008,
2010). They found that there is a nonlinear relationship between electricity demand and price which
implies that the price elasticities vary with both the time and the day of the year. Similarly, Taylor,
Schwarz, and Cochell (2005) found substantial variation in own price elasticity values among customers
when they estimated the average hourly own price and substitute elasticities in the United Kingdom.
These results were supported by that of Danao’s (2001) and Yoo, Lee, and Kwak’s (2007) studies which
revealed that the short-run residential demand for electricity is income and price inelastic. The results
also showed that household size, urban location, age and educational level of the household head have
significant positive effects on household electricity consumption. In a separate study in Bombay, the
elasticities of residential demand for electricity in terms of price and income are -0.70 and 0.34,
respectively (Tiwari, 2000).
Ishi and Joutz (2009) modeled the residential and industrial electricity demand in the Philippines. The
results indicate a long run cointegrating relationship among residential electricity consumption, income,
and the stock of electric appliances. In the industrial sector there is a long-run relationship between
industrial electricity consumption and GDP. The lack of significant price responses appears to be the
result of government development policies. Llanto et al. (1988) also estimated the demand elasticities
of Philippine electricity focusing on the Manila Electric Company franchise area. Long-run price and
6
income elasticities are found to be generally larger in magnitude than short-run elasticities and
environmental variables have varying degrees of effects on demand for electricity.
In the case of urban Indian households, 30,000 households were surveyed to find out the relationship
between seasonal price and income elasticities of residential demand for electricity. Electricity demand
function was estimated in three seasons, such as winter, monsoon, and summer. The factors such as
price, income, household size, and other household characteristics were studied to see its effect on
electricity demand. The study found that the demographic and geographical characteristics have a
significant effect on electricity demand. Also, the electricity demand is price and income inelastic in all
three seasons (Filippini & Pachauri, 2003),
In Pakistan, using time series data from 1979 to 2006, Nasir, Tariq, and Arif (2008) estimated electricity
demand model to investigate income and price elasticities of electricity demand. Their results showed
that electricity demand is price inelastic in both short run and long run. Moreover, income elasticity is
almost unitary in short run as well as in long run. In addition, household size has a strong positive impact
on electricity demand in Pakistan.
Wills (2002) estimated the short- and long-run responses by households to changes in the price of
electricity using data which permit measurement of the marginal price of electricity, the inframarginal
demand charge, and estimates of household appliance stocks. The price elasticities of high- and low-
level users of electricity were compared. The theoretical bias in price elasticity estimates resulting from
neglect of the inframarginal demand charge was found to be empirically insignificant. Taylor (1975),
likewise, tried to analyze the residential demand for electricity using both the marginal and average
prices as predictors in the demand function.
The residential, industrial, and total electricity demand was also estimated by Kamerschen and Porter
(2004) using partial adjustment and simultaneous equation approaches. Flow-adjustment models
yielded positive price elasticity estimates. The simultaneous equation approach suggests that residential
customers are more price sensitive than industrial customers. Weather was found to have the greatest
impact on the residential sector, and cold weather appears to affect demand more than hot weather.
Ubogu (2002) in his attempt to determine the short and long-run income elasticities in Nigeria found
the figures to be below unity, while those of urbanization were above unity. Urbanization was,
however, found to be the most sensitive variable with respect to changes in the sector's electricity
demand. Previous level of industrial electricity consumption and degree of urbanization were the main
explanatory variables for changes in the industrial sector's demand for electricity. Industrial output and
income were not found to be significant variables in explaining changes in the industrial sector's demand
for electricity.
Holtedahl and Joutz (2000) tried to separate the short and long-term effects through the use of an error
correction model. In the long run, the income elasticity is unitary elastic. The own-price effect is
negative and inelastic. In an error correction framework, the short- run income and price effects are
small and less than the long-run effects.
Llanto et al., (1988) also recognized that the price response is vital to the allocation of electric resources
in peak demand periods. Unfortunately, many end-customers currently face a complex nonlinear pricing
scheme and lack the necessary information to take advantage of incentive structure. An important
distinction can be made about the ability of customers to react to pricing signals. In the short-run,
7
customers must use their existing infrastructure, technologies and resources to react to changes in
prices. Thus, their ability to react to the price changes is lower in the short-run than in the more distant
future or “long-run,” when customers can adapt with technologies and future innovation. As such, it can
be expected that given the proper price signals, demand responsiveness should increase over time as
customers are given the opportunity to react to them ( Lafferty et al., 2001).
Based on the related literatures, it can be summarized that the short-run residential electricity demand
is affected by household disposable income, population growth, price of electricity, degree of
urbanization, household size, urban location, age, educational level of the household head, previous
level of electricity consumption, weather, stock of electrical equipment, and the rate of utilization.
3.0 MODEL FOR ENERGY DEMAND
Electricity demand is characterized by two important dimensions: that electricity consumption is a

derived demand and residential households face unusual pricing structure. The derived nature of
electricity allows for a distinction in what households can do in the short run and in the long run.
Additionally, the declining nature of block tariff structure implies that the large consumers may be
subsidized unintentionally by low electricity consumers which introduces equity problems and raises
concern for incentives to conserve. The equity issue raised by the declining block tariff stems from
charging various groups of household different prices at the margin. For instance, it is generally known
that the cost of generating or distributing extra kilo-watt hour electricity at peak hours (when system is
loaded) exceeds the cost of generating same quantity of electricity during less peak hours (in Figure 1
between 0 and q1). On the other hand, the major criticism of a two-part tariff is that the constant
charge for quantity of electricity consumption between 0 and q1 in Figure 1 may exceed the reservation
wage of low-income consumers (a case prevalent in low income countries) and, therefore, violate the
efficiency criterion of competitive market. Arguments along the efficiency criterion have given impetus
to regulatory interventions by government. In the Philippines, such an intervention may take the form of
restructuring pricing scheme to include time-of-day or peakload pricing. In such a scheme, pricing will
increase beyond qi. This type of increasing block or tiered pricing scheme was used by Weiss & White
(2005) to model household electricity pricing by California utilities. Under increasing block price scheme,
the consumer pays a lower price pi for quantity between 0 and qi and p2 beyond qi (Figure 1). In
contrast, in the Philippines, albeit pricing scheme allows for an increase in price (generation charge per
kWh) beyond qi, but average price beyond qi may show a decreasing function and thus skewing price in
favor of large consumers.
4.0 HOUSEHOLD DEMAND DECISIONS FOR ELECTRICITY
Electricity consumption belongs to a class of demand known as “derived demand” which means that
electricity is not consumed directly by households but are dependent on the flow of services provided
by a portfolio of household’s durable energy-consuming appliances (Reiss & White, 2005). In a typical
household setting, appliances such as air conditioning, microwave, refrigerator, washing machine,
computer, and the like use varying quantities of electricity to render some degree of utility to
households. The relationship between the decision process of electricity use and appliance is similar to
when households make the decision to supply certain amount of labor in the labor market. For instance,
when a household decides to work for 10 hours instead of 40 hours a week, constraint has been placed
on how much they can purchase with a given income. In other words, the decisions to work and how
much to buy are interdependent. In the same manner, when a household buys an appliance, electricity
8
consumption per kilowatt hour is specified and, therefore, the appliance and electricity consumption are
interdependent.
This phenomenon allows for a basic distinction between what households can do immediately to curtail
electricity consumption and what might not be possible given the nature of appliance. Appliances, once
purchased, constitute a fixed stock. The timeframe within which a household can replace or buy a new
one is regarded as long run while that time period within which a household faced with budgetary
constraints cannot afford to buy another appliance is known as short run. Consequently, own price of
electricity will tend to play an important role in electricity demand in the short run. Given the nature of
appliances, it is useful to model a household decision as to whether it is in the short run or long run.
Following economic theory, it is expected that households may possess greater degree of flexibility to
changes in electricity demand in the long run rather than in the short run. What has not been
sufficiently explored in the literature is whether households possess some degree of control over
electricity consumption in the short run. If replacing household appliances in the short run is impossible
due to huge cash outlay involved, then conservation practices may offer reasonable options to control
electricity use. This paper models a short run household decision.
In the short run, household appliances are fixed so that the intensity of use will be affected by electricity
prices, gross monthly income, and other noneconomic factors. In a typical demand modeling, the
quantity desired of electricity can be augmented with adjustment of electricity demand which satisfies
both conditions of linear and nonlinear pricing scheme. Following Action, Mitchel & Mowill (1976), this
demand function can be represented as
where is quantity of electricity consumed by household, is the price of electricity of an

individual electricity consumer, is income of an individual electricity consumer, and is other
variables that influence the consumption of electricity, individual consumer’s electricity
adjustment due to stock of appliance; and represents variation in utility and intensity of
electricity. Assuming continuous differentiability of functions, adjustment process for variables in
equation 1 can be represented in mathematical notation as
Since we are modeling short run electricity demand, no changes in the stock of appliance of the
consumer is expected. Therefore, the relevant terms are those enclosed in the bracket as term is
essentially equal to zero.
In the case of typical goods sold under competitive markets, consumers’ face single pricing scheme in
which aggregated demand function will equal , while aggregated supply function will
equal . Given marginal price, , equilibrium will occur at . In the case
of electricity demand, consumers of electricity face price schedule which is a function of quantity of
electricity consumed. This price schedule produces where a constant price, & there
9
after prevails. Under declining block tariff rate, residential electricity consumption allows for a constant
price, , fixed at a given level of electricity consumption and series of additional charges represented
by as consumption of electricity increases. The total tariff bill for a given residential consumer is
given as
where TBill (q) is a consumer’s total bill for consumption level q. is the bill for category one
consumers, is generation charge per kWh for quantity not exceeding . is bill for category two
consumers, generation charge per kWh for quantity of electricity exceeding ,quantities as shown in
Figure 1.
It is helpful to model appliance specific demand function to incorporate the varying nature of household
appliances. This heterogeneous nature of appliances implies that different factors will affect appliances
across households. For econometric specification, the categories of appliances considered are air
conditioning, computer, microwave, washing machine, and refrigerator. Given these appliances, the
total electricity used by household would equal electricity consumption by each category of appliance.
The number of appliances a household owns can be defined in terms of such as = 1, 2 …, . The
quantity of electricity demanded by households depends on the number of
appliance in use. Following Reiss and White (2005), total portfolio of electricity demanded can be
expressed as
L
QE   d l qel (4)
l 1
10
where QE is total residential electricity consumption of all categories of appliance specified above;
while
1 if household owns category l appliance
dl  
0 if otherwise
Electricity demand in equation 4 can take a linear form as
QEl   0l   pl   yl   zl   l (5)
where QE is quantity of electricity consumed, p is the price of electricity, y is household income, z is

other variables that influence electricity consumption, and  is unobservable characteristics. The l term
indicates that equation (5) may be specified for each of the five appliances mentioned above.
The declining tariff block rate shown in Figure 1 implies that the additional discharge rate charged (p2)
as electricity consumption exceeds q1, is on average less than (p1). Reciprocal functional form on the p
variable is more appropriate for the independent variables. Schmidt (2005) recommends reciprocal
relationship when a downward sloping demand curve is assumed and  2  0 in equation 6 is greater
1
than 0. As long as the term , remain non-negative,  0 will be positive and the demand curve will stay
p
above the horizontal line. The estimable equation for reciprocal functional form can be given as
1
Qel   0l  1l   2 yl   3 zl   l (6)
p
where  ' s are simply the estimated coefficients of p , y , and z variables.
The challenge of our estimation process is to estimate non linear regression model with a demand
function relating response predictor variables to household consumption of electricity under declining
tariff price schedule faced by households. This model is ideal in the context of household electricity
demand where tariff schedules are nonlinear and marginal price of electricity consumed by household is
more relevant than average price. Following Reiss and white (2005) and Schmidt (2005), nonlinear
regression model can be written as
y  f ( , xi )   i (7)
where  is a vector of parameters to be estimated, xi is a vector of predictor variables, and

i N (0,1) is normally distributed random error with mean 0 and variance 1.
11
The relationship between the latent, y  and the observed y can be written as
 y  1if yi  0 
*
  (8)
 y  0 if yi  0
*
the binary dependent variable takes the value 1 in case an individual household owns one type of
appliance l from equation 4 and 0 if otherwise. We define standard normal distribution function as
P(y =1) = F (  , xi ) (9)
Equation (9) can be written as
p   0  1 X 1  ...   k X k (10)
Equation (10) simply tells us that if  k > 0, increase in X k will increase the chance that p (y =1) . The
reverse is true if  k < 0.
Alternatively, equation (7) can be written (Schmidt, 2005 p. 369) so that the probability that a household
owns l appliance is  (x' ) and the joint probability or likelihood function of all residential household
electricity consumers can be expressed using a standard probit model as
Prob(Y1 x) =   (x' ).  1   (x' )  (11)

l 1,2..... L
y1 y1
l 1 l 0
The  (.) term is the cumulative distribution function, which is the level of X corresponding to the Z
score on a standard normal curve (Schmidt, 2005 p. 403). The probability that an individual household
owns a given type of appliance can be written as Pr(Y  1) and the probability that an individual
household choose not to own a given type of appliance can be written as Pr(Y  0) .Equation (11)
simply implies that given a reasonable sample size, maximum likelihood approach allows for observing
both values 1 and 0 that maximizes the value of the log likelihood function. The sign of log likelihood will
turn out be negative since the chance that each household owns a category of appliance or does own
the category of appliance is less than one.
12
When all X’s are evaluated at the sample means, we can estimate marginal effects which reflects the
chance that the electricity consumption of a household who owns a certain category of appliance
changes as one unit of X variable changes. Essentially, the marginal effect allows us to capture by how
much households’ electricity consumption changes as the X’s change which can be described as
p
  (x' k ) (12)
X k
Equation (12) simply tells us that the probability derivative with respect to X variable is equal to  (.)
cumulative distribution function multiplied by  k .Following Schmidt (2005), we implement this through
calculating estimated values of probability derivatives.
The conventional point price elasticity formula for price elasticity in the short run as in Epsey and Epsey
(2004) can be written as:
 PE 
E PE
PE E

 1   2 AE
PE
E
 (13)
where the estimated  ’s are price coefficients of electricity and AE is the mean appliance stock. As
discussed earlier, the price elasticities estimates are expected to be small or less responsive in the short
run. On the other hand, long run elasticities are expected to be higher than short run because
households can make replacement decisions on the type of appliance to use. Equation (13) is treated as
generic for the five appliances in use by households.
In the case of income elasticity of demand, we are interested in the elasticity of quantity of electricity
demanded with respect to income of household. Thus we can modify equation (13) to incorporate
income as
 YE 
E Y
Y E

  1   2 AE
Y
E
 (14)
where the estimated  ’s are income coefficients of electricity and AE is the mean appliance stock.
Equation (14) is treated as generic as well for the five appliances in use by households.
5.0 THE DATA
The study was conducted in 10 barangays in Dasmarinas, Cavite, Philippines. The barangay is the basic
unit or the lowest level of political and governmental subdivision in the Philippines. Every barangay is
under the supervision of municipalities and cities. Among the municipalities in the province of Cavite,
Dasmarinas has the highest number of households and with the highest number of residential electricity
consumers totaled at 112,010 customers (Meralco, 2008).
13
Primary data were gathered through personal interview with the housewives. Only the legally connected
residential customers were interviewed. The electric bill validated the legality of customers and the rate
class. The rate class was identified and confirmed the type of customer as residential. The monthly price
of electricity, monthly electricity demand, and the number of residential customers in Cavite were
sourced out from Meralco.
A sample size of 403 households was drawn from the complete list provided by the NSO using
systematic sampling method. Every 5th household was interviewed until the sample size was met.
Accessibility, safety, and security of the area during data gathering were also considered. Personal
interview with the housewives, who were believed to be the most knowledgeable persons in the
household about electricity consumption, was employed. However, there were respondents, other than
the housewives, who entertained and answered the personal interview. Segmentation of respondents
was primarily based on their electricity consumption.
6.0 RESULTS AND DISCUSSION
6.1 Estimates of Electricity Demand
Estimates of electricity demand coefficients using reciprocal functional model are shown in Table 1. It
shows the monthly estimated demand parameters for all households and for the five appliances
modeled in the study. Considering that this study is concerned with price and electricity demand
elasticity’s, we focus on price and electricity demand interpretations. Generally, parameter signs of the
variables carry the expected signs. The first column in Table 1 shows the explanatory variables
commonly used in electricity consumption demand equations. The second column shows the electricity
consumption demand estimates for all households in the study. Columns 3 to 7 show the parameter
estimates for the five appliances considered in the study. For all households, the price parameter
estimate implies that a one Peso (Philippine currency) increase on average price of electricity would, on
average, reduce monthly electricity consumption by approximately 19,739 watts or 19.7 kWh per month
(or 236.86 kWh per year). Given that average monthly electricity consumption for all households in the
study is 139 kWh, 19.7 kWh reductions due to price would amount to 14 percent of average household
consumption. Fourteen percent reduction in electricity consumption implies that
14
Table 1. Estimate of electricity demand model using reciprocal functional form
VARIABLE ALL REF COMP AIRCON MICROWAVE WASHMACH
Constant -228.657721*** 12.478641 -0.947973 1.714223 -1.315612 0.537762
PRICE -19739.22002** -2310.76012** 37.422081 -3.565891 354.845101 -109.931401
NTVs 14.535341*** 6.243997*** 0.898318* 1.542468** 7.361433*** 0.678231*
NFANs 1.103322 2.007461** 0.202041 1.423145*** 1.428851 0.526336**
FLRAREA 0.044435 0.012128 0.000423 0.019314 -0.024711 0.000113
NOBRMS 4.793631 0.134206 0.047781 0.159427 1.015144 0.012658
MHHNW -0.562147 -0.866431 -0.136733 0.052268 -0.451152 -0.239728
GROSSINC 0.001858*** 0.000021 0.000011 -0.000022 0.000106 -0.000006
NOHH -0.376748 -0.528063 0.047721 -0.112489 0.205945 0.113272
REFSIZE 0.636835 0.004412 0.020238 -0.046968 0.527111** 0.101312*
ECP -1.026676 0.414972 -0.046716 -0.031105 -0.209721 0.070029
Income level
Php2000-
11000 -144.633311*** -3.726291 -0.094471 -6.041528** -9.060712 -0.529113
Php12000- -
50000 -104.179512*** -0.191549 0.102214 6.465606*** -9.598033* -0.068734
R-squared 0.832763 0.225562 0.173997 0.135409 0.166642 0.080461
*** 1%; **5%; *10%

15
household may possess some control on electricity consumption in response to slight price changes, in
the short run if the right incentives are applied. All appliances, except computer and microwave, carry
the expected negative sign, according to theory.
Under some circumstances, positive price sign may be justified when regulation rules on tariff allow
utility companies to charge additional price either due to peak hours or marginal cost considerations in
providing additional power supply to a substation to buffer electricity supply. In the Philippines, illegal
electricity tapped by “squatters” is rampant and may necessitate extra cost being passed on to other
consumers.
The explanatory variables used in this study are generally consistent with mainstream literature on
electricity consumption demand. The number of TVs (NTVs), number of fans (NFans), floor area
(FLRAREA), number of bedrooms (NOBRMS), member of household not working (MHHNW), gross
income (GROSSINC), and refrigerator size (REFSIZE) are estimated to increase electricity consumption.
On the other hand, number of household (NOHH), electricity consumption practices (ECP), and income
levels are estimated to reduce electricity consumption. The unexpected sign of NOHH is surprising in the
sense that one would expect households with more members to consume more electricity. One could
also interpret the negative parameter to imply that poorer household tends to have more family
members and fewer appliances (which should under normal circumstances affect electricity
consumption through use). Either way, NOHH is not statistically significant. Additionally, degrees of
variation across appliances, in terms of goodness of fit, level of significance, and signs of coefficients of
explanatory variables are evident. For instance, the overall goodness of fit is weakest in the case of
washing machine followed by air conditioner. One may surmise that in terms of electricity consumption,
this may have less to do with the behavior of household consumption patterns than say choice of
appliance used in the model.
6.2 Marginal Effects
Table 2 indicates the estimated price effects of different appliances. The estimated coefficients of the
probit model on individual appliances (not shown here, because the coefficients of probit are not
directly interpretable) have been used to compute the marginal effects. The marginal effects can be
interpreted as the estimated change in monthly appliance electricity consumption due to a unit change
in the explanatory variable. All appliances, except ref. and computer are statistically significant and
showed varying degrees of price sensitivities. The price parameter estimate of REF (−32.4) implies that a
one peso per kilowatt hour increase in the marginal price of electricity would reduce a household’s
monthly consumption by approximately 0.0324 kWh (-32.4 watt/1,000 watt per kilowatt) per month
(Table 2). Given that on average a typical household’s refrigerator and microwave appliances contribute
29 kWh and 46 kWh, respectively of electricity consumption every month (total average electricity
consumption for one month for the sample household using all appliances is 139 kWh). A PhP100.00
increase in the price of electricity would represent an 11 percent (0.0324 kWh X Php100.00) reduction in
electricity consumption or 3.24 kWh reductions per month or about 39 kWh annual reductions. Faced
with this demand structure, it is not expected that households would discontinue a universal appliance
like a refrigerator in the short run. Reduction in electricity consumption in the short run may occur
through electricity consumption practices (ECP) such as turning lights off or discontinuing the use of
airconditioner. Estimated coefficients of the other appliances such as air conditioner, microwave, and .
16
Table 2. Estimate of marginal effects of household appliances, Dasmarinas, Cavite, Philippines
VARIABLE REF COMP AIRCON MICROWAVE WASHMACH
Constant 0.0426376 51.203948 -0.184019 -0.008718 0.066791**
PRICE -32.405071 -345.206862 -552.64521** -317.70580** -30.864079*
NTVs 0.060228** -0.540803 0.249057** 0.196695** 0.056858*
NFANs 0.038801*** 0.068145 0.080081* 0.038911 0.034811**
FLRAREA 0.000001 -0.003287 -0.000701 -0.001116* -0.000603**
NOBRMS 0.002464 0.153694 0.061145 0.024211 0.043466**
MHHNW -0.012084 0.062336 0.012499 0.001548 -0.027932**
GROSSINC -0.000001 -0.000021 -0.000001 -0.000002 0.000001
NOHH -0.010607 -0.195731 -0.023501 0.015697 -0.008671
REFSIZE 0.004293 -0.075156 0.015425 0.018000** 0.007571*
ECP 0.006308 0.010230 -0.016344 -0.029166*** 0.003145
Income level
Php2000-11000 -0.026377 -0.166552 -0.078747 -0.126170 -0.049311
Php12000-50000 0.042637 0.114204 -0.187124 -0.315292*** -0.072993
*** 1%; **5%; *10%
washing machine may be interpreted in the same manner. Electricity consumption practices show a
positive sign (albeit, not significant) which suggests that very few options are available for households to
conserve electricity consumption using refrigerator. In the case of Microwave, it is expected that
conservation practices will reduce electricity as the negative and statistically significant coefficient (-
0.029166) indicates.
17
6.3 Price and Income Elasticities
It is assumed that the stock of appliances is relatively fixed in the short-run. Given that households may
adjust their consumption of electricity patterns in the future through the use of more efficient
appliances, short-run price and income elasticities should differ from long-run elasticities. Estimates of
appliance-specific price and income elasticities presented in Table 3 are percentage change in a
household’s monthly electricity consumption due to one percentage change in the marginal price and
income. The estimates indicate very limited (i.e., inelastic demand) price responsiveness to households’
electricity consumption. This implies that a one percent increase in the marginal price of electricity is
estimated to have a less than one percent change in electricity consumption of households. Evidently,
appliance-specific price elasticities differ across appliance portfolios. These differences reflect both the
mean monthly consumption of the appliance and the coefficient of the appliance price used in the point
elasticity computation. All appliances, except computer and Microwave, carry the expected negative
sign. This is not unexpected since under declining block tariffs, high volume consumers of electricity who
are more likely to afford appliances such as microwave and computer may have less incentive to
conserve. In other words, benefits of low rates are conferred to high volume consumers while low
volume consumers seem to pay higher rates on average.
The positive income elasticity with respect to electricity demand for refrigerator, computer and
microwave reinforces the fact that due to the declining block tariffs, increase in income would tend to
produce a normal good effect. Additionally, this low response to electricity demand as income changes
may the fact that appliance stocks are fixed in the short run and income is not expected to change
dramatically within a short horizon. On average, modest income increase may induce more electricity
consumption. Another way to look at this is that household demand response may change less
proportionately than income change producing positive or very small responses.
18
Table 3. Price and income elasticities of household by appliance
Mean Elasticity of Price Income

Electricity Demand
Household Appliance
Refrigerator -0.090 1.30
Computer 0.028 0.15
Aircon -0.0006 -0.08
Microwave 0.009 0.048
Washing machine -0.026 -0.02
All households -0.0175 0.0018
Table 4 shows a greater degree of less elastic price demand for household monthly income group of
PhP12,000 - PhP50,000 than for households in income group PhP2,000 - PhP11,000. This result is not
surprising since lower income households are more likely to react to electricity price increases. One may
argue that when appliance is bought, the lower income households are less likely to buy more efficient
appliance in the short run.
19
Table 4. Price elasticity by household income, Dasmarinas, Cavite, Philippines
Mean Elasticity of Price

Electricity Demand
Household monthly
income level (PhP)
2, 000 – 11, 000 -0.0022

12,000 – 50,000 -0.00065
7.0 CONCLUSIONS AND POLICY IMPLICATIONS
The results of price elasticity of demand are both interesting and surprising. Despite the unstable energy
prices, responses to energy demand remain low. In the case of appliance-specific price elasticities, air
conditioner appears to be the most price-unresponsive of the five appliances while refrigerator and
microwave turn out to be elastic. This is not surprising given the nature of humidity during summer
season or the general humid condition in tropical countries. The increasing use of microwave and
refrigerator may reflect in large part, avoidance of food spoilage and food poisoning.
The price variable of the marginal effects provides very relevant and intuitive understanding of
households’ appliance response to changes in energy price. The price variable for all appliances is of the
expected negative sign and significant, except for refrigerator and computer. The findings on the price
variable suggest that there are potential benefits in the awareness and opportunities for load reduction.
The current declining block tariff of the utility company seems to be sending the wrong price signals and
could reflect long-run possibilities for less market participation to provide efficient appliances. In other
words, if high volume consumers of electricity face lower rates, incentives to replace portfolio of
appliance for efficient use of electricity will diminish.
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23
A STRATEGIC FRAMEWORK FOR VALUE ENHANCING ENTERPRISE RISK

MANAGEMENT
Lai Fong Woon
Universiti Teknologi Petronas, Perak, Malaysia
Noor Azlinna Azizan

