encyclopedia of business and finance volume 1

AND

ENCYCLOPEDIA OF

BUSINE$$FINANCE

EBF half title 9/22/00 5:01 PM Page 1

ii

EDITOR-IN-CHIEF

Burton S. KaliskiNew Hampshire College

ASSOCIATE EDITORS

Roger LuftEastern Illinois University

Dorothy MaxwellSacopee Valley High School

Jim MaxwellSan Jose State University (retired)

Mary Ellen OliverioPace University

Allen TruellBall State University

Editorial Board

AND

ENCYCLOPEDIA OF

BUSINE$$FINANCE

BURTON S. KALISKI,Editor-in-Chief

VOLUME 1

EBF V1. title page 9/22/00 5:02 PM Page 1

Encyclopedia of Business and Finance

Copyright © 2001 Macmillan Reference USA

All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means, elec-tronic or mechanical, including photocopying, recording, or by any information storage and retrieval system,without permission in writing from the Publisher.

Macmillan Reference USA Macmillan Reference USAAn imprint of the Gale Group An imprint of the Gale Group27500 Drake Rd. 1633 BroadwayFarmington Hills, MI 48331-3535 New York, NY 10019

Library of Congress Catalog Card No.: 00-107932

Printing number1 2 3 4 5 6 7 8 9 10

ISBN 0-02-865065-4 (set).—ISBN 0-02-865066-2 (v. 1).—ISBN 0-02-865067-0 (v. 2)

Printed in the United States of America by the Gale Group

Gale Group and Design is a trademark used herein under license.

v

Preface . . . . . . . . . . . . . . . . . . . vii

Acknowledgments . . . . . . . . . . . . . . ix

List of Articles . . . . . . . . . . . . . . . xii

List of Contributors . . . . . . . . . . . . xvii

Encyclopedia of Business and Finance . . . . . 1

Index . . . . . . . . . . . . . . . . . . . 899

Contents

vi

PROJECT EDITORS

Allison McClintic Marion

Brian Rabold

CONTRIBUTING PROJECT EDITOR

Nancy Matuszak

MANAGER, COMPOSITION AND ELECTRONIC PREPRESS

Mary Beth Trimper

ASSISTANT MANAGER, COMPOSITIONPURCHASING AND ELECTRONIC PREPRESS

Evi Seoud

BUYER

Stacy Melson

IMAGE DATABASE SUPERVISOR

Randy A. Bassett

IMAGING COORDINATOR

Pamela A. Reed

SENIOR IMAGING SPECIALIST

Robert Duncan

PRODUCT DESIGN MANAGER

Kenn Zorn

ART DIRECTOR

Cynthia Baldwin

DESIGNER

Mark Berger

INDEXER

Sylvia Coates

MACMILLAN REFERENCE USA

PUBLISHER

Elly Dickason

Editorial and Production Staff

vii

Business is the backbone of American society andis one of the keys to making our system work aswell as it has for more than two hundred years.Yet as a body of knowledge, business is muchyounger. There has been, to this point, no organ-ized work that has attempted to present the disci-pline of business in a single place. The majorpurpose of the Encyclopedia of Business andFinance is to summarize the body of knowledgethat we know as business in a single place and inlanguage accessible to the layperson.

This two-volume collection of more thanthree hundred entries presents a wealth of infor-mation about the major functional areas of busi-ness: accounting, economics, finance, informationsystems, law, management, and marketing. Thearticles vary in length and in depth, in biblio-graphic support, and in writing style. Thus, thereader will encounter a variety of approaches anddiscern a number of perspectives about business.Some articles are quantitative, since some aspectsof business are numerically based. Other articlestend more toward the qualitative, to accommo-date the more descriptive aspects of business.Some of the articles present a historical perspec-tive, incorporating long-proven knowledge, whileothers focus more on current concepts and newerdata. All entries have the same goal: to provideuseful knowledge about the business and financialworld.

Because of their importance, we have givenspecial treatment to two topics: careers and

ethics. In each case, a lead entry is followed by anarticle about that topic in each of the functionalareas of business. Thus, there are articles aboutcareers in accounting, economics, finance, infor-mation systems, law, management, and market-ing, as well as a similar series of articles for ethics.

There is also a strong emphasis on organiza-tions in the field of business and government.Wherever an organization is discussed, the articleprovides a Web site for further information.Relevant federal legislation is also featured in thiswork. All acts that have had a major impact onbusiness are included in the Encyclopedia.

The entries are arranged in the usual alpha-betical order, with extensive cross-referencing ofthree types. First, there are “See” references, refer-ring the reader to an entry by another name. Forexample, under Bait and Switch Advertising onefinds the line “See Advertising.” The second typeof cross-referencing is the “See Also” reference. Atthe conclusion of the article on Insurance, forexample, one reads “See Also Personal FinancialPlanning.” The third type of cross-referencing isthe Related Articles listing. At the conclusion ofmost articles, there is a list of other articles thatmay shed more light on the topic just discussed.

Is the knowledge contained in this work thedefinitive and final word on each topic? Theanswer is “most certainly not.” In this day and ageof dynamic and rapidly growing knowledge, apositive answer would be quite inappropriate.However, this is not necessarily a negative. The

Preface

PREFACE

viii ENCYCLOPEDIA OF BUSINESS AND FINANCE

information contained in this Encyclopedia isvalid and reliable and enables readers to do fur-ther research by going easily accessible sources.Today’s technological environment thus offers aunique opportunity that was not available to pre-vious generations: to extend one’s knowledge onevery topic presented.

This work was designed for different types ofusers. The middle school student may be lookingfor a starting point for a paper on careers. Thehigh school student may be seeking backgroundon a major research topic, such as the corporateform of organization. The businessperson may beseeking a summary of antitrust laws. The busi-ness teacher may be preparing a lesson on the his-tory of computers. The interested layperson maysimply want to learn about something new, suchas government accounting standards or matrixorganization.

The Encyclopedia of Business and Finance canserve as a survey document for the many aspectsof business or as a guide to those aspects. It can bethe beginning point of lengthy secondaryresearch, the background for primary research, orthe ending point for research on a specific itemcovered within its pages. It can be used to help askquestions or to find answers. It can be used as a

summary of existing knowledge or the basis foracquiring new knowledge.

A number of individuals deserve to be men-tioned for their contributions to this project.First, I must thank the five associate editors onthis project: Roger Luft, Dorothy Maxwell, JimMaxwell, Mary Ellen Oliverio, and Allen Truell.Without their tireless efforts at securing contrib-utors of quality, we would have a very small work.Second, great appreciation goes to Elly Dickason,Publisher of Macmillan Reference USA, for herinspiration in conceiving of this project and get-ting it off the ground. Third, I want to express myindebtedness to Allison Marion, Editor at theGale Group, for her professional work in keepingthis project running to its conclusion. Fourth, Imust thank all the contributors for the bestefforts that each put forth. Writing for an ency-clopedia is not a financially rewarding activity;however, it is a contribution to posterity, so whateach contributor has written is of great intangiblevalue to knowledge and to future scholars.Finally, I speak for all of the people involved inwhat has been a lengthy project when I thank ourfamilies for their encouragement and support.

BURTON S. KALISKI

ix

The editors wish to thank the copyright holdersof the excerpted criticism included in this volumeand the permissions managers of many book andmagazine publishing companies for assisting usin securing reproduction rights. We are alsograteful to the staffs of the Detroit Public Library,the Library of Congress, the University of DetroitMercy Library, Wayne State University Purdy/Kresge Library Complex, and the University ofMichigan Libraries for making their resourcesavailable to us. Following is a list of the copyrightholders who have granted us permission toreproduce material in this volume of theEncyclopedia of Business and Finance Everyeffort has been made to trace copyright, but ifomissions have been made, please let us know.

PHOTOGRAPHS AND ILLUSTRATIONSAPPEARING IN THE ENCYCLOPEDIA OFBUSINESS AND FINANCE WERE RECEIVEDFROM THE FOLLOWING SOURCES:

89th Annual Chicago Auto Show (workersput the final touches on displays), photograph.Associated Press/AP. Reproduced by permis-sion.—Ace Hardware logo (displayed outside theSt. Louis Convention Center) photograph.Associated Press/AP. Reproduced by permis-sion.—Al Lundberg (left), with Terry Brewer(center) and Al Anderson (right)(talking aboutthe tents that will be used for temporary housingfor migrant farm workers), photograph.Associated Press/AP. Reproduced by permis-

sion.—Allen, Tim, photograph. AssociatedPress/AP. Reproduced by permission.—AmericanElectric Power’s Muskingum River Plant, photo-graph. Associated Press/AP. Reproduced by per-mission.—Andreas, Michael (standing, arms atsides), Chicago, Illinois, 1998, photograph.AP/Wide World Photos. Reproduced by permis-sion. Associated Press/Ford Motor Company.—Berners-Lee, Tim, photograph. AssociatedPress/AP. Reproduced by permission.—Billboarddisplaying a Joe Camel advertisement(Vehiclespassing by), photograph. Associated Press/AP.Reproduced by permission.—Billboards alongthe Palmetto expressway, photograph. AssociatedPress/AP. Reproduced by permission.—Bush,George (center) signing the Americans withDisabilities Act, Harold Wilke (rear left), EvanKemp (left), Sandra Parrino, and Justin Dart(right), Jefferson Memorial in the background,photograph. Associated Press/AP. Reproduced bypermission.—Bush, President George (standing,center), Mexican President Carlos Salinas Gortari(left), Canadian Prime Minister Brian Mulroney(right), Julie Puche (seated, left), Carla Hills (cen-ter), and Michael Wilson (right), photograph.Bettmann/Corbis. Reproduce—Businesswomantele-commuting to her office (laptop on desk),photograph. Michael Pole/Corbis. Reproduced bypermission.—Camdessus, Michel, photograph.AFP/Corbis. Reproduced by permission.—Carlson, Chester (standing with first Xeroxcopier), photograph. Corbis-Bettmann. Repro-

Acknowledgments

ACKNOWLEDGMENTS

x ENCYCLOPEDIA OF BUSINESS AND FINANCE

duced by permission.—Chicago Cubs logo, pho-tograph. Sandy Felsenthal/Corbis. Reproduced by permission.—Clinton, William Jefferson(announcing a new equal pay initiative forwomen), photograph. Associated Press/AP.Reproduced by permission.—Clinton, WilliamJefferson (speaking at podium to America’s cor-porate leaders), photograph. Associated Press/AP.Reproduced by permission.—Construction ofthe light rail line (connecting downtownPortland with Portland International Airport),photograph. Associated Press/AP. Reproduced bypermission.—Consumer labor activists (protest-ing a meeting of the American PetroleumInstitute), photograph. Bettmann/Corbis. Repro-duced by permission.—Customers (entering aTarget store), photograph. Associated Press/AP.Reproduced by permission.—Deming, Edward,photograph. Bettmann/Corbis. Reproduced bypermission.—Demonstrators (carrying signsexpressing concern over genetically modifiedfoods), photograph. Associated Press/AP.Reproduced.—Dickman, Donald, photograph.Associated Press/AP. Reproduced by permis-sion.—Dingell, Congressmen John, photograph.Associated Press/AP. Reproduced by per-mission.—Escalante, Roberto, photograph.Associated Press/AP. Reproduced by permis-sion.—Facade of the New York Stock Exchange,photograph. Corbis Corporation. Reproduced bypermission.—Federal Reserve Building, photo-graph. Lee Snider/Corbis. Reproduced by permis-sion.—Four employees of McCellan’s IGA FamilyStore (standing in an aisle of the supermarket),photograph. Philip Gould/Corbis. Reproducedby permission.—Francis, Robert, photograph.Associated Press/AP. Reproduced by permis-sion.—Friedman, Milton, photograph. ArchivePhotos, Inc./Camera Press, Ltd. Reproduced bypermission.—Gates, Bill, photograph. AssociatedPress/AP. Reproduced by permission.—Gates,Craig, photograph. Associated Press/AP. Repro-duced by permission.—Gilbreth, Lillian Evelynand Frank Gilbreth (standing together), photo-graph. Underwood & Underwood/Corbis. Repro-duced by permission.—Greenspan, Alan,photograph. Associated Press/AP. Reproduced by

permission.—Group of inner city youths (hold-ing signs and protesting outside Nike Town store,New York), photograph. Associated Press/AP.Reproduced by permission.—Group of peoplewatching girl with hula hoop. Public Domain.—Hill, Anita (seated, testifying, wearing lightdress), Washington D.C., 1991, photograph.AP/Wide World Photos. Reproduced by per-mission.—Hollerith, Herman, photograph.Bettmann/Corbis. Reproduced by permission.—Hollerith tabulator and sorter, photograph.Hulton-Deutsch Collection/Corbis. Reproducedby permission.—IBM Personal Computer AT,photograph. Bettmann/Corbis. Reproduced bypermission.—Inslee, Jay, photograph. AssociatedPress/AP. Reproduced by permission.—Japanesebusinessman (pointing at an electronic stockboard on which most of the share prices areblinking “plus” signals), photograph. AssociatedPress/AP. Reproduced by permission.—Japaneseworker (taking inventory of Toyota trucks andminivans for export at the Yokohama port), pho-tograph. Associated Press/AP. Reproduced bypermission.—Johnson, Lyndon Baines, photo-graph. Bettmann/Corbis. Reproduced by permis-sion.—Johnson, Lyndon Baines (seated, turnedtoward the people behind him), photograph.Bettmann/Corbis. Reproduced by permission.—Kennedy, Joseph P., photograph. Bettmann/Corbis. Reproduced by permission.—Keynes,John Maynard (seated), photograph. UPI/Corbis-Bettmann. Reproduced by permission.—Man(scooping rice out of a gigantic pan), photo-graph. James Marshall/Corbis. Reproduced bypermission.—Marx, Karl, photograph. ArchivePhotos. Reproduced by permission.—Maslow,Abraham (wearing crew neck sweater overchecked shirt), photograph. UPI/Corbis Bett-mann. Reproduced by permission.—McCloy,John J. (1895-1989), photograph. Bettmann/Corbis. Reproduced by permission.—McDonald’s employees, (serving customers at ain Moscow), photograph. Associated Press.Reproduced by permission.—McGregor,Douglas, photograph. Bettmann/Corbis.Reproduced by permission.—McLuhan, Mar-shall, photograph. Bettmann/Corbis. Reproduced

ACKNOWLEDGMENTS

ENCYCLOPEDIA OF BUSINESS AND FINANCE xi

by permission.—Men in line for jobs at E.F.Keating during the Depression, photograph. TheLibrary of Congress.—Morgan, J. P., photograph.Archive Photos. Reproduced by permission.—Mundell, Robert, photograph. Reuters NewmediaInc./Corbis. Reproduced by permission.—Nader,Ralph, photograph. Associated Press/AP.Reproduced by permission.—National LaborRelations Board supervising steel workers’ voteon union representation, 1937, photograph.UPI/Corbis-Bettmann. Reproduced by permis-sion.—New York City street (crowded withChristmas shoppers and traffic, in front of Macy’sdepartment store), photograph. Bettmann/Corbis. Reproduced by permission.—Non-prescription medicine labels (shown with warn-ings printed on them before and after the newlabeling system, 1999), photograph. AssociatedPress/AP. Reproduced by permission.—Pacioli,Fra Luca, photograph. Achivo Iconografico,S.A./C. Reproduced by permission.—Pascal,Blaise, painting. The Library of Congress.—Patent certificates, photograph. Charles E.Rotkin/Corbis. Reproduced by permission.—People (seated in a circle, during the morningtrade in the Japanese markets), photograph.Associated Press/AP. Reproduced by permis-sion.—People stretching (during a corporatemanagement training session), photograph.Layne Kennedy/Corbis. Reproduced by permis-sion.—Pepsi television ad (showing a boy gettingsucked into a Pepsi bottle), photograph.Associated Press/AP. Reproduced by permis-sion.—President Roosevelt resurrecting theSherman Anti-Trust Law, political cartoon byBartholomew.—Proctor & Gamble Co. head-quarters, photograph. Associated Press/AP.Reproduced by permission.—Prodi, Romano,photograph. Associated Press/AP. Reproduced bypermission.—Raines, Franklin (standing atpodium), 1996, photograph. AP/Wide WorldPhotos. Reproduced by permission.—SafetyRecall posters, photograph. Associated Press/CPSC. Reproduced by permission.—Sakic, Joe(Colorado Avalanche center), photograph.Associated Press/AP. Reproduced by permis-sion.—Samaranch, Juan Antonio (back to cam-

era)(listening to Michael Knight during theSydney Organizing Committee for the OlympicGames by video conference, InternationalOlympic Committee headquarters), photograph.AFP/Corbis. Reproduced by permission.—Schumpeter, Joseph (seated, wearing light-col-ored suit), photograph. Corbis-Bettmann.Reproduced by permission.—Sculley, John, SteveJobs and Steve Wozniak, photograph. UPI/Corbis-Bettmann. Reproduced by permission.—Segregation sign (officer placing segregationsign), Jackson, Mississippi, 1956, photograph.AP/Wide World Photos. Reproduced by per-mission.—Socrates (marble bust), photograph.Gianni Dagli Orti/Corbis. Reproduced by per-mission.—Taylor, Frederick W. (1856-1915),photograph. Bettmann/Corbis. Reproduced bypermission.—The New York Stock Exchange(trading floor), photograph. Associated Press/AP.Reproduced by permission.—Trains in CNRailyard, photograph. Paul A. Soulder/Corbis.Reproduced by permission.—Two men workinga UNIVAC computer, photograph. Corbis-Bettmann. Reproduced by permission.—Vehiclesparked in front of a WalMart store (on Hawaii’sbig island), photograph. James Marshall/Corbis.Reproduced by permission.—Walker, James(left) and Elena Kholodenko, photograph.Associated Press/AP. Reproduced by permis-sion.—Warden, John (arriving at the federalcourt) Washington DC 1998, photograph byTyler Mallory. AP/Wide World Photos. Repro-duced by permission.—Weber, Max (wearingdark suit, greying beard, frowning), photograph.The Library of Congress.—West, Wade H., pho-tograph. Corbis. Reproduced by permission.—White, Harry Dexter, photograph. Bettmann/Corbis. Reproduced by permission.—Wilson,Woodrow, photograph. The Library ofCongress.—Woman at desk (with dictaphoneand earphones), photograph. Bettmann/Corbis.Reproduced by permission.—Women operatingmachinery (in a munitions factory, Europe, ca.1914-1918), photograph. Corbis. Reproduced bypermission.—Workers in cubicles making calls,photograph. Associated Press/AP. Reproduced bypermission.

xiii

List of Articles

ACCOUNTING

Harvey Hendrickson

ACCOUNTING CYCLE

Allie F. Miller

ACCOUNTING: HISTORICALPERSPECTIVES

Charles W. Wootton

ACCOUNTING INFORMATIONSYSTEMS

Theodore J. Mock

ACTIVITY-BASED MANAGEMENTCOSTING

Clifford Brown

ADVERTISING

Allen D. Truell

ADVERTISING AGENCIES

John Swope

AMERICAN INSTITUTE OFCERTIFIED PUBLICACCOUNTANTS

Robert Mednick

AMERICAN MANAGEMENTASSOCIATION

Nikole Pogeman

AMERICAN MARKETINGASSOCIATION

Mary Jean Lush

AMERICANS WITH DISABILITIESACT

Nikole Pogeman

ANALYTICAL PROCEDURES

Jean C. Bedard

ANTITRUST LEGISLATION

Janel Kupferschmid

ARTIFICIAL INTELLIGENCE

James Hansen

ASSURANCE SERVICES

Don Pallais

AUDIT COMMITTEES

Louis Braiotta, Jr.

AUDITING

Mohammad Abdolmohammadi

BALANCE OF TRADE

Lisa Huddlestun

BANKRUPTCY

Rosario Girasa

BEHAVIORAL SCIENCE MOVEMENT

Marcia Anderson

BENCHMARKING

Mary L. Fischer

BONDS

Allie F. Miller

BUDGETS AND BUDGETING

Roger Doost

BUREAU OF LABOR STATISTICS

Bernard H. Newman

BUSINESS CYCLE

David Bowers

BUSINESS PROFESSIONALS OFAMERICA

Jewel Hairston

CAPITAL INVESTMENTS

Douglas R. Emery

CAPITAL MARKETS

Surendra Kaushik

CAREERS IN ACCOUNTING

Bernard H. Newman

CAREERS IN ECONOMICS

Wendy Rinholen

CAREERS IN FINANCE

Mark Wilson

CAREERS IN INFORMATION

Linda J. Austing, DeborahHughes

CAREERS IN LAW FOR BUSINESS

Craig A. Bestwick

CAREERS IN MANAGEMENT

Thaddeus McEwen

CAREERS IN MARKETING

Randy L. Joyner

CAREERS OVERVIEW

Judith Chiri-Mulkey

CERTIFIED INTERNAL AUDITORS(CIA)

Charles H. Calhoun

CERTIFIED MANAGEMENTACCOUNTANT (CMA)

Kathy Williams

CERTIFIED PUBLIC ACCOUNTANT(CPA)

Anthony T. Krzystofik

LIST OF ARTICLES

xiv ENCYCLOPEDIA OF BUSINESS AND FINANCE

CHANGE PROCESS

Cheryl Noll

CHANNELS OF DISTRIBUTION

Lou E. Pelton

CHIEF FINANCIAL OFFICERS ACT

Jean E. Harris

CIRCULAR FLOW

Roger Luft

CIVIL RIGHTS ACTS

Nikole Pogeman

CLASSICS

Karen Puglisi

COLLECTIVE BARGAINING

Paula Luft

COMMUNICATION CHANNELS

Marie E. Flatley

COMMUNICATION IN BUSINESS

Sharon Lund O’Neil

COMPETITION

Marcy Satterwhite

COMPILATION AND REVIEWSERVICES

Vicky B. Hoffman

COMPUTER GRAPHICS

Walter A. Hamilton

CONSUMER ADVOCACY ANDPROTECTION

Patricia Spirou

CONSUMER AND INDUSTRIALGOODS

Earl Meyer

CONSUMER BEHAVIOR

Lauren Block

CONSUMER BILL OF RIGHTS

Mary Jean Lush

CONSUMER PRICE INDEX

Beth Haynes

CONSUMER PRODUCT SAFETY ACTOF 1972

Phyllis Bunn

CONSUMER PROTEST

Mary Jean Lush

CONTRACTS

Keith Bice

COOPERATIVE

Marcy Satterwhite

COPYRIGHTS

Randy L. Joyner

CORPORATE EDUCATION

Diane Clevesy

CORPORATION

G.W. Maxwell

COST ALLOCATION

Clifford Brown

COST-BENEFIT ANALYSIS

Mary Michel

COST-VOLUME-PROFIT ANALYSIS

G. Stevenson Smith

COSTS

Roman L. Weil

COTTAGE INDUSTRIES

Julie Watkins

CREDIT/DEBIT/TRAVEL CARDS

Burton S. Kaliski

CRIME AND FRAUD

Allen D. Truell

CURRENCY EXCHANGE

Denise Woodbury

CUSTOMER SERVICE

Barry L. Reece

DATABASES

Gary Hansen

DECA

Robert G. Berns

DECISION MAKING

Marcy Satterwhite

DEREGULATION

James Rinehart

DERIVATIVES

Patrick Casabona

DESKTOP PUBLISHING

William H. Baker

DISCOUNT STORES

Winifred Green, Earl Meyer

DIVERSITY IN THE WORKPLACE

Patrick Highland

DIVISION OF LABOR

Donna McAlister Kizzier

DOCUMENT PROCESSING

Linda J. Austin

ECONOMIC ANALYSIS

Ralph Wray

ECONOMIC CYCLES

Paula Luft

ECONOMIC DEVELOPMENT

Ellen Szarleta

ECONOMIC SYSTEMS

Denise Woodbury

ECONOMICS

Roger Luft

ECONOMICS: A HISTORICALPERSPECTIVE

Roger Luft

ELECTRONIC COMMERCE

Miklos A. Vasarhelyi

E-MAIL

Marsha Bayless

EMPLOYEE ASSISTANCE PROGRAMS

Patrick Highland

EMPLOYEE BENEFITS

Marcy Satterwhite

EMPLOYEE COMPENSATION

Lee Wonsick Lee

EMPLOYEE DISCIPLINE

Marcia Anderson

ENTREPRENEURSHIP

Robert Berns, Jewel Hairston

ENVIRONMENTAL PROTECTIONAGENCY

Mary Jean Lush

EQUAL EMPLOYMENTOPPORTUNITY ACT

Nikole Pogeman

EQUAL PAY ACT

Nikole Pogeman

ERGONOMICS

Pat Graves

ETHICS IN ACCOUNTING

Mary B. Greenawalt

ETHICS IN ECONOMICS

Roger Luft

ETHICS IN FINANCE

Anand Shetty

LIST OF ARTICLES

ENCYCLOPEDIA OF BUSINESS AND FINANCE xv

ETHICS IN INFORMATIONPROCESSING

Annette Vincent

ETHICS IN LAW FOR BUSINESS

Carson Varner

ETHICS IN MANAGEMENT

Thomas Haynes

ETHICS IN MARKETING

John Swope

ETHICS OVERVIEW

Keith Goree

EUROPEAN UNION

David McGrady

FACSIMILE REPRODUCTION

Dorothy Maxwell

FACTORS OF PRODUCTION

Michael Brun

FADS

Jennifer Jenness

FAIR PACKAGING AND LABELINGACT OF 1966

Phyllis Bunn

FEDERAL RESERVE SYSTEM

Melvin Morgenstein

FEDERAL TRADE COMMISSION ACTOF 1914

Phyllis Bunn

FINANCE

Surendra Kaushik

FINANCE: HISTORICALPERSPECTIVES

Mary Ellen Oliverio

FINANCIAL ACCOUNTINGSTANDARDS BOARD

Dennis R. Beresford

FINANCIAL FORECASTS ANDPROJECTIONS

Bernard H. Newman

FINANCIAL INSTITUTIONS

Surendra Kaushik

FINANCIAL STATEMENT ANALYSIS

Mary B. Greenawalt

FINANCIAL STATEMENTS

Victoria Shoaf

FISCAL POLICY

David McGrady

FOOD AND DRUGADMINISTRATION

Mary Jean Lush

FOOD, DRUG, AND COSMETIC ACT

Phyllis Bunn

FORECASTING IN BUSINESS

Roger Luft

FOREIGN CORRUPT PRACTICES ACTOF 1977

Charles H. Calhoun

FRAUDULENT FINANCIALREPORTING

Gerard A. Lange

FUTURE BUSINESS LEADERS OFAMERICA

Jill White

GENERALLY ACCEPTEDACCOUNTING PRINCIPLES

Edmund L. Jenkins

GLOBAL ECONOMY

Norman Wright

GOODS AND SERVICES

Earl Meyer

GOVERNMENT ACCOUNTING

Mary L. Fischer

GOVERNMENT ACCOUNTINGSTANDARDS BOARD

Jesse Hughes

GOVERNMENT AUDITINGSTANDARDS

Bernard H. Newman

GOVERNMENT FINANCIALREPORTING

Robert J. Muretta, Jr.

GOVERNMENT ROLE IN BUSINESS

Allen D. Truell

GROSS DOMESTIC PRODUCT

Gregory Valentine

HARDWARE

Armand Sequin

HEALTH ISSUES IN BUSINESS

Brenda Reinsborough

HUMAN RELATIONS

Patrick Highland

HUMAN RESOURCE MANAGEMENT

Christine Jahn

INCOME TAX, HISTORY OF

Jean E. Harris

INDEPENDENCE STANDARDSBOARD

C. Richard Baker

INFORMATION PROCESSING

Mary Alice Griffin

INFORMATION PROCESSING:HISTORICAL PERSPECTIVES

James Miles

INFORMATION SYSTEMS

Theo B. A. Addo

INFORMATION TECHNOLOGY

Linda J. Austin

INSTITUTE FOR INTERNALAUDITORS

Steven E. Jameson

INSTITUTE OF MANAGEMENTACCOUNTANTS

Kathy Williams

INSURANCE

Edward J. Keller, Jr.

INTEGRATED SOFTWARE

Judith Chiri-Mulkey

INTERACTIVE TECHNOLOGIES

Philip D. Taylor

INTEREST RATE(S)

Henry H. Davis

INTERNAL CONTROL SYSTEMS

Audrey A. Gramling

INTERNATIONAL ACCOUNTINGSTANDARDS

Mahendra R. Gujarathi

INTERNATIONAL FEDERATION OFACCOUNTANTS

Frederick D. S. Choi

INTERNATIONAL INVESTMENT

Masaaki Kotabe

INTERNATIONAL MONETARY FUND

Bernard H. Newman

INTERNATIONAL TRADE

Allen D. Truell

INTERNET

Lloyd Bartholome

INTERSTATE COMMERCE

Patricia Spirou

LIST OF ARTICLES

xvi ENCYCLOPEDIA OF BUSINESS AND FINANCE

INTERSTATE COMMERCECOMMISSION

Mary Jean Lush

INTRANET

Armand Sequin

INVENTORY CONTROL

Mark Lefebvre

JOB ANALYSIS AND DESIGN

Richard Bortz

JOB ENRICHMENT

Marcy Satterwhite

JOB SATISFACTION

Beryl McEwen

LABOR UNIONS

Paula Luft

LAW IN BUSINESS

Carson Varner

LEADERSHIP

Lee Wonsick Lee

LIFESTYLES

Michelle Voto

LISTENING SKILLS IN BUSINESS

Jan Hargrave

MACROECONOMICS/MICROECONOMICS

Lisa Huddleston

MANAGEMENT

Roger Luft

MANAGEMENT INFORMATIONSYSTEMS

Lloyd Bartholome

MANAGEMENT/LEADERSHIP STYLES

Thomas Haynes

MANAGEMENT: AUTHORITY ANDRESPONSIBILITY

Cheryl Noll

MANAGEMENT: HISTORICALPERSPECTIVES

Roger Luft

MANUFACTURING

Thomas Haynes

MARKETING

Allen D. Truell

MARKETING CONCEPT

Earl Meyer

MARKETING: HISTORICALPERSPECTIVES

James E. Stoddard

MARKETING MIX

Allen D. Truell

MARKET RESEARCH

Christine Latino

MARKET SEGMENTATION

Earl Meyer

MASS MARKETING

Earl Meyer

MEETING MANAGEMENT

Brenda Reinsborough

MONETARY POLICY

Edward Hsieh

MONEY SUPPLY

Hassan Mohammadi

MONOPOLY

Michael Spahr

MOTIVATION

Pat Graves

MULTIMEDIA SYSTEMS

George Mundrake

MUTUAL FUNDS

Anand Shetty

NATIONAL ASSOCIATION OF STATEBOARDS OF ACCOUNTANCY

Louise Dratler Haberman

NATIONAL BUSINESS EDUCATIONASSOCIATION

G.W. Maxwell

NATIONAL LABOR RELATIONSBOARD

Tod Rejholec

NATIONAL RETAIL FEDERATION

Mary Jean Lush

NATIONAL TRANSPORTATIONSAFETY BOARD

Mary Jean Lush

NEGOTIATION

Donna McAlister Kizzier

NETWORKING

Dennis LaBonty

NORTH AMERICAN INDUSTRYCLASSIFICATION SYSTEM

Mary Michel

NOT-FOR-PROFIT ACCOUNTING

G. Stevenson Smith

OCCUPATIONAL SAFETY ANDHEALTH ADMINISTRATION

Mary Jean Lush

OFFICE TECHNOLOGY

Linda J. Austin

OFFICE TECHNOLOGY: HISTORICALPERSPECTIVES

B. June Schmidt

OLIGOPOLY

Rajeev K. Goel

OPERATIONS MANAGEMENT

Janel Kupferschmid

OPPORTUNITY COST

Denise Woodbury

ORGANIZATIONAL BEHAVIOR ANDDEVELOPMENT

Cheryl Noll

ORGANIZATIONAL STRUCTURE

Christine Jahn

OUTSOURCING

Carolyn Ashe

PARTNERSHIP

Keith Bice

PATENTS

Randy L. Joyner

PERFORMANCE APPRAISAL

Lee Wonsick Lee

PERFORMANCE AUDITS

Douglas E. Ziegenfuss

PERSONAL FINANCIAL PLANNING

Joel Lerner

POLICY DEVELOPMENT

Marie Flatley

PRICE FIXING

Patricia Spirou

PRICING

Allen D. Truell

PRIVACY AND SECURITY

Lisa E. Gueldenzoph

PRODUCT LABELING

Michael Milbier

PRODUCT LINES

Michael Milbier

LIST OF ARTICLES

ENCYCLOPEDIA OF BUSINESS AND FINANCE xvii

PRODUCT MIX

Michael Milbier

PROFESSIONAL EDUCATION

Connie Anderson

PROGRAMMING

Theo B. A. Addo

PROMOTION

Allen D. Truell

PUBLICITY

Jennifer Jennes

PUBLIC OVERSIGHT BOARD

Nashwa George

QUALITY MANAGEMENT

Roger Luft

READING SKILLS IN BUSINESS

B. June Schmidt

RECORDS MANAGEMENT

Carolyn Ashe

RETAILERS

Patricia Spirou

ROBINSON-PATMAN ACT OF 1936

Phyllis Bunn

SCHOOL TO CAREER MOVEMENT

Winnifred Bolinsky

SCIENTIFIC MANAGEMENT

Marcia Anderson

SECURITIES ACTS: REQUIREMENTSFOR ACCOUNTING

Samir B. Fahmy

SECURITIES AND EXCHANGECOMMISSION

Mary Jean Lush

SERVICE INDUSTRIES

Alan G. Krabbenhoft

SEXUAL HARASSMENT

Clarice Brantley

SHERMAN ANTITRUST ACT OF 1890

Phyllis Bunn

SHOPPING

Audrey Langill

SINGLE-AUDIT ACT

Margaret Hicks

SMALL BUSINESS ADMINISTRATION

Mary Jean Lush

SOCIAL RESPONSIBILITY

Thomas Haynes

SOFTWARE

Wanda Samson

SOLE PROPRIETORSHIP

G.W. Maxwell

SPEAKING SKILLS IN BUSINESS

Jan Hargrave

SPREADSHEETS

Betty Brown

STAGGERS RAIL AND MOTORCARRIER ACTS OF 1980

Phyllis Bunn

STANDARDS-BASED WORKPERFORMANCE

James Miles

STANDARD COSTING

Bernard H. Newman

STANDARD METROPOLITANSTATISTICAL AREAS

Mary Jean Lush

STATEMENTS ON MANAGEMENTACCOUNTING

B. Douglas Clinton

STATE SOCIETIES OF CPAS

Kathleen A. Simons

STOCK EXCHANGES

Ian Domowitz

STOCK INDEXES

Joel Lerner

STOCKS

Joel Lerner

STRATEGIC MANAGEMENT

Norman Wright

STRESS, WORK-RELATED

Jim Rucker

SUPPLY AND DEMAND

John Conant

TARGET MARKETING

Tatum Turner

TAXATION

Jeffrey Jacobs

TELECOMMUNICATION

Mary Alice Griffin, Susan EvanaJennings

TELECOMMUTING

Carol Jones

TELEMARKETING

Earl Meyer

TELEPHONE SKILLS

Dorothy Maxwell

TEMPORARY EMPLOYMENT

Dorothy Maxwell

TIME MANAGEMENT

Carrie Foley

TIME VALUE OF MONEY

Roman L. Weil

TRADEMARKS

Randy L. Joyner

TRADE SHOWS

Earl Meyer

TRADING BLOCS

Masaaki Kotabe

TRAINING AND DEVELOPMENT

David Hyslop

TRANSFER PAYMENTS

Michael Nelson

UNIFORM CERTIFIED PUBLICACCOUNTANT EXAMINATION

Anthony T. Krzystofik

UNITED STATES GENERALACCOUNTING OFFICE

Jean E. Harris

VIDEOCONFERENCING

James Miles

VOICE MESSAGING

Christine Irvine

WHOLESALING

Patricia Spirou

WORD PROCESSING

William H. Baker

WORK GROUPS

Tena B. Crews

WORK MEASUREMENT

Nashwa George

WRITING SKILLS IN BUSINESS

G.W. Maxwell

xix

Mohammad AbdolmohammadiBentley College

AUDITING

Theo B. A. AddoSan Diego State University

INFORMATION SYSTEMSPROGRAMMING

Connie AndersonUniversity of Nebraska

PROFESSIONAL EDUCATION

Marcia AndersonSouthern Illinois University,

CarbondaleBEHAVIORAL SCIENCE

MOVEMENTEMPLOYEE DISCIPLINESCIENTIFIC MANAGEMENT

Carolyn AsheUniversity of Houston

OUTSOURCINGRECORDS MANAGEMENT

Linda J. AustinTomball, Texas

CAREERS IN INFORMATIONPROCESSING

DOCUMENT PROCESSINGOFFICE TECHNOLOGY

C. Richard BakerUniversity of Massachusetts,

DartmouthINDEPENDENCE STANDARDS

BOARD

William H. BakerBrigham Young University,

ProvoDESKTOP PUBLISHINGWORD PROCESSING

Lloyd BartholomeUtah State University, Logan

INTERNETMANAGEMENT INFORMATION

SYSTEMS

Marsha BaylessStephen A. Austin State

UniversityE-MAIL

Jean C. BedardNortheastern University


Dennis R. BeresfordUniversity of Georgia


Robert G. BernsBowling Green State University

DECAENTREPRENEURSHIP

Craig A. BestwickSan Francisco, California

CAREERS IN LAW FORBUSINESS

Keith BiceIndianapolis, Indiana

CONTRACTSPARTNERSHIP

Lauren BlockNew York, New York

CONSUMER BEHAVIOR

Winnifred BolinskyAllentown, Pennsylvania

SCHOOL TO CAREERMOVEMENT

Richard BortzSouthern Illinois University,

CarbondaleJOB ANALYSIS AND DESIGN

David BowersCase Western Reserve

UniversityBUSINESS CYCLE

Louis Braiotta, Jr.SUNY, Binghamton

AUDIT COMMITTEES

Clarice BrantleyPensacola, Florida

SEXUAL HARASSMENT

Clifford BrownBentley College

ACTIVITY-BASEDMANAGEMENT COSTING

COST ALLOCATION

Michael BrunIllinois State University


Phyllis BunnDelta State University

CONSUMER PRODUCT SAFETYACT OF 1972

List of Contributors

LIST OF CONTRIBUTORS

xx ENCYCLOPEDIA OF BUSINESS AND FINANCE

FAIR PACKAGING ANDLABELING ACT OF 1966

FEDERAL TRADE COMMISSIONACT OF 1914

FOOD, DRUG, AND COSMETICACT

ROBINSON-PATMAN ACT OF1936

SHERMAN ANTITRUST ACT OF1890

STAGGERS RAIL AND MOTORCARRIER ACTS OF 1980

Charles H. CalhounWestport, Connecticut

CERTIFIED INTERNALAUDITORS (CIA)

FOREIGN CORRUPT PRACTICESACT OF 1977

Patrick CasabonaSt. John’s University

DERIVATIVES

Judith Chiri-MulkeyColorado Springs, Colorado

CAREERS OVERVIEWINTEGRATED SOFTWARE

Frederick D. S. ChoiNew York University

INTERNATIONAL FEDERATIONOF ACCOUNTANTS

Diane ClevesyBradford, Massachusetts

CORPORATE EDUCATION

B. Douglas ClintonCentral Missouri State

UniversitySTATEMENTS ON

MANAGEMENT ACCOUNTING

John ConantIndiana State University

SUPPLY AND DEMAND

Tena B. CrewsState University of West

GeorgiaWORK GROUPS

Henry H. DavisEastern Illinois University

INTEREST RATE(S)

Ian DomowitzPennsylvania State University

STOCK EXCHANGES

Roger DoostClemson University


Douglas R. EmeryUniversity of Miami, Coral

GablesCAPITAL INVESTMENTS

Samir B. FahmySt. John’s University

SECURITIES ACTS:REQUIREMENTS FORACCOUNTING

Mary L. FischerUniversity of Texas, Tyler

BENCHMARKINGGOVERNMENT ACCOUNTING

Marie FlatleyDel Mar, California

COMMUNICATIONSCHANNELS

POLICY DEVELOPMENT

Carrie FoleyWest Baldwin, Maine

TIME MANAGEMENT

Nashwa GeorgeJersey City, New Jersey

PUBLIC OVERSIGHT BOARDWORK MEASUREMENT

Rosario GirasaPace University

BANKRUPTCY

Rajeev K. GoelIllinois State University

OLIGOPOLY

Keith GoreeSt. Petersburg, Florida

ETHICS OVERVIEW

Audrey A. GramlingWake Forest University

INTERNAL CONTROL SYSTEMS

Pat GravesEastern Illinois University

ERGONOMICSMOTIVATION

Mary B. GreenawaltThe Citadel

ETHICS IN ACCOUNTINGFINANCIAL STATEMENT

ANALYSIS

Mary Alice GriffinValdosta State University

INFORMATION PROCESSINGTELECOMMUNICATIONS

Lisa E. GueldenzophBowling Green State University

PRIVACY AND SECURITY

Mahendra R. GujarathiBentley College

INTERNATIONAL ACCOUNTINGSTANDARDS

Louise Dratler HabermanNew York, New York

NATIONAL ASSOCIATION OFSTATE BOARDS OFACCOUNTANCY

Jewel HairstonBowling Green State University

BUSINESS PROFESSIONALS OFAMERICA

ENTREPRENEURSHIP

Walter A. HamiltonSouth Hadley, Massachusetts

COMPUTER GRAPHICS

Gary HansenBrigham Young University,

ProvoDATABASES

James HansenBrigham Young University,

ProvoARTIFICIAL INTELLIGENCE

Jan HargraveHouston, Texas

LISTENING SKILLS IN BUSINESSSPEAKING SKILLS IN BUSINESS

Jean E. HarrisPennsylvania State University,

HarrisburgCHIEF FINANCIAL OFFICERS

ACTINCOME TAX, HISTORY OFUNITED STATES GENERAL

ACCOUNTING OFFICE

Beth HaynesBrigham Young University,

HawaiiCONSUMER PRICE INDEX

Thomas HaynesIllinois State University


ENCYCLOPEDIA OF BUSINESS AND FINANCE xxi

ETHICS IN MANAGEMENTMANAGEMENT/LEADERSHIP

STYLESMANUFACTURINGSOCIAL RESPONSIBILITY

Harvey HendricksonFlorida International University

ACCOUNTING

Margaret HicksHoward University

SINGLE-AUDIT ACT

Patrick HighlandIowa City, Iowa

DIVERSITY IN THEWORKPLACE

EMPLOYEE ASSISTANCEPROGRAMS

HUMAN RELATIONS

Vicky B. HoffmanUniversity of Pittsburgh

COMPILATION AND REVIEWSERVICES

Edward HsiehCalifornia State University, Los

AngelesMONETARY POLICY

Lisa HuddlestunGreenup, Illinois

BALANCE OF TRADEMACROECONOMICS/MICROEC

ONOMICS

Jesse HughesKingwood, Texas

GOVERNMENT ACCOUNTINGSTANDARDS BOARD

David HyslopBowling Green State University


Christine IrvineNagodoches, Texas

VOICE MESSAGING

Jeffrey JacobsQuinnipiac College

TAXATION

Christine JahnSpringfield, Illinois

HUMAN RESOURCEMANAGEMENT

ORGANIZATIONAL STRUCTURE

Steven E. JamesonNorwalk, Connecicut

INSTITUTE FOR INTERNALAUDITORS

Edmund L. JenkinsNorwalk, Connecticut


Jennifer JennesHooksett, New Hampshire

FADSPUBLICITY

Carol JonesCalifornia State Polytechnic

UniversityTELECOMMUTING

Randy L. JoynerGreenville, North Carolina

CAREERS IN MARKETINGCOPYRIGHTSPATENTSRESEARCH IN BUSINESSTRADEMARKS

Burton S. KaliskiNew Hampshire College


Surendra KaushikPace Univeristy

CAPITAL MARKETSFINANCIAL INSTITUTIONS

Edward J. Keller, Jr.Franklin Square, New York

INSURANCE

Donna McAlister KizzierUniversity of Nebraska, Lincoln

DIVISION OF LABORNEGOTIATION

Masaaki KotabeBlue Bell, Pennsylvania

INTERNATIONAL INVESTMENTTRADING BLOCS

Alan G. KrabbenhoftRoosevelt University

SERVICE INDUSTRIES

Anthony T. KrzystofikHadley, Massachusetts

CERTIFIED PUBLICACCOUNTANT (CPA)

UNIFORM CERTIFIED PUBLICACCOUNTANT EXAMINATION

Janel KupferschmidBloomington, Illinois

ANTITRUST LEGISLATIONOPERATIONS MANAGEMENT

Gerard A. LangeSt. John’s University


Audrey LangillDerry, New Hampshire

SHOPPING

Christine LatinoAtkinson, Connecticut

MARKET RESEARCH

Lee Wonsick LeeNewington, Connecticut

EMPLOYEE COMPENSATIONLEADERSHIPPERFORMANCE APPRAISAL

Mark LefebvreBow, New Hampshire

INVENTORY CONTROL

Joel LernerSullivan County Community

CollegePERSONAL FINANCIAL

PLANNINGSTOCK INDEXESSTOCKS

Paula LuftDahinda, Illinois

COLLECTIVE BARGAININGECONOMIC CYCLESLABOR UNIONS

Roger LuftDahinda, Illinois

CIRCULAR FLOWECONOMICSECONOMICS: A HISTORICAL

PERSPECTIVEETHICS IN ECONOMICSFORECASTING IN BUSINESSMANAGEMENTMANAGEMENT: HISTORICAL

PERSPECTIVESQUALITY MANAGEMENT

Mary Jean LushDelta State University


CONSUMER BILL OF RIGHTSDEMOGRAPHICS


xxii ENCYCLOPEDIA OF BUSINESS AND FINANCE

ENVIRONMENTALPROTECTION AGENCY


INTERSTATE COMMERCECOMMISSION

NATIONAL RETAILFEDERATION

NATIONAL TRANSPORTATIONSAFETY BOARD

OCCUPATIONAL SAFETY ANDHEALTH ADMINISTRATION

SECURITIES AND EXCHANGECOMMISSION

SMALL BUSINESSADMINISTRATION

STANDARD METROPOLITANSTATISTICAL AREAS

Dorothy MaxwellCornish, Maine

FACSIMILE REPRODUCTIONTELEPHONE SKILLSTEMPORARY EMPLOYMENT

G.W. MaxwellCornish, Maine

CORPORATIONNATIONAL BUSINESS

EDUCATION ASSOCIATIONSOLE PROPRIETORSHIPWRITING SKILLS IN BUSINESS

Beryl McEwenGreensburough, North Carolina

JOB SATISFACTION

Thaddeus McEwenGreensburough, North Carolina


David McGradyEastern Illinois University

EUROPEAN UNIONFISCAL POLICY

Robert MednickChicago, Illinois

AMERICAN INSTITUTE OFCERTIFIED PUBLICACCOUNTANTS

Earl MeyerLutz, Florida

CONSUMER AND INDUSTRIALGOODS

DISCOUNT STORESGOODS AND SERVICESMARKET SEGMENTATIONMARKETING CONCEPTMASS MARKETINGTELEMARKETINGTRADE SHOWS

Mary MichelManhattan College

COST-BENEFIT ANALYSISNORTH AMERICAN INDUSTRY

CLASSIFICATION SYSTEM

Michael MilbierSt. Louis, Missouri

PRODUCT LABELINGPRODUCT LINESPRODUCT MIX

James MilesPittsford, New York

INFORMATION PROCESSING:HISTORICAL PERSPECTIVES

STANDARDS-BASED WORKPERFORMANCE

VIDEOCONFERENCING

Allie F. MillerDrexel University

ACCOUNTING CYCLEBONDS

Theodore J. MockUniversity of Southern

CaliforniaACCOUNTING INFORMATION

SYSTEMS

Hassan MohammadiIllinois State University

MONEY SUPPLY

Melvin MorgensteinPlainview, New York


George MundrakeBall State University

MULTIMEDIA SYSTEMS

Robert J. Muretta, Jr.Westbook, Maine


Michael NelsonIllinois State University

TRANSFER PAYMENTS

Bernard H. NewmanPace University

BUREAU OF LABOR STATISTICSCAREERS IN ACCOUNTINGFINANCIAL FORECASTS AND

PROJECTIONSGOVERNMENT AUDITING

STANDARDSINTERNATIONAL MONETARY

FUND

STANDARD COSTING

Cheryl NollEastern Illinois University

CHANGE PROCESSMANAGEMENT: AUTHORITY

AND RESPONSIBILITYORGANIZATIONAL BEHAVIOR

AND DEVELOPMENT

Mary Ellen OliverioPace University


Sharon Lund O’NeilHouston, Texas

COMMUNICATION INBUSINESS

Don PallaisRichmond, Virginia

ASSURANCE SERVICES

Lou E. PeltonUniversity of North Texas


Nikole PogemanBartonvill, Illinois


AMERICANS WITHDISABILITIES ACT

CIVIL RIGHTS ACTSEQUAL EMPLOYMENT

OPPORTUNITY ACTEQUAL PAY ACT

Karen PuglisiHooksett, New Hampshire

CLASSICS

Zane QuibleOklahoma State University

OFFICE LAYOUT

Barry L. ReecePittsboro, North Carolina

CUSTOMER SERVICE

Brenda ReinsboroughYarmouth, Maine

HEALTH ISSUES IN BUSINESSMEETING MANAGEMENT

Tod RejholecBridgeport, Illinois

NATIONAL LABOR RELATIONSBOARD


ENCYCLOPEDIA OF BUSINESS AND FINANCE xxiii

James RinehartFrancis Marion University

DEREGULATION

Wendy RinholenGalva, Illinois


Jim RuckerFort Hays State University

STRESS, WORK-RELATED

Wanda SamsonFremont, Nebraska

SOFTWARE

Marcy SatterwhiteCharleston, Illinois

COMPETITIONCOOPERATIVEDECISION MAKINGEMPLOYEE BENEFITSJOB ENRICHMENT

B. June SchmidtVirginia Polytechnic Institute

and State UniversityOFFICE TECHNOLOGY:

HISTORICAL PERSPECTIVESREADING SKILLS IN BUSINESS

Armand SequinEmporia State University

HARDWAREINTRANET

Anand ShettyIona College

ETHICS IN FINANCEMUTUAL FUNDS

Victoria ShoafSt. John’s University


Kathleen A. SimonsBryant College

STATE SOCIETIES OF CPAS

G. Stevenson SmithWest Virginia University

COST-VOLUME-PROFITANALYSIS

NOT-FOR-PROFITACCOUNTING

Michael SpahrNashua, New Hampshire

MONOPOLY

Patricia SpirouManchester, New Hampshire

CONSUMER ADVOCACY ANDPROTECTION

FRANCHISESINTERSTATE COMMERCEPRICE FIXINGRETAILERSWHOLESALING

James E. StoddardAppalachian State University

MARKETING: HISTORICALPERSPECTIVES

John SwopeEast Carolina University

ADVERTISING AGENCIESETHICS IN MARKETING

Ellen SzarletaIndiana University, Northwest


Philip D. TaylorWesleyan College

INTERACTIVE TECHNOLOGIES

Allen D. TruellUniversity of Missouri,

ColumbiaADVERTISINGCRIME AND FRAUDGOVERNMENT ROLE IN

BUSINESSINTERNATIONAL TRADEMARKETINGMARKETING MIXPRICINGPROMOTION

Tatum TurnerManchester, New Hampshire

TARGET MARKETING

Gregory ValentineUniversity of Southern Indiana

GROSS DOMESTIC PRODUCTINCOME

Carson VarnerIllinois State University

ETHICS IN LAW FOR BUSINESSLAW IN BUSINESS

Miklos A. VasarhelyiRutgers University, Newark

ELECTRONIC COMMERCE

Annette VincentUniversity of Southwestern

LouisianaETHICS IN INFORMATION

PROCESSING

Michelle VotoLondonberry, New Hampshire

LIFESTYLES

Julie WatkinsBrownfield, Maine

COTTAGE INDUSTRIES

Roman L. WeilUniversity of Chicago

TIME VALUE OF MONEY

Jill WhitePensacola, Florida

FUTURE BUSINESS LEADERS OFAMERICA

Kathy WilliamsMontvale, New Jersey

CERTIFIED MANAGEMENTACCOUNTANT (CMA)

INSTITUTE OF MANAGEMENTACCOUNTANTS

Mark WilsonColumbus, Ohio

CAREERS IN FINANCE

Denise WoodburyBrigham Young University,

HawaiiCURRENCY EXCHANGEECONOMIC SYSTEMSMONEYOPPORTUNITY COST

Charles W. WoottonEastern Illinois University


Ralph WrayBloomington, Indiana

ECONOMIC ANALYSIS

Norman WrightBrigham Young University,

HawaiiGLOBAL ECONOMYSTRATEGIC MANAGEMENT

Douglas E. ZiegenfussVirginia Beach, Virginia

PERFORMANCE AUDITS

ABSOLUTE ANDCOMPARATIVE ADVANTAGES(SEE: Marketing)

ABSOLUTE ANDRELATIVE PRICES(SEE: Pricing)

ACCOUNTING

Accounting is a field of specialization critical tothe functioning of all types of organizations. Ac-counting often is referred to as ‘‘the language ofbusiness’’ because of its role in maintaining andprocessing all relevant financial information thatan entity requires for its managing and reportingpurposes.

Accountants often have a specific sub-specialization and function at one of several lev-els. Preparation for the field is provided by secon-dary schools, postsecondary business schools,community colleges, and four-year colleges anduniversities.

WHAT IS ACCOUNTING?

Accounting is a body of principles and conven-tions as well as an established general process forcapturing financial information related to an en-tity’s resources and their use in meeting the en-tity’s goals. Accounting is a service function that

provides information of value to all operatingunits and to other service functions, such as theheadquarters offices of a large corporation.

Origin of Accounting Modern accounting istraced to the work of an Italian monk, LucaPacioli, whose publication in A.D. 1494 describedthe double-entry system, which continues to bethe fundamental structure for contemporary ac-counting systems in all types of entities. Whendouble-entry accounting is used, the balancesheet identifies both the resources controlled bythe entity and those parties who have claims tothose assets.

Early histories of business identify the book-keeper as a valuable staff member. As businessesbecame more complex, the need for more astutereview and interpretation of financial informa-tion was met with the development of a newprofession—public accounting. In the UnitedStates, public accounting began in the latter partof the nineteenth century. The first organizationwas established in 1887; the first professional ex-amination was administered in December 1896.

In the early days of the twentieth century,numerous states established licensing require-ments and began to administer examinations.During the first century of public accounting inthe United States, the American Institute of Cer-tified Public Accountants (and its predecessororganizations) provided strong leadership tomeet the changing needs of business, not-for-profit, and governmental entities.

A

1

Fra Luca Pacioli’s 1494 publication described the double-entry system.

Generally Accepted Accounting Principles(GAAP) No single source provides principles forhandling all transactions and events. Over time,conventional rules have developed that continueto be relevant. Additionally, groups have beenauthorized to establish accounting standards.The Financial Accounting Standards Board(FASB) assumed responsibility for accounting

standards and principles in 1973. It is authorizedto amend existing rules and establish new ones.In 1992, the Auditing Standards Board estab-lished the GAAP hierarchy. At the highest level ofthe hierarchy are FASB statements and interpre-tations; APB opinions were issued from 1959 to1973 by the Accounting Principles Board (APB),and Accounting Research Bulletins, issued until

ACCOUNTING

2 ENCYCLOPEDIA OF BUSINESS AND FINANCE

1959 by the Committee on Accounting Proce-dure (CAP); both the APB and CAP were com-mittees of the American Institute of CertifiedPublic Accountants (AICPA).

What type of unit is served by accounting?Probably no concept or idea is more basic toaccounting than the accounting unit or entity, aterm used to identify the organization for whichthe accounting service is to be provided andwhose accounting or other information is to beanalyzed, accumulated, and reported. The entitycan be any area, activity, responsibility, or func-tion for which information would be useful.Thus, an entity is established to provide theneeded focus of attention. The informationabout one entity can be consolidated with that ofa part or all of another, and this combinationprocess can be continued until the combinedentity reaches the unit that is useful for the de-sired purpose.

Accounting activities may occur within oroutside the organization. Although accounting isusually identified with privately owned, profit-seeking entities, its services also are provided tonot-for-profit organizations such as universitiesor hospitals, to governmental organizations, andto other types of units. The organizations may besmall, owner-operated enterprises offering a sin-gle product or service, or huge multi-enterprise,international conglomerates with thousands ofdifferent products and services. The not-for-profit, governmental, or other units may be local,national, or international; they may be small orvery large; they may even be entire nations, as innational income accounting. Since not-for-profitand governmental accounting are covered else-where in this encyclopedia, the balance of thisarticle will focus on accounting for privatelyowned, profit-seeking entities.

What is the work of accountants? Accountantshelp entities be successful, ethical, responsibleparticipants in society. Their major activities in-clude observation, measurement, and communi-cation. These activities are analytical in natureand draw on several other disciplines (e.g., eco-nomics, mathematics, statistics, behavioral sci-

ence, law, history, and language/communica-tion).

Accountants identify, analyze, record, andaccumulate facts, estimates, forecasts, and otherdata about the unit’s activities; then they translatethese data into information that can be useful fora specific purpose.

The data accumulation and recording phasetraditionally has been largely clerical; typicallyand appropriately, this has been called bookkeep-ing, which is still a common and largely manualactivity, especially in smaller firms that have notadopted state-of-the-art technology. But with ad-vances in information technology and user-friendly software, the clerical aspect has becomelargely electronically performed, with internalchecks and controls to assure that the input andoutput are factual and valid.

Accountants design andmaintain accountingsystems, an entity’s central information system,to help control and provide a record of the en-tity’s activities, resources, and obligations. Suchsystems also facilitate reporting on all or part ofthe entity’s accomplishments for a period of timeand on its status at a given point in time.

An organization’s accounting system pro-vides information that (1) helps managers makedecisions about assembling resources, control-ling, and organizing financing and operating ac-tivities; and (2) aids other users (employees, in-vestors, creditors, and others—usually calledstakeholders) in making investment, credit, andother decisions.

The accounting system must also provideinternal controls to ensure that (1) laws and en-terprise policies are properly implemented; (2)accounting records are accurate; (3) enterpriseassets are used effectively (e.g., that idle cashbalances are being invested to earn returns); and(4) steps be taken to reduce chances of losingassets or incurring liabilities from fraudulent orsimilar activities, such as the carelessness or dis-honesty of employees, customers, or suppliers.Many of these controls are simple (e.g., theprenumbering of documents and accounting forall numbers); others require division of dutiesamong employees to separate record keeping and

ACCOUNTING

ENCYCLOPEDIA OF BUSINESS AND FINANCE 3

custodial tasks in order to reduce opportunitiesfor falsification of records and thefts or misap-propriation of assets.

An enterprise’s system of internal controlsusually includes an internal auditing functionand personnel to ensure that prescribed datahandling and asset/liability protection proce-dures are being followed. The internal auditoruses a variety of approaches, including observa-tion of current activities, examination of pasttransactions, and simulation—often using sam-ple or fictitious transactions—to test the accu-racy and reliability of the system.

Accountants may also be responsible for pre-paring several types of documents. Many of these(e.g., employees’ salary and wage records) alsoserve as inputs for the accounting system, butmany are needed to satisfy other reporting re-quirements (e.g., employee salary records may beneeded to support employee claims for pen-sions). Accountants also provide data for com-pleting income tax returns.

What is the accountant’s role in decision mak-ing? Accountants have a major role in providinginformation for making economic and financialdecisions. Rational decisions are usually based onanalyses and comparisons of estimates, which inturn, are based on accounting and other data thatproject future results from alternative courses ofaction.

External or financial accounting, reporting,and auditing are directly involved in providinginformation for the decisions of investors andcreditors that help the capital markets to effi-ciently and effectively allocate resources to enter-prises; internal, managerial, or management ac-counting is responsible for providinginformation and input to help managers makedecisions on the efficient and effective use ofenterprise resources.

The accounting information used in makingdecisions within an enterprise is not subject togovernmental or other external regulation, so anyrules and constraints are largely self-imposed. Asa result, in developing the data and informationthat are relevant for decisions within the enter-prise, managerial accountants are constrained

largely by cost-benefit considerations and theirown ingenuity and ability to predict future con-ditions and events.

But accounting to external users (financialaccounting, reporting, and auditing) has manyregulatory constraints—especially if the enter-prise is a ‘‘public’’ corporation whose securitiesare registered (under the United States SecuritiesActs of 1933 and 1934) with the Securities andExchange Commission (SEC) and traded pub-licly over-the-counter or on a stock exchange.Public companies are subject to regulations andreporting requirements imposed and enforced bythe SEC; to rules and standards established for itsfinancial reports by the FASB and enforced by theSEC; to regulations of the organization where itssecurities are traded; and to the regulations of theAICPA, which establishes requirements and stan-dards for its members (who may be either inter-nal or external accountants or auditors).

If the entity is a state or local governmentalunit, it is subject to the reporting standards andrequirements of the Government AccountingStandards Board. If the entity is private and not aprofit-seeking unit, it is subject to various report-ing and other regulations, including those of theInternal Revenue Service, which approves its taxstatus and with which it must file reports.

Largely as a result of the governmental regu-lation of private profit-seeking businesses thatbegan in 1933, an increasingly clear distinctionhas been made between managerial or internalaccounting and financial accounting that islargely for external users. One important excep-tion to this trend, however, was the changeadopted in the 1970s in the objectives of financialreporting such that both managerial and finan-cial accounting now have the same objective: toprovide information that is useful for makingeconomic decisions.

But it must be recognized that although thefinancial accounting information reported tostakeholders comes from the organization’s ac-counting system, its usefulness for decision mak-ing is limited. This is because it is largely histori-cal—it reflects events and activities that occurredin the past, not what is expected in the future.

ACCOUNTING


Even estimated data such as budgets and stan-dard costs must be examined regularly to deter-mine whether these past estimates continue to beindicative of current conditions and expectationsand thus are useful for making decisions. Thushistorical accounting information must be exam-ined carefully, modified, and supplemented tomake certain that what is used is relevant toexpectations about the future.

But it also must be recognized that account-ing can and does provide information that iscurrent and useful in making estimates aboutfuture events. For example, accounting providescurrent-value information about selected items,such as readily marketable investments in debtand equity securities and inventories, and it pro-vides reports on what the organization plans toaccomplish and its expectations about the futurein budgets and earnings forecasts.

Who uses accounting information for decisionmaking? The information developed by the ac-countant’s information system can be useful to:

● Managers in planning, controlling, and evalu-ating their organization’s activities

● Owners, directors, and others in evaluatingthe performance of the organization and de-termining operating, compensation, and otherpolicies

● Union, governmental, regulatory, taxing, envi-ronmental, and other entities in evaluatingwhether the organization is conforming withapplicable contracts, rules, laws, and publicpolicies and/or whether changes are needed;

● Existing and potential owners, lenders, em-ployees, customers, and suppliers in evaluatingtheir current and future commitments to theorganization

● Accounting researchers, security analysts, secu-rity brokers and dealers, mutual-fund manag-ers, and others in their analyses and evalua-tions of enterprises, capital markets, and/orinvestors

The services that accounting and the ac-countant can provide have been enhanced inmany ways since the 1970s by advances in com-puters and other information technology. The

impact of these changes is revolutionizing ac-counting and the accounting profession. But thechanges have yet to reach their ultimate poten-tial. For example, accounting in the 1990s beganto provide current-value information and esti-mates about the future that an investor or otheruser would find useful for decision making. Theavailability of computer software and the Inter-net greatly enhanced the potential for data andinformation services. Such changes create oppor-tunities for accounting and accountants and alsowill require substantial modifications in the tra-ditional financial accounting and reportingmodel.

What is the profession of accounting? At thecore of the profession of accounting is the certi-fied public accountant (CPA) who has passed thenational CPA examination, been licensed in atleast one state or territory, and engages in thepractice of public accounting/auditing in a publicaccounting or CPA firm. The CPA firm providessome combination of two or more of four typesof services: accounting, auditing, income taxplanning and reporting, and management advis-ing/consulting. Analysis of trends indicates thatthe demand for auditing services has peaked andthat most of the growth experienced by publicaccounting firms is in the consulting area.

Accounting career paths, specializations, orsubprofessions for CPAs who join profit-seekingenterprises include being controllers, chief finan-cial officers, or internal auditors. Other careerpaths include being controllers or chief financialofficers in not-for-profit or government organi-zations and teaching in colleges and universities.Students should note that non-CPAs also couldenter these subprofessions and that certificates,but not licenses, could be earned by passing ex-aminations in several areas, including internalauditing, management accounting, and bankauditing.

How do environmental changes impact the ac-counting profession? Numerous changes in theenvironment make the practice of accountingand auditing much different in the new centurythan it was in the 1970s. For example, profes-

ACCOUNTING


sional accounting firms now actively compete forclients by advertising extensively in various me-dia, a practice that at one time was forbidden bytheir code of professional conduct. Mergers ofclients have led CPA firms into mergers as well,such that the Big Eight is now the Big Five andthe second-tier group has been reduced fromtwelve firms to about five. Another result of com-petition and other changes has been that some ofthe largest employers of CPAs now include in-come tax and accounting services firms such asH&R Block and an American Express subsidiary.

Competition among CPAs also has led theSEC to expand its regulatory and enforcementactivities to ensure that financial reports are rele-vant and reliable. From its inception, the SEC hashad legal authority to prescribe the accountingprinciples and standards used in the financialreports of enterprises whose securities are pub-licly traded, but it has delegated this responsibil-ity to the accounting profession. Since 1973, thatorganization has been the FASB, with which theSEC works closely. But since the FASB is limitedto performing what is essentially a legislativefunction, the SEC has substantially increased itsenforcement activities to ensure that the FASB’sstandards are appropriately applied in financialreports and that accountants/auditors act in thepublic interest in performing their independentaudits—for which the Securities Acts have giventhe CPA profession a monopoly.

How does a student prepare for the accountingprofession? Persons considering entering the ac-counting profession should begin by doing someself-analysis to determine whether they enjoymathematical, problem- or puzzle-solving, orother analytical activities; by taking some apti-tude tests; or by talking with accounting teachersor practitioners about their work.

Anyone interested in becoming an account-ing professional should expect to enter a rigorousfive-year education program and to earn a mas-ter’s degree in order to qualify to enter the pro-fession and to sit for the CPA examination. Tobuild a base for rising to the top of the profession,students should select courses that help themlearn how to think and to define and solve prob-

lems. The courses should help them to developanalytical (logical, mathematical, statistical),communication (oral, reading, writing), com-puter, and interpersonal skills. The early part ofthe program should emphasize arts and sciencescourses in these skill-development areas.

The person should begin to develop word-processing, data-processing, and Internet skillslong before entering college and should expect tomaintain competence in them throughout his orher professional career. These skills greatly en-hance and facilitate all phases and aspects of whataccounting and accountants attempt to do. Whatcan be done is limited only by technology and bythe sophistication of the system, its operators,and users.

(SEE ALSO: Accounting cycle; Careers in accounting;Financial Accounting Standards Board; CertifiedManagement Accountant; Generally Accepted Ac-counting Principles; Government accounting; Institutefor Internal Auditors; Institute of Management Ac-countants; International Accounting Standards;International Federation of Accountants; National As-sociation of Boards of Accountancy; Public OversightBoard; Uniform Certified Public Accountant exami-nation; United States General Accounting Office;Securities Acts: Requirements for accounting)

BIBLIOGRAPHY

Hansen, Don R., and Mowen, Maryanne M. (2000).Management Accounting, 5th ed. Cincinnati, OH: South-western College Publishing.

Kimmel, Paul D., Weygandt, Jerry J., and Kieso, Donald E.(2000). Financial Accounting, 2d ed. New York: Wiley.

HARVEY S. HENDRICKSON

ACCOUNTING CYCLE

The primary objectives of the accounting func-tion in an organization are to process financialinformation and to prepare financial statementsat the end of the accounting period. Companiesmust systematically process financial informationand must have staff who prepare financial state-ments on a monthly, quarterly, and/or annualbasis. To meet these primary objectives, a series

ACCOUNTING CYCLE


of steps is required. Collectively these steps areknown as the accounting cycle. The steps, applica-ble to a manual accounting system, are describedbelow. Later, there will be a brief discussion of acomputerized processing system.

THE STEPS OF THE CYCLE

1. Collect and analyze data from transactionsand events: As transactions and events re-lated to financial resources occur, theyare analyzed with respect to their effecton the financial position of the company.As an example, consider the sales for aday in a retail establishment that are col-lected on a cash register tape. These salesbecome inputs into the accounting sys-tem. Every organization establishes achart of accounts that identifies the cate-gories for recording transactions andevents. The chart of accounts for the re-tail establishment mentioned earlier inthis paragraph will include Cash andSales.

2. Journalize transactions: After collectingand analyzing the information obtainedin the first step, the information is en-tered in the general journal, which iscalled the book of original entry. Jour-nalizing transactions may be done contin-ually, but this step can de done in abatch at the end of the day if data fromsimilar transactions are being sorted andcollected, on a cash register tape, for ex-ample. At the end of the day, the sales of$4,000 for cash would be recorded in thegeneral journal in this form:Cash 4000

Sales 4000

3. Post to general ledger: The general journalentries are posted to the general ledger,which is organized by account. All trans-actions for the same account are collectedand summarized; for example, the ac-count entitled ‘‘Sales’’ will accumulate thetotal value of the sales for the period. Ifposting were done daily, the ‘‘Sales’’ ac-

count in the ledger would show the totalsales for each day as well as the cumula-tive sales for the period to date. Postingto ledger accounts may be less frequent,perhaps at the end of each day, at theend of the week, or possibly even at theend of the month.

4. Prepare an unadjusted trial balance: At theend of the period, double-entry account-ing requires that debits and credits re-corded in the general ledger be equal.Debit and credit merely signify position—left and right, respectively. Some accountsnormally have debit balances (e.g., assetsand expenses) and other accounts havecredit balances (e.g., liabilities, owners’equity and revenues). As transactions arerecorded in the general journal and sub-sequently posted to the ledger, allamounts recorded on the debit side ofaccounts (i.e., recorded on the left side)must equal all amounts recorded on thecredit side of accounts (i.e., recorded onthe right side). Preparing an unadjustedtrial balance tests the equality of debitsand credits as recorded in the generalledger. If unequal amounts of debits andcredits are found in this step, the reasonfor the inequality is investigated and cor-rected before proceeding to the next step.Additionally, this unadjusted trial balanceprovides the balances of all the accountsthat may require adjustment in the nextstep.

5. Prepare adjustments: Period-end adjust-ments are required to bring accounts totheir proper balances after consideringtransactions and/or events not yet re-corded. Under accrual accounting, reve-nue is recorded when earned and ex-penses when incurred. Thus, an entrymay be required at the end of the periodto record revenue that has been earnedbut not yet recorded on the books. Simi-larly, an adjustment may be required torecord an expense that may have been in-curred but not yet recorded.

ACCOUNTING CYCLE


6. Prepare an adjusted trial balance: As withan unadjusted trial balance, this step teststhe equality of debits and credits. How-ever, assets, liabilities, owners’ equity, rev-enues, and expenses will now reflect theadjustments that have been made in theprevious step. If there should be unequalamounts of debits and credits or if an ac-count appears to be incorrect, the dis-crepancy or error is investigated and cor-rected.

7. Prepare financial statements: Financialstatements are prepared using the cor-rected balances from the adjusted trialbalance. These are one of the primaryoutputs of the financial accounting sys-tem.

8. Close the accounts: Revenues and expensesare accumulated and reported by period,either a monthly, quarterly, or yearly. Toprevent their not being added to or com-ingled with revenues and expenses of an-other period, they need to be closedout—that is, given zero balances—at theend of each period. Their net balances,which represent the income or loss forthe period, are transferred into owners’equity. Once revenue and expense ac-counts are closed, the only accounts thathave balances are the asset, liability, andowners’ equity accounts. Their balancesare carried forward to the next period.

9. Prepare a post-closing trial balance: Thepurpose of this final step is two-fold: todetermine that all revenue and expenseaccounts have been closed properly andto test the equality of debit and creditbalances of all the balance sheet accounts,that is, assets, liabilities and owners’ eq-uity.

COMPUTERIZED ACCOUNTING SYSTEM

A computerized accounting system saves a greatdeal of time and effort, considerably reduces (ifnot eliminates) mathematical errors, and allowsfor much more timely information than does a

manual system. In a real-time environment, ac-counts are accessed and updated immediately toreflect activity, thus combining steps 2 and 3 asdiscussed in the preceding section. The need totest for equality of debits and credits through trialbalances is usually not required in a computer-ized system accounting since most systems testfor equality of debit and credit amounts as theyare entered. If someone were to attempt to inputdata containing an inequality, the system wouldnot accept the input. Since the computer is pro-grammed to post amounts to the various ac-counts and calculate the new balances as newentries are made, the possibility of mathematicalerror is markedly reduced.

Computers may also be programmed to rec-ord some adjustments automatically at the end ofthe period. Most software programs are also ableto prepare the financial statement once it hasbeen determined the account balances are cor-rect. The closing process at the end of the periodcan also be done automatically by the computer.

Human judgment is still required to analyzethe data for entry into the computer system cor-rectly. Additionally, the accountant’s knowledgeand judgment are frequently required to deter-mine the adjustments that are needed at the endof the reporting period. The mechanics of thesystem, however, can easily be handled by thecomputer.

(SEE ALSO: Accounting; Accounting information sys-tems)

BIBLIOGRAPHY

Dansby, Robert, Kaliski, Burton, and Lawrence, Michael(1999). College Accounting. St. Paul, MN: EMC Para-digm.

Ingram, Robert W., and Baldwin, Bruce A. (1998). FinancialAccounting: A Bridge to Decision Making. Cincinnati, OH:South-Western College Publishing.

Larson, Kermit D. (1997). Essentials of Financial Accounting.Boston: Irwin/McGraw-Hill.

Meigs, Robert F., Meigs, Mary A., Bettner, Mark, and Whit-tington, Ray. (1998). Financial Accounting. Boston:Irwin/McGraw Hill.

Needles, Belverd E., and Powers, Marian (1998). FinancialAccounting. Boston: Houghton Mifflin.

ACCOUNTING CYCLE


Porter, Gary A., and Norton, Curtis L. (1998). FinancialAccounting. Fort Worth, TX: Dryden Press.

ALLIE F. MILLER

ACCOUNTING: CONCEPTUALFRAMEWORK(SEE ALSO: Accounting)


With the establishment of the first English colo-nies in America, accounting or bookkeeping, asthe discipline was referred to then, quickly as-sumed an important role in the development ofAmerican commerce. Two hundred years, how-ever, would pass before accounting would sepa-rate from bookkeeping, and nearly three hundredyears would pass before the profession of ac-counting, as it is now practiced, would emerge.

For individuals and businesses, accountingrecords in Colonial America often were very ele-mentary. Most records of this period relied onthe single-entry method or were simply narrativeaccounts of transactions. As rudimentary as theywere, these records were important because thecolonial economy was largely a barter and creditsystem with substantial time passing before pay-ments were made. Accounting records were oftenthe only reliable records of such historical trans-actions.

THE EMERGENCE OF ACCOUNTING

Prior to the late 1800s, the terms bookkeeping andaccounting were often used interchangeably be-cause the recording/posting process was centralto both activities. There was little need for finan-cial statements (e.g., income statements) becausemost owners had direct knowledge of their busi-nesses and, therefore, could rely on elementarybookkeeping procedures for information.

Although corporations (e.g., banks, canalcompanies) were present in the United Statesprior to the early 1800s, their numbers were few.

Beginning in the late 1820s, however, the numberof corporations rapidly increased with the cre-ation and expansion of the railroads. To operatesuccessfully, the railroads needed cost reports,production reports, financial statements, and op-erating ratios that were more complex than sim-ple recording procedures could provide. AlfredD. Chandler, Jr. (1977), noted the impact of therailroads on the development of accounting inhis classic work, The Visible Hand, when he stated‘‘after 1850, the railroad was central in the devel-opment of the accounting profession in theUnited States’’ (p. 110).

With the increase in the number of corpora-tions, there also arose a demand for additionalfinancial information that A.C. Littleton (1933/1988) in his landmark book, The Rise of the Ac-counting Profession, called ‘‘figure’’ knowledge.With no direct knowledge of a business, investorshad to rely on financial statements for informa-tion, and to create those statements, more com-plex accounting methods were required. The ac-countant’s responsibility, therefore, expandedbeyond simply recording entries to include thepreparation, classification, and analysis of finan-cial statements. As John L. Carey (1969) wrote inThe Rise of the Accounting Profession, ‘‘the nine-teenth century saw bookkeeping expanded intoaccounting’’ (p. 15).

Additionally, as the development of the cor-poration created a greater need for the services ofaccountants, the study of commerce and ac-counting became more important. Althoughthere had been trade business schools and pub-lished texts on accounting/bookkeeping, tradi-tional colleges had largely ignored the study ofbusiness and accounting. In 1881, however, theWharton School of Finance and Economy wasfounded, and two years later, the school addedaccounting to its curriculum. As other majoruniversities created schools of commerce, ac-counting secured a significant place in the curric-ulum.

With a separation of management and own-ership in corporations, there also arose a need foran independent party to review the financialstatements. Someone was needed to represent the

ACCOUNTING: HISTORICAL PERSPECTIVES


owners’ interest and to verify that the statementsaccurately presented the financial conditions ofthe company. Moreover, there was often an ex-pectation that an independent review would dis-cover whether managers were violating their fi-duciary duties to the owners. Additionally,because the late nineteenth century was a periodof major industrial mergers, someone wasneeded to verify the reported values of the com-panies. The independent public accountant, aperson whose obligation was not to the managersof a company but to its shareholders and poten-tial investors, provided the knowledge and skillsto meet these needs.

In 1913, the responsibilities of and job op-portunities for accountants again expanded withthe ratification of the Sixteenth Amendment tothe Constitution, which allowed a federal incometax. Accountants had become somewhat familiarwith implementing a national tax with the earlierpassage of the Corporation Excise Tax Law. De-spite the earlier law, however, many companieshad not set up proper systems to determine tax-able income and few were familiar with conceptssuch as depreciation and accrual accounting.

As tax rates increased, tax services becameeven more important to accounting firms andoften opened the door to providing other servicesto a client. Accounting firms, therefore, were of-ten engaged to establish a proper accountingsystem and audit financial statements as well asprepare the required tax return.

Thus, in contrast to bookkeeping which of-ten had been considered a trade, the responsibili-ties of accounting had expanded by the earlytwentieth century to such an extent that it nowsought professional status. One foundation of theestablished professions (e.g., medicine, law) wasprofessional certification, which accounting didnot have. In 1896, with the support of severalaccounting organizations, New York State passeda law restricting the title certified public account-ant (CPA) to those who had passed a state exami-nation and had acquired at least three years ofaccounting experience. Similar laws were soonpassed in several states.

PROFESSIONAL ORGANIZATIONS

Throughout the history of accounting, profes-sional organizations have made major contribu-tions to the development of the profession. Forexample, in 1882, the Institute of Accountantsand Bookkeepers of New York (IABNY) was or-ganized with the primary aim of increasing thelevel of educational resources available for ac-countants. In 1886, the IABNY became the Insti-tute of Accounts, and it continued to be active inpromoting accounting education for nearlytwenty years. Meanwhile, the first national orga-nization for accounting educators, the AmericanAssociation of University Instructors in Ac-counting (AAUIP), was organized in 1916. In1935, the AAUIP was reorganized as the Ameri-can Accounting Association.

The national public accounting organization,the American Association of Public Accountants(AAPA), was incorporated in 1887. Reflecting theneed of most professions for a code of ethics, theAAPA added a professional ethics section to itsbylaws in 1907. The AAPA was reorganized as theAmerican Institute of Accountants in the UnitedStates of America and then later as the AmericanInstitute of Accountants (AIA). In 1921, theAmerican Society of Certified Public Account-ants (ASCPA) was established and became a rivalto the AIA for leadership in the public accountingarea. The rivalry continued until 1937, when theASCPA merged with the AIA. In 1957, the AIAbecame the American Institute of Certified Pub-lic Accountants (AICPA).

In contrast to the public accounting empha-sis of the AIA and ASCPA, the National Associa-tion of Cost Accountants (NACA) was foundedin 1919. The NACA placed an emphasis on thedevelopment of cost controls and proper report-ing within companies. In 1957, the NACAchanged its name to the National Association ofAccountants (NAA) in recognition of the expan-sion of managerial accounting beyond traditionalcost accounting. Then, in 1991, recognizing itsemphasis on the managerial aspects of account-ing, the NAA became the Institute of Manage-ment Accountants.



EXTERNAL AND INTERNAL REGULATION

During the nineteenth century, the federal gov-ernment generally allowed accounting to regulateitself. Then, in 1913, Congress established theFederal Reserve System and, one year later, theFederal Trade Commission (FTC). From thisdate forward, federal agencies have had an in-creasing impact on the profession of accounting.

The government’s first major attempt at theformalization of authoritative reporting stan-dards was in 1917 with the Federal ReserveBoard’s publication of Uniform Accounting. In1918, the bulletin was reissued as Approved Meth-ods for the Preparation of Balance Sheet State-ments. Although directed toward auditing thebalance sheet, the report presented model in-come and balance sheet statements. Because theproposal was only a recommendation, however,its acceptance was limited.

The impetus for stricter financial reportingwas provided by the collapse of the securitiesmarket in 1929 and the revelation of massivefraud in a company listed on the New York StockExchange (NYSE). In 1933, the NYSE announcedthat companies applying for a listing on the ex-change must have their financial statementsaudited by an independent public accountant.The scope of these audits had to follow the re-vised guidelines set forth by the Federal Reservein 1929.

Another major innovation in the regulationof accounting was the passage of the SecuritiesAct of 1933 and the Securities and Exchange Actof 1934. The 1933 act conferred upon the FTCthe authority to prescribe the accounting meth-ods for companies to follow. Under this act, ac-countants could be held liable for losses thatresulted from material omissions or misstate-ments in registration statements they had certi-fied. The 1934 act transferred the authority toprescribe accounting methods to the newly estab-lished Securities and Exchange Commission(SEC) and required that financial statements filedwith the SEC be certified by an independent pub-lic accountant.

With the creation of the SEC and the passageof new securities laws, the federal government

assumed a central role in the establishment ofbasic requirements for the issuance and auditingof financial reports. Additionally, these acts in-creased the importance of accountants and en-larged the accountant’s responsibility to the gen-eral public. Under these acts, not only didaccountants have a responsibility to the public,they were now potentially liable for their actions.

In 1938, the SEC delegated much of its au-thority to prescribe accounting practices to theAIA and its Committee on Accounting Proce-dures (CAP). In 1939, CAP issued its first of fifty-one Accounting Research Bulletins. Respondingto criticism of CAP, the AICPA (formerly theAIA) in 1959 replaced the CAP with the Account-ing Principles Board (APB). The APB was de-signed to issue accounting opinions after it hadconsidered previous research studies, and in1962, the APB issued its first of thirty-one opin-ions. Although the SEC had delegated much of itsstandard-setting authority to the AICPA, thecommission exercised its right to approve allstandards when it declared that companies didnot have to follow the rules set forth in APB No.2, The Investment Credit.

Responding to criticism of the APB, a studygroup chaired by Francis M. Wheat was estab-lished to review the board structure and the rule-making process. The committee recommendedthat an independent, full time, more diverse stan-dards board replace the APB. Following the rec-ommendations, the Financial Accounting Stan-dards Board (FASB) was established in 1973. Thisboard is independent of the AICPA and issued itsfirst statement in 1973.

THE CHANGING GENDERIZATION OF THEWORK FORCE

With the separation of bookkeeping from ac-counting, the demand for women bookkeepersdramatically increased, and by 1930, over 60 per-cent of all bookkeepers were women. A similarincrease in the demand for women accountants,however, did not occur. Although World War IIcreated some opportunities for women in ac-counting, at the start of the second half of thetwentieth century, accounting still was not con-



sidered an appropriate career for most women.In fact, in 1950, only 15 percent of the more than300,000 accountants in the United States werewomen. Moreover, less than 4 percent of collegestudents majoring in accounting then werewomen.

In the 1960s, social and legal events beganthat ultimately provided opportunities forwomen in the profession of accounting. As theseevents occurred, the overall demand for account-ing services and accountants also greatly in-creased. This demand became so large that thetraditional labor pool of men was not sufficientto maintain the accounting work force. Concur-rently, women majoring in accounting increaseddramatically from less than 5 percent of all ac-counting majors in 1960 to over 50 percent in1985.

Given the increase of women accounting ma-jors and the inability of the traditional labor poolto meet the work force demand, accounting (es-pecially public accounting) increased the hiringof women. By 1990, women comprised a major-ity of the accounting work force. It would be theturn of the twenty-first century, however, beforewomen began to obtain a significant number ofupper-level management positions in account-ing.

THE TWENTY-FIRST CENTURY

The accountant, the accounting firm, and theaccounting profession of the twenty-first centuryare quite different from what existed at the begin-ning of the twentieth century. In contrast to abookkeeper manually recording entries in a largebound volume, an accountant is now responsiblefor information concerning all facets of a busi-ness and is dependent on the latest technology forprocessing that information. In contrast to smalllocal firms, accounting firms now can be largeinternational organizations with reported reve-nues of billions of dollars. In addition to thetraditional audit/attest information, accountingfirms provide their clients with tax services, fi-nancial planning, system analysis, consulting,and legal services. At the beginning of the twenti-eth century, the accounting profession was just

emerging. Today, the profession is comprised ofthousands of men and women working in publicand private firms as well as profit and nonprofitorganizations as members of management teamsor as valued consultants.

(SEE ALSO: American Institute of CPAs; National As-sociation of Boards of Accountancy)

BIBLIOGRAPHY

Carey, John L. (1969). The Rise of the Accounting Professionfrom Technician to Professional 1896-1936. New York:American Institute of Certified Public Accountants.

Carey, John L. (1970). The Rise of the Accounting Professionto Responsibility and Authority 1937-1969. New York:American Institute of Certified Public Accountants.

Chandler, Alfred D. Jr., (1977). The Visible Hand: The Man-agerial Revolution in American Business. Cambridge, MA:Harvard University Press.

Chatfield, Michael, and Vangermeersch, Richard, eds.(1996). The History of Accounting: An International Ency-clopedia. New York: Garland.

Edwards, James Don. (1978). History of Public Accounting inthe United States. Tuscaloosa, AL: University of AlabamaPress.

Hills, George H. (1982). The Law of Accounting and Finan-cial Statements. New York: Garland. (Original work pub-lished 1957)

Johnson, H. Thomas, and Kaplan, Robert S. (1987).Relevance Lost: The Rise and Fall of Management Account-ing. Boston: Harvard Business School Press.

Littleton, A.C. (1988). Accounting Evolution to 1900. NewYork: Garland. (Original work published 1933)

Lockwood, Jeremiah. (1938). ‘‘Early University Education inAccountancy.’’ Accounting Review 38(2): 131-143.

Miranti, Paul J. Jr., (1990). Accountancy Comes of Age: TheDevelopment of an American Profession. Chapel Hill: Uni-versity of North Carolina Press.

Previts, Gary John, and Merino, Barbara Dubis. (1998). AHistory of Accountancy in the United States: The CulturalSignificance of Accounting. Columbus: Ohio State Univer-sity Press.

Reid, Glenda E., Acken, Brenda T., and Jancura, Elise G.(1987). ‘‘An Historical Perspective on Women in Ac-counting.’’ The Journal of Accountancy 163(5) (May):338-355.

Study on Establishment of Accounting Principles. (1972)‘‘Recommendation on the Study on Establishment ofAccounting Principles.’’ The Journal of Accountancy133(5) (May): 66-71.



Wootton, Charles W., and Kemmerer, Barbara E. (1996).‘‘The Changing Genderization of Bookkeeping in theUnited States, 1870-1930.’’ Business History Review 70(4)(Winter): 541-586.

Wootton, Charles W., and Kemmerer, Barbara E. (2000).‘‘The Changing Genderization of the Accounting Work-force in the US, 1930-1990.’’ Accounting, Business & Fi-nancial History 10(2) (July): 303-324.

CHARLES W. WOOTTON

CAROL J. NORMAND

ACCOUNTING INFORMATIONSYSTEMS

Accounting Information Systems (AISs) com-bine the study and practice of accounting withthe design, implementation, and monitoring ofinformation systems. Such systems use moderninformation technology resources together withtraditional accounting controls and methods toprovide users the financial information necessaryto manage their organizations.

AIS TECHNOLOGY

Input The input devices commonly associ-ated with AIS include: standard personal compu-ters or workstations running applications; scan-ning devices for standardized data entry;electronic communication devices for electronicdata interchange (EDI) and e-commerce. In ad-dition, many financial systems come ‘‘Web-en-abled’’ to allow devices to connect to the WorldWide Web.

Process Basic processing is achieved throughcomputer systems ranging from individual per-sonal computers to large-scale enterprise servers.However, conceptually, the underlying process-ing model is still the ‘‘double-entry’’ accountingsystem initially introduced in the fifteenth cen-tury.

Output Output devices used include com-puter displays, impact and nonimpact printers,and electronic communication devices for EDIand e-commerce. The output content may en-compass almost any type of financial reports

from budgets and tax reports to multinationalfinancial statements.

MANAGEMENT INFORMATIONSYSTEMS (MIS)

MISs are interactive human/machine systemsthat support decision making for users both inand out of traditional organizational boundaries.These systems are used to support an organiza-tion’s daily operational activities; current and fu-ture tactical decisions; and overall strategic direc-tion. MISs are made up of several majorapplications including, but not limited to, thefinancial and human resources systems.

Financial applications make up the heart ofan AIS in practice. Modules commonly imple-mented include: general ledger, payables, pro-curement/purchasing, receivables, billing, inven-tory, assets, projects, and budgeting.

Human resource applications make upanother major part of modern information sys-tems. Modules commonly integrated with theAIS include: human resources, benefits adminis-tration, pension administration, payroll, andtime and labor reporting.

AIS—INFORMATION SYSTEMS IN CONTEXT

AISs cover all business functions from backboneaccounting transaction processing systems to so-phisticated financial management planning andprocessing systems.

Financial reporting starts at the operationallevels of the organization, where the transactionprocessing systems capture important businessevents such as normal production, purchasing,and selling activities. These events (transactions)are classified and summarized for internal deci-sion making and for external financial reporting.

Cost accounting systems are used in manufac-turing and service environments. These allow or-ganizations to track the costs associated with theproduction of goods and/or performance of ser-vices. In addition, the AIS can provide advancedanalyses for improved resource allocation andperformance tracking.

Management accounting systems are used toallow organizational planning, monitoring, and

ACCOUNTING INFORMATION SYSTEMS


control for a variety of activities. This allowsmanagerial-level employees to have access to ad-vanced reporting and statistical analysis. The sys-tems can be used to gather information, to de-velop various scenarios, and to choose an optimalanswer among alternative scenarios.

DEVELOPMENT

The development of an AIS includes five basicphases: planning, analysis, design, implementa-tion, and support. The time period associatedwith each of these phases can be as short as a fewweeks or as long as several years.

Planning—project management objectivesand techniques The first phase of systems devel-opment is the planning of the project. This en-tails determination of the scope and objectives ofthe project, the definition of project responsibili-ties, control requirements, project phases, projectbudgets, and project deliverables.

Analysis The analysis phase is used to bothdetermine and document the accounting andbusiness processes used by the organization. Suchprocesses are redesigned to take advantage of bestpractices or of the operating characteristics ofmodern system solutions.

Data analysis is a thorough review of the ac-counting information that is currently being col-lected by an organization. Current data are thencompared to the data that the organizationshould be using for managerial purposes. Thismethod is used primarily when designing ac-counting transaction processing systems.

Decision analysis is a thorough review of thedecisions a manager is responsible for making.The primary decisions that managers are respon-sible for are identified on an individual basis.Then models are created to support the managerin gathering financial and related information todevelop and design alternatives, and to make ac-tionable choices. This method is valuable whendecision support is the system’s primary objec-tive.

Process analysis is a thorough review of theorganization’s business processes. Organizationalprocesses are identified and segmented into a

series of events that either add or change data.These processes can then be modified or reengi-neered to improve the organization’s operationsin terms of lowering cost, improving service, im-proving quality, or improving management in-formation. This method is appropriate when au-tomation or reengineering is the system’sprimary objective.

Design The design phase takes the conceptualresults of the analysis phase and develops de-tailed, specific designs that can be implementedin subsequent phases. It involves the detailed de-sign of all inputs, processing, storage, and out-puts of the proposed accounting system. Inputsmay be defined using screen layout tools andapplication generators. Processing can be shownthrough the use of flowcharts or business processmaps that define the system logic, operations,and work flow. Logical data storage designs areidentified by modeling the relationships amongthe organization’s resources, events, and agentsthrough diagrams. Also, entity relationship dia-gram (ERD) modeling is used to document large-scale database relationships. Output designs aredocumented through the use of a variety of re-porting tools such as report writers, data extrac-tion tools, query tools, and on-line analyticalprocessing tools. In addition, all aspects of thedesign phase can be performed with software toolsets provided by specific software manufacturers.

Reporting is the driving force behind an AISdevelopment. If the system analysis and designare successful, the reporting process provides theinformation that helps drive management deci-sion making. Accounting systems make use of avariety of scheduled and on-demand reports. Thereports can be tabular, showing data in a table ortables; graphic, using images to convey informa-tion in a picture format; or matrices, to showcomplex relationships in multiple dimensions.

There are numerous characteristics to con-sider when defining reporting requirements. Thereports must be accessible through the system’sinterface. They should convey information in aproactive manner. They must be relevant. Accu-racy must be maintained. Lastly, reports must



meet the information processing (cognitive) styleof the audience they are to inform.

Reports are of three basic types: A filter reportthat separates select data from a database, such asa monthly check register; a responsibility report tomeet the needs of a specific user, such as a weeklysales report for a regional sales manager; acomparative report to show period differences,percentage breakdowns and variances betweenactual and budgeted expenditures. An examplewould be the financial statement analytics show-ing the expenses from the current year and prioryear as a percentage of sales.

Screen designs and system interfaces are theprimary data capture devices of AISs and are de-veloped through a variety of tools. Storage isachieved through the use of normalized data-bases that assure functionality and flexibility.

Business process maps and flowcharts are usedto document the operations of the systems. Mod-ern AISs use specialized databases and processingdesigned specifically for accounting operations.This means that much of the base processingcapabilities come delivered with the accountingor enterprise software.

Implementation The implementation phaseconsists of two primary parts: construction anddelivery. Construction includes the selection ofhardware, software and vendors for the imple-mentation; building and testing the networkcommunication systems; building and testing thedatabases; writing and testing the new programmodifications; and installing and testing the totalsystem from a technical standpoint. Delivery isthe process of conducting final system and useracceptance testing; preparing the conversionplan; installing the production database; trainingthe users; and converting all operations to thenew system.

Tool sets are a variety of application develop-ment aids that are vendor-specific and used forcustomization of delivered systems. They allowthe addition of fields and tables to the database,along with ability to create screen and otherinterfaces for data capture. In addition, they helpset accessibility and security levels for adequate

internal control within the accounting applica-tions.

Security exists in several forms. Physical secu-rity of the system must be addressed. In typicalAISs the equipment is located in a locked roomwith access granted only to technicians. Softwareaccess controls are set at several levels, dependingon the size of the AIS. The first level of securityoccurs at the network level, which protects theorganization’s communication systems. Next isthe operating system level security, which pro-tects the computing environment. Then, data-base security is enabled to protect organizationaldata from theft, corruption, or other forms ofdamage. Lastly, application security is used tokeep unauthorized persons from performing op-erations within the AIS.

Testing is performed at four levels. Stub orunit testing is used to insure the proper operationof individual modifications. Program testing in-volves the interaction between the individualmodification and the program it enhances. Sys-tem testing is used to determine that the programmodifications work within the AIS as a whole.Acceptance testing ensures that the modificationsmeet user expectations and that the entire AISperforms as designed.

Conversion entails the method used to changefrom an old AIS to a new AIS. There are severalmethods for achieving this goal. One is to run thenew and old systems in parallel for a specifiedperiod. A second method is to directly cut over tothe new system at a specified point. A third is tophase in the system, either by location or systemfunction. A fourth is to pilot the new system at aspecific site before converting the rest of the or-ganization.

Support The support phase has two objec-tives. The first is to update and maintain the AIS.This includes fixing problems and updating thesystem for business and environmental changes.For example, changes in generally accepted ac-counting principles (GAAP) or tax laws mightnecessitate changes to conversion or referencetables used for financial reporting. The secondobjective of support is to continue developmentby continuously improving the business through



adjustments to the AIS caused by business andenvironmental changes. These changes might re-sult in future problems, new opportunities, ormanagement or governmental directives re-quiring additional system modifications.

ATTESTATION

AISs change the way internal controls are imple-mented and the type of audit trails that existwithin a modern organization. The lack of tradi-tional forensic evidence, such as paper, necessi-tates the involvement of accounting professionalsin the design of such systems. Periodic involve-ment of public auditing firms can be used tomake sure the AIS is in compliance with currentinternal control and financial reporting stan-dards.

After implementation, the focus of attesta-tion is the review and verification of system oper-ation. This requires adherence to standards suchas ISO 9000-3 for software design and develop-ment as well as standards for control of informa-tion technology.

Periodic functional business reviews shouldbe conducted to be sure the AIS remains incompliance with the intended business functions.Quality standards dictate that this review shouldbe done according to a periodic schedule.

ENTERPRISE RESOURCE PLANNING (ERP)

ERP systems are large-scale information systemsthat impact an organization’s AIS. These systemspermeate all aspects of the organization and re-quire technologies such as client/server and rela-tional databases. Other system types that cur-rently impact AISs are supply chain management(SCM) and customer relationship management(CRM).

Traditional AISs recorded financial informa-tion and produced financial statements on a peri-odic basis according to GAAP pronouncements.Modern ERP systems provide a broader view oforganizational information, enabling the use ofadvanced accounting techniques, such as activ-ity-based costing (ABC) and improved manage-rial reporting using a variety of analytical tech-niques.

(SEE ALSO: Accounting; Internal Control Systems)

THEODORE J. MOCK

ROBERT M. KIDDOO

ACHIEVEMENT MOTIVATIONTHEORY

(SEE: Motivation)

ACTIVITY-BASEDMANAGEMENT

Activity-based management (ABM) is an ap-proach to management in which process manag-ers are given the responsibility and authority tocontinuously improve the planning and controlof operations by focusing on key operationalactivities. ABM strategically incorporates activityanalysis, activity-based costing (ABC), activity-based budgeting, life-cycle and target costing,process value analysis, and value-chain analysis.Enhanced effectiveness and efficiencies are ex-pected for both revenue generation and cost in-currences. Since the focus is on activities, im-proved cost management is achieved throughbetter managing those activities that consume re-sources and drive costs. The focus for control isshifted away from the financial measurement ofresources to activities that cause costs to be in-curred.

As an overall framework, ABM relies on ABCinformation. ABC deals with the analysis andassignment of costs. In order to complete costanalyses, activities need to be identified and clas-sified. An activity dictionary can be developed,listing and describing all activities within an orga-nization, including information on each activity’slocation, performance measure(s), and keyvalue-added and non-value-added attributes.(See ‘‘ABC/ABM Dictionary,’’ which was used tohelp construct many of the definitions used inthis entry.) ABC information is extremely helpfulin the strategic analysis of areas such as processand plant layout redesign, pricing, customer val-

ACHIEVEMENT MOTIVATION THEORY


ues, sourcing, evaluation of competitive position,and product strategy.

ACTIVITY AND ACTIVITY ANALYSIS

An activity is a business task, or an aggregation ofclosely related purposeful actions, with clear be-ginning and ending points, that consumes re-sources and produces outputs. An activity couldbe a single task or a simple process. Resources areinputs, such as materials, labor, equipment, andother economic elements consumed by an activ-ity in the production of an output. Outputs areproducts, services, and accompanying informa-tion flowing from an activity. In seeking continu-ous business improvement, an overall examina-tion of variations in performances of keyorganizational activities and their causes is re-ferred to as activity analysis. Performance is mea-sured by a financial or nonfinancial indicator thatis causally related to the performance (addingvalue to a product or service) of an activity andcan be used to manage and improve the perform-ance of that activity.

The level of an activity within an organiza-tion depends on that level of operations sup-ported by that activity. For instance, a unit-levelactivity is one that is performed directly on eachunit of output of an organizational process. Abatch-level activity is one performed on a smallgroup, or batch, of output units at the same time.For example, the setup activity to run a batch jobin a production process and the associated costfor completing such a setup is a batch-level activ-ity. A customer-sustaining activity supports anindividual or a particular grouping of customers,such as mailings or customer service. A product-sustaining activity supports an individual prod-uct or product line, such as product (re)design or(re)engineering. These last two types of activitiesare sometimes referred to as service-sustainingactivities. Lastly, a facility-sustaining activity sup-ports an entire facility, such as the actions of themanager of an entire plant, with an associatedcost equal to the manager’s compensation pack-age. Not every activity within an organization issignificant enough to isolate in an activity analy-sis.

A process is a set of logically related activitiesperformed in order to achieve a particular objec-tive, such as the production of a unit of productor service. Identification of all such processeswithin an organization along with a specificationof the relationships among them provides a valuechain. Value chains are often presented in termsof functional areas (a function provides the orga-nization with a particular type of service or prod-uct, such as finance, distribution, or purchasing).Within each of these key processes, activities canbe classified as primary activities, secondary ac-tivities, and other activities. Primary activitiescontribute directly to the providing of the finalproduct or service. Secondary activities directlysupport primary activities. The ‘‘other activities’’category is comprised of those actions too farremoved from the intended output to be individ-ually noted. They should be examined to deter-mine if they are necessary and should be contin-ued.

VALUE-ADDED AND NON-VALUE-ADDED

Each of the key (primary and secondary)activities noted from our analysis must be catego-rized as either value-added or non-value-added.This analysis is referred to as value analysis. Anactivity is value-added to the extent that its per-formance contributes to the completion of theproduct or service for consumers. While value-added activities are necessary, the efficiency withwhich they are performed often can be improvedthrough best practice analysis and bench-marking. This process of improvement is referredto as business process redesign or reengineering.

Because many activities may not fit neatlyinto a value-added/non-value-added dichotomy,weightings may be assigned to indicate the extentto which an activity is value-added, such as ascale ranging from one to eight, with an eightrepresenting total value-additivity and a zero,none. A non-value-added activity transforms aproduct or service in a way that adds no useful-ness to the product or service. Non-value-addedactivities should be minimized or eliminated. Anoverall value-chain analysis would examine allthe activities and associated processes in an at-

ACTIVITY-BASED MANAGEMENT


tempt to provide greater value at the same cost,the same value at less cost, or both.