Universiti Malaysia Pahang, Malaysia.
azlinna@ump.edu.my
M. Fazilah Abdul Samad

University of Malaya, Kuala Lumpur, Malaysia
ABSTRACT
Enterprise risk management (ERM) is a new management concept fast ascending the corporate agenda
globally. Its relevancy and popularity as a management technique are abetted by the changing business
practices and burgeoning regulatory requirements on risk management. The shift in paradigm in
heightened risk awareness in the wake of several high profile and deep impact corporate governance
scandal and financial mismanagement cases as well as increased terrorist threat on the physical assets
of firms has compelled firms to be more pro-active in addressing risk issues.
ERM is defined as the process of identifying and analyzing risk from an integrated, company-wide
perspective. It is a structured and disciplined approach in aligning strategy, processes, people,
technology and knowledge with a purpose of evaluating and managing the uncertainties the enterprise
faces as it creates value. It focuses risk management function from primarily defensive to increasingly
offensive and strategic in nature.
However, the neo-classical finance theory (NCFT) postulates that firm-specific risk is irrelevant and that
only the covariance of the firm’s asset returns to the market portfolio which is measured by the beta in
the capital asset pricing model (CAPM) matters. This suggests that implementation of ERM will not
enhance the firm’s value. This notion is in stark contrast to the phenomena of increased acceptance of
ERM by industry practitioners.
As such, we propose a ERM framework to theorize a model capturing the causal relationships of the risk
that strategically associated with firms’ business performance and cost of capital. We highlight the
notion of managing firms’ unsystematic (specific) risk via an enterprise risk management framework that
leads to the enhancement of shareholders’ value. The mechanism through which firms’ value
enhancement takes place is by developing a strategic conceptualization of risk premium.
Keywords: Enterprise Risk Management, Value Proposition, Strategic Risk Premium.
----------------------------------------------------------------------------------------------------------------------------------
24
1.0 INTRODUCTION
Until recently, risk management in its many forms is not regarded by managers as a management
discipline (Thompson, 2003). The meaning and application of risk management are often misunderstood
at many levels of management. What has inclined to transpire is that the paradigm and execution of risk
management initiatives by risk managers are strongly influenced by the biasness of the managers’
individual expertise and perspectives.
This biasness comes in the areas of financial markets, occupational health and safety, insurance, project
management, technology, and political risk management. There is nothing wrong with these approaches
of risk management. But the weakness lies with the fact that their focus is limited and lacks an
integrated framework.
Hence, establishing a common framework for all types of operational risks will tremendously enhance
the acceptance of risk management as an effective management tool throughout organizations
(Thompson, 2003). One such framework is known as enterprise risk management (ERM).
ERM is defined as the process of identifying and analyzing risk from an integrated, company-wide
perspective. It is a structured and disciplined approach in aligning strategy, processes, people,
technology and knowledge with a purpose of evaluating and managing the uncertainties the enterprise
faces as it creates value. It focuses risk management function from primarily defensive to increasingly
offensive and strategic in nature. However, the neo-classical finance theory (NCFT) postulates that firm-
specific risk is irrelevant and that only the covariance of the firm’s asset returns to the market portfolio,
such as that measured by the beta in the capital asset pricing model (CAPM), matters. This suggests that
implementation of ERM is of no value to firms. Nonetheless, this notion is in stark contrast to the
phenomena of increased acceptance of ERM by industry practitioners.
This paper provides a theoretical appraisal of a value maximization enterprise risk management (ERM)
implementation framework. The theoretical underpinning is based on the theoretical determinants
argument of corporate risk management to maximize firms’ value. The proposed ERM implementation
framework highlights the importance of managing the various firm-specific risks besides the systematic
risk.
2.1 Determinants of Traditional Risk Management
Due to a lack of academic literature regarding the determinants of enterprise risk management (ERM),
Liebenberg and Hoyt (2003) looked to the literature that deals with determinants of traditional risk
management activities such as hedging and corporate insurance demand.
According to Liebenberg and Hoyt (2003), corporate insurance demand by firms with well-diversified
shareholders is not driven by risk aversion. Since these shareholders are able to costlessly diversify
idiosyncratic risk, insurance purchases at actuarially unfair rates reduce stockholder wealth.
25
However, when viewed as part of the firm’s financing policy, corporate insurance may increase firm
value through its effect on reducing (i) agency cost, (ii) expected bankruptcy costs, (iii) the firm’s tax
liabilities, and (iv) the costs of regulatory scrutiny.
Corporate hedging, on the other hand, reduces expected bankruptcy costs by reducing the probability of
financial distress. Hedging literature also suggest that this form of risk management potentially mitigates
incentive conflicts, reduces expected taxes, and improves the firm’s ability to take advantage of
attractive investment opportunities (Smith and Stulz, 1985).
However, according to Liebenberg and Hoyt (2003), the traditional risk management approach has been
characterized as highly disaggregated method of managing firm risk in which various categories of risk
are managed in separate units within the firm.
2.2 Value Maximization Theories of Corporate Risk Management
Justification for corporate risk management can easily be accepted with the intuition that shareholders
are risk-averse and their interests are well served if firms manage risk on their behalf. The efficacy of this
application of risk management in corporate environment is also backed by finance literature. For
instance, studies in the 1980s and 1990s by Smith & Stulz (1985), Mayers & Smith (1982), Amit &
Wernerfelt (1990), Froot, Scharfstein & Stein (1993), Tufano (1996), Cummins et al. (1998), saw an
emerging paradigm on the role of risk in determining corporate value.
Literature on corporate risk management link the rationale for such initiatives in ensuring business
performance to the following hypotheses: (i) profit maximization (Andrews, 1980; Porter, 1980) (ii)
financial distress cost (Wall & Pringle, 1989; Bettis, 1983), (iii) lowering tax burden (Nance, Smith, and
Smithson, 1993), (iv) costly external financing (Nance, Smith, and Smithson, 1993; Ahmed, Beatty, and
Takeda, 1997), (v) informational asymmetries (Froot, Scharfstin, and Stein, 1993; Healy & Palepu, 1995),
(vi) agency cost (Tufano, 1998; Cummins 1998).
2.3 Managing risk individually vis-à-vis integrated approach
Meagher and O’Neil (2000) pointed out that the current risk management approaches are fragmented,
treating risks as disparate and easily compartmentalized. Bierc (2003) supported this argument by saying
that risk is typically viewed as something to be avoided or mitigated – and to be separated, categorized
and addressed in silo. Bierc (2003) continued to argue that risk management has often been practiced to
merely comply with the many new rules and regulations, which has failed to add any sustainable value.
To meet the needs of future business, Meagher and O’Neil (2000) advocated that risk management
process should be one that improves the linkage of risk and opportunity and positions it as a source of
competitive advantage. The process should seek a wider concept and understanding of risks that
present themselves within the setting of an organization. The undertaking of these risks then should be
lined up with corporate strategies, objectives, and goals (IAAS, 2008).
In addition, the risk management approach should be positive and proactive, value-based and broadly
focused, embedded in processes, integrated in strategy and total operations, and continuous. Miller
(1992) cautioned that corporate risk management is not limited to the assessment of exposure to losses
and application of appropriate financial risk management practices. He pointed out that financial and
26
strategic responses are interrelated in such a way that decision making in either area to the exclusion of
the other would be suboptimal.
2.4 Operational Definition of Enterprise Risk Management (ERM)
Chapman (2003) defined ERM as the process of identifying and analyzing risk from an integrated,
company-wide perspective.
Meagher and O’Neil (2000) on the other hand, described enterprise-wide risk management (EWRM) as a
structured and disciplined approach in aligning strategy, processes, people, technology and knowledge
with a purpose of evaluating and managing the uncertainties the enterprise faces as it creates value.
Stoke (2004) viewed enterprise-wide risk management (ERM) to become an essential element of
modern business as the focus for corporate risk management is shifting from operational hazards and
pure financial risks to a much more strategic view of threats to business success and an appetite for
upside risk. Stoke added that by combining this with a more holistic, top-down approach to risk strategy
and appetite, companies can focus their attention on most significant threats to business objectives and
achieve even greater value from risk management.
Liebenberg and Hoyt (2003) concurred that unlike the traditional “silo-based” approach to corporate risk
management, ERM enables firms to benefit from an integrated approach in managing risk that shifts the
focus of risk management function from primarily defensive to increasingly offensive and strategic.
In a nutshell, the concept of ERM entails a paradigm shift which dictates that the focus of risk
management has to be shifted from the conventional operational hazards and pure financial risks to a
much more strategic view of threats to business success. A robust and dynamic risk management
framework should also promote an appetite for upside risk.
2.5 The Process of Enterprise Risk Management
The framework for business risk management process traditionally will not run away from the following
basic steps: evaluating, identifying, measuring, treating, and monitoring risk. The Committee of
Sponsoring Organizations of the Treadway Commission’s (COSO) ERM’s model consists of 8 components:
internal environment, objective setting, event identification, risk assessment, risk response, control
activities, information and communication, and monitoring (COSO, 2004; Chapman, 2003). In
comparison, the Arthur Andersen Business Risk Management Process (BRMP) develops a risk
management framework that comprises 7 elements: (i) establish the business risk management process,
(ii) assess business risks, (iii) develop business risk management strategies, (iv) design/implement risk
management capabilities, (v) monitor risk management performance, (vi) continuously improve risk
management capabilities, (vii) information for decision making (Meagher and O’Neil, 2000).
To ensure successful enterprise-wide risk management process implementation, Meagher and O’Neil
(2000) emphasized the following 4 dimensions: (i) moving away from fragmented approach, towards an
integrated and systematic framework that gives credibility to the risk management role within the
business; (ii) identifying risk management goals and linking them to enterprise’s strategies; (iii)
delegating responsibility for risks and making managers accountable to the board for continuously
27
improving the management of those risks; (iv) do not only managing individual risks, but being able to
systematically pool them and assess risk as a portfolio for the enterprise as a whole.
In comparison to the old silo-approach of risk management, ERM proponents argue that an integrated
approach of risk management increases firm value by reducing inefficiencies inherent in the traditional
approach, improving capital efficiency, stabilizing earnings, and reducing the expected costs of external
capital and regulatory scrutiny (Liebenberg and Hoyt 2003). Bierc (2003) introduced the concept of
strategy risk management (SRM). According to Bierc, SRM should be developed and pursued with
substantial regard to the key drivers that would impact success and value of a corporation. It should
keep an organization focused on the things that drive success, providing tools that effectively measure
“execution”.
2.6 The Concept of ERM
Based on the argument taken from the value maximization theory of corporate risk management, we
posit that implementation of ERM program by firms can create value for shareholders.
The conceptual framework is such that ERM implementation will lead to some tangible and intangible
benefits to the firm. These benefits include outcomes like optimizing risk/return profile of the company,
reducing earning volatility (Lam, 2003), strengthening management’s confidence in business operations
and risk monitoring, creating smooth governance procedures, enriching corporate reputation, improving
clarity of organization-wide decision making and chain of command, encouraging corporate
entrepreneurship, and boosting enterprise’s profitability (Crouhy et al.,2006; Bailey et al., 2004;
Belmont, 2004; Lam, 2003; Bettis, 1983). These benefits derived from ERM implementation, in turn, will
define the distinctive competitiveness of the firm.
This causal relationship is depicted by the arrow A in the path diagram in Figure 1.
28
Figure 1: Path Diagram of Conceptual Framework
ERM CSFs of Effective

Challenges Implementation*
B
C
ERM ERM Benefits

Implementatio A
n
D
Intensity E
Lower Cost Business

of Capital Performance
Shareholder value creation
 Solid arrows indicate causal relationships

 Dotted arrows indicate moderating effects
 * indicates moderating factors
However, our ERM framework reckons that any potential challenges that may be faced by the firm
either before or during the implementation process will affect its commitment and intensity level for its
planned ERM program. These challenges can be in the areas of finance, people, information,
infrastructure, structure, and priorities. These challenges become a moderating factor to the intensity
and commitment levels of ERM practices by the firm. The influence of this moderating factor is
represented by the dotted arrow B in Figure 2 above.
Similarly, the outcome and efficacy of such an ERM program will depend on the effective
implementation of it. The effective implementation, in turn, hinges on to what extent the firm pays
attention to some critical success factors (CSFs) during implementation phase of such a program. Since
ERM program is relatively new in the corporate management history in the area of business
performance improvement techniques, implementing ERM program can be seen as equivalent to
29
instituting a corporate change management program which requires a substantial amount of mindset
and paradigm shift within the organization concerned to ensure the program achieves its intended
purposes. In the same context, it follows that implementing ERM program can also be regarded as a
business process re-engineering (BPR) agenda of the firm.
According to Khong and Richardson (2003), “BPR is the fundamental rethinking and radical redesign of
the business processes to achieve dramatic improvements in critical measures of performance such as
cost, quality, service and speed”. They emphasized that BPR projects must be implemented
appropriately so that dramatic improvement could be achieved and its implementation process must be
monitored closely. Al-Mashari and Zairi claimed that BPR implementation process is complex. They
categorized the implementation process into five dimensions namely, Change of Management System
and Culture, Management Competence, Organizational Structure, BPR Project Management, IT
Infrastructure. Each dimension consists of various critical success factors (Al-Mashari and Zairi quoted by
Khong and Richardson, 2003).
In the context of our ERM framework, these BPR’s critical success factors become the second
moderating factor in influencing the outcomes of the ERM program. This relationship is indicated by the
dotted arrow C as in Figure 2.
All the tangible and intangible benefits as a result of ERM program implementation will then lead to
lower cost of capital as shown by arrow D and contribute to business performance such as improve
price-to-earning ratio of share price as depicted by arrow E. The lowering of cost of capital is due to risk
premium reduction as a result of the firm lowering its idiosyncratic or unsystematic risk profile1. The
improving price-to-earning ratio of the firm’s share prices on the other hand, happens because investors
are willing to pay a higher price for the company’s share at a given level of earning-per-share (EPS) due
to the firm’s perceived lower risk profile. These two causal relationships represent the value creation
from ERM program.
2.7 Rebuttal of the Risk Management Irrelevance Proposition: Systematic versus Unsystematic
risks
The classical finance theory (CFT) advocates two primary risk management tools for investors in their
wealth investment, namely, (i) diversification2 and (ii) asset allocation3. These two concepts of investors’
risk management tools were first studied and popularized by Harry Markowitz (Belmont, 2004).
Harry Markowitz in 1952 extended his work by introducing a Model of Portfolio Theory. He theorized a
relationship between risk and return. Markowitz’s model of portfolio theory emphasizes on risk return
1
Discussion of the research model on the interaction between a risk premium framework and the firm’s
unsystematic risk is presented in the later part of this chapter.
2
Diversification of portfolio means the exercise of distributing portfolio holding across a greater number of assets
(i.e. to include more than one asset type in the investment holding such as combining stocks, bonds, money
market instruments, commodities, real estate and etc in order to reduce exposure to risk).
3
Asset allocation, on the other hand, entails the decision of determining the amount of wealth being invested
across asset classes.
30
trade-off in terms of mean-variance efficient portfolio, hence the introduction of the Efficient Frontier of
various assets combination and weight. An efficient frontier of an investment domain (Figure 2)
represents a set of “efficient portfolios” that maximize expected returns at a given level of portfolio risk,
or that minimize portfolios risk for a given expected return (Belmont, 2004).
Figure 2: The Efficient Frontier
Efficient Frontier
Expected
Return
Variance of Return
Source: Belmont (2004), pp.22.
However, Markowitz (1952) posited that there are as many efficient portfolios that lie on the efficient
frontier as there are investor risk preferences. Nonetheless, by referring to this efficient frontier and
base on their risk preferences, investors can construct risk-return efficient portfolios that offer them the
optimal return (Belmont, 2004); that is, a diversified portfolio of securities that provide investors with
the highest level of return for a given level of risk (Chatterjee et al., 1999). Essentially, Markowitz’s
model of portfolio theory also stipulates that investors can only get a higher return but accepting a
higher level of risk along the “efficient frontier” (Chatterjee et al., 1999).
Applying these two powerful options of diversification and asset allocation advocated by the CFT, neo-
classical financial theory (NCFT) (i.e. Modern Portfolio Theory and CAPM) on the other hand, postulates
that any internal risk management effort undertaken by the firm to reduce its firm-specific risk will be of
no value to shareholders because shareholders can easily employ the above two risk management
options, and arguably at a cheaper cost, to attain the same purpose and effect through building an
investment portfolios. This argument holds true unless firm-specific risk management can prove to
result in the increase of the present value of the firm’s cash flow. As such, internal risk management by
the firm should focus only on reducing its systematic risk by such ways of hedging or buying insurance
(Belmont, 2004).
This conclusion of NCFT somehow runs counter to the initial value proposition of corporate risk
management by the CFT. For instance, Markowitz’s model of portfolio theory would suggest that if
31
managers could find ways to minimize the firm’s cash flows volatility, or “total risk”4, then they could
create value for shareholders as long as the stabilized cash flows would not come at the expense of their
expected value. NCFT such as CAPM, which extended Markowitz’s portfolio theory, demonstrated that
in equilibrium, the “market portfolio” is the only one efficient portfolio that applies to all investors,
regardless of their risk preferences. Hence, therein gives rise to the notion of beta. Thus, according to
CAPM, beta risk is the only risk that investors should be concerned about in equilibrium (Chatterjee et
al., 1999).
Notwithstanding so, it is worth noting that according to another school of thought, i.e. a classic efficient
market theory, even the management of systematic risk is futile. This is because it will not add value to
shareholders since the costs of such activities like hedging and buying insurance policies will completely
offset the value of eliminating such systematic risk. Hence, a zero sum game ensued for shareholders
(Belmont, 2004; Doherty, 2000).
2.8 Recent Challenges to CAPM
Chatterjee et al. (1999) highlighted that CAPM’s theoretical veracity has been questioned by many
scholars owing to its simplifying assumptions which do not conform to reality. For instance, they cited
examples such as Kadlec & McConnel (1994), Levy (1978) and Merton (1987) who doubted that
investors are fully diversified as assumed by CAPM; Roll and Ross (1994) who claimed the impossibility
to construct a fully diversified portfolio; Teece (1984) who referred to CAPM’s static equilibrium as a
“fictitious state”; Grossman & Stiglitz (1980), Stein (1988, 1989) who rejected CAPM’s perfect market
assumption from economic of information point of view on the premise of information asymmetries
that exist in the markets; Arrow (1974) who stressed that the reason why markets fail and organizations
form is because markets do not distribute information thoroughly, albeit efficiently. Due to these
asymmetries, Chatterjee et al. (1999) noted that it has created principal-agent problems which
prompted agency theorists championing the setting up of a proper governance mechanism within
corporate structure.
Besides, CAPM’s predictive validity has also been challenged. Fama & French (2004) and Chatterjee et al.
(1999) cited examples of Reinganum (1981); Lakonishok and Shapiro (1986); Merton (1987); Bhandari
(1988); Chan, Hamao and Lakonishok (1991), who doubted the predictive ability of beta. These authors
provided empirical evidence which indicated that investors concern more than just beta. In addition,
Chatterjee et al. (1999) also highlighted other studies; such as Levy (1978); Basu (1983); Merton (1987);
Bhandari (1998) which suggested that the predictive power of non-market (firm-specific) factors (i.e.
earnings-to-price ratio; leverage) are better than beta alone when it comes to predicting stock returns.
In conclusion, in determining a firm’s risk premium, investors are concerned with more than just the
covariance of the firm’s earnings with that of market portfolio, or beta. Other state variables (i.e.
inflation) as previously cited and firm-specific elements are as just relevant and important in deciding a
firm’s share prices and in estimating long-term returns (Fama & French, 2004; Chatterjee et al., 1999).
The growing recognition of firm-specific measures in asset pricing, nonetheless, has posed “a challenge
to CAPM because of their atheoretical nature” (Chatterjee et al., 1999: 558). Fama and French label
these measures as “empirical anomalies” because they are not given any “special standing in asset-
4
“Total risk is defined as the standard deviation in a firm’s returns over some specifies time period-say, 150 trading
days” (Chatterjee et al., 1999:564). In the concept of portfolio risk, total risk is the sum of systematic (market) risk
and unsystematic (firm-specific) risk.
32
pricing theory” (Fama & French quoted by Chatterjee et al., 1999: 558). Notwithstanding so, these
measures are given due recognition by authors like Fama, French, Lakonishok, Haugen, DeBondt, and
others in estimating a firm’s risk premium (Fama & French, 2004; Chatterjee et al., 1999).
2.9 Unsystematic risk and risk premium: CAM modification
CAPM’s theoretical framework clearly indicates that there is no favorable risk pricing effect for reduction
in unsystematic risk, hence implying that any deliberate effort on the part of the firms to manage their
unsystematic risk is futile. However, assuming if there would be a positive effect on managing
unsystematic risk, how would this notion impacts the variables in the CAPM formula then? It should
follow that variable r, representing the required rate of return for an asset or a project, should be
reduce due to the lower risk profile (either perceived or otherwise). A lowered r, which is also used for
discounting firms’ expected cash flows, should yield a higher firm value as follows:
Firm value =  E(CFt) / (1 + rt) t
Where  E(CFt) is the sum of all expected cash flows, t is the time period, and r is the discount rate.
And according to NCFT, on the basis of maximizing shareholders’ wealth, the appropriate firm-decision
rule is for managers to pursue all investment opportunities that will yield a positive net present value
(NPV) (Belmont, 2004).
In CAPM’s formula E(r) = Rf + mi [ E(Rm) - Rf ], where Rf is the risk free rate, mi is the firm’s (asset) beta
or the correlation coefficient of that particular firm to the market portfolio. The term [ E(R m) - Rf ] is the
market potfolio’s risk premium and the term mi [ E(Rm) - Rf ] is the firm’s risk premium. The reduction
of expected or required rate of return, E(r), will be significantly influenced by the firm’s risk premium
term, or mi [ E(Rm) - Rf ]. The return on a risk-free asset (Rf) and the expected return on the market [
E(Rm) ] are externality variables to the firm that there is nothing much managers can do to influence
them managerially hoping that these variables can change in the direction that favoring the firm for risk
pricing reduction. The same applies to the firm’s beta (mi). Beta measures the covariance of the firm’s
return to that of the market, or in other words, the measurement for the firm’s systematic risk. The only
way the beta of the firm will change is by way of the firm varying its existing business line so that its
business risk profile relative to that of the market shifts. One example of this is to initiate business
diversification through either the firm’s product lines or target markets. But this managerial
maneuvering involves the systematic risk aspect of the firm. As such, in order to capture the positive
effect of managing a firm’s unsystematic risk and reflect it in the CAPM formulation, we may attempt to
include an additional variable, i.e. , to impact the firm’s risk premium term. This variable should take a
negative value so that it can have diminishing effect on the term mi [ E(Rm) - Rf ] such that the new risk
premium term of the firm becomes mi [ E(Rm) - Rf ] - . Thus, the modified CAPM formula that
recognizes the effect of managing a firm’s unsystematic risk shall be:
E(Ri) = Rf + mi [ E(Rm) - Rf ] - 
Conceptually, it should be noted in the above formula that the effect of unsystematic risk does not come
in the form of a direct reward for bearing them in the way similar to bearing systematic risk in the asset
pricing model. Rather, the reward comes from the nature for its successful reduction or elimination. This
notion runs counter to the concept of market risk in asset pricing. Whereas investors are being
rewarded for bearing market risk because it is not diversifiable. Nonetheless, the notion of unsystematic
33
risk management does not suggest that firms to be rewarded for bearing unsystematic risks. This is
because those risks are diversifiable. However, the notion suggests that firms to be rewarded for their
ability to reduce those unique risks that they face. The rationale for this reward system is by giving the
recognition that managing firms’ unsystematic risk can result in firms enhancing their capability to
improve earnings. This earnings improvement can come in the form of reducing or eliminating negative
profit variation, reducing cost of financial distress, minimizing agency problem, enhancing corporate
brand name and the likes. Managers, thus, should endeavor to manage firms’ unsystematic risk well
enough to earn the largest possible value of - as possible from the investors in order to reduce the
firms’ required rate of return (risk premium) or cost of capital.
In the context of asset pricing, the idea for managing firms’ unsystematic risk comes from the hypothesis
where it is postulated that investors would welcome such a reduction in firms’ specific risks. As a result,
investors would demand a relatively lower risk premium for their investment in the firm. Nonetheless, in
transforming the above hypothesis into precise mathematical formulation, the challenge would emerge
in the area of firms’ valuation. The measurability of firms’ value enhancement as a result of this
unsystematic risk management would hinge on the market’s ability to identify and quantify the
reduction of each firm-specific risk for a reward (i.e. the reduction in discount rate)., that is, the , as
mentioned above.
2.10 A Strategic Conceptualization of Risk Premium: The CLS Model
To begin with, we may describe the apparent contradictory conclusions of neo-classical financial theory
(NCFT) that sits on one camp and classical/strategy theory on the other by drawing reference to some
anecdotal evidences of the practices of corporate risk management in the real world. Risk management
in the context of NCFT would only mean diversification, asset allocation and to a certain extent, the
hedging or transfer of risk (Belmont, 2004). However, Belmont (2004: 21) also pointed out that, in the
real world realm, corporate risk management activities include “a logical and systematic method of
establishing the context, identifying, analyzing, evaluating, mitigating, monitoring and communicating
risk associated with any financial activity, function or process in a way that will enable organizations to
minimize financial losses and maximize financial opportunities”.
In comparison, a stark distinction of the concept of ERM to the notion of risk management by NCFT is
the management of unsystematic risk or firm-specific risk. Apart from managing systematic risks, our
ERM framework also highlights the importance for managing unsystematic risk with the belief that it will
lead to an enhanced shareholders value. This concept blends perfectly well with the value enhancing
notion as postulated by strategy theory.
Hence, to bridge the gap of the seemingly contradicting conclusions regarding unsystematic risk
management between modern financial theory and strategy research, it requires a model that fits well
within the two disciplines. This model will serve as the value enhancing transmission mechanism of
enterprise risk management. And one such model is related to the risk premium of the firm.
To this end, our framework attempts to theorize a model capturing the causal relationships of the risk
that strategically associated with firms’ business performance and cost of capital. We highlight the
notion of managing firms’ unsystematic (specific) risk via an enterprise risk management framework that
leads to the enhancement of shareholders’ value. The mechanism through which firms’ value
enhancement takes place is by developing a strategic conceptualization of risk premium.
34
The focus is on the adaptation of a model called “a dynamic framework of a firm’s risk premium”
developed by Chatterjee, Lubatkin, and Schulze (1999) which will reconcile and fill-in the gap between
modern financial theory and strategy theory.
We refer to this risk premium model developed by Chatterjee et al. (1999) as the CLS risk premium
model.
2.11 The CLS risk premium Model
The CLS model was developed based on the assumption that investors do care about firm-specific risk.
This is owing to the fact most investors are not as fully diversified and markets are not as perfect as
CAPM assumes. The interactions among constructs in the CLS risk premium model take reference from
information economics, resource-based view of the firm, and the industry structural view of strategy
(Chatterjee et al., 1999). The information economics highlights the existence of information
asymmetries in the market and notices that the belief among market participants to be heterogeneous.
The resource-based view of the firm provides explanation that the asymmetries that happen in the
resources markets are caused by the characteristics of the resources in which they are lumpy,
heterogeneous, and to be acquired with a cost. The industry structural view of strategy on the other
hand, sees asymmetries in market power distribution in the input and output markets (Chatterjee et al.,
1999).
In developing the CLS risk premium model, Chatterjee et al. (1999) postulated that investors are
exposed to various classes of firm-specific risk in a world of partial diversification and imperfect markets.
And this notion forms the core of the CLS model. In other words, CLS model makes extension to the
CAPM notion where apart from recognizing the sensitivity of a firm’s expected returns to
macroeconomic uncertainties, CLS risk premium model also gives inclusion to the sensitivity of a firm’s
expected returns to three additional classes of firm-specific risks. This is the part where CAPM has
omitted.
CLS model categorizes these three classes of unsystematic risk as tactical, strategic, and normative risk.
As Chatterjee et al. (1999) pointed out that, tactical risk exists mainly in information asymmetries, whilst
strategic risk comes from imperfections in the resource and output markets, and finally normative risk
presents itself in the forces that define institutional norms.
2.12 Tactical risk
The nature of tactical risk lies with the uncertainty in firm’s expected earnings. It is based on the
assumption that investors are averse to earnings surprises owing to information asymmetries. Hence,
investors will request lower risk premium from firms who can stabilize earnings.
Firms can employ three strategies to manage tactical risk. That is, the use of financial tactics, hedges,
and real options. Chatterjee et al. (1999) pointed out that financial tactics include earnings
management, governance, and liquidity.
35
Figure 3: The CLS Risk Premium Model
Tactical risk
L
H
I
Macroeconomic G Risk premium N Normative risk

risk
K
J
Strategic risk M
The use of financial tactics has a direct link to risk premium as depicted by arrow H in Figure 4. Whereas
the use of hedges and real options present indirect relationship between firm-specific actions and
macro-economic risk to the firm’s risk premium as indicated by arrow I in Figure 3.
2.13 Strategic risk
The nature of strategic risk is due to the uncertain performance outcomes from the firm’s committed
resources. It is caused mainly by imperfections in resource and output markets (Chatterjee et al., 1999).
Since firms’ survival in the marketplace hinges on how well the firms formulate strategy in committing
and deploying their scarce yet precious resources to stay competitive, it follows then that risks exist if
the goal to attain and sustain such competitive advantage from the committed resources cannot be
achieved.
Thus CLS model defines strategic risk as “the probability that a firm can isolate its earnings from
macroeconomic and industry-specific disturbances” (Chatterjee et al., 1999:560). This risk is represented
by arrows J and K in Figure 3.
The concept of earnings isolation can find its core in strategy literature such as those of Barney (1991)
and Rumelt (1984). As pointed out by Chtterjee at al. (1999), strategy literature provides good accounts
for various determinants of strategic risk. These include the firm-structure view, resource-based view,
knowledge-based view, and strategic options view.
For instance, Porter (1980) analyzed strategic risk from the firm-structure view. He categorized strategic
risk in his “five forces” analysis of market rivalry. Chatterjee at al. (1999) postulated that firms that are
able to flex their market power to stabilize and enhance their cash flows by leveraging and sustaining
their structural advantages will enjoy lower risk premiums.
The resource-based view (RBV) of strategic risk argues that a firm may keep its resource-based
advantages from the knowledge of its rivals. This is because valuable resources are sometimes
36
intangible and tacit, coupled with the fact that their distribution is not homogeneous. The nature of
these advantages hence, enables a firm to keep them invisible from the detection of competitors. As a
result, it will help cripple competitors’ effort to strategize against the firm (Barney, 1991; Connor, 1991).
Chatterjee at al. (1999) deduced the fourth determinant of strategic risk from strategic options literature
such as that of Sanchez (1993). Chatterjee et al. (1999) explained that strategic options might have
originated from “real” options, which are contingent in nature, but later turned to its form when firm
committed its resources to the contracts due to changes in market conditions. According to Raynor
(2008), strategic options are fundamentally different from growth options in that their focus is not to
create possible avenue for new growth, but to create the opportunity to redirect strategy in the existing
business model. Chatterjee et al. (1999: 561) reckoned that strategic options are investments that are
difficult to undo once committed. Firms undertake such commitment in order to “mitigate specific
sources of macroeconomic and industry-specific disturbances risk”. Miller (1998) noted that the use of
strategic options is due to the unavailability of other type of options, like hedges. Nonetheless, Raynor
(2008) pointed out that to manage strategic risk effectively a firm has to establish a portfolio of strategic
options so that it can create “strategic flexibility” without compromising the need to commit.
Normative risk and dynamic forces
CLS model posits that risk premium advantages attained through active management of tactical and
strategic risks are temporary. Due to competitive forces, any previous advantages will be imitated by
competitors and will be neutralized after some time. At this point, the ability of tactical and strategic risk
management to reduce risk premium will diminish and they will become “nothing more than a source of
variance about some baseline level of firm-specific risk” (Chatterjee et al., 1999: 562). Tactical and
strategic actions will then lose its uniqueness and differentiating factor but become institutionalized and
pre-requisites for firm to stay in the industry (Chatterjee et al., 1999; Scott, 1995; Hamel & Prahalad,
1994). This relationship is presented by arrows L and M in Figure 3.
Normative risk, thus, is defined as the risk premium (or penalty) that a firm is subjected to if it fails to
comply with its institutional norms or rules that it is expected to follow (Graf, 2004; Chatterjee et al.,
1999). These norms represent the common expectations of the firm’s stakeholders (i.e. investors,
regulators, interest groups) with regards to its behavior (Graf, 2004). CLS model stresses that complying
to pre-requisite norms will not yield firms any reward but will be slapped with higher risk premium if
firms fail to observe them. This is owing to investors having to bear additional risk without the promise
of higher return (Chatterjee et al., 1999). Financial accounting literature such as Jones (1996) provided
indirect support for this assertion. Jones noted consistent evidence that the incremental information
provided by going-concern audit opinions had an influence on investors’ reaction (Jones quoted by
Chatterjee et al., 1999). This relationship is depicted by arrow N in Figure 3.
As such, firms have to ensure their proper compliances to institutional norms and industry rules so to
avoid penalty charged onto their risk premium.
2.15 Summary of CLS Risk Premium Model
CLS risk premium model highlights the notion that there are dynamic relationships between
unsystematic risk (i.e. tactical, strategic, and normative risks) and a firm’s risk premium. Thus, firm-
specific activities and skills derived from the active management of those risks will influence a firm’s risk
premium. This argument is well supported by the current theories of strategy (Graf, 2004).
37
However, this assertion is apparently inconsistent with CAPM which does not acknowledge such a
relationship. CAPM defines that all firm-specific activities, which are measured by the variance of the
error term in the market model, as unsystematic risk. And this unsystematic risk is not correlated with
risk premium. Thus, it is irrelevant (Belmont, 2004; Chatterjee et al., 1999). Nonetheless, as has been
discussed earlier, the theory of CAPM has been subjected to much challenges of late. This is especially
with the beta being doubted by many studies to be a reliable proxy of a firm’s risk premium (Chatterjee
et al., 1999).
The concept of CSL model, on the other hand, takes a multivariate approach. The constructs of the
model include macroeconomic, tactical, strategic, and normative risks, all of which are omitted by
CAPM. Besides, CSL model also pays due recognition to the dynamic of the continuous interplay
between elements of the firm’s activities and market forces (Chatterjee et al., 1999). This approach of
conceptual assertion not only comes in tandem with the studies of strategic management, but also
offers to connect the former with the theories in financial economics in providing a solid and robust
conceptual framework for enterprise risk management (ERM). This linkage of theories from the two
disciplines (i.e. strategic management and financial economics) enables the building of a new theory
postulating that ERM can lead to improved business performance and enhanced shareholders value. In
effect, Chatterjee et al. (1999: 563) suggested building “a more conceptually complete asset pricing
model” with the combination of contributions from the empirical discovery of financial economics as
well as the conceptual description of strategic management.
Risk premium is a crucial element for firms. It has a profound impact on firms’ cost of capital. Firms with
risky profiles in the eyes of investors will suffer from incurring higher costs when raising capital. This
comes in the form of either selling equity at lower prices or issuing bond/debt with higher
coupon/interest rates (Chatterjee et al., 1999). Firms encountering this situation will face an unfavorable
strategic opportunity set (Copeland et al., 2005). Besides, higher capital costs will return lower present
value when discounting firm’s future earnings. As such it can become a source of competitive
disadvantage when a firm faces its rivals in accessing capital markets (Belmont, 2004; Chatterjee et al.,
1999).
3.0 THE THEORETICAL FRAMEWORK
From the discussion thus far, we postulate that a dynamic ERM framework will enhance shareholders
value through enhanced business performance and the reduction of the firms’ cost of capital.
We hence theorize that a firm’s commitment and implementation intensity of its ERM program will be
determined by the various challenges faced during such implementation process. The success of such
ERM implementation, thus the amount of benefits received, in turn, is affected by how well the
corporations manage some critical success factors hinging on the effective implementation of the ERM
program.
We further theorize that in the event of corporations successfully implement the ERM program, the
benefits received from such effective execution will have a long-term positive impact in creating value
for the corporations’ shareholders. This value creation process is achieved via a two-pronged process.
38
Firstly, shareholders’ value is created by way of lowering the corporations’ cost of capital which takes
place through a dynamic framework of risk premium reduction mechanism (CLS risk premium model) as
discussed earlier.
Figure 4: Theoretical framework’s diagram
ERM Program
Challenges CSFs of
implementation
ERM ERM Benefits

Implementation
Intensity
Tactical risk
Macroeconomic risk Risk premium Normative risk
Strategic risk
Dynamic model of a firm’s risk premium
Business
Lower Cost of
Performance
Capital
Shareholders value creation
 Solid arrows indicate causal

relationships
 Dotted arrows indicate moderating
effects
 * indicates moderating factors
Note: Figure 4 is reproduced from Figure 1 with the inclusion of the dynamic model of a firm’s risk
premium which works as the transmission mechanism of the value-enhancing effect of ERM framework.
39
Secondly, the value is created by means of a generic improvement of business performance. This
improvement encompasses all functional areas such as finance, operations, marketing, human
resources, and governance.
The final result of this two-pronged value creation process is the higher return of share prices for
shareholders. These theoretical relationships are depicted by Figure 5.
In addition, the CSFs for effective implementation of ERM program posited within this theoretical
framework can in turn, serve as predictors for having a successful ERM program for the firms.
4.0 HYPOTHESES DEVELOPMENT - VALUE MAXIMIZATION OF ERM
Discussion laid out earlier on (i) the rebuttal of neo-classical finance theory on unsystematic risk; (ii)
recent challenges to CAPM theory; and (iii) a strategic risk premium model; have provided both
empirical and conceptual support for a value-enhancing corporate risk management through our ERM
framework. Drawn from this discussion, we develop the following hypotheses:
4.1 Hypotheses for Direct Effect
H1: Managing firm-specific risk through ERM will be rewarded by the equity market
H2: ERM implementation outcomes have a positive association with cost of capital
H3: ERM implementation outcomes have a positive association with overall business performance
H4: ERM implementation outcomes have a positive association with reducing firm’s overall risk
premium
H5: ERM implementation outcomes have a positive association with reducing firm’s macroeconomic
risk
H6: ERM implementation outcomes have a positive association with reducing firm’s tactical risk
H7: ERM implementation outcomes have a positive association with reducing firm’s strategic risk
H8: ERM implementation outcomes have a positive association with reducing firm’s normative risk
H9: ERM implementation outcomes have a positive association with profit maximization of firm
H10: ERM implementation outcomes have a positive association with minimizing financial distress
cost
H11: ERM implementation outcomes have a positive association with lowering tax burden
H12: ERM implementation outcomes have a positive association with avoiding costly external
financing
H13: ERM implementation outcomes have a positive association with reducing information friction/
asymmetries
H14: ERM implementation outcomes have a positive association with minimizing agency cost
40
Hypotheses for Indirect Effect (Moderating Factors)
Our ERM framework postulates two moderating effects. The corresponding hypotheses are:
H15: Challenges faced by firm will impact ERM implementation intensity

H16: CSFs of ERM implementation process have an effect on the outcomes or benefits received from
ERM program
5.0 THE METHODOLOGY
5.1 The Analytic - Structural Equation Model for Path Analysis
The estimation of the multiple interrelated dependence relationships as per our ERM framework
discussed preciously involves the incorporation of latent and manifest variables. According to Hair et al.
(1998: 585), a latent variable is a “hypothesized and unobserved concept that can only be approximated
by observable or measurable variables”. On the other hand, the manifest or the observed variables are
gathered “from respondents through various data collection methods (e.g., surveys, tests,
observations)”.
For instance, all the variables shown in Figure 5 namely, ERM Program Challenges, ERM Implementation
Intensity, CSFs of Implementation, ERM Benefits, Dynamic Framework of Firm’s Risk Premium, Lower
Cost of Capital, and Business Performance are latent variables. These latent variables or observed
concepts in turn, will be individually measured by another set of manifest variables respectively. These
manifest variables are presented as statements in survey questionnaires to be answered by
respondents.
As far as data analysis procedure is concerned, we can address these multiple issues (as per the multiple
causal relationships in the ERM framework) simultaneously with a single multivariate technique. Since
the development of our ERM framework mentioned above embodies theoretical issues, we ought to
rigorously test its theoretical soundness.
To this end, we propose employing structural equation modeling (SEM) for the analysis. SEM is a path
model whose analytical procedure is an extension of several multivariate techniques such as multiple
regression and factor analysis. SEM enables the comprehensive examination of “a series of dependence
relationships simultaneously” (Hair et al., 1998: 578). The primary purpose of setting up a structural
equation model for path analysis is to validate theory by testing the total, direct, and indirect effects of
latent and manifest factors (variables). The path analysis also allows investigation for the effect of
mediation (intervention) that exists among variables (Anderson & Gerbing, 1988; Hair et al., 1998; Chin,
1998; Hoe, 2008).
SEM consists of measurement model or confirmatory factor analysis (CFA) and structural model (Hoe,
2008). Measurement model in SEM refers to the process of specifying indicators for each construct and
the assessment of the each construct’s reliability in estimating the causal relationship. Structural model,
on the other hand, refers to the set of one or more dependence relationships linking the hypothesized
model’s constructs (Hair et al., 1998). SEM’s statistical supremacy, namely its ability to detect and reject
a poor model, is derived from the fact that it combines both measurement and structural models into a
simultaneous statistical test to estimate a series of separate, but interdependent, multiple regression
41
equations (Hoe, 2008; Chin, 1998; Hair et al., 1998). In applying SEM, a researcher will “draw upon
theory, prior experience, and the research objectives to distinguish which independent variables predict
each dependent variable” (Hair et al., 1998: 584). According to Hair et al. (1998), in a structural model,
some independent variables become dependent variables in subsequent relationships.
Hoe (2008: 76) noted that SEM is especially effective in inferential data analysis and the testing of
hypothesis “where the pattern of inter-relationships among the study constructs are specified a priori
and grounded in established theory”. Besides, according to Chin (1998: 7), SEM offers researchers with
great flexibility to “(a) model relationships among multiple predictor and criterion variables, (b)
construct unobservable latent variables, (c) model errors in measurements for observed variables, and
(d) statistically test a priori substantive/theoretical and measurement assumptions against empirical
data (i.e., confirmatory analysis)”.
5.2 Path Diagram
Figure 5 depicts a pictorial portrayal of the relationships among all concepts/constructs in our ERM
framework. This pictorial portrayal is termed as a path diagram. It serves as the basis for a path analysis
to empirically estimate the strength of each relationship (represented by each path) depicted in the
diagram (Hair et al., 1998).
Referring to the causal relationships path diagram in Figure 5, one independent variable of ERM
challenges (X1) predicts the dependent variable ERM intensity (Y1) [arrow A]. Likewise, dependent
variable of ERM benefits (Y2) is predicted by two independent variables of ERM intensity (Y 1) [arrow B]
and implementation CSFs (X2) [arrow C]. Lastly, dependent variable shareholders value (Y3) is predicted
by variable ERM benefits (Y2) [arrow D].
42
Figure 5: Path Diagram of ERM Relationships
X2
Implementation
CSFs
C
Y2 D Y3
ERM Benefits Shareholders

B Value
Y1
ERM Intensity
X1
ERM
Challenges
Mathematically, these causal relationships can be stated in the following equations:
Y1 = b1X1 - path A
Y2 = b2Y1 + b3X2 - path B and C
Y3 = b4Y2 - path D
where
Y1, Y2, and Y3 are endogeneous variables; whereas
X1 and X2 are exogeneous variables; and
bi in all equations are the coefficients for the strength of causal relationships among constructs Y i and Xi .
43
6.0 CONCLUSION
We can conclude from the discussion earlier that the views of modern financial theory (neo-classical
finance theory) and that of strategy theory are somehow contradicting when it comes to corporate risk
management; in this context the efficacy of ERM.
In effect, the argument made by modern financial theory also runs contrary to that of classical theory
(i.e. Markowitz) in this respect. Nevertheless, as Bettis (1983: 409) aptly put it: “To alter either result is
to disrupt significantly the logical structure of the underlying discipline”.
But then, how can one provide plausible and sensible explanations in an effort to describe this
discrepancy and to even reconcile the difference?
Therefore, it will be of great interest and significance to attempt to provide a theoretical linkage among
the three schools of thought, namely the classical finance theory, neo-classical finance theory, and
strategy theory.
Our ERM framework, hence, endeavors to provide such linkage.
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48
A PRELIMINARY STUDY OF TOP SMEs IN MALAYSIA: KEY SUCCESS FACTOR VS

GOVERNMENT SUPPORT PROGRAM
Daisy Kee Mui Hung
School of Management, Universiti Sains Malaysia
daisy@usm.my
Azura Abdullah Effendi

Lilis Suriety Abdul Talib
Noor Afiza Binti Abdul Rani
ABSTRACT
Given that SMEs have been identified as main growth engines under Ninth Malaysia Plan (9MP), there is
now a pertinent need to provide SMEs with the necessary management skills and know-how in order to
compete, sustain and succeed in today’s challenging business environment. This paper is based on
quantitative research to examine the real contributing factors towards excellence performance among
top SMEs in coping with the rapid changes in today business world. And further the paper reviews the
effectiveness of government support program. In the preliminary study conducted, a sample of 20 top
SMEs winners of Malaysia Enterprise Award 2004-2008 was selected and 11 of them responded. The
findings showed that there are six main factors (networking, product, ability to focus on market,
customer, supportive management, and leadership) contribute to the success of local SMEs. Lacks of
accessibility of government support however do not stop them from achieving a greater height. The
paper provides guidelines as to how these successful practices may be adopted and used for future
direction by even start-up enterprise.
Field of Research: SMEs, Key Success Factors, Government Support Program, Malaysia.
----------------------------------------------------------------------------------------------------------------------------------
1.0 INTRODUCTION
During the 17th APEC Economic Leaders’ Meeting (AELM) in Singapore (2009), one of the main thrust
under the APEC’s inclusive growth agenda is to enhance opportunities for all segments of the members’
societies to benefit from growth. The development of SMEs is therefore identified by the 2009 Leader
Declaration as an important area of emphasis for APEC for the coming years. SMEs constitute more than
90% of all businesses in the APEC region, employ between 50% and 80% of the workforce and generate
about 30% of the exports. In Malaysia, 99.2% of businesses are SMEs, contributing 32% of the nation’s
gross domestic product (New Sunday Times, March 2009), it is evident that the present of a resilient
SMEs sector assumes a pivotal role towards the overall economy of the nation. Under the Ninth
Malaysia Plan (9MP: 2006-2010), the government has allocated an extensive funding of RM3.8 billion
(2008) and RM11.9 billion (2010) for SMEs with the purpose to improve and develop SMEs. Given that
SMEs have been identified as main growth engines under 9MP, there is now a pertinent need to provide
SMEs with the necessary management skills and know-how in order to compete, sustain and succeed in
today’s challenging business environment.
49
SMEs can be defined and interpreted in many ways based on their characteristics. In Malaysia, generally
SMEs are defined based on fixed quantitative criteria such as number of full time employees and annual
sales turnover. Understanding the definition of SMEs is very essential especially in facilitating the
government in formulating effective development policies, support programs, as well as provision of
technical and financial assistance. According to SME Corp Malaysia, the definition of SMEs differs
according to sector, as shown in below (see Table 1):
a) Manufacturing, manufacturing-related services and agro-based industries:
Small enterprises are defined as companies with sales turnover between RM250,000 and less than
RM10 million, or with between 5 and 50 full time employees, while medium enterprises are those with
sales turnover between RM10 million and RM25 million, or with between 51 and 150 full time
employees.
b) Services, primary agriculture, and information & communication technology:
Small enterprise are defined as companies with sales turnover between RM250,000 and less than RM1
million, or with between 5 and 19 full time employees, while for medium enterprises between 20 and 50
full time employees.
Table 1: Definition of SMEs by SME Corp Malaysia

Manufacturing, Manufacturing Services , Primary Agriculture and
Related Services and Agro-Based Information & Communication
industries Technology
Numbers of Full time employees

Micro < 5 employees < 5 employees
Small 5-50 employees 5-19 employees
Medium 51-150 employees 20-50 employees
Annual Sales Turnover
Micro <RM250 000 < RM200 000
Small RM250 000 & RM10 million RM200 000 & RM1 million
Medium RM10 million & RM25 million RM1 million & RM5 million
Aligned with the SME working group theme for 2009 “Helping SMEs Access Global Markets and
Overcome Trade Barriers”, Malaysia government have provided numerous support program aimed at
preparing sustainable growth for SMEs. These assistance programs include infrastructure supports,
financial and credit assistance, technical and training assistance, extension and advisory services as well
as marketing and market research. According to SME Annual Report (2008), a total of 202 programs
valued at RM3 billion in 2008 have been implemented involving a total of 598,000 SMEs, representing a
two-fold increase from the number of beneficiaries in 2007. In enhancing the capacity and capability of
SMEs, a total of 174 programs valued at RM3.04 billion were implemented in 2009. In the current
challenging economic period, many of the government policy measures introduced, including those in
the stimulus packages, are to ensure that SMEs continue to have access to financing. Besides additional
funds in the form of microfinancing, the new funds and schemes are in the form of guarantee facilities
to ensure that viable companies including SMEs that experience temporary cash flow problem continue
to have access to financing.
50
Despite the fact that there is strong government support, SMEs are still facing difficulty in their business
operations. Although, several SMEs have been acknowledged by the government as well as private
agencies for their achievement and excellent performance, they represent only a small portion of the
total number of SMEs in the country. In general, problems encountered by SMEs are caused by internal
and external environment, such as lack of capabilities and resources, poor management, low
technology, competition, economics, technology, socio-cultural, and international factors (Hashim,
2000). According to Ghosh and Kwan (1996), the problems faced by SMEs in Malaysia are cost, shortage
of workers, and competition. Furthermore, the economic crisis provides a big challenge to business
operation and adds to the difficulty in assessing financial assistance or funding to overcome the
shortage of capital in expanding their businesses.
Recognizing the significant role played by SMEs in the nation’s economic development, the question
arise on what are the real contributing factors towards the excellent performance among top SME’s in
today’s rapidly changing business world? This study was initiated to examine key success factors that are
being adopted by top SMEs and to provide some insights into SME supporting agencies and their
assistance program. Hopefully, this study will provide some useful information to motivate new start-up
enterprises and more of the existing SMEs to adapt and adopt to top SMEs practices that fit with the
nature of their business to ultimately improve their performance. Furthermore, understanding the
characteristics and constraints that are faced by SMEs will provide valuable input for the government to
improve the assistance programs and to also allocate more funding to this vital sector.
For this purpose, key success factors (KSFs) and government support program (GSP) are examined by
studying the winners of the Malaysia Enterprise 50 Award. This award is organized by Small and Medium
Industries Development Corporation (SMIDEC) (today known as SME Corp Malaysia) in collaboration
with Deloitte Malaysia. This annually organized event is aimed at acknowledging the companies that
have distinct value preposition, coupled with necessary alignment and allocation of resources to
effectively execute its business plan. In other words, these companies are strategically positioned and
operationally efficient companies. Winners of this award are selected based on two main categories:
Active Posturing and Operational Finesse. Each nominee will be short-listed based on initial screening
criteria and later, an interview will be arranged with these organizations to evaluate their management
capabilities and key management on the business plan.
This paper is comprised of the following: a literature review to examine the key success factors and
government support programs that were examined and mentioned in previous studies, a research
methodology and procedure to describe the methods employed in this study, results of the empirical
study, and finally, a brief discussion and conclusion of the study.
2.0 KEY SUCCESS FACTORS
A KSF is regarded as a skill or a resource that a business can invest in, which explains a major part of the
observable differences in perceived value of the offer and/or relative costs of bringing that offer to the
marketplace (Bisp, Sorensen & Grunert 2001, p.55). According to Ghosh, Liang, Meng, and Chan (2001),
KSFs are defined as factors critical to excellent performance of the company rather than survival.
Hashim (2000) described success as effectiveness of enterprises in accomplishing their objectives. The
success factors that were identified are satisfying customer needs, close working relationship between
top management and employee, regionalization, leadership, availability of financial and technology
resources, and support. Further, Hashim and his associates (2003) found that strong and supportive
leadership, employee commitment, employee involvement, encouragement of new ideas, tolerance of
51
risks, ambiguity, conflict, open communication among employees, profit sharing, market and customer
orientated, and emphasis on entrepreneurial behaviors are important KSFs.
For an organization to be successful, Ayadurai and Ahmad (2006) believed that the entrepreneur must
possess characteristics which are: innovative, creative, farsighted, right attitude in business dealing,
never give up attitude, having knowledge in business, business-minded, able to work long hours, having
good networking and a host of contacts, independent, as well as resilient. Rose, Kumar, and Yen (2006)
suggested success factors as personal initiative, promotion of product and services, understanding
market needs, and examining customer feedback. Besides that, innovation was also indicated as one of
the key elements of success (Sinha, 2003) and there is significant relationship between distinctive
capabilities and innovativeness on the performances of SMEs (Man & Wafa, 2007).
3.0 GOVERNMENT SUPPORT PROGRAM
Recognizing the important role played by SMEs in the nation’s economic activities, the government has
introduced several assistance programs and incentives and they are called GSP. The areas that are
considered essential by the government in terms of providing assistance are: management expertise,
finance, land/building, facilities, and information about the market and tax deduction (Hashim et al,
2003). The government has allocated RM15.6 billion or 2% of GDP to address key areas such as
facilitating access to financing, enhancing capacity building, reducing the cost of doing business and
assisting vulnerable groups, including micro enterprises (SME annual report, 2008). In the 2010 budget,
the government has put more attention on SMEs development in terms of enhancing the capacity and
capability to face with global challenges.
Although the government has allocated a huge amount for financial assistance and provided various
programs for SMEs, all this effort is seen as useless when the impact of business activities are found to
be insignificant. This situation occurs when the assistance program is offered through a number of
government or private agencies without appropriate observation. According to Abdullah, Latif, Bakar,
and Nor (2001), the ineffectiveness of assistance programs is due to: limited number of SMEs receive full
range of assistance, inefficient allocation of resources, and the programs focusing on developing only
new enterprises. While in Indonesia, the lack of government support programs were due to
inappropriate targeting of training, a lack of budget for managing and maintenance, a lack of qualified
trainers, often exceeding their skills or machinery available or conversely focusing on skills they had
already mastered, and difficulties in matching training to workshop (Tambunan, 2007). Aside from that,
some SMEs do not know how to apply for assistance, have no confidence in their proposal, and think
they need someone in order to obtain government assistance (Shieh Lee, 1990). Furthermore, several
previous studies have addressed that SMEs are still unaware of the availability of management training
programs (Hashim, Ahmad, & Hassan, 2007) and financial assistance programs (Hashim, Ahmad, &
Zakaria, 2007).
Empirically, there have been limited attempts to determine factors that can help overcome the SME’s
weaknesses as well as those factors that contribute to their success. Hence, we ask, what are the real
contributing factors to local SME’s excellent performance in today’s rapidly changing business world?
This paper is aimed at examining the KSFs of Malaysian SMEs by studying the organizations that won the
2004-2008 Enterprise 50 Award. Simultaneously, the interest of this study is to provide some insights
into SME supporting agencies and their assistance programs. This information may be used as a
guideline by new start-up enterprises and existing SMEs for exploiting their potential and consequently
for improving the effectiveness of the relevant Government support programs.
52
4.0 METHODOLOGY
4.1 Sample
This preliminary study focused at the organization level and therefore the unit of analysis was the
organization. The identification of right respondents is essential to ensure the contribution of this study
generates new knowledge that would be beneficial to SMEs. Therefore, the sample was drawn from Top
SMEs winners of Malaysia Enterprise 50 Award 2004-2008. A total of 20 questionnaires were
distributed, and 11 were returned, for a response rate of (55%). Only one respondent answered the
questionnaire as a representative of the organization. The respondents of this study are the decision
makers (Chief executive officer, senior manager, managing director or human resource manager). The
majority of the respondents are drawn from manufacturing industry (64%). Over 80% of them market
products abroad. Table 2 presents the profile of organization surveyed.
Table 2: Organization Profile