ACTIVITY-BASED COSTING

Because costs are initially assigned from resourcecost pools to activity cost pools and from there tofinal cost objects, activity-based costing is viewedas a two-stage allocation process. Once activitieshave been identified, an activity-based costinganalysis can be completed. Activity-based costingis a form of cost refinement, designed to obtaingreater accuracy than traditional allocations incost assignments for product costing and deci-sion-making purposes. Costs are assigned to ac-tivities from resource cost pools. Costs are firstaccumulated according to the type of resource,such as materials or labor, with which they areassociated. Then resource (cost) drivers, whichmeasure the consumption of a resource by anactivity, are identified and used to assign the costsof resource consumptions to each activity. Theresult of this assignment is an activity cost poolfor each activity.

From the activity cost pool, the focus shifts toone or more activity drivers. An activity drivermeasures the frequency or intensity with which acost object requires the use of an activity, therebyrelating the performance of an activity’s tasks tothe needs of one or more cost objects. A costobject is why activities are performed; it is a unitof product or service, an operating segment ofthe organization, or even another activity forwhich management desires an assignment ofcosts for unit costing or decision making pur-poses. The activity cost pools are then reassignedto the final cost objects according to the intensitywith which each cost object used the respectiveactivity drivers.

A cost driver may be defined to be ‘‘anyfactor that has the effect of changing the level oftotal cost for a cost object.’’ (Blocher et al., 1999,p. 8) In general, four types of cost drivers can beidentified: volume-based, activity-based, struc-tural, and executional (Blocher, et al., 1999,p. 61). Activity-based management focuses onactivity-based cost drivers. In investigating andspecifying cost drivers, many methods are used,

such as cause-and-effect diagrams, cost simula-tions, and Pareto analysis.

Traditional cost assignment systems typicallywould assign directly to the cost objects the costsof those resource consumptions that can be eco-nomically traced directly to units of output re-quiring the resources. The remaining costs, re-ferred to as indirect costs, would be accumulatedinto one or more cost pools, which would subse-quently be allocated to the cost objects accordingto volume-related bases of allocation. When dif-ferent products consume resources at rates thatare not accurately reflected in their relative num-bers (volumes), a traditional cost allocation ap-proach will result in product cost cross-subsidi-zation. That is, a high-volume, relatively simpleproduct will end up overcosted and subsidizing asubsequently undercosted, low-volume, rela-tively complex product, resulting in inaccurateunit costing and suboptimal product-line pricingdecisions and performance evaluations. Activity-based costing tries to take the nonuniformity ofresource consumption across products into ac-count in the assignment of costs.

(SEE ALSO: Management)

BIBLIOGRAPHY

‘‘ABC/ABM Dictionary.’’ http://www.saffm.hq.af.mil/

SAFFM/FMC/ABC/dictionary.htm.

Blocher, Edward J., Chen, Jung H., and Lin, Thomas W.

(1999). Cost Management: A Strategic Emphasis. NewYork: Irwin/McGraw-Hill.

Cooper, Robin, Kaplan, Robert S., Maisel, Lawrence S.,

Morrissey, Eileen, and Oehm, Ronald M. (1992).Implementing Activity-Based Cost Management: Moving

from Analysis to Action. Montvale, NJ: Institute of Man-agement Accountants.

Hilton, Ronald W., Maher, Michael W., and Selto, Frank H.

(1999). Cost Management: Strategies for Business Deci-sions. New York: Irwin/McGraw-Hill.

CLIFFORD BROWN

LAWRENCE KLEIN

ACTIVITY-BASED MANAGEMENT


Billboards are a popular form of advertising.

ADVERTISING

Advertising is often thought of as the paid, non-personal promotion of a cause, idea, product, orservice by an identified sponsor attempting toinform or persuade a particular target audience.Advertising has taken many different forms sincethe beginning of time. For instance, archaeo-logists have uncovered walls painted in Romeannouncing gladiator fights as well as rock paint-ings along Phoenician trade routes used to adver-tise wares. From this early beginning, advertisinghas evolved to take a variety of forms and topermeate nearly every aspect of modern society.The various delivery mechanisms for advertisinginclude banners at sporting events, billboards,Internet Web sites, logos on clothing, magazines,newspapers, radio spots, and television commer-cials. Advertising has so permeated everyday lifethat individuals can expect to be exposed to morethan 1,200 different messages each day. Whileadvertising may seem like the perfect way to get a

message out, it does have several limitations, themost commonly noted ones being its inability to(1) focus on an individual consumer’s specificneeds, (2) provide in-depth information about aproduct, and (3) be cost-effective for small com-panies.

FORMS OF ADVERTISING

Advertising can take a number of forms, includ-ing advocacy, comparative, cooperative, direct-mail, informational, institutional, outdoor, per-suasive, product, reminder, point-of-purchase,and specialty advertising.

Advocacy Advertising Advocacy advertising isnormally thought of as any advertisement, mes-sage, or public communication regarding eco-nomic, political, or social issues. The advertisingcampaign is designed to persuade public opinionregarding a specific issue important in the publicarena. The ultimate goal of advocacy advertisingusually relates to the passage of pending state or

ADVERTISING


federal legislation. Almost all nonprofit groupsuse some form of advocacy advertising to influ-ence the public’s attitude toward a particular is-sue. One of the largest and most powerful non-profit advocacy groups is the AmericanAssociation of Retired Persons (AARP). TheAARP fights to protect social programs such asMedicare and Social Security for senior citizensby encouraging its members to write their legisla-tors, using television advertisements to appeal toemotions, and publishing a monthly newsletterdescribing recent state and federal legislative ac-tion. Other major nonprofit advocacy groups in-clude the environmental organization Green-peace, Mothers Against Drunk Driving (MADD),and the National Rifle Association (NRA).

Comparative Advertising Comparative adver-tising compares one brand directly or indirectlywith one or more competing brands. This adver-tising technique is very common and is used bynearly every major industry, including airlinesand automobile manufacturers. One drawback ofcomparative advertising is that customers havebecome more skeptical about claims made by acompany about its competitors because accurateinformation has not always been provided, thusmaking the effectiveness of comparison advertis-ing questionable. In addition, companies that en-gage in comparative advertising must be carefulnot to misinform the public about a competitor’sproduct. Incorrect or misleading informationmay trigger a lawsuit by the aggrieved companyor regulatory action by a governmental agencysuch as the Federal Trade Commission (FTC).

Cooperative Advertising Cooperative adver-tising is a system that allows two parties to shareadvertising costs. Manufacturers and distribu-tors, because of their shared interest in selling theproduct, usually use this cooperative advertisingtechnique. An example might be when a soft-drink manufacturer and a local grocery store splitthe cost of advertising the manufacturer’s softdrinks; both the manufacturer and the store ben-efit from increased store traffic and its associatedsales. Cooperative advertising is especially ap-pealing to small storeowners who, on their own,

could not afford to advertise the product ade-quately.

Direct-Mail AdvertisingCatalogues, flyers, let-ters, and postcards are just a few of the direct-mailadvertising options. Direct-mail advertising hasseveral advantages, including detail of informa-tion, personalization, selectivity, and speed. Butwhile direct mail has advantages, it carries anexpensive per-head price, is dependent on theappropriateness of themailing list, and is resentedby some customers, who consider it ‘‘junk mail.’’

Informational Advertising In informationaladvertising, which is used when a new product isfirst being introduced, the emphasis is on pro-moting the product name, benefits, and possibleuses. Car manufacturers used this strategy whensport utility vehicles (SUVs) were first intro-duced.

Institutional Advertising Institutional adver-tising takes a much broader approach, concen-trating on the benefits, concept, idea, orphilosophy of a particular industry. Companiesoften use it to promote image-building activities,such an environmentally friendly business prac-tices or new community-based programs that itsponsors. Institutional advertising is closely re-lated to public relations, since both are interestedin promoting a positive image of the company tothe public. As an example, a large lumber com-pany may develop an advertising theme aroundits practice of planting trees in areas where theyhave just been harvested. A theme of this naturekeeps the company’s name in a positive light withthe general public because the replanting of treesis viewed positively by most people.

Outdoor Advertising Billboards and messagespainted on the side of buildings are commonforms of outdoor advertising, which is often usedwhen quick, simple ideas are being promoted.Since repetition is the key to successful promo-tion, outdoor advertising is most effective whenlocated along heavily traveled city streets andwhen the product being promoted can be pur-chased locally. Only about 1 percent of advertis-ing is conducted in this manner.

ADVERTISING


Persuasive Advertising Persuasive advertisingis used after a product has been introduced tocustomers. The primary goal is for a company tobuild selective demand for its product. For exam-ple, automobile manufacturers often producespecial advertisements promoting the safety fea-tures of their vehicles. This type of advertisementcould allow automobile manufactures to chargemore for their products because of the perceivedhigher quality the safety features afford.

Product Advertising Product advertising per-tains to nonpersonal selling of a specific product.An example is a regular television commercialpromoting a soft drink. The primary purpose ofthe advertisement is to promote the specific softdrink, not the entire soft-drink line of a com-pany.

Reminder Advertising Reminder advertisingis used for products that have entered the maturestage of the product life cycle. The advertisementsare simply designed to remind customers aboutthe product and to maintain awareness. For ex-ample, detergent producers spend a considerableamount of money each year promoting theirproducts to remind customers that their prod-ucts are still available and for sale.

Point-of-Purchase Advertising Point-of-pur-chase advertising uses displays or other promo-tional items near the product that is being sold.The primary motivation is to attract customers tothe display so that they will purchase the product.Stores are more likely to use point-of-purchasedisplays if they have help from the manufacturerin setting them up or if the manufacturer pro-vides easy instructions on how to use the dis-plays. Thus, promotional items from manufac-turers who provide the best instructions or helpare more likely to be used by the retail stores.

Specialty Advertising Specialty advertising is aform of sales promotion designed to increasepublic recognition of a company’s name. A com-pany can have its name put on a variety of items,such as caps, glassware, gym bags, jackets, keychains, and pens. The value of specialty advertis-ing varies depending on how long the items used

in the effort last. Most companies are successfulin achieving their goals for increasing public rec-ognition and sales through these efforts.

ADVERTISING OBJECTIVES

Advertising objectives are the communicationtasks to be accomplished with specific customersthat a company is trying to reach during a partic-ular time frame. A company that advertises usu-ally strives to achieve one of four advertisingobjectives: trial, continuity, brand switching, andswitchback. Which of the four advertising objec-tives is selected usually depends on where theproduct is in its life cycle.

Trial The purpose of the trial objective is toencourage customers to make an initial purchaseof a new product. Companies will typically em-ploy creative advertising strategies in order to cutthrough other competing advertisements. Thereason is simple: Without that first trial of aproduct by customers, there will not be any re-peat purchases.

Continuity Continuity advertising is a strat-egy to keep current customers using a particularproduct. Existing customers are targeted and areusually provided new and different informationabout a product that is designed to build con-sumer loyalty.

Brand Switching Companies adopt brandswitching as an objective when they want cus-tomers to switch from competitors’ brands totheir brands. A common strategy is for a com-pany to compare product price or quality inorder to convince customers to switch to itsproduct brand.

Switchback Companies subscribe to this ad-vertising objective when they want to get backformer users of their product brand. A companymight highlight new product features, price re-ductions, or other important product informa-tion in order to get former customers of its prod-uct to switchback.

ADVERTISING


ADVERTISING BUDGET

Once an advertising objective has been selected,companies must then set an advertising budgetfor each product. Developing such a budget canbe a difficult process because brand managerswant to receive a large resource allocation topromote their products. Overall, the advertisingbudget should be established so as to be con-gruent with overall company objectives. Beforeestablishing an advertising budget, companiesmust take into consideration other market fac-tors, such as advertising frequency, competitionand clutter, market share, product differentia-tion, and stage in the product life cycle.

Advertising Frequency Advertising frequencyrefers to the number of times an advertisement isrepeated during a given time period to promote aproduct’s name, message, and other importantinformation. A larger advertising budget is re-quired in order to achieve a high advertisingfrequency: Estimates have been put forward thata consumer needs to come in contact with anadvertising message nine times before it will beremembered.

Competition and Clutter Highly competitiveproduct markets, such as the soft-drink industry,require higher advertising budgets just to stayeven with competitors. If a company wants to bea leader in an industry, then a substantial adver-tising budget must be earmarked every year. Ex-amples abound of companies that spend millionsof dollars on advertising in order to be key play-ers in their respective industries (e.g., Coca Colaand General Motors).

Market Share Desired market share is also animportant factor in establishing an advertisingbudget. Increasing market share normally re-quires a large advertising budget because a com-pany’s competitors counterattack with their ownadvertising blitz. Successfully increasing marketshare depends on advertisement quality, compet-itor responses, and product demand and quality.

Product Differentiation How customers per-ceive products is also important to the budget-setting process. Product differentiation is often

necessary in competitive markets where cus-tomers have a hard time differentiating betweenproducts. For example, product differentiationmight be necessary when a new laundry detergentis advertised: Since so many brands of detergentalready exist, an aggressive advertising campaignwould be required. Without this aggressive ad-vertising, customers would not be aware of theproduct’s availability and how it differs fromother products on the market. The advertisingbudget is higher in order to pay for the additionaladvertising.

Stage in the Product Life Cycle New productofferings require considerably more advertisingto make customers aware of their existence. As aproduct moves through the product life cycle,fewer and fewer advertising resources are neededbecause the product has become known and hasdeveloped an established buyer base. Advertisingbudgets are typically highest for a particularproduct during the introduction stage and grad-ually decline as the product matures.

SELECTING THE RIGHTADVERTISING APPROACH

Once a company decides what type of specificadvertising campaign it wants to use, it mustdecide what approach should carry the message.A company is interested in a number of areasregarding advertising, such as frequency, mediaimpact, media timing, and reach.

Frequency Frequency refers to the averagenumber of times that an average consumer isexposed to the advertising campaign. A companyusually establishes frequency goals, which canvary for each advertising campaign. For example,a company might want to have the average con-sumer exposed to the message at least six timesduring the advertising campaign. This numbermight seem high, but in a crowded and competi-tive market repetition is one of the best methodsto increase the product’s visibility and to increasecompany sales. The more exposure a companydesires for its product, the more expensive theadvertising campaign. Thus, often only large

ADVERTISING


companies can afford to have high-frequency ad-vertisements during a campaign.

Media Impact Media impact generally refersto how effective advertising will be through thevarious media outlets (e.g., television, Internet,print). A company must decide, based on itsproduct, the best method to maximize consumerinterest and awareness. For example, a companypromoting a new laundry detergent might farebetter with television commercials rather thansimple print ads because more consumers arelikely to see the television commercial. Similarly,a company such as Mercedes-Benz, which mar-kets expensive products, might advertise in spe-cialty car magazines to reach a high percentage ofits potential customers. Before any money isspent on any advertising media, a thorough anal-ysis is done of each one’s strengths and weak-nesses in comparison to the cost. Once the analy-sis is done, the company will make the bestdecision possible and embark on its advertisingcampaign.

Media Timing Another major considerationfor any company engaging in an advertising cam-paign is when to run the advertisements. Forexample, some companies run ads during theholidays to promote season-specific products.The other major consideration for a company iswhether it wants to employ a continuous or puls-ing pattern of advertisements. Continuous refersto advertisements that are run on a scheduledbasis for a given time period. The advantage ofthis tactic is that an advertising campaign can runlonger and might provide more exposure overtime. For example, a company could run anadvertising campaign for a particular productthat lasts years with the hope of keeping theproduct in the minds of customers. Pulsing indi-cates that advertisements will be scheduled in adisproportionate manner within a given timeframe. Thus, a company could run thirty-twotelevision commercials over a three- or six-month period to promote the specific product iswants to sell. The advantage with the pulsingstrategy is twofold. The company could spendless money on advertising over a shorter time

period but still gain the same recognition becausethe advertising campaign is more intense.

Reach Reach refers to the percentage of cus-tomers in the target market who are exposed tothe advertising campaign for a given time period.A company might have a goal of reaching at least80 percent of its target audience during a giventime frame. The goal is to be as close to 100percent as possible, because the more the targetaudience is exposed to the message, the higherthe chance of future sales.

ADVERTISING EVALUATION

Once the advertising campaign is over, compa-nies normally evaluate it compared to the estab-lished goals. An effective tactic in measuring theusefulness of the advertising campaign is to mea-sure the pre- and post-sales of the company’sproduct. In order to make this more effective,some companies divide up the country into re-gions and run the advertising campaigns only insome areas. The different geographic areas arethen compared (advertising versus nonad-vertising), and a detailed analysis is performed toprovide an evaluation of the campaign’s effec-tiveness. Depending on the results, a companywill modify future advertising efforts in order tomaximize effectiveness.

SUMMARY

Advertising is the paid, nonpersonal promotionof a cause, idea, product, or service by an identi-fied sponsor attempting to inform or persuade aparticular target audience. Advertising hasevolved to take a variety of forms and has per-meated nearly every aspect of modern society.The various delivery mechanisms for advertisinginclude banners at sporting events, billboards,Internet Web sites, logos on clothing, magazines,newspapers, radio spots, and television commer-cials. While advertising can be successful at get-ting the message out, it does have several limita-tions, including its inability to (1) focus on anindividual consumer’s specific needs, (2) providein-depth information about a product, and (3) becost-effective for small companies. Other factors,

ADVERTISING


such as objectives, budgets, approaches, and eval-uation methods must all be considered.

BIBLIOGRAPHY

Boone, L. E., and Kurtz, D. L. (1992). Contemporary Market-ing, 7th ed. New York: Dryden.

Churchill, G. A., and Peter, P. J. (1995).Marketing: CreatingValue for Customers. Boston: Irwin.

Farese, L., Kimbrell, G., and Woloszyk, C. (1991).MarketingEssentials. Mission Hills, CA: Glencoe/McGraw-Hill.

Kotler, P., and Armstrong, G. (1993). Marketing: An Intro-duction, 3d ed. Englewood Cliffs, NJ: Prentice-Hall.

Semenik, R. J., and Bamossy, G. J. (1995). Principles ofMarketing: A Global Perspective, 2d ed. Cincinnati, OH:South-Western.

ALLEN D. TRUELL

MICHAEL MILBIER


Advertising agencies are independent businessesthat evolved to develop, prepare, and place ad-vertising in advertising media for sellers seekingto find customers for their goods, services, andideas (American Association of AdvertisingAgencies, 2000). Advertisers use agents when theybelieve the agency will be more expert than theyare at creating advertisements or at developing anadvertising campaign. As businesses have becomemore complex and diversified, many of themhave consulted agencies to help them carry outtheir marketing communication efforts.

The modern advertising agency provides avariety of important services to clients, includingmedia planning and buying, research, market in-formation, sales promotion assistance, campaigndevelopment and creation of advertisements, plusa range of services designed to help the advertiserachieve marketing objectives. The first docu-mented advertising agency in the United Stateswas the N. W. Ayer Agency, established in 1877(Gilson, 1980). Prior to this time, advertisingagents were space brokers—agents who solicitedads from businesses and then sold them to news-papers that had difficulty getting out-of-townadvertising (Gilson, 1980; Russell and Lane,1998).

EVOLUTION OF THE ADVERTISINGAGENCY FROM THE 1870s TO THE

EARLY 1900s

During the late nineteenth century, most adver-tising appeared in newspapers, on posters, and inhandbills (Wells et al. 2000). Because it was diffi-cult to reproduce illustrations, most of these adswere simple text-based items.

By 1900, the first specialized magazines hadbegun to appear in the United States. Magazinessuch as Field & Stream (in 1895) and GoodHousekeeping (in 1900) established niche mar-kets, which allowed for mass marketing to con-sumers with varied interests. Also, print technol-ogy had evolved considerably, making full-colorillustrations possible. Advertising agencies beganto use the new technology to create more attrac-tive advertisements for the new niche markets,thus becoming creative centers rather thanmerely space brokerages.

The late nineteenth and early twentieth centu-ries were times of public concern about unethicalbusiness practices.Many professions formed theirown organizations to create ethical standards ofoperation. The American Association for Adver-tising Agencies (AAAA) was founded in 1917,partially in response to these ethical concerns.

Newspapers also set their own ethical stan-dards concerning rates charged for advertise-ments. By 1917, publishers had agreed to set a flatrate of 15 percent as the standard commission anadvertising agency would receive—with the ex-ception of local advertising, for which there wasgenerally no predetermined commission (Russelland Lane, 1998).

In addition, two laws were passed to alleviateconcerns about unethical advertising practices.The Federal Trade Commission Act of 1914 wasoriginally designed to make all unfair methods ofcompetition unlawful. It was not until 1922 thatadvertising was legally regulated under this act.The case that set this legal precedent was FTC v.Winsted Hosiery Company (1922) (Russell andLane, 1998). The Pure Food and Drug Act of 1906was the first act that limited the advertising ofpatent medicines—drugs that were advertised



A popular Pepsi-Cola television advertisement from the mid-1990s.

using exaggerated claims of effectiveness—foruse by children.

EVOLUTION OF THE ADVERTISINGAGENCY FROM 1920 TO THE EARLY 1950s

By the 1920s, the majority of advertising agencieshad determined that most family purchasing de-cisions were either made by or influenced by

women (Goodrum and Dalrymple, 1990). Thus,advertising agencies created full-color magazineadvertisements for goods such as expensive auto-mobiles, refrigerators, and radios. Newspaperscontinued to use simple advertisements.

Although Guglielmo Marconi had inventedthe first operating radio in 1895, radio becamepopular for home and family use only in the early



1920s. In that decade, as a result of radio’s massappeal, advertising agencies produced radio pro-grams for the sole purpose of attracting con-sumers for popular national products. For exam-ple, soap operas were originally created for thepurpose of advertising Procter & Gamble’s soapproducts (Gilson, 1980).

The 1930s were a time of renewed publicinterest in legislation concerning unfair and de-ceptive business practices. The 1934 Wheeler-LeaAmendment to the Federal Trade Commission Actenabled the Federal Trade Commission (FTC) toprotect consumers from deceptive advertising inthe food, drug, therapeutic device, and cosmeticindustries (Russell and Lane, 1998). TheRobinson-Patman Act of 1936 prevented manu-facturers from providing promotional allowancesto a retail customer unless it also offered promo-tional allowances to that customer’s competitors.

Although World War II suspended produc-tion of many peacetime goods and services, manyadvertising agents found employment workingfor the War Advertising Council, which was re-sponsible for mobilizing public support for thewar effort. This organization later became the AdCouncil.

EVOLUTION OF THE ADVERTISINGAGENCY FROM THE 1950s TO THE

EARLY 1990s

The end of World War II saw a culmination ofmore than a decade of unsatisfied consumer de-mand as a result of the Great Depression and war.Most markets for goods and services found awilling consumer base for new products—including television sets. Due to the proliferationof television sales in the 1950s, advertising agen-cies began to combine the visual impact of printads with the aural impact of radio to create alifelike effect. This, in turn, created a change inthe structure of advertising agencies. For exam-ple, prior to the 1950s, the main source of crea-tivity was the person writing the advertising mes-sage—referred to as the copywriter. As televisionmade more consumers comfortable with visualimagery, the art director and artist became moreimportant (Goodrum and Dalrymple, 1990).

It was during the 1950s that large numbers ofreturning veterans began to marry and have chil-dren—the generation of children known as baby-boomers. For the first time in the United States,advertising agencies found it profitable to marketcertain goods and services directly to the youthmarket. Ads for blue jeans and stereo equipmentappeared in newspaper inserts, in youth-orientedniche market magazines, and on television.

During the 1960s, large accounts from For-tune 500 companies migrated from the largeragencies to smaller, more responsive agencies(Goodrum and Dalrymple, 1990). The newer,more creative advertisements proved popularand profitable. The profits allowed agencies tospend more money on advertising research—often employing behavioral psychologists to de-sign elaborate studies of consumer buying behav-ior (Goodrum and Dalrymple, 1990). It was thefunction of the behavioral psychologist to deter-mine why consumers buy goods and services.

Advances in product design during the 1960sand 1970s resulted in few differences betweenmost products—a problem known as productparity (Goodrum and Dalrymple, 1990)—andforced advertising agencies to become more cre-ative in order to differentiate their client’s prod-uct from competitors’ equally good products. Allof this creativity had a cost—it became very ex-pensive to produce two-minute TV advertise-ments. Advertising agencies solved the cost di-lemma by designing thirty-second televisioncommercials with memorable advertising slo-gans—short phrases designed to keep a con-sumer’s attention and maintain recognition of aparticular brand of good or service.

Advertising agency clients began to demandresults for increasingly expensive ads—in theform of research data from the end-consumer(Goodrum and Dalrymple, 1990). However, thecost of this research, including the employmentof advertising researchers, was too great for smallagencies, forcing smaller agencies to merge intolarger ones during the 1980s (Goodrum and Dal-rymple, 1990). During this decade, some adver-tising agencies moved from traditional radio andTV advertising toward sales promotion techniques



(such as rebates, coupons, and sweepstakes) thatoffered measurable proof of increased sales(Wells et al., 2000).

EVOLUTION OF THE ADVERTISINGAGENCY FROM 1991 TO THE PRESENT

Present-day advertising agencies employ many ofthe techniques that were popular in the earlyyears of advertising. Newspapers continue to ad-vertise primarily in text format, although colorinserts are becoming popular. Advertising agen-cies continue to be able to advertise in smallerand smaller niche-market magazines. Radio re-mains a popular advertising medium in localmarkets. The widespread availability of cable TVand satellite transmission has fragmented televi-sion advertising into niche markets. However,some changes in the advertising industry con-tinue to change how advertising agencies operate.These changes are discussed below.

Globalization. Advertising agencies are underincreasing pressure to create ads for products in aglobal market, often advertising the same brandto different markets around the world. Agenciesmust often consider culture, language, and cus-toms when designing an advertisement tailoredto the international market. Today, in order tomeet the demands of a global market, advertisersare forming large multinational agencies andcontinuing to debate whether to standardize ad-vertising globally or to segment advertisementsby culture or nationality (Wells et al., 2000).

The Internet. Although the Internet contin-ues in be most accessible in developed countries,satellite transmission may soon make Internetaccess available to most people worldwide. TheInternet allows advertising agencies to target con-sumers worldwide and to conduct market re-search inexpensively. The easy access to marketresearch information may allow advertisingagencies to continue developing ads to reachsmaller and smaller niche markets worldwide. Atthe same time, certain forces are reducing theavailability and use of information gathered overthe Internet. For example, the Children’s OnlineProtection Act (1998), or COPA, is a U.S. law

that affects business transactions by children us-ing the Internet. COPA requires Web sites solicit-ing personal information from children underthe age of 13 to prominently post a privacy policyand require parental consent for the release ofpersonal information provided by those childrenbefore any business can be transacted. Manycountries are developing laws similar to COPA,and it remains to be seen how COPA and otherimpending legislation will affect advertisingagencies that conduct business globally.

The Role of Government in Advertising As of2000, the Ad Council acts as an advertisingagency that addresses social ills such as drunkdriving, racial intolerance, and domestic violence(Russell and Lane, 1998; The Ad Council, 2000).The Ad Council will probably expand its role asan advertising agency that serves as a catalyst forsocial change.

Changing Incentives While the 15-percentcommission on gross sales has been around forsome time, it is now common to offer otherincentives, such as box seats at sporting eventsand music concerts (Mayer, 1991).

EVOLVING CAREER FIELDS INADVERTISING

Today’s advertising agencies include a vast arrayof specialists who work together to create a com-plete and thorough advertising campaign. Ac-count managers allocate agency resources, in-cluding time, money, and personnel forindividual projects. An account manager oftenassembles a team of individuals, each bringing aparticular advertising specialty to the project. Theteam includes an art director, creative director,artist(s), copywriters, and designers. The teammay also include other specialists such as mediaanalysts, product testers, researchers, and publicrelations consultants.

BIBLIOGRAPHY

Ad Council, The. (2000). http://www.adcouncil.org.

American Association of Advertising Agencies. (2000).http://www.aaaa.org.



Balachandran, M.E., and Smith, M.O. (2000).‘‘E-Commerce: The new frontier in marketing.’’ BusinessEducation Forum 54(4): 37-39.

Gilson, C.C. (1980). Advertising Concepts and Strategies.New York: Random House.

Goodrum, C. and Dalrymple, H. (1990). Advertising inAmerica: The First 200 Years. New York: Harry N.Abrams.

Mayer, M. (1991). Whatever Happened to Madison Avenue?Boston: Little, Brown.

Norris, J.D. (1990). Advertising and the Transformation ofAmerican Society: 1865-1920. Westport, CT: Greenwood.

Russell, J.T., and Lane, W.R. (1998). Kleppner’s AdvertisingProcedure, 10th ed. Upper Saddle River, NJ: Prentice-Hall.

Wells, W., Burnett, J., and Moriarty, S. (2000). Advertising:Principles & Practice. Upper Saddle River, NJ: Prentice-Hall.

SCOTT WILLIAMS

JOHN A. SWOPE

AGGREGATE INCOME(SEE: Income)

AMERICAN INSTITUTEOF CERTIFIEDPUBLIC ACCOUNTANTS

The American Institute of Certified Public Ac-countants (AICPA) is the premier national pro-fessional organization for the certified public ac-countant (CPA) profession in the United States.Its founding in 1887 was a milestone in establish-ing accountancy as a profession distinguished byrigorous educational requirements, high profes-sional standards, a strict code of professional eth-ics, and a commitment to serving the public in-terest.

As of 2000, its membership numbers morethan 336,000 certified public accountants fromaround the country employed in various types ofenvironments. Approximately 45 percent work inbusiness and industry, nearly 40 percent work inpublic accounting firms, and still others are onthe staffs of government bodies and agencies orare employed by educational institutions. In ad-

dition, some members work in the legal profes-sion, offer consulting services, or have retired.Along with these membership segments, theAICPA has associates (those who have passed theUniform CPA Exam and are in the midst offulfilling the other requirements to becomeCPAs), as well as student and international affili-ates. All together, the AICPA represents morethan 350,000 people.

The AICPA’s primary mission is to providethe resources, information, and leadership neces-sary to enable CPAs to perform services in thebest professional manner to benefit the public aswell as employers and clients. Activities includeadvocacy, certification and licensing, communi-cations, recruiting and education, standards de-velopment, and performance monitoring. Incarrying out its mission, the Institute works withlocal CPA societies in fifty-four accountancy ju-risdictions (the fifty states plus Washington,D.C., Puerto Rico, the U.S. Virgin Islands, andGuam), giving priority to those areas where pub-lic reliance on CPA skills is greatest.

In light of its scope and resources, the AICPAis the national representative of CPAs before gov-ernments, regulatory bodies, and other organiza-tions in protecting and promoting members’ in-terests while preserving public confidence in thefinancial reporting system. It also promotes pub-lic awareness of and confidence in the integrity,objectivity, competence, and professionalism ofCPAs. Most notably, to enhance key businessdecision makers’ understanding of the skills andknowledge of CPAs, the AICPA launched the na-tion’s first advertising campaign conducted onbehalf of a profession. Having completed fiveconsecutive successful years, the comprehensivead campaign included television, radio, print,and Web site advertisements nationwide.

Through its volunteer member committeesand professional staff, the AICPA also establishes,monitors, and enforces professional standards, aswell as assisting members in continually improv-ing their professional conduct, performance, andexpertise. It also promotes and protects the CPAdesignation and encourages, among the statesthat license CPAs, the highest possible level of

AGGREGATE INCOME


uniform certification and licensing standards. Infact, the AICPA develops the Uniform CPA Ex-amination, which is administered to all candi-dates for the CPA designation in all states andU.S. licensing jurisdictions.

As the largest association for the accountingprofession, the AICPA is also the primary infor-mation resource for CPAs and on the CPA pro-fession. As such, the AICPA, as of 2000, is devel-oping an Internet-based vertical portal that willprovide CPAs with resources to better servicesmall to medium-sized business clients and orga-nizations. It will deliver information and servicesto the CPA more quickly, efficiently, and cost-effectively than is readily available today. Thegoal of the portal is to become the ultimatee-business destination for both the professionaland business needs of CPAs, their clients, andemployers. AICPA Online, the Institute’s Website (www.aicpa.org), offers the public the mostcomprehensive single source of information thatexists on the CPA profession. For its members,the Institute houses the nation’s most extensiveaccounting library and publishes numerous vol-umes of technical standards and topical publica-tions.

Another mission of the AICPA is to encour-age highly qualified individuals to become CPAs.Through member educators, recommendationsfor accounting curriculum, targeted recruitment,and promotional materials, the AICPA helps toensure the continuous flow of qualified CPAsinto the profession. Besides supporting the devel-opment of outstanding academic programs forstudents, the AICPA also is a major provider ofeducational courses and materials for continuingprofessional education, which is required bymost jurisdictions for the continued licensing ofCPAs and membership in the AICPA.

The AICPA’s initiatives carried out on behalfof the CPA profession are numerous and alwaysevolving to keep in step with the changing needsof a very diverse membership in a volatile busi-ness environment. As a major component of thisgoal, the AICPA in 1998 launched the ongoingCPA Vision Project (www.cpavision.org).Through this nationwide grassroots initiative, the

CPA profession defined its own future, cullingthe views of CPAs in all segments of the profes-sion throughout the nation. By consensus, theprofession crafted a Core Purpose and VisionStatement and identified a new set of core values,services, and competencies that will characterizethe work of CPAs in the future. The CPA Vision,a collective term for these findings, will extendthe CPA’s unique skills, expertise, and training tonew services and products that bring uniqueadded value on an ongoing basis to an ever-changing marketplace.

In an effort to identify areas where CPAs canmarket new services built on their special exper-tise and to drive markets to members, the Insti-tute developed ‘‘assurance services,’’ which aredesigned to improve the quality of information,or its context, for decision makers. Decisionmakers can be management, users of financialand nonfinancial information, or even con-sumers. The AICPA trains and licenses CPAs tooffer an exclusive assurance service and seal forWeb sites of companies engaging in electroniccommerce over the Internet. Known as CPAWebTrust, the service indicates by means of aspecial WebTrust seal that appears on a com-pany’s Web site that a CPA has verified the com-pany’s business practices, transaction integrity,and privacy and security measures. The seal isintended to give consumers assurance in con-ducting e-commerce transactions on that Website. Other assurance services include CPA El-derCare Services (providing financial and nonfi-nancial services to assist older clients), CPASysTrust (increasing confidence in systems thatsupport a business or activity), and CPA Perform-ance View (facilitating an entity’s development ofa performance measurement system tailored toits unique mission and strategic plan).

For the increasing number of CPAs who aremembers of management in corporations of allsizes—referred to as members in ‘‘business andindustry’’—the AICPA established the Center forExcellence in Financial Management (CEFM). TheCEFM is a virtual resource for the many AICPAprograms, products, services, internal resources,and external partnerships that support the work

AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS


of business and industry members. Those of-ferings include a broad benchmarking program,special conferences, group and self-study profes-sional education courses, research on leading-edge management accounting topics, and newpublications. The CEFM also aims to keep mem-bers current on the skills, knowledge, technolo-gies, and management techniques required byCPAs to fill decision-making roles as key mem-bers of their companies’ management teams.

Embracing the talent and multiple perspec-tives offered by America’s many demographicgroups, the AICPA has adopted a diversity state-ment that it hopes will serve as a model for theCPA profession as well as other professional or-ganizations. In that statement, the AICPA vowsto take the lead in encouraging, valuing, andfostering diversity in its membership and thework force by identifying, recognizing, and sup-porting strategies and efforts within the organiza-tion and the profession dedicated to achievingthose diversity objectives.

In all its wide-ranging efforts on behalf of theCPA profession, the AICPA maintains the goal ofbecoming the best professional association in ex-istence. In June 1998, it became the first profes-sional membership organization in the UnitedStates to earn the ISO 9001 certification, awardedby the International Organization of Standardsusing a certification system based on a series ofinternational standards for quality managementand assurance.

Organizationally, the AICPA is member-driven and -managed. It carries out its missionand objectives through the volunteer work ofapproximately 2,000 members who serve on agoverning council, board of directors, boards,committees, subcommittees, and task forces. Thegoverning council, the nearly 300-member gov-erning body of the AICPA, meets twice a year andis responsible for establishing general policy. Toensure representation from all fifty-four account-ancy jurisdictions, one AICPA member is desig-nated by each CPA state society for a one-yearterm, and members from state societies with va-cancies on the council are elected each year for athree-year term. In addition, the board of direc-

tors, past chairs, and twenty-one members-at-large serve on the council.

The board of directors, the executive com-mittee of the council, advances the Institute’scontinuing objectives through leadership andmanagement. Its twenty-three members consistof sixteen directors and three public (non-CPA)members who serve for three-year terms, as wellas the chair, vice chair, immediate past chair, andthe president, who is a member of the Institutestaff.

With a staff of approximately seven hundred,the AICPA has four office locations. Its head-quarters is located at 1211 Avenue of the Ameri-cas, New York, NY 10036-8775. The other sitesare in Washington, D.C.; Jersey City, New Jersey;and Lewisville, Texas.

(SEE ALSO: Accounting; Accounting: historical perspec-tives)

BARRY C. MELANCON


The American Management Association (AMA)is the world’s leading membership-based man-agement development organization. The busi-ness education and management developmentprograms offered by the AMA provide its mem-bers and customers the opportunity to learn su-perior business skills and the best managementpractices available. The AMA fulfills this goalthrough a variety of seminars, conferences, as-sessments, customized learning solutions, books,and on-line resources. The range of programsoffered by the AMA includes finance, humanresources, sales and marketing, manufacturing,and international management, as well as numer-ous others.

The philosophy of the AMA is to be a non-profit, membership-based educational organiza-tion that assists individuals and enterprises in thedevelopment of organizational effectiveness,which is the primary sustainable competitive ad-vantage in a global economy. A major goal of the

AMERICAN MANAGEMENT ASSOCIATION


AMA is to identify the best management prac-tices worldwide to provide assessment, design,development, self-development, and instructionservices. The AMA meets this goal with an abun-dance of print and electronic media and learningmethodologies, which are designed for the solepurpose of enhancing the growth of individualsand organizations.

The origins of the AMA can be traced back to1913, when the National Association of Corpora-tion Schools was founded. Around 1922, the Na-tional Association of Corporation Schoolsmerged with the Industrial Relations Associationof America, which had been founded in 1918.The result of the merger was the National Per-sonnel Association. Shortly after the merger, in1923, the National Personnel Association’s boardof directors chose the new name of the AmericanManagement Association. The modern AMA, asit is known today, began with a consolidation offive closely related national associations, whichwere all dedicated to management education.The consolidation of the organizations into oneorganization prompted the regents of the StateUniversity of New York to grant the AMA thetitle of an educational organization.

The AMA offers numerous beneficial pro-grams aimed at a variety of people. In addition toits traditional programs, the AMA also providesprograms for high school and college studentsand has special partnerships with local manage-ment training organizations. More informationis available from the American Management As-sociation at 1601 Broadway, New York, NY10019; (212) 586-8100 (phone), (212) 903-8168(fax), (800) 262-9699 (customer service); or www.amanet.org.

NIKOLE M. POGEMAN


During the mid-1930s, the American MarketingSociety (organized in 1931) and the NationalAssociation of Teachers of Marketing (foundedin 1915) arrived at two realizations: both organi-

zations held common interests in marketing, andmany of their publications and membershipsoverlapped. Following such realizations, the ideaof merging the groups became a reality in 1937with the inception of the American MarketingAssociation (AMA).

AMA is a professional, nonprofit organiza-tion for marketers with more than 500 NorthAmerican professional chapters and worldwidemembership (in ninety-two countries) in excessof 45,000. AMA also furthers students’ profes-sional development through approximately 400collegiate chapters globally.

AMA was organized to advance marketingscience and has always emphasized improvingmarketing management through marketingknowledge gained through researching, record-ing, and disseminating information. Today,AMA strives to encourage greater interest in andconcern for education, to assist marketing pro-fessionals in their efforts toward personal andcareer development, and to promote integrationof ethical considerations and general marketingpractices.

In 1938, AMA agreed to work with the U.S.Bureau of the Census to unify government agencymarketing definitions. The AMA board debatedappropriate definitions and, in 1985, approveddefinitions for marketing (‘‘The process of plan-ning and executing the conception, pricing, pro-motion and distribution of ideas, goods and ser-vices to create exchanges that satisfy individualand organizational objectives)’’ andmarketing re-search (the ‘‘function that links the consumer,customer, and public to the marketer throughinformation.’’) (AMA, Definitions, 1999).

AMA disseminates information through fourscholarly journals, which provide forums forsharing marketing research efforts; three businessmagazines, which provide discussions on emerg-ing marketing issues for senior-level marketingexecutives; and one newsletter, which addressesall aspects of marketing, including insights onethics, new products, and more. Online versionsof these publications are available at www.ama.org/pub. More information is available fromAMA at 250 South Wacker Dr., Suite 200, Chi-

AMERICAN MARKETING ASSOCIATION


cago, Illinois 60606; (312) 648-0536 or (800)AMA-1150; or, http://www.ama.org.

BIBLIOGRAPHY

American Marketing Association (AMA). ‘‘AMA at aGlance.’’ Archived at: http://www.ama.org/about/ama/atglance.asp. 1999.

AMA. ‘‘Contacts at AMA.’’ Archived at: http://www.ana.org/contact/. 1999.

AMA. ‘‘Definitions.’’ Archived at: http://www.ama.org/aboutama/marketdef.asp. 1999.

AMA ‘‘Six Decades of Leading and Learning AmericanMarketing Association 1937 to 1997.’’ Archived at:http://www.ama.org/about/ama/sixtieth/index.asp.1999.

AMA. ‘‘About Us.’’ Timeline. Archived at: http://www.ama.org/about/ama/sixtieth/timeline.asp. 1999.

MARY JEAN LUSH

VAL HINTON

AMERICANS WITHDISABILITIES ACT

The Americans with Disabilities Act of 1990(ADA) is a comprehensive civil rights act forpeople with disabilities. On July 26, 1990, Presi-dent George Bush signed the ADA into law aswide-ranging legislation intended to make Amer-ican society more accessible to people with disa-bilities and to prohibit discrimination on thebasis of disability. The act is divided into fivetitles:

1. Employment. Businesses must providereasonable accommodations in all aspectsof employment to protect the rights ofindividuals with disabilities.

2. Public services. People with disabilitiescannot be denied participation in publicservice programs or activities that areavailable to people without disabilities.

3. Public accommodations. All new con-struction must be accessible to individualswith disabilities.

4. Telecommunications. Telecommunicationcompanies must have a telephone relay

service for individuals who use telecom-munications devices for the deaf (TTYs)or similar devices.

5. Miscellaneous. This title includes a provi-sion prohibiting coercing, threatening, orretaliating against individuals with disabil-ities or those assisting them in assertingtheir rights under the ADA.

The protection of the ADA applies primarily, butnot exclusively, to individuals with physical andmental disabilities.

Built on a foundation of statutory, legal, andprogrammatic experience, the ADA was modeledafter the Civil Rights Act of 1964 and the Rehabil-itation Act of 1973. In order to understand thebasis for the enactment of the ADA, one mustlook at certain historical events of the 1970s andthe disability rights movement. First and fore-most has been the desire of individuals with disa-bilities to work toward their goal of full participa-tion in American society, which led to theRehabilitation Act of 1973 and the Individualswith Disabilities Education Act of 1974 that sostrongly influenced the ADA.

Effects the ADA may have on businesses in-clude restructuring or altering the layout of abuilding, modifying equipment, and removingbarriers. For example, in September 1999,Greyhound Bus Lines of Dallas, Texas, removedarchitectural barriers and began to provide assis-tance to passengers with disabilities by means oflift-equipped buses. Another example of the ef-fects of the ADA occurred in February 1997,when Harrison County, Mississippi, gave peoplewho are deaf or hard of hearing an equal oppor-tunity to serve as jurors.

The Americans with Disabilities Act of 1990has been regarded as the most sweeping piece oflegislation since the Civil Rights Act of 1964.More information on the ADA is available at(800)514-0301 (voice) or (800)514-0383 (TDD).

BIBLIOGRAPHY

The Consumer Law Page; http://consumerlawpage.com

Department of Rehabilitation Web Site; http://www.rehab.cahwnet.gov/adaoview.htm�overview

AMERICANS WITH DISABILITIES ACT


President George Bush signed the Americans with Disabilities Act into law on July 26, 1990.

Indiana University/Purdue University Web Site; http://www.iupui.edu/�aao/legis.html

Job Accomodation Network; http://janweb.icdi.wvu.edu/kinder/overview/htm

U.S. Department of Justice Web Site; http://www.usdoj.gov/crt/ada/adahom1.htm

NIKOLE M. POGEMAN


Analytical procedures have become increasinglyimportant to audit firms and are now consideredto be an integral part of the audit process. Theimportance of analytical procedures is demon-strated by the fact that the Auditing StandardsBoard, the board that establishes the standards



for conducting financial statement audits, has re-quired that analytical procedures be performedduring all audits of financial statements. TheAuditing Standards Board did so through theissuance of Statement on Auditing Standards(SAS) No. 56 in 1988, which requires that analyt-ical procedures be used by auditors as they planthe audit and also in the final review of thefinancial statements. In addition, SAS No. 56encourages auditors to use analytical proceduresas one of the procedures they use to gather evi-dence related to account balances (referred to inauditing as a substantive test). The purpose ofthis article is to provide the reader with a generalunderstanding of analytical procedures and todescribe the process that auditors use in applyinganalytical procedures.

SAS No. 56 describes analytical procedures asthe ‘‘evaluation of financial information made bya study of plausible relationships among bothfinancial and nonfinancial data’’ (AICPA, 1998,56 p. 1). Accounting researchers have helped toclarify the process that auditors use to performanalytical procedures by developing models thatdescribe the various stages of the process. Onesuch model developed by Hirst and Koonce(1996) describes the performance of analyticalprocedures as consisting of five components: ex-pectation development, explanation generation,information search and explanation evaluation,decision making, and documentation. Due to theimportance of each of these five components tounderstanding the analytical procedures process,each of them is described in more detail.

The first step in the analytical proceduresprocess is the development of an expected ac-count balance. SAS No. 56 and auditing text-books (e.g., O’Reilly et al., 1998) provide someguidance as to the sources of information anauditor can use to develop these expectations.Examples of such sources include the following:

● Financial information from comparable priorperiods adjusted for any changes expected toaffect the current-period balances. For exam-ple, an expectation of sales revenues for thecurrent year might be based on the prioryear’s sales, adjusted for factors such as price

increases or the known addition or loss ofmajor customers.

● Expected results based on budgets or forecastsprepared by the client or projections of expec-ted results prepared by the auditor from in-terim periods or prior comparable periods.

● Available information from the company’s in-dustry. For example, changes in sales revenueor gross margin percentages might be basedon available data from industrywide statistics.

● Nonfinancial information. For example, salesrevenue for a client from the hotel industrymight be based on available data as to roomoccupancy rates.

After an auditor has developed an expecta-tion for a particular account balance (e.g., salesrevenue), the next step in the analytical proce-dures process is to compare the expected balanceto the actual balance. If there is no significantdifference (referred to by auditors as a materialdifference) between the expected and actual bal-ance, this conclusion provides audit evidence insupport of the account balance being examined.However, if there is a material difference betweenthe expected and actual balance, the auditor willinvestigate this difference further. At this pointthe auditor will develop an explanation for thedifference. Hirst and Koonce (1996) interviewedauditors from each of the six largest accountingfirms and found that the source of the explana-tion usually depends on what types of analyticalprocedures are being performed. If analyticalprocedures are being performed during the plan-ning phase of the audit, the auditor usually asksthe client the reason for the unexpected differ-ence. However, if the analytical procedures arebeing performed as a substantive test (method ofobtaining corroborating evidence) or during thefinal review phase of the audit, in addition toasking the client, auditors will often generatetheir own explanation or ask other members ofthe audit team for an explanation.

When developing an explanation for an un-expected change in account balances, an auditorconsiders both error and nonerror explanations.Nonerror explanations are sometimes referred toas environmental explanations, since they refer to



changes in the business environment in whichthe client operates. For example, an environmen-tal explanation for an unexpected decline in grossprofit (sales revenue less cost of sales) may be thatthe client faces increasing foreign competitionand has been forced to reduce selling prices. Anerror explanation, on the other hand, might bethat the client has failed to record a profitable saleto a major customer. If this mistake is uninten-tional, then auditors refer to the mistake as an‘‘error.’’ However, if this mistake was intentional(i.e., the client failed to record the sale on pur-pose), auditors refer to the mistake as a ‘‘fraud.’’Auditors are much more concerned about errorsand fraud than changes resulting from environ-mental factors. In fact, auditors are most con-cerned about fraud, since this raises doubts aboutthe integrity of the client as well as about theprocess of recording transactions affecting otheraccount balances.

Once an auditor has a potential explanation,whether self-generated or obtained from the cli-ent, the next step in the analytical proceduresprocess is to search for information that can beused to evaluate the adequacy of the explanation.Similar to the explanation generation phase ofthe process, the extent of information search andexplanation evaluation depends on the type ofanalytical procedures being performed. Hirst andKoonce (1996) found that during the planningphase of analytical procedures, auditors do littleif any follow-up work to evaluate an explanation.Instead, consistent with SAS No. 56, auditorstypically use analytical procedures at the plan-ning stage to improve their understanding of theclient’s business and to develop the audit plan forthe engagement. For example, if analytical proce-dures performed on inventory during audit plan-ning indicated the inventory balance was higherthan expected, the auditor would most likely ad-just the audit plan by increasing the number ofaudit tests performed on inventory or assigningmore experienced personnel to the audit of in-ventory. Thus, if an error or fraud has occurredwith inventory, the revised audit plan for obtain-ing corroborating evidence will lead to detectionof the error or fraud.

If analytical procedures are being performedas a substantive test, the auditor will need togather information to evaluate the explanationbeing considered, since the primary purpose ofsubstantive analytical procedures is to provideevidence as to the validity of an account balance.The type and amount of corroboration for theexplanation will vary based on factors such as thesize of the unexpected difference, the significanceof the difference to the overall financial state-ments, and the risks (e.g., internal control andinherent) associated with the account balance(s)affected. As any of these factors increase, thereliability of the information obtained in supportof the explanation should also increase. SAS No.56 provides guidance for auditors in the evalu-ation of the reliability of data. Some of the factorsto be considered by the auditors include the fol-lowing:

● Data obtained from independent sources out-side the entity are more reliable than data ob-tained from sources within the entity.

● If data are obtained from within the entity,data obtained from sources independent fromthe amount being audited are more reliable.

● Data developed under a system with adequatecontrols are more reliable than data from asystem with poor controls.

After an auditor gathers information for pur-poses of evaluating an analytical procedures ex-planation, it is a matter of professional judgmentin determining whether the evidence adequatelysupports the explanation. This is one of the mostimportant steps of the analytical procedures pro-cess and is referred to as the decision phase of theprocess. Factors the auditor should consider inevaluating the acceptability of an explanation in-clude the materiality of the unexpected differ-ence, reliability of the evidence obtained to sup-port the explanation, and whether theexplanation is sufficient to explain a material(significant) portion of the unexpected differ-ence. If, after evaluating the evidence, the auditorfinds that the explanation being considered doesnot adequately explain the unexpected differ-ence, the auditor should return to the ‘‘explana-



tion generation’’ phase of the process. If the audi-tor believes that the audit evidence obtainedadequately supports the explanation, the auditormay proceed to the final step of the process,which is ‘‘documentation.’’ While the extent ofwritten documentation will vary depending onthe materiality of the unexpected difference, theaudit work papers will generally include a writtendescription of material unexpected differences,an explanation for the difference, evidence thatcorroborates the explanation, and the judgmentof the auditor as to the adequacy of the explana-tion.