Variable Category Frequency Percentage
Company Status Bumiputra 3 27.27
Non-Bumiputra 8 72.72
Number of Employees <50 2 18.18
50-100 3 27.27
101-150 6 54.55
Average Annual Turnover <1 Million 1 9.09
1-5 Million 2 18.18
5 -10 Million 1 9.09
10-25 Million 7 63.63
Organization type Manufacturing 7 63.63
Non-Manufacturing 4 36.37
Market Level International 9 81.81
National 2 18.18
A survey questionnaire was developed by the authors. The authors critically reviewed the questionnaire
items, noting any vague areas or wording, appropriateness of measures and scales, ease of response,
length and time to complete the questionnaire. A group of management experts was referred to review
the survey items. The questionnaire was revised until the refinement process is completed. Parts of the
instruments were adapted from previous research (e.g., Ghosh & Kwan, 1996; Morrison & Brennan,
2000) led to the development of a 13-item KSFs scale and a 10-item GSP scale. The five point Likert scale
is employed in this study and they are labeled as such: (1) ‘strongly disagree’ and (5) ‘strongly agree’.
5.0 DISCUSSION OF FINDING
The results were analyzed using SPSS. The means and standard deviations for the study variables are
presented in Tables 3 and 4.
53
Table 3: Key Success Factors of Top SMEs in Malaysia

No Key Success Factors Mean Standard
deviation
1 A good networking 4.36 0.50
2 A good product/services feature 4.27 0.64
3 Able to identify and focus on market 4.18 0.60
4 A good customer and client relationship 4.18 0.40
5 A committed, supportive, and strong management team 4.09 0.83
6 A visionary, capable, and strong leadership 4.09 0.83
7 Able to develop and sustain capabilities 4.00 0.77
8 Adopting a correct strategy 4.00 0.63
9 Availability of financial and technology resources 3.90 0.70
10 Regionalization / internalization 3.90 0.30
11 A good human resource management practices 3.81 0.75
12 A good and responsive organization system 3.81 0.73
13 A good government support 3.00 1.18
Table 4: Effectiveness of Government Support

Standard
No Do government bodies/agencies… Mean
deviation
provide consultation to your organization through an informal
1 1.19 1.54
network?
2 communicate economic development policies to local community? 1.72 1.48
3 Identify economics development opportunities in your local area? 1.72 1.48
provide channels that handle the problems and issues facing by your
4 2.00 1.67
organization? (such as advisory bodies)
5 provide consultation to your organization through a formal network? 2.18 1.54
6 have a flexible policies and regulations? 2.36 1.36
dedicate resources to promoting economic development ?(e.g.
7 2.72 1.49
Economic Planning Unit)
8 provide relevant information/ knowledge that assist your organization? 2.81 1.47
create a local business environment that encourages business
9 2.90 1.51
development?
provide relevant information/ knowledge that benefit to your
10 3.00 1.61
organization? (such as seminars, courses, conferences)
The key factors that contribute to the success of Malaysian Top SMEs winners are presented in Table 3.
The top six KSFs in order of importance are (1) a good networking; (2) a good product/services feature;
(3) ability to identify and focus on market, (4) a good customer and client relationship; (5) a committed,
supportive and strong management team; and (6) a visionary, capable and strong leadership. As
indicated by the results, building and developing the right networks and contacts emerge as the most
critical factor to the success of top SMEs in Malaysia. The findings appear to support the previous
studies (Johannisson, 1990; Starr & MacMillan, 1990). Johannisson (1990) reported that building and
54
developing the kind of relationships and networks likely to benefit the business. Starr and MacMillan
(1990) suggested that good networks provide entrepreneurs with access to expertise and various
support. To summarize, this study suggest that the need to establish personal connections and networks
are important for the local SMEs or entrepreneurs to navigate a safe course and get various forms of
supports in this unpredictable customers demands and competitive business environment.
The second most important factor in determining the success of SMEs, however, is a good product
feature. This might indicate that Malaysian entrepreneurs tend to focus on what the customers want
and preferences. A good product or service feature is one way to attract customer. Evidence has shown
that competition is one major cause of switching behavior among customers to a new provider because
of the attraction posed by them (Keaveney, 1995). Ability to identify and focus on market and good
customer relationship are perceived as equally important by Malaysian successful entrepreneurs. It is
reflected by the strong focus on competition and competitors’ practices in Malaysian market. It is also
consistent with the previous studies (Duncan, 1991; Dehayes & William, 1990; Ghosh & Kwan, 1996;
Huck & Thaddeus, 1991; Prescott, 1986) that identification and focus on a market niche and being close
to the customers are most frequent reasons that contribute to the small business’ success.
Apart from the factors above, Malaysian entrepreneurs treated both supportive management team and
visionary leadership are vital factors contributing to local SMEs’ excellent performance. This suggests
that leaders are encouraged to focus on aspects such as providing care and support and promote the
development of followers. Strong, capable and visionary leaders have influential power to guide and
motivate followers distinctly in achieving organizational goals. It is consistent with the study by Tucker
and Russell (2004) who commented that an organization needs transformational leaders who provide
new direction, new inspiration, and new behaviors for their organizations. These leaders are the change-
agents in the organization which is crucial in an ever-changing world.
It is interesting to note that a good government support is not perceived as an important and critical
factor that contributes to the success of local SMEs who are global players. As indicated by Table 4, GSP
is seen as ineffective in contributing toward the organizational success (mean reported are below 3.00).
The main issues addressed by SMEs are lack of (1) consultation through informal network; (2)
communication of policies to local; and (3) identify economic development opportunities. Even though
these assistance programs are offered, it appears that SMES facing difficulties in accessing the
government support. Lacks of accessibility of government support program, however do not stop them
from achieving a greater height. It is further supported by Table 5 where entrepreneurs are asked to
rate the effectiveness of GSP from a scale of 1 (the least effective) to 10 (the most effective), over 80%
of the respondents rated 4 and below. The finding shows that GSP is perceived unfavorably by top SMEs
winners. Its causes are discussed as below
Australia's Virgin Blue, founded in 2000 by Sir Richard Branson, had predicted a loss for its first three
years but instead made USD 500,000 in operating profits in its first seven months. So far, AirAsia is
indeed in the right track. By November 2005, they will add another 60 Airbus into their fleet. This
activity will support their objectives to increase recent flight frequencies and opening new country
destination, which is likely to be China and India. If those all blueprints successfully accomplished,
maybe, next time we look up to the sky, we will not be able see blue anymore. We’ll see AirAsia.
55
Table 5: Effectiveness of Government Support rated by Respondents

Scale Frequency Percentage
1 1 9.09
2 1 9.09
3 3 27.27
4 4 36.37
5 1 9.09
6 1 9.09
7-10 0 0
Note: 1 ‘the least effective’; 10 ‘the most effective’
Respondents are provided with a list of GSP and they are asked to state (1) if they have used the GSP; (2)
programs that are attended or utilized; and (3) reasons for not fully utilizing GSP. Overall, all
respondents have received some sorts of the assistance program and 20% have attended the training
program. The assistance program that utilized by Top SMEs are Human Development Fund (40%) and
Matching Grant for Certification and Quality Management Systems (30%) (See Table 6). Most of the
assistance programs that provided by government are not fully utilized due to the complicated
application procedures involved, limited allocation of resources, and some activities are meant for new
enterprises (Refer Table 7). It is in line with the previous research by Abdullah et al (2001) who reported
that the ineffectiveness of assistance programs is due to: limited numbers of SMEs receive full range of
assistance, inefficient allocation of resources, and the programs focusing on developing only new
enterprises. It is interesting to find that the complicated procedure of financing application is ranked as
the top reason for not receiving the full range of assistance. The main author approached local SME
bank and it is found that SME banks will normally take two to three months for the processing of loan.
On top of that, SME banks require numerous supporting documents comparing to commercial banks.
Commercial banks normally take less than a week before the financing was approved. Of these top
SMEs, only one does not know how to apply the assistance program. This finding contradicts with Shieh
Lee (1990)’s study where she reported that some SMEs do not know how to apply for assistance, have
no confidence in their proposal, and think they need someone in order to obtain government assistance.
The possible reason could be that top SMEs represent only a small portion of the total number of
Malaysian SMEs.
Table 6: GSP that are utilized by Top SMEs

Assistances and Program Frequency Percentage
Received Government assistance programs 10 100
Attend training program under GSP 2 20
Executive Franchise Scheme (PNB) 1 10
Small Entrepreneur Corporation Scheme (CGCM)
1 10
4 40
Human Development Fund (MOHR)
1 10
Matching Grant for Enhancing Product Packaging (SMIDEC)
Matching Grant for certification and quality management
3 30
system (SMIDEC)
56
Table 7: Reasons for not utilizing GSP

Reason for not utilizing GSP Frequency Percentage
Inefficient allocation of resources 2 20
Not aware of such assistance 1 10
Government assistance is for new enterprise 2 20
Do not know how to apply 1 10
Worry of 'trade' or information being leaked 1 10
The procedures are complicated 3 30
6.0 CONCLUSION
Understanding the real contributing factors to local SMEs’ excellent performance through the lens of
entrepreneurs is essential because it provides entrepreneurs, particularly young entrepreneurs with
knowledge about the way they should operate their business and encourage them to be aware of
potentially powerful strategies that could used for future direction. As such, an analysis of the key
success factors of top SMEs who are the existing global players would contribute towards propelling
SMEs to a greater height for its future success in Asian region. The interest of the Malaysian government
in developing and expanding the growth of small and medium enterprises (SMEs) has been flourishing
for many years. However, despite the existence of numerous Government assistance programs, SMEs
still encounter a variety of problems in their operations. GSP are seen as insufficient and not delivering
enough towards developing and strengthening local SMEs. The study provides some insights into SME
supporting agencies for exploiting their potential and consequently for improving the effectiveness of
the relevant GSP. For policy makers and ministries, the results could serve as a reference in formulating
policies or support programs aimed at assisting SMEs to gain better access to global markets, technology
and finance as well as to improve their management capabilities. A better understanding of the KSFs of
top SMEs and accessibility of GSP could be achieved if future research could extend to a larger sample.
SELECTED REFFERENCES
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bumiputra’s entrepreneurs in SMEs: Evidence from Malaysia.
www.sbaer.uca.edu/research/icsb/2001/F-3-1/F-3-3.pdf
Ayadurai, S., & Ahmad, W. R. (2006). A study on the critical success factors of women entrepreneurs in
small and medium enterprises (SMEs) in Malaysia. Paper presented at the International Council for Small
Business (ICSB) 51st World Conference, Melbourne, Australia.
Bisp, S., Sorensen, E., & Grunert, K. G. (2001). Using the key success factor concept in competitor
intelligence and benchmarking. Competitive Intelligence Review, 9(3), 55-67.
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Dehayes, D. W., & William, L. H. (1990). University alumni small business research program: A study of
emerging businesses, Centre for Entrepreneurship and Innovation, Indiana University, Bloomington.
Duncan, I. (1991). An introduction to entrepreneurs, CMA Magazine, 65(9), 32.
Ghosh, B.C., & Kwan, W. (1996). An analysis of key success factors of SMEs: A cross national study of
Singapore and Australia/New Zealand. ICSB, Sweden, in the proceedings of selected papers.
Ghosh, B.C., Liang, T.W., Meng, T.T., & Chan, B. (2001). The key success factors, distinctive capabilities
and strategic thrust of top SMEs in Singapore. Journal Business Research, 51,209-221.
Hashim, M.K. (2000). A proposed strategic Framework for SMEs success. Malaysian Management
Review, 35(2), 32-43.
Hashim, M.K., Ahmad, S., & Hassan, R. (2007). An evaluation of SMEs management training programs. In
M.K. Hashim (Eds.), Small and medium-sized enterprises development in Malaysia. Program and
evaluation (pp. 49-67). Sintok: UUM Publication.
Hashim, M.K., Ahmad, S., & Zakaria, M. (2007). An assessment of the manufacturing SME financial
assessment programs. In M.K. Hashim (Eds.), Small and medium-sized enterprises development in
Malaysia. Program and evaluation (pp. 33-48). Sintok: UUM Publication.
Hashim, M.K., Mahajar, A.J., & Ahamd, S. (2003). Innovative practices of Malaysian Firms: Some
evidence from Enterprise 50 Winners. Malaysian Management Review, 38 (2), 19-27.
Huck, J. F., & Thaddeus, M. (1991). Competencies Needed for Small Business Success-Perceptions of
Jamaican Entrepreneurs, Journal of Small Business Management, 29(4), 90-93.
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Small Business Journal, 9(1), 3-4.
Man, M.K., & Wafa, S.A. (2007). The relationship between distinctive capabilities and the performance of
small and medium-size enterprises (SMEs) in Malaysia. In Proceedings of the 13th Asia Pacific
Management Conference, Melbourne, Australia, 11-19
Morrison, R., & Brennan, G. (2000). Creating a seamless local government and small business interface
for better regional economic development outcomes. Paper presented at the ICSB World Conference,
Brisbane, Australia.
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2009.
Prescott, E. (1986). How to be small and successful. Public Relations Journal, 42(2), 31-32.
Rose, R.C., Kumar, N., & Yen, L.L. (2006). Entrepreneurs success factors and escalation of small and
medium-sized enterprises in Malaysia. Journal of Social Sciences, 2(3), 74-80.
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Sieh Lee, M. L. (1990). Malaysia’s industrial and entrepreneur profile. Malaysia Management Review,
25(2),
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Leadership and Organizational Studies, 10(4), 103-112.
www.smidec.gov.my
59
ANALYSIS OF INCOME AND EXPENDITURE OF HOUSEHOLDS IN THE EAST COAST

OF PENINSULAR MALAYSIA
Noorhaslinda Kulub Abd. Rashid
lindarashid@umt.edu.my
Aslina Nasir
pzna84@gmail.com
Nik Hashim Nik Mustapha

nhm06@umt.edu.my
Nik Fuad Kamil
Faculty of Management and Economics

Universiti Malaysia Terengganu (UMT)
ABSTRACT
Analysis of expenditure and income patterns of households in Malaysia that focuses on income,
expenditure, loan, and saving is important. This study analyzes the impact of post global economic crisis
on the income and expenditure patterns of Malaysian households. The study identifies major
components of household’s expenditure on food, education, and health; as well as saving and loan, in
relation to household income. In Pahang, Kelantan and Terengganu, the total expenditures come from
the variables such as income, housing loan, automobile loan and expenditure for education. These
variables were selected due to the highly significant value that contributed to the Total of Expenditures
(EXTO).
Keywords: expenditure, income, household.
----------------------------------------------------------------------------------------------------------------------------------
1.0 INTRODUCTION
In Malaysia the slogan ’Spend Wisely’ is often promoted and advertised at shopping centers as well as in
the media. The slogan addresses the importance of wise spending under whatever economic situations.
With the increase in Consumer Consumption Index (CPI) for goods and services, wise spending is the
only solution to reduce consumer problems. Consumer problems are many but it revolves around the
balancing act of income, expenditure, loan, and savings.
Income level is the major factor that determines consumption spending of an individual. However,
income is not the only factor that influences spending, as loan and saving also affect spending. Spending
of course fulfill the needs for basic necessity of an individual and family members. Leon Zurawicki &
Nestor Braidot (2004), reported that households tend to make an adjustment to their income and
60
expenditures to fulfill their needs during an economic crisis or recession. Stephen (2001) disclosed that
consumption and expenditures pattern changes along with changes in income level.
2.0 ISSUES IN INCOME AND EXPENDITURE
Recession and fluctuations in the economy would normally cause changes in the socioeconomic and
social standing of the populace. These changes often lead to social crisis (Walton & Manuelyan, 1998).
Atsushi Maki (2006) reported that economic crisis lead to sudden changes in saving behavior as well as
lifestyle. However variation in income among the population would lead to wider income disparity
between households. Household expenditure and income disparity can lead to significant differences in
either rural or urban setting in terms of expenses on basic needs. An urban household tends to increase
consumption based on the increment of income in order to improve their lifestyle (Farkhanda Shamim &
Eatzaz Ahmad, 2007). Micheal Beine et. al (2001) found that households in United States prefer to spend
their money at shopping centers rather than use their leisure time for other activities.
This research seeks to know the factors that influence household income and expenditure in Malaysia.
Households often change their spending patterns whenever economic crisis occurs. In 1986, 1997 till
1998 and in 2008, Malaysian had experienced significant changes in the economy arising from currency
speculation and global economic crisis. Households in Malaysia spend their money wisely in respond to
the structural changes in the economy.
3.0 RESEARCH OBJECTIVES
The general objective of this research is to analyze levels of household’s income and patterns of
expenditure among the East Coast population. The specific objectives is to analyze post global economic
crisis on the income and expenditure patterns of the East Coast households. To identify major
components of household’s expenditure of the East Coast households as the percentage of total income
in terms of food, education, health, utility as well as saving and loan. To determine factors that influence
household’s propensity to consume on major components of expenditure in relation to income. To
estimate an empirical two stage least square model for the household’s expenditure.
4.0 ANALYTICAL FRAMEWORK
Simple random sampling was used as the basis in the selection of the respondents. Three states in the
East Coast of Peninsular Malaysia were selected namely Pahang, Kelantan and Terengganu. The
selection of districts and mukims was purposively based on the suggestion from District Officers due to
their knowledge and wide experience about the survey areas. In Pahang, two selected districts were
Kuantan (urban) and Pekan (rural), while for Kelantan, the selected districts were Kota Bharu (urban)
and Kuala Krai (rural). Lastly for Terengganu, Kuala Terengganu and Setiu were chosen to represent the
urban and rural area respectively.Based on mukims selected in each state, respondents were drawn by
simple random sampling technique.
5.0 THE DISTRIBUTION OF HOUSEHOLD SAMPLING FOR EACH STATE & DISTRICT
To make it more clear, the information provided on the below table shows how the distributions of
respondents (household) will be made.
61
From Figure 1, the number of total respondents for three states are 645 which separated into urban and
rural area. In Pahang, the number of urban area, Kuantan and rural area,Pekan are 118 and 100
respectively with total of respondents in both area 218. While, the total number of respondents in
Kelantan is 214 with 110 and 104 number of respondents respectively in Kota Bharu (urban) and Kota
krai (urban). For Terengganu, the number of respondents in Kuala Terengganu is 103 that represent as
an urban area whereas Setiu represent as a rural area with 110 of respondents. So, the total number of
respondents in Terengganu is 213.
6.0 ANALYSIS
In this research, two types of analysis were used – the descriptive and inferential analysis (Correlation
and Regression). Descriptive analysis is the one of analysis method to describe the data or certain
information in the simple way, more clear, orderly and easy to be understanding. Usually the data will
be interpret and analyzed according to the years of research (whether time series or cross sectional
data) to make it more clearance. Furthermore, this statistic data will be transformed into schedule or
graph according to information suitability. Correlation analysis is used to achieve the second objective of
study. This analysis involved the hypothesis testing that will be established between income and quality
of life indicators based on secondary data. While for regression analysis, on the other hand is used
based on regression model form so-called “Simultaneous Equation” to identify the relationship and the
pattern of expenditure that interrelated to each others. In this research the expenditure will be divided
into six components such as food, education, utility consumption, saving and loan payment.
7.0 RESULT AND DISCUSSION
In general, are relatively low which selected at least 0.3 because the study were using the cross-
sectional data. Based on the result as shown in Table 1, there are 8 equation systems for Pahang
household according to their value of which over than 0.3.
62
Most of t-values for Equation 1 in Pahang are significant at 0.01 and 0.05. There is positive relationship
between INC (income) and EXTO (Expenditure Total) whereby the EXTO clarify as an endogenous
variable. About 1 percent (1%) increased in income necessitate an increase of 0.21 percent (%) in total
of expenditure (Refer to equation 1). This scenario is consistent to the Engel Theory, which can be
explained by the function that relates the equilibrium quantity for individual with their income level
(Ahmad Mahdzan Ayob, 1991). It means that, the income level will generate to their spending behavior
(total expenditures).
While, for two variables such as HLO (Housing Loan) and ALO (Automobile Loan), there are highly
correlated or strongly relationship with EXTO (Expenditure Total) at 0.01 level of significant or 99.0 %
(probability level). As a conclusion, the reason of their total of expenditure is more than their income is
most of them like to spend more money to fulfill their needs by making loan such as housing loan and
automobile loan from any financial.
Next, if refer to the Equation 2, there is also the same findings as in Equation 1 whereby INC as an
endogenous variable. The Equation 1 and 2 have inter related each other because in this study the 2SLS
Equation Systems were used simultaneously. The highly correlated variables at 0.01 level of significant
are EXTO, FSA (Family Size) and also DEP (Dependent). It shows that the number of family members and
the number of dependent in family’s will influence the income level whether it is sufficient or not. That’s
why in the case of Pahang, The value for TBL (Total Borrowing Loan) can be rank as the highest value
among the variables. The household tend to make loans if there is insufficient for make their
expenditures for certain item.
63
Table 1: Results of 2SLS Regression Analysis for Pahang
Endogenous Variables
Regressor
EXTO EXF EXC EXE SAV TBL INC EXL
Constant 593.37 50.457 -185.16 -105.28 93.024 9.3627 -204.62 -254.57
(3.127)*** (0.8788) (-1.983)** (-1.774)** (0.9972) (0.253) (-0.2916) (-1.715)**
EXTO 0.1339 0.1184 0.04215 1.2146 0.623
(10.69)*** (2.987)*** (0.5834) (7.809)*** (5.715)***
INC 0.1207 0.00209 0.05506 0.00612 -0.07507
(1.808)** (0.1405) (1.1013) (0.4128) (-0.8983)
HLO 1.2539 1.1058
(4.475)*** (21.05)***
ALO 0.948 -0.1184 1.0478
(3.244)*** (-1.057) (20.63)***
FSA 20.779 -33.942 2.6439 546.72 25.319
(3.422)*** (-1.05) (0.3979) (4.738)*** (0.4503)
AGE 1.6877 1.9913 -0.5563 19.937
(1.759)* (1.304) (-0.3261) (1.835)
EXT 0.6924
(2.056)**
EXE 3.0281
(3.197)***
Exogenous
EDLO -0.00995 0.9955
Variables
(-1.044) (10.77)***
TBL 0.02925
(0.5981)
DEP 28.408 22.723 5.1121 -593.59 -81.063
(2.559)** (3.3260)*** (0.1466) (-4.963)*** (-1.381)
DPE -20.238 -261.97 -100.83
(-0.5295) (-0.6156) (-0.9873)
DSE 32.554 -586.13 -35.931
(0.8906) (-1.388) (-0.3439)
DUE 45.403 -475.37 31.354
(1.149) (-1.041) (0.2813)
SEX -14.968
(-0.5297)
MST -31.917
(-0.3394)
LOC 72.742
(1.645)
R2 0.5924 0.5827 0.3619 0.3093 0.3851 0.9288 0.3755 0.5864
DW 1.9382 1.6312 1.7452 1.8111 1.8921 1.7928 1.9037 1.6199
* significant at 0.1 level or 90%
** significant at 0.05 level or 95%
*** significant at 0.01 level or 99%
64
EXTO  593.37  0.1207INC  1.2539HLO 0.948ALO  3.0281EXE ………..(Equation 1)

EXF  50.457  0.1339 EXTO  20.779 FSA  1.6877 AGE
EXC  185.16  0.1184 EXTO  0.1184 ALO  28.408 DEP  1.9913 AGE
EXE  105.28  0.00209 INC  0.6924 EXT  0.00995 EDLO  22.723DEP  20.238 DPE  32.554 DSE
 45.403DUE  14.968SEX
SAV  93.024  0.04215 EXTO  0.05506 INC  33.942 FSA  0.5563 AGE  5.1121DEP  72.742 LOC
TBL  9.3627  0.9955 EDLO  1.1058 HLO  1.0478 ALO  0.00612 INC  2.6439 FSA
INC  204.62  1.2146 EXTO  546.72 FSA  19.937 AGE  593.59 DEP  261.97 DPE  586.13DSE  475.37 DUE
…(Equation 2)
EXL  254.57  0.07507 INC  0.623EXTO  81.063DEP  31.917 MST  25.319 FSA  100.83DPE
 35.931DSE  31.354 DUE
Where
EXTO = Expenditures total EXF = Food Expenditures

EXE = Education Expenditures TBL = Total Borrowing Loan
EXL = Loan Expenditures INC = Income
HLO = Housing Loan ALO = Allowance Loan
FSA = Family’s Size AGE = Age
EXT = Transportation Expenditures EDLO = Education Loan
DEP = Dependent DPE = Private
DSE = Self Employment DUE = Unemployment
SAV = Saving
The findings in Kelantan are slightly as same as Pahang where by the TBL (Total Borrowing Loan) still
show the highest =0.6831. Most of t-values for Equation 1 in Kelantan are significant at 0.05 and 0.01.
There is positive relationship between INC (income) and endogenous variable, EXTO (Expenditures
Total). About 1 percent (1%) increased in income means that 0.14 percent (%) changes in total of
expenditure (Refer to equation 1). Besides of income, there are three independent variables that have
strongly relationship with EXTO at significant level at 0.05 and 0.01, which identified as EXE
(Expenditures for Food), INC (Income), HLO (Housing Loan), and lastly ALO (Automobile Loan).
If refer to the Equation 2, there is also the same findings as in Equation 1 whereby endogenous variable,
INC have strongly relationship (0.05 and 0.01 level of significant) between INC and five exogenous
variables such as EXTO, FSA (Family Size), DEP (Dependent), DSE (Dummy for Self Employment) and DUE
(Dummy for Unemployment). So, based on these findings, the number of family members and the
number of dependents in family’s strongly contributed to the level of income. In addition, with the self
employment and unemployment of the household, it gives an impact to the level of income as a whole.
65
Table 2: Results of 2SLS Regression Analysis for Kelantan
Regressor EXTO INC
EXF EXE TBL EXL
(Eq. 1) (Eq. 2)
399.93 53.191 17.241 194.39 -171.26 -416.18
Constant
(4.587)*** (0.795) (0.5165) (2.355)** (-0.2954) (-3.847)***
0.1454 1.3411 0.7407
EXTO
(8.039)*** (8.387)*** (7.609)***
3.0656
EXE
(5.81)***
0.0881 0.00569 -0.01586 -0.0704
INC
(2.114)** (0.5587) (-0.3653) (-1.064)
1.4789 1.5557
HLO
(6.447)** (7.209)***
1.0093 1.0551
ALO
(6.377)** (7.362)***
4.5656 -7.2618 342.37 12.183
2
FSA
(0.8886) (-0.4676) (5.899)*** (0.4433)
2.3312 10.781
AGE
(2.072)** (1.119)
Exogenous 0.0698
EXT
Variables (0.542)
0.0511 0.9731
EDLO
(2.135)** (12.5)***
-0.00188
TBL
(-0.1088)
26.422 -370.82 -60.343
DEP
(6.545)*** (-5.268)*** (-2.019)**
-5.6517 -361.00 -57.645
DPE
(-0.2201) (-1.049) (-0.6626)
-19.89 -506.44 90.486
DSE
(-0.8924) (-1.726)** (1.162)
-11.224 -904.18 -0.5819
DUE
(-0.4147) (-2.741)*** (-0.00599)
-24.285
SEX
(-1.407)
6.8921
MST
(0.0954)
R2 0.6493 0.4439 0.3314 0.6831 0.3949 0.4953
DW 1.9334 1.7258 1.8048 1.9356 1.6200 1.7707
In Kelantan, there are 6 equation systems with their significant variables at 99%, 95% and 90%.
66
EXTO  399.93  3.0656 EXE  0.0881INC  1.4789 HLO  1.0093 ALO ………………(Equation 1)
EXF  53.191  0.1454 EXTO  4.5656 FSA  2.3312 AGE
EXE  17 . 241  0 . 00569 INC  0 . 0698 EXT  0 . 0511 EDLO  0 . 00188 TBL  26 . 422 DEP  5 . 6517 DPE
 19 . 89 DSE  11 . 224 DUE  24 . 285 EXE
TBL  194.39  0.01586 INC  1.5557 HLO  1.0551ALO  7.2618 FSA  0.9731EDLO
INC  171.26  1.3411EXTO  342.37 FSA  10.781AGE  370.82 DEP  361.00 DPE  506.44 DSE  904.15 DUE
…………..(Equation 2)
EXL   416 .18  0 .7407 EXTO  0 .0704 INC  12 .183 FSA  60 .343 DEP  57 .645 DPE  90 .486 DSE  0 .5819 DUE
Table 3: Results of 2SLS Regression Analysis for Terengganu