The purpose of this article has been to pro-vide the reader with a basic understanding ofanalytical procedures. Space limitations, how-ever, preclude discussing in more detail some ofthe complexities associated with analytical proce-dures. Thus, the interested reader is referred toStatement on Auditing Standards No. 56(AICPA, 1988) or to Montgomery’s Auditing(O’Reilly et al., 1998) for a more in-depth discus-sion. Further, while the focus of this article hasbeen on the use of analytical procedures duringfinancial statement audits, portions of analyticalprocedures can also be helpful to both manage-ment and investors. For example, managers of abusiness may develop certain key ratios and sta-tistics, which can be used to monitor the progressof the business. For example, a manager may usedata such as the number of new customers, num-ber of customer complaints, and other customersatisfaction measures to monitor the sales reve-nue and profitability of the company. An investormight also use analytical procedures to evaluatehis or her investment portfolio. For example, aninvestor may try to forecast the future sales of acompany based on knowledge of the industry inwhich the company operates and the prior saleshistory of the company. The sales forecast couldthen be used to develop an earnings forecast forthat company, which is a critical component indeveloping an investment decision. Thus, whileanalytical procedures are an integral part of theaudit process, they can also be a useful tool formanagers and investors.

(SEE ALSO: Financial statement analysis; Accounting;Auditing)

BIBLIOGRAPHY

American Institute of Certified Public Accountants. (1988).Statement on Auditing Standards No. 56: Analytical Proce-dures. New York: Author.

Hirst, Eric D., and Koonce, Lisa. (Fall 1996). ‘‘Audit Analyti-cal Procedures: A Field Investigation.’’ Contemporary Ac-counting Research: 457-486.

O’Reilly, Vincent M., McDonnell, Patrick J., Winograd,Barry N., Gerson, James S., and Jaenicke, Henry R.(1998) Montgomery’s Auditing, 12th ed. New York:Wiley.

JEAN C. BEDARD

JAMES J. MARONEY


In the United States, toward the last part of thenineteenth century, widespread business combi-nations known as trust agreements existed. Theseagreements usually involved two or more compa-nies that combined with the purpose of raisingprices and lowering output, giving the trusteesthe power to control competition and maximizeprofits at the public’s expense. These trust agree-ments would result in a monopoly. To combatthis sort of business behavior, Congress passedantitrust legislation.

In 1890 Congress passed the Sherman An-titrust Act, which forbade all combinations orconspiracies in restraint of trade. The act con-tained two substantive provisions. Section 1 de-clared illegal contracts and conspiracies in re-straint of trade, and Section 2 prohibitedmonopolization and attempts to monopolize.When an injured party or the government filedsuits, the courts could order the guilty firms tostop their illegal behavior or the firms could bedissolved. The Sherman Antitrust Act pertainedonly to trade within the states, and monopoliesstill flourished as companies found ways aroundthe law.

In 1914 Congress passed the Clayton Act asan amendment to the Sherman Act. The ClaytonAct made certain practices illegal when their ef-



A cartoon illustrating antitrust legislation attacking monopolies.

fect was to lessen competition or to create amonopoly. The main provisions of this act in-cluded (1) forbidding discrimination in price,services, or facilities between customers; (2) de-termining that antitrust laws were not applicableto labor organizations; (3) prohibiting require-ments that customers buy additional items in

order to obtain products desired; and (4) makingit illegal for one corporation to acquire the stockof another with intention of creating a monop-oly. Because loopholes were also present in theClayton Act, the Federal Trade Commission(FTC) was established to enforce the antitrustlegislation.



Passed in 1914, the Federal Trade Commis-sion Act provided that ‘‘unfair methods of com-petition in or affecting commerce are hereby de-clared unlawful.’’ The FTC consists of fivemembers appointed by the president and has thepower to investigate persons, partnerships, orcorporations in relation to antitrust acts. Exam-ples of unlawful trade practices includemisbranding goods quality, origin, or durability;using false advertising; mislabeling to misleadconsumer about product size; and advertising orselling rebuilt goods as new. The act also gave theFTC the power to institute court proceedingsagainst alleged violators and provided the penal-ties if found guilty.

The Robinson-Patman Act of 1936 strength-ened the price discrimination provisions of theClayton Act. One amendment involved the dis-crimination in rebates, discounts, or advertisingservice charges; underselling and penalties. An-other provided for the exemption of non-profitinstitutions from price-discrimination provi-sions. The main purpose of this act was to justifythe differences in product costs between cus-tomers and clarify the Robinson-Patman Act.

The Celler-Kefauver Antimerger Act, passedin 1950, extended the Clayton Act’s injunctionagainst mergers. Since the purpose of this act wasto forbid mergers that prevented competition,corporations that were major competitors wereprohibited from merging in any manner. Thisamendment extended the FTC’s jurisdiction toall corporations. This act, however, was not in-tended to stop the merger of two smaller compa-nies or the sale of one in a failing condition. Dueto court decisions that had weakened the ClaytonAct, the Celler-Kefauver Antimerger Act was nec-essary to restrict mergers.

Although antitrust laws have contributedenormously to improving the degree of competi-tion in our system, they have not been a completesuccess. A sizable number of citizens would liketo see these laws broadened to cover professionalbaseball teams, labor unions, and professionalorganizations. Without the antitrust legislationthat now exists, however, our economy would beworse off in the end.

(SEE ALSO: Sherman Antitrust Act of 1890; Robinson-Patman Act of 1936; Federal Trade Commission Actof 1914)

BIBLIOGRAPHY

Antitrust statutes. http://www.stolaf.edu/people/becker/antitrust/statutes/shermann.html.

Boarman, Patrick M. (1993). ‘‘Antitrust Laws in GlobalMarket. Challenge.’’ Jan/Feb: 30-45.

Mueller, Charles E. (1997). ‘‘Antitrust Law and EconomicsReview.’’ http://home.mpinet.net/cmueller/ii-03.html.

http://www.stolaf.edu/people/becker/antitrust/statutes/clayton.html.

http://www.stolaf.edu/people/becker/antitrust/statutes/ftc.html.

JANEL KUPFERSCHMID

ARTIFICIAL INTELLIGENCEComputer systems are becoming commonplace; in-deed, they are almost ubiquitous. We find them cen-tral to the functioning of most business, governmen-tal, military, environmental, and health-careorganizations. They are also a part of many educa-tional and training programs. But these computersystems, while increasingly affecting our lives, arerigid, complex and incapable of rapid change. Tohelp us and our organizations cope with the unpre-dictable eventualities of an ever-more volatile world,these systems need capabilities that will enable themto adapt readily to change. They need to be intelli-gent. Our national competitiveness depends increas-ingly on capacities for accessing, processing, and ana-lyzing information. The computer systems used forsuch purposes must also be intelligent. Health-careproviders require easy access to information systemsso they can track health-care delivery and identifythe most recent and effective medical treatments fortheir patients’ conditions. Crisis management teamsmust be able to explore alternative courses of actionand support decision making. Educators need sys-tems that adapt to a student’s individual needs andabilities. Businesses require flexible manufacturingand software design aids to maintain their leadershipposition in information technology, and to regain itin manufacturing. (Grosz and Davis, 1994)

The history of artificial intelligence (AI) predatesthe development of the first computing ma-



chines. On a general level, intelligence has beenthe subject of philosophical study for 2000 years.At the computational level, mathematician AlanTuring constructed a framework for AI duringthe era of analog computers.

While precise definitions are still the subjectof debate, AI may be usefully thought of as thebranch of computer science that is concerned withthe automation of intelligent behavior. The intentof AI is to develop systems that have the ability toperceive and to learn, to accomplish physicaltasks, and to emulate human decision making. AIseeks to design and develop intelligent agents aswell as to understand them. Currently, the mainfields of research and development include thefollowing:

1. Natural languages: These studies focus onproblems related to natural language in-terface, machine translation, understand-ing spoken language, and so forth.

2. Expert systems: No generalizable solutionsare researched, but expertise is used todeal with ill-defined problems and rela-tionships.

3. Cognition and learning: Investigations arebeing made into modes of thinking,learning, and problem solving.

4. Computer vision: Efforts are being madeto develop principles and algorithms formachine vision and the interpretation ofvisual data.

5. Automatic deduction: This area deals withthe resolution of problems, theoremproving, and logic programming.

FOUNDATIONS

The term ‘‘AI’’ was applied about 1956, giving aformal name to work that had been developingover the previous five or six years. Individualsand organizations have an abiding interest in AIfor several important reasons, including the fol-lowing:

1. To preserve expertise that might be lostwhen an acknowledged expert is unavail-able.

2. To create organizational knowledge basesso that others may learn from past prob-lem-solving successes.

3. To help decision makers be consistent intheir evaluation of complex problems.

During its early years AI was dominated byreliance on logic as a means of representingknowledge and on logical inference as the pri-mary mechanism for intelligent reasoning. In the1990s other paradigms arrived on the scene,some of which had a dramatic impact. Artificialneural networks (ANNs) were motivated by as-sumptions about how the brain functions—particularly the ideas of massively parallel con-nections, each of which performs simple compu-tational tasks. Taken together, they representknowledge as a property of patterns of relation-ships. Genetic algorithms apply principles of bio-logical evolution to the problems of searchingcomplex solution spaces. The programs do notuse logical reasoning either, but evolve towardbetter and better solutions to complex problems.

Multiagent systems have recently come to thefore of AI research. This emergence has beendriven by a recognition that intelligence may bereflected by the collective behaviors of largenumbers of very simple interacting members of acommunity of agents. These agents can be com-puters, software modules, or virtually any objectthat can perceive aspects of its environment andproceed in a rational way toward accomplishing agoal.

A variety of disciplines have influenced thedevelopment of AI. These include philosophy( l o g i c ) , ma th ema t i c s ( i n t r a c t i b i l i t y ,computability, algorithms), psychology (cogni-tion), engineering (computer hardware and soft-ware), and linguistics (knowledge representationand natural-language processing).

Long before the development of computers,the notion that thinking was a form of computa-tion motivated the formalization of logic. Theseefforts continue today. Graph theory providedthe architecture for searching a solution space fora problem. Operations research, with its focus onoptimization algorithms, used graph theory and



other methods to solve complex decision-makingproblems.

In 1950, Alan Turing proposed what has be-come known as the Turing Test for defining in-telligent behavior. The idea was to specify re-quirements that a computer would have toexhibit in order to demonstrate intelligence.Briefly, the Turing Test proposes that the com-puter should be interrogated via telecommunica-tions by a human. Intelligence is exhibited by thecomputer if the interrogator cannot tell whetherthere is a human or a computer at the other end.In order to pass the test, a computer would needto have capabilities for natural-language process-ing, knowledge representation, automated rea-soning, and machine learning.

AN EVOLUTION OF APPLICATIONS

While computer systems have become common-place, they are generally rigid, complex, andincapable of rapid change. According to A Reportto ARPA on Twenty-First Century Intelligent Sys-tems, for us and our organizations to cope withthe unpredictable eventualities of an ever-morevolatile world, these systems need capabilitiesthat will enable them to adapt readily to change.The report argues that our national competitive-ness depends increasingly on capacities for ac-cessing, processing, and analyzing information(Grosz and Davis, 1994).

One of the early milestones in AI was Newelland Simon’s General Problem Solver (GPS). Theprogram was designed to imitate human prob-lem-solving methods. This and other develop-ments such as Logic Theorist and the GeometryTheorem Prover generated enthusiasm for thefuture of AI. Simon went so far as to assert that inthe near-term future the problems that comput-ers could solve would be coextensive with therange of problems to which the human mind hasbeen applied.

Soon difficulties in achieving this objectivebegan to manifest themselves. In scaling up fromearlier successes, problems of intractability wereencountered. A search for alternative approachesled to attempts to solve typically occurring casesin narrow areas of expertise. This prompted the

development of expert systems. A seminal modelwas MYCIN, developed to diagnose blood infec-tions. Having about 450 rules, MYCIN was ableto perform as well as many experts. This andother expert-systems research led to the firstcommercial expert system, R1, implemented atDigital Equipment Corporation (DEC) to helpconfigure orders for new computer systems. Sub-sequent to R1’s implementation, it was estimatedto save DEC about $40 million a year.

Other classic systems include the PROSPEC-TOR program for determining the probable loca-tion and type of ore deposits and the INTERNISTprogram for performing medical diagnosis ininternal medicine.

THE FUTURE

A Report to ARPA on Twenty-First Century Intelli-gent Systems identified four types of systems thatwill have a substantial impact on applications:intelligent simulation, intelligent information re-sources, intelligent project coaches, and robotteams (Grosz and Davis, 1994).

Intelligent simulations generate realistic simu-lated worlds that enable extensive affordabletraining and education that can be made avail-able any time and anywhere. Examples may behurricane crisis management, exploration of theimpacts of different economic theories, tests ofproducts on simulated customers, and techno-logical design—testing features through simula-tion that would cost millions of dollars to testusing an actual prototype.

Intelligent information resources systems(IRSS) will enable easy access to information re-lated to a specific problem. For instance, a ruraldoctor whose patient presents with a rare condi-tion might use IRSS to help assess different treat-ments or identify new ones. An educator mightfind relevant background materials, including in-formation about similar courses taught else-where.

Intelligent project coaches (IPC) could func-tion as co-workers, assisting and collaboratingwith design or operations teams for complexsystems. Such systems could remember and recallthe rationale of previous decisions and, in times



of crisis, explain the methods and reasoning pre-viously used to handle that situation. An IPC foraircraft design, for example, could enhance col-laboration by keeping communication flowingamong the large, distributed design staff, the pro-gram managers, the customer, and the subcon-tractors.

Robot teams could contribute to manufactur-ing by operating in a dynamic environment withminimal instrumentation, thus providing thebenefits of economies of scale. They could alsoparticipate in automating sophisticated labora-tory procedures that require sensing, manipula-tion, planning, and transport.

CONCLUSION

AI is a young field and faces many complexities.Nonetheless, the Spring 1998 issue of AI Maga-zine contained articles on the following innova-tive applications of AI: This is suggestive of thebroad potential of AI in the future.

1. ‘‘Case- and Constraint-Based ProjectPlanning for Apartment Construction’’

2. ‘‘CREWS–NS: Scheduling Train Crews inThe Netherlands’’

3. ‘‘An Intelligent System for Case Reviewand Risk Assessment in Social Services’’

4. ‘‘CHEMREG: Using Case-Based Rea-soning to Support Health and SafetyCompliance in the Chemical Industry’’

5. ‘‘MITA: An Information-Extraction Ap-proach to the Analysis of Free-Form Textin Life Insurance Applications’’

BIBLIOGRAPHY

AI Magazine. (Spring 1998).

Grosz, Barbara, and Davis, Randall, eds. (1994). A Report toARPA on Twenty-First Century Intelligent Systems.

Luger, George F., and Stubblefield, William A. (1998).Artificial Intelligence: Structures and Strategies for Com-plex Problem Solving, 3d ed. Reading, MA: Addison-Wesley.

Russell, Stuart J., and Norvig, Peter. (1995). Artificial Intelli-gence: A Modern Approach. Upper Saddle River, NJ:Prentice-Hall.

JAMES V. HANSEN

ASSURANCE SERVICES

Assurance services are a class of services providedby certified public accountants (CPAs) in publicpractice. While the term is sometimes used in-consistently among individual CPA firms, theAmerican Institute of Certified Public Account-ants (AICPA) Special Committee on AssuranceServices defined assurance services as ‘‘indepen-dent professional services that improve the qual-ity of information, or its context, for decision-makers.’’

Assurance services are rooted in the CPA’stradition of independent verification of data pre-pared by others. They differ from many serviceshistorically provided by CPAs in that they repre-sent an expansion of the information and formsof reports provided. Indeed, they represent anevolution in the nature of services provided byCPAs, as CPAs have begun to provide servicesnot just on accounting information but on manyother types of information that people need inorder to make decisions.

THE EVOLUTION OF CPA SERVICES

Since the early part of the twentieth century,CPAs have audited financial statements. Theaudit is the CPA’s defining service and, asidefrom preparation of income taxes, the servicemost closely associated with the CPA profession.In an audit of financial statements, the CPA ex-amines the transactions that underlie an entity’sfinancial statements and reports whether the fi-nancial statements are fairly stated in conformitywith generally accepted accounting principles.Such an opinion is required by the Securities andExchange Commission (SEC) for companieswhose stock is publicly traded and is often de-manded by others, such as lenders, for entitiesthat are not subject to the SEC.

Beginning in the 1970s, financial statementusers requested that CPAs provide some of thebenefits of audits at a lower cost. As a result, CPAsbegan providing a lower-level service, called areview, on financial statements. Reviews are basedon inquiry and analytical procedures applied tofinancial statement amounts, rather than on the

ASSURANCE SERVICES


more rigorous procedures required in an audit,such as physical inspection and confirmationwiththird parties. The review culminates in a reportthat provides limited assurance, that is, that theCPA is not aware of any material modificationsthat should be made to the accompanying finan-cial statements in order for them to be in con-formity with generally accepted accounting prin-ciples. Reviews are used for quarterly financialstatements of publicly held companies. Reviewsare performed for privately owned companieswhen the financial statement user wants someassurance about the statements but do not requirethe level of assurance provided in an audit.

CPAs also provide a third level of service onfinancial statements, the compilation. This ser-vice, provided only to privately owned compa-nies, is usually done in connection with helpingthe company record its transactions and trans-form its records into financial statements. Theaccountant does not do any tests of the under-lying data, but helps put the data into financialstatement form and reads the statements for ma-terial misstatements. The compilation report ex-presses no assurance, but if the accountant dis-covers material misstatements, they must becorrected or described in the CPA’s report.

The 1980s brought additional expansion ofthe CPA’s role. Users wanted CPAs to use theaudit and review services to report on subjects inaddition to financial statements, such as the effec-tiveness of internal control and the company’scompliance with laws, regulations, or contracts.The profession’s response was the creation ofstandards for attestation engagements. In an attes-tation engagement, the CPA applies the tools usedin audits and reviews to provide assurance onwhether the subject matter of the engagement(such as internal control ormanagement’s discus-sion and analysis of operations) complies withapplicable criteria for measurement and disclo-sure. The result is a report much like an audit(reasonable assurance) or review (limited assur-ance) of financial statements. In addition, CPAscan apply procedures specifically designed by theexpected users of the report to financial or nonfi-nancial items. This service is neither an audit nor a

review. These engagements, called agreed-uponprocedures engagements, result in a report inwhich the CPA describes the procedures appliedand their results but provides no overall conclu-sion.

By the 1990s CPAs were being asked to ex-pand still further into additional services, includ-ing those that involve subjects far removed fromfinancial reporting and that do not involve anexplicit report or conclusion. This area of ser-vice—assurance services—is an extension of theaudit/attest tradition. It is generally distinct fromcommon consulting services, which generally ei-ther provide advice to clients or create internalsystems. Probably the most famous assuranceservice is that provided in controlling and count-ing the ballots for the annual Oscars ceremony.Another common assurance service involvesCPAs observing the drawing of numbers in statelotteries.

Figure 1 is a pictorial depiction of the rela-tionship among CPA services.

Assurance services might involve the type ofreports provided in more traditional attestationengagements or they might provide less struc-tured communications, such as reports withoutexplicit conclusions or reports that are issued onlywhen there are problems. Assurance services areoften desired to be more customized to informa-tion needs of decision makers in specific circum-stances. To be responsive to those needs, the formof CPA communication is expected to be moreflexible. Thus, a significant difference betweenassurance and attestation engagements is that as-surance engagements do not necessarily result in astandard form of report, whereas attestation en-gagements (andmore familiar audits and reviews)do. Yet assurance services require adherence tokey professional qualities by practitioners.

ELEMENTS OF ANASSURANCE ENGAGEMENT

The important elements involved in assuranceengagement are:

● Independence

● Professionalism

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Assurance Managementconsulting

Other (e.g., tax)

Compilation

Attestation

Audit/examination

Agreed uponprocedures

Review

Universe of CPA Services

Figure 1SOURCE: Assurance Services: Definition and Interpretive Commentary. AIPCA Committee on Assurance Services, Final Report.

● Information or context improvement

● Decision makers

The CPA should be independent in order toprovide an assurance service; that is, he or sheshould have no vested interest in the informationreported on. The CPA’s only interest should bethe accuracy of the information, not whether theinformation portrays results favorable or unfa-vorable to either the entity that prepares the in-formation or the one that uses it.

An assurance service is a professional service,meaning it draws on the CPA’s experience, ex-pertise, and judgment. It is based on the skillsbrought to bear in more traditional services, suchas measurement, analysis, testing, and reporting.

Information in an assurance service can befinancial or nonfinancial, historical or forward-looking, discrete data or information about sys-tems, internal or external to the decision maker.The information’s context relates to how it ispresented. An assurance service improves the in-formation or its context by providing assuranceabout its reliability, increasing its relevance, ormaking it easier to use and understand.

Decision makers are the users of the infor-mation and immediate beneficiaries of the assur-ance service. They might be internal to an entity,

such as the board of directors, or a trading part-ner, such as a creditor or customer. The goal ofan assurance service is to improve the informa-tion or its context so that decision makers canmake more informed—and presumably better—decisions. The decision maker need not be theparty engaging the CPA or paying for the service.

The needs of decision makers are evolving.For decades their needs were generally met byperiodic cost-based financial statements. As in-formation technology advances and needs be-come more decision-specific, decision makers arelikely to:

Replace their need for . . .

With a need for . . .

periodic information

historical data

cost-based information

financial information

static statements

real-time or continuous data

forward-looking data

value-based information

comprehensive data thatincludes nonfinancial

information

searchable databases

ASSURANCE SERVICES


Assurance services, how they are delivered,and the types of information they deal with areevolving to meet these changing needs.

Although the needs of each decision makerare unique, in research done by the Special Com-mittee on Assurance Services, decision makersexpressed keen interest in better informationabout topics such as:

● Business risks

● Product quality

● Performance measures

● Quality of processes and systems

● Strategic plan execution

● Government performance

TYPES OF ASSURANCE SERVICES

The Special Committee on Assurance Servicesidentified hundreds of assurance services thatCPAs provide. It also identified several servicesthat it believed would be of particular appeal todecision makers in the near future. They in-cluded the following.

Comprehensive risk assessments. The CPAidentifies and assesses the various risks facing anorganization, such as the operating environment,operating systems, or information systems. Therisks might be internal, external, or regulatory.The CPA can help prioritize the risks and assessthe entity’s efforts to control or mitigate risksfaced.

Business performance measurement. Manyorganizations use, or should use, data to run theirbusinesses other than that emanating from thefinancial reporting system. The service deals withidentifying or providing explicit assurance on thefinancial or nonfinancial measures used to evalu-ate the effectiveness or efficiency of the organiza-tion’s activities. While CPAs have historicallybeen involved in the development of financialstatement information, their skills and knowl-edge can add similar value to the creation ofother information that can monitor the organiza-tion’s results and its effectiveness in implement-ing strategic plans.

Electronic commerce. As more business isconducted electronically (via the Internet or inbusiness-to-business electronic data interchangesystems) participants have concerns about theintegrity and security of data transmitted in fur-therance of those transactions. An assurance ser-vice can help to address the risks and promotethe integrity and security of electronic transmis-sions, electronic documents, and the supportingsystems. One such service, CPA WebTrust, pro-vides explicit assurance about the disclosure of anentity’s business policies and about the controlsover privacy and information integrity in con-sumer purchases over the Internet.

Systems reliability. As information technol-ogy advances, it becomes increasingly commonfor critical information to be produced and actedon electronically. Accordingly, decision makersneed confidence that the information is continu-ously reliable. There is an increased need forassurance that systems are designed and operatedto produce reliable data in such areas as informa-tion about customers, suppliers, and employees,project costing, rights and obligations related tocontractual agreements, and competitors andmarket conditions. In systems reliability engage-ments, CPAs provide assurance about the designand operation of such systems.

Elder care services. The CPA assists the in-creasing population of older adults with a widerange of services such as bill paying, providingassurance that health care providers are pro-viding services in conformity with the client’scriteria, and consulting on care alternatives andhow to pay for them. The CPA provides indepen-dent, objective information to protect vulnerableclients from potentially unethical individuals andbusinesses as well as more traditional services(such as financial control) for nontraditional cli-ents.

Policy compliance. The CPA provides assur-ance that a company complies with its own poli-cies. The policies—such as ones involvingtreatment of women or minorities, conflicts ofinterest, animal testing, environmental matters,or customer service-might be based on internal

ASSURANCE SERVICES


concerns, calls for social accountability, or lawsand regulations.

Trading partner accountability. The CPA pro-vides assurance that the client’s trading part-ners—such as suppliers, customers, or joint ven-ture partners—have appropriately fulfilled theirresponsibilities. Common situations involvecollecting rents or royalties based on sales madeby another entity or agreements regarding use oflowest prices or specific billing practices.

Mergers and acquisitions. The CPA appliesthe types of services done on a client’s recordsand practices to a potential acquisition. He or shecan, for example, provide insights into the acqui-sition target’s business risks, appropriateness ofaccounting methods, the value of its assets, or theadequacy of its systems and controls.

BIBLIOGRAPHY

AICPA Special Committee on Assurance Services, Final Re-port.http://www.aicpa.org/assurance.

Elliott, Robert K., and Pallais, Don M. (1997). ‘‘Are YouReady For New Assurance Services?’’ Journal of Account-ancy June: 47-51.

Pallais, Don M., Spradling, L. Scott, and Ecklund, Kathy J.(1998). Guide to Nontraditional Engagements. FortWorth, TX: Practitioners Publishing Company

DON M. PALLAIS

ATTESTATION(SEE: Assurance Services)

AUDIT COMMITTEES

Audit committees are a key institution in thecontext of corporate governance because theyhelp boards of directors fulfill their financial andfiduciary responsibilities to shareholders.Through their audit committees, boards of direc-tors establish a direct line of communicationbetween themselves and the internal and externalauditors as well as the chief financial officer. Suchan organizational structure and reporting re-

sponsibility in an environment of free and unre-stricted access enables full boards of directors notonly to gain assurance about the quality of finan-cial reporting and audit processes, but also toapprove of significant accounting policy deci-sions. Moreover, strong and effective audit com-mittees, through their planning, review, andmonitoring activities, can recognize problemareas and take corrective action before suchproblems impact the company’s financial state-ments and investors. Thus, audit committeeshave an important role in helping boards of di-rectors avoid litigation risk because such com-mittees provide due diligence related to financialreporting.

REQUIREMENT FOR AUDIT COMMITTEES

Audit committees have long been seen as animportant group in assuring greater corporateaccountability in the United States. The value ofsuch committees has been noted by the U.S.Congress, the U.S. Securities and Exchange Com-mission, the New York Stock Exchange, and theAmerican Institute of Certified Public Account-ants. Audit committees are required by the NewYork Stock Exchange, American Stock Exchange,and National Association of Securities Dealers(NASDAQ/NMS issuers).

Key recommendations and decisions in theevolution of audit committees in the UnitedStates include the following

1940 The Securities and Exchange Commis-sion (SEC) recommended the establish-ment of audit committees (AccountingSeries Release No. 19). Specifically, theSEC recommended that shareholderselect the auditors at annual meetings anda committee of nonofficer directorsnominate the auditors. Also, the NewYork Stock Exchange Board of Governorsissued a similar recommendation.

1967 The executive committee of the Ameri-can Institute of Certified Public Account-ants (AICPA) recommended that publiclyheld corporations establish audit com-

AUDIT COMMITTEES


mittees to nominate the auditors anddiscuss the audit.

1972 The SEC issued Accounting Series Re-lease No. 123, ‘‘Standing Audit Commit-tees Composed of Outside Directors.’’

1973 The New York Stock Exchange (NYSE)issued a white paper, ‘‘Recommendationsand Comments on Financial Reportingto Shareholders and Related Matters,’’strongly recommending that each listedcompany form an audit committee.

1974 The SEC amended Regulation 14A deal-ing with the proxy rules. Registrants arerequired to disclose in their proxy state-ments the existence of audit committeesand the names of the committee mem-bers.

1977 A NYSE audit committee policy state-ment required each domestic corporationlisted on the exchange to establish andmaintain an audit committee of outsidedirectors before July 1, 1978.

1987 The National Commission on FraudulentFinancial Reporting recommended thatthe SEC require that all public compa-nies have audit committees.

1987 The National Association of SecuritiesDealers required each NASDAQ/NMS is-suer to establish an audit committee.

1991 Congress passed the Federal Deposit In-surance Corporation Improvement Act.The law provided for the establishmentof audit committees for insured deposi-tory institutions that have total assets of$150,000,000 or more.

1993 American Stock Exchange required itslisted companies to establish audit com-mittees.

1994 The American Law Institute issuedPrinciples of Corporate Governance:Analysis and Recommendations. The Insti-tute strongly supported and endorsed theconcept of audit committees.

1999 The Independence Standards Board is-sued its first standard, ‘‘IndependenceDiscussions with Audit Committees,’’which requires independent auditors toissue an annual independence confirma-tion to the audit committee of the com-pany.

1999 The SEC approved changes to its rules toimplement several of the recommenda-tions by the Blue Ribbon Committee onImproving the Effectiveness of CorporateAudit Committees. Registrants are re-quired to disclose information about au-dit committee composition and practices.

In addition to the presence of audit commit-tees on U.S. stock exchanges, a number of stockexchanges in Canada, Europe, Africa, the MiddleEast, and the Asia/Pacific region have adoptedaudit committees. As worldwide financial mar-kets expand and more companies are listed onmajor stock exchanges in different countries, theinternational investing public’s demand for con-sistent and equal oversight protection throughthe use of audit committees will continue. Inaddition, international investors are concernedabout the quality of corporate governance be-cause of the impact of financial collapses andalleged frauds on securities markets.

In response, a number of stock exchangeshave adopted audit committees to increase trans-parency and competence in the management oftheir listed member companies in order to dealeffectively with attracting foreign equity invest-ment.

ORGANIZATION AND STRUCTURE OFAUDIT COMMITTEES

Boards of directors form their audit committeesby either passing a board resolution or amendingcorporate bylaws. Audit committees’ responsibil-ities should be clearly defined and documented intheir charter. Although the scope of the auditcommittees’ responsibilities is predetermined byboards, the committees should be allowed toexpand their charge with board approval and

AUDIT COMMITTEES


investigate significant matters that impact finan-cial reporting disclosures.

Boards of directors should carefully give con-sideration to the following points with respect totheir appointments of directors to audit commit-tees:

1. Number of directors: The number of inde-pendent directors appointed to auditcommittees depends on the nature of thebusiness and industry dynamics, the sizeof the company, and the size of the boardof directors. The general consensus seemsto be that three to five members are ade-quate.

2. Composition: Because members of auditcommittees have varied backgrounds andoccupations, they provide a mix of skillsand experience. Although the membershave different levels of expertise, it isstrongly advisable to have at least one in-dividual who has a financial accountingbackground.

3. Meetings: Audit committees meet fromone to four times each year, with three orfour meetings being the most commonschedules.

NATURE OF AUDITCOMMITTEES RESPONSIBILITIES

Boards of directors define the role and responsi-bilities of their audit committees. This jurisdic-tional charge is usually disclosed in the auditcommittees’ written charter, which includes theterms of reference, such as mission statement,membership (size and composition), term of ser-vice, frequency of meetings, scope of responsibil-ities, and reporting responsibilities. Audit com-mittees are primarily responsible for the qualityrelated to such matters as:

● External auditing process

● Internal auditing process

● Internal controls

● Conflicts of interest (code of corporate con-duct, fraud presentation)

● Financial reporting process

● Regulatory and legal matters

● Other matters (interim reporting, informationtechnology, officers’ expense accounts)

Although boards of directors have definedthe responsibilities of audit committees, boardsmay expand the scope of the audit committees’charter; however, boards should avoid dilutingthe committees’ charge with information over-load. Recognizing that audit committees operateon a part-time basis and serve in an advisorycapacity to boards, it is essential that boards placelimitations on the scope of the committees’charge. Such a scope limitation enables boards toevaluate the committees’ performance as well asprotect the committees against legal claims fortheir inactions that are outside their charge. Anillustration of the roles and responsibilities ofaudit committees is disclosed in the annual proxystatement of a company.

BLUE RIBBON COMMITTEE ON IMPROVINGTHE EFFECTIVENESS OF CORPORATE

AUDIT COMMITTEES

On September 28, 1998, Arthur Levitt, chairmanof the SEC, presented an address at the New YorkUniversity Center for Law and Business entitled‘‘The Numbers Game.’’ He discussed matters re-lated to the issues involving the quality of finan-cial reporting (e.g., earnings management, re-serves, audit adjustments, revenue recognition,creative acquisition accounting, in-process re-search and development, and restructuringcharges). Because these issues impact a firm’squality of earnings and market capitalization(e.g., price-earnings ratios), Levitt requested a re-sponse from the entire financial community.

In response to Levitt’s concerns, in October1998, the New York Stock Exchange and theNational Association of Securities Dealers cre-ated the Blue Ribbon Committee on Improvingthe Effectiveness of Corporate Audit Commit-tees. In February 1999, the committee issued itsreport, which contains ten recommendationsdesigned to (1) strengthen the independence ofaudit committees; (2) increase the effectivenessof audit committees; and (3) improve the rela-

AUDIT COMMITTEES


tionship between boards and their audit com-mittees the activities of auditors and manage-ment. In December 1999, the SEC approvedchanges to its rules to implement several of theBlue Ribbon Committee’s recommendationswith respect to audit committee compositionand practices.

In view of the aforementioned recommenda-tions of the Blue Ribbon Committee, it is clearlyevident that the scope for the responsibilities ofaudit committees will significantly increase.Therefore, it is essential that audit committeesengage in an active continuous educational im-provement program to help their boards dis-charge their fiduciary responsibilities to share-holders.

The duties of the Audit Committee are (a) torecommend to the Board of Directors a firm ofindependent accountants to perform the exami-nation of the annual financial statements of theCompany; (b) to review with the independentaccountants and with the Controller the pro-posed scope of the annual audit, past audit expe-rience, the Company’s internal audit program,recently completed internal audits and othermatters bearing upon the scope of the audit; (c)to review with the independent accountants andwith the Controller significant matters revealedin the course of the audit of the annual financialstatements of the Company; (d) to review on aregular basis whether the Company’s Standardsof Business Conduct and Corporate Policies re-lating thereto has been communicated by theCompany to all key employees of the Companyand its subsidiaries throughout the world with adirection that all such key employees certify thatthey have read, understand and are not aware ofany violation of the Standards of Business Con-duct; (e) to review with the Controller any sug-gestions and recommendations of the indepen-dent accountants concerning the internal controlstandards and accounting procedures of theCompany; (f) to meet on a regular basis with arepresentative or representatives of the InternalAudit Department of the Company and to reviewthe Internal Audit Department’s Reports of Op-

erations; and (g) to report its activities and ac-tions to the Board at least once each fiscal year.

(SEE ALSO: Auditing; Securities and Exchange Com-mission)

BIBLIOGRAPHY

American Institute of Certified Public Accountants. (1978).Audit Committees, Answers to Typical Questions AboutTheir Organization and Operations. New York: Author.

American Law Institute. (1994) Principles of Corporate Gov-ernance: Analysis and Recommendations. Philadelphia,PA: Author.

Blue Ribbon Committee on Improving the Effectiveness ofCorporate Audit Committees. (1999). Report and Recom-mendations of the Blue Ribbon Committee on Improvingthe Effectiveness of Corporate Audit Committees. NewYork: New York Stock Exchange and Washington, DC:National Association of Securities Dealers.

Braiotta, L. (1986). ‘‘Audit Committees: An InternationalSurvey.’’ The Corporate Board May/June: 18-23.

Braiotta, L. (1994). The Audit Committee Handbook. NewYork: Wiley.

Bristol-Myers Squibb Company. (1999). Notice of 1999 An-nual Meeting and Proxy Statement. New York: Author.

National Commission on Fraudulent Financial Reporting.(1987). Report of the National Commission on FraudulentReporting. Washington, DC: Author.

New York Stock Exchange. (1983). ‘‘Corporate Responsibil-ity: Audit Committee, Sec. 303.00.’’ In New York StockExchange Listed Company Manual. New York: Author.

Securities and Exchange Commission. (1999). Audit Com-mittee Disclosure, Release No. 34-42266. Washington,DC: Author.

LOUIS BRAIOTTA, JR.

AUDITING

The objective of an audit is to provide assurancethat an assertion corresponds with some estab-lished criteria. An audit involves gathering andevaluating evidence to support the assertions andpreparing a communication indicating the workdone by the auditor and his or her opinion re-garding the degree of correspondence betweenthe assertions and established criteria.

AUDITING


TYPES OF AUDITS

Two primary types of audits are financial auditsand compliance audits. In a financial audit, themanagement of a business asserts that the finan-cial statements are prepared in accordance withgenerally accepted accounting principles(GAAP), which are the applicable criteria. Thefinancial statement auditor attests to the degreeof correspondence between those financial state-ments and GAAP. In a compliance audit, anindividual or business asserts that it is complyingwith specific laws, regulations, policies or proce-dures. The compliance auditor provides assur-ance that the entity is, in fact, complying withthose applicable criteria. More details are pro-vided below.

Audits are related to a wide range of criteria.Operational, or performance, audits evaluate theeffectiveness and/or efficiency of an organization.For example, an auditor may determine whetheror not a recipient of government funds is per-forming the funded services in a cost-efficientmanner. The term ‘‘attestation engagement’’ in-cludes audits and other services in which an audi-tor is engaged to issue a written communicationthat expresses a conclusion about the reliabilityof a written assertion that is the responsibility ofanother party. For example, an auditor may attestto the reliability of awards programs. The keycomponents are an assertion made by one partywith the expectation that a third party will rely onit and an attestor providing a written report onthe assertion. Assurance services are independentprofessional services, including attestation ser-vices, that improve the quality of information orits context for decision makers. Developing areasfor assurance services include Webtrust, whichprovides assurance regarding controls related toelectronic commerce.

TYPES OF AUDITORS

The three broad groups of auditors are external,internal, and governmental. Certified public ac-countants (CPAs) are external, independent au-ditors who are licensed by individual states toprovide auditing services. The public accounting

profession has played an active role in developingand providing attestation services. The AmericanInstitute of Certified Public Accountants(AICPA), a voluntary national professional orga-nization, represents the accounting profession inthe United States in general and the public ac-counting profession in particular. The AICPApublishes books, journals, and other materials,manages aWeb site (www.aicpa.org), lobbies leg-islators, and sets professional standards. Stateprofessional societies, such as the New York StateSociety of CPAs, provide support on a local level.The United States Securities and Exchange Com-mission (SEC), in requiring publicly held compa-nies to have annual audits, promoted the role ofthe CPA in providing services of this nature (i.e.independent, professional, external verification).SEC requirements are discussed below.

Internal auditors are employees of organiza-tions. In publicly owned companies, internal au-ditors typically report to senior management andthe board of directors, through its audit commit-tee. Internal auditors are primarily involved incompliance and operational audits. The Instituteof Internal Auditors (IIA), an international orga-nization, is the professional organization repre-senting the internal auditing profession. The IIApublishes materials, encourages local chapter ac-tivities, offers certification as a certified internalauditor (CIA), and provides general support forpracticing internal auditors. (For more informa-tion, go to http://nan.shh.fi/raw/iia/.)

Government auditors evaluate their ownagencies and those for which they are responsi-ble, including recipients of funds. These auditorsexist on the national, state, and local levels. Inter-nal Revenue Service (IRS) auditors and GeneralAccounting Office (GAO) auditors are the mostvisible government auditors. IRS auditors exam-ine tax returns. (For more information, go tohttp://www.irs.gov/.) The GAO is responsible foroversight, review, and evaluation of federal agen-cies and recipients of federal funds. The GAOreports to the U.S. Congress. (For more informa-tion, go to http://www.gao.gov/index.htm.)

AUDITING


FINANCIAL AUDITS

The objective of a financial audit is to determinewhether the financial statements are prepared inaccordance with generally accepted accountingprinciples (GAAP). The management of an orga-nization is responsible for preparing the financialstatements. The auditor is responsible for render-ing an opinion on the fairness of those financialstatements based on his or her audit.

When preparing the financial statements,management must follow GAAP, which are theprinciples and practices that govern financial re-porting. Formal Statements of Financial Ac-counting Standards are issued by the FinancialAccounting Standards Board (FASB), an inde-pendent standards-setting organization in theUnited States. (For more information, go to www.rutgers.edu/Accounting/raw/fasb/.) The AuditCommittee of the company’s board of directorsacts as a liaison with the auditors who are per-forming the financial statement audit.

SECURITIES AND EXCHANGE ACT OF 1934

The Securities and Exchange Act of 1934 requirespublicly held companies to file Form 10-Ks withthe Securities and Exchange Commission (SEC)within 90 days after the end of the fiscal year.This filing must include audited financial state-ments and an independent auditors report. TheSEC was established to protect investors, and therequirement to publish audited annual financialstatements plays a role in meeting that objective.(For more information, go to www.sec.gov.)

Nonpublic companies may have their finan-cial statements audited for several reasons. Thecompany may be planning to go public in thenear future and will need audited financial state-ments for several years prior to an initial publicoffering. A bank or other creditor may requireaudited financial statements annually. A businessmay voluntarily hire an auditor to provide theowners with assurance that its financial state-ments are reliable.

CPA FIRMS

Audited financial statements that will be sub-mitted to the SEC or to others are audited byCPAs. These CPAs practice in public accountingfirms, many of which are referred to as profes-sional services firms. The largest firms are com-monly referred to as ‘‘The Big Five.’’ These fivefirms are: Arthur Andersen & Co. (http://www.arthurandersen.com/), Deloitte & Touche(http://www.dttus.com/), Ernst & Young(http://www.ey.com), KPMG Peat Marwick(h t tp : / /www.kpmgcampus . com/) , andPricewaterhouseCooper (http://www.pwcglobal.com/). These companies, and many other publicaccounting firms, operate as limited liability part-nerships (LLPs) and thus carry LLP designationin their names. In addition to accounting andauditing services, many CPA firms offer tax andconsulting services. These consulting services in-clude systems design, litigation support, pensionand benefits consulting, and financial planning.

GENERALLY ACCEPTEDAUDITING STANDARDS

The external, independent CPA must follow gen-erally accepted auditing standards (GAAS) whenperforming the financial statement audit. Theseten broad standards include three general re-quirements for the individual auditor, three stan-dards for fieldwork, and four reporting stan-dards. Authoritative guidance regarding theapplication of these ten general standards is pro-vided in Statements on Auditing Standards(SASs), which are issued by the AICPA’sAuditing Standards Board.

The general standards require the CPA to beproficient in accounting and auditing, to be inde-pendent from his or her client, and to exercisedue professional care. Before accepting an auditclient, the auditor must determine if he or shewill be able to provide the necessary services on atimely basis and must have no financial or mana-gerial relationship with the company whose fi-nancial statements are being audited.

The fieldwork standards address what is re-quired when actually performing the audit work.

AUDITING


The auditor must plan the engagement and su-pervise assistants. The auditor must obtain anunderstanding of the company’s internal con-trols. The auditor must obtain sufficient compe-tent evidence to support the financial statementassertions.

The reporting standards set requirements forthe auditor’s report. The report must explicitlyrefer to GAAP and must state an opinion on thefinancial statements as a whole. If there has beena change in accounting principles used by thecompany or inadequate disclosure of significantinformation, the auditor’s report should addressthose issues.

TYPES OF AUDITOR’S REPORTS

The auditor can issue five types of reports onfinancial statements: unqualified opinion, un-qualified opinion with explanatory language,qualified opinion, adverse opinion, or disclaimerof opinion.

If the financial statements present fairly, inall material respects, an entity’s financial position(i.e., the balance sheet), results of operations (i.e.,the income statement), and cash flows (i.e., thestatement of cash flows) in conformity withGAAP, and if the audit is performed in accord-ance with GAAS, then a standard unqualifiedreport can be issued. The standard unqualifiedreport is as follows:

Independent Auditor’s Report

We have audited the accompanying balance sheets ofX company as of December 31, 20X2 and 20X1, andthe related statements of income, retained earnings,and cash flows for the years then ended. These finan-cial statements are the responsibility of the Com-pany’s Management. Our responsibility is to expressan opinion on these financial statements based onour audits.

We conducted our audits in accordance with gen-erally accepted auditing standards. Those standardsrequire that we plan and perform the audit to obtainreasonable assurance about whether the financialstatements are free of material misstatement. Anaudit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the finan-cial statements. An audit also includes assessing theaccounting principles used and significant estimates

made by management, as well as evaluating theoverall financial statement presentation. We believethat our audits provide a reasonable basis for ouropinion.

In our opinion, the financial statements referredto above present fairly, in all material respects, thefinancial position of X Company as of [at] December31, 20X2 and 20X1, and the results of its operationsand its cash flows for the years then ended in con-formity with generally accepted accounting princi-ples.

Under certain circumstances, which are spec-ified in the professional guidance, an auditoradds explanatory words or paragraph to a reportin which an unqualified opinion is expressed.The unqualified opinion is not affected. Thereare nine situations in which such explanationsare allowed. Among the most common are thoseinstances in which there has been a change inaccounting principle with which the auditor con-curs. In such instances, the auditor adds a para-graph after the opinion paragraph. The addi-tional paragraph identifies briefly the accountingchange.

The auditor would issue a qualified opinionin situations where the auditor views a departurefrom GAAP as being material, but not pervasiveor highly material relative to the entire set offinancial statements; or when the auditor has notbeen able to obtain sufficient competent evidencepertaining to a material, but not pervasive orhighly material, part of the financial statements.The auditor must add an explanatory paragraphbefore the opinion paragraph describing the rea-son for the qualification and then qualify theopinion paragraph. In the case of inadequate evi-dence, which is referred to as a scope limitation,the second paragraph of the report would alsobeen modified.

If, in the auditor’s judgment, pervasive orhighly material deviation(s) from GAAP existand the auditee cannot be persuaded to adjust thefinancial statements to the satisfaction of the au-ditor, then the auditor must express an adverseopinion. In this condition, the auditor expressesan opinion that the financial statements taken asa whole do not present fairly the financial posi-

AUDITING


tion, results of operations, and cash flows of thecompany in accordance with GAAP.

A disclaimer of opinion, which basicallymeans giving no opinion, is issued when thescope limitation (typically lack of evidence re-garding financial statement assertions) is so per-vasive or highly material that the auditor cannotdraw conclusions as to the fairness of the finan-cial statements, taken as a whole. A disclaimer isalso issued when the auditor lacks independencefrom the auditee. Disclaiming an opinion is alsopermitted, but not required, in conditions ofmajor uncertainty about the company’s ability tocontinue as a going concern for a year followingthe date of the financial statements.

CODE OF PROFESSIONAL CONDUCT

The AICPA Code of Professional Conduct guidesthe CPA in the performance of professional ser-vices, including audits. The code consists of prin-ciples, rules, interpretations, and rulings, goingfrom the very broad to the very specific.

The six ethical principles of professional con-duct provide the basis for the rest of the code.CPAs are expected to exercise professional andmoral judgments in all their activities. CPAsshould act in the public interest. CPAs shouldperform all their work with the highest sense ofintegrity. CPAs should be free of conflicts of in-terest when performing professional services.CPAs should observe the profession’s technicaland ethical standards. CPAs in public practiceshould observe these principles of the Code ofProfessional Conduct in determining the scopeand nature of services to be provided.

The rules address more specific ethical con-cerns. CPAs are required to be independent, toact with integrity and objectivity, and to followand comply with applicable standards. When ex-pressing an opinion on financial statements, theCPAmust use GAAP as the criteria for evaluatingfairness. Client information is confidential. Con-tingent fees, commissions, or referral fees are notacceptable when providing audit services. CPAsshall not commit discreditable acts, advertise indeceptive ways, or practice in a form of organiza-tion that is not permitted by state law.

The interpretations provide more detail re-garding the rules. The independence rule has themost interpretations. Interpretations give guid-ance on issues such as financial and managerialrelationships with the client, honorary director-ships, loans, litigation, and firm and family rela-tionships. Interpretations of other rules addressissues such as conflicts of interest, competency,departures from promulgated GAAP, disclosureof confidential client information, sale of a prac-tice, contingent fees in tax matters, client’s rec-ords, governmental requirements in attest ser-vices, and CPAs operating a separate business.

Rulings are answers to specific questions.They provide guidance to CPAs regarding partic-ular concerns that surface in providing profes-sional services. Examples include whether or nota CPA can accept a gift from a client, when anindividual can refer to him- or herself as a CPA,and the recruiting of personnel to fill a clientposition.

COMPLIANCE AUDITS

The objective of a compliance audit is to deter-mine whether the auditee is following prescribedlaws, regulations, policies, or procedures. Theseaudits can be performed within a business orga-nization for internal purposes or in response torequirements by outside groups, particularlygovernment. Compliance audits can also be per-formed on individuals, for example, a compli-ance audit of an individual’s tax return.

Typically, internal auditors are involved withcompliance audits, within an organization, al-though independent CPAs perform this work aswell. A compliance audit may focus on internalcontrols and whether or not the organization isfollowing the internally prescribed policies andprocedures. As part of the compliance audit, theauditor will obtain evidence supporting the asser-tion that the controls are being followed. Basedon the auditor’s evaluation of the evidence, he orshe will usually write a report discussing the find-ings and making recommendations for improve-ment. A compliance audit could also look at ex-ternal laws and regulations. The auditor wouldassess whether or not the organization, or the

AUDITING


applicable part of the organization such as themarketing department, is adhering to specificlaws and regulations, such as the Foreign CorruptPractice Act of 1977. This law prohibits businessentities from bribing officials of other govern-ments in order to win business contracts.

Standards to be used when auditing federalgovernment agencies and recipients of federalfunds are found in ‘‘Government Auditing Stan-dards,’’ issued by the Comptroller General of theUnited States. This publication, which is referredto as the ‘‘Yellow Book,’’ includes additionalauditing standards that must be followed, in ad-dition to GAAS. As part of any Yellow Bookaudit, the auditor must evaluate compliance withlaws and regulations.

The auditor must perform several steps.First, the auditor must identify pertinent lawsand regulations. Then, the auditor assesses therisks of material noncompliance; in so doing, theauditor must consider and assess internal con-trols. Next, the auditor designs steps and proce-dures to test compliance with laws and regula-tions to provide reasonable assurance that both

unintentional and intentional instances of mate-rial noncompliance are detected. The auditormust issue a report on the tests of compliance inwhich all instances of noncompliance or illegalacts must be reported.

(SEE ALSO: Assurance services; Audit Committees;Government Auditing Standards)

BIBLIOGRAPHY

Messier, William F. Jr., (1997). Auditing: A Systematic Ap-proach. New York: Irwin McGraw-Hill.

MOHAMMAD J. ABDOLMOHAMMADI

ELLIOTT S. LEVY

AUDITOR REPORTS(SEE: Auditing)

AUTHORITY(SEE: Management: Authority and Responsibility)

AUTHORITY


BABY BOOMERS(SEE: Lifestyles)

BAIT ANDSWITCH ADVERTISING(SEE: Advertising)

BALANCE OF TRADE

Even though the United States has many naturalresources and the ways and means to use them inmanufacturing, it cannot provide its people withall that they want or need. For this reason, theUnited States participates in international trade,which is the exchange of goods and services withother nations. Without international trade,goods would either cost more or not be available.

Throughout the world, there are substantialdifferences in the natural resources available. Forexample, Canada, with its huge forests, is a majorproducer of lumber and paper products; theMiddle East has rich oil reserves; and the coastalregions of the world are leaders in the fishingindustry.

Without international trade, each countrywould have to be totally self-sufficient. Eachwould have to make do only with what it couldproduce on its own. This would be the same as anindividual being totally self-sufficient, providingall goods and services, such as clothing and food,

that would fulfill all wants and needs. Interna-tional trade allows each nation to specialize in theproduction of those goods it can produce mostefficiently. Specialization, in turn, causes totalproduction to be greater than it would be if eachnation tried to be self-sufficient.