Regressor EXTO EXF INC TBL EXL
Constant 458.52 13.774 3565.0 -164.09 -546.29
(3.534)*** (0.162) (3.723)*** (-2.223)** (-2.746)***
EXTO 0.0905 0.8776 0.07594
(5.37)*** (4.328)*** (10.39)***
INC 0.07515 0.069 0.07096
(1.436) (2.677)*** (-1.185)
HLO 1.3856 1.001
(9.011)*** (15.34)***
ALO 1.4144 0.7556
(6.948)*** (8.223)***
FSA 20.288 161.33 12.519 23.34
(3.565)*** (2.099)** (1.765)** (1.203)
AGE 2.9636 -24.661
(2.309)** (-2.069)**
EXT
Exogenous
Variables EXE 3.046
(6.565)***
EDLO 0.8633
(10.74)***
DEP -359.8 -86.608
(-4.582)** (-3.30)***
DPE -385.44 141.41

(-0.8428) (1.295)
DSE -766.03 351.97
(-1.645) (3.001)***
DUE -156.67 351.91
(-0.309) (2.928)***
SEX
MST -113.69
(-0.9866)
2
R 0.7127 0.3083 0.3019 0.8226 0.482
DW 1.5575 1.5612 1.7637 2.0195 1.7979
67
Compared to Pahang and Kelantan, Terengganu has 5 equation systems with their significant variables
at 99%, 95% and 90% as below. Most of t-values for Equation 1 in Terengganu are significant at 0.01.
There is positive relationship between INC (income) and endogenous variable, EXTO (Expenditures
Total). About 1 percent (1%) increased in income means that 0.13 percent (%) increase in total of
expenditures (Refer to equation 1). Contrast to the case of Pahang and Kelantan, Terengganu does not
have any relationship between income and total of expenditures. With highest value in TBL (Total
Borrowing Loan), means that Terengganu household tend to spend more money by making loan even
though they are insufficient of income. It means that in Terengganu, income does not contribute to the
expenditure pattern among the households. Nevertheless, there are three independent variables that
have strongly relationship with EXTO at significant level at 0.05 and 0.01, which identified as EXE
(Expenditures for Food), INC (Income), HLO (Housing Loan), and lastly ALO (Automobile Loan).
Next, for Equation 2, the endogenous variable, INC has highly correlated to the four exogenous variables
such as EXTO, FSA, AGE (Age) and DEP at 0.01 and 0.05 level of significant. Compared to Pahang and
Kelantan, Terengganu has strongly relationship between INC and AGE because the more their age, the
less productive to contribute to the job market. Furthermore, after their pension period, their income is
not sufficient to bear the members of family. That’s why the relationship between INC and AGE are
negative.
EXTO  458.52  0.07515 INC  1.3856 HLO  1.4144 ALO  3.046 EXE …………(Equation 1)
EXF  13.774  0.0905 EXTO  20.288 FSA  2.9636 AGE
INC  3565.0  0.8776EXTO  161.33FSA  24.661AGE  359.8DEP  385.44DPE  766.03DSE  156.67 DUE
………(Equation 2)
TBL  164.09  0.0069 INC  1.001HLO  0.7556 ALO  12.519 FSA  0.8633EDLO
EXL  546.29  0.07594EXTO  0.07096INC  23.34FSA  86.608DEP  141.41DPE  351.97 DSE  351.91DUE  113.69MST
8.0 ANALYSIS OF EXPENDITURE
In Pahang, Kelantan and Terengganu, the total expenditures come from the variables such as income,
housing loan, automobile loan and expenditure for education. These variables were selected due to the
highly significant value that contributed to the Total of Expenditures (EXTO). The detail explanations for
these variables can be illustrated as below whereby the total expenditures for income, housing loan,
automobile loan and education expenditure with their slightly differences respectively.
Table 1: Correlation between Income and Total Expenditure
INC PAHANG KELANTAN TERENGGANU

200 1454 994 1336
400 1478 1012 1351
600 1502 1030 1366
800 1526 1047 1381
1000 1550 1065 1396
1200 1574 1082 1411
1400 1599 1100 1426
1600 1623 1118 1441
1800 1647 1135 1457
2000 1671 1153 1472
68
Figure 2: Correlation between Income and Total Expenditure
Based on the Figure 2 in above, the correlation between income and total expenditure shows the
difference trend in three states. Pahang shows the highest value, followed by Terengganu and lastly
Kelantan whereby the higher the income values the higher the total of expenditures. These strongly
relationship means that once the income level increase even 1%, the total expenditure tends to be
higher with proportionately.
Table 2: Correlation between Housing Loan and Total Expenditure
HLO PAHANG KELANTAN TERENGGANU

200 1873 1343 1623
400 2124 1639 1900
600 2375 1935 2177
800 2625 2231 2454
1000 2876 2527 2731
1200 3127 2822 3008
1400 3378 3118 3285
1600 3628 3414 3562
1800 3879 3710 3839
2000 4130 4005 4117
69
Figure 3: Correlation between Housing Loan and Total Expenditure
Next, the housing loan and total expenditure in Figure 3 show the different pattern for these three
states compared to the Figure 2 in above. Pahang was the first ranking in making housing loan, followed
by Terengganu and then Kelantan. Based on the findings in this surveying to the urban and rural area for
each state, majority of the respondent agreed that the expensive housing loan especially in urban area
has increased the total expenditure among of them. Instead of the standard of living in Kelantan was
relatively cheaper compared to the Pahang and Terengganu, the large proportion in making housing
loan made them suffering to survive in comfortable residence.
In terms of making automobile loan, the correlation between automobile loan and total expenditure are
dramatically different in Terengganu compared to Pahang and Kelantan. There is a gap between
Terengganu and these two states on making automobile loan, shown in Figure 4 as below.
Table 3: Correlation between Automobile Loan and Total Expenditure
ALO PAHANG KELANTAN TERENGGANU

300 1871 1324 1720
600 2156 1627 2145
900 2440 1930 2569
1200 2724 2233 2993
1500 3009 2536 3418
1800 3293 2838 3842
2100 3578 3141 4266
2400 3862 3444 4691
2700 4146 3747 5115
3000 4431 4049 5539
70
Figure 4: Correlation between Automobile Loan and Total Expenditure
Lastly, the same findings that we can see in these three states are education expenditure. The
correlation between education expenditure and total expenditure are approximately similar each other.
It means that in theses three states, the education is one of the important aspects to be emphasized in
order to born the higher level education person and first class mentality students. So that, majority of
the parent agreed that investment in education aspects can guaranteed the positive return and benefit
for their children in the future.
Table 4: Correlation between Education Expenditure and Total Expenditure
EXE PAHANG KELANTAN TERENGGANU

200 1959 1385 1651
400 2565 1998 2260
600 3170 2611 2870
800 3776 3224 3479
1000 4382 3837 4088
1200 4987 4450 4697
1400 5593 5063 5306
1600 6198 5677 5916
1800 6804 6290 6525
2000 7410 6903 7134
71
Figure 5: Correlation between Education Expenditure and Total Expenditure
9.0 CONCLUSION
Based on our discussion in above, it is very important to highlight the household income and
expenditure in order to know how their spending pattern in the context of nowadays situation. From the
expenditure items that mentioned before this, all Malaysian especially among the household should
have good information and knowledge to manage their money and to put the priority expenses of the
total expenditures. The following below are the steps or guidance in thrift spending:
• Get to know the thrift store shopping to avoid losing money
Thrift stores fit most any budget and are not just for people with low income. Experienced savvy
shoppers pay cheap prices for household goods, gift items, and clothes that others can no longer use.
There are advantages to shopping at thrift stores, especially at the beginning of school and around the
holidays. But thrift store shopping has disadvantages too, and consumers are advised to know the
store's policies before making any expensive purchases. There are thrift store items that shoppers
should avoid to keep from losing money.
• Make a budget
A budget is absolutely one of the best tools that help us to spend less than what we make. It started
with how we make a budget in order to spend wisely and thrift. An effective budget is needed to getting
out of debt and unnecessary items. Everyone who does not budget spends more money than those who
do. It is very simple as that and very useful to apply. It doesn’t have to be painful and can even be fun.
• Limited Promotion and Unbeneficial Advertisement
In terms of government role, they should limit the promotion, campaign and advertisement for certain
company in order to educate the household to spend wisely. Sometimes unbeneficial advertisement is
72
very easy to influence the society to make a debt by using their credit card and also easier to spend
more than they do.
• Individual awareness
The awareness among the individual is the main important aspect to be emphasized in order to educate
them in how to be good money spender. Furthermore, with unstable economic and financial, it is very
important to saving our money for contingency items in the future.
As a conclusion, learning to manage the money wisely takes time and effort, but it also depends on the
individual and others in the society on how to make it reality
REFERENCES
Atsushi Maki, (2006). Changes In Japanese Household Consumption and Saving Behavior Before, During
and After The Bubble Era : Empirical Analysis using NSFIE Micro-data Sets. Japan and the World
Economy.
Farkhanda Shamim and Eatzaz Ahmad, (2007). Understanding Household Consumption Patterns in
Pakistan. Journal of Retailing and Consumer Services.
Leon Zurawicki and Nestor Braidot, (2005). Consumers During Crisis : Responses From The Middle Class
in Argentina. Journal Of Business Research.
Michel Beine, Francis Bismans, Frederic Docquier and Sebastian Laurent, (2001). Life-Cycle Behaviour Of
US Household A Nonlinear GMM Estimation On Pseudopanel Data. Journal Of Policy Modeling.
Syed, O.A. 1996. Poverty Eradication From Islamic Perspectives [online]. Available from:
http://vlib.unitarkl1.edu.my/staff-publications/datuk [Accessed in Disember 2009].
Cutler, J. (2005). The Relationship Between Consumption, Income and Wealth in Hong Kong. Pacific
Economic Review, 10 (2), 217-241.
Dejuan, J. P. and J. J. Seater. (1999). ‘The permanent income hypothesis: Evidence from the consumer
expenditure survey’ Journal of Monetary Economics, 43, 351-376.
73
DO TRANSACTIONAL, TRANSFORMATIONAL AND SPIRITUAL LEADERSHIP STYLES

DISTINCT? : A CONCEPTUAL INSIGHT
Zaini Jamaludin
Lecturer, Faculty of Management and Muamalah,
Selangor International Islamic University College, Malaysia.
zainijamaludin@yahoo.co.uk
Nik Mutasim Nik Ab. Rahman

Zafir Khan Muhammad Makhbul
Fazli Idris
Associate professor, Malaysian National University.
ABSTRACT
Leadership is a critical element in ensuring the sustainability of an organization. Research in the field of
leadership has never been saturated with theoretical and conceptual quests for leadership styles that
work with any situation and followers’ condition. Bernard Bass, for instance has adopted the political
leadership paradigm of transactional and transformational leadership styles introduced by Burn to the
social science fields. Efforts by Bass were well accepted by other researchers and enormous studies have
been done to test the applicability of the leadership paradigm in many sub-fields of social sciences for the
past 30 years. Studies have found that transformational leadership style leads to increased productivity,
employee morale, job satisfaction, organizational commitment and organizational citizenship behavior.
The findings also suggest that the latter compliments the transactional leadership style. However,
recently scepticism was raised on the ability of the transformational leadership style to effectively fulfil
follower’s inner need and with respect to the lack of spiritual element in the ethical conduct of leaders.
Hence, this brings interest in research on a new leadership paradigm which takes into account the
spiritual element in leadership. In spiritual leadership, questions are raised about what it means to be
human, what we really mean by growth and what value and power distributions are needed to enhance
both organizations and society as a whole. This paper attempts to investigate further these questions in
the context of the various leadership styles mentioned. In due course, the results of a pilot study will be
offered to support the argument.
Keywords: Transactional Leadership, Transformational Leadership, Spiritual Leadership, Leadership

Paradigm, Leadership Insight, Leadership Style.
----------------------------------------------------------------------------------------------------------------------------------
1.0 INTRODUCTION
One of the important atributes of leaders that attracts the interest of many researchers is their
leadership styles (Adeyemi-Bello 2001). According to Lok and Crawford (2004), leadership contributes
significantly to the success or failure of an organisation. The psychological profile of leaders could be
reflected in the performance of the organisation (Adeyemi-Bello 2001). Consistent with this observation,
Al-Mailam (2004) argued that high-quality leadership is regarded as vital in bringing success to any
74
group activity. He further added that enthusiasm, charisma and dedication are some of the
characteristics of leadership that transform an organisation into a successful entity (Al-Mailam 2004).
Strong and effective leadership creates high involvement and shared commitment that stimulates
people to overcome obstacles to achieving maximum results (Blake and Mouton 1985). Some studies
have found that leadership style has positive impact on workers work commitment (Bycio et.al. 1995;
Koh et.al. 1995; Karrasch 2003; Sun 2004; Ross and Gray 2006; Nguni et.al. 2006).
Sheh (2002) argued that in a number of organisations, overall bad performance might not always occur
because of poor administration systems but might also be due to poor organisational leadership. In
complex social interactions, leadership provides the integrating capacity for moulding social institutions:
governmental, business or religious (Kakabadse et.al. 2002). Mullin (2005) suggest that today’s
leaderships are no longer dependent on the controlling and directing skills but rather on the
inspirational concept of working together with others and developing vision that is generally accepted.
Yulk (2006) stated that the ability to influence is the core to leadership and powerful leaders have
significant impact on the life of their followers and future of the organisation.
Thus, the objective of this paper is to examine whether the transactional, transformational and spiritual
leadership are conceptualy distinct. It is important to know if any of this leaderships style are overlaping
between each other especially among transformational and spiritual leadership style. It’s will be able to
answer the scepticism that was raised on the ability of the transformational leadership style to
effectively fulfil follower’s inner need and with respect to the lack of spiritual element in the ethical
conduct of leaders. Hence, this brings interest in research on a new leadership paradigm which takes
into account the spiritual element in leadership.
2.0 LOCUS OF LEADERSHIP
The strength of a leader depends on the way he or she gains support from the followers. Therefore, the
essence of the leader-follower relationship is the interaction between persons with different levels of
motivation and power potentials, in pursuit of common or at least a joint purpose (Banerji and Krishnan
2000). The success of an organisation relies on the leadership style practiced by it’s leader. Enthusiasm,
charisma and dedication are some of the characteristics of leadership that transform an organisation
into a successful entity capable of meeting its own goals and objectives while giving value to customers,
clients and other stakeholders. (Al-Mailam 2004).
By employing appropriate leadership styles, leaders can influence followers job satisfaction,
commitment and productivity (Mosadeghrad and Yarmohammadian 2006). Research by Parish et.al.
(2008) found that there are positive relationship between organisational change and workers
commitment. They argue that factors such as vision, leader-follower relationship, job motivation and
role autonomy influence commitment to change. Thus, leaders who intend to make any changes must
consider not only the organisational performance but also its impact on the followers.
Tannenbaum and Schmidt (1973) offered a formula for effective leadership, that is E = f (l, f, s) where E
(effective leadership) is a function of l (leader), f (followers) and s (situation). Based on this formula, it
was argued that effective leaders are influenced by the traits or behavior of the leaders, their followers’
support and the micro and macro situation of the organisation they led. Klein and House (1995)
described that leaders act as spark, followers represent the flammable element and the situation
resembles oxygen. Thus, charismatic leaders motivate their followers with the support of condusive
situation. However, as a word of caution, the nature of the leader and follower relationship is said to be
75
vulnerable to the corrupting influences in the form of power abuse and chaos associated with change
(Storr 2004).
In relation to the above formula of effective leadership, Hur (2008) maintains that leadership is an
interaction between leader, follower and the social and task environment. He further added that
leader’s personality traits have been a major concern when determining leadership effectiveness, where
as follower’s personal characteristics and the task environment have not been as often considered in
any study of overall leadership effectiveness. This statement is strengthen by his findings that suggest
that leadership style is not being influenced by the characteristics of follower and task environment. In
support of this, Allio (2009) agreed that the ’evil’ behavior is more on the consequence of the situation
and system (the lucifer effect) rather than the character of the individual. Factors such as environmental
and individual depression might influence one’s behavior even though it is not reflective of their real
self.
On another note, Palmer (1994) stressed that, the majority of books or material related to leadership
discuss about power and the ability of leaders to lead their organisation towards positive achievement.
Effective leaders are said to use their power and act in ways that bring benefits to their followers and
the organisation. Palmer also noted that there are only small portion of knowledge that shows that
some effective leaders can bring the follower and organisation towards the negative direction and
promoting social disaster. This statement is supported by Washbush and Clements (1999) who claim
that people who employ personal power see followers as utilitarian tools, incapable of independent
thought and captured by the magnetism of an overwhelming personality. They also argued that this
’dark face’ of effective leadership is not being discuss in the leadership books and training.
Washbush and Clements (1999) added, it is important to realize that not all these counterproductive
behaviors emanate from leaders. However, inspired and empowered followers can take action that
produce decidedly negative consequences for the leader. For example, followers who have strongly
authoritarian personalities are likely to conform unquestioningly of they may react to the charismatic
qualities of the leader by mimicking or idealizing. Additionally, followers may seek to ingratiate
themselves with leaders to be valued and rewarded. Such reaction can deprive leaders of important
feedback and alternative perspective. Thus, competence alone does not sufficient to be effective leader.
It must be supported by good followers and also conducive organisation environment.
76
Figure 1 shows the Locus of Leadership which consist of three factors, i.e., the leader, the followers and
the situation (Wagner and Hollenbeck 2005). Ability, experience and knowledge play a big role in
contributing to effectiveness of a leader. However, this does not deny the importance of the followers
as supporters and people who help accomplish the leader’s mission. The situation is equally important
to ensure a conducive environment for execution of action plans. Mahatma Ghandi is known as a
charismatic leader in India and the same goes to Adolf Hitler in German. Both, however, have different
leadership styles. Hence, the key success factor among these the three elements in the locus of
leadership would be other than the leadership style. A leader should have the necessary skills that allow
them to use the appropriate leadership style based on the situation or tasks (Howard 2005)
3.0 TRANSACTIONAL AND TRANSFORMATIONAL LEADERSHIP PARADIGM
James Burns (1978) in pioneering the transformational and transactional leadership paradigm argued
that transactional leadership is characterized by a ”swapping” or ”trading” or ”bargaining” motive in an
exchange process and lacks durable engagement between leader and the led. Transformational
leadership on the other hand, involves the mutual ”rising” of both sides to higher levels of motivation
and morality. In support of Burns’ opinion on the latter, Bass (1997) further clarified that
transformational leadership paradigm move the followers beyond their self-interests for the good of the
group, organisation and society. According to this author, this new leadership paradigm does not
replace the conceptions of leadership as exchanges that are contingent on followers’ performance,
rather, it enhances the role of leaders in enlarging and elevating followers’ motivation, understanding,
maturity and sense of self-worth.
Bernard Bass and his colleague in several of their works (Bass 1981;1985;1990;1997; Bass and Avolio
1993;1994; Avolio et.al. 1999; Bass et.al. 2003) have offered lots of effort to enhance the transactional
and transformational leadership paradigm introduced by Burn (1978) to the organisational management
discipline (Chakraborty and Chakraborty 2004). According to Burn, the main distinction, and the central
feature of transformational and transactional leadership is based on the process by which leaders
motivate followers or how leaders appeal to the followers’ values and emotions (Nguni, Sleegers and
Denessen 2006). The transaction – transformational paradigm views leadership as either a matter of
contingent reinforcement of followers by a transactional leader or the change within the followers
beyond their self-interests for the good of the group, organisation, or society by a transformational
leader (Bass 1997).
Transactional leadership is grounded by an exchange relationship and refers to a situation where leaders
provide rewards to followers who achieve good performance and, on the contrary put on punishment to
those who are not. Transformational leadership, on the other hand increases followers’ motivation to
achieve higher performance, commitment and trust to the organisation (Bass 1985). Thus, while rules
and regulations dominate the transactional organisation, adaptability forms the important characteristic
of the transformational organisation (Bass 1997). On another note, Simola, Barling and Turner (2010)
stressed that transformational leadership is strengthened by accrued benefits while transactional
leadership is solely based on the economics exchange. Additionally, Bass and Avolio (1994) argued that
although the transformational and transactional leadership are different paradigms, they are not
mutually exclusive. The authors suggest that an effective leader should posses both transactional and
transformational leadership styles.
According to Al-Mailam (2004), through adoption of transactional leadership style, a leader acts as an
agent of change and makes meaningful exchanges with employees. Accordingly, these result in
77
improvements in productivity (constructive transaction). On the other hand, he maintains that a

transformational leader empowers workers to achieve an articulated vision of the organisation and its
mission, leading to increases in productivity, employee morale, job satisfaction as well as heightened
personal and professional growth. The effects of transformational leadership style on job satisfaction,
commitment, efficiency and organisational improvement has been empirically supported a number of
researchers (Sahin 2004). Mullin (2005) added that the process of transformational leadership would
result in highly motivated and committed followers, develop a vision that is able to transform the
organisation and increase followers’ idealism and values apart from than inculcating feelings of justice,
loyalty and trust. The positive impact of transformational leadership on numerous performance
indicators and job satisfaction is a value added over and above the impact of transactional leadership
(Bass 1985).
Despite, the positive observations with respect to the impact of transformational leadership, several
scholars have raised certain points of weaknesses on the leadership paradigm. These include aspects of
unidirectional influence flowing emanating from the leaders to the followers, and the issue of over
identification with the leaders which creates overdependence on the leaders (Yulk 1999). Antonakis
et.al. (2003) suggest the need to explore other leadership constructs that more comprehensively cover
the shortcomings within the Full Range Leadership (FRL) model introduced by Bass and Avolio (1997).
Besides the above, the transformational leadership paradigm was also criticized for lacking the morale
and ethical elements (Bass and Steidlmeier 1999). Transformational leadership is deemed to cause
followers to give their trust, admiration, loyalty and obedience to leaders and to do directed tasks
without questioning (Yukl 2006). However, Quatro et.al. (2007) argued that transformational leadership
theory may be particularly relevant to the spiritual domain.
Bass has refered to leaders such as Mahatma Ghandi and Martin Luther King Jr. as a real
transformational leader but their goal is too narrow; maintaining the followers (Odom and Green 2003).
Thus, Quatro et.al. (2007) reminded that not all leader with charismatic’s appeal will have strong moral
value, and indeed some may have motives leaning more toward personal power and self-
aggrandizement. Chakraborty and Chakraborty (2004) has relate the transformational leadership with
spiritual element. According to them, the background of transformational leadership as proposes by
Burns (1978) has left the spiritual element as the human ultimate goal. Even the index of Bass-Avolio
book does not show any entries for spirituality or transcendence or consciousness (Chakraborty and
Chakraborty 2004). However, Fairholm (1996) found that 63% from his respondents mentioning the
spiritual aspect as fundamental in developing their value, trust and ethical behavior.
4.0 IS SPIRITUAL LEADERSHIP A NEW PARADIGM?
Spirituality is a long-neglected phenomenon in studies on leadership (Kakabadse, Kouzmin and

Kakabadse 2002). However, recently there is increasing interest in incorporating spirituality in
management theories, management development and practice. Some authors cited increased pressures
of society, development of IT, increased globalisation, including the pressures of population,
environment and food demands, as elements also contributing to the increased interest in examining
the concept (Kakabadse et.al. 2002). While work is critical to economic wellbeing, it is insufficient to
effectively fulfil the needs of human beings (Fairholm 1996). In this respect, Fry (2003) argues that
spiritual leadership taps into the fundamental needs of both leaders and followers for spiritual survival
in order to be more organisationally committed and productive.
78
Fry (2003) mentions that people have to satisfy certain needs in order to survive and he considers
spirituality as one of the basic needs. It is shown that, in the situation where spirituality were not given
sufficient emphasis, workers seem to lose meaning, motivation and further to these, the excitement in
completing tasks (Kriger and Seng 2005). Therefore, leaders have an important role in ensuring that the
spiritual needs of the workers are fulfilled in order to enhance their work quality and productivity.
Matured leaders as well as workers in organisations do not merely search for economic rewards with
resapect to work done but also seek the spiritual satisfaction (Fairholm 1996). Hence, the role of leaders
is more crucial to the survival and adaptation of social institutions than the management of control
systems or efficiency audits (Kakabadse et.al. 2002).
Spirituality in leadership is conceived by many as awareness within individuals of a sense of

connectedness that exists with their inner selves and the world (other people and environment)
(Kakabadse et.al. 2002). In this context, Fry (2003) define spiritual leadership as comprising the values,
attitudes and behaviours that are necessary to intrinsically motivate one’s self and others so that they
have a sense of spiritual survival through calling and membership. Hence, the purpose of spiritual
leadership is to create vision and value congruence across the strategic, empowered team and individual
levels and ultimately, to foster higher levels of organisational commitment and productivity (Fry, Vitucci
and Cedillo 2005). Spirituality is an inherent characteristic of all human being, which encompasses the
sacredness of everything, is nondenominational, broadly inclusive and embracing everyone, and
involves experiencing or achieving a godlike self through connection (Fernando et.al. 2009).
According to Dent et.al. (2005), spirituality should constitute a new paradigm in leadership. Fry et.al.
2005 noted that spiritual leadership paradigm provides an integrating framework for the Army’s
transformation effort, especially as it relates to increasing levels of intrinsic motivation, commitment,
productivity and well-being. In practice, spiritual leadership is driven by inner life or spiritual practice
(Fernando et.al. 2009). However, early empirical attempts at testing the relationship between
spirituality and leadership have found that the characteristics of leaders do not commonly include
notions of spirituality (Dent et.al. 2005). Without desire to manipulate others, spiritual leaders can be
distinguished from transformational leaders by motives such as altruistic love, a sense of wholeness,
harmony and wellbeing (Fernando et.al. 2009).
As the studies continue on this leadership paradigm, some scholar has place a critique on the
weaknesses of transformational leadership paradigm. Researchers has come out towards deeper
”softness” or ”subjectivism” in the development of leadership theory (Chakraborty and Chakraborty
2004). There is a part of us is not just physical, a part that we are comfortable in calling spirit; it
integrates guiding principles of wholeness, relationship, inner wisdom and inner authority (Fairholm
1996). Fry (2003) has mentions that people have to satisfy some certain needs to survive and he
considers spirituality as one of the basic needs. Thus, a growing chorus of scholarly voices is arguing that
spirituality is necessary in organisation (Benefiel 2005). He added that organisational science can no
longer avoid analyzing, understanding and treating organisation as spiritual entities. Spirituality goes
beyond these ideas and provides the underpinning necessary to make them work in our personal and
professional lives; spirituality implies a relationship with something intangible beyond the self (Fairholm
1996).
Dent et.al. (2005) stated that deliberations on the concept of spirituality is still in its infancy state and as
such is marked by differences in definitions and other basic characteristics. Dent et.al. (2005) and Fry
(2003) propose that studies are required to further develop its conceptual distinctions. While spirituality
can make ones’ lives more meaningful, promoted connection and generally make the world a better
79
place, more research and theoretical classification is needed to prevent spirituality from becoming just
another management fad (Fernando et.al. 2009).
5.0 PILOT TEST
The authors conducted a pilot test to determine whether the spiritual, transformational and
transactional leadership styles are distinct constructs. The instrument used for the transactional and
transformational leadership styles was the Multifactor Leadership Questionnaires (MLQ) developed by
Burns (1978). These measures include two dimensions of transactional leadership style (contingent
rewards and management by exceptions) and three dimensions of transformational leadership style
(charismatic, intelectual simulation and individual consideration). As for the spiritual leadership style,
questionnaires develop by Fry et.al. (2005) were used which consists of three dimensions; altruistic love,
leader vision and hope/faith.
The questionnaires were distributed to political workers from a political party. 36 questionnaires were
gathered and analysed. The reliability procedure carried out on the measures revealed Cronbach Alphas
of .808 for transformational leadership, .841 for transactional leadership and .906 for spiritual
leadership. These values indicate that the instruments are reliable. Further to the reliability test,
discriminant analysis was conducted to ensure that all the three constructs are distinct from each other.
Table 5.1 shows the result of the Collinearity Diagnostics and Coefficient test. There would be an issue of
multicollinearity should the variance proportions exceed 0.9 for any row that has condition index
greater than 30 (Gaur and Gaur 2006).
Table 5.1 Collinearity Diagnostics
Condition Variance Proportions

Model Dimension Eigenvalue Index (Constant) TRNSFRM TRNSK SPRTL
1 1 3.957 1.000 .00 .00 .00 .00
2 .034 10.816 .01 .02 .86 .02
3 .006 24.728 .10 .14 .00 .98
4 .003 38.119 .89 .83 .14 .00
Besides, multicollinearity problem can also be detected via the collinearity statistics. There is no
multicollinearity problem if the tolerance is smaller than 1.0 and variance inflation factor (VIF) less than
10 though it is better to have a value which approximates to 1.0 (Gaur and Gaur 2006). However, low
tolerance value contribute to lack of information toward the model and result in error in statistical test
(Kinnear and Gray 2004). Thus, the pilot test results prove that all three leadership styles are distinct
between one another.
80
Table 5.2 Coefficients Output of SPSS
Unstandardized Standardized
Coefficients Coefficients Collinearity Statistics
Model B Std. Error Beta T Sig. Tolerance VIF
1 (Constant) 1.134 1.207 .939 .355
TRNSFRM .117 .199 .084 .587 .561 .835 1.198
TRNSK .515 .104 .665 4.944 .000 .945 1.058
SPRTL .083 .139 .085 .599 .554 .854 1.171
6.0 DISCUSSION
Result from this study has strengthened the point that all three leadership are distinguish between each
other. The multicollinearity test proved that none of the leadership styles are overlaping. The finding is
inline with Zwart (2000), who’s found no significant relationship between spirituality and
transformational leadership within the workplace. Therefore, it is suggested that more research needs
to be done especially in distinguishing the spiritual leadership from other leadership paradigm such as
transformational and transactional leadership.
81
Figure 6.1 showing the graph of leadership paradigm and it’s motive to explain the differences of each
paradigm using Maslow Hirarchy of Needs. There is no arguement that transactional leadership focus on
the exchange relationship between leader and follower. Clarification, completion and compliance are
factors that underlie transactional leadership (Bass 1985). Transactional leaders motivates followers by
appealing to their self-interest and it is based on exchange relationship, whereby follower compliance is
exchanged for expected rewards (Nguni et.al. 2006). While the transactional leader motivates followers
to perform as expected to own the rewards, the transformational leader typically inspires followers to
do more than originally expected (Den Hartog et.al. 1997). Transformational leadership creates change
by offering a vision that attracts followers and appealing to high ideals and moral value in order to
change workplace culture and productivity (Friedman 2004).
Transformational leadership entails raising the levels of motivation of their followers beyond exchange
values and thus achieve a higher levels of performance and followers ”self-actualisation” (Nguni et.al.
2006). This term was used by Abraham Maslow in his article, A Theory of Human Motivation. Maslow
explicitly defines self-actualization to be "the desire for self-fulfillment”; the tendency for the individual
to become actualized in what his/her potential is. This tendency might be phrased as the desire to
become more and more what one is, to become everything that one is capable of becoming. Maslow
used the term self-actualization to describe a desire, not a driving force that could lead to realizing one's
capabilities. Maslow did not feel that self-actualization determined one's life; rather, he felt that it gave
the individual a desire, or motivation to achieve budding ambitions. A more explicit definition of self-
actualization according to Maslow is growth-motivated rather than deficiency-motivated. This
explanation emphasizes the fact that self-actualization cannot normally be reached until other lower
order necessities of Maslow's hierarchy of needs are satisfied; in this issue is the economic stability.
As work has become the centerpiece of our lives. We spend too much of our time at work or in work-
related social and leisure activities. While work is critical to economic wellbeing, it is not meeting our
needs as human being (Fairholm 1996). In many cases, economics achievement does not bringin joy and
excitement in live. The emptiness is always related to the lack of spirituality needs. Spirituality implies a
relationship with something intangible beyond the self (Fairholm 1996). The self-actualization is only a
part of achievement in our live. What more important according to Benefiel (2005) is “the second half of
the journey”, which it is more towards our own transformation than about material gain (spirituality).
Theories of leadership focus on motivation followers (Bass 1990). Motivation includes the forces, either
external or internal to a person, that arouse enthusiasm and persistence to pursue a certain course of
action (Fry 2003). He argued that extrinsic motivation satisfy lower order needs (i.e. money, material)
and intrinsic motivation satisfy higher order needs (i.e. meaning of life). Spirituality means beginning to
become aware of a consciousness higher than that of the body-mind centered ego, and the ability to live
more and more in it under its guidance (Chakraborty and Chakraborty 2004). The effect of spiritual
leadership in establishing the sense of leader and follower spiritual survival is to create value
congruence across the strategic, empowered team and individual levels to ultimately foster higher levels
of organizational commitment, productivity and employee well-being (Fry et.al. 2005) with the guidance
of the ‘ultimate power’
7.0 CONCLUSION
Though the spiritual element has been identified to be significant to leadership more than 20 years ago,
the key reason of excluding it from the leadership and other management practice is due to the
confusion and confounding surrounding the distinction between religion and spirituality. The study has
brought new insight in distinguishing leadership paradigm especially among transformational and
82
spiritual leadership. The discussion on the motive of motivation based on Maslow Hierarchy of Needs
shows the differences between each leadership paradigm. Nevertheless, the paradigms as mentioned by
Bass (1990) are not mutually exclusive. Leaders would still have to consider the other elements in the
leadership locus (leader, follower and situation) to choose the appropriate leadership style, especially
the motivation factor of follower either extrinsic or intrinsic. Benefiel (2005) has discussed the route of
the journey from the first half (fulfilling the Maslow hierarchy) to the second half of the journey
(maintaining relationship with the higher power). Therefore, the leader has to consider each follower
condition and level in order to be an effective leader.
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CAN THE MODEL OF THE RIBA-FREE ISLAMIC COMMERCIAL BANK PROVIDE A

NEW PARADIGM FOR THE FUTURE OF GLOBAL BANKING?: A THEORETICAL
REVIEW
Nico P. Swartz
University of the Free State, Faculty of Law
swartznp.rd@ufs.ac.za
ABSTRACT
The study shows that there is a need for riba-free banks in all countries where Muslims live. However,
most countries operate under conventional banking laws, and it is futile to expect the situation to
change; and it does not need to change. The interaction between the traditional Islamic and the
conventional Western bank will make possible the setting up of a new type of bank, i.e. riba-free
commercial banks. This riba-free commercial bank will serve as a new paradigm for global banking.
Under the riba-free commercial bank, all current account services rendered by the conventional model
will be provided. The difference is that where, in the conventional system, six components (interest,
services cost, overhead costs, risk premium, profit, compensation for inflation) are treated as a
compound to justify riba, the riba-free commercial system treats these components separately in order
to avoid riba. The result will be that interest stands to be charged, while riba is to be prohibited. Riba-
free, but not cost-free, loans and advances will form the basis of riba-free commercial banking. It means
that riba-free commercial banks must be free of the encumbrances of charitable loans. In this riba-free
commercial model, interest is to be associated with trade or profit, which is permissible in Islam. In riba-
free commercial banking, aspects of both conventional and Islamic finances are combined. This will allow
Islamic societies to have the best of both worlds, and this is the model of banking the world is waiting
for. It is now up to the Muslim and conventional bankers and others to take steps to establish such riba-
free commercial banks (not interest-free) in all countries of the world.
----------------------------------------------------------------------------------------------------------------------------------
1.0 INTRODUCTION
In the Middle-East, Islamic banks came into being as a consequence of the oil-price hike of 1973 and the
resultant flow of huge amounts of money into the oil-producing countries. The only income-earning
investment options available were those offered by the conventional banks (Western), and these were
based on interest. The Western banks, on the one hand, provide all the conventional facilities, both
nationally and internationally, and they dominate the field. On the other hand, this practice appealed to
the Muslim religious conscience, and they started searching for riba-free alternatives. Their aim is to rid
the economy of riba, and they began with the riba-free banking system. However, the Muslim
community encountered a problem with the banking system as it exists today, and this article aims to
address their concerns. There is, therefore, a need for a banking system that can accommodate both
Islamic and conventional methods of finance. This paper tries to explore this phenomenon. It also
suggests that Muslims and non-Muslims could have the best of both worlds. This paper aims to establish
87
a “mixed” system which combines aspects of conventional and Islamic banking practices. This “mixed”
system came to be associated with riba-free (Islamic) commercial banking.
2.0 USURY (RIBA) AND INTEREST
Historically, usury (riba) and interest were always treated as one and the same thing. It was only in the
post-Christian, post-Renaissance period of European history that the term interest was used as a
substitute for usury to wriggle out of the religious and moral prohibition. Currently, there is an ongoing
dispute among scholars about whether the Qur’an advocates a total ban on interest. The dispute arises
from a lack of consensus about the meaning of riba, which is the Arabic word for the predetermined
return on the use of money.1
This paper purports to explore the notion that there is a difference between usury and interest. Money-
lending transactions involve usury and interest.2 It is therefore necessary to have an interface between
riba and interest.3 This will enable Muslims to follow their religious precepts without creating serious
distortions in their economies.4
According to the injunctions of the Holy Qur’an, anything recovered in excess of the principal amount is
specifically prohibited in money-lending transactions. In money transactions, the Holy Qur’an permits
the lenders to take back only the amount advanced and no more.5 Prima facie it seems that interest, like
riba, is also prohibited. This will, however, be futile for commercial banking, because the notion of trade
is included in interest. From this perspective, an increase on the amount lent must not be viewed
prematurely as riba.
Riba means excess. In Islamic jurisprudence, it encompasses an increase in the principal.6 This
explanation still does not distinguish riba form interest as riba, and interest entails both “increase” and
“excess.”7 The interface between riba and interest come to the fore only when riba is being viewed as
“[the] doubling of a sum…” when the debtor cannot pay it back at the moment when it becomes due. 8
On the strength of this, riba may not be regarded as synonymous with interest. This notion is fostered
by the perception that not all Islamic scholars agree on the Qur’anic prohibition of all forms of interest.9
In light of the argument above, this paper tries to solve the problem by defining riba as high or excessive
rates of interest only. The implication to be deduced from this point of view is that bank interest is not
riba and is therefore to be allowed. This notion is endorsed by the phrase: “…it is not clear that the
Qur’an’s ban on the institution of interest is applicable as it prevails today.”10
1
Mahmood Yousefi et al “Islamic Banking and Friedman’s Rule” (1995) vol. liii, no.1, Review of Social Economy,
67.
2
Shahid Hasan Siddiqui Islamic Banking (1994) 10.
3
Ibid 11.
4
Mahmood Yousefi et al (1995) 66.
5
Siddiqui (1994) 13.
6
Siddiqui (1994) 17.
7
8
9
10
88
It is important that the perception that interest is not increase simpliciter be imprinted in the minds of
humankind. If this notion is not to be accepted, interest may be tantamount to riba. However, there is
an element of increase that is known as profit, which is permissible. Hence the Qur’anic verse: “…Allah
hath permitted trade and forbidden riba.”11 Mahmood Yousefi writes: “Most Islamic scholars do not
object to profit [interest] since it is viewed as a return on capital which is subject to risk and is not
predetermined.”12 It should be noted that, while the Qur’an prohibits a fixed or predetermined rate of
return on financial assets, it does not forbid uncertain rates of return (such as profits [interest]) on
financial transactions).13 Since risk bearing is regarded as a justification for profit, Islam does permit
“mudarabah” (a type of profit sharing) and “musharakah” (partnership).14 It is acceptable to be
compensated for losses incurred, because one’s money was not available for use (the doctrine of
“damnum emergens”). Interest is the consideration or compensation payable to the financier. 15 Bank
interest is therefore regarded as different from riba and should not be seen as prohibited by the Holy
Qur’an. Interest on commercial loans does not amount to riba and is therefore permissible. It has been
argued that interest charged by banks on production loans for trade, industry, and agriculture does not
fall within the ambit of riba.16
Prohibiting interest will distort the credit market. That, in turn, will adversely affect the capital
development of the economy. If a zero interest rate was simply imposed on the market, borrowers
would act as if capital is not scarce, and lenders would not receive any pecuniary reward for providing
such capital.17 It is only the compound interest (doubled and redoubled) which is prohibited and not a
normal or simple (bank) rate of interest.18 Charging interest is to be justified by the temporary loss of
money by the lender, and a possible gain and advantage of it to the borrower.19
Khurshid Ahmad cited Henry W. Spiejel in The New Palgrave: A Dictionary of Economics (1987:769): “…in
modern parlance only exorbitant interest is considered usurious.”20 Raymond De Roover writes in his
article Economic Thought: Ancient and Medieval Thought in the International Encyclopaedia of the Social
Sciences (1968:434): “…usury is an exorbitant, oppressive interest rate…” 21 Interest is the reciprocal of
usury and is rather moderate. In other words, money transactions with a moderate rate of interest are
permissible.22 Argument in favour of interest is that it is compensation to the money lender for his risk
and sacrifice. If the borrower has taken a loan to invest in a profitable business, the lender has the pre-
emptory right to claim interest. When the borrower is earning profit on the lender’s money, why should
the lender be denied a share in the profit?23 Interest on the basis of actual productivity and profitability
of a venture is perfectly legitimate. Capital has a price, and this is to be determined in the light of its real
productivity and profitability.
11
A. Yusuf Ali ‘Commemorating the 1400th Anniversary of the Holy Quran’ (1987A.H. – 1967 CE) (2:275).
12
13
14
15
Siddiqui (1994) 17.
16
Siddiqui (1994) 19.
17
18
Siddiqui (1994) 22.
19
Siddiqui (1994) 24.
20
Khurshid Ahmad “Elimination of riba: Concept and Problems” (1994) Institute of Policy Studies 40.
21
Khurshid Ahmad (1994) 40.
22
Muhammad Iqbal Siddiqi Model of an Islamic Bank (1986) 8.
23
Siddiqi (1986) 34-5.
89
This paper has revealed an interface between interest and riba. It is alleged that riba means usury, an
exorbitant and oppressive rate of interest, the opposite of normal or simple (bank) interest. Whereas
riba relates to loans contracted by the poor and the needy persons for consumption purposes, interest
constitutes a reward on commercial, productive, and profitable loans. Interest stands for a reasonable
rate of return on capital, while riba represents an excessive, exorbitant, and exploitative rate of
interest.24 Most Islamic scholars do not object to profit, since it is viewed as a return on capital which is
subject to risk and is not predetermined.25 Profit is thus equated with moderate or bank interest.
3.0 INTERACTION BETWEEN CONVENTIONAL AND ISLAMIC BANKS

3.1 A vindication of interest
In the case of conventional banking, a bank charges the borrowers interest on their loans and pays the
depositors interest on their deposits. Both are called interest, though the former is always larger than
the latter and, in Islamic contexts, stands to be associated with riba. As indicated above, only riba is to
be prohibited and not interest. The prohibition of all forms of interest is therefore ridiculous. If there are
claims that the charging of all forms of interest be prohibited, how is a bank to meet its operational
costs?26
The purpose of borrowing is to invest in a venture and make a profit. It therefore seems reasonable for
the lender to ask for a share of what was gained. The reward (interest) is fixed in advance, and for the
safety of the capital, collateral is demanded. Charging reasonable interest is seen by many to be logical:
“…banks charge a modest rate of interest. Such loans are an indispensable business need today.” 27
Luther (1483-1546), Zwingly (1484-1531), and Sir Francis Bacon (1561-1626) advocated that interest
should be permitted. It (interest) was rendered legal and moral and has become an integral part of the
conventional economic theory. By means of practice, this theory was reinforced so that it has now
become difficult to think of any economic theory without interest as an integral part of it. Today
practically everywhere, charging and paying interest is legal, and it is acceptable in both theory and
practice.28
3.2 The conventional model: The operational costs of a bank
All forms of traditional Western financial relationships involve the payment or receipt of interest. 29 The
conventional model dictates that, when money is lent, the lender is allowed to demand that more than
his principal be returned.30 Under the conventional model, loans are given on fixed-return basis. It
means that a bank may charge a fee for its service. This is not riba, but these fees should not be made
into a source of income for the banks. The criterion for fixing the fees must be the actual expenditure
which the banks have incurred in scrutinizing the applications, making decisions, and maintaining
accounts until loans are repaid.
24
Khurshid Ahmad (1994) 38.
25
Mahmood Yousefi (1995) 68.
26
Siddiqi (1986) 28.
27
Siddiqi (1986) 28.
28
http://www.islamicbanking.nl/article4.html (5 of 24).
29
Steve Cocheo “Disinterest Banking” (2007) ABA Banking Journal 53.
30
http://www.islamicbanking.nl/article3.html (4 of 23),
90
Gafoor proposes that the interest charged by conventional banks be taken and split into six components
in order to eliminate the element of riba. The six components are: (i) interest paid to the depositor, (ii)
cost of overheads, (iii) cost of services, (iv) a risk premium, (v) profit or remuneration to the bank, and
(vi) compensation for the value loss of capital due to inflation.31
There are costs related to services, including legal and other charges paid by the bank for services such
as the evaluation of the collateral, the preparation of loan documents, postage, etc.32 This cost is specific
to the concerned loan and needs to be borne entirely by the concerned applicant. This is the actual cost
incurred by the bank and is independent of the size of the loan or the period of repayment.33 There is
thus no resemblance of it with riba.34 The overhead costs go towards the maintenance of the bank,
including staff salaries and office expenses. This cost is necessary to maintain the bank, whose services
the community, the depositors, and the borrowers need.35 It is not riba.36
Profit is viewed as legitimate remuneration for providing a service, for example carrying money from the
lender to the borrower and back, keeping the money safe, receiving and paying money to both the
depositors and the borrowers, and buying and selling services from third parties, e.g. hiring a lawyer for
title checking.37 The remuneration of the bank for arranging these services can obviously not be
regarded as riba. However, if it is computed as a percentage of the loan amount, there may be some
room for doubt. If it is computed to recover the cost of the services that the bank provide, it is
legitimate remuneration or profit and therefore not riba.38 With risk premium, instead of the banks
joining a deposit-insurance scheme, the borrowers join in a loan-default insurance scheme. This is
designed to compensate the bank in case of defaults. Delays are discouraged and early settlements are
encouraged. The premium is proportional to the size of the loan.39 No riba is involved.
With regard to the last element, the value of capital is being affected by the depreciation of the
currency. This lost must be compensated in fairness to the capital holders. This component is the
amount that needs to be paid to the capital holders (depositors) in order to restore their capital to its
original value.40 This is also not riba.
With regard to this model, two types of “low-interest” lending schemes (educational loans and housing
loans) will be examined to see if they involve riba. For example, a philanthropist who wants to help
needy students could proceed in several ways: He could hand out a certain amount to every needy
student who applies until his money is depleted. After that, he would not be able to help any more
students unless he brings in new funds. He could, in the second place, require the students to pay him
31
ALM Gafoor Participatory Financing through Investment Banks and Commercial Banks (1996) 25.
ALM Gafoor Commercial Banking in the Presence of Inflation (1999) 88.
ALM Gafoor Interest-Free Commercial Banking (1995, 2002) 3, 29, 32.
32
Gafoor (1999) 88.
33
Gafoor (1995, 2002) 4.
34
35
Gafoor (1995, 2002) 5.
36
http://www.islamicbanking.nl/article4.html (15 of 24)
37
Gafoor (1995, 2002) 4.
Gafoor (1999) 88.
38
http://www.islamicbanking.nl/article4.html (16 of 24)
39
40
91
back once they are employed. From the money thus recovered, he could help more students. This would
then require the employment of a person to disburse the funds, keep records, receive payments, etc.
Unless the philanthropist provides fresh funds every year for the upkeep of the office, the original funds
would be used for this purpose as well, and eventually the operation will shut down. In the last instance,
he could proceed as in the second case above, but also require of the students to pay for the upkeep of
the office, in addition to repaying the full amount of the loan.41 The philanthropist does not ask or
receive any monetary benefit for himself. In Islamic parlance, no riba is involved. Although there is cost
involved in borrowing, it is not riba. Rather, it is interest.
Unfortunately, Muslims take the word interest literally and equate it to riba. This paper has established
that there are several differences between interest and riba. Everything that is called interest is not
necessarily riba. Such an understanding may help Muslims to benefit from several so-called low-interest
loan schemes (which may currently be rejected out of hand) without any qualms about getting involved
in riba dealing. One such low-interest scheme is the housing loans organized by governments.
Governments will prefer to make use of the banking system. It simply deposits money with the bank,
gives specifications as to who qualifies, and leaves the rest to the bank. The government does not
require any interest on its deposits, but the bank must make sure that the original capital remains intact
by ensuring proper loan recovery. No riba is involved in this scheme, since the government does not
demand or receive any amount in addition to its capital.
These two cases involve interest and not riba.42 If a riba component is present in these two cases, it will
be illegal and morally reprehensible. This will be the case where profit rates turns out to be very high.
Riba is therefore indicative of exploitation and injustice, but in the case of interest, benefits will trickle
down to society through reduced costs and lower prices, and it will eventually help curb inflation.
After this interplay between the conventional and Islamic model, it is the aim of this paper to stress that
both models, on their own, would not be sufficient to set a paradigm for global banking. With the
integration of these models, a new paradigm for the future of global banking can, however, be set. This
new paradigm can be named riba-free (not interest-free) commercial banking.
4.0 RIBA-FREE COMMERCIAL BANKING AS A COURIER OF MONEY (A VIA MEDIA BETWEEN