Goods and services sold to other countriesare called exports; goods and services boughtfrom other countries are called imports. The U.S.Bureau of the Census, Foreign Trade Division,indicates that U.S. exports include such goods ascorn, wheat, soybeans, plastics, iron and steelproducts, chemicals, and machinery, while im-ports include such goods as chemicals, crude oil,machinery, diamonds, and coffee.

The balance of trade is the difference be-tween the dollar amount of exports and the dol-lar amount of imports. The United States hasmany trade partners. Table 1 shows the U.S.balance of trade with three selected nations.

In order to have a trade surplus, a countrymust export (sell) more than it imports (buys).The opposite of a trade surplus is a trade deficit.This occurs when a country imports (buys) morethan it exports (sells). As can be seen from Table1, a country can have a trade surplus with onecountry and a trade deficit with another. TheBureau of the Census records indicate that for themonth of November 1998 the United States had atrade surplus with such countries as Saudi Ara-bia, the Netherlands, Australia, and Brazil. Dur-ing the same month, the United States had a

B

55

United States Trade with Selected Countries, 1998

Goods Good Balance Exported Imported of Country (In Millions) minus (In Millions) equals Trade

Japan 58 − 122 = −64 Canada 154 − 175 = −21 Australia 12 − 5 = +7

(exports − imports = balance of trade)

Table 1SOURCE: U.S. Bureau of the Census, Foreign Trade Division, 1998.

trade deficit with such countries as Japan, China,Canada, and Mexico.

The Bureau of the Census also reports thatthe United States experienced its first trade deficit(total of all exports minus total of all imports) ofthe twentieth century in 1971, with a trade deficitof approximately $1.5 billion. A record high tradedeficit occurred in 1998, when imports exceededexports by approximately $230 billion. Table 2shows the U.S. balance of trade for the years 1960through 1998. As can be easily seen in the table,the U.S. trade deficit continues to increase.

As stated earlier, total production increaseswhen a nation specializes in the production ofthose goods it can produce most efficiently in-stead of attempting to be totally self-sufficient.Allen Smith (1986), states that ‘‘a country thatcan produce a product more efficiently than an-other country is said to have an absolute advan-tage in the production of that product’’ (p. 315).When a nation can use fewer resources to pro-duce the same amount of a product, it has anabsolute advantage in the production of thatproduct. For example, Brazil has an absoluteadvantage over the United States in the produc-tion of coffee, and the Middle East has an abso-lute advantage over the United States in the pro-duction of crude oil. Because of its ideal climate,Ecuador can produce bananas more efficientlythan the United States; therefore, Ecuador has anabsolute advantage over the United States in theproduction of bananas. However, the UnitedStates has an absolute advantage over Ecuador in

the production of most products. Both nationsbenefit by trading those products that each na-tion can produce more efficiently. Nations usu-ally will not trade with other nations unless thereare gains to be made by each nation. However,the gains made will not necessarily be equal.

Smith (1986) also states that ‘‘any time anation has an absolute advantage in the produc-tion of two goods or services, the nation has acomparative advantage in the production of thatgood or service where the absolute advantage isgreater’’ (p. 315). In other words, if a nation has atwo-to-one absolute advantage in the productionof one product and a three-to-one absolute ad-vantage in the production of another product,the comparative advantage lies with the productwith the larger ratio. Smith (1986) also states that‘‘even though a nation has an absolute disadvan-tage in the production of two products, it has acomparative advantage in the production of thatproduct in which the absolute disadvantage isless’’ (p. 316). For example, even though a nationhas a disadvantage in the production of a certainproduct, if that disadvantage is small comparedto its disadvantage in the production of otherproducts, it still has a comparative advantagewith the former product.

When the United States buys goods fromanother country, it usually pays for the goods inthe currency of the exporting country. There aremany transactions that involve the exchange ofmoney between nations. The balance of pay-ments is an accounting record of the difference

BALANCE OF TRADE


Total Total Year Balance Exports Imports

1960 4,609 19,626 15,018 1961 5,476 20,190 14,714 1962 4,583 20,973 16,390 1963 5,289 22,427 17,138 1964 7,006 25,690 18,684 1965 5,333 26,699 21,366 1966 3,830 29,372 25,542 1967 4,122 30,934 26,812 1968 837 34,063 33,226 1969 1,290 37,332 36,042 1970 3,225 43,176 39,951 1971 −1,476 44,087 45,563 1972 −5,729 49,854 55,583 1973 2,389 71,865 69,476 1974 −3,884 99,437 103,321 1975 9,551 108,856 99,305 1976 −7,820 116,794 124,614 1977 −28,353 123,182 151,534 1978 −30,205 145,847 176,052 1979 −23,922 186,363 210,285 1980 −19,696 225,566 245,262 1981 −22,267 238,715 260,982 1982 −27,510 216,442 243,952 1983 −52,409 205,639 258,048 1984 −106,702 223,976 330,678 1985 −117,711 218,815 336,526 1986 −138,280 227,159 365,438 1987 −152,119 254,122 406,241 1988 −118,526 322,426 440,952 1989 −109,400 363,812 473,211 1990 −101,719 393,592 495,311 1991 −66,723 421,730 488,453 1992 −84,501 448,164 532,665 1993 −115,568 465,091 580,659 1994 −150,630 512,626 663,256 1995 −158,801 584,742 743,543 1996 −170,214 625,075 795,289 1997 −181,488 689,182 870,671 1998 −230,852 682,977 913,828

Trade BalanceGoods on a Census Basis

VALUE IN MILLIONS OF DOLLARS1960 THRU 1998

Table 2NOTE: Balances are rounded.

SOURCE: U.S. Bureau of the Census, Foreign Trade Division,February 19, 1999.

between the amount of money that a countryreceives and the amount of money that it paysout during a year. A positive balance of paymentsmeans that a country receives more money in ayear than it pays out. Likewise, a negative balanceof payments occurs when a country pays outmore money than it takes in. Any transaction

that involves payments between countries is in-cluded in the balance of payments. The largestcomponent of the balance of payments is thebalance of trade, but many more financial trans-actions are included, such as foreign aid to othernations, government support of military person-nel stationed in other nations, and money spentby tourists.

The importing and exporting of goods andservices are controlled by the U.S. government.Three of the most common barriers to trade aretariffs, import quotas, and embargoes. A tariff is atax imposed by the government on importedgoods. An import quota places a limit on theamount of a product that may be imported orexported during a given period of time. An em-bargo occurs when the government halts the im-port or export of a certain product.

BIBLIOGRAPHY

Gottheil, Fred M., and Wishart, David. (1997). Principles ofEconomics with Study Guide. Cincinnati: South-WesternCollege Publishing.

Smith, Allen W. (1986). Understanding Economics. NewYork: Random House.

U.S. Bureau of the Census, Foreign Trade Division. http://www.census.gov/foreign-trade/site1/1998.

LISA S. HUDDLESTUN

BANKRUPTCY

Bankruptcy law was created initially to enablepersons inundated with debt to have a new be-ginning. It is also designed to permit individualsand business entities to have additional time topay and compromise existing debts without liq-uidating all assets. The U.S. Constitution, Article1, Section 8(4) grants the power exclusively toCongress ‘‘[T]o establish . . . uniform laws on thesubject of bankruptcies throughout the UnitedStates.’’ The current Code is based on the Bank-ruptcy Reform Act of 1978 as amended. Bank-ruptcy Courts, under the supervision of U.S. Dis-trict Courts, administer petitions under thestatute.

BANKRUPTCY


The Code is divided into a number of chap-ters, the most important of which are Chapter 7(‘‘Liquidation’’), Chapter 11, (‘‘Reorganiza-tion’’), and Chapter 13, (‘‘Adjustment of Debts ofan Individual with Regular Income’’). The re-maining chapters concern definitions, case ad-ministration, a discussion of creditors’ claims,debtors’ duties, estate of the debtor, U.S. trustees,municipal indebtedness, and debts of farm fami-lies.

CHAPTER 7: LIQUIDATION

A Chapter 7 proceeding is ‘‘bankruptcy’’ as envi-sioned by most persons. The crux of such a pro-ceeding is the collection and reduction to cash ofall nonexempt assets owned by the debtor; themonies, to the extent available, are distributed toclasses of creditors.

Petition. The proceeding is begun by the fil-ing of a petition with the clerk of the BankruptcyCourt. The petition may be ‘‘voluntary’’ or ‘‘in-voluntary.’’ A ‘‘voluntary’’ petition is one filed bythe debtor individually or with the debtor’sspouse. The filing of a voluntary petition operatesautomatically as an order of relief, which meansthat all nonexempt civil lawsuits and any othercivil proceedings (e.g., foreclosures and sheriff’sseizures) are suspended.

An involuntary proceeding may be begun bythe filing of a petition as follows: (1) Where thereare twelve or more creditors, then three or morecreditors who are owed a minimum amount of$10,775 are required to file; or (2) if there arefewer than twelve claimants, then any one ormore creditors with claims totaling at least$10,775 may file the petition. Farmers and non-profit corporations are exempted from an invol-untary filing. The court, after notice and hearingfor cause, may require creditors filing an invol-untary petition to post a bond to indemnify thedebtor for damages in the event of a dismissal ofthe involuntary petition.

Creditor’s meeting and appointment of atrustee. The debtor is required to file a list ofcreditors, a schedule of assets and liabilities, and astatement concerning details of the debtor’s fi-

nancial affairs. Within a reasonable time of filingof the petition, the court appoints an interimtrustee and a first meeting of creditors is called.At such meeting, the debtor is required toundergo an examination under oath by the credi-tors. The creditors may then select a qualifiedperson to act as trustee. If none is selected, thenthe interim trustee remains in such capacity. Theduties of a trustee include collecting all assetsowned by or owed to the debtor, examining anddetermining debts payable, accounting for allproperty received, instituting lawsuits if neces-sary to collect indebtedness due the estate, andreporting to the creditors at the final meeting ofcreditors.

Exemptions. The Bankruptcy Code is rathergenerous in its provisions concerning propertythe debtor may keep after filing for bankruptcy.The debtor is given the choice of choosing eitherexemptions provided by the laws of the state inwhich the debtor resides or exemptions per-mitted under the Code, whichever is more gener-ous.

Under the Bankruptcy Act, a debtor maykeep the following assets:

1. Debtor’s interest up to $16,150 in realtyused as a principal residence or as a bur-ial plot

2. Debtor’s interest in a motor vehicle up to$2,575 in value

3. Debtor’s interest up to $425 in any oneitem or aggregate of $8,075 of unused ex-emption in household goods

4. Debtor’s interest up to $1,075 in jewelryfor personal, household, or family use

5. Debtor’s interest in any other property upto $850 plus unused amount of the$8,075 exemption

6. Debtor’s interest up to $1,625 in imple-ments, professional books, or tools of thetrade of the debtor or dependent

7. Unmatured life insurance contract ownedby the debtor, except a credit life insur-ance contract

BANKRUPTCY


8. Debtor’s interest up to $8,625 inunmatured life insurance

9. Professionally prescribed health aids forthe debtor or dependent

10. Social Security, unemployment compensa-tion, veteran’s, disability, or illness bene-fits

11. Payments for losses payable under acrime victim’s reparation statute; wrong-ful death benefits, life insurance proceeds;and award up to $16,150 arising frompersonal injury award.

Voidable transfers. In order to prevent certaincreditors and insiders from gaining an unfairadvantage over other creditors, the Code permitsthe trustee to set aside certain transfers of prop-erty made by the debtor that enabled the creditorto receive more than would otherwise have beenreceived. A trustee, except for certain limited ex-ceptions, may avoid the transfer of property ofthe debtor made to a creditor on account of anantecedent debt owed by the debtor made whilethe debtor was insolvent within 90 days beforefiling of the petition. If the transfer was made toan insider (to a relative, partner, or corporationwith whom the debtor has a close relationship),then a transfer made within one year of filingmay be avoided.

Fraudulent transfers. The trustee may avoid atransfer of assets made by the debtor to anytransferee within one year of filing the petitionwhere such transfer was made to defraud credi-tors or where the transfer was made for less thanits fair market value. The trustee is empowered toinvalidate such transfer after having returned theamount paid by a good-faith purchaser.

Exceptions to discharge. Although the debtorhas the right to keep certain property, the debtoris not discharged from all debts. The followingsums continue to be due and owing even afterrelief is granted:

1. Taxes due three years prior to filing

2. Payment for property obtained underfalse pretenses

3. Monies owed to creditors the debtorfailed to list or schedule

4. Monies obtained through fraud, embez-zlement, or larceny

5. Alimony, maintenance, and child support

6. Monies owed for willful and maliciousinjury by the debtor

7. Government fines, penalties, or forfeituresincurred within three years

8. Money due to a government unit or non-profit institution of higher education foran educational loan within seven yearsunless payment would impose unduehardship upon the debtor or the debtor’sdependents

9. Debts not dischargeable under a priorbankruptcy proceeding

10. Judgments arising due to driving whileintoxicated

11. Credit card debts and cash advances ex-ceeding $1,075 incurred within sixty daysof filing and debt incurred within sixtydays of filing for purchase of luxurygoods over the sum of $1,075 to any onecreditor

Priority of distribution. All creditors are nottreated equally. There are several levels of priorityin the distribution of assets. A creditor with asecurity lien on property (e.g., bank mortgage)has priority over other creditors.

In descending order, the following unsecuredcreditors are entitled to the expenses and claims:

1. Administrative expenses incurred by thetrustee

2. Post-petition credit extended to debtors

3. Claims up to $4,300 for wages, salaries,or commissions earned by an individualwithin ninety days of filing of the petition

4. Claims for contributions to employeebenefit plans up to $4,300 for servicesrendered up to 180 days before filing ofpetition

BANKRUPTCY


5. Claims up to $4,300 for a person operat-ing a grain storage or fish produce stor-age or processing facility

6. Claims by consumers up to $1,950 fordeposits made for purchase, lease, orrental of property or for the purchase orconsumer goods or services

7. Claims for alimony, maintenance, orchild support

8. Income and other taxes due to govern-mental units

9. The remaining unsecured creditors

CHAPTER 11: REORGANIZATION

One of the goals of the Bankruptcy Act is to allowa business to continue to operate, if possible, inorder to prevent the inevitable discharge of em-ployees from a bankrupt firm. Accordingly, Con-gress permits either a voluntary petition or invol-untary petition under this Chapter. Theproceedings may be commenced, with certainexceptions, by an individual or business entity,such as a partnership or corporation.

The debtor may file a voluntary petitionwithin 120 days of the order of relief. An involun-tary petition may be filed by the trustee, credi-tor’s committee, creditor, and other interestedparties if the debtor has not filed a plan withinthe said 120 days, or the plan filed by the debtorhas not been accepted within 180 days.

The plan permits the debtor to remain inpossession of the business unless there is fraud orgross mismanagement. The plan has to specifythose claims or interests not impaired under theplan from those that will be so impaired. Eachclass of claims is to be treated equally unless theclaimant otherwise consents. The plan may pro-vide for the debtor to remain in possession; forcertain assets to be transferred to other entities;for a consolidation or merger; for the sale ofproperty subject to the rights of lienholders; forthe satisfaction or modification of a lien; andother terms. The plan may impair a class ofclaims whether they are secured or unsecured.

The court must confirm the plan. Confirma-tion may be granted only if the plan complies

with the statute, has been proposed in good faith,is not forbidden by law, is fair and equitable, hasbeen accepted by at least one class of claimants,and confirmation of it is not likely to end inliquidation. A plan is fair and equitable as tosecured claims if the holders thereof retain theirlien on the secured property or receive equivalentvalue.

Collective bargaining agreements previouslyentered into by the debtor are subject to the plan.The plan must be offered by the debtor to theunion and be discussed with the union; if there isno resolution, a hearing must be held by thecourt to determine whether a modification willbe permitted.

CHAPTER 13: ADJUSTMENT OF DEBTS OFINDIVIDUAL WITH REGULAR INCOME

A gainfully employed person may be inundatedwith debts that cannot be paid in full but may bepaid if that person were extended additional timeto pay. Accordingly, Congress created a Chapter13 filing that permits such a debtor withunsecured debts of less than $269,250 and se-cured debts of less than $807,750 to voluntarilyfile a plan that provides for the submission ofearnings to a trustee, the payment in full of allallowable claims unless a creditor agrees other-wise, and the classification of claims with thesame treatment of all claims within each class.The plan may modify the rights of holders ofsecured claims except holders of a security inter-est in real property used as a principal residenceby the debtor.

The plan must be confirmed by the Bank-ruptcy Court. The court will do so if the plan wasproperly filed, fees were paid, the plan was madein good faith, and the value of property to bedistributed allows holders of unsecured claims toreceive no less than what they would have re-ceived under Chapter 7. As to secured claimants,the plan will be allowed where the holder of theclaim has agreed to the plan, the plan providesthat the holder retains the lien securing the prop-erty, and the value of property to be distributed isnot less than the allowed amount of such claim.The debtor may, in the alternative, surrender the

BANKRUPTCY


property securing the claim to the holder of thelien. Once the plan is confirmed and lived up to,the debtor will be discharged.

FUTURE TRENDS

Because of intense lobbying efforts by banks andother creditors’ organizations, there have beenproposals for significant changes in the law, suchas the Bankruptcy Reform Act of 2000. This actwould make all exemptions federal in nature, sothat debtors in one state are not treated moreadvantageously than those in another. Debtorswould be required to undergo credit counselingbefore filing a petition. Substantially enhancedrequirements of proof of inability to pay within afive-year period would be necessary. Credit carddebts would undergo much greater scrutiny. Re-sorting to Chapter 13 plans of payments wouldbe made mandatory in some cases. Passage ofsuch legislation appears to be dependent on thepolitical party having control over both the Con-gress and the presidency.

BIBLIOGRAPHY

Bankruptcy Code, Rules and Official Forms. (annual). St.Paul, MN: West Publishing.

Cowans, David R. (1998). Bankruptcy Law and Practice. NewYork: Lexus Publishing.

Epstein, David G., Nickles, Steve H., and White, James J.(1993). Bankruptcy. St. Paul, MN: West Publishing.

ROY J. GIRASA

BANKS AND BANKING

(SEE: Financial Institutions)

BARBIE DOLLS

(SEE: Classics)

BARTER

(SEE: Currency Exchange)

BEHAVIORAL MANAGEMENTTHOUGHTS(SEE: Management)

BEHAVIORAL SCIENCEMOVEMENT

The exact date of when the behavioral science, orhuman relations, movement came into being isdifficult to identify; however, it was not until thesecond half of the nineteenth century that muchattention was paid to workers’ needs, since therewas little understanding of how those needs affecttotal worker productivity. Prior to that time,most managers viewed workers as a device thatcould be bought and sold like any other posses-sion. Long hours, low wages, and miserableworking conditions were the realities of the aver-age worker’s life.

Then, at the beginning of the twentieth cen-tury, Frederick Winslow Taylor, one of the mostwidely read theorists on management, intro-duced and developed the theory of scientificmanagement. The basis for scientific manage-ment was technological in nature, emphasizingthat the best way to increase output was to im-prove the methods used by workers. Accordingto this perspective, the main focus of a leadershould be on the needs of the organization, notthe needs of the individual worker. Taylor andhis followers were criticized on the grounds thatscientific management tended to exploit workersmore than it benefited them.

In the 1920s and early 1930s, the trendstarted by Taylor was gradually replaced by thebehavioral science movement, initiated by EltonMayo and his associates through the famousHawthorne studies. Efficiency experts at theHawthorne, Illinois, plant of Western Electricdesigned research to study the effects of illumina-tion on worker productivity. At first, nothingabout this research seemed exceptional enoughto arouse any unusual interest, since efficiencyexperts had long tried to find the ideal mix ofphysical conditions, working hours, and workingmethods that would stimulate workers to pro-



Psychologist Abraham Maslow proposed a newmotivation theory in 1943.

duce at maximum capacity. Yet by the time theHawthorne studies were completed ten yearslater, there was little doubt that they were one ofthe most important organizational studies,causing the behavioral science movement togather momentum. The major conclusion of theHawthorne Studies was that attention to workers,not illumination, affected productivity. Essen-tially, then, the scientific management movementemphasized a concern for output, while the be-havioral science movement stressed a concern forrelationships among workers.

Various individuals have made importantcontributions to the behavioral science move-ment. In 1943 psychologist Abraham Maslowproposed a theory of motivation according towhich workers’ behavior is determined by a widevariety of needs. Motivation starts when an indi-vidual experiences a need; the individual thenformulates a goal, which, upon achievement, willsatisfy the need. Maslow identified these needsand arranged them in a hierarchy, positing that

lower-level needs must be satisfied, at least inpart, before an individual begins to strive to sat-isfy needs at a higher level (Maslow, 1954).

Douglas McGregor, Maslow’s student, stud-ied worker attitudes (McGregor, 1960). Accord-ing to McGregor, traditional organizations arebased on either of two sets of assumptions abouthuman nature and human motivation, which hecalled Theory X and Theory Y. Theory X assumesthat most people prefer to be directed; are notinterested in assuming responsibility; and aremotivated by money, fringe benefits, and thethreat of punishment. Theory Y assumes thatpeople are not, by nature, lazy and unreliable; itsuggests that people can be basically self-directedand creative at work if properly motivated.

Management is often suspicious of strong in-formal work groups because of their potentialpower to control the behavior of their members,and as a result, the level of productivity. In 1950George C. Homans developed a model of socialsystems that may be useful in identifying wherethese groups get their power to control behavior(Homans, 1950).

In the 1960s another psychologist, FrederickHerzberg, examined sources of worker satisfac-tion and dissatisfaction (Herzberg, 1959).Herzberg cited achievement, responsibility, ad-vancement, and growth as job satisfiers—factorsthat motivate workers. He also proposed thatother aspects of the job environment called jobmaintenance factors—company policy, supervi-sion, working conditions, interpersonal relations,salary and benefits—contribute to the desiredlevel of worker satisfaction, although these fac-tors rarely motivate workers.

Also in the 1960s, another behavioral scienceresearcher, Chris Argyris, presented his immatu-rity-maturity theory (Argyris, 1964). He said thatkeeping workers immature is built into the verynature of formal organizations. These concepts offormal organizations lead to assumptions abouthuman nature that are incompatible with theproper development of maturity in the humanpersonality. He saw a definite incongruity be-tween the needs of a mature personality and thestructure of formal organizations.



More and more leaders in both for-profitand nonprofit organizations recognize the im-portance of the goals of the behavioral science(human relations) movement. Those goals con-sist of fitting people into work situations in sucha manner as to motivate them to work togetherharmoniously and to achieve a high level of pro-ductivity, while also providing economic, psy-chological, and social satisfaction.

BIBLIOGRAPHY

Argyris, Chris. (1964). Integrating the Individual and theOrganization. New York: Wiley.

Benton, Douglas A. (1998). Applied Human Relations. Up-per Saddle River, NJ: Prentice-Hall.

Greenberg, Jerald. (1999). Managing Behavior in Organiza-tions: Science in Service to Practice. Upper Saddle River,NJ: Prentice-Hall.

Hersey, Paul, Blanchard, Kenneth H., and Johnson, DeweyE. (1996). Management of Organizational Behavior. Up-per Saddle River, NJ: Prentice-Hall.

Herzberg, Frederick, Mausner, Bernard, and Snyderman,Barbara. (1959). The Motivation to Work. New York:Wiley.

Homans, George C. (1950). The Human Group. New York:Harcourt, Brace & World.

Maslow, Abraham H. (1954). Motivation and Personality.New York: Harper & Row.

McGregor, Douglas. (1960). The Human Side of Enterprise.New York: McGraw-Hill.

Rue, Leslie W., and Byars, Lloyd L. (1990). Supervision: KeyLink to Productivity. Homewood, IL: Irwin.

Whetten, David A., and Cameron, Kim S. (1995).Developing Management Skills. New York: HarperCol-lins.

Wray, Ralph D., Luft, Roger L., and Highland, Patrick J.(1996). Fundamentals of Human Relations. Cincinnati,OH: South-Western Educational Publishing.

Yukl, Gary. (1994). Leadership in Organizations. EnglewoodCliffs, NJ: Prentice-Hall.

MARCIA ANDERSON

BENCHMARKING

Benchmarking is a process of comparing an orga-nization’s or company’s performance to that ofother organizations or companies using objective

and subjective criteria. The process comparesprograms and strategic positions of competitorsor exemplary organizations to those in the com-pany reviewing its status for use as referencepoints in the formation of organization decisionsand objectives. Comparing how an organizationor company performs a specific activity with themethods of a competitor or some other organiza-tion doing the same thing is a way to identify thebest practice and to learn how to lower costs,reduce defects, increase quality, or improve out-comes linked to organization or company excel-lence.

Organizations and companies use bench-marking to determine where inputs, processes,outputs, systems, and functions are significantlydifferent from those of competitors or others.The common question is, What is the best prac-tice for a particular activity or process? Data ob-tained are then used by the organization or com-pany to introduce change into its activities in anattempt to achieve the best practice standard iftheirs is not best. Comparison with competitorsand exemplary organizations is helpful in deter-mining whether the organization’s or company’scapabilities or processes are strengths or weak-nesses. Significant favorable input, process, andoutput benchmark variances become the basisfor strategies, objectives, and goals. Often, a gen-eral idea that improvement is possible is the rea-son for undertaking benchmarking. Bench-marking, then, means looking for and findingorganizations or companies that are doing some-thing in the best possible way and learning howthey do it in order to emulate them. Organiza-tions or companies often attempt to benchmarkagainst the best in the world rather than the bestin their particular industry.

A problem with benchmarking is it may re-strict the focus to what is already being done. Byemulating current exemplary processes, bench-marking is a catch-up managerial tool or tech-nique rather than a way for the organization orcompany to gain managerial dominance or mar-keting share. Benchmarking can foster new ideasor processes when management uses noncom-petitive organizations or companies outside its

BENCHMARKING


own industry as the basis of benchmarking. Whatif new ideas are not generated? It is possible thatno one in some other organization or companyhas had a great idea that is applicable to theinput, process, or outcome that the organizationis attempting to improve or change by bench-marking.

Benchmarking is not a competitive analysis.Benchmarking is the basis for change. It is aboutlearning. The organization performing thebenchmark analysis uses the information foundin the process to establish priorities and targetprocess improvements that can change businessor manufacturing practices. Benchmarking com-monly takes one of four forms.

Generic benchmarking investigates activitiesthat are or can be used in most businesses. Thistype of benchmarking makes the broadest use ofdata collection. One difficulty is in understandinghow processes translate across industries. Yet ge-neric benchmarking can often result in an orga-nization’s drastically altering its ideas about itsperformance capability and in the reengineeringof business processes.

Functional benchmarking looks at similarpractices and processes in organizations or com-panies in other industries. This type of bench-marking is an opportunity for breakthrough im-provements by analyzing high-performanceprocesses across a variety of industries and orga-nizations.

Competitive benchmarking compares the or-ganization’s processes to those of direct competi-tors. In competitive benchmarking, a consultantor other third party rather than the organizationitself collects and analyzes the data because of itsproprietary nature.

Internal benchmarking compares processesor practices within the organization or companyover time in light of established goals. Advantagesof internal benchmarking include the ease of datacollection and the definition of areas for futureexternal investigations. The primary disadvan-tage of internal benchmarking is a lower proba-bility that it will yield significant process im-provement breakthroughs.

Each form of benchmarking has advantagesand disadvantages, and some are simpler to con-duct that others. Each benchmarking approachcan be important for process analysis and im-provement. Breakthrough improvements aregenerally attributed to the functional and generictypes of benchmarking.

Eight steps are typically employed in thebenchmarking process.

1. Identify processes, activities, or factors tobenchmark and their primary characteris-tics.

2. Determine what form is to be used: ge-neric, functional, competitive, or internal.

3. Determine who or what the benchmarktarget is: company, organization, industry,or process.

4. Determine specific benchmark values bycollecting and analyzing information fromsurveys, interviews, industry information,direct contacts, business or trade publica-tions, technical journals, and othersources of information.

5. Determine the best practice for eachbenchmarked item.

6. Evaluate the process to which bench-marks apply and establish objectives andimprovement goals.

7. Implement plans and monitor results.

8. Recalibrate internal base benchmarks.

A recurring problem that must be addressed dur-ing the eight steps is the determination of criteriato ensure that inaccuracies or inconsistencies donot occur that will make any comparison mean-ingless.

The eight steps of the benchmarking processcan be summarized as an improvement analysis.That is, the organization investigates another or-ganization to find out what it does and how it isdone. During the investigation, what goes rightand what goes wrong is determined. This infor-mation is then used for the improvement of ac-tivities or processes. When the activities and pro-cesses of the organization making the

BENCHMARKING


investigation are equal to or better than the mea-surements found during the investigation, nochange is warranted because the investigating or-ganization has the better practice.

Another view of benchmarking is as an orga-nization gap analysis. The organization deter-mines what it lacks in terms of what it knows andhow it does things. The shortfalls that initiate thegap analysis can be activities and processes orthey can be tactics and strategies. The organiza-tion must then determine what other organiza-tion is good at doing those things that can beimproved or changed for the better. A very sys-tematic investigation is made of the organizationwith the best practices to discover what is done,how it is done, how it is implemented, and how itfits into the organization’s operations. The find-ings of the systematic investigation then becomethe basis of revision or modification for the orga-nization doing the investigation.

Benchmarking efforts typically collect infor-mation on responsibilities, program design, op-erating facilities, technical know-how, brandimages, levels or integration, managerial talent,and cost or financial performance. Financial orcost data are often the category of greatest con-cern because these are factors in the input, pro-cessing, and output activities of the organizationor company.

Benchmarking is frequently referred to as a‘‘wake-up call.’’ Organizations and companiesbenchmark for many reasons: They want to de-termine where they spend their time and howmuch value they add, or they are curious abouthow they stack up against others. Through theknowledge gained by benchmarking, organiza-tions and companies redefine their roles, addmore value, reduce costs, and improve perfor-mances.

The electronics industry has a unique style ofbenchmarking. Here benchmarking involvesrunning a set of standard tests on a system tocompare its performance with that of others.That is, it is a tool for measuring the power andperformance of hardware and software systemsand applications as well as the capacity of a sys-

tem. There are four categories of benchmarkingin the electronics industry:

● An application-based benchmark runs real ap-plications or parts of applications either in fullor modified versions.

● A synthetic benchmark emulates applicationsactivity.

● A playback test uses logs of one type of sys-tem call (e.g., disk calls) and plays the callsback in isolation.

● An inspection test exercises a system or com-ponent to emulate an application activity.

The synthetic and playback benchmarks areused to get a rough idea of how a system orcomponent performs. If application-basedbenchmarks are available that match the applica-tion, they are used to refine the evaluation. Theinspection benchmarks are used to determinewhether a system or component is functioningproperly. These benchmarks use a well-definedtesting methodology based on real-world use of acomputer system. They measure performance ina deterministic and reproducible manner thatallows the system administrator to judge the per-formance and capacity of the system. Bench-marks provide a means of determining tuningparameters, reliability, bottlenecks, and systemcapacity that can provide marketing and buyinginformation.

Although benchmarking in the electronicsindustry is a testing mechanism or process, it,too, is a technique for learning, change, andprocess improvement. Benchmarking is an effec-tive way to ensure continuous improvement orprogress toward strategic goals and organiza-tional priorities. A real benefit of benchmarkingcomes from the understanding of processes andpractices that permit a transfer of best practicesor performances into the organization. At itsbest, benchmarking stresses not only processes,quality, and output but also the importance ofidentifying and understanding the drivers of theactivities.

(SEE ALSO: Activity-based management costing;Performance Appraisal; Work Measurement)

BENCHMARKING


BIBLIOGRAPHY

Blinn, James D. (1998). ‘‘Benchmarking Can Help ControlCost of Risk.’’ National Underwriter October: 24-25.

Camp, Robert C. (1989). Benchmarking: The Search for In-dustry Best Practices That Lead to Superior Performance.Milwaukee, WI: ASQC Quality Press.

Camp, Robert C. (1995). Business Process Benchmarking:Finding and Implementing Best Practices. Milwaukee, WI:ASQC Quality Press.

Camp, Robert C., ed. (1998). Global Cases in Benchmarking:Best Practices from Organizations Around the World. Mil-waukee, WI: ASQC Quality Press.

George, Steven. (1992). The Baldrige Quality Ssystem: TheDo-It-Yourself Way to Transform Your Business. NewYork: Wiley.

Hammer, Michael, and Champy, James. (1993).Reengineering the Corporation: A Manifesto for BusinessRevolution. New York: HarperCollins.

Hurwicz, Michael. (1998). ‘‘Behind the Benchmarks,’’ ByteApril: 75-81.

MARY L. FISCHER

BENEFITS(SEE: Employee Benefits)

BONDS

A bond is a type of interest-bearing security is-sued by an organization that needs funds. Theissuer—a corporation, governmental agency, ormunicipality—compensates the bondholders bypaying interest for the life of the bond. At matu-rity, the bondholder will be repaid for the fundslent. Maturity dates vary, but bonds are mostcommonly used for long-term debt. The discus-sion here will focus primarily on such long-termbonds. Corporate bonds and government bondsfrom the perspective of issuers will be introducedfirst. Investing in bonds from the point of view ofindividuals will be discussed later.

CORPORATE BONDS

Most corporate bonds are sold in $1,000 denomi-nations. This $1,000 is the par (or face) value ofthe bond. When bonds are issued, the actual

price paid by the bondholder may be the parvalue (face value) or an amount below (referredto as issued at a discount) or above (referred to asissued at a premium) par value. Regardless of theamount received when they are issued, at matu-rity the corporation will pay the par value (or$1,000 per bond) to the bondholders. While thebonds are held by the bondholders, the corpora-tion will pay the holders interest at a rate speci-fied on the bond. Interest payments are usuallymade semi-annually. As an example, a corpora-tion issues fifteen-year, 6 percent $1,000 bondswith a total par value of $300,000,000 on Novem-ber 1, Year 1. If the bonds sell at par, the corpora-tion would receive $300,000,000 at issuance (lessthe cost of underwriting). Over the fifteen years,the corporation would pay its bondholders$9,000,000 ($300,000,000 � 6% � 1⁄2 year) everysix months on May 1 and on November 1, fortotal interest of $270,000,000 over the fifteenyears. At maturity on November 1, Year 16, itwould also return the $300,000,000 par value tothe bondholders.

When corporations issue bonds, they gener-ally do not sell directly to the public; rather, theysell their entire issues to underwriters, which actas ‘‘middlemen’’ for the corporation and thebondholders. The underwriter, in turn, will sellthe bonds to the bondholders. As compensationfor its services, the underwriter sells the bonds tothe bondholders for slightly more than what itpaid the corporation. Once the bonds are sold,the underwriter is no longer involved with thebond issue.

The stated (also called the coupon ornominal) rate of interest relative to the market(sometimes referred to as the real or effective) ratedetermines whether a bond will sell for anamount equal to its par value, at a discount, or ata premium. When purchasing a corporate bond,the investor knows the stated rate of interest, therate that determines the periodic interest pay-ment. This stated rate is fixed during the life ofthe bond. The market rate of interest (i.e., theinterest rate demanded by investors in the mar-ket), however, fluctuates, usually on a daily basisin the secondary market. This fluctuation is due

BENEFITS


to a number of factors, some of which are federalmonetary policy, investors’ perception of growthand strength of the economy, and investors’ in-creasing or decreasing fear regarding inflation.When the stated rate equals the market rate, thebonds sell at par value. If, however, the stated rateis less than the market rate, investors are unwil-ling to pay the par value of the bonds; thus thebonds would sell at a discount. As an example, abond has a stated rate of interest of 6 percent, butthe current market rate of return for bonds ofsimilar quality is 7 percent. In order to induce theinvestor to buy the bonds, the bonds will sell foran amount less than par that provides the inves-tor a 7 percent return, the market rate. The oppo-site relationship can also exist: that is where thestated rate of the bonds is greater than the marketrate. In that situation, the bonds would sell for apremium. When the bonds are sold, the issuerwill ‘‘lock in’’ the market rate of interest thatexisted on that date. This will be the real interestrate for the issuer over the life of the bond.Similarly, an investor will ‘‘lock in’’ that samemarket rate and will earn that return for the timehe or she holds the bonds, possibly until thebonds mature.

If bonds sell at par, they are said to sell for100, meaning they are selling for 100 percent oftheir par value. If bonds sold for 981⁄2, they wouldhave sold at a discount, in this case for 981⁄2percent of their par value. Bonds sold at a pre-mium sell at an amount greater than 100 such as1011⁄4. As bond prices fall—that is sell for lessthan par value—the rate of return rises for thereasons stated above. Conversely, as bond pricesrise, rate of return falls.

Bonds are registered in the name of the per-son who purchased them. The registered ownerreceives the interest on the interest payment date.With the use of electronic processing, however,most bonds are book entry, meaning there is nocertificate or document issued. The bondholderholds a ‘‘virtual’’ bond, and the corporation’scomputer files merely contain the names andaddresses of those to whom interest checks willbe sent on the appropriate dates. Additionally,with the ability to transfer funds electronically,

corporations are able to deposit interest pay-ments directly into their bondholders’ bank ac-counts.

Some corporate bonds are issued with a callprovision. This allows the issuing corporation to‘‘call’’ the bonds—that is, buy them back fromthe bondholders—before their maturity date.This call provision is likely to be exercised by thecorporation if the market interest rates havefallen since the bonds were issued. This allowsbonds with a high interest rate to be retired andreplaced by lower-interest bonds.

Another feature of some bonds allows thebondholders to convert bonds into shares ofcommon stock of the issuing company. These arereferred to as convertible bonds. This is often anattractive feature to bondholders who want toswitch from being a creditor of the corporationto an owner if the company’s stock begins toappreciate in value. The conversion ratio (e.g., 40shares of common stock for each $1000 bond)would be specified.

The bond market is dominated by institu-tional investors, such as insurance companies,mutual funds, and pension funds, but bonds canbe purchased by individual investors as well.Bonds are traded in the both the primary marketand the secondary market. The primary marketrefers to the initial sale of bonds by the underwri-ters. The secondary market refers to the sale ofbonds subsequent to their original sale by issueror underwriter.

Bonds are one of the primary ways corpora-tions raise large amounts of capital. A corpora-tion can sell previously unissued shares of stock(equity) to shareholders, or it can borrow themoney by issuing bonds (debt). There are advan-tages and disadvantages to both.

By issuing equity, the corporation does notincrease debt, thus avoiding paying interest tobondholders. This method of raising capital,however, causes a dilution of ownership to exist-ing shareholders and, thus, may not be favoredby the current owners. If the corporation issuesbonds, it will be required to pay interest, butthere will be no change in the ownership struc-ture of the company. Furthermore, the corpora-

BONDS


tion’s management hopes—and expects—thatthey will earn a greater return than the interestthey are paying on the bonds. As an example, ifthe cost of borrowing on bonds is 6 percent, butthe corporation is able to earn 10 percent on themoney it has borrowed from the bondholders,the 4 percent difference earned above the cost ofborrowing accrues to the existing shareholders.Thus, shareholders earn a 4 percent return onfunds borrowed from bondholders.

An important consideration for a corpora-tion deciding whether to issue stocks or bonds isthe tax deductibility of the bond interest. Interestpaid on bonds is a tax-deductible expense on acorporation’s income tax return, meaning theirtaxable income will be reduced by the amount ofinterest paid. Their after-tax cost of borrowing is,as a result, less than the interest paid on thebonds. As an example, if a corporation issues 6percent bonds and has an average tax rate is 40percent, the after-tax interest rate on the bonds is3.6 percent [(6% � (1 � tax rate)].

GOVERNMENT BONDS

The U.S. federal government borrows largeamounts of money. Since the late 1970s, the fed-eral government has consistently spent moremoney than it has collected in taxes. (In the late1990s, that trend began to reverse.) In order tohave adequate money to pay for its expenditures,the United States borrows money. Bonds issuedby the federal government have different namesdepending on their maturity date. Those whichhave a maturity date of less than a year are called‘‘Treasury bills’’ (or ‘‘T-bills’’ for short). Debtinstruments with maturities from one to tenyears are called notes; those with maturities ex-ceeding ten years are called bonds. Collectively allare referred to as Treasuries.

Federal bonds are auctioned according to aschedule, for example, thirteen-week T-bills areauctioned every Monday and two-year treasurynotes on the last Wednesday of every month. Theresults of these auctions, including market inter-est rates, are reported in the financial press. Theserates not only reflect the interest the bondholderwill earn; they also influence interest rates for

debts such as mortgages, car loans, and creditcards.

State and local governments also borrowmoney by selling municipal bonds (frequentlyreferred to as ‘‘munis’’). Municipal bonds areeither general obligation or revenue bonds. Gen-eral obligation bonds (also known as ‘‘GOs’’) willbe paid off by money received from taxes andpossibly by user fees. The costs of buildingschools and sewers are paid for through generalobligation bonds. A revenue bond is one that isissued by an enterprise that serves a public func-tion. Examples include airports, utility compa-nies, toll roads, universities, and hospitals. Themoney to pay the bond interest and the bonds atmaturity will be generated by these enterprises’revenue-generating activities.

While interest on corporate bonds is fullytaxable to the bondholder, interest on Treasuriesis exempt from state (but not federal) incometax. Interest on municipal bonds is exempt fromfederal income tax. If the municipal bond is is-sued by the jurisdiction in which the bondholderresides, the interest is tax-exempt by both thefederal government and the state government. Ifthere is a local income tax, the interest is tax-exempt at this level, too. Thus in some instancesthe bondholder has a triple exemption. Becauseof the tax-exempt nature of municipal bonds,their rates are usually one- to two-percentagepoints lower than that of comparable taxablecorporate bond, for which there is no tax exemp-tion.

INVESTING IN BONDS

There is no centralized market for corporatebonds excepted for those listed on exchanges. Aninvestor who wishes to buy or sell bonds mustcontact a broker or dealer who might carry thatparticular bond in inventory. A dealer who doesnot have that bond would contact another dealerwho did. Because of the transaction costs in-volved in buying and selling corporate bonds inthe secondary market, they may not be an attrac-tive investment for investors. Treasuries may bepurchased directly from the government. Theyare also much more easily obtained in the secon-

BONDS


dary market from brokers because they are gen-erally available.

Bonds typically earn a return greater thanthat offered by a bank on its savings account orcertificates of deposit (CDs), which are amongthe safest of investments since they are currentlyguaranteed up to a value of $100,000 in insuredbanks.

Bonds are considered relatively safe for sev-eral reasons. When buying a bond, the bond-holder knows how much interest will be paidperiodically from the issuing corporation (orgovernment). Thus, there is little uncertainty re-garding the return.

Bonds are also considered relatively safe be-cause the issuers of bonds most likely will beevaluated by one of the credit-rating agencies—Moody’s, Standard & Poor’s (S & P), or Fitch.These agencies evaluate the creditworthiness ofcorporations and of state and local governments.

Although bonds are among the safer invest-ments, there are several risks associated withthem. Probably the biggest risk to the investor ismarket risk. This is the risk an investor facesshould interest rates rise after the bonds havebeen purchased. As mentioned above, when in-terest rates rise, the price of bonds falls (and viceversa). If an investor bought bonds that wereyielding 6 percent, the return is 6 percent as longas the bonds are held, possibly until maturity. Ifinterest rates rise above 6 percent, however, thebonds are no longer paying the market rate ofinterest. Furthermore, if the investors were to sellthe bonds, they would sell for less than what waspaid for them. All bonds—corporate, Treasuries,and munis—are subject to market risk.

Another risk associated with investing in cor-porate and municipal bonds (but not Treasuries)is the credit risk (or credit-rating risk) of theissuer. Since a bond is a loan, a bondholder has toassess the likelihood that the issuer will be able topay the periodic interest payments and thebond’s par value at maturity. Credit rating agen-cies are well respected and widely used to help aninvestor assess the credit risk of corporate andmunicipal bonds. Although the ratings the agen-cies use and how they determine them vary

slightly, they generally rate the bonds from ex-tremely safe investments to wildly speculativeones.

With Treasury bonds, there is virtually nocredit risk since most investors see them as hav-ing the full faith of the U.S. government behindthem. Because of this perceived absence ofdefault, investors typically use the rate offered onTreasuries as the benchmark against which otherinvestments are evaluated.

Another risk associated with investing inbonds is call risk. As mentioned previously, somebonds are callable at the discretion of the issuer.This means that the issuer may retire the bonds,paying the bondholder the par value (and usuallya small ‘‘call premium’’ as well) and any accruedinterest since the last interest payment date. Theissuer returns the money to the investor. A cor-poration (or municipal government) usually callsbonds only when interest rates have fallen. Ifbonds are called, the investor now would be backin the market buying bonds yielding a lower re-turn. Furthermore, if the investor had originallypurchased the bonds at a premium, it is likelythat the original purchase price would not berealized when the bond is called. Corporate andmunicipal bonds may be callable. U.S. Treasuriesare not.

In spite of the risks mentioned, bonds are stillconsidered an attractive investment for many in-vestors. Prices of bonds are much less volatilewhen compared to prices of stocks. Defaults onbonds are also quite rare. Furthermore, even if acorporation faces liquidation because of financialdistress, bondholders would be among the first toreceive corporate assets, since they are creditorsof the corporation. According to conventionalwisdom, bonds strike an acceptable compromisebetween risk and return.

(SEE ALSO: Capital markets; Finance; Financial insti-tutions)

BIBLIOGRAPHY

Bodie, Zvi, Kane, Alex, and Marcus Alan J., (1999).Investments. Boston: Irwin/McGraw-Hill.

BONDS


Emery, Douglas R., Finnerty, John D., and Stowe, John D.(1998). Principles of Financial Management. Upper Sad-dle River, NJ: Prentice-Hall.

Levy, Haim, and Alderson, Michael J. (1998). Principles ofCorporate Finance. Cincinnati, OH: South-Western Col-lege Publishing.

Mahony, Stephen. (1996). Mastering Government Securities.London: Pitman.

Ross, Stephen A., Westerfield, Randolph W., and Jaffe,Jeffrey. (1999). Corporate Finance. Boston: Irwin/McGraw-Hill.

ALLIE F. MILLER

BRANDING(SEE: Product Labeling)

BREAK-EVEN ANALYSIS(SEE: Cost-Volume-Profit Analysis)

BROKERS AND DEALERS(SEE: Financial Institutions)


A budget is a financial plan for the upcomingperiod. A capital budget, on the other hand, in-volves an organization’s proposed long-rangemajor projects. The focus of this section is onbudget. Public and private entities both engage inthe budgetary process. A government budgetstarts with the projection of sources and amountsof revenue and allocates the potential receiptsamong projects and legislatively mandated pro-grams based on projected needs and public pres-sure. Government entities actually record bud-gets in the accounting records against whichexpenditures can be made.

A budget is a quantitative plan of operationsthat identifies the resources needed to fulfill theorganization’s goals and objectives. It includesboth financial and nonfinancial aspects.Budgeting is the process of preparing a plan, com-

monly called a budget. Amaster budget comprisesoperating budgets and financial budgets. Operat-ing budgets identify the use of resources in oper-ating activities. They include production budgets,purchase budgets, human resources budgets, andsales budgets. Financial budgets identify sourcesand outflows of funds for the budgeted opera-tions and the expected operating results for theperiod. Some variations of budgets arecontinuous budgets and continuously updated bud-gets. Rather than preparing one budget for theupcoming year, in a continuous budget one up-dates the budget for the following twelve monthsat the end of each month or each quarter. Such abudget remains more current and relevant. Agood budget uses historical data as a base and forreference but at the same time incorporates an-ticipated costs and volumes based on a compre-hensive knowledge and understanding of bothinternal and external factors that affect the busi-ness.

COMPONENTS OF THE MASTER BUDGET

The master budget includes a sales budget, whichshows expected sales in units and in dollars. Amerchandising firm needs to budget for thegoods it needs to purchase for resale; these pur-chases become its cost of sales. A manufacturingorganization’s master budget includes a produc-tion budget, which uses the sales budget andinventory levels anticipated at the beginning andend of the period to determine how much toproduce.

The production budget needs to be explodedinto budgets for direct material, direct labor, andmanufacturing overhead. Direct material and di-rect labor are items clearly identifiable in thefinished product. Manufacturing overhead in-cludes all costs of manufacturing except for directmaterial and direct labor, such as machine depre-ciation, utilities, and supervision. The direct ma-terial budget explodes the production into basicingredients; quantities to be purchased are antici-pated based on expected inventory levels at thebeginning and end of the period. With the help ofthe purchasing department, the prices for theneeded materials are computed to arrive at the

BRANDING


material purchases budget. The direct labor bud-get uses industrial engineering guidelines andproduction needs to estimate labor requirements.The human resources department provides thelabor rates for the skill levels required. Overheadcosts are estimated based on production level andappropriate cost drivers (i.e., the factors thatcause costs to vary). Some overhead costs areconsidered variable because they vary with thelevel of output. Others are considered fixed be-cause the level of output does not affect theamount of those costs. For example, the produc-tion supervision cost is assumed to be the sameregardless of how much is produced within ashift in a plant. One can, then, estimate produc-tion costs and cost per unit for goods to beproduced. Cost of goods sold can now be deter-mined based on the inventory levels of finishedgoods. Selling and general administration costsare then estimated, taking into considerationthose costs that vary with sales, such as salescommission, as well as fixed costs that remain thesame regardless of the level of sales, such as officerent. The information put together so far givesone all one needs to prepare a forecasted incomestatement.

At this point, one develops the cash budget.This item starts with cash at the beginning of theperiod plus cash that will be generated throughcollection of receivables, cash sales, and othersources minus anticipated minus cash disburse-ments, which include payroll disbursements,payment for taxes, and accounts payable depend-ing on the terms for payment. The resulting cashbalance may be negative—more disbursementsthan receipts; in this case, one determines bor-rowing needs. A positive cash balance may bemore than needed for operating expense; suchexcess cash may be deposited in a temporaryinvestment account. The final part of masterbudget preparation is the forecasted balancesheet, where the anticipated cash balance, invest-ments, accounts receivable, inventory, fixed as-sets, accounts payable, wages payable, taxes pay-able, long-term liabilities, and equity accountsare recorded to assure that the two sides of the

equation balance; that is assets � liabilities �equity.

THE BUDGETING PROCESS

Budgeting is—or should be—the result of team-work. A top-down budget is a budget that is essen-tially imposed on the organization by top man-agement. This may be an efficient way to preparea budget but because of lack of participation bythe employees, such budgets often bring withthem a level of employee resentment and resis-tance that leads to problems in implementationof what is proposed. Employees do not feel asense of ownership in a budget in which theyhave not been participants. A participatory orbottom-up budget, on the other hand, starts withthe employees in each department determiningtheir needs and requirements in order to achievethe company goals. Because employees feel asense of ownership in such budgets, they attemptto meet or exceed those expectations. A balancebetween the two extremes can often be achieved.Top management should be involved in settingthe tone and providing the guidelines and pa-rameters within which the budget will be set.Incentives should be put into place so that thosewho achieve or exceed the budgetary expecta-tions will receive suitable rewards for their ef-forts.

There must also be guidelines to discouragebudgetary slacks and abuses whereby the re-quested budget amounts are in excess of antici-pated needs in order for the department to lookbetter and reap some rewards. A very tight bud-get, on the other hand, may prove discouragingand unattainable. No matter what approach istaken, it is important to realize that the budgetshould serve as a map and guideline in antici-pating the future. Top management must take itseriously in order for the employees to take itseriously as well. At the same time, the budgetshould not be seen as a strict and unchangeabledocument. If opportunities arise, circumstanceschange, and unforeseen situations develop, thereis no reason why the budget should be an impedi-ment to exploring and taking advantage of suchopportunities. Many companies form a budget



committee to oversee the preparation and execu-tion of the budget. The budget can also be seen asa tool that helps in bridging the communicationsgap between various parts of the organization.Sales, production, purchasing, receiving, indus-trial relations, sales promotion, warehousing,computing, treasury, quality control, and allother departments see their roles and understandthe roles of the other players in achieving thegoals of the organization. Such participation alsonecessitates budget negotiation among the vari-ous parties to the budgetary process until thebudget is finalized. Goal congruence occurs whenthe goals of the employees and the goals of thecompany become intertwined and meshed to-gether. A budget that does not consider the goalsof the employees often fails. The finalization ofthe budget requires acceptance by the affecteddepartments and approval and sign-off by topmanagement. If circumstances change due to fac-tors such as change in product mix, costs, sellingprices, negotiated labor rates, or engineeringspecifications, there may be a need for budgetrevision.