CONVENTIONAL AND ISLAMIC BANKING
Like the conventional and the traditional Islamic model, the riba-free commercial banking also provides
services for a payment. It accepts deposits, guarantees their safety and full return, and provides all
current account facilities such as cash receipts, cheque collection and payment, electronic and other
types of fund transfers, etc. Depositors agree that their funds may be used to grant loans to borrowers,
and the bank guarantees the full return of their deposits. They (the depositors) do not demand nor are
they paid any financial returns on their deposits. The depositors, therefore, do not deal in riba. The
borrowers, on the other hand, are granted loans on condition that the capital, which belongs to the
depositors, is returned in full, and they pay the bank a fee for making the funds available to them. The
fee includes, as mentioned above, all the costs incurred by the bank and remuneration (interest/profit)
for providing the service. Since the owner-lender did not demand an extra amount (which would be
41
42
92
riba), the borrower does not pay any extra amount (to the owner-lender) apart from the principal
amount. Therefore this bank’s (riba-free commercial bank) lending operation is free of riba.43
The payment made by the borrower to the courier for the service is not riba (because the payment is
based on human labour, and it is unlikely that the charges will be excessive). Herewith, the traditional
perception of banks as moneylenders must be changed to that of couriers of money (the service-
delivery element = human labour). Passive participation in economic activities is therefore rejected.
Active human involvement is rather encouraged. Islam advocates the commitment to hard work through
which the accumulation of wealth is acceptable. It (Islam) recognizes that the meshing of capital with
labour will prove to be a productive source. Capital is rather idle unless labour transforms it.44 This
notion argues against the idleness of human beings in their participation in economic activities. Under
this model, financial vehicles of the traditional Islamic model, like mudarba, stand to be employed.
Through mudarba, idle capital is to be transfer to an entrepreneur and not a financier. In other words,
mudarba is a combination of capital and entrepreneurship.45 It means that, in the new riba-free
commercial model, the traditional Islamic model is to be adopted where a return, equivalent to the
amount of the zakat, must be sought.46 With regard to the traditional Islamic model, a zakat payment
can be perceived as analogous to a return-on-investment, which amounts to an interest rate of 2.5%.
Hammad argues that the zakat payment should be set off by an equivalent or by more income;
otherwise the capital sum will decline.47 This implies that interest is allowable, albeit less.
It is mainly the depositors’ money that the banks lend to borrowers. In this sense, they are the couriers
of money. As such, the riba-free commercial banking is designed as a courier of money – it is a service
provider in the field of banking and finance. In this sense, this bank’s operations are all riba-free, and the
fees it charges for its services have nothing to do with riba.
The Islamic riba-free commercial banking does, however, not adopt all of the traditional Islamic vehicles
or modes of finance, for example, qard-e-hasan loans. Unlike the traditional Islamic model, the riba-free
commercial model will not be able to write off the loans of persons who are unable to repay them and
to consider this as an act of charity. This is, in their view, a consequence of equating a bank to a
moneylender who lends his own money. The question that could be voice against qard-e-hasan is the
following: Does an entity that holds other people’s money in trust have any right to provide charity out
of it? Riba-free commercial bankers may opine that this will undermine the promise to return the full
amount to the depositors. On the question of how the shortfall may be provided for, the metaphor can
be used of a branch manager of a chain of banks who was given the authority to determine which of his
borrowers is under financially under pressure, as well as the power to write off these loans. Such
practices pose an open invitation to corruption and fraud.48 Charitable loans should therefore be left to
private individuals and charity organizations. A bank, like the riba-free commercial bank, being a courier
of other people’s money, must not become involved in charitable loans.
43
http://www.islamicbanking.nl/article3.html (7 and 8 of 23).
44
AE Hammad Islamic Banking (1989) 25-6.
45
SMH Zaman Practical Options for Central and Commercial Banking (1994) 205.
46
Hammad (1989) 26. Zakat is an imperative tax levied on Muslim’s wealth, and must be discharged by every
Muslim regardless of age or state of mind. The intention with zakat, is the abolition of the hoarding of wealth. It is
to be levy on productive assets, rather than one’s dwelling and clothing. It could be considered charity, but in
another sense it is an imperative source of funds.
47
Hammad (1989) 31.
48
93
Compatibility with conventional banking is one of the desired goals in devising a riba-free commercial
bank.49 The bank (riba-free commercial bank) is able to guarantee the depositor’s capital, have
assessable assets, and income that is sufficient to maintain the bank. This maintenance of surety of
capital will satisfy banking authorities. Herewith, the riba-free commercial bank also qualifies, like the
two other models, to be registered as a deposit-taking bank. There seems to be certain advantages of
the riba-free commercial banks under conventional laws. They are: that riba-free commercial banks will
ensure proper auditing and monitoring which inspire confidence in the bank. It (riba-free commercial
banks) will be set up in all countries of the world to be of service to the Muslim and non-Muslim. It can
also be set up in non-Muslim countries and will be able to offer conventional commercial banking
services. Unlike interest-free banks, it thus has a good chance of survival. The considerable number of
Muslims living in non-Muslim countries will enjoy the possibility to bank with a riba-free bank which is
competitive and offers all the facilities of a conventional bank. Some people will appreciate the chance
to bank without riba, provided the value erosion of their capital due to inflation is compensated and all
other banking facilities are offered. People who eschew riba for reasons other than religious belief will
also appreciate the opportunity given by this type of bank. The riba-free commercial bank will be able
easily to communicate and deal with other banks, within and outside their own country.50
5.0 CONCLUSION
Traditional Islamic banks, as they operate today, do not offer the advantages propounded by riba-free
commercial banks, even within the few Muslim countries where they are permitted to operate on their
own terms. It is worth giving some serious thought to the proposed riba-free commercial bank
advocated in this paper. In the riba-free commercial bank, interest charged by a bank is split into several
components in order to avoid riba. This innovative stratagem is rather new and can serve as a paradigm
for future global banking. According to the riba-free commercial bank, bank interest, not riba (excessive
compound interest), stands to be charged. Riba-free commercial banks must be free of the
encumbrances of charitable loans (traditional Islamic economy) on the one hand and of excessive or
compound interest (Western conventional economy) on the other hand. Some bankers fear that when
all loans are eliminated, the banking system will collapse. The paper stresses that the bank earns its
agency charges. This is its major source of income. The riba-free commercial banks perform all the
conventional banking functions on the basis of commission, service charges, or remunerations. The
question of a bank’s right to claim a share in profit or remuneration for its service (interest) is settled in
this paper.
BIBLIOGRAPHY
Ahmad K
1994. Elimination of Riba: Concept and Problems. In Elimination of Riba from the Economy. Institute of
Policy Studies. Shirkat Press: Lahore.
Ali YA
1387AH-1967CE. Commemorating the 1400th Anniversary of the Holy Qu’ran. Sartaj Company: Durban.
49
50
http://www.islamicbanking.nl/article3.html (10 and 11 of 23).
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Cocheo S
2007. Disinterested Banking. American Bankers Association. ABA Banking Journal, November.
Gafoor ALM
1996. Participatory Financing through Investment Banks and Commercial Banks. A.S. Noordeen.
Persetakar Zafar Sdn Bhd. Kuala Lumpur.
Gafoor ALM
1999. Commercial Banking in the Presence of Inflation. A.S. Noordeen. Persetakan Sdn Bhd. Kuala
Lumpur.
Gafoor ALM
1995, 2002. Interest-Free Commercial Banking. Revised Edition. A.S. Noordeen. Persetakan Sdn Bhd.
Kuala Lumpur.
Gafoor ALM
2002. Riba-free Commercial Banking. Apptec Publications: Groningin, in
http://www.islamicbanking.nl/article3.html
Gafoor ALM
2002. Interest, Usury, Riba, and the Operational Costs of a Bank, in
http://www.islamicbanking.nl/article4.html
Hammad AE
1989. Islamic Banking. Zakat and Research Foundation: Ohio.
Siddiqi MI
1986. Model of an Islamic Bank. Kazi Publications: Lahore.
Siddiqi SH
1994. Islamic Banking. Royal Book Company: Karachi.
Yousefi M et al
1995. Islamic Banking and Friedman’s Rule. Review of Social Economy, vol. liii, no. 1.
Zaman, S.M.H. 1994. Practical Options for Central and Commercial Banking. In Elimination of Riba from
the Economy. Institute of Policy Studies. Shirkat Press: Lahore
95
OKUN’S LAW IN MALAYSIA: AN AUTOREGRESSIVE DISTRIBUTED LAG (ARDL)

APPROACH WITH HODRICK-PRESCOTT (HP) FILTER
Ngoo Yee Tingi
Lecturer, Faculty of Accountancy & Management, UTAR.
ngooyt@utar.edu.my
Loi Siew Lingii

PHD candidate, Faculty of Economy and Management, University Putra Malaysia.
loisiewling@hotmail.com
ABSTRACT
Okun’s Law has present in most of the European countries. It explained the negative relationship
between output growth and unemployment rate. It has been a norm for the existence of the negative
relationship between output growth and unemployment. The impact of high unemployment rate is
direct, right after the recession or the decrease of output growth. It is therefore important to discover the
effect of the relationship because from there, we will be able to effectively determine the suitable policy.
This paper tends to examine the existence of Okun’s relationship in terms of Malaysia context using a
rather new econometric approach. The relationship is measured by applying the first difference and gap
model with Hodrick-Prescott filter (HP filter), furthered with Autogressive Distributed Lag (ARDL) to
determine the co-integration between the variables and their causality. The main reason of applying
ARDL is because of the small sample of data and it’s applicability on the order of integration, which is
regardless even if the regressors are stationary. Additional to that, the method enables us to find the
relationship between unemployment and output without determining the natural rate of output nor
natural rate of unemployment.
We found that the Okun’s coefficient is -1.825 percent which is significant at 1 percent error, indicating
that the model is 99 percent robust. This indicates that the Okun’s model is stable in the long run for
Malaysia and the bidirectional relationship is found to exist between unemployment rate and output
growth. As such, Okun’s law is useful not only to prove the negative relationship between unemployment
rate and output growth in Malaysia, but is also a robust tool to be applied in measuring their coefficient
estimations.
Field of Research: Growth & Innovation.

Keywords: Okun’s Law, Difference-gap model, HP filter, ARDL, causal relationship.
----------------------------------------------------------------------------------------------------------------------------------
1.0 INTRODUCTION
The initial Okun’s law explained the negative relationship between output growth and change in
unemployment rate. A negative output growth will cause a high rise in unemployment and vice versa.
Over the time, Okun’s law has revolved from varities of different versions to the current gap and
dynamic version. The coefficient found from the estimation will enable one country to determine the
96
extension of an effect on output growth to unemployment. The lower the coefficient level, the higher
security of the job will be when recession occurs.
The main concern of the recession is the effect of the negative growth towards unemployment in the
country. If the unemployment rate is seriously affected as the result of low output growth, people
without job and income will find difficulties to make a living. Tentatively, we would assume the
unemployment rate will increase when there is negative growth in the country. However, it is also
important to analyse and watch out if the effect of the changes in the country’s growth to the changes
of unemployment is damaging to the citizen of Malaysia and in which the appropriate policies were
needed.
Malaysia has undergone the typical negative relationship of output growth and unemployment. There is
this pattern that Malaysia faces positive effect of unemployment when the economic transformed from
agriculture sector to manufacturing sector, negative effect when there is a world wide recession or crisis
and positive again when the economy recovered from the phenomena. We observed an upward trend
of output growth from year 2000 to 2997 but the overall unemployment rate is constant at the mean of
3.45 percent. Therefore, the focus of this paper is to examine the existence of Okun’s relationship in
terms of Malaysia context as well as to find out the effect of output growth to unemployment rate. The
relationship is measured by applying the first difference and gap model with HP filter (Hodrick-Prescott
filter), furthered with ARDL (Autogressive distributed lag) to determine the cointegration between the
variables and their causal relationship and the stability of Okun’s Law in the long run.
Knotek (2007) observed three ways of finding the Okun’s Law. First, the different version of Okun’s Law
captured the changes in the unemployment rate from one quarter to the next quarter. Second, the gap
version captures unemployment to the gap between potential output and actual output, in which was
also applied by Thirlwall (1969) in calculating natural rate of output growth and the third, the dynamic
version implied the past output, current of output and past unemployment to affect the unemployment.
Last but not least, the production-function version, of which combined the theory of production
function (labour, capital and technology) with the gap version of Okun’s Law.
Amornthum (2002) classified the finding of potential output to 2 categories: statistic approach and
economic approach. The statistical approach will locate potential output by extracting the cyclical trend
from the business cycle by applying the Hodrick-Prescott (HP) filter. HP filter is commonly used to
determine the business cycle dynamics, of which is also applied by Lee (2000) in the research.
Meanwhile, the economic approach focuses more on the economic theories and the most common
method will be the production function approach where Okun (1962) was the first to estimate the
potential GNP. Petkov (2008) enhanced the method by combining both statistical and economic
approach applying HP into Autoregressive Distributed Lag Approach (ARDL). HP was applied in order to
capture the Non Accerlerating Inflation Rate of Unemployment (NAIRU). This was furthered with error
correction model (ECM) and the final finding was that although the Okun’s coefficient may changes over
time, the model continues to show strong relationship between output growth and unemployment. In
other word, this model falls into the dynamic version of measuring output suggested by Knotek.
Additional to that, Knotek also explained the dynamic relationships using the rolling regression method,
applying a sample of 13 years data for each rolling regression.
97
NAIRU measurement was also applied by Vougas (2003) to determine the natural rate unemployment at
Greece to estimate Greek unemployment using dynamic model as well. However, the NAIRU was
estimated from augmented Phillips curve with past inflation adding to with the hysteresis theory, the
previous unemployment rate to determine the natural rate of unemployment, revealing a similarity of
dynamics version.
Although Amornthum found that the Okun’s coefficient may changes over time, Lee (2000) discovered
that the coefficient changes over different countries. Lee supports the validity of Okun’s law, but not the
robustness of Okun’s law application of other OECD countries. The research applied the first difference
version and gap version, followed by HP filter, the Beveridge-Nelson decomposition procedure, and the
Kalman filter based on the NAIRU framework. Thus, the research found strong evidence of structural
change in the Okun relationship. However, when Lee expanded the model to the error-correction
framework and allowing the asymmetric effects, the relationship of the Okun’s Law is not as robust as
reported by Okun in his finding. The estimates were different from one country to another between US
and other OECD due to the sensitiveness of the choice of models, including the first-difference and the
‘gap’ specification.
Where the innovation and cyclical were concerned, Evans (1989) and Weber (1995) used a bivariate VAR
model to explain the dynamics between output and unemployment. The model was used to estimate
the innovations and the cycle trend. Besides adopting bivariate VAR, Weber (1995) also compared the
result with the other three different methods of estimation (static Ordinary Least Squared (OLS),
cointegrating regression and ARDL). Weber found that the estimates are sensitive to which method is
adopted. This is consistent with Lee’s finding on the sensitivity of the choice of the models. It is found
that the coefficient is rather sensitive to the method used to estimate cyclical output and
unemployment. The static estimates supported Okun’s original estimate but the dynamic estimation
suggested smaller value for the coefficient.
Okun’s (1962) findings pave an important background on the analysis of the relationship between
output growth and unemployment. The initial finding of Okun’s law predicts that if output were to
increase by 3 percentage point, it will reduce the unemployment rate by 1 percent. This was agreed by
Weber (1995) but he found smaller value of coefficient if dynamic specifications were applied. However,
when applied to Malaysia, Zaleha et al. (2007) found the existence of Okun’s law in Malaysia with
coefficient of -1.75, significant only at 1 percent level, indicating that decreasing a one percent of
unemployment will increase output by 1.75 percent. The insignificant finding here is also similar to Lee’s
finding of unstable Okun’s model and the model tends to vary across countries and periods. Additional
to that, two-way causality was found between unemployment and output growth in Malaysia and the
estimated full unemployment rate and normal output growth are 3.5 percent and 8.15 percent
respectively.
Thirlwall (1969) found that either neglecting the estimation of natural rate of growth over a past period
or not, will show equal result. The natural rate of growth can de derived directly from the same
regression. Thirwall commented that the labour hoarding in Okun’s law can be solved by reversing the
dependent and independent variables in the regression equation. However, this comment was criticized
by Monhollon and Cullison (1970). They argued that the least squares regression technique will have a
biased estimation. Additional to that, Okun’s Law also neglected the re-entry of discourage worker
effect in the labour hoarding element. Despite all the critics, Thirlwall’s natural rate of growth technique
98
is still considered consistent as the result was applicable for long run where the short run effect can be
avoided and this included the short term effect of labour hording and re-entry of discouraged workers.
Although Okun’s Law applies to most of the country, but according to Prachowny (1993) Okun’s law is
insufficient in the measurement on the efficiency of production. Prachowny found that labour input as
well as other factors of production especially the changes in weekly hours and capacity utilization will
have independent effects on the output gap.
In conclusion, Okun’s Law has transformed from the simply equation between unemployment and
output growth into a dynamic model and was applied in the forecast in the relationship for policy
making. Although the there are limitations in using Okun’s law, but it provides at least a basic
background of the relationship between the two variables.
3.0 THEORETICAL BACKGROUND
Arthur Okun (1962) believes the adverse relationship between output and the unemployment rate is not
a simple relationship; Okun’s law attempted to relate the change in the unemployment rate to the
deviation of the rate of output growth from the normal growth rate.
The Okun’s law specification estimation is:

u t  u t 1   ( g yt  g y ) (Eq 1)
where ut is the unemployment rate in year t , ut-1 the unemployment rate in year t-1, gyt the growth rate
of output from year t-1 to year t and gy is the normal growth rate. According to Okun, the unemployment
rate decreases about 1 percentage point for every 3 increases in real GDP. However the later research
and data have shown that the relationship between output and unemployment is not as stable as what
Okun’s law has predicted.
4.0 DESCRIPTION OF VARIABLES AND DATA ANALYSIS
ln( u t )    (ln GDPgap ) (Eq 2)
The data set used for this study is sourced from Bank Negara Malaysia’s Malaysia quarterly data from
2000 (I) to 2007(IV). The ut is the unemployment growth rate. The national income gap is the output gap
which is estimated using Hodrick-Prescott filter (HP). This approach is based on a linear filter aimed at
removing low frequency variation from a series. HP filter is also a weight parameter of which rules the
smoothness of the resulting trend line. All variables are entered in natural log form and the choice of log
formulation permits direct estimation of the elasticity.
5.0 METHODOLOGY AND ANALYSIS
The objective of this article is to employ cointegration and error-correction modelling to test the causal
relationship between unemployment rate and real national income growth rate by using quarterly data
for Malaysia from year 2000 to 2007.
99
We use a relatively new estimation technique, which is the bounds testing approach to cointegrate
within an autoregressive distributive lag (ARDL) framework, as proposed by Pesaran and others (Pesaran
and Pesaran,1997; Pesaran and Shin,1999; Pesaran et al., 2001). The main reason to employ ARDL in this
study is mainly due to the order of integration is no longer a sensitive issue, it can be applied regardless
of whether the regressors are I(0) or I(1), as normally the nature of national income is non stationary. In
addition, the bound test stressed good small sample properties in comparison to standard cointegration
analysis and without the pre conditions for stationarity. The following autoregressive distributed lag,
ARDL [p,q] model will be estimated in order to test the cointegration relationship between
unemployment rate and national income.
A three-stage procedure was followed to test the direction of causality. The starting point for testing the
long run relationship among variables is preceded by tests for the integrated order of series as only
variables integrated in I(0) and I(1) may be cointegrated. Augmented Dickey Fuller (ADF) and KPSS unit
roots were employed where the null hypothesis of ADF is a series is I(1) while null hypothesis of KPSS is a
series is I(0).
If the order of integration variables is zero or one, we can confidently apply ARLD to test the
cointegration between unemployment and national income gap. In this stage, it involves testing for the
existence of a long run equilibrium relationship between unemployment rate and national income gap
within a multivariate framework. This involves examining the existence of a long-run relationship using
the following unrestricted error-correction model (UECM):
p q
UN t     1UN t 1   2Y t 1   1 Yt i    2 UN t i  t Eq 3
i 1 i 1
ARDL approach consists first in specifying and estimating a general distributed lag model. In order to
justify retention of lagged level variables in Eq 3 which implies cointegration among them, Pesaran et al.
(2001) proposed applying the familiar F-test with new critical values that they tabulate, followed by a
joint significance test, where the null and alternative hypotheses are as below:
HO: γ1 = γ2=0,
HA: γ1 ≠ γ2 ≠0.
Two asymptotic critical value bounds provide a test for cointegration when the independent variables
are I(d) with 0 ≤ d ≤ 1. The lower bound assumes that all the repressors are I(0) , and the upper bound
assumes that they are I (1) .If the computed F-statistics is less than lower bound critical value, it does not
reject null hypothesis of no cointegration. However, if the computed F-statistics is greater than upper
bound critical value, then it rejects null hypothesis, which means that there are steady state equilibrium
between the variables in the model. This leads to pinpoint potential structural breaks and establish the
suitable significant lags in the variables.
First unit estimation shows that the growth rate of unemployment rate is stationary data, however the
national income gap variables has unit root problems at I(0) and is stationary at first difference level.
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Table 1 Result of Unit Root Test

ADF KPSS
Level Form Constant with Constant with
Constant trend Constant trend
UN -5.2174 *** -5.6665 *** 0.4049 0.1700
Y -1.9832 -2.7081 0.0457 * 0.0457 **
ADF KPSS
First Different Constant with Constant with
Constant trend Constant trend
UN -7.4842 *** -7.3856 *** 0.2165 0.206
-
Y -24.3679 *** 24.0828 *** 0.250 0.245
Notes: The asterisk indicates the following levels significance: *** 1%, **5% & * 10%.
From the Table 2, the results of ARDL bound test are shown. According to the computed F statistics, null
hypothesis of no cointegration in lag order 1, 2 and 3 are rejected at 1 percent significance. The
computed F-statistics for lag order are above the upper and bound critical value. Hence, the presence of
a long run cointegration is occurring in between the UN and its determinants are confirmed based on
the result of bounds testing. As suggested by AIC and Durbin Watson stat, lag order 1 was chosen.
Table 2: The Result of the F-test for Cointegration

Lag Order on Each First Differenced Variable
1 2 3 4
UN 22.5590*** 10.845*** 10.0381*** 5.5808
AIC -1.7518 -1.6846 -1.9754 -1.8264
Durbin Watson Stat 2.2560 1.679 2.0823 1.9127
Notes: The critical value of F-statistics for lower bound and upper bound are 5.395 and 6.350 respectively, at the
5% significance level. The critical value of F-statistics for lower bound and upper bound are 8.170 and 9.285
respectively, at the 1% significance level Sources from Pesaran et al. (2001, p. 300), Table CI(iii) Case III unrestricted
intercept and no trend. The asterisk indicates the following levels significance: * 5%, ***1%
Table 3: Result of Long Run Elasticities of Okun’s Law in Malaysia

Normalized Variable
C Y
U -0.0033 -1.8250***
The asterisk indicates the following levels significance: * 5%, ***1%
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The Okun coefficient in Table 3 also shown the immediate impact of changes in the national income gap
is negative and significant at the 1 percent level which means that 1 percent decrease in output growth
will increase unemployment rate by 1.825 percent.
Next, we construct Granger causality test augmented with a lagged error correction term where the
series are cointegated. Given the ARDL test that suggested that UN and Y are cointegrated, we augment
the Granger-type causality test with a lagged error correction term. Thus, the Granger causality test
involves specifying a multivariate VECM in lag order one.
The existence of a cointegrating relationship among UN and Y suggests that there must be Granger
causality in at least one direction, but it does not indicate the direction of causality between the
variables. Table 4 examines short run and long run Granger causality within the Error-Correction
Mechanism (ECM). The F statistics on the explanatory variables in each of the three equations indicates
the statistical significance of the short-run causal effects. In the equation when Y is the dependent
variable, the t-statistic on the coefficient of the lagged error-correction term indicates the statistical
significance of the long-run causal effect.
Table 4: Result of Granger Causality

Dependent Variable UN Y ECT
UN - 19.0550 *** -0.1166 ***
(-3.68361)
Y 26.0765 *** - 0.0509 ***
(-10.0122)
a
Notes: The Wald statistic, which test the join significance of the lagged values of the independent variables is
reported. This statistic is to be compared with F-statistics.
b
the t-statistics reported in parentheses.
The asterisks indicate the following levels of significance: * 10%, ** 5% and *** 1 %
The causality relationships between UN and Y are summarised in Table 4. From the Wald test statistics
that exceed the critical F values, implying the null hypotheses of the independent variables do not cause
the dependent variable. The ECTs in Table 4 indicated that there exists a mechanism in correcting the
disequilibrium between unemployment rate and national income. This finding, therefore, confirms the
long run Okun’s Law relationship is stable and the bi-directional causality in Okun’s equations.
6.0 CONCLUDING REMARKS
We empirically supported that for quarterly data and with the use of ARDL approach, Okun’s law applies
in Malaysia, and the Okun’s coefficient is -1.85. Likewise, VECM causality tests in the Granger sense run
in a bidirectional way between unemployment and national output.
We found that the Okun’s coefficient is -1.825 percent which is significant at 1 percent error indicating
that the model is 99% robust. This indicates that the Okun’s model is stable for Malaysia and the
bidirectional relationship is found to exist between unemployment rate and output growth and it is
stable in the long run. Okun’s law is useful not only to prove the negative relationship between
unemployment rate and output growth in Malaysia, but it is also a robust tool to be applied in
measuring their coefficient estimates.
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The findings are only consistent at the causality relationship with the findings from Zaleha (2007) and
have different coefficient as compared to theirs. This may due to our different definition of dependant
variable. In our model, we tend to investigate the change of output growth on unemployment and they
tend to investigate the change of unemployment on output growth. Additional to that, we used the gaps
method where unemployment is regressed upon output gap while Zaleha (2007) measured their model
with the JJ cointegration measure. The different findings are consistent with the discussions from Lee
and Weber that the findings are sensitive to the different choice of models.
The application of ARDL and the result from ARL with HP gap was applied here because of the small
sample of data and it’s applicability on the order of integration, regardless whether the regressors are
stationary or not. It would be useful to test on the small sample of data and ignore the stationarity of its
regressors. Petkov (2008) agreed to the work by Pesaran and Shin in their use of Autogressive
Distributed Lag Approach which allows the test for cointegration ( to determine the long run relation ) to
be done on the series that are I(0), I(1), or even I(d) where d is a non-integer. According to Petkov, this
ARDL is said to be a possible remedy when the empirical applications contain violation of theoretical
assumptions, the fractional cointegration is now one of the most active research areas in econometrics
and it helps to enhance the methods of dynamic modelling.
The possible explanation to the findings of this high coefficient of -1.85 may be due to the HP filter
which rules the smoothness of the resulting trend line and thus ignore the natural rate of
unemployment and natural rate of output. Additional to that, the job securities in Malaysia is low and
the tendency of recession to job loss is high. There is also a trend of jobs offered in contract based
rather than permanent. The need for the correct policies to counter recession is important, knowing the
effect on unemployment is rather severe. It is important for the policy makers to note the policies to
increase the protection for the low skilled workers especially those who work in the production line.
They are the high risk people who will be badly affected once economy turns bad. Incentives are
suggested for the employers to keep the low skill workers even in bad time.
The methods used and the results presented in this paper provide insights into the effects on the
unemployment rate of deviations of national output. This evidence supports the results of other authors
for different series and periods, which allows us to use it as an alternative instrument of analysis and
forecasting for the policy designing.
The limitation of this research is that our data covers only for the period from 2000 to 2007 quarterly,
not inclusive of the period during the economic crisis. The way forward for this paper is to expand the
period of the data and take the discussion deeper into analysing the shock of the economic crisis’s effect
on Okun’s Law. Thus it is also suggested to take the research deeper into the dynamics modelling or to
further the research on jobless recovery condition in Malaysia.
REFERENCES
Amornthum, Somchai, 2002, ‘Japan’s Potential Growth: An HP Filter Approach.’, University of Hawai’I at
Manoa.
Edward S. Knotek, II. 2007, ‘How useful is Okun's law?’, Economic Review. Federal Reserve Bank of
Kansas City, Fourth Quarter, 73-103.
103
Mohd Noor, Zaleha, Mohamed Nor, Norashidah and Abdul Ghani, Judhiana, 2007,
‘The Relationship Between Output And Unemployment In Malaysia: Does Okun's Law exist?’,
International Journal of Economics and Management, 13), 337-344.
Lee, Jim. 2000, ‘The Robustness of Okun’s Law: Evidence from OECD Countries’, Journal of
Macroeconomics, 22, 331-56.
Monhollon, Jimmie R. and Cullison, William E. 1970, ‘Okun’s Law and the Natural Rate of Growth:
Comment’, Southern Economic Journal, 372), 231-232.
Okun, A.M. 1962, ‘Potential GNP: Its Measurement and Significance’, Proceedings of the Business and
Economic Statistics, 98-103.
Pesaran, M.H., Shin, Yong Cheol and Smith, R. 2001, ‘Bound Testing Approaches to the Analysis of Level
Relationships’, Journal of Applied Econometrics, 16, 289-326.
Petkov, Boris. 2008, ‘The Labour Market and Output in the UK – Does Okun’s Law Still Stand?’,
Discussion Papers Bulgarian National Bank, DP/69/2008.
Prachowny, M.F.J. 1993, ‘Okun’s Law: Theorectical Foundations and Revisited Estimates’, Review of
Economics and Statistics, 752), 331-336.
Schreft, Stacey L. and Singh, Aarti. 2003, ‘A Closer Look at Jobless Recoveries’, Economic Review. Federal
Reserve Bank of Kansas City, Second Quarter, 45-73.
Thirlwall, A.P. 1969, ‘Okun’s Law and the Natural Rate of Growth’, Southern Economics Journal, 361), 87-
89.
Vougas, Dimitrios V. 2003, ‘Unemployment in Greece. Journal of Policy Modelling’, 25, 107-112.
Weber, Christian E. 1995, ‘Cyclical Output, Cyclical Unemployment, and Okun’s Coefficient: A New
Approach’, Journal of Applied Econometrics, 10, 433-445
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THE EFFECT OF OWNER’S GENDER AND AGE TO FIRM PERFORMANCE: A REVIEW

ON MALAYSIAN PUBLIC LISTED FAMILY BUSINESSES
Noor Afza Amran
College of Business,
Universiti Utara Malaysia,
Sintok, Kedah, Malaysia.
ABSTRACT
There are lack of studies that discuss the importance of owner’s gender and age with firm performance.
Thus, the objective of this study is to examine the relationship between owner’s gender and age with the
business performance, which is measured using Tobin’s Q (Q) and Earnings Per Share (EPS). This study
uses secondary data approach. The sample size is 182 Malaysian family companies listed on Bursa
Malaysia over the period of 2003 to 2007. Findings from this study show that there is a difference
between male-led and female-led companies with firm performance. Male owners are found to enhance
greater firm value than female owners, when based on the market value (Tobin’s Q). In term of owner’s
age, both the market value (Q) and accounting value (EPS) do show a negative relationship with
business performance. This explains that matured owners are found to be underperformed, while the
young owners are more aggressive in enhancing the firm value. Interestingly, the findings have shown
that factors such as owner’s gender and age do enhance company performance, especially for Malaysian
family businesses. Regulators, stakeholders and potential investors need to be alert that gender and age
plays an important role in the family company success.
Keywords: Owner, gender, age, family business, performance, Malaysia.
----------------------------------------------------------------------------------------------------------------------------------
1.0 INTRODUCTION
The issue of gender and age in the family-controlled companies is debated among the family companies.
The question that arises is that who shall be the next leader in the family company? Most companies
would prefer to select male compared to female successor. Family companies are similar to monarchies
in which the eldest son becomes the uncontested successor (Alcorn, 1982; Kuratko, 1993; Kets de Vries,
1996). Men are view as more status worthy, competent and rationale (Conway, Pizzamighio & Mount,
1996; Fiske, Cuddy, Glick & Xu, 2002). In Asian countries, Chinese family businesses prefer male to
female because the male successor will carry the family name. Moreover, male managers tend to be
more competitive, have larger networks, more supportive, tough and able to faced competition. There is
also a perception that male perform better than female. There is a strong perception that society favors
male over female (Prasso, 1996). Female, on the other hand are more nurturing, supportive in the work
environment, do not focus on the financial performance as an important element for firm survival, but
they are more likely to focus more on the primary objectives of the firm (Butner & Moore, 1997). Dumas
(1989) and Hollander and Bukowitz (1990) suggested that the father-daughter relationship is more
harmonious and different in nature. Daughters willingly assumed the role of caretakers for both of the
father and the business. They are less likely than sons to be in conflict with their fathers.
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Studies examining and comparing the performance of male-and female-owned businesses are few and
their findings are mixed (Fischer, et. al, 1993), with the majority of the studies based conducted in the
United States, Canada, and England. Experts evidence that male-led businesses perform better than
female-led (Loscocco, Robinson, Hall & Allen, 1991, Fischer, Reuber & Dyke, 1993, Shim & Eestlick, 1998,
Alowaihan, 2004). However, studies do evidence that female also perform better than male leaders
(Fahed-Sreih & Djoundourian, 2006; Cuba, Decenzo & Anish, 1983; Conway, Pizzamighio & Mount, 1996;
Fiske, Cuddy, Glick & Xu, 2002). There are also studies that claim there is no difference between male
and female-led owner with firm performance (Kalleberg & Leicht, 1991; Watson, 2002; Farrell & Hersch,
2005). In term of owner’s age, family companies found that founder’s age relate to succession
(Lansberg, 1988). Firms also prefer to have older individuals to manage the companies (Becker, 1973),
and the managerial success is higher (Brockmann & Simmonds, 1997). Young owners were claimed to be
less confidence (Smith & Amoako-Adu, 1999) and aggressive in making decision (Carlsson & Karlsson,
1970).
Based on the literatures discuss above, the issue on owner’s gender, age with firm performance have
motivated researcher to explore based on the Malaysian scenario. The objective of this study is to
examine the owner’s gender and age with firm performance. This study aims to find out the answers
whether there is any association between owner’s gender and age with business performance. In term
of the contribution, this study is expected to enrich the literatures and discussion regarding gender, age
and family business performance in Malaysia. Further, by using the Malaysian public listed companies,
so the findings may be applicable to Malaysian family businesses to ponder the importance of gender
and age issues.
The organization of this paper is structured as follows. In the introduction section, an overview on
gender and age with firm performance are discussed. This is followed by the discussion on the
motivation, objective and contribution of the study. The next part discusses the theoretical framework
and hypothesis developments. Research methodology is then explained in the next section. Next, this
paper highlights a section on results and discussions. The last section covers on the conclusion,
limitations and future research in this area.
2.0 THEORETICAL FRAMEWORK AND HYPOTHESES DEVELOPMENT
2.1 Owner’s Gender and Firm Performance
Several studies found that male-owned businesses outperformed female–owned businesses. Loscocco,
et al. (1991) found that firms owned by male outperformed firms owned by female in terms of sales
volumes and income. Research claims that female’s lack of industry experience and their concentration
in less profitable sectors of the economy contributed significantly to their lower sales and income. Not
only firm’s size generated more sales to male-controlled firms than female–controlled firms, but also
females were not able to generate as much financial benefit from size as males. These findings were
supported in a comparative study conducted by Fischer, et al. (1993).
Firms owned by male consistently outperformed those of female with respect to number of employees,
annual sales and income. This research also found that men’s businesses exhibited a higher level of
productivity than those of female in terms of sales per employee. Moreover, they found that female had
less relative business experience than male, which they suggest indicative of the barriers that women
face with respect to access to business experience (Fischer et al., 1993).
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Shim and Eestlick (1998) found that Hispanic female business owners had fewer years of business
experience, fewer employees, and smaller annual sales than their male counterparts. However, they
argue that female-owned business were as likely to achieve higher growth stage as their male
counterparts. These findings were supported by the findings of Fasci and Valdez (1998) who note
significant differences between male-owned firms and female-owned firms with respect to the ratio of
profit to gross revenue. They suggest that work experience and age of business contributed significantly
to that difference. In their sample, women had less experience and their firms were younger than those
of male, which they argued, came as a result of socialization practices, family roles, and lack of networks
or contacts. Alowaihan (2004) found that female had less business experience, higher education levels,
and were older than their male counterparts. Furthermore, the results show that female-owned firms
suffered from liability of newness and their financial performance was significantly lower than male-
owned firms.
On the other hand, a study by Fahed-Sreih and Djoundourian (2006) found that more than two-thirds of
the Lebanese firms favor female CEOs in managing the family firms. The daughter-father relationship
appears to be more mutually supportive and daughters appear to prepare more thoroughly than sons to
take the control of the family business (Hartman, 1987). Nelton (1998) states that daughters and wives
are rising to leadership positions in family firms more frequently than in the past, and that the
occurrence of daughters taking over businesses in traditionally male-dominated industries is increasing
rapidly. In contrast, there are also studies that claim female are often thought to be disadvantaged
relative to male in the business arena. It is commonly believe that female-owned businesses are less
successful and fail more often than male-owned businesses (Cuba, Decenzo, & Anish, 1983). Women are
seen as less competent in general but ‘nicer’ at communal tasks even though these tasks themselves are
less valued (Conway, Pizzamighio & Mount, 1996; Fiske, Cuddy, Glick & Xu, 2002).
There are also studies that claim there is no difference between male and female-led owner with firm
performance. Kalleberg and Leicht (1991) conduct in-depth research on how survival and success among
small firms headed by male and female, related to industry differences, organizational structures, and
attributes of owner-operators. The authors concluded that female’s firms were not more likely to fail,
nor less successful than those headed by male. These findings contradicted the long held belief of
female’s inferiority in running the businesses. Moreover, they suggested that processes underlying small
business performance headed by male were similar to those headed by female.
On the other hand, they found that firms headed by female were smaller and had lower level of gross
earnings than those headed by male. Male had more experience in terms of prior self-employment than
female. In spite of that, Kalleberg and Leicht (1991) argue that these factors had no bearing on
survivability and success of these firms. These findings were supported with study conducted by Watson
(2002) in Australia, which found no significant differences between the financial performance of male-
and female-controlled businesses in terms of total income to total assets, the return on assets, and the
return on equity, although female-owned businesses were significantly smaller and generated less profit
and income. Furthermore, he suggests that, after removal of the control variables, there was evidence
to suggest that female-controlled businesses outperformed male-controlled businesses (Watson, 2002).
There is an insignificant abnormal return on the announcement of a female added to a board.
Companies include female in the board as to respond to either internal or external calls for diversity
(Farrell & Hersch, 2005). Arguments on owner’s gender studies are inconclusive. Asian countries
including Malaysia are found to favour male owners to head the company, especially in Chinese family
companies. Also, some of family businesses in Malaysia do practice a monarchy system, whereby males
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are seen to be the leader, more powerful, strong and as a risk taker. So, based on the above arguments,
this study hypothesized that:
H1: Ceteris paribus, there is a difference in firm performance between male-led and female-led family
businesses.
2.2 Owner’s Age and Firm Performance
The measurement for firm performance such as Tobin’s Q and EPS are well-established and have been
applied in past studies in overseas by Becker (1973), Smith & Amoako-Adu (1999), and Brockmann &
Simmonds (1997).Thus based on these literatures, further study is applied in Malaysian setting to see for
any difference. Past study claims that family’s approach to succession planning is often highly related to
the founder’s age (Lansberg, 1988). It is evidence that age of the owner are important as a determinant
of succession-planning processes among male-led, but not among female-led businesses (Harveston,
Davis & Lyden, 1997). Research indicates that matured executives tend to have a stronger commitment
to the organization (Becker, 1973). The preparations for succession may be a means by which the owner
demonstrates commitment to the organization and its future, while controlling for the firm risk. As the
owner age increases, his or her awareness of the need to prepare for the inevitable transition of
ownership and control increases, and along with it, the need for succession planning. Thus, in ensuring
the succession planning to be realised, the owner’s need to ensure that companies are making profits.
Then only the family companies can be passed to the next generation.
According to Smith and Amoako-Adu (1999) in Canada, the stock market or firm performance reacts
negatively to the appointment of young family successors. This reaction shows that due to successor’s
young age, investors seem to have less confidence and it also reflects a lack of management experience
in the successors. Thus, age does affect the firm performance. Brockmann and Simmonds (1997) argue
that managerial success (firm performance) is positively correlated with age. It is argued that when the
manager is mature in age, thus the chances of firm’s managerial success is higher as compared to
younger manager. This may also be due to the level of experience that the manager’s possess. Another
study evidence that each age-level reacts to the environmental forces called "stimulus pressure" by
changing in the aggregate. Younger people change faster than older people and grab faster
opportunities, so indirectly these actions do help to increase the firm performance. While mature
people tend to be more risk averse than younger people (Carlsson & Karlsson, 1970). Based on the
arguments, it is expected that as for Malaysian family businesses, age does influence the firm value.
Most of the owners in Malaysian family businesses are senior and experience people. Further, the
influence of the founder does influence the company performance. For example, the late Tan Sri Lim
Goh Tong has a great influence on Genting Bhd. He was an experience owner, and he has led the
company for a long time. The transfer of power only took place in year 2003, to his son, Tan Sri Lim Kok
Thay. So, this study hypothesized that:
H2: Ceteris paribus, matured family owner shows a higher firm performance than young family owner.
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Based on the literature reviews discussed below, the following is the proposed theoretical framework
for this study.
Owner’s gender (H1)

Firm performance
Tobin’s Q
Owner’s age (H2) EPS
3.0 RESEARCH METHOD AND DESIGN
3.1 Sample Selection
This study utilised secondary data on the Malaysia public listed firms. The sample size used in this study
were 182 Malaysian family firms listed on Main Board and Second Board of Bursa Malaysia (excluding
banking and finance, and insurance sectors) over the period of 2003 to 2007. The family company’s data
was obtained from the annual reports, company announcements and business magazines. Meanwhile
data on gender and owner’s age, firm size, firm age, debt and industry type were gathered from annual
reports. All the data was hand collected. The financial data was gathered from the Thomson Financial
Datastream Advance. A cross-checking was done with the annual reports to make sure the reliability and
consistency of the data.
3.2 Research Model and Measurement
The research model is discussed as below.
Perfit = b0 + b1Genderit + b2Ageit +b3Fageit + b4Fsizeit +b5Debtit +b6Indit +I + it
Where:
Perf = Tobin’s Q and Earnings Per Share-EPS (tested one at a time).

Gender = Owner’s gender
Age = Owner’s age
Fage = Firm age
Fsize = Firm size
Debt = Business debt
Ind = Industries
I = Disturbances related to cross sectional specific components
it = Error term
3.3 Model Specification
The sample of this study consists of all family-controlled companies on Bursa Malaysia. The companies
are defined as family-controlled companies if they meet the following criteria: (1) Founding CEO is the
acting CEO or successor of CEO is acting CEO related by blood or marriage, (2) at least two family
members in its management, and (3) families have equity ownership (direct and indirect shareholdings)
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of minimum 20% in the company. The definition of family-controlled company is in line with the
previous studies (Villalonga & Amit, 2007; Anderson & Reeb, 2003). For the dependent variable, Tobin’s
Q (Q) is defined as market value of common equity plus book value of preferred shares and debt divided
by book value of total assets. Earnings Per Share (EPS) is defined as published earnings of ordinary
shares divided by average number of shares issued during the period.
The hypotheses variables are owner age and gender. Owner age is measure using dummy (0, 1). The
owner with the age of less than 40 years old is coded as zero and if it is more than 40 years, than it is
coded as 1. Gender explains whether the owner is male or female and it is coded using dummy (0, 1).
Male owner is coded as one, while female owner is coded as zero.
The control variables are firm age, firm size, debt and industries. Firm age is defined as the number of
years since incorporation. Firm size is measured as natural log of book value over total assets. Debt is
the book value of long-term debt by total assets. Industries is defined whether the companies involved
in consumer products, industrial products, plantation, trading services, construction, infrastructure
projects, technology, hotels, properties or mining.
4.0 RESULTS AND DISCUSSIONS
4.1 Descriptive Results
Table 1
Type of Board (from 2003 to 2007)
Frequency Percentage
Main Board 661 72.6
Second Board 249 27.4
Total 910 100.0
From Table 1, this data explains that 72.6% (661 companies) of the family-controlled companies are
from the Main Board. The remaining 27.4% (249 companies) are from the Second Board.
110
Table 2
Type of Industry in Bursa Malaysia (from 2003 to 2007)
Frequency Percentage
Consumer Product 186 20.4
Industrial Product 301 33.1
Plantation 66 7.3
Trading Services 102 11.2
Construction 95 10.4
Infrastructure Project 5 0.5
Technology 20 2.2
Hotel 10 1.1
Property 125 13.7
Total 910 100.0
Table 2 illustrates the data based on the industry types. Industrial product is the highest sector in this
sample with 33.1% (301 companies). The second place is the consumer product 20.4% (186 companies).
Then followed by the property 13.7% (125 companies), trading services 11.2% (102 companies) and
construction 10.4% (95 companies) respectively.
111
Table 3
Correlation Coefficients
other
EPS Q age gender fsize fage debt cp ip ts prop s
EPS 1
Q .133** 1
*
age -.055 -.059 1
gender .043 .010 .106*** 1
fsize .366** -.144*** -.017 .085** 1
*
fage .054 -.084** -.043 .067** .163*** 1
debt .021 -.070** .018 .000 .459*** .101*** 1
cp -.025 -.026 .059 -.037 - -.057 - 1
*** **
.212 .080
ip -.052 .074** -.008 -.037 - .036 - - 1
.158*** .076** .356***
ts -.043 -.132*** -.085** .072** .008 .052 .070** - - 1
*** ***
.180 .250
prop -.005 .049 -.038 -.099** .273*** .013 .109** - - - 1
*
.202*** .281*** .142***
others .147** .244*** .061 .072** .172*** .079** .040 - - - - 1
* .179*** .248*** .126*** .141***
Note: *** Significant at 0.001, ** significant at 0.05, * significant at 0.1
EPS is the published earnings for ordinary shares divided by average number of shares issued during the period,
Tobin’s Q is the market value of common equity plus book value of preferred shares and debt divided by book
value of total assets, gender = male or female owner, age = Owner age, Fsize = Firm size, Fage = Firm age, Debt =
Business debt, cp = consumer products, ip = industrial products, plant = plantation, ts = trading services, others =
construction, infrastructure projects, technology, hotels, properties or mining.
Table 3 presents the correlation matrix between the variables. EPS has a strong positive correlation with
firm size and other industries. Meanwhile Tobin’s Q has a negative relationship with firm size, firm age
and debt. But for industry types, Tobin’s Q shows a positive relationship with industrial product, trading
services and others. Owner’s age is strongly related positively with the gender, but negatively related
with trading services. Gender is found to be positively related with firm age, firm size, trading services
and others, but negatively related with property sector. Firm size is positively related with firm age,
debt, property and others. However, consumer product and industrial product are found to be
associated negatively. Firm age has positive direction with debt and others. Debt is negatively related
with consumer product and industrial product, but in positive direction with property. For all the
industries, there are found to be negatively related with each other. Overall, based on the Table 3, there
is no multicollinearity problem between the variables.
112
4.2 Univariate Tests
Table 4
Frequency and Mean Differences Based on Owner’s Gender
Gender N Mean Std. Deviation Std. Error Mean

EPS Female 36 .06247 .153140 .025523
Male 874 .10328 .186044 .006293
Tobin’s Q Female 36 .800025 .0794647 .0132441
Male 874 .805279 .1032482 .0034924
Note: EPS is the published earnings for ordinary shares divided by average number of shares issued during the
period, Tobin’s Q is the market value of common equity plus book value of preferred shares and debt divided by
book value of total assets.
Table 4 indicates that male owner represent about 96.04% (874 individuals) of the family companies in
Malaysia. This result explains that Malaysian family-controlled companies still favour the male to lead
the companies. This finding is in line with previous studies that claim family companies prefer son to be
the successor. It is like a monarchy system whereby the son, especially the eldest will become the
uncontested successor (Alcorn, 1982; Kuratko, 1993; Kets de Vries, 1996; Prassco, 1996). Moreover,
Asian countries like Malaysia do still abide with the culture that male is more powerful than female, and
male does dominate the business better than female.
Meanwhile, female owner only represent 4.96% (36 individual). These show that there is a small
representation of female owners in the Malaysian family market. But, it is a good starts that female does
also involved in the family companies and they are accepted to head the family businesses (Nelton,
1998; Fahed-Sreih & Djoundourian, 2006).
Table 5
Frequency and Mean Differences Based on Owner’s Age
Age N Mean Std. Deviation Std. Error Mean
EPS < 40 yrs 174 .11493 .188116 .014261
= > 40 yrs 736 .09853 .184188 .006789
Tobin’s Q < 40 yrs 174 .816159 .0857475 .0065005
= > 40 yrs 736 .802450 .1058163 .0039004
period. Tobin’s Q is the market value of common equity plus book value of preferred shares and debt divided by
book value of total assets.
Table 5 presents frequency and mean differences for owner’s age. Based on the proportion of age, it
shows that most of the owners are around the age of more than 40 years old. The number is about
80.9% or 736 owners who are considered to be matured and have more experience in managing the
business. Meanwhile younger owners’ age of less than 40 years are about 19.1% with total of 174
individuals. This result explains that matured owners are more favourable to lead the family businesses.
They have stronger commitment (Becker, 1973), risk-averse and more experience in managerial decision
113
making (Carlsson & Karlsson, 1970). The younger owners’ has captured less investors’ attention and they
are lack of experience (Smith & Amoako-Adu, 1999). However, some family companies do appoint the
young leaders to run the family businesses. It is a good step to give the young leaders exposure on how
to strategized business and be competitive in the market. The young leaders may have better ideas,
creative, more challenging and open for comments and improvements.
4.3 Multivariate Tests
Table 6
Regression Analysis of Gender, Age with EPS and Tobin’s Q
Tobin’s Q EPS
Beta t Beta t
Constant - 21.842 - -9.680
Gender (H1) .060** 1.956 -.001 -.032
Age (H2) -.092*** -3.019 -.058** -1.888
Fsize -.212*** -5.771 .478*** 12.979
Fage -.109*** -3.526 -.008 -.256
Debt .024 .692 -.182*** -5.331
Cp .253*** 5.401 .059 1.262
Ip .390*** 7.647 .016 .304
Ts .117*** 2.840 -.028 -.681
Prop .356*** 8.184 -.095** -2.183
Others .496*** 12.028 .073* 1.776
R2 .189 .184
Adj. R2 .180 .175
F-value 20.984 20.286
Sig. .000 .000
*** Significant at 0.001, ** significant at 0.05, * significant at 0.1
period, Tobin’s Q is the market value of common equity plus book value of preferred shares and debt divided by
book value of total assets, Age = Owner age, Gender = owner is male or female, Fsize = Firm size, Fage = Firm age,
Debt = Company debt, Industries = consumer products, industrial products, plantation, trading services,
construction, infrastructure projects, technology, hotels, properties or mining.
Table 6 highlights based on two performance indicators (EPS and Tobin’s Q). Gender shows a significant
positive relationship with Tobin’s Q. From these findings, male owners have shown higher company
performance than female owners. Therefore, this study supports previous studies (Loscocco et al., 1991;
Fischer et al., 1993; Shim & Eestlick, 1998) that male perform better than female. The factors that
influence the male to better manage the businesses may be due to the characteristics of the male who is
more risk taker, easy to accept comments, challenge, and rationale in decision making (Conway et al.,
1996; Fiske et al., 2002). There is evidence that H1 can be partially accepted as it is proved to be
significant for Tobin’s Q (0.060**), but not with EPS (-0.001). It shows that market-based measurement
(Tobin’s Q) is more sensitive than the accounting-based measurement (EPS) for variable gender.
The owner’s age is found to have significant negative relationship with Tobin’s Q (-0.092***) and EPS (-
0.058**). The finding is negatively than what is being hypothesized. The results explain that as the age
114
of the owner increases, the firm performance decreases. Factors such as young people change faster
and more aggressive than matured people (Carlsson & Karlsson, 1970) could justify why the results are
contradict to the hypothesis. Thus, this study does not support H 2, because matured owners do not able
to enhance the company performance. Instead, young owners have shown to influence firm value
positively.
Firm size is significant and negatively related with Tobin’s Q, but significant and positively related with
EPS. Thus, the results are not consistent for both performance indicators. Firm age is significant and
negative relationship with Tobin’s Q. Meanwhile, debt shows a significant and negative relationship with
EPS. For industries, property does show a significant negative relationship with EPS, but others do have a
significant and positive direction with Tobin’s Q.
5.0 CONCLUSION, LIMITATIONS AND FUTURE STUDY
In a nutshell, there is evidence that owner’s gender and age do affect family business performance.
There is difference in performance, when businesses are being manages by male or female owners.
Male owners are found to enhance firm performance higher than female owners. In term of owner’s
age, the findings do reveal that young owners do perform better than mature owners. The results from
this study should be seen as an incremental step in compiling knowledge on gender and age with family
company performance. To advance our knowledge in this area, future researchers might choose a
qualitative research approach or mixed method approach. Perhaps, future study may extend the sample
size to longer time horizon , consider issues specific to male and female managerial preparations and
actions in managing the family businesses.
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McGraw Hill.
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Journal of the Academy of Marketing Science, 19 (summer): 223-244.
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JOURNAL OF GLOBAL BUSINESS AND ECONOMICS

Prof. Dr. Zulganef Assoc. Prof. Dr. Hossein Ali Momeni

Assoc. Prof. Dr. Hassan Ali Dr. Haslindar Ibrahim

Assoc. Prof. Dr. Dina Rady Dr. Abdussalam Ismail Onagun

Assoc. Prof. Dr. Roderick Bugador Dr. Clare D’Souza

Dr. Daisy Kee Mui Hung Dr. Zulnaidi Yaacob

Dr. Zarina Md Nor Dr. Nek Kamal Yeop Yunus

Dr. Abdul Raheem Mohamad Yusof

ABSTARCTING AND INDEXING SERVICES

RESIDENTIAL DEMAND FOR ELECTRICITY IN DASMARINAS, CAVITE, PHILIPPINES

A STRATEGIC FRAMEWORK FOR VALUE ENHANCING ENTERPRISE RISK MANAGEMENT

A PRELIMINARY STUDY OF TOP SMEs IN MALAYSIA: KEY SUCCESS FACTOR VS

ANALYSIS OF INCOME AND EXPENDITURE OF HOUSEHOLDS IN THE EAST COAST

DO TRANSACTIONAL, TRANSFORMATIONAL AND SPIRITUAL LEADERSHIP STYLES

OKUN’S LAW IN MALAYSIA: AN AUTOREGRESSIVE DISTRIBUTED LAG (ARDL)

THE EFFECT OF OWNER’S GENDER AND AGE TO FIRM PERFORMANCE: A REVIEW

RESIDENTIAL DEMAND FOR ELECTRICITY IN DASMARINAS, CAVITE, PHILIPPINES

Alice T. Valerio, PhD

Ananias Permalino, Jr., MBA

2.0 LITERATURE REVIEW

3.0 MODEL FOR ENERGY DEMAND

Electricity demand is characterized by two important dimensions: that electricity consumption is a

4.0 HOUSEHOLD DEMAND DECISIONS FOR ELECTRICITY

where is quantity of electricity consumed by household, is the price of electricity of an

Electricity demand in equation 4 can take a linear form as

where QE is quantity of electricity consumed, p is the price of electricity, y is household income, z is

where  ' s are simply the estimated coefficients of p , y , and z variables.

where  is a vector of parameters to be estimated, xi is a vector of predictor variables, and

Equation (9) can be written as

Prob(Y1 x) =   (x' ).  1   (x' )  (11)

5.0 THE DATA

6.0 RESULTS AND DISCUSSION

6.1 Estimates of Electricity Demand

Table 1. Estimate of electricity demand model using reciprocal functional form

VARIABLE ALL REF COMP AIRCON MICROWAVE WASHMACH

Constant -228.657721*** 12.478641 -0.947973 1.714223 -1.315612 0.537762

PRICE -19739.22002** -2310.76012** 37.422081 -3.565891 354.845101 -109.931401

NTVs 14.535341*** 6.243997*** 0.898318* 1.542468** 7.361433*** 0.678231*

NFANs 1.103322 2.007461** 0.202041 1.423145*** 1.428851 0.526336**

FLRAREA 0.044435 0.012128 0.000423 0.019314 -0.024711 0.000113

NOBRMS 4.793631 0.134206 0.047781 0.159427 1.015144 0.012658

MHHNW -0.562147 -0.866431 -0.136733 0.052268 -0.451152 -0.239728

GROSSINC 0.001858*** 0.000021 0.000011 -0.000022 0.000106 -0.000006

NOHH -0.376748 -0.528063 0.047721 -0.112489 0.205945 0.113272

REFSIZE 0.636835 0.004412 0.020238 -0.046968 0.527111** 0.101312*

ECP -1.026676 0.414972 -0.046716 -0.031105 -0.209721 0.070029

R-squared 0.832763 0.225562 0.173997 0.135409 0.166642 0.080461

*** 1%; **5%; *10%

6.2 Marginal Effects

Table 2. Estimate of marginal effects of household appliances, Dasmarinas, Cavite, Philippines

VARIABLE REF COMP AIRCON MICROWAVE WASHMACH

Constant 0.0426376 51.203948 -0.184019 -0.008718 0.066791**

PRICE -32.405071 -345.206862 -552.64521** -317.70580** -30.864079*

NTVs 0.060228** -0.540803 0.249057** 0.196695** 0.056858*

NFANs 0.038801*** 0.068145 0.080081* 0.038911 0.034811**

FLRAREA 0.000001 -0.003287 -0.000701 -0.001116* -0.000603**

NOBRMS 0.002464 0.153694 0.061145 0.024211 0.043466**

MHHNW -0.012084 0.062336 0.012499 0.001548 -0.027932**

GROSSINC -0.000001 -0.000021 -0.000001 -0.000002 0.000001

NOHH -0.010607 -0.195731 -0.023501 0.015697 -0.008671

REFSIZE 0.004293 -0.075156 0.015425 0.018000** 0.007571*

ECP 0.006308 0.010230 -0.016344 -0.029166*** 0.003145

Php2000-11000 -0.026377 -0.166552 -0.078747 -0.126170 -0.049311

Php12000-50000 0.042637 0.114204 -0.187124 -0.315292*** -0.072993

PRICE -19739.22002 -2310.76012 37.422081 -3.565891 354.845101 -109.931401

NTVs 14.535341* 6.243997* 0.898318* 1.542468 7.361433* 0.678231*

NFANs 1.103322 2.007461 0.202041 1.423145* 1.428851 0.526336**

* 1%; 5%; *10%

PRICE -32.405071 -345.206862 -552.64521 -317.70580 -30.864079*

NTVs 0.060228 -0.540803 0.249057 0.196695** 0.056858*

* 1%; 5%; *10%