OTHER BUDGETING TECHNIQUES

An incremental budget is a budget that is preparedbased on prior-year figures, allowing for factorssuch as inflation. Although such an approach isused by some government entities, most peoplefrown upon such a practice because it is contraryto the whole notion of a budget, which is sup-posed to be a calculated and wise anticipation ofthe future course of events with due consider-ation of all potential factors. A zero-based budget,on the other hand, is a budget that does not takeanything for granted. It starts from point zero foreach budgetary element and department eachyear and attempts to justify every dollar of expen-diture. Although some industries had implemen-ted such a method earlier, it was first used inpreparing the state of Georgia’s budget in theearly 1970s and was later used to prepare thefederal budget in late 1970s during PresidentCarter’s administration. However, it was soonabandoned because the paperwork generated andtimeframe necessary to do this task proved to be

too cumbersome for the federal government.Kaisen budgeting, a term borrowed from Japa-nese, is a budgeting approach that explicitly de-mands continuous improvement and incorpo-rates all the expected improvements in thebudget that results from such a process. Activity-based budgeting is a technique that focuses oncosts of activities or cost drivers necessary forproduction and sales. Such an approach facili-tates continuous improvement. An easily attain-able budget often fails to bring out the employ-ees’ best efforts. A budget target that is verydifficult to achieve can discourage managersfrom even trying to attain it. So budget targetsshould be challenging and at the same time at-tainable.

MONITORING THE BUDGET

A flexible budgetmodifies the budget to the actuallevel of performance. Obviously, if the originalbudget is prepared for say, one thousand units ofa product, but two thousand units are produced,comparing the original budget to the actual vol-ume of output does not provide meaningful in-formation. Accordingly, the budgeted costs perunit for all variable costs can be used and multi-plied by the actual volume of output to arrive atthe flexible change proportionately to the level ofoutput for the former and to the level of sales forthe latter cost. Fixed costs, such as rent, however,do not normally change with the level of produc-tion or sales. These budgeted costs, therefore, arenot adjusted and left intact even though the vol-ume of sales and output may be different fromthe originally budgeted levels.

Ultimately, a good budget is one which notonly uses good budgeting techniques but is alsobased on a sound knowledge of the business aswell as the external factors that affect it. Thebudget serves as a planning tool for the organiza-tion as a whole as well as its subunits. It providesa frame of reference against which actual per-formance can be compared. It provides a meansto determine and investigate variances. It alsoassists the company in planning again based onthe feedback received considering the changingconditions. An attainable, fair, and participatory



budget is also a good tool for communication,employee involvement, and motivation.

BIBLIOGRAPHY

Blocher, Edward J., Chen, and Lin. (1998). Cost Manage-ment: A Strategic Emphasis. Boston, MA: McGraw-Hill.

Horngren, Charles T., Foster, and Datar. (1999). Cost Ac-counting: A Managerial Emphasis, 10th ed. Upper SaddleRiver, NJ: Prentice Hall.

Raiborn, Cecily A., Barfield, and Kinney. (1966). Insights:Readings in Managerial Accounting, 2nd ed. St. Paul, MN:West.

Schick, Allen, ed. (1980). Perspectives on Budgeting. Wash-ington, DC: American Society for Public Administration.

Willson, James D. (1995). Budgeting and Profit PlanningManual. Boston, MA: Warren, Gorham, Lamont.

Young, Mark S. (1997). Readings in Management Account-ing, 2nd ed. Englewood Cliff, NJ: Prentice Hall.

ROGER K. DOOST


‘‘Is employment below or above the level of lastmonth?’’ ‘‘What has happened to prices duringthe past month?’’ Such questions—and thou-sands of others about a wide range of labor-related topics—are answered by personnel of theBureau of Labor Statistics (BLS). When the BLSwas established by Congress on June 27, 1884, itsmission was stated in these words: ‘‘The generaldesign and duties of the Bureau of Labor shall beto acquire and diffuse among the people of theUnited States useful information on subjectsconnected with labor, in the more general andcomprehensive sense of that word, and espe-cially upon its relation to capital, the hours oflabor, social, intellectual, and moral prosperity.’’The BLS is an independent national statisticalagency that collects, processes, analyzes, and dis-seminates essential statistical data to the citizensof the United States, the U.S. Congress, otherfederal agencies, state and local governments,businesses, and labor. The president appointsthe head of the BLS, the commissioner, withapproval by the Senate for a specific term that

does not coincide with that of his administra-tion.

The BLS is distinct from the policy-makingand enforcement activities of the Department ofLabor. The BLS is impartial, with a strong com-mitment to integrity and objectivity; its data havecredibility because of the standards maintainedthroughout the agency. The major areas of BLSactivity are as follows:

● Employment and unemployment

● Prices and living conditions

● Compensation and working conditions

● Productivity and technology

● Employment projections

● Safety and health statistics

Employment and unemployment: In additionto monthly figures on employment and unem-ployment, the BLS does a comprehensivebreakdown of the age, sex, and racial and eth-nic composition of the work force as well as ofindustries and occupations in which the work-ers are employed. Other characteristics are alsotracked, including patterns of regional employ-ment and the extent of participation in work byteenagers, blacks, Hispanics, women, and olderAmericans.

Price and living conditions: Each month theConsumer Price Index (CPI) and the ProducersPrice Index (PPI) are prepared. The BLS alsoreports how households spend their incomes.

Compensation and working conditions: Com-prehensive studies of employee compensation—wages and benefits—are undertaken that relateto occupations, industries, and areas of thecountry. An initiative begun in 2000 will pro-duce national employment cost indexes, em-ployment cost levels, and employee benefitincidence.

Productivity and technology: This office pro-duces productivity measures for industries andfor major sectors of the U.S. economy. Addition-ally, it provides comparisons for key BLS laborstatistics series as well as training and technicalassistance in labor statistics to people from othercountries.



Employment projections: There is much in-terest in the projections provided by this unit ofthe BLS. Information about future employmentgrowth—and the nature of that growth—is ofcritical importance to public officials, businesses,young people preparing for careers, and thosewho design educational programs at all levels.

Safety and health statistics: The extent ofworkplace injuries and illnesses is the concern ofthe office that compiles safety and health statis-tics. Information analyzed and summarized in-cludes job-related injuries and illnesses by indus-try, nature of the injury or illness, and theworkers involved. There is also a compilation ofwork-related deaths. The statistics provided areuseful in developing safety and health standards,in controlling work hazards, and in the allocationof resources for workplace inspection, training,and consultation services.

THE MANNER OF WORK AND SOURCESOF INFORMATION

The BLS, as is the case for all federal agencies,functions in an open environment. As changesare contemplated, they are discussed with usersand advisory committees and described in pub-lished materials. Fair information practices areused; maintaining confidentiality of individualresponses is assured. The BLS promises the pub-lic that users will be provided assistance in under-standing the uses and limitations of data pro-vided.

The BLS gathers its information frombusiness and labor groups throughout the coun-try through voluntary advisory councils. Thecouncils were established in 1947; current mem-bers meet with BLS staff for discussions related tosuch matters as planned programs and day-to-day problems the BLS faces in collecting, record-ing, and analyzing statistics as well as in thepublishing of reports.

KEY PUBLICATIONS

The most widely distributed publications, whichare available in public as well as other libraries,

include: Monthly Labor Review, Employment andEarnings, and Occupational Outlook Quarterly.Additionally, a variety of surveys, including thoserelated to the Consumer Price Index and theProducer Price Index, are published.

RESPONSE TO CHANGE INTHE WORKPLACE

Rapid technological changes, globalization ofworld markets, and demographic shifts are allforces that are reshaping the U.S. workplace inrelation to the nature and types of jobs, the com-position of the work force, and workers’ educa-tion, skills, and experiences. The BLS in its Re-vised Strategic Plan 1997-2002 stated that it ‘‘hasbeen and will continue to be responsive to users’need to understand changes.’’

The BLS has undertaken efforts to improveits programs so that they capture workplace andwork-force changes. The Current Population Sur-vey, which provides monthly data on the demo-graphic and educational characteristics of thework force, includes supplemental surveys onworkplace issues such as contingent employ-ment, worker displacement, and work schedules.A new monthly survey of job openings and laborturnover for the country and major industrysectors will provide information that had notbeen available earlier.

EMPLOYMENT OPPORTUNITIES

As of the end of 1999, there were approximatelytwenty-six hundred BLS employees working inWashington, D.C., and in the regional offices ineight cities: Boston, New York, Philadelphia, At-lanta, Chicago, Dallas, Kansas City, and SanFrancisco. The BLS reports that there is a contin-uing need for economists, mathematical statisti-cians, and computer specialists. There is a morelimited need for administrative and financial spe-cialists as well as for many types of techniciansand assistants. Employment is restricted by law toU.S. citizens. Most professional jobs require abachelor’s degree or its equivalent in experience.Specific qualifications and educational require-ments are described in BLS pamphlets available



from the agency and also on the Internet(http://www.usajobs.opm.gov/).

BIBLIOGRAPHY

Goldberg, Joseph P., and Moye, William J. (1985). The FirstHundred Years of the Bureau of Labor Statistics. Washing-ton, DC: U.S. Government Printing Office.

BERNARD H. NEWMAN

BUSINESS CYCLE

The business cycle is the ups and downs of thegeneral level of economic activity. All modern,industrialized countries have fluctuations in theirrates of economic activity, leading to the observa-tion that one nation’s economy is ‘‘booming’’while another economy is in a ‘‘recession.’’ Whenan economy goes from a positive to a negativerate of growth, it is said to have reached a ‘‘peak’’and entered a recession. When an economy goesfrom a negative to a positive rate of growth, it issaid to have reached a ‘‘trough’’ and entered a‘‘recovery.’’

WHAT IS THE BUSINESS CYCLE?

Although something worthy of being called ‘‘thebusiness cycle’’ does exist, attempts at finer classi-fications or subcategories of business cycles havenot been particularly fruitful. Some economistshave simply used a broad dichotomy between‘‘major’’ and ‘‘minor’’ cycles. Descriptively thiscan be meaningful. A particularly severe reces-sion is referred to as a ‘‘depression.’’ The Depres-sion of the 1930s was quantitatively differentfrom the 1990-1991 recession. The output of theeconomy fell by almost 50 percent in the formerand by less than 1 percent in the latter.

It is sometimes useful to speak of the cycles ofspecific time series; that is, the interest rate cycle,the inventory cycle, the construction cycle, andso forth. Given the diversity of general economiccycles, one can find turns in the general level ofeconomic activity in which individual sectors ofthe economy do, at least for a time, appear to beindependent of the rest of the economy. The

most frequently mentioned individual cycles arethe inventory cycle, the building or constructioncycle, and the agricultural cycle. The standardbusiness cycle is sometimes referred to as theinventory cycle, and some business cycle theoristspopularly explain the severity of turns in theeconomy by the coincidence of timing in theindividual cycles.

The idea of the timing of individual timeseries relative to the general level of businessimplies specific dates for the business cycle. Howdoes one establish the peaks and troughs for thebusiness cycle? To say whether something leadsor lags the business cycle, one must have someframe of reference; hence, the business cycle isreferred to as the reference cycle and its peaks andtroughs as reference turning points. (See Table 1.)

For the United States, the reference turningpoints are established by the National Bureau ofEconomic Research (NBER), a nonprofit re-search organization. This organization, originallyunder the guidance of Wesley Claire Mitchell(1874–1948), pioneered business cycle researchin the late 1920s. Today the NBER’s decisionsregarding the reference cycle are taken as gospel,although they are, in fact, quite subjective. Nosingle time series or group of time series is de-creed to be the reference cycle. A committee ofprofessional business cycle analysts convened bythe NBER establishes the official peaks andtroughs in accordance with the following defini-tion:

Business cycles are a type of fluctuation found in theaggregate economic activity of nations that organizetheir work mainly in business enterprises: a cycleconsists of expansions occurring at about the sametime in many economic activities, followed by simi-larly general recessions, contractions and revivalswhich merge in the expansion phase of the next cycle;this sequence of changes is recurrent but not periodic;in duration business cycles vary from more than oneyear to ten or twelve years; they are not divisible intoshorter cycles of similar character with amplitudesapproximately their own. (Burns and Mitchell,1946, p. 3)

With slight modification, this definition has beenused since 1927. Although most of the definition

BUSINESS CYCLE


is self-explanatory, it is not all that rigorous. Itdoes not say something like, for example, if thetotal output of the economy (real GDP) falls at anannual rate of 1 percent for two consecutivequarters, we have entered a recession. The defini-tion does say unambiguously that business cyclesare ‘‘recurrent but not periodic.’’ The only realconstraint in the definition is that if you define abusiness cycle, say, from peak to peak, youshould not be able to find another cycle of equalamplitude between those two peaks. If so, youdid it wrong.

As of mid-2000, Table 1 is still relevant. Themost recent turning point identified by the NBERwas March 1991. As of April 2000, the U.S. econ-omy continued to expand. Notice from the tablethat all that is established with regard to the busi-ness cycle is the peak and trough of each cycle.This determination tells us absolutely nothingabout the rate of rise or fall in the general level ofeconomic activity, nothing about the magnitudeof the boom or the severity of the recession. Themost commonly used series as a proxy for thebusiness cycle when more than just turningpoints is required is real GDP if one can get bywith quarterly data, or the industrial productionindex if monthly data are required. The industrialproduction index is a measure of economic activ-ity published monthly by the Federal ReserveBoard in Washington, D.C. As might be guessedfrom the attention given them by the media, theconsumer price index and the unemploymentrate are commonly used measures of the severityof the business cycle. Neither corresponds veryclosely to the reference cycle.

THEORIES OF THE BUSINESS CYCLE

The first lecture in an introductory economicscourse usually makes the point that the expendi-tures of one economic unit are the incomes ofother economic units. This provides a fairly firmbasis for expecting sympathetic movements inmany sectors of the economy. A good theoreticalbasis and substantial empirical support exist forcumulative upward and downward movement inthe economy. One sector’s expansion is the basisfor another sector’s expansion, general prosperity

lowers risk and makes credit more readily avail-able, and so on; but the weakest part of businesscycle theory and the toughest problem in fore-casting is turning points. Why does the generalupward or downward movement end? Some-times it is obvious. When, for example, a warbegins or ends with a commensurate and dra-matic change in military expenditures, the causeof the beginning or end of an economic boom isfairly unambiguous. Historically, however, only asmall minority of the turning points are the resultof specific, identifiable occurrences. There aremany theories as to other causes of the businesscycle.

In 1917 an eminent American economist bythe name of J. M. Clark published an articleentitled ‘‘Business Acceleration and the Law ofDemand: A Technical Factor in Economic Cy-cles.’’ His technical factor was the observationthat with a fixed capital-output ratio, a smallpercentage change in final sales would give rise toa large percentage change in investment. Eachinnovation generates a temporary demand forthe required investment goods. Once the initialinvestment has been made, the replacement mar-ket requires a lower rate of investment. This isreferred to as the principle of acceleration. If ittakes $10 worth of steel mills to produce $1worth of steel per year, growth in demand forsteel by $1 will temporarily generate $10 worth ofdemand for steel mills.

Another early business cycle theorist, JosephSchumpeter (1883–1950), noted that nothing isconstant over the business cycle and nothing everreally returns to its starting place. That is whatmakes each business cycle unique. The economygrows and changes with each cycle—new prod-ucts, new firms, new consumers. As Schumpeterobserved in 1939, ‘‘As a matter of history, it is tophysiology and zoology, not to mechanics, thatour science is indebted for an analogous distinc-tion which is at the threshold of all clear thinkingabout economic matters’’ (p. 37). The economygrows and changes. He referred to this as theprocess of ‘‘creative destruction.’’

Schumpeter concluded that what most of usconsider ‘‘progress’’ is at the source of the prob-

BUSINESS CYCLE


Business cycle reference dates Duration in months Cycle Contraction (trough from Expansion Trough from Peak from Trough Peak previous peak) (trough to peak) previous trough previous peak

December 1854 June 1857 — 30 — — December 1858 October 1860 18 22 48 40 June 1861 April 1865 8 46 30 54 December 1867 June 1869 32 18 78 50 December 1870 October 1873 18 34 36 52

March 1879 March 1882 65 36 99 101 May 1885 March 1887 38 22 74 60 April 1888 July 1890 13 27 35 40 May 1891 January 1893 10 20 37 30 June 1894 December 1895 17 18 37 35

June 1897 June 1899 18 24 36 42 December 1900 September 1902 18 21 42 39 August 1904 May 1907 23 33 44 56 June 1908 January 1910 13 19 46 32 January 1912 January 1913 24 12 43 36

December 1914 August 1918 23 44 35 67 March 1919 January 1920 7 10 51 17 July 1921 May 1923 18 22 28 40 July 1924 October 1926 14 27 36 41 November 1927 August 1929 13 21 40 34

March 1933 May 1937 43 50 64 93 June 1938 February 1945 13 80 63 93 October 1945 November 1948 8 37 88 45 October 1949 July 1953 11 45 48 56 May 1954 August 1957 10 39 55 49

April 1958 April 1960 8 24 47 32 February 1961 December 1969 10 106 34 116 November 1970 November 1973 11 36 117 47 March 1975 January 1980 16 58 52 74 July 1980 July 1981 6 12 64 18

November 1982 July 1990 16 92 28 108 March 1991 8 — 100 —

Average, all cycles: 1854–1991 (31 cycles) 18 35 53 153 1854–1919 (16 cycles) 22 27 48 249 1919–1945 (6 cycles) 18 35 53 53 1945–1991 (9 cycles) 11 50 61 61

Average, peacetime cycles: 1854–1991 (26 cycles) 19 29 48 348 1954–1919 (14 cycles) 22 24 46 447 1919–1945 (5 cycles) 20 26 46 45 1945–1991 (7 cycles) 11 43 53 53

Survey Of Current Business

BUSINESS CYCLE EXPANSIONS AND CONTRACTIONS

1. 30 cycles.2. 15 cycles.3. 25 cycles.4. 13 cycles.

NOTE--Figures printed in bold italic are the wartime expansions (Civil War, World Wars I and II, Korean war and Vietnam war), the postwar contractors, and the full cycles that induce the wartime expansions.

Table 1NOTE: Figures printed in bold italic are the wartime expansions (Civil War, World Wars I and II, Korean war and Vietnam war), thepostwar contractors, and the full cycles that induce the wartime expansions.

SOURCE: National Bureau of Economic Research, Inc. 1050 Massachusetts Avenue. Cambridge MA 02133.

BUSINESS CYCLE


lem. He felt that as entrepreneurs come up withnew ways of doing things, this disturbs the equi-librium and creates fluctuations. Schumpeter dis-tinguishes between inventions (which may gatherdust for years) and innovations, which are com-mercial applications of previous inventions. In-ventions occur randomly through time. Innova-tions tend to be bunched, thereby creating cyclesof economic activity.

Many business cycle theorists give a promi-nent role to the monetary system and interestrates. Early in the twentieth century, a Swedisheconomist, Knut Wicksell (1851–1926), arguedthat if the ‘‘natural’’ rate of interest rose abovethe ‘‘bank’’ rate of interest, the level of economicactivity would begin to increase. In contempo-rary terms, the natural rate of interest is whatbusinesses expect to earn on real investment. Thebank rate is the return on financial assets in gen-eral and commercial bank loans in particular.The boom begins when, for whatever reason, thecost of borrowing falls significantly below expec-ted returns on investment. This difference be-tween the rate of return on real and financialassets generates a demand for bank loans by in-vestors seeking to exploit the opportunity forprofit. The economy booms.

At some point the bank rate will start to riseand/or the real rate will start to fall. When theexpected rate of return on investment falls belowthe rate at which funds can be borrowed, theprocess will begin to reverse itself—and the re-cession is on. As bank loans are paid off (ordefaulted on), bank credit is reduced, and theeconomy slows accordingly.

In recent years, business cycles theory hascentered on the argument about the source ofcyclical instability. The question of the rootcauses of ups and downs in the level of economicactivity received a lot of attention in the 1980sand 1990s.

Figure 1 shows how the parties to the debateare divided up. First, there is the question ofwhether the private sector of the economy isinherently stable or unstable—which is to say, dothe observed fluctuations originate in the govern-ment or private sector? On one side are what

might be called classical economists, who areconvinced that the economy is inherently stable.They contend that, historically, government pol-icy has destabilized it in a perverse fashion. Onthe other side are what might be calledKeynesians, named after the famous British econ-omist John Maynard Keynes (1883–1946). Key-nesians think that psychological shifts in con-sumers’ purchasing and savings preferences andin businesses’ confidence are a substantial sourceof instability.

There is a whole body of literature onpolitical business cycles. As a contemporary econ-omist, William D. Nordhaus, noted in 1989,‘‘The theory of the political business cycle, whichanalyzes the interaction of political and economicsystems, arose from the obvious facts of life thatvoters care about the economy while politicianscare about power’’ (p. 1). The idea is that politi-cians in power will tend to follow policies topromote short-term prosperity around electiontime and allow recessions to occur at other times.The evidence that the state of the economy influ-ences voting patterns is strong, as is the apparentdesire of incumbent politicians to influence theeconomy; but it is difficult to make a case that theoverwhelming determinant of the level andtiming of business fluctuations is politically de-termined. At some points in recent history, polit-ically determined policies were apparently a de-termining factor and at other times not.

With respect to the impact of governmentalpolicies, there is a dispute as to the relative im-portance of monetary policy (controlling themoney supply) and fiscal policy (government ex-penditures and taxes). Those who believe thatmonetary policies have had a generally destabiliz-ing effect on the economy are known asmonetarists. Most economists accept the fact thatfiscal policy, especially in wartime, has been asource of cyclical instability.

As noted above, it is the so-called Keynesianeconomists who think that the private sector isinherently unstable. While noting the historicalinstability of investment in tangible assets, theyhave also emphasized shifts in liquidity prefer-ence (demand for money) as an independent

BUSINESS CYCLE


Current Arguments in Business Cycle Theory

Source of Fluctuations

Government Private

Monetary Fiscal Monetary Nonmonetary (Monetarists) (Keynesian) (Keynesian (Real Business Cycles) [Political Business Cycle] Liquidity Preference)

Figure 1

source of instability. As a counter to the standardKeynesian position, there has in recent yearsarisen a school of thought emphasizing real busi-ness cycles. This school contends that nonmone-tary variables in the private sector are a majorsource of cyclical instability. They contend thatthe observed sympathetic movements betweenmonetary variables and the level of economicactivity result from a flow of causation from thelatter to the former. The changes in real factorscause the monetary factors to change, not viceversa. In this way they are somewhat likeWicksell, discussed earlier.

(SEE ALSO: Economic Cycles)

BIBLIOGRAPHY

Blanchard, Oliver. (2000). ‘‘What Do We Know about Mac-roeconomics That Fisher and Wicksell Did Not?’’ Na-tional Bureau of Economic Research Working Paper No.W7550, February. New York: National Bureau of Eco-nomic Research.

Burns, Arthur F., and Mitchell, Wesley C. (1946).MeasuringBusiness Cycles. New York: National Bureau of EconomicResearch.

Clark, J. M. (1917). ‘‘Business Acceleration and the Law ofDemand: A Technical Factor in Economic Cycles.’’Journal of Political Economy March: 217-235.

Hicks, J. R. (1958). The Trade Cycle. London: Oxford Uni-versity Press.

King, Robert, and Plosser, Charles. (1984). ‘‘Money, Creditand Prices in a Real Business Cycle.’’ American EconomicReview June: 363-380.

King, Robert, and Rebelo, Sergio. (2000). ‘‘ResuscitatingReal Business Cycles.’’ National Bureau of EconomicResearch Working Paper No. W7534, February. NewYork: National Bureau of Economic Research.

Long, John, and Plosser, Charles. (1983). ‘‘Real BusinessCycles.’’ Journal of Political Economy February: 777-793.

Lucas, Robert E. (1981). Studies in Business Cycle Theory.Cambridge, MA: MIT Press.

Lucas, Robert E., and Sargent, Thomas J., ed. (1981).Rational Expectations and Econometric Practice. Minne-apolis: University of Minnesota Press.

Mankiw, N. Gregory. (1989). ‘‘Real Business Cycles: A NewKeynesian Perspective.’’ The Journal of Economic Perspec-tives Summer: 79-90.

Mitchell, Wesley Claire. (1952). The Economic Scientist. NewYork: National Bureau of Economic Research.

Nordhaus, William D. (1989). ‘‘Alternative Approaches tothe Political Business Cycle.’’ Brookings Papers on Eco-nomic Activity 2:1-50.

Rotemberg, Julio J., and Woodford, Michael. (1996). ‘‘Real-Business-Cycle Models and the Forecastable Movementsin Output, Hours, and Consumption.’’ The AmericanEconomic Review March: 71-89.

Schumpeter, Joseph. (1939). Business Cycles. New York:McGraw-Hill.

Schumpeter, Joseph. (1961). The Theory of Economic Devel-opment. New York: Oxford University Press.

Su, Vincent. (1996). Economic Fluctuations and Forecasting.New York: HarperCollins.

Wicksell, Knut. (1901). Lectures on Political Economy. NewYork: Augustus M. Kelly.

Willet, Thomas D., ed. (1988). Political Business Cycles: ThePolitical Economy of Money, Inflation, and Unemploy-ment. Durham, NC: Duke University Press.

BUSINESS CYCLE


Zarnowitz, Victor. (1992). Business Cycles, Theory, History,Indicators, and Forecasting. Chicago: University of Chi-cago Press.

DAVID A. BOWERS

BUSINESS PROFESSIONALSOF AMERICA

Business Professionals of America (BPA) is a na-tional vocational student organization for indi-viduals preparing for careers in business and/oroffice occupations. With nineteen state associa-tions and 45,000 members in middle, secondary,and post-secondary schools throughout NorthAmerica, BPA strives to contribute to the prepa-ration of a world-class work force by advancingleadership, citizenship, and academic and tech-nological skills. Using a co-curricular focus, BPAintegrates local programs and services into abusiness classroom curriculum and focuses onreal-world teaching and learning strategies. Addi-tionally, BPA develops professionalism in stu-dents and teachers through unique programs andservices (Business Professionals of America,1993).

Historically, the need for a student organiza-tion serving individuals in vocational office pro-grams was recognized shortly after the passage ofthe Vocational Education Act of 1963. The arti-cles of incorporation for the Office EducationAssociation, the original name of BPA, were offi-cially filed in 1966. The name was changed toBusiness Professionals of America on July 1, 1988(Business Professionals of America, 1996).

Business Professionals of America offers itsstudent, teacher, and alumni members a variety

of programs and services. The National Leader-ship Conference annually hosts national officerelections and competitive events that allow stu-dents to demonstrate workplace skills obtainedthrough the business classroom curriculum andIndustry Certification and Behavioral Skills As-sessment (‘‘Workplace Skills Assessment Pro-gram,’’ 1998). Awards programs also recognizesuccesses of members and chapters.

Various written materials and the officialquarterly journal, Communique, provide mem-bers with services, updates, and promotional op-portunities. Additionally, scholarship programsare sought at universities to encourage participa-tion in business education at the post-secondarylevel. More information is available from Busi-ness Professionals of America, 5454 ClevelandAve., Columbus, Ohio 43231-4021, orhttp://www.bpa.org/.

REFERENCES

Business Professionals of America. (1993). ‘‘Today’s stu-dents. Tomorrow’s business professionals’’ [Brochure].Columbus, OH: Author.

Business Professionals of America. (1996). ‘‘Business Profes-sionals of America (formerly OEA).’’ Available:http://www.bpa.org/partners/bpa/history.html. 1996.

‘‘Workplace Skills Assessment Program.’’ (1998). BusinessProfessionals of America, October:1-3.

JEWEL EVANS HAIRSTON

BUSINESS TOBUSINESS MARKETING(SEE: Industrial Marketing)

BUSINESS PROFESSIONALS OF AMERICA


CABBAGE PATCH DOLLS(SEE: Fads)

CAPITAL(SEE: Factors of Production)

CAPITAL BUDGETING(SEE: Budgets and Budgeting)

CAPITAL INVESTMENTS

Companies make capital investments to earn areturn. This is like individuals wanting to ‘‘make’’money when they invest in stocks and bonds. Theamount of money ‘‘made’’ or ‘‘lost’’ is measuredas the investment’s rate of return. When makingan investment, the expected rate of return is de-termined by the amount, timing, and riskiness ofthe funds expected from the investment.

RATE OF RETURN

Amount. An investment’s rate of return isexpressed as a percentage. For example, if a com-pany invests $1,000 and expects to get back$1,100 one year from today, it expects to earn 10percent (� (1,100 � 1,000)/1,000). If the com-pany expects $1,200 (instead of $1,100), it ex-pects to earn 20 percent. So a rate of return

depends first on the amount of money expectedback from the investment.

Timing. Just as getting more money producesa higher rate of return, getting the money sooneralso produces a higher rate of return. If a com-pany earns 10% in six months that’s a higher rateof return than 10% earned in one year. So aninvestment’s rate of return also depends on whenthe company expects to get the money back.

Risk. For most capital investments, theamount of money and/or the time at which thecompany expects to get it back are uncertain.What are the chances it will get exactly what itexpects? What are the chances it will get more orless? What are the chances it will get a lot more ora lot less—or even lose all the money investedand get nothing back? The risk of the investmentdepends on these chances, and, in turn, how theinvestment’s rate of return is calculated dependson this risk. So the third important dimension ofan investment’s rate of return is the risk con-nected with the amount of money a companyexpects to get back from the investment.

Time value of money. When a company eval-uates a capital investment, the amount of moneyexpected back from the investment is adjustedfor its timing and risk. For example, suppose acompany expects to get $100 one year from to-day. If it had that $100 now, it could invest themoney—for example, earn interest from abank—and have more than $100 next year. If the

C

81

money earned 5 percent, the company wouldhave $105 next year. If we ‘‘reverse’’ this process,the $100 the company expects to get next year isworth less than $100 today. At 5 percent interest,next year’s $100 is worth only $95.24 (�$100/1.05) today. (This is because if the company had$95.24 now and earned 5 percent on the money,it would have $100 next year.) Similarly, if thereis risk connected with the expected money—thecompany expects $100, but could get more orless—its value today is less than $95.24. And theriskier it is, the lower its value today.

Typically, in order to make ‘‘fair’’ compari-sons, the value of all the amounts of moneyexpected back from capital investments are con-verted into what are called present values. Therate of return used to calculate the present valuefor a capital investment is called the cost of capi-tal. The cost of capital is the minimum rate ofreturn the company must earn to be willing tomake the investment. It is the rate of return thecompany could earn if, rather than making thecapital investment, it invested the money in analternative, but comparable, investment. The costof capital exactly reflects the riskiness of themoney expected back from the capital invest-ment. The mathematical methods used to calcu-late present values are called the time value ofmoney and are explained in more detail in thebooks in the bibliography.

Net present value (NPV). A capital invest-ment’s net present value (NPV) is the amount ofvalue the company expects the investment to cre-ate. The NPV equals the sum of the presentvalues of all of the money expected back from theinvestment minus the investment’s cost.

MAKING CAPITAL INVESTMENTS

The capital investment process includes the fol-lowing:

1. Generating ideas for capital investments

2. Classifying capital investments

3. Evaluating and choosing proposed capitalinvestments

Generating Ideas The first—and most impor-tant—part of the capital investment process isgenerating new ideas. Ideas for capital invest-ments can originate anywhere in a company. Of-ten plant managers are responsible for identi-fying potential projects that will enable theirplants to operate on a different scale or on a moreefficient basis. For instance, a plant managermight suggest adding 10,000 square feet of pro-duction space to a plant or replacing a piece ofequipment with a newer, more efficient machine.Ideas for better types of equipment that can helpthe company operate more efficiently may comefrom individuals on the plant floor. After screen-ing out undesirable ideas, managers send theones that appear to be attractive to the divisionallevel, with supporting documentation.

Division management not only reviews suchproposals but also adds ideas of its own. Forexample, division management may propose theintroduction of a new product line. Alternatively,management may want to combine two plantsand eliminate the less efficient one. Such ideas areless likely to come from the plant managers!

This bottom-up process results in ideas per-colating upward through the organization. Ateach level, ideas submitted by lower-level manag-ers are screened, and attractive ones are for-warded to the next level. In addition, managers atsuccessively higher levels, who are in a position totake a broader view of the company’s business,add ideas that may not be visible—or desirable—to lower-level managers.

At the same time, there is also a top-downprocess at work in most companies. Strategicplanners will generate ideas regarding new busi-nesses the company should enter, other compa-nies it might acquire, and ways to modify itsexisting businesses to achieve greater profitabil-ity. Strategic planning is a critical element in thecapital investment process. The processes com-plement one another; the top-down process gen-erates ideas of a broader, more strategic nature,whereas the bottom-up process generates ideas ofa more project-specific nature.

In addition, many companies have a researchand development (R&D) group, either within a

CAPITAL INVESTMENTS


production division or as a separate department.An R&D group often provides new ideas forproducts that can be sent on to a marketingresearch department.

Classifying Capital Investments Analysis costsmoney. Therefore, certain types of investmentsreceive only cursory checks before approval,whereas others are subjected to extensive analy-sis. Generally, less costly and more routine in-vestments are subjected to less extensive evalu-ation. As a result, companies typically categorizeinvestments and analyze them at the level judgedappropriate to their category. Potential invest-ments in each category may have a lot in com-mon and are able to be analyzed similarly. Auseful set of investment classifications is:

Maintenance projects

Cost-saving/revenue-enhancement projects

Capacity expansions in current businesses

New products and new businesses

Projects required by government regulationor company policy

Maintenance expenditures: At the most basiclevel, a company must make certain investmentsto continue to be a healthy, profitable business.Replacing worn-out or damaged equipment isnecessary to continue in business. Therefore, themajor questions concerning such investments are‘‘Should we continue in this business?’’ and if so,‘‘Should we continue to use the same productionprocess?’’ Since the answers to these questions areso frequently ‘‘yes,’’ an elaborate decision-mak-ing process is not needed, and typically suchdecisions are approved with only routine review.

Cost savings/revenue enhancement: Projects inthis class include improvements in productiontechnology to realize cost savings and marketingcampaigns to achieve revenue enhancement. Thecentral issue is increasing the difference betweenrevenue and cost; the result must be sufficient tojustify the investment.

Capacity expansion in current businesses: De-ciding to expand the current business is inher-ently more difficult than approving maintenanceor cost-saving proposals. Firms have to consider

the economics of expanding or adding new facili-ties. They must also prepare demand forecasts,keeping in mind competitors’ likely strategies.Marketing consultants may help, but this class ofprojects naturally has more uncertain return pro-jections than do maintenance or replacementprojects.

New products and new businesses: Projects inthis category, which include R&D activities, areamong the most difficult to evaluate. Theirnewness and long lead times make it very difficultto forecast product demand accurately. In manycases, the project may be of special interest be-cause it would give the company an option tobreak into a new market. For example, a com-pany that has a proprietary technology mightspend additional R&D funds trying to developnew products based on this technology. If suc-cessful, these new products could pave the wayfor future profitable investment opportunities.Access to such opportunities represents valuableoptions for the company.

Meeting regulatory and policy requirements:Government regulations and/or company poli-cies concerning such things as pollution controland health or safety factors are viewed as costs.Often, the critical issue in such projects is meet-ing the standards in the most efficient manner—at the minimum cost.

Evaluating Proposals The typical stages forthe development and approval of a capital invest-ment proposal are the following:

1. Approve funds for research that may re-sult in a product idea.

2. Approve funds for market research thatmay result in a product proposal.

3. Approve funds for product developmentthat may result in a usable product.

4. Approve funds for plant and/or equip-ment for the production and sale of thenew product.

Each stage involves an investment decision atone or more levels of the company. At each stage,the company reestimates the value expected to becreated—the NPV—of going ahead. With this

CAPITAL INVESTMENTS


kind of sequential appropriation of funds, anautomatic progress review is enforced, enablingearly cancellation of unsuccessful projects. Ateach stage there are options to abandon, post-pone, change, or continue.

Proposed expenditures that are larger thancertain company-set limits generally require awritten proposal from the initiator. Typically,such limits are higher in smaller privately ownedcompanies, which tend to have relatively infor-mal organizational structures. Most companiesuse standard forms, and these are often supple-mented by written memoranda for larger, morecomplex projects. Also, there may be consultingor other studies prepared by outside experts; forexample, economic forecasts from economicconsultants.

For a successful company, a maintenanceproject might require only limited supporting in-formation. In contrast, a new product wouldrequire extensive information gathering andanalysis. At the same time, within a category,managers at each level usually have upper limitson their authority regarding both expenditureson individual assets and the total expenditure fora budgeting period. In this way, larger projectsrequire the approval of higher authority.

For example, at the lowest level, a depart-ment head may have the authority to approve$50,000 in total equipment purchases for theyear. However, that same person might have toobtain specific approval from higher authority tospend more than $10,000 for any single piece ofequipment. A plant manager might have authori-zation limits of $500,000 per year and $100,000per piece of equipment, for example.

A system of authorization, such as illustratedin the preceding paragraph, requires more exten-sive review and a greater number of inputs toapprove larger expenditures. The hierarchical re-view structure reflects the obvious fact thatmisjudging a larger project is potentially morecostly than misjudging a smaller one.

CAPITAL INVESTMENT INOTHER COMPANIES

Sometimes companies make capital investmentsin other companies. In concept, these are just likeany other capital investment. They range fromthe simple—such as buying stock in anothercompany in a ‘‘passive’’ investment—to acquir-ing (purchasing) another company outright ormerging with another company. With an acquisi-tion or merger, the details connected with suchthings as taxes, ‘‘corporate cultures,’’ distributionof responsibilities, and logistics, among others,can be exceedingly complex.

Companies give many different reasons foracquisition or merger. In most cases, they want toachieve operating efficiencies and/or economiesof scale. For example, in a merger the companiesmay be able to save money marketing, produc-ing, and delivering their products by combiningtheir operations and eliminating duplication.Combining may also allow greater efficiency incoordinating activities across the companies’units.

A company may be able to expand morecheaply and more quickly through an acquisitionor merger. There are also other possible reasons,such as realizing tax benefits and capturing sur-plus cash. The essence of all the possible reasonsis a belief that the merger or acquisition is a goodcapital investment. Therefore, the analytical toolsand basic decision rules are the same for mergersand acquisitions as they are for other capital in-vestments. However, particular care must betaken in applying these tools because of the enor-mous size and complexity of the investment.

Beyond the basic investment considerations,there can also be important legal considerationsconnected with a merger or acquisition. Theseinclude aspects such as compliance with federalantitrust law, state anti-takeover statutes, finan-cial securities laws, and the charters of the corpo-rations involved.

(SEE ALSO: Finance; Financial Institutions)

CAPITAL INVESTMENTS


BIBLIOGRAPHY

Brealey, Richard A., Meyers, Stewart C., and Marcus, Alan J.(1999). Fundamentals of Corporate Finance. Boston:Irwin/McGraw-Hill.

Emery, Douglas R., Finnerty, John D., and Stowe, John D.(1998). Principles of Financial Management. Upper Sad-dle River, NJ: Prentice-Hall.

Ross, Stephen A., Westerfield, Randolph W., and Jordan,Bradford D. (1998). Fundamentals of Corporate Finance.Boston: Irwin/McGraw-Hill.

DOUGLAS R. EMERY

JOHN D. FINNERTY

CAPITALISM(SEE: Economic Systems)

CAPITAL MARKETS

ROLE OF CAPITAL MARKETS

The capital market provides financing to meetthe denomination, liquidity, maturity, risk (withrespect to credit, interest rate, and market), andother characteristics desired by those who have asurplus of funds and those who have a deficit offunds. The capital market as a whole consists ofovernight to long-term funding. The short tomedium end of the maturity spectrum is calledthe money market proper, and the long end isidentified as the capital market. The financialinstruments range from money market instru-ments to thirty-year or longer bonds in creditmarkets, equity instruments, insurance instru-ments, foreign-exchange instruments, hybrid in-struments, and derivative instruments. There hasbeen an explosion of innovation in the creationand development of instruments in the moneyand capital markets since about 1960 in both debtand equity instruments.

Some of the important (by volume) moneymarket instruments are Treasury bills, federalagency securities, federal funds, negotiable certif-icates of deposits, commercial paper, bankers’ ac-ceptances, repurchase agreements, eurocurrencydeposits, eurocurrency loans, futures instru-ments and options instruments. Similarly, some

of the key capital market instruments are U.S.securities; U.S. agency securities; corporatebonds; state and local government bonds; mort-gage instruments; financial guarantees; secu-ritized instruments; broker-dealer loans; foreign,international, and global bonds; and eurobonds.

THE CAPITAL MARKET IN THEUNITED STATES

The capital market in the United States is highlydeveloped, marked by sophisticated technology,specialized financing institutions and functions,wide-ranging geographic locations, and continu-ous innovation in financial products and servicesto meet the needs of financial investors and thoseseeking to acquire finances. There are both directand indirect markets. Corporations, for example,engage in direct finance when they invest in oneanother’s paper directly without the services ofbrokers and other specialized intermediaries,similar to the proverbial entrepreneur gettingfinance from an uncle. Most of the financing inthe United States, however, is done indirectlythrough financial intermediaries who substitutetheir credit for the credit of the borrower (user)of funds. The total amount of credit raised annu-ally in the United States is around $2,200 billion,of which debt instruments account for $2,000billion and equity instruments (net) for $200 bil-lion.

Money and capital market instruments aretraded directly among participants, in the over-the-counter (OTC) markets and in organized ex-changes. Many of the exchanges specialize in thetype of securities traded, thus giving focus anddepth to that instrument or market. The majorU.S. exchanges are the New York Stock Exchange(NYSE), Philadelphia Stock Exchange, PacificStock Exchange, Boston Stock Exchange, Cincin-nati Stock Exchange, Midwest Stock Exchange,Chicago Board of Trade (CBT), Chicago Mercan-tile Exchange (CME), international money mar-ket (IMM), National Association of SecuritiesDealers Automated Quotations System (Ameri-can Exchange) (NASDAQ-AMEX), and Globex.The regional exchanges—such as Boston, Cin-cinnati, Midwest, Pacific, and Philadelphia—

CAPITAL MARKETS


Facade of the New York Stock Exchange in 1928.

each list a small number of regional companies tofacilitate their raising of capital in the market.The national/international markets are NYSE,NASDAQ-AMEX, CBT, and CME.

The NYSE, organized by twenty-four brokersin 1792, is the oldest and the largest exchange inthe U.S. capital market. It states its mission asfollows: ‘‘To add value to the capital-raising and

asset management process by providing the high-est-quality and most cost-effective self-regulatedmarketplace for the trading of financial instru-ments, promote confidence in and understand-ing of that process, and serve as a forum fordiscussion of relevant national and internationalpolicy issues.’’ According to the NYSE, it is ‘‘thelargest equities marketplace in the world and is

CAPITAL MARKETS


home to 3,025 companies worth more than $16trillion in global market capitalization. As ofyear-end 1999, the NYSE had 280.9 billion shareslisted and available for trading worth approxi-mately $12.3 trillion. Over two-thirds of the ros-ter of NYSE companies have listed here withinthe last 12 years. These companies include across-section of leading U.S. companies, midsizeand small capitalization companies. Non-U.S. is-suers play an increasingly important role on theNYSE. As of July 1999, 382 non-U.S. companieswere listed here—more than triple the number 5years ago’’ (www.NYSE.com).

Organized in 1971, NASDAQwas the world’sfirst electronic stock market. According to itsmission statement, NASDAQ-AMEX’S purposeis ‘‘to facilitate capital formation in the publicand private sector by developing, operating andregulating the most liquid, efficient and fair secu-rities market for the ultimate benefit and protec-tion of the investor.’’ Its vision is ‘‘to build theworld’s first truly global securities market . . . aworldwide market of markets built on a world-wide network of networks . . . linking pools ofliquidity and connecting investors from all overthe world . . . assuring the best possible price forsecurities at the lowest possible cost.’’ Stocks ofover 5000 companies are traded on the NAS-DAQ-AMEX (www.Nasdaq.com).

INITIAL PUBLIC OFFERINGS AND ROLE OFVENTURE CAPITAL IN THE

CAPITAL MARKETS

Stock markets provide high-growth, innovativecompanies with a means of raising large amountsof long-term capital by selling company shares tooutside investors. It is said that the company is‘‘floated’’ on the stock market through an initialpublic offering (IPO). An IPO offers many com-panies the best way of financing their continuedgrowth and for most venture capitalists is thepreferred exit route (best way of profiting fromventure capital investment) for their investments.However, an IPO involves for the entrepreneursome loss of control over the company, propor-tional to the amount of equity that is sold tooutside investors. The entry standards imposed

for a full listing on traditional stock markets maybe too rigorous for young, technology-basedcompanies. Recently, however, a number of initi-atives have been taken by traditional stock mar-kets as well as by new market operators to createnew stock markets for high-growth, innovativecompanies. These offer all the benefits of a publicequity market, such as an increased public profileand access to new capital and investors, withsimplified entry requirements.

Efficient and liquid risk capital stock marketsplay a large role as a source of financing for high-growth companies and are necessary for the de-velopment of venture capital by offering an exitroute for investors. In the United States, theNASDAQ market has been developing for morethan twenty-five years and has become the mar-ket of choice for raising capital to finance fast-growing enterprises. At the turn of the twenty-first century, the 5,500 companies quoted on itemployed approximately 9 million people.

Venture capital, which consists of fundsraised on the capital market by specialized opera-tors, is one of the most relevant sources of financ-ing for innovative companies. Venture capitalistsbuy shares or convertible bonds in a company.They do not invest in order to receive an immedi-ate dividend, but rather to allow the company toexpand and ultimately increase the value of theirinvestment. Hence, they are interested in innova-tive small companies with very rapid growthrates. Some venture capitalists specialize in cer-tain business sectors (e.g., biotechnology, infor-mation technology). Others may only invest atcertain stages in the development of a project orcompany.

In the United States, the amount offered inthe IPO market has been growing exponentially,from $20.7 billion in 1998 to $47 billion in 1999.The fourth quarter of 1999 alone accounted for$22.3 billion.

FINANCIAL INNOVATION AND THEMARKETS IN DERIVATIVE INSTRUMENTS

Financial innovation was one of the most influ-ential trends in international financial marketsin the 1980s and 1990s. A large number of new

CAPITAL MARKETS


financial products and instruments were createdas the traditional barriers between financial in-stitutions were increasingly eroded. Banks, forexample, are increasingly competing with mar-kets for what was once considered to be tradi-tional intermediated credits. Markets are becom-ing more global, and competition betweenfinancial institutions has intensified. This in-crease in financial innovation has taken place inan environment of steady deregulation coupledwith significant advances in information andcommunication technologies. Securitization,perhaps the most important trend in interna-tional financial markets in the 1980s and early1990s, continues to redefine the operations ofbanks and has important regulatory implica-tions. Both bank and nonbank financial institu-tions are relying more on income from off-bal-ance-sheet activities. A greater share of creditnow flows through capital-market channels,which are characterized by less supervision incomparison to banks. Deregulation, improvedtechnology, growing competition, and volatileexchange and interest rates are the main stimu-lus for financial innovation. Innovation can im-prove the efficiency of international financialmarkets by offering a broader and more flexiblerange of instruments for borrowing. It alsoprovides hedging instruments that can helpbanks, borrowers, and investors to manage therisks associated with volatile exchange andinterest rate.

The derivatives market took a major stepforward with the formation of the Chicago Boardof Trade (CBOT) in 1848. It developed standard-ized agreements as to the quality, quantity, deliv-ery time, and location, and called futures con-tracts for trading of grains in 1865. Thedevelopment of financial futures resulted from achanging world economy following World WarII. Futures contracts provide for efficient forwardpricing and risk-management.

In the early 1970s, approximately 13 millionfutures contracts were traded in the UnitedStates—most of which were agricultural. By themid 1980s, the number of contracts being tradedexploded to over 230 million, with only a quarter

related to agricultural products. Today, there arefutures contracts for interest rates, stock indexes,manufactured and processed products, non-storable commodities, precious metals, as well asforeign currencies. Furthermore, proposals fornew contracts continue to grow.

The Chicago Mercantile Exchange (CME) isanother major futures exchange in the U.S. TheMerc’s diverse product line consists of futuresand options on futures in agricultural commodi-ties, foreign currencies, interest rates and stockindexes. In the mid-1960s, it introduced a futurescontract on a non-storable commodity—livecattle. In 1972 it launched a contract in foreigncurrency futures.

The U.S. futures industry operates under anextensive regulatory umbrella. Federal legislationgoverning the industry has existed since 1924.The Commodity Futures Trading Commission(CFTC), established under the 1974 amendmentsto the Commodity Exchange Act (CEA), has far-reaching authority over a wide variety of com-modity industry activities.

The technology of creating, disseminating,and trading instruments (securities) has in-creased the efficiency of allocating financing inlarger quantities at lower cost of transactions, aswell as lower cost of funds because of increasedsupplies from increased market participation bysurplus and deficit units.

ROLE OF THE SECURITIES ANDEXCHANGE COMMISSION

The Securities and Exchange Commission (SEC)was organized under the Securities Act of 1934 tocreate fair market conditions in the securitiesmarkets by setting standards for and require-ments of information from the issuer of the secu-rity to the general public. This process createscompetitive and fair pricing and trading of secu-rities, and it prevents abuse and fraud by issuers,brokers, and dealers. Issuers are required to filedetailed information with the SEC on all publiclytraded securities, which becomes available to thepublic on an equal basis. Privately traded securi-ties and investments by wealthy individuals areexempt from registration, based on the assump-

CAPITAL MARKETS


tions that these investors understand the risksinvolved in a given security and that they are ableto tolerate the consequences of those risks if theymaterialize.

ROLE OF THE FEDERAL RESERVE SYSTEMIN THE CAPITAL MARKET

The Federal Reserve plays a key role in the func-tioning of the capital market in the U.S. econ-omy and, by extension, in the world economy. Itmanages the overall liquidity and credit condi-tions in the U.S. financial system. The Fed main-tains a noninflationary level of liquidity in theeconomy, on an ongoing basis, in order to fosterconditions for maximum sustainable growth ofthe economy. It does so by regulating the moneysupply through the banking system and its inter-action with the public. The Fed pays similar at-tention to availability of credit; in that regard itis authorized to set the margin rate on stockpurchases, thus exercising a direct role in the useof credit in equity market transactions. The Fedis also the commercial and investment banker tothe federal government; in this capacity, it con-ducts the Treasury’s operations in the U.S. Trea-sury securities bond market through the securi-ties dealers recognized by it and so authorized tobe dealers in U.S. Treasury bills, notes, andbonds.

ROLE OF THE U.S. TREASURY IN THECAPITAL MARKET

The U.S. Treasury is the biggest player in theU.S. credit markets. Because the market in U.S.government securities is the largest, most active,and most liquid market, it creates a base forconditions in the U.S. credit markets. The Trea-sury operations bridge the timing of the cashinflows and outflows of the government. Theyare also used to finance the budget deficit, whichbecame routine for three decades up to 1999,and beginning in 2000 to begin to retire the ac-cumulated debt out of the government budgetsurplus.

REGULATORY REQUIREMENTS ON THECAPITAL MARKET

Regulation plays an important role in a fair andorderly functioning of the capital market. Parts ofthe market are more heavily regulated than otherparts. Commercial banking, for example, is oneof the most regulated parts of the financial ser-vices industries. This heavy regulation is based onthe fact that large bank failures, due to eitherfraud or mismanagement, can destabilize bank-ing markets and lead to loss of faith in the bank-ing system—and therefore in the currency andmoney (as the liability of commercial banks). TheGramm-Leach-Bliler (Financial Modernization)Act of 1999 has reduced or eliminated the needfor many of the regulations on commercial banksand their activities and affiliations with invest-ment banks and insurance companies by allow-ing competition for the same or similar productsoffered by the three.

THE KEY CAPITAL MARKETS OUTSIDE THEUNITED STATES

The increasing integration of the world economyand the growth of other economies have led tothe emergence of several key financial centers, theprime examples of which are London, Tokyo,Frankfurt, Zurich, Paris, Hong Kong, and Singa-pore. As of 2000, the bourses in Paris, Brussels,and Amsterdam had announced their plannedmerger, as had the London Stock Exchange andFrankfurt Stock Exchange.

The Euromarket has grown steadily sinceabout 1960 with the emergence and growth of theEurocurrency (initially Eurodollar) market andfollowed by the Euronote, Eurobond, andEuroequity markets. The euro, introduced as thecurrency of the European Monetary Union onJanuary 1, 1999, consists of the currencies ofeleven countries—Austria, Belgium, Finland,France, Germany, Ireland, Italy, Luxembourg,the Netherlands, Portugal, and Spain. It will be-gin to circulate in 2002 and will eliminate theneed for a significant part of the Euromarketmarket, as the eleven currencies will be replacedby one European currency. The Euromarket will

CAPITAL MARKETS


continue to shrink as further European countriesjoin the European Union and adopt its currency.The Eurocurrency market will, however, con-tinue to provide a mechanism for internationaland global financing in the euro, the dollar, theyen, and other currencies in international tradeand finance. The euro area capital market, theU.S. capital market, and the Asian capital marketwill be the three key capital markets in thetwenty-first century.

(SEE ALSO: Finance; Financial Institutions)

BIBLIOGRAPHY

Board of Governors of the Federal Reserve System. (1999).The Federal Reserve System: Purposes and Functions,Washington, DC.

Gramm-Leach-Bliler (Financial Modernization) Act, 1999.

Hakansson, Nils H. (1989). ‘‘Financial Markets.’’ In TheNew Palgrave: Finance, John Eatwell, Murray Milgate,and Peter Newman, eds. (pp. 135-144) New York: TheMacmillan Press Limited.

Investment Company Act, 1940.

Kidwell, David S., Peterson, Richard L., and Blackwell,David W. (2000). Financial Institutions, Markets, andMoney, 7th ed. New York: Dryden Press.

Mishkin, Frederic S. (1997). The Economics of Money, Bank-ing and Financial Markets, 5th ed. New York: Addison-Wesley.

Molyneux, Philip, and Shamroukh, Nidal. (1999). FinancialInnovation. New York: Wiley.

Rose, Peter S. (2000). Money and Capital Markets, 7th ed.New York: Irwin McGraw-Hill.

Tobin, James. (1989). ‘‘Financial Intermediaries.’’ In TheNew Palgrave: Finance, John Eatwell, Murray Milgate,and Peter Newman, eds. (pp. 35-52). New York: TheMacmillan Press Limited.

SURENDRA K. KAUSHIK

MASSIMO SANTICCHIA


Accounting positions range from bookkeepingclerks who maintain financial data in computerand paper files to chief financial officers who areresponsible for providing leadership in the designand operations of a total accounting informationsystem and its output of financial statements.

OVERVIEW OF ACCOUNTING AS ANOCCUPATION FIELD

The U.S. Department of Labor identifies ac-counting essentially at two levels. At the ‘‘execu-tive, administrative, and managerial’’ occupa-tional level, accountants and auditors areincluded. Under ‘‘bookkeeping, accounting, andauditing clerks,’’ positions are available to thosewith some training and interest in working withfinancial records.

Persons employed in accounting are gener-ally expected to have strong computer, analytical,interpersonal, and communications skills in ad-dition to sound knowledge in accounting relatedto the level of the position. Career opportunitiesare available for individuals with varying levels offormal education.

In general, the rate of growth of employmentin accounting is expected to be the average of thatfor all occupations through 2008, as projected bythe U.S. Department of Labor. The impact ofcomputer technology will continue to change thenature of demand for employees in accounting,but growth in business activity and the turnoverof personnel assure appealing opportunities forthose individuals who are technically preparedand gain relevant on-the-job experience.

Accounting is a field that is appealing toindividuals who enjoy working with figures andwho appreciate the need for impeccable accuracyand careful adherence to policies and schedules.Increasingly, those who work in accounting mustbe computer-savvy. Thus, individuals who arechallenged by the continuing need to learn newsoftware, and new ways of work find the field ofinterest. Those individuals who choose to be-come certified must continue to be learners, be-cause all certifications have a continuing profes-sional education requirement to maintaincertification. Even accountants who are not certi-fied enroll in a range of in-company and othertypes of programs to upgrade their skills andknowledges.

Accountants must be individuals of high in-tegrity so that those who read financial informa-tion prepared or audited by accountants haveconfidence in the credibility of such information.



Accountants who are certified are expected toadhere to professional codes of ethics that imposerules and regulations to encourage behavior inrelation to their work that maintains the credibil-ity of financial reporting, both within the organi-zation and outside the organization.

CAREERS FOR CERTIFIED ACCOUNTANTS

Professional accounting positions that require atleast an undergraduate college degree and certifi-cation are certified public accountant (CPA), cer-tified management accountant (CMA), certifiedinternal auditor (CIA), and the certified govern-ment financial manager(CGFM).

Certified Public Accountant. The most com-mon path for the aspiring CPA is to begin em-ployment in a public accounting firm as a staffaccountant. Most states in the United States re-quire experience in auditing for certification.While public accounting firms hire recent gradu-ates of college programs for beginning positions,such firms expect new employees to have takenthe examination or be planning to sit for it.While many CPAs leave public accounting toenter other positions in all types of organizations,some remain in public accounting. The promo-tional opportunities in public accounting forCPAs are related to level of responsibility. Suc-cessful staff accountants become seniors; seniorsbecome managers; a limited number of managersbecome partners. In many public accountingfirms, there are more levels of professional staffthan indicated in the preceding sentence. In addi-tion to accounting and auditing, public account-ing firms provide other services, such as tax ad-visement and management consulting. SomeCPAs choose to move to other services after theygain experience in accounting and auditing.Others decide to establish their own firms; in1998, for example, 10 percent of accountantswere self-employed. Many choose to work inother types of positions after gaining certificationand experience. Many accept positions in corpo-rations, not-for-profit entities, and governmentagencies, where promotional opportunities in-clude both accounting and nonaccounting re-

sponsibilities. Some become chief executive offi-cers in major corporations.

Accountants in Organizations. The range ofpositions for accountants in organizations is ex-tensive. Accountants are employed in corporatereporting, in controller’s offices, and in budgetand strategic planning departments. Certificationis provided for management accountantsthrough the Institute of Management Account-ants. To be certified as a certified managementaccountant, a candidate must successfully com-plete a comprehensive examination that includesaccounting and related topics relevant to thebroad responsibilities assumed by managementaccountants. There is a requirement for workexperience in some aspect of management ac-counting before a candidate is certified. CMAshave many promotional opportunities in organi-zations. They are identified for leadership posi-tions, in much the same way as CPAs, at execu-tive levels of their own and other organizations.

Internal Auditors. Many accountants chooseto work as internal auditors. The Institute ofInternal Auditors provides a certification pro-gram for candidates who seek to be certified in-ternal auditors. Certification requires experienceas an internal auditor. In many organizations,especially large ones, there is a separate depart-ment of internal audit that provides valuableoversight of the total organization. Internal audi-tors who are certified are expected to adhere tothe professional standards as they perform theirresponsibilities. CIAs have promotional opportu-nities in internal auditing through moving intomanagerial positions within the department ormoving to operational units where they assumesupervisory and executive responsibilities.

Government Accountants. The most com-mon certification for government accountants isthat provided by the Association of GovernmentAccountants. An examination and relevant expe-rience are required. The designation achieved bya successful candidate is certified governmentfinancial manager. Government accountants areemployed throughout the public sector, at fed-eral, state, and local levels.



CAREERS FOR ACCOUNTANTSWITHOUT CERTIFICATION

There are more accountants in the United Stateswho are uncertified than there are those who arecertified. Of the slightly more than 1 millionworkers classified as accountants and auditors inthe United States in 1998, fewer than half werecertified. Individuals who have studied account-ing at the community college, business college, oruniversity level are employed for beginning ac-counting positions. Through on-the-job trainingand experience, many of these individuals moveinto higher-level positions.

Many individuals who study in accountingprograms in universities choose not to be certi-fied. Others study some accounting as an electiveprogram and then enter a beginning accountingposition as a staff accountant, for example.

Many promotional opportunities are avail-able to accountants. Technical skills and manage-rial skills are both important if an individualaspires to higher-level positions. Employees whoare knowledgeable about accounting and con-tinue to learn as new accounting rules and inter-pretations are introduced by professional bodiesare invaluable to employers. However, suchknowledge must be accompanied by strong orga-nizational and interpersonal skills if promotionalopportunities are to be realized.

CHANGING REQUIREMENTS FORACCOUNTANTS AND AUDITORS

Knowledge of accounting and auditing continuesto be critical to handling job responsibilities.However, such knowledge alone is not sufficient.Accountants are expected to have advanced com-petencies in handling a variety of accounting andauditing software and in designing accountinginformation systems. Furthermore, accountantsand auditors are expected to strategically analyze,interpret, and assess the information from thesystems they develop and implement. For exam-ple, the need for a broader, yet deeper, educationhas resulted in many states requiring a 150-hourcollege program for those who aspire to be CPAs.

It is expected that all states will have such arequirement by 2008.

CAREERS IN ACCOUNTING THAT DO NOTREQUIRE A COLLEGE DEGREE

As noted before, there are positions in account-ing that are identified by the U.S. Labor Depart-ment as requiring less than a college degree. Avariety of bookkeeping, accounting, and auditingclerks are needed in all types of organizations; in1998, there were 2.1 million such clerks. As re-ported by the U.S. Department of Labor Statis-tics, approximately a fourth of these workerswere in wholesale and retail trade. The outlookfor employment (to 2008) is that virtually all jobopenings will be related to replacement of indi-viduals who have left positions. There is highturnover in this category of workers as workersmove to other types of positions, including onesthat represent promotions, or leave the laborforce.

Most positions require a high school diplomaand exist in virtually every industry in the UnitedStates. Such workers are expected to know basiccomputer software programs. Most U.S. compre-hensive and vocational high schools offer coursesin accounting and in computer software applica-tions. Also, proprietary business colleges as wellas junior and community colleges have programsthat prepare students with the basic knowledgeand skills needed in many beginning accountingpositions. Many employers provide training onthe job for the specific applications that new em-ployees need to understand and use. Many em-ployers provide training when there are softwareor system changes in the accounting informationsystem.

The key task of accounting-related clerks is tomaintain financial records. Such workers com-pute, classify, process, and verify numerical data.In large as well as mid-size businesses, for exam-ple, there are departments that handle accountspayable, accounts receivable, or cash. For suchdepartments, companies seek employees whohave a basic understanding of accounting princi-ples, possess an organized style of work, and canhandle communications with vendors (in ac-



counts payable), customers (in accounts receiva-ble), or personnel in human resources (benefits,pensions). Ability to work under pressure andmeet deadlines is also important in some posi-tions. Entry-level workers are generally responsi-ble for handling the details of transactions andfor preparing schedules that show the results ofprocessing transactions.

Promotional opportunities are available inmany organizations. Individuals who continuetheir education on a part-time basis and whodisplay maturity and wisdom in their associa-tions with co-workers are considered good candi-dates for supervisory positions. Responsible, de-pendable managers often began as clerks butwere willing to continue to learn not only allaspects of their jobs but also the total work of theorganization in relation to the accounting func-tion.

CAREERS IN ACCOUNTING RELATED TODOCTORAL DEGREES

University programs that lead to doctoral degreesin accounting provide graduates who find em-ployment in college teaching and in technicalpositions in public accounting firms, professionalstandard-setting organizations, and other organi-zations in which high-level expertise in such spe-cializations as accounting theory, accounting sys-tems design, or accounting policy are in demand.

Opportunities for accountants withdoctorates reflect the need for accountants tohave leading-edge vision in a rapidly changingglobal business environment. Advanced studiesleading to a doctorate will provide individualswith theoretical understanding who can devisenew principles to assure the relevance of financialinformation that is reported to shareholders andothers. Advanced studies will also provide indi-viduals who can design the effective and efficientaccounting information systems needed in busi-ness and government.

SPECIALIZATIONS WITHIN THE FIELDOF ACCOUNTING

Bodies such as the American Institute of CertifiedPublic Accountants (AICPA) provide specialized

credentials in such fields as personal financialplanning and information technology for indi-viduals who are CPAs. As of mid-2000, theAICPA began discussion of some type of interna-tional business professional designation thatwould complement the CPA credential. It is thebelief of the leadership of the AICPA that holdersof a global credential would have national andinternational recognition and credibility as busi-ness professionals who can function in the globalmarketplace. This effort is relevant because a newinternational accounting standard-setting struc-ture is scheduled for implementation as of Janu-ary 1, 2001.

Other initiatives in the United States relate toenvironmental accounting, forensic accounting,international accounting, and fraud accounting.Organizations with missions related to a special-ization are active in establishing standards toguide practitioners who choose to participate inthe field.

RELATED FIELDS

Accounting is often referred to as ‘‘the languageof business.’’ That language has wide application.Many occupations are open to those who haveboth a background in accounting and analyticalskills. Among occupations in which accountingtraining is perceived to be valuable are budgetofficers, lending officials in banks, securities ad-visers, financial analysts, and FBI investigativeagents.

(SEE ALSO: Accounting; Assurance Services; Auditing)

BIBLIOGRAPHY

American Institute of Certified Public Accountants. www.aicpa.org.

Institute of Internal Auditors. www.theiia.org.

Institute of Management Accountants. www.imanet.org.

U.S. Department of Labor, Bureau of Labor Statistics.(2000). Occupational Outlook Handbook. 2000-2001 Edi-tion. Bulletin 2520. U.S. Department of Labor, Washing-ton, DC.

BERNARD H. NEWMAN

MARY ELLEN OLIVERIO




Economists study how society uses, regulates,and distributes its natural and human-made re-sources such as land, labor, raw materials, andmachinery to produce goods and services(Horizons, 2000). In simpler terms, they studyhow effectively society meets its human and ma-terial needs. Economists also study how eco-nomic systems address three basic questions:What shall we produce?; How shall we produceit?; For whom shall we produce it? They thencompile, process, and interpret the answers tothese questions (‘‘Economists,’’ 1997). Econo-mists may analyze the relationship between sup-ply and demand and develop theories and modelsto help predict these future relationships. Theyhelp provide a logical, ordered way of looking atvarious problems. They attempt to explain socialconcerns such as unemployment, inflation, eco-nomic growth, business cycles, tax policy, orfarm prices. Most economists apply their skills tosolve problems in specific areas, such as transpor-tation, labor, heath, finance, marketing, corpo-rate planning, energy, or agriculture. Businessfirms, banks, insurance companies, labor unions,governmental agencies, and others seek advicefrom economists to use in their decision making(Horizons, 2000).

THREE GENERAL TYPES OF ECONOMISTS

Theoretical economists, employing mathematicalmodels, develop theories to examine major eco-nomic phenomena, such as the causes of businesscycles or inflation or the effects of unemploy-ment, energy prices, or tax laws. Most econo-mists, however, concern themselves with thepractical application of economic policy to suchareas as finance, labor, agriculture, health, andtransportation (Harkavy, 1990). Although thereare widely ranging careers open to economists,there are three main career paths: business, gov-ernment, and academia. Each type of economistapplies the economic approach to decision-mak-ing in a different setting.

Business economists work in such areas asmanufacturing, mining, transportation, commu-

Alan Greenspan, chairman of the Federal ReserveBoard.

nications, banking, insurance, retailing, privateindustry, securities and investment firms, man-agement consulting firms, and economic andmarket research firms, as well as trade associa-tions and consulting organizations (Careers,2000). Many private firms, both large and small,recruit undergraduate economics majors forjobs. These jobs are general-purpose ones forwhich employers seek bright, highly-motivatedstudents who can learn a specific businessthrough on-the-job training. To become a pro-fessional business economist requires graduatetraining. Business economists perform such tasksas forecasting the business environment, inter-preting the impact of public/governmental policyon the firm, and collecting and processing data.They also supply information to managementthat affects decisions on the marketing and pric-ing of company products, as well as providinglong- and short-term economic forecasts (‘‘Eco-nomics,’’ 1997). For example, a business firm’smanagers might ask its marketing analysts to



Career OpportunitiesFor Which An Economics Background is Well Suited

• Economist• Business Manager• Property Manager• Labor Relations Specialist• Market Research Analyst• Securities Broker• Urban/Regional Planner• Public Administrator• Government Economist• Industrial Traffic Manager• Technical Writer• International Trade Specialist• Farm and Land Appraiser• Food Store Manager• Marketing Advisor• Professional Farm Manager• Sales Representative• Statistician• Journalist (especially business reporting)• Actuary• Researcher• Agricultural Economist• Tax Economist• Tax Examiner/Collector/Revenue Agent• Political Scientist• Stockbroker

• Commodities Trader/Broker• Financial Analyst• Financial Investment Analyst• Population Studies Analyst• Bank Administrator• Business Administrator• Investor Relations Manager• Chamber of Commerce Analyst• Transportation Planner• Commodity Analyst• Data Analyst• Cost Analyst• Credit Analyst• Rate Analyst• Bank Research Analyst• Compensation/Benefits Coordinator• Financial Researcher• Investment Banking Analyst• Compensation Analyst• Cost Estimator• Demographer• Public Administrator• Regional Planner• Underwriter• Management Consultant

Table 1

provide specific information on which to basemarketing and pricing policies. Using economet-ric modeling techniques, the analysts developprojections of market reactions to various pricelevels throughout the industry; and on the basisof these projections, the mangers can make in-formed pricing decisions. Informed, rational de-cision making on economic matters is what eco-nomics is all about.

Government Economists work for federal,state, and local governments in a wide variety ofpositions involving analysis and policy making.The federal government is a major source of em-ployment for economists with an undergraduatedegree; information about job openings in vari-ous agencies is available from the Federal Em-ployment Information Center. A bachelor’s de-gree in economics is a good qualification for anentry-level position; a person can advance tohigher positions by obtaining a graduate degreeor by promotion from within. There are jobs forlabor, international, development, and popula-

tion economists, as well as micro- and macroeco-nomists (Careers, 1995). Economists who workfor government or private research agencies as-sess economic trends in order to formulate policyin such areas as agriculture, forestry, business,finance, labor, transportation, urban economics,or international trade and development(Horizons, 2000). Working for Congress is a rela-tively new area for economists. Legislation andthe issues facing Congress are becoming morecomplex and economic in nature, and as a result,members of Congress are turning to economistsfor advice on these issues.

Academics is another major area in whicheconomists are found. Economics professorsteach basic macro- and microeconomics courses(the ‘‘big picture’’ versus individual companies/persons) as well as courses on advanced topics,such as economic history and labor economics.They also do research, write papers and books,and give lectures, contributing their knowledgeto the advancement of the discipline (‘‘Econo-



Additional Career Opportunities Availablewith Certain Skills, Interests, or Further

Education

• Business Credit Manager• Loan Administrator• Consumer Credit Manager• Inventory Control Specialist• Farm Manager• Purchasing Agent/Buyer• Lawyer• Accountant, Public Practice• Market Interviewer• System Analyst• Hospital Administrator• Consumer Credit Manager• Underwriter• Foreign Service Officer• Cooperative Extension Agent• Job Analyst• Personnel Manager• Marketing/Sales Manager• Editor• Demographer• Consultant• Real Estate Investor• Entrepreneur/Businessperson• Foreign Correspondent• Soil Conservation Specialist• Financial Planner Investment Analyst• Time Management Specialist• Survey Designer• Market Research Statistician• Media Buyer• Bank Examiner• Energy Researcher• Environmental Researcher• Lobbying Researcher• Real Estate Development Researcher• Political Campaign Organizer• Historical Researcher• Institutional Researcher• FBI/CIA Agent• General Accountant• Economics Professor

Table 2

mists,’’ 1997). In order to teach at a four-yearcollege, it is essential to have a Ph.D. in econom-ics. Faculty members usually divide their timeamong teaching, research, and administrative re-sponsibilities. Many academic economists alsohave the opportunity to consult either for busi-ness or government.

RELATED USES FOR ANECONOMICS DEGREE

Economics is widely recognized as a solid back-ground for many jobs and professions in busi-

Related Occupations

• Insurance Agent/Broker• Financial Aid Director• Retail Store Manager• Legal Assistant• Real Estate Agent• Legal Assistant• Collection Agent• Public Relations Specialist• Claim Adjuster/Examiner• Computer Programmer• Systems Analyst• Construction Estimator• Investment Counselor• Health Policy Planner• Affirmative Action Representative

Table 3

ness, government, and the law. Economics ma-jors have a wide range of choices and a great dealof flexibility when deciding on a profession (Ta-bles 1, 2, 3).

An undergraduate major in economics canbe an ideal preparation for work on a Master ofBusiness Administration degree, and many grad-uate business schools encourage students to takeat least some economics courses. Studying eco-nomics is also excellent preparation for becom-ing a lawyer; many believe that economics is oneof the best backgrounds for success in law schoolbecause of its emphasis on a logical approach toproblems, logical reasoning, and analytical skills.Publishing companies and trade associations alsoemploy economists. Newspapers provide eco-nomics majors with opportunities to write abouteconomic and business events. The demand foreconomics teachers in secondary schools is grow-ing as economics becomes an increasingly impor-tant and popular course (Careers, 1995).

WORK CONDITIONS

Economists generally work in offices or class-rooms. The average work week for governmenteconomists is forty hours, but the schedules ofacademic and business economists are less pre-dictable. Regular travel may be necessary to col-lect data or attend conferences or meetings. In-ternational economists may spend as much as 30



percent of their time traveling and 40 percent oftheir time on the telephone or the Internet re-searching current trends in foreign economic sys-tems (for this subgroup, language skills are im-portant) (Economist, 2000).

Economists in nonteaching positions oftenwork alone writing reports, preparing statisticalcharts, and using computers, but they may alsobe part of a research team. Faculty economistshave flexible work schedules, dividing their timeamong teaching, research, consulting, and ad-ministrative duties (Horizons, 2000). High levelsof satisfaction are found throughout this field,which encourages discussion, detailed examina-tion, and lively disagreement.

DESIRABLE PERSONAL QUALITIES

The field of economics rewards creative, curious,analytical, and logical thinkers. Helpful qualitiesfor an economist include the following:

● The ability to work accurately with details

● The ability to work well independently as wellas with others

● The ability to be objective and systematic inone’s work

● Patience and persistence (since economistsand marketing research analysts must spendlong hours on independent study and problemsolving)

● Effective communication skills

● Intellectual curiosity

● The ability to collect, organize, interpret, andanalyze data

● Leadership ability

● The ability to present findings clearly, bothorally and in writing

● The ability to make decisions based on experi-ence and using data

● Enjoyment of the research process

Especially for advancement purposes, it ishelpful to continue pursuing education and totake graduate-level courses. It is also importantto be able to work successfully under the pressureof deadlines and tight schedules and to be able tobear the responsibility of knowing that the infor-

mation provided will affect the future policies ofcurrent employers (Horizons, 2000).

EDUCATION AND TRAINING

People who are interested in this field should beable to work accurately and precisely, becauseeconomics entails careful analysis of data. Goodcommunications skills are also necessary. Oneshould also take as many mathematics and com-puter science courses as possible in high school(‘‘Economics,’’ 1997).

A college major in economics is the basicpreparation for a career in economics. Studentsshould also study political science, psychology,sociology, finance, business law, international re-lations, statistics, regression analysis, and econo-metrics. Those who are comfortable with thewritten and spoken word have a significantlyhigher rate of advancement and overall job satis-faction than those who are not (Economist, 2000).

Although most professional economists holda master’s degree or a doctorate, a bachelor’sdegree often suffices for an entry-level position inbusiness or government, perhaps in an econom-ics-related area such as sales or marketing, begin-ning research, or administrative and manage-ment training (‘‘Economics,’’ 1997). The primaryresponsibilities in entry-level positions are thecollection, adaptation, and preparation of data.In the federal government, applicants for entry-level economist positions must have a bachelor’sdegree with a minimum of twenty-one semesterhours of economics and three hours of statistics,accounting, or calculus (Horizons, 2000). How-ever, additional courses and/or superior aca-demic performance are likely to be required. Theimportance of quantitative analysis makes ithighly desirable for those planning a career ineconomics to take courses in mathematics, statis-tics, sampling theory and survey design, andcomputer science (Harkavy, 1990).

Postgraduate degrees in economics, withconcentration in areas such as economic theory,econometrics, comparative economic systems,economic planning, labor economics, and inter-national economics, are generally required foradvancement in government or private industry



(Harkavy, 1990). Business economists with agraduate degree and experience may advance tomanagement or executive positions in banks, in-dustry, or other organizations, where they deter-mine business and administrative policy(Horizons, 2000). A master’s degree is usually theminimum requirement for a job as an instructorin junior and community colleges. For a facultyposition in most colleges and universities, how-ever, a Ph.D. is normally required. A Ph.D. plusextensive publications in academic journals arerequired for a professorship, tenure, and promo-tion. Economists in education may advance to bedepartment heads or to administrative or re-search positions (‘‘Economists and Marketing,’’2000).

Overall, good mathematical and analyticalskills are essential; persistence, objectivity, andcreativity in problem solving are important; andcomputer skills and excellent communicationskills are invaluable. No special licensing or certi-fication is required for economists (Harkavy,1990).

LOCATION OF JOBS

Generally economists who are not in academiawork in large cities, where there is the highestconcentration of major financial and governmentpower; New York City and Washington, DC, aremain centers of employment, along with Chicagoand Los Angeles. Academic positions are spreadthroughout the country. American economistsare also employed in foreign countries by inter-national companies and organizations and byU.S. government agencies (‘‘Economists,’’ 1997).

EARNINGS AND PROSPECTIVEJOB OUTLOOK

Economists are the highest-paid social scientists.The highest-paid economists in business are insecurities and investment, insurance, and retailand wholesale trade. The lowest-paid economistswork in education, nonprofit research institu-tions, and real estate (Harkavy, 1990).

Job opportunities for economists should bebest in manufacturing, financial services, adver-tising, and consulting firms. The complexity of

modern national and international markets willcontinue to spur a demand for those skilled inquantitative analysis. In addition, lawyers, ac-countants, engineers, and urban and regionalplanners, among others, will continue to needeconomic analysis. The majority of openings willcome about as the result of replacement needs forthose retiring or leaving the profession for someother reason (Harkavy, 1990).

Demand for qualified marketing research an-alysts should be strong because of the increas-ingly competitive economy. Marketing researchprovides organizations with valuable feedbackfrom purchasers that enables companies to eval-uate consumer satisfaction and plan more effec-tively for the future. As companies seek to expandtheir market and consumers become better in-formed, the need for marketing professionals willincrease (‘‘Economists and Marketing,’’ 2000).

Economists with a bachelor’s degree will facestrong competition in securing jobs in businessor industry; some may find positions as manage-ment or sales trainees or as research or adminis-trative assistants. Those with master’s degreesand a strong background in marketing and fi-nance will have the best prospects in business,banking, advertising, and management consult-ing (Harkavy, 1990). Those holding doctoral de-grees in economics and marketing are likely toface strong competition for teaching positions incolleges and universities. However, opportunitiesshould be good in other areas, such as industryand consulting firms.

CONCLUSION

Economics is the only social science for which aNobel Prize is awarded—an indication of its im-portance. Economic concepts have been appliedin the natural sciences; both the theory of naturalselection and the study of ecology, for example,have drawn extensively on economic concepts.Economics is both a theoretical and an applieddiscipline. It analyzes the way an economy can bechanged and improved through learning how thevarious parts of society affect each other andstudying the relationships between government,business, and the individual (Basta, 1991). Eco-



nomic concepts are so powerful and versatile thatthey have been applied to attempts to understandnearly every aspect of human activity. Economicsprovides important insights in areas from gov-ernment fiscal and monetary policy, to business,to law and property rights, to poverty and healthissues, to environmental and natural resourceissues, to the choice of marriage partners.

BIBLIOGRAPHY

Basta, Nicolas. (1991). ‘‘Economics.’’ Major Options: TheStudent’s Guide to Linking College Majors and CareerOpportunities During and After College. New York:Stonesong Press.

Careers in Economics. (1995). http://www.sju.edu/�nfox/careers.htm.

Careers in Economics/Student Resources/McGraw-Hill.(2000). McGraw-Hill Higher Education: The McGraw-Hill Companies. http://www.mhhe.com/economics/sharp/student/careers.mhtml.

‘‘Economics,’’ (1997). VGM’s Careers Encyclopedia, 4th ed.Chicago: NTC Publishing Group.

‘‘Economists.’’ (1997). Encyclopedia of Careers and Voca-tional Guidance, vol. 2. Chicago: J.G. Ferguson Publish-ing.

‘‘Economists and Marketing Research Analysts.’’ (2000).Occupational Outlook Handbook. Washington, DC: U.S.Department of Labor—Bureau of Labor Statistics.

Economist. (2000). [On-line]. Princeton Review Online/Ca-reer: Princeton Review Publishing, L.L.C. http://www.review.com.

Harkavy, Michael (1990). ‘‘Economists.’’ 101 Careers: AGuide to the Fastest-Growing Opportunities. New York:Wiley.

Horizons. (2000). [Computer program]. Springfield: IllinoisCareer Information System, Illinois Occupational Infor-mation Coordinating Committee. http://ioicc.state.il.us/etc.htm.

Questions and Answers. (2000). http://www.wiu.edu/users/miecon/wiu/whymajor/questions–answers.html.

WENDY RINHOLEN

CAREERS IN FINANCE

In exploring careers in finance, one quickly be-gins to realize that there are a variety of jobs, withseveral types of organizations, requiring varyinglevels of education and training. Unfortunately,

the word finance reveals few details about whatone actually does as work in a finance career. TheCareer Guide to Industries (edition 2000-2001),produced by the Bureau of Labor Statistics, orga-nizes finance careers according to three broadcategories: banking, insurance, and securities andcommodities. Careers in the banking industry fo-cus on providing loans, credit, and payment ser-vices to individual and large institutional cus-tomers. Insurance industry jobs focus onproviding clients with protection against finan-cial losses and hardships due to such things asfire. Finally, securities and commodities careersare typically what most people think of whenconsidering a career in finance. These jobs focuson advising and assisting individual and institu-tional investors with purchasing and sellingstocks, bonds, and commodities.

BANKING CAREERS

The majority of jobs in the banking industry areclerical and administrative support positions.Bank tellers make up the bulk of the clericalpositions in banking institutions. Tellers work di-rectly with customers, assisting them with basicbanking services such as depositing funds andcashing checks. New accounts clerks, also calledcustomer service representatives, assist customerswith opening and closing bank accounts and withapplying for loans or credit cards. As a result,bank tellers and new accounts clerks need to beknowledgeable about a wide range of bankingservices and be able educate customers aboutthese services.

There are several other entry-level adminis-trative positions in the banking industry. Book-keeping, auditing, and accounting clerks areneeded to help maintain and update financialrecords, process deposit slips and checks, andenter data. Credit or loan clerks are responsiblefor organizing the paperwork needed to completethe required records for approved loans or linesof credit. Banks also need secretaries, recep-tionists, and computer operators to assist withthe many administrative support duties.

According to the Career Guide to Industries,25 percent of the positions in the banking indus-

CAREERS IN FINANCE


try are comprised of executive, administrative,and managerial occupations. Examples of theseoccupations include loan officers, trust officers,and financial managers. Loan officers are respon-sible for determining whether or not a customercan pay back a loan and then approving or de-clining the customer’s loan application. They alsohelp to bring in new business by developing rela-tionships with customers who will need bankloans in the future. Loan officers and counselorsalso tend to specialize in either commercial, con-sumer, or mortgage lending. Trust officers areresponsible for managing the finances of cus-tomers or organizations that have been placed intrust with the bank. Very often they are calledupon to be the executor of an individual’s estateupon that person’s death. Last, financial manag-ers supervise operations at branch offices or de-partments to make sure customers receive qualityservice.

Education and training requirements for fi-nance careers in banking vary according to thespecial skills required for success and the level ofresponsibility. Bank tellers and clerks typicallyneed, at minimum, a high school education.Some basic skills and interests needed for successas a teller or clerk are math skills, interpersonalcommunication skills, and comfort in handlinglarge amounts of money. Typically banks providetellers and clerks with additional training on theorganization’s procedures and regulations. TheAmerican Institute of Banking, AmericanBankers Association, and the Institute of Finan-cial Education all offer accredited courses foradvanced training. Bank tellers and clerks takethese educational courses to prepare for moreresponsibilities and to assist with career advance-ment. However, most banks have their owntraining programs.

Financial managers, loan officers, and trustofficers usually have a college degree if not amore advanced professional or graduate degree.Most study business administration or earn adegree with a major in business administration.Any college degree plus a master of business ad-ministration or a law degree are excellent prepa-ration for one of these financial management

positions. Managers who also sell securities needto be licensed by the National Association ofSecurities Dealers.

Earnings in the bank industry reflect theamount of responsibility and education requiredof the position. As a result, the more responsibil-ity and education a job requires, the higher thesalary. As the amount of responsibility increases,so does salary, as can be seen in the salary rangesof commercial loan officers, trust officers, andtop executives. Other factors that influence salaryare experience, length of time with the bank, andlocation and size of the bank.

Employment in the banking industry is ex-pected to grow at 3 percent, which is much lowerthan the growth rate of the overall economy,which is expected to increase 15 percent between1998 and 2008. The downsizing and cost cuttingthat occurred in this industry in the early to mid-1990s is expected to decline. Most of the growthin the banking industry is expected to occur insmall regional credit unions and banks. As banksbecome more automated and ATMs are able toprovide more services, fewer bank tellers andclerks will be needed. Areas of growth can befound in customer service representatives forstaffing call centers and trust officers to adminis-ter the estates of an aging population.

INSURANCE INDUSTRY CAREERS

The Career Guide to Industries states that morethan 40 percent of the positions in the insuranceindustry are administrative support positionssuch as secretaries, bookkeepers, word proces-sors, and clerks. These support positions oftenrequire skills and knowledge that are specific tothe insurance industry. For example, because in-surance policy clerks focus on processing insur-ance policy applications, changes to policies, andcancellations, they need to have a strong under-standing of insurance policies. They often verifyboth the completeness of an application and theaccuracy of the insurance company’s records. In-surance claims examiners and investigators ofteninvestigate questionable claims or claims that ex-ceed the amount the insurance company is wil-ling to pay. Investigators and examiners spend

CAREERS IN FINANCE


most of their time checking claim applicationsfor accuracy, obtaining information needed fordecisions from experts, and consulting currentpolicy about claims.

Executive, managerial, and administrativejobs make up about 30 percent of the positions inthe insurance field. Three examples of job titlesfound at this level of employment in the insur-ance industry are risk manager, sales manager,and underwriter. Risk managers develop the poli-cies the insurance company follows when makingdecisions regarding claims. These policies are de-veloped by analyzing historical data about natu-ral disasters, car accidents, and other situationsthat may result in physical or financial loss. Salesmanagers sell insurance products, assist clientswith questions about policies, and supervise staff.They make up the majority of managers in localsales offices. Finally, underwriters review applica-tions for insurance and the level of risk involvedin agreeing to issue an insurance policy. Essen-tially, the underwriter determines whether to ac-cept or reject the application and how much aclient should pay in premiums.

A smaller percentage, about 15 percent, ofsalaried employees in the insurance industry ismade up of salespeople, often called insurancebrokers or insurance agents, who focus on sellinginsurance policies to businesses and individualcustomers. Insurance agents can sell insuranceexclusively for one insurance company or insur-ance policies issued by several different insurancecompanies. Some of the typical types of insur-ance polices an agent or broker may sell includehealth, life, annuities, property, casualty, and dis-ability. In addition to these services, some agentsare now licensed to sell mutual funds, annuities,and securities.

An even smaller career field in the insuranceindustry is the area of actuary science. Althoughthere may not be as many actuaries as there aresalespeople in insurance, they are very importantto the industry. Actuaries set rates paid by cus-tomers at a level where the premiums that arecollected will generate enough money to coverthe claims that are paid out. Yet the premiumscan’t be too expensive or customers will switch to

other insurance companies. Actuaries accom-plish this by studying the probability of an in-sured loss and the premium rates of other insur-ance companies.

Education requirements for jobs in theinsurance industry vary, depending on the posi-tion and its responsibilities. Many of the entry-level clerical positions in the insurance industryrequire only a high school diploma. Higher-levelexecutive, managerial, and sales positions requiremore education, with employers usually prefer-ring to hire college graduates. Most managerialpositions are filled by promoting people fromwithin the organization. Such employees usuallyhave a college education, some special training inthe insurance industry, and experience with thecompany. Actuaries typically have a college de-gree in actuary science, math, or statistics. Aftercompleting college, actuaries must pass a series ofexams over a period of five to ten years to becomefully qualified. Overall, advancement opportuni-ties are good in the insurance industry.

Earnings for insurance clerks and clericalstaff are below those of insurance examiners, ad-justers, and investigators. Higher yearly salariesare typical for higher-level general managers andtop executives. Salaries for sales agents are diffi-cult to pinpoint because many salespeople arepaid a salary, plus commissions, plus bonuses forreaching sales goals. In addition, an agent’s earn-ings will rapidly increase as he or she gains expe-rience and develops a client base.

The employment rate for the insurance in-dustry is projected to increase more slowly thanthe average for all industries combined. Jobgrowth in the insurance field is expected to belimited by the downsizing of large insurancecompanies, computerization, and a trend thatpoints toward direct-mail and telephone salescampaigns. One area of growth in this industry isthat of financial services and products sales. An-other growth area stems from the need to coverlarge liability awards resulting from lawsuits. Fi-nally, the number of claims professionals willgrow faster than any other position in the indus-try because of the need for better customer ser-

CAREERS IN FINANCE


vice and actual inspection of damaged propertyor consultation with doctors.

SECURITIES AND COMMODITIES CAREERS

There are large numbers of workers in this area ofthe finance industry. The national brokeragecompanies have extensive systems of branch of-fices throughout the country; as a result, thesebrokerage firms employ the majority of the work-ers in this industry. Headquarters for these firmsare located in New York City, where most of theexecutives and support personnel work. Mutualfund management companies and regional bro-kerages also employ many people. Although it isvery well known, the New York Stock Exchangeactually employs a small number of people com-pared to the rest of the industry.

A great deal of attention is focused on track-ing performance, transactions, and the value ofinvestments. Brokerage clerks are responsible forthe majority of the daily operations and for pro-cessing much of the paperwork that is generated.These positions are often considered entry-leveljobs with the potential for promotion into securi-ties sales and even into higher positions. Forexample, a sales assistant takes calls from clients,writes up the order, processes the paperwork, andkeeps clients updated on their portfolio’s per-formance. With experience and a license to buyand sell securities, brokerage clerks can be pro-moted into higher-level sales positions.

The largest number of people employed inthe securities and commodities industry can befound in three occupations: securities, commodi-ties, and financial services sales. These careersinvolve buying and selling shares of stocks, mu-tual funds, and other financial services. The ma-jority of these workers are sales representativeswho work directly with individual investors.They are known as brokers, account executives,or financial consultants. Securities and commod-ities brokers differ in the investments they buyand sell. Securities brokers typically buy and sellstocks, bonds, and mutual funds. Commoditiesbrokers buy and sell futures contracts for metals,energy supplies such as oil, and agriculturalproducts. In addition to buying and selling secu-

rities, brokers can advise and educate their clientson investments, saving for retirement, and toler-ance for risk. Overall, brokers spend a great dealof time marketing their services and products inorder to establish a strong customer following.

Financial planners go a step further in advis-ing and educating their clients. They often pro-vide advice on investments, investing for retire-ment, tax planning, and employee benefits. Theirstrategy tends to be more of a comprehensiveapproach to advising clients on financial matterswhen compared to brokers. These planners canalso buy and sell stock, mutual funds, bonds, andannuities.

Investment bankers and financial analystsmake recommendations about potential profitsfrom investments in specific companies by re-viewing the companies’ financial records andevaluating market trends. They also play a veryimportant role in determining the market valuefor stocks that are traded publicly or stocks beingpurchased when a company is merging with oracquiring another company. Financial analystsoften specialize in a specific industry sector, suchas technology stocks.

Another career in the securities and com-modities area of the finance industry is that ofportfolio manager. These finance professionalsare responsible for investing large amounts ofmoney. The portfolios they manage are oftenmutual funds, pension funds, trust funds, andfunds for individuals who are investing very largeamounts of money. Most importantly, portfoliomanagers must have a clear understanding of amutual fund’s or a client’s investment goals inorder to ensure that the investment decisionsthey make meet the financial goals and guidelinesset by the mutual fund or client.

As a whole, the workers in this area of thefinance industry are well educated and highlytrained. Even entry-level brokerage clerk posi-tions often require a college degree. Also, to sellsecurities professionals are required to pass anexamination testing their knowledge of invest-ments. The National Association of SecuritiesDealers (NASD) conducts this testing and li-censes professionals to sell a variety of investment

CAREERS IN FINANCE


products. Most brokers and sales assistants ob-tain the Series 7 license from the NASD by pass-ing the General Securities Registered Representa-tive Exam. In addition to passing the exam, theseprofessionals are required to take classes on regu-latory issues and new investment products inorder to keep their licenses. Currently, there is nospecial licensing requirement to become a finan-cial planner. However, many financial plannersearn a certified financial planning (CFP) or char-tered financial consultant (ChFC) designation.The CFP is issued through the CFP Board ofStandards and the ChFC is offered by the Ameri-can College. A series of exams on investments,taxes, insurance, retirement, and estate planningmust be passed in order to receive one of thesedesignates. In addition, the CFP must follow therules and regulations set forth by the CFP Boardof Standards.

Most of the workers in the entry-level analystand managerial positions have a college degreeand studied finance, general business administra-tion, economics, accounting, or marketing. Inorder to advance, many take part in managementtrainee programs where they briefly work andlearn about different departments. To advancefurther and gain access to higher salaries andmore prestigious positions, many people obtain amaster’s degree in business administration.

For many brokers and commodities dealers,income is based on a salary and on commissionsfrom the sale or purchase of stocks, bonds, orfutures contracts. When the economy is strongthese commissions and bonuses are much higherthan they are when the economy is in a slump.Another factor in determining earnings in thisarea of finance is the amount of assets the man-ager is responsible for managing.

Yearly earnings for entry-level brokerageclerks are at the start of the scale. Further up thescale are financial analysts and sales agents. At thenext level are the financial managers. The high-est-paid professionals in the securities and com-modities industry are general managers and topexecutives. Many firms also offer their employeesprofit sharing and stock options. Plus, most sala-

ried employees receive health benefits, paid vaca-tion, and sick leave.

Job growth in this industry is being fueled byseveral factors. First, more than ever, people areinvesting in securities as a way to save money andplan for retirement, resulting in a large influx ofmoney into the stock market. Second, althoughon-line trading is reducing the need for directcontact with brokers, there is still a need forinvestment advice. Finally, the increased de-mands of investing in a complex global markethave created a need for skilled investment man-agers. According to the Occupational OutlookHandbook, these factors have contributed to anemployment growth projection of 40 percent forthis segment of finance careers, which is muchgreater than the 15 percent projected for all otherindustries combined.

(SEE ALSO: Finance)

BIBLIOGRAPHY

Career Guide to Industries, 2000-2001 Edition. (1999). Bu-reau of Labor Statistics. Baltimore: United Press.

Careers in Focus: Financial Services. (1998). Chicago: Fergu-son Publishing Company

Occupational Outlook Handbook, 2000-20001 Edition.(1999). Bureau of Labor Statistics. (1999). Baltimore:United Press.

Pandy, Anil, and Okusanya, Omotayo T. (1999). The Har-vard Business School Guide to Careers In Finance 2000Edition. Boston: Harvard Business School Publishing.

MARK D. WILSON

CAREERS ININFORMATION PROCESSING

The demand for computer and information sys-tems professionals exists and continues to grow.The U.S. Commerce Department’s Office ofTechnology Policy (1982) reported that between1996 and 2006, U.S. businesses and schools willrequire more than 1.3 million new informationtechnology workers to fill jobs. In the twenty-firstcentury, 70 percent of all jobs will require skills incomputer and network use.

CAREERS IN INFORMATION PROCESSING


The U.S. Bureau of Labor Statistics (1998)reported that the fastest-growing computer ca-reer positions through the year 2006 will be com-puter engineer, systems analyst, computer repairtechnician, and programmer. There is also highdemand for systems analysts, computer scien-tists, network administrators, and database man-agers.

Careers in computers and information pro-cessing, also called information technology (IT),require a unique combination of conceptualskills in creative problem solving and criticalthinking, technical hands-on skills, and commu-nications and interpersonal skills, as well as anunderstanding of business and industry needs.

Career opportunities in computer industriescan be grouped into four areas:

● Companies that manufacture computer-relatedequipment (hardware)

● Companies that develop software

● Companies that hire information systems pro-fessionals to work with software and hardwareproducts

● Companies and organizations that providecomputer-related training and education

Many service companies exist to support each ofthese four areas—firms that sell computer sup-plies or provide consultation on analysis, design,programming, and networking projects.

CAREERS IN THE COMPUTERHARDWARE INDUSTRY

The computer equipment, or hardware, industryconsists of manufacturers and distributors ofcomputer systems and computer-related equip-ment such as monitors, printers, and communi-cations equipment.

Computer equipment manufacturers are or-ganizations with thousands of employees inmany locations worldwide. IBM, for example, isone of the largest computer companies, withmore than 200,000 employees and sales of morethan $80 billion in 1998. Numerous start-upcompanies have taken advantage of rapidchanges in equipment technology to create new

products and new job opportunities in areas suchas networking, multimedia, and fiber-optics.

In addition to the companies that make end-user equipment, thousands of companies buildcomponents such as motherboards, input andoutput devices, and power supplies. Job titles thatinvolve the design and manufacture of computerequipment include computer engineer, softwareengineer, and technical writer. A computer engi-neer designs, builds, tests, and evaluates com-puter chips, circuit boards, computer systems,and peripheral devices. Computer engineers needa B.S. in electrical or computer engineering. Theymust be very detailed-oriented and good at prob-lem solving.

Software engineers develop system softwaresuch as operating systems, utilities, and softwaredrivers. The minimum education required is aB.S. in computer science. Important capabilitiesinclude good analytical skills, an ability to workwith abstract concepts, and attention to detail.

Technical writers produce technical publica-tions, such as reference manuals, procedure man-uals, and product documentation. The minimumeducation requirement is a B.S. in engineering,science, or a related discipline. Technical writersneed good writing skills as well as knowledge ofthe products, processes, and procedures.

CAREERS IN THE COMPUTERSOFTWARE INDUSTRY

Companies in the computer software industrydevelop, manufacture, and support a wide rangeof software products, such as operating systemsand other systems software, productivity soft-ware, network software, software developmenttools, and Internet software and technologies.Some companies specialize in a particular type ofsoftware product, such as business productivitysoftware, utility programs, or multimedia andgraphic design tools. Other firms produce andsell multiple software products.

The software industry had sales in 1998 ex-ceeding $200 billion. The largest software com-pany, Microsoft, has more than 300 products andtechnologies, more than 20,000 employees, andsales of more than $11 billion in 1998.



Careers in the software industry involve de-signing and programming all kinds of softwareproducts, such as application software for busi-nesses, productivity software, educational pro-grams, entertainment software, and systems soft-ware. Careers in the computer software industryinclude programmer, software engineer, softwareanalyst, and technical writer. A programmer de-signs, writes, and tests computer programs. Edu-cational requirements are a B.S. in computer sci-ence or computer information systems.Programming requires logical thinking and closeattention to detail; it calls for patience, persis-tence, exacting analysis skills, and the ability tomeet deadlines. Ingenuity and imagination areimportant skills because programmers design so-lutions and test their work for potential failures.Increasingly, interpersonal skills are importantfor programmers working in teams and interac-ting directly with users. Systems programmerswho work with the software that controls thecomputer’s operation must have capabilities intechnical analysis and abstract concepts.

Systems analysts and software analysts con-duct requirements analysis, design software solu-tions, and oversee the software development pro-cess. The minimum education requirement is aB.S. in computer science. Software analysts musthave good communication and interpersonalskills, a mastery of the design and developmentprocess, and good project management skills.

CAREERS AS INFORMATIONSYSTEMS PROFESSIONALS

In many organizations, the information systems(IS) department includes information systemsprofessionals, who set up and manage the com-puter equipment and software to ensure that itproduces information for decision-making. Fourbasic groups of information systems careers arein operations, systems development, technicalservices, and end-user computing.

Operations Jobs in operations include com-puter operator, communications specialist, andlocal area network (LAN) engineer. A computeroperator monitors computer system perform-

ance, runs jobs, performs backups, and restoresfiles and systems. A high school diploma is re-quired.

A communications specialist installs, moni-tors, and evaluates data and/or voice communi-cations equipment and software and isresponsible for connections to the Internet andother wide area networks (WANs). The mini-mum educational requirement is a B.S. in infor-mation systems or electrical engineering technol-ogy.

A LAN engineer installs and maintains localarea networks. An example of a LAN engineer is aWindows NT systems engineer. Network engi-neers are expected to have the capabilities andexperience to take responsibility for entire pro-jects and address issues such as network design,network management, security, scalability, andperformance. For network engineers, experienceas a senior network engineer plus solid skills inNT troubleshooting, problem solving, teamwork,and communications are essential.

Systems Development Systems developmentcareers include systems analyst, application pro-grammer, Webmaster, Web designer/site builder,Internet specialist, and technical writer. Systemsanalysts assess user requirements and design in-formation systems solutions. They must thinklogically, have good communication skills, andlike working with ideas and people. They oftendeal with a number of tasks and projects simulta-neously. Although computer scientists and sys-tems analysts may work independently, they of-ten work in teams on large projects. They mustcommunicate effectively with computer person-nel, such as programmers and managers, as wellas with other staff who have a limited technicalcomputer background but are subject-matter ex-perts in a business functional area. A B.S. in man-agement information systems is required.

Application programmers convert the systemdesign into the appropriate computer language,such as C, Java, or Cobol. The minimum educa-tional requirement is an A.A.S. in informationsystems. The application programmer’s skills aresimilar to those of the systems programmer. AWebmaster maintains an organization’s Web site



and creates or helps users create Web pages. Theminimum educational requirement is an A.A.S.in information systems. A Web designer/sitebuilder’s minimum educational requirement is aB.S. in computer science of information systems.The skill set for both jobs includes abilities inWeb-site development languages such as C��,Java, and HTML. This job involves the automa-tion of customer service and help desk functions,as well as ongoing maintenance and develop-ment. A strong understanding of the business isessential. Strong prioritizing and customer ser-vice skills are necessary. This career involvesproject work and consulting.

The Internet specialist’s minimum educationis a B.S. in information systems or electrical engi-neering technology. This position requires skillsin senior-level networking, LANs and WANs, theInternet, security, e-commerce, Unix, WindowsNT, and Novell applications. Effective communi-cation skills are essential. This career requires anoutgoing personality and the ability to work wellwith users.

Technical writers work with analysts, pro-grammers, and users to create system documen-tation and user manuals. The minimum educa-tional requirement is a B.S. in informationsystems.

Technical Services Three primary careers intechnical services are database analyst, systemprogrammer, and quality assurance specialist.Database analysts assist systems analysts and pro-grammers in developing or modifying applica-tions that use an organization’s database. Theminimum education is a B.S. in computer scienceor information systems.

A system programmer installs and maintainsoperating system software and provides technicalsupport to the programmer’s staff. The mini-mum educational requirement is a B.S. in com-puter science or information systems.

A quality assurance specialist reviews pro-grams and documentation to ensure that theymeet the organization’s standards. The mini-mum educational requirement is a B.S. in com-puter science or information systems.

End-User Computing End-user computingpositions include PC support specialists and helpdesk analysts. The PC support specialist installsand supports personal computer equipment andsoftware. The minimum educational require-ment is an A.A.S. in information systems. Thehelp desk analyst provides user/customer tele-phone support for hardware, software, or tele-communications systems. The minimum educa-tional requirement is an A.A.S. in informationsystems.

Executive Positions Executive positions in in-formation services are senior-level positions in anorganization, such as chief technology officer.The chief technology officer develops a strategictechnology organizational plan and oversees theimplementation of the plan and high-level ITpolicy issues. A chief technology officer must beable to provide creative solutions, have solidtechnology skills, and understand the businessbeing supported. Excellent analytical skills andthe ability to balance priorities while paying at-tention to the bottom line are crucial. A prereq-uisite for the position is a background as a techni-cal strategist; both in-depth and broad-basedknowledge and experience are important, as areexcellent communications, interpersonal, andmanagement skills.

CAREERS IN EDUCATION AND TRAINING

Extensive opportunities in computer-related ed-ucation and training exist because of the in-creased sophistication and complexity of today’scomputer products and the rapid developmentand deployment of new products. Schools, col-leges, universities, and private companies all needqualified instructors. The high demand for in-structors, in fact, has led to a shortage of qualifiedinstructors and trainers in universities and cor-porate environments.

CONTINUING EDUCATION

Rapid technological changes and the global mar-ketplace continue to increase the need for on-going continuing education to keep knowledgeand skills current. Employers, hardware and soft-



ware vendors, colleges and universities, and pri-vate training institutions offer continuing educa-tion opportunities. Additional training isprovided by professional development seminarsoffered through professional organizations.

INDUSTRY CERTIFICATIONS

Industry certifications provide employers assur-ance of a standard level of competency, skill, orquality in a particular area. Many organizationsoffer technical certification programs for theirproducts. Standard curricula, training programs,and examinations are used to determine if aperson is qualified for certification. A certificateis proof of professional achievement, a level ofcompetence accepted and valued by the industry.Certificates enhance employment portfolios andcareer opportunities. Many employers give pref-erence in hiring to applicants with certification.In addition, certification can lead to promotionsand help advance careers.

BIBLIOGRAPHY

Cannings, Terence R., and Finkel, Leroy. (1993). The Tech-nology Age Classroom. Wilsonville, OR: Franklin, Beedle,& Associates.

Edwards, John. (1999). ‘‘Employment in 1999: Opportuni-ties amid Challenges.’’ Computer 32 (January):19.

Enhanced Occupational Outlook Handbook, The. (1997). In-dianapolis, IN: JIST Works.

Fafard, Lina. (1999). ‘‘New Career Chart Toppers.’’Computerworld, May 24:57.

Kleinman, Carol. (1992). 100 Best Job$ for the 1990s andBeyond. Chicago, IL: Dearborn Financial Publishing.

New Book of Knowledge, The. (1994). Danbury, CT: Grolier.

Saettler, Paul. (1990). The Evolution of American EducationalTechnology. Englewood, CO: Libraries Unlimited.

Shelly, Gary, Cashman, Thomas, Vermaat, Misty, andWalker, Tim. (1999). Discovering Computers 2000: Con-cepts for a Connected World. Cambridge, MA: CourseTechnologies.

Terry, George, and Stallard, John. (1984). Office Manage-ment and Control. 9th ed. Richard D. Irwin.

U.S. Bureau of Labor Statistics and Source EDP, 1998 SalarySurvey.

U.S. Bureau of Labor Statistics. ‘‘Occupational Employ-ment, Training, and Earnings.’’ [stats.bls.gov]. March 30,1998

U.S. Commerce Department. Office of Technology Policy(1998).

York, Thomas. (1999). ‘‘Shift in IT Roles Ahead: Changes inBusiness and Technology will alter IT careers.’’InfoWorld 21(3)(January 18): 75.

LINDA J. AUSTINDEBBIE HUGHES

CAREERS IN LAWFOR BUSINESS

A wide variety of choices are available for a careerin law. However, work and determination arerequired to complete law school and pass a statebar examination.

To be admitted to law school, students musthave completed a bachelor’s degree, althoughgenerally without restriction concerning thechoice of undergraduate major. Law studentshave bachelor’s degrees in business, engineering,science, history, politics, and many other disci-plines.

ENGAGING IN LAW PRACTICE

The individual states administer the licensing oflawyers. Requirements for attorneys to enter thelaw field vary from state to state. Generally, aprospective lawyer must pass a state bar examina-tion following graduation from law school. In avery few states, a person is automatically admit-ted to practice upon graduation from law school.It is possible for a person to sit for bar examina-tions and become licensed to practice in morethan one state.

The states also control discipline once law-yers are admitted to practice. Complaints fromclients or others may be made to the state bar,which reviews them and imposes discipline, ifnecessary. Discipline may range from fines orsuspensions up to disbarment. In many states,the state supreme court reviews disciplinary ac-tions imposed upon lawyers.

AREAS OF LEGAL PRACTICE

Lawyers deal with business organizations, indi-viduals, international business, labor relations,



educational law, poverty law, legal research andwriting, and other areas.

Legal practice with domestic business organi-zations In the United States, attorneys engagedirectly with business organizations in manyfields in which they practice.

Publicly held corporations: Many areas oflaw involve publicly held corporations(stock available for purchase by any inves-tor). For example, control and manage-ment have legal ramifications, as do capitalprocurement and maintenance. Attorneysare called upon to settle a wide range ofdisputes, such as those developing betweenstockholder and corporation.

Antitrust legislation: Antitrust laws prohibitprice fixing, which could result when busi-nesses gain monopoly power in their field.Major legislation in this realm includes theSherman Act of the 1890s, the Clayton Actof 1914, and the Cellar-Kefauver Act of1950. The Robinson-Patman Act prohibitsmanufacturers from discriminating againstsmall retailers in favor of large chains.These acts are enforced by the FederalTrade Commission and the Antitrust Divi-sion of the Department of Justice.

Unfair trade practices: These laws involvevarious types of business competition, es-pecially with reference to trademarks, pricemaintenance, and price discrimination.

Patents: Patents are issued by the Patentand Trademark Office of the U.S. govern-ment. They grant inventors exclusive rightsto make, sell, and use inventions in theUnited States for a given period of time.Patents often require an attorney’s counsel.

Copyrights: Copyrights provide protectionfor original works of literary, dramatic,musical, or artistic expression. The Copy-right Office of the Library of Congress ad-ministers these laws.

Trademarks: Trademarks are used to distin-guish one business firm’s products fromanother. Their symbols may be a word or

words, name, design, picture, or sound.Trademark rights have an indefinite life. Acompany may register its trademark withthe U.S. Patent and Trademark Office inArlington, Virginia, or with the trademarkoffice in its state.

Accounting: Accounting statements providefinancial details concerning the operationof a business or other form of organiza-tion. Balance sheets list assets (things thatare owned), liabilities (debts), and networth (assets minus liabilities). Incomestatements show net income for a periodof time (income minus expenses). Businessfirms, particularly those with stockholders,must prepare honest and conservative fi-nancial statements. Very stringent lawshave been passed dealing with accountingpractices.

Negotiations: Attorneys orchestrate a varietyof negotiations. including those involvinginjury claims, criminal charges, family dis-putes, and commercial disputes.

Business organizations: Business organiza-tions become involved with the law of em-ployment, agency, partnership, limitedpartnership, and other types of unincorpo-rated associations.

Regulated industries: Price, supply, and ser-vices are a part of Regulation C control invarious industries, such as transportationagencies and public utilities. Regulatorypolicy can involve interaction among legis-latures, administrative agencies, and thecourts. Advanced legal work may be re-quired for business planning and counsel-ing concerning corporate and tax issues.Clients often need representation beforeregulatory bodies and at administrativehearings.

Contracts: Attorneys become involved inthe creation of promissory liability, the in-terpretation of words and conduct as wellas the nature of obligations assumed byentering into contracts. They also solveproblems relating to breach of contract,



unfairness as a reason for avoiding con-tractual liability, and the rights of thosenot a party to the contract.

The Uniform Commercial Code: Articles 3,4, and 5 concern negotiable instruments,bank collection systems, and letters ofcredit. Article 9 deals with secured transac-tions; Article 7, with documents of title.

Creditors’ and debtors’ rights: Attorneys dealwith consumer credit regulation, includingattachments, garnishments, assignments forthe benefit of creditors, judgments, andbankruptcy.

Insurance law: This branch as law dealswith property, life, and liability insurance;fire and automobile insurance forms; andthe regulation of insurance companies’policies and practices.

Remedies: Remedies of quasi-contract, con-structive trust, equitable lien, and reforma-tion must be applied to redress enrichmentsecured by tort, part performance of con-tract, duress, or mistake.

Government contracts: Laws and regulationsapply to contracts with governmental bod-ies and agencies.

Legal practice for individuals Individuals needa wide range of legal services in the area of busi-ness. Some services are provided for investors orowners in business situations; others, for personsfinding themselves in difficulty.

Trust and estates: Legal consideration mustbe given to community property systems,federal gift and estate taxes on propertytransfers, estate planning not involvingproperty, living wills, delegation of healthcare decision-making, and gifts to as wellas guardianship of minor children. Relatedlegal forms involve living trusts and giftstrategies.

Family law: Family law can involve rela-tionships of married couples, unmarriedcouples, or couples undergoing divorce.Additional family relationships that mayinvolve lawyers include parent and child.

unmarried parents, neglected children, fos-ter care, and adoption.

Taxes: Attorneys can assist in tax planningfor individuals. especially where issues arisebetween the taxpayer and the Internal Rev-enue Service or state taxing authorities.They also deal with taxation implicationsfor corporate organization, reorganization,and liquidation. Some attorneys deal withinternational tax problems, such as juris-dictional rules, tax situations between in-dustrialized countries and developingcountries, and host country taxation offoreign persons.

Real estate transactions: In this field, law-yers deal with options, binder contracts,and rights and duties between vendor andvendee among other things. Lawyers alsopractice in basic land contract and mort-gage law as well as real estate recordingsystems. They work with both land-usecontrols and water-rights laws. They mayalso deal with environmental law and insti-tutions.

Legal practice for international businessInternational trade in the world is becomingmore prevalent and increasingly legally complex.This increases openings for interested attorneys.

International legal practice may involve is-sues of recognition and nonrecognition of gov-ernments and nations, interpretation of treatiesand other international agreements, the effect ofpeace and war, and international claims.

Lawyers may advise on the risks, assump-tions, and benefits of doing business in a foreigncountry. Questions may arise concerning inter-national commercial transactions and invest-ments, the impact of U.S. securities and antitrustlaws, and trade laws of the United States andother countries.

Labor relations law State and federal laws dealwith employee representation, collective bar-gaining, and employer-union practices. Theselaws, the National Labor Relations Act, and re-lated federal and state labor laws often make legalcounsel necessary.



Attorneys provide counsel in collective bar-gaining and with the negotiation and arbitrationprocesses.

Statutes such as these involving fair employ-ment practices, workers’ compensation, fair lab-or standards, unemployment compensation, andSocial Security protect workers against insecurity,discrimination, economic exploitation, andphysical damage. Their purpose is to guardagainst unequal opportunity linked to race, sex,religion, age, physical disability, and other fac-tors.

Legal questions linked to public policy arisefrom representation questions, limitations on theright to strike, grievance arbitration, impasseprocedures, and the scope of bargaining.

Educational law practice Legal issues arisefrom educational financing, integration and seg-regation, punishment methods applied to chil-dren, and alternatives to public school education.

Poverty law Although often unable to pay,the poor frequently require legal services. Someindigents make contact with public-interest lawfirms or offices that provide legal services for thepoor. In this area, lawyers deal with issues such aswelfare rights, health, education, public assis-tance, or housing.

Legal research and writing Some lawyers en-gage in legal research and writing. This workinvolves library and computerized research, briefand memorandum writing, organization of legalmaterial, and prediction of rules of law. Much ofthis activity takes place in law schools or at theappellate court level.

Other areas of law practice There are a num-ber of additional areas of law practice. Theseinclude legal problems related to technology andsociety, bioethics, science, psychiatry, and at-tempts to achieve progress in developing coun-tries.

U.S. COURT SYSTEM

The court system also offers career opportunities.An understanding of our court system is relevantto a career discussion. The courts in the United

States fall within two classifications: the federalcourt system and the state court systems.

Federal court system The federal court systemcomprises the Supreme Court, circuit courts ofappeal, and district courts. There are also special-ized federal courts.

The U.S. Supreme Court is the final court ofappeal for both civil and criminal law. It wascreated by Section 1, Article III of the U.S. Con-stitution. Title 28 of the U.S. Code establishes itsjurisdiction. The Court’s organization is specifiedby legislation, although the rules governing casepresentations are formulated by the Court itself.

Judicial review is an important power givento the U.S. Supreme Court. This refers to (1)declaring invalid laws that violate the U.S. Con-stitution, (2) asserting the supremacy of federallaws or treaties if they differ from state and locallaws, and (3) serving as the final authority on theinterpretation of the U.S. Constitution.

The U.S. Supreme Court includes a chiefjustice and eight associate justices. Appointed bythe president with the approval of the Senate,they serve for life or until they retire, resign, orare impeached.

The U.S. Supreme Court has original juris-diction in some cases, particularly where a state isa party or diplomatic personnel are involved. Theremaining cases come from lower courts. Re-quests for review number approximately 4,500annually; less than 200 cases are selected fordecision by the U.S. Supreme Court.

Some appeals to the U.S. Supreme Courtcome from any of the twelve federal courts ofappeal or the ninety-four federal district courts.These cases involve the U.S. Constitution, federallaws or cases in which the U.S. government is aparty, disputes between residents of differentstates (‘‘diversity’’ jurisdiction), or matters as-signed by federal legislation.

Appeals also come from specialized federalcourts. The Court of Military Appeals reviewscourts-martial cases appealed from militarycourts. These cases concern offenses committedby members of the armed forces and are some-times brought before the U.S. Supreme Court.



The U.S. Court of Claims hears cases dealingwith claims against the federal government. Itsdecisions may also be appealed to the U.S. Su-preme Court. In addition, the U.S. SupremeCourt may rule on cases involving decisions ofU.S. Custom offices, such as import duties.

State court systems Each state has its owncourt system. These courts are created by statestatute or constitution to enforce state civil andcriminal laws. Most of the states have trial courts,intermediate courts of appeal, and a supremecourt.

Most states have local trial courts—municipal, county, district, and small-claimscourts. Millions of civil and criminal cases aretried at this level. Other state courts may includepolice courts, magistrate’s courts, justices of thepeace, and probate or surrogate courts that han-dle wills and inheritances. There are also trafficcourts, juvenile courts, and domestic relationscourts.

State appeals courts (sometimes called‘‘error-correcting’’ courts) review trial courtcases to determine if errors caused an incorrectdecision. Their decisions may be appealed to thefederal courts, including the U.S. Supreme Courtin certain instances.

Supreme courts in each state, like the U.S.Supreme Court at the federal level, interpret theirstate constitutions, statutes enacted by their statelegislatures, and the body of state common law.

BIBLIOGRAPHY

Martindale Hubbell Law Directory, Areas of Practice Index.(1998). Reed Elsevier. (www.martindale.com)

The Official Guide to U.S. Law Schools, the annual jointpublication of the Association of American Law Schoolsand the Law School Admission Services, published eachfall. Available at most college book stores or can beordered directly from Law School Admission Services,Box 2000, Newtown PA 18940

University of Wisconsin Law School. ‘‘Preparation for LawStudy.’’ www.law.wisc.edu/admissions/lawatwis/pret.htm. December 1998.

U.S. Court System. www.syr.edu/jajcarro/compulegal/court.html.

CRAIG A. BESTWICKG. W. MAXWELL


Management is a very exciting and rewardingcareer. A career in management offers status,interesting work, and the satisfaction of workingclosely with other people. People are consideredthe most important resource in organizations. Ifthey perform effectively, the organizations willsucceed. Managers work closely with people,ranging from top managers to clerical workers, toensure that organizations achieve their objec-tives.

A management career also offers the oppor-tunity to make the world a better place. Managershelp organizations succeed. When organizationsare successful, there is better utilization of re-sources, less stress among employees, less chaosin society, and a better quality of life for all.Effective managers play an important role inshaping the world in which we live. Certo (1997)emphasized this point when he stated that oursociety would not be as developed as it is todaywithout effective managers to guide its organiza-tions.

WHAT DO MANAGERS DO?

Management is a people job. The manager coor-dinates the work of other people to ensure thatthe unit is run efficiently and profitably. A man-ager may have direct responsibility for a group ofpeople in one department or a team of peoplefrom several different departments. For somemanagers, it could mean supervising one person.

Managers provide overall direction and lead-ership for the organization. The manager setsclear objectives for the team and makes sure theyknow what the focus is, assigns duties to teammembers, and encourages them to perform thoseduties. The manager also evaluates the team’sactual performance against organizational objec-tives and decides on promotions and salary in-creases where appropriate. When team membersare not performing satisfactorily, the mangermakes the changes necessary to ensure that theyreach the company’s objectives. Managers usetheir people skills and business skills, such asmarketing and cost controls, to achieve the com-



pany’s objectives while at the same time makingsure to stay within budget.

The manager’s job is varied. Managers areinvolved with planned and unplanned activities.These activities include scheduled and unsched-uled meetings, inspection tours, report writing,new product launches, disagreements amongemployees, customer grievances, and changes inbusiness trends. According to Miller and associ-ates (1996), a manager should be able to shiftcontinually from person to person and from onesubject or problem to another. A manager who isalso the business owner makes all the daily deci-sions involved in the business.

Managers make things happen in organiza-tions. They decide what will be done, who will doit, when will it be done, and what resources willbe used. They hire and train new employees, andthey coordinate their departments’ activities withother departments. Managers are the heart oforganizations, the force that unites everything inthe organization to ensure optimum efficiencyand profitability.

TYPES OF MANAGEMENT CAREERS

In large organizations, managers work in a vari-ety of areas, including operations, human re-sources, finance, and marketing:

● Operations managers see that the company’sproducts and/or services meet quality stan-dards and satisfy the needs of customers andclients. They plan production schedules to en-sure the most efficient use of plant, man-power, and materials. The operations manageris responsible for production control, inven-tory control, quality control, plant layout, andsite selection. New graduates will start as man-agement trainees. After successfully completingthe program they will be promoted to produc-tion supervisor, then to plant manager. Thetop management position is vice president foroperations.

● Human resources managers provide the orga-nization with competent and productive em-ployees. The duties of the human resourcesmanager include human resource planning,recruiting and selecting employees, trainingand development, designing compensation and

benefits systems, and formulating performanceappraisal systems. In small firms one personmay be responsible for all the human resourceactivities, while in large firms separate depart-ments deal with each function.

● Financial managers deal with the financial re-sources of the organizations. They are respon-sible for such activities as accounting, cashmanagement, and investments. They also keepup-to-date records for the use of funds, pre-pare financial reports, and gather informationto assess the financial status of the organiza-tion.

● Marketing managers are responsible for get-ting customers and clients to buy the organi-zation’s products or services. They develop thebusiness marketing strategy, set prices, andwork closely with advertising and publicitypersonnel to see that products are promotedadequately.

Apart from the career opportunities in thespecialized areas of management discussedabove, management careers are also available ingovernment agencies, hospitals, not-for-profitagencies, museums, educational institutions, andeven political organizations. Good managers arealso needed in foreign and multinational compa-nies. All organizations exist for certain purposesand need good managers to guide their opera-tions to achieve the best possible results. Regard-less of the type of organization, managers areobviously one of its most important resources.

There are many specific management posi-tions. Their titles and duties are described below.

Management trainees work under the super-vision of an experienced manager while learning.They receive formal training in a variety of man-agement areas. The management trainee positionis designed to prepare trainees for work as ad-ministrators or managers. Their duties includeproviding customer service, preparing workschedules, and assisting with coordination ofsupport services.

Labor relations managers have an interest inlabor law and are good communicators. They ne-gotiate collective bargaining agreements and de-velop grievance procedures to handle complaints.When problems arise between management and



labor, they interpret and administer the laborcontract and resolve the disputes according to theterms of the contract. They also work closely withthe human resources director on issues such aswages, benefits, pensions, and work practices.

Administrative services managers coordinateand direct supportive services of larger businessesand government agencies. They are responsiblefor services such as clerical support, records man-agement, payroll, conference planning, informa-tion processing, and materials distribution andscheduling. However, recent corporate restruc-turing has resulted in many organizations out-sourcing their administrative services. Thismeans that the demand for administrative ser-vices managers will greatly increase in companiesproviding management consulting, managementservices, and facilities support services.

Food service managers have very similarduties to restaurant managers, catering manag-ers, and fast-food restaurant managers. In fact,the food service manager works in a variety offacilities, including fast-food restaurants, hospi-tals, and school cafeterias. Food service managerscoordinate all aspects of the food and beverageactivities for the organization. They set the stan-dard for quality food service, hire and assignemployees, and plan menus. They also performsome clerical duties, such as payroll and inven-tory.

Building managers, also called real estatemanagers, administer rental properties—such asapartment buildings and office buildings—forthe owners. As the agents of the owners, theymarket vacant space, negotiate leases, set andcollect rents, and arrange for security and main-tenance of the properties. They also handle all thebookkeeping and accounting records and pro-vide periodic reports to the owners.

Fitness center managers are physically fit andinterested in exercise science. Companies, gov-ernment agencies, and cruise ships with fitnessfacilities are looking for managers who can de-velop programs that satisfy customers’ health andfitness needs. The fitness center manger conductsresearch to identify customer needs, developsand manages programs for the center and its

clients, and monitors health and safety require-ments. In small centers, the manager is also re-sponsible for delivering fitness training andmaintaining center equipment.

City managers, also called town managers,are responsible for the day-to-day operations ofvarious departments of city government. A mainresponsibility of city managers is to prepare bud-gets for the city council’s approval. The city man-ager must also provide reports to the councilmembers on ongoing and completed projects.

Health services managers work in clinics, hos-pitals, and health maintenance organizations(HMOs). They make most of the business oroperational decisions in the health care facility.The health services manager establishes billingprocedures, handles budgets, supervises staff, andinteracts with the public. Health services manag-ers start as management trainees or assistant ad-ministrators.

Hotel and motel managers are responsible forthe full range of activities in a lodging establish-ment. These include guest registration andcheckout, housekeeping, accounting, mainte-nance and security, and food service. The man-ager is also responsible for coordinating activi-ties, such as meetings and other special events. Inlarge hotels, assistant managers are responsiblefor the operations of various departments. Hotelmanagers begin as department heads and, aftergaining experience, are promoted to manager.

Retail managers supervise employees anddeal with customer complaints. In addition, theyare responsible for managing the store inventory.They keep up-to-date records of merchandise,make pricing decisions, and decide on advertis-ing and promotions. The retail manager workslong hours and may be employed in a wide vari-ety of stores, including department stores, dis-count stores, or specialty stores. Retail managersoften begin as assistant managers responsible fora department in a large store. They are then pro-moted to merchandising manager or to storemanager.

Sales managers exist in almost every firm andperform one of the most important functions inthe organization. They find customers for the



company’s products and/or services and there-fore provide revenues for the company. They re-cruit, hire, train, and supervise the company’ssales force. Sales managers begin as sales repre-sentatives. Being a successful sales representativeleads to promotion to senior sales representativeor sales supervisor, then to a sales manager.

Procurement managers, sometimes calledpurchasing agents or industrial buyers, buy thesupplies and materials needed by a company.They must be knowledgeable about the variousvendors and their offerings. They must acquirethe best possible deals for their company in termsof price, quality, delivery, and payment sched-ules. Managers in large companies sometimesspecialize in specific types of purchases.

EDUCATIONAL REQUIREMENTS

Educational requirements for a career in man-agement vary. However, most employers requirea college degree in either the liberal arts, socialsciences, or business administration. A master’sdegree in business administration (MBA) is also acommon requirement. For students interested ingetting into management trainee programs inmajor corporations, an MBA gives the best op-portunity for these top programs. AnMBA or themaster’s degree in health services administrationis generally required for a career in health servicemanagement.

Apart from major corporations, many otherorganizations have management trainee pro-grams that college graduates can enter. Such pro-grams are advertised at college fairs or throughcollege job placement services. These programsinclude classroom instruction and might last oneweek or as long as one year. Training for a de-partment store manager, for example, might in-clude working as a salesperson in several depart-ments, in order to learn about the store’sbusiness, before being promoted to assistantmanager.

In small organizations, depending on thetype of industry, experience may be the onlyrequirement needed to obtain a position as man-ager. When an opening in management occurs,the assistant manager is often promoted to the

position, based on past performance. In largeorganizations a more formal process exists. Themanagement position to be filled is advertisedwith very specific requirements concerning edu-cation and experience.

Persons interested in a career in managementshould have good communication skills and beable to work well with a variety of people, rangingfrom other managers, supervisors, and profes-sionals, to clerks and blue-collar workers. Theyshould be analytical, flexible, and decisive. Theyshould also be able to coordinate several activitiessimultaneously and be able to solve problemsquickly. Ability to work under pressure and copewith deadlines is also important.

Recruiters look for self-starters who can usetheir initiative, recognize what needs to be done,like responsibility, and have high ethical stan-dards. Self-starters and team players are the typesof people corporations are looking for.

CAREER OPPORTUNITIES IN MANAGEMENT

According to the U.S. Bureau of Labor Statistics(1996), the number of managerial jobs is expec-ted to increase by 17 percent by 2005. The great-est increase in management positions is projectedto be in health services, management consulting,marketing, advertising, and public relationsfields. Opportunities for management careers infinancial services, restaurant and food service,and real estate industries will also grow at a fasterthan average rate through 2005. Educational in-stitutions, industrial production, and administra-tive services are expected to grow about as fast asthe average for all occupations through 2005.

The outlook for management careers is good,despite the headlines about downsizing and cor-porate restructuring. As the economy continuesto grow, many businesses are expanding, and thiscreates additional opportunities for managementjobs. Also, as the economy becomes more global,an increasing number of American firms are ex-panding overseas, and an equally large number offoreign companies are doing business in theUnited States. This means that despite the layoffsof some middle-level managers, there continuesto be a worldwide need for good managers.



Women and minority managers. The future isbright for women and minorities interested inmanagement. Title VII of the Civil Rights Act1964 bans discrimination in employment on thebasis of race, color, religion, sex, or national ori-gin. Many companies, because of affirmative ac-tion rules, are actively seeking out women andminorities to fill management positions.

As a result, women are well represented atthe lower levels of management; however, thenumber of top executive positions remains low.Only about 10 percent of the top jobs in the 500largest U.S. companies are held by women. How-ever, companies are taking steps to attract andpromote women executives.

Minority groups remain underrepresented atall levels of management. A Rutgers Universitystudy (cited in Certo, 1997) found that in 400Fortune 1000 companies, less than 9 percent of allmanagers were members of a minority group(p. 16). Since more and more new entrants intothe labor market are members of various minor-ity groups, it is becoming essential for business torecruit talented minority managers.

There are numerous opportunities for man-agement careers available in all types of organiza-tions, especially small and medium-sized compa-nies. Every organization is looking for competentmanagers who can increase employee perform-ance and help the company to be successful.Mosley and associates (1996) put it best whenthey said: ‘‘Managers in organizations of all sizes,in all industries, and at all levels have an impacton performance . . . they make the differencebetween success and failure for their companies’’(p. 7).

SOURCES OF ADDITIONAL INFORMATION

American Hotel and Motel Association1201 New York Avenue, NWWashington, DC 20005-3931

American Management Association135 West 50th StreetNew York, NY 10020

Administrative Management Society4622 Silver RoadTrevose, PA 19047

National Management Association2210 Arbor BoulevardDayton, OH 45439

Women in Management30 North Michigan AvenueChicago, IL 60602

BIBLIOGRAPHY

Boone, Louis E., and Kurtz, David L. (1998). ContemporaryBusiness. Forth Worth, TX: Dryden Press, HarcourtBrace and Company.

Certo, Samuel C. (1997). Modern Management. Upper Sad-dle River, NJ: Prentice-Hall.

Griffin, Ricky W. (1999) Management. Boston: HoughtonMifflin.

Miller, Donald S., Catt, Steven E., and Carbon, James R.(1996). Fundamentals of Management. St. Paul, MN:West Publishing Company.

Mosley, Donald C., Pietri, Paul H., and Megginson, Leon C.(1996). Management: Leadership in Action. New York:HarperCollins.

Robbins, Steven P., and Coulter, Mary. (1999).Management. Upper Saddle River, NJ: Prentice-Hall.

U.S. Bureau of Labor Statistics. (1996). Occupational Projec-tions and Training Data. (Bulletin No. 2471). Washing-ton, DC: Author.

THADDEUS MCEWEN


Is a career in marketing for you? To be successfulin a marketing career, an individual must havegood communication, critical thinking, and peo-ple skills. In addition to these skills, a majority ofindividuals employed in marketing-related occu-pations possess excellent time-managementskills, the ability to work with a wide variety ofpeople, and a capacity for self-motivation. Theseindividuals must be able to establish timelines,goals, and objectives—and adhere to them.

According to the U.S. Bureau of Labor Statis-tics, the number of individuals who earn a livingin marketing-related careers—advertising, sales,or public relations—is projected to increase rap-idly between the turn of the century and the year2005 (Levine and Salmon, 1999). Currently,almost a third of all Americans are employed in



marketing-related positions, and marketing prin-ciples are being applied to more and more busi-ness and nonbusiness organizations—servicefirms, nonprofit institutions, political candidates,and so forth (http://www.bls.gov/opub/rtaw/rtawhome.htm). Therefore, a high demand forindividuals with marketing training is emergingas a critical criterion for employment in the earlyyears of the twenty-first century. Two major ex-planations have been offered for the continu-ously increasing demand for marketing skills—(1) deregulation of major industries (banking,telecommunications, and transportation) and (2)increased foreign competition.

Considering the increased role of marketingin the U.S. economy, members of the twenty-first-century work force need to be familiar withthe major marketing-related occupations. Ac-cording to Kotler (1994) and Khlupin andShibiko (1998), the major marketing occupationsare: (1) advertising, (2) brand and product man-agement, (3) industrial marketing, (4) interna-tional marketing, (5) marketing research, (6)new-product planning, (7) physical distribution/distribution management, (8) public relations,(9) retail marketing, and (10) sales and salespromotion marketing. A discussion of each ofthese major marketing occupations follows.

Advertising. Advertising is a vital business ac-tivity that requires planning skills, fact-gatheringability, creativity, artistic talent, and written andverbal communication skills. Individuals who areemployed in advertising typically perform thefollowing tasks: (1) search for factual informa-tion, (2) read avidly, (3) borrow ideas, (4) talk tocustomers, (5) develop print layouts, packagedesigns, storyboards, corporate logotypes, trade-marks, and symbols, (6) specify style and size oftypography, and (7) arrange advertisement de-tails for reproduction. Thus, advertising involvesall components of marketing—product, price,promotion, and place. Because all the above tasksrequire working with people who are clients orpotential clients, an individual must be persona-ble, diplomatic, and sincere. Further, he or sheneeds to be self-motivated and able to present

information about a product to varying audi-ences.

Brand and product management (BPM). Indi-viduals involved in BPM are planners, directors,and controllers of the positioning of consumerpackaged goods for sale in a dramatically andquickly changing marketplace. BPM marketersuse research as well as packaging, manufacturing,and forecasting to position products for sale tothe most appropriate audience. Individuals em-ployed in this aspect of marketing must have theleadership capability to move a product fromobscurity to a national awareness in a relativelyshort period of time. Usually BPM marketers’job-related responsibilities increase with thegrowth and development of a particular product.Thus, successful BPM marketers operate in ahigh-pressure, fast-paced, and constantly chang-ing environment, since a major component ofBPM marketing focuses on the financial positionof the product under development. In addition,BPMmarketers must be results-oriented and cre-ative; possess strong interpersonal, communica-tion, and analytical skills; have entrepreneurialleanings; and exhibit high levels of diplomacy,perseverance, and drive.

Industrial marketing. Industrial marketinginvolves the planning, sale, and service of prod-ucts used for commercial or business purposes.In addition to having excellent oral and writtencommunication skills, industrial marketers mustbe self-reliant individuals with the ability to un-derstand customer requirements as well as theknowledge to propose the purchase of a particu-lar product that will satisfy customers’ needs andwants. In essence, industrial marketers are con-sultants who assist clients in ascertaining the ap-propriate product for their particular needs.Whether employed in sales, service, product de-sign, or marketing research positions, industrialmarketers must develop and maintain ongoingbusiness relationships with suppliers of goodsand services as well as with clients. Therefore, theselling relationship is a process of maintainingand building a continuous business relationship.As in any marketing-related career, industrialmarketers must have excellent people skills as



well as good oral and written communicationskills. In addition, a successful industrial mar-keter should have a broad educational back-ground with an emphasis in technology in orderto be able to link that technology to human needsand wants.

International marketing. With the increasingrole of foreign industry in the United States aswell as increasing U.S. interests abroad, individu-als with relevant foreign language skills, as well asan understanding of selected foreign cultures, areneeded to assist with the day-to-day operationsof business. In order to be able to conduct busi-ness effectively and efficiently and to implementmarketing strategies abroad, international mar-keters need to understand the social, economic,and political climates of foreign countries. Mar-keting personnel interested in this area may berequired to travel and/or relocate to a foreigncountry to oversee company operations and tocreate a presence in that country’s economy. Inaddition to the language requirement, potentialinternational marketers need appropriate com-munication skills as well as diplomatic skills inorder to work with foreign leaders and functionin foreign economic systems.

Marketing research. Marketing researchersare asked to ascertain the reason(s) that a partic-ular product is or is not being purchased byconsumers. Based on the interpretation of datacollected in marketing research, market research-ers make recommendations for enhancing oreliminating existing products as well as develop-ing new products. In addition, promotional ac-tivities are based on data collected by marketingresearchers. Individuals employed in marketingresearch occupations must understand statistics,data/information-processing analysis, psychol-ogy, consumer behavior, and communication.Marketing researchers interact with other mar-keting occupations to define problems within aparticular product line as well as to identify theappropriate processes to be used to analyze andresolve those problems. A critical component ofthis position is the ability to present solutions tobusiness problems in a manner that is easilyunderstood by colleagues and constituents. Spe-

cifically, marketing researchers provide informa-tion concerning consumers, marketing environ-ment, and competition to relevant internal andexternal publics. Therefore, strong analytical,methodological, and communication skills are amust for success in this arena.

New-product planning. New-product plan-ning involves the creation and development ofnew products for an organization. Because indi-viduals who enter this arena typically have beensuccessful in other areas of marketing, they tendto have an excellent knowledge of and back-ground in marketing, to be familiar with theprocesses for conducting marketing research, tobe capable of generating sales forecasts, and tohave a background in technology. A new-prod-uct-planning marketer conceptualizes, re-searches, and evaluates new ideas. During theevaluation process, the new-product-planningmarketer considers both the feasibility of the pro-duction of the product and the product’s poten-tial profitability. These individuals must also pos-sess the ability to motivate, coordinate, and directothers. New-product planning is applicable tothe marketing of consumer products, consumerservices, hospital and medical services, and pub-lic service programs, to name only a few areas.Because new-product development is constantlychanging, a person who enters this field shouldhave a high degree of tolerance for uncertaintyand the unknown, yet nonetheless be able todevelop a definite ‘‘agenda’’ and a ‘‘report card’’to inform superiors about success with newproducts.

Physical distribution/distribution manage-ment. Physical distribution is one of the largestarenas of marketing and has been defined as theanalysis, planning, and control of activities con-cerned with the procurement and distribution ofgoods. Activities involved with the physical dis-tribution process include transporting, ware-housing, forecasting, processing orders, inven-torying, production planning, selecting sites, andservicing customers. Individuals employed in thismarketing area are concerned with the processesor methods needed to deliver the product fromthe manufacturer to the wholesalers to the retail-



ers to, ultimately, the consumer. The physicaldistribution process is an extensive and diversearea that involves the physical transportation ofproducts and the various activities associatedwith purchasing, selling, and channel-manage-ment functions. Individuals who enter physicaldistribution marketing need interpersonal lead-ership ability in order to deal with diverse andchallenging internal and external publics as wellas excellent analytical and communication skills.

Public relations. Public relations marketerseither assist in the management of the images ofproducts or individuals or anticipate and handlepublic problems or complaints. Thus individualsemployed in the public relations aspect of mar-keting create an image or message for or about anindividual or an organization as well as maintain-ing that image with the media. This image ormessage needs to be communicated effectively,efficiently, and persuasively to the intended audi-ence. To be successful in public relations, anindividual needs to be people-oriented and tohave excellent oral and written communicationskills as well as a background in journalism.

Retail marketing. Individuals in retailing oc-cupations deal directly with consumers or cus-tomers. Retail marketing also involves the man-agement of sales personnel, selection andordering of merchandise, and promotion of se-lected merchandise, as well as inventory control,store security, and product accounting. Typicaljobs are as buyers, sales managers, departmentmanagers, and store managers. To be successfulin retail marketing, individuals must be self-mo-tivated and possess excellent people skills. A rap-idly growing component in retail marketing isdirect-response marketing (DRM). DRM at-tempts to deliver the product from the manufac-turer to the consumer by the use of direct mail,print and broadcast media, telephone marketing,catalogues, in-home presentations, door-to-doormarketing, electronic ordering and funds trans-fer, and video text. Attributes needed for successin the area of DRM include creativity, initiative,perseverance, and quantitative competence. Inessence, retail marketers use their professionalknowledge and competence to improve company

profits by informing various publics of appropri-ate assortments of goods and service in locationsthat are easily accessible.

Sales and sales promotion marketing. Salesand sales promotion marketers (SSPMs) need athorough understanding of their company’sproducts. SSPMs must not only sell a product butalso develop and maintain effective relationshipswith customers. The main goal of SSPMs is toinform customers about and provide them withappropriate products in an expeditious manner.Such individuals focus on providing informationto potential clients/customers by interacting withthem directly and personally. Beyond this, theyclose sales and maintain existing accounts to en-sure client/customer satisfaction and loyalty. Tobe successful, an individual must know the prod-uct, the customer(s), and the market(s). Further,a good understanding of people and appropriatepeople skills are a must in order to deal withdiverse and challenging internal and externalpublics. Because the process of selling involvespersuasive two-way communication between aseller and a client, individuals in this area ofmarketing must be people-oriented as well asknowledgeable about the product and the man-ner in which the product can be used to satisfybuyers’ needs and wants.

CONCLUSION

In the twenty-first century, the role of marketingin the U.S. economy will change as consumersreact to ever-changing technology and as busi-nesses respond to an ever-changing marketplace.Because of changing technology and the chang-ing marketplace, the roles and functions of con-ventional marketing as it is known today will beconstantly rethought and redefined. In addition,the four Ps of marketing—product, price, place,and promotion—will also be redefined and re-structured. With the dynamic changes facing themarketing environment, the demand for market-ing-oriented personnel will continue to increase,making marketing-related careers an exciting oc-cupational choice for the twenty-first century.



BIBLIOGRAPHY

http://www.careers-in-marketing.com/ad.htm. (March2000).

http://www.cob.niu.edu/mktg/career.html. (March 2000).

http://www.cob.ohio-state.edu/dept/mkt/career.html.(March 2000).

http://www.hayek.cob.niu.edu/mktg/career.html. (March2000).

Khlupin, M. M., and Shibiko, D. (1998). http://www.cob.ohio-state-eud/�mkt/careers/.

Kotler, P. (1994). Principles of Marketing, 6th ed. UpperSaddle River, NJ: Prentice-Hall.

Levine, C., and Salmon, L. (1999). ‘‘The 1998 SOC: Bridgeto Occupational Classification in the 21st Century.’’Occupational Outlook Quarterly 43:27-33.

http://www.marshall.use.edu./marketing/course–career/career-models.html. (March 2000).

National Retail Federation http://www.nrf.com/services/info/careers. (March 2000).

Report on the American Workforce. http://www.bls.gov/opub/rtaw/rtawhome.htm. (1999).

RANDY L. JOYNER

CAREERS OVERVIEW

The concept of careers ranges from descriptionsof jobs, occupations, or vocations to the patternof work and work-related activities that developthrough a lifetime. Career is defined in theMerriam-Webster Collegiate Dictionary (1999) as‘‘a field for or pursuit of consecutive progressiveachievement especially in public, professional, orbusiness life.’’

The perception of a career has various con-notations. A ‘‘career’’ could be a ‘‘job.’’ A job,again as defined in the Merriam-Webster Colle-giate Dictionary (1999), is ‘‘a regular remunera-tive position; something that has to be done:task.’’ A job might be washing dishes or typingreports. In other works, a job is a task.

An occupation, yet again as defined in theMerriam-Webster Collegiate Dictionary (1999), is‘‘an activity in which one engages; the principalbusiness of one’s life: vocation.’’ An occupationmay mean practicing law, teaching school, and soforth. In other words, an occupation is a voca-tion.

Careers are the patterns of work and work-related activities that develop through a lifetime.Having several careers during a lifetime is notuncommon. One may train to become a businessteacher—a satisfying occupation (vocation) foryears. After that, one may leave teaching andtrain to become a financial planner (a secondvocation).

Also, having more than one job within acareer is common. A business teacher might be-gin teaching middle school general business sub-jects (a first job), then progress to teaching secon-dary-level business subjects (another job). Whileteaching secondary business subjects, the sameperson might supervise the publication of theschool’s yearbook (still within the career field ofeducation).

CHOOSING A CAREER

To be successful in a vocation, it is first necessaryto obtain knowledge about choosing a career andthen to acquire the education needed to grow inthat career and in the job(s) pursued within thatcareer.

The Myers-Briggs Personality Test, availableat employment offices, at school career/collegecenters, or on the Internet, could be a first step inchoosing a career. Based on the work of KarlJung, the test was developed by Katherine Briggsand her daughter Isabel Briggs Myers, to deter-mine whether someone was primarily extro-verted or introverted, sensing or intuitive, think-ing or feeling, judging or perceiving. Combiningthese traits, they formed sixteen distinct person-ality types, known as the Myers-Briggs Personal-ity Types. Understanding your own and otherpeople’s personality types can help in finding the‘‘perfect’’ job and make it easier to manage per-sonal and professional relationships.

Along with the Myers-Briggs PersonalityTest, a person should consider the followingwhen choosing a career:

1. Skills you currently possess and need toacquire

2. Education you have and will need

3. Salary you will accept

CAREERS OVERVIEW


4. Working conditions in which you wouldbe comfortable

5. Working schedule you prefer (day ornight shift, part-time, or full-time work,etc.)

Anyone searching for a position—whetherthis is a first job or the next step up the careerladder—needs to go through the following steps.

Know which jobs are for you. The informa-tion from the Myers-Briggs Personality Test willgive an idea of your abilities and interests. How-ever, this is not the sole source of information fordetermining the ‘‘perfect’’ job(s). School or pub-lic libraries, job counselors, and employmentagencies all have information and testing facilitiesto assist in finding the ‘‘perfect’’ job.

Prepare a flawless resume. Sales representa-tives know that when calling on a potential cus-tomer, displaying their product in the most fa-vorable way enhances the prospect of a sale. Thesame principles apply when searching for a job.You are selling yourself based largely on yourresume—your education, experience, abilities,and talents that apply to their company or orga-nization.

There are two primary resume formats. Oneis the traditional hard-copy format. The second isthe ‘‘scanner ready format’’ meaning that theresume is ready to be posted on the Internet,distributed via e-mail, or submitted to employerswith scannable databases. Because a computersoftware program will probably read your resumeinitially, you must be sure to include a keywordparagraph in the resume. Keywords are criticalwords matching you up with the required jobqualifications. For instance, if you were applyingfor a job as a programmer, the keyword para-graph might look like this:

Keywords: Programmer, Unix, C, C��, Cobol,Java, Systems Engineer, and Solaris

The keywords are critical if an employer hasresume-tracking software. Make sure they fit thepositions for which you are applying. It is alsoimportant that your experience and backgroundmatch the job you want.

Your resume and cover letter are the firstdocuments that the potential employer or re-sume-tracking system sees or scans. Even if thecompany has resume-tracking software, whenyour resume pops up from a search, a humanresources professional will read it. You must cre-ate that all-important excellent first impression.

Search for jobs. Acquire knowledge aboutvarious career choices. The following is a list ofthe most popular careers for the twenty-first cen-tury (Occupational Outlook Handbook, 2000).(The 21st Century, 1999): (1) air transportation-related occupations, (2) engineering and engi-neering technicians, (3) architects and surveyors,(4) computer, mathematical, and operations re-search, (5) scientists and science technicians, (6)legal, (7) social scientists, (8) social and recre-ation workers, (9) teachers and instructors,counselors, and library occupations, (10) healthdiagnosticians, (11) health assessment and treat-ing, (12) health technologists and technicians,(13) communications-related, (14) visual artsand design, (15) performing arts.

Determine what education is needed. Re-search the qualifications necessary. Use the Inter-net to begin gathering facts on a particular career.Firm-specific data can be found in books such asHoover’s Handbook of American Business, Dunn’sRegional Business Directory, and other businessdirectories available on-line or in library refer-ence sections. Judy Kaplan Baron, a nationallycertified career counselor in San Diego, recom-mends reading about your target occupation inresources such as the Occupational OutlookHandbook published by the U.S. Department ofLabor.

Baron believes that it does not occur to mostpeople to use friends, co-workers, and neighborsas referral sources: ‘‘You may have what you needas a referral living right next door.’’

Research the company and/or industry. Thetask of business research has gotten easier, sincethe Internet contains information on almost ev-ery business. Use search engines to gather infor-mation on public and private companies or useinformation gleaned from your local library.

CAREERS OVERVIEW


Prepare for an interview Knowledge is power,especially in an interview. The more you knowabout the company and what is going to occur inan interview, the more likely you are to be anintelligent candidate. If you familiarize yourselfwith the interview procedure, you can talk confi-dently to a potential employer. Rather thanworrying about the upcoming interview, spendyour time rehearsing and preparing for the inter-view.

Be aware of implicit rules during the inter-view. Never ask for a job and respect the inter-view’s time limits. When time is up, offer to endthe meeting. Maintain the conversation only ifurged by the interviewer to do so.

Close the interview by asking the interviewerto suggest other people with whom you mighttalk. Then ask if you may mention the inter-viewer’s name when you contact those recom-mended.

Within twenty-four hours of the interview,send a thank-you note. John Klube, site managerfor the Army Career and Alumni Program at FortCarson, Colorado (1998), also recommends ad-ditional follow-up, stating that never hearingfrom a candidate again makes interviewers feelused. He recommends contacting interviewersagain four or five weeks after the initial interviewto thank them again and to let them know howany referrals worked out.

Figure the Level of Your Salary. Check withemployment agencies, read the want ads in localpapers, and talk with others to find out what yoursalary should be. There are Internet sites, such assalary.com or homefair.com, that will calculateand compare the cost of living in cities world-wide. You choose the origin and destination sites.For example, if you currently live in Denver, Col-orado, and want to move to Boston, Massachu-setts, input that information. The on-line calcu-lator would tell you that if you make $100,000 inDenver, you would need to make $154,621 inBoston.

SEARCH STRATEGIES

TheMyers-Briggs Personality Test, discussed ear-lier, is useful in helping determine your interestsand capabilities. The figures published by Ber-nard Haldane Associates (Vincent, 1998), a na-tionwide career search firm, show that nearly 70percent of all jobs are acquired by those who mixpersonal initiative with a compelling search strat-egy: building professional contacts and makingthemselves known to employers. A job seekerdoes this through brief, data-gathering dialogueswith corporate managers and referrals by thosemanagers to other knowledgeable sources; candi-dates can gather real-world tips for career successand gain valuable professional contacts.

Roles of colleges and universities. Most of thecareers listed earlier require education beyondhigh school. The length and type of educationvaries from technical training to a doctoral de-gree.

Advances in technology have changed thetraditional role of the college and university. TheInternet, computer-assisted training (enhancedby video technology and courseware authoringtools), interactive CD-ROMs, and distance learn-ing can provide education beyond high school.Training for a career involves competencies con-sistent with the demands of business and indus-try. Computer skills, subject-matter skills, andthe soft skills of human relations and workplaceethics are central to the curriculum.

BIBLIOGRAPHY

Graham, Donna M. (1998). ‘‘Your Resume Gets You theInterview; Your Portfolio Gets You the Job.’’ CareerMa ga z i n e . h t t p : / /www . ca r ee rmag . com/db /cmag–articles–resume–graham.

Klube, John. (1998). ‘‘The Interview.’’ http://www.acap.army.mil/acap/conusall.htm.

Merriam-Webster Collegiate Dictionary. (1999). http://www.m-w.com/.

‘‘Myers Briggs Personality Test. Career Finder—Personality.’’ America Online. (1999).

The 21st Century—Meeting the Challenges to Business Ed-ucation—NBEA Yearbook. (1999). http://www.nbea.org.

CAREERS OVERVIEW


Vincent, Lynn. (1998). ‘‘Company Research Pays Off in a‘Special Needs’ Job Search.’’ http://www.intranet.csupomona.edu/�sciman/html/library/internet/eresumes/crm21.com.html.

JUDITH CHIRI

CELLER-KEFAUVERANTI-MERGER ACT OF 1980(SEE: Antitrust Legislation)

CENTRALIZATION ANDDECENTRALIZATION(SEE: Organizational Structure)

CERTIFIED INTERNALAUDITOR

A certified internal auditor (CIA) is an individualwho has met the requirements for certification asestablished by the Institute of Internal Auditors(IIA). Requirements relate to education, experi-ence, and successful completion of an examina-tion. Achieving the credential as a certified inter-nal auditor is tangible evidence of meetingprofessional qualifications established by the IIA.

The IIA, established in 1941 at a meeting inNew York City, now has a worldwide member-ship of more than 70,000 in more than 100counties. The CIA examination was first admin-istered in 1974.

THE EXAMINATION

The CIA examination is offered twice a year, oncein May and once in November. The exam hasfour parts:

Part I: Internal audit process

● Auditing

● Professionalism

● Fraud

Part II: Internal audit skills

● Problem solving and evaluating audit evidence

● Data gathering, documentation, and reporting

● Sampling and mathematics

Part III: Management control andtechnology

● Management control

● Operations management

● Information technology

Part IV: Audit environment

● Financial accounting

● Finance

● Managerial accounting

● Regulatory environment

Each part of the exam consists of 80 multi-ple-choice questions. To complete the examina-tion successfully, a candidate must be familiarwith the Institute of Internal Auditors’ Standardsfor the Professional Practice of Internal Auditingand the institute’s Code of Ethics. It is not neces-sary to be a member of the IIA in order to takethe examination. However, a one-year free mem-bership is offered to any nonmember who passesthe CIA examination.

The Board of Regents, which administers theCIA exam, recognizes the accomplishments ofother professional certifications. Therefore, indi-viduals who already have a certification are eligi-ble to receive credit for part of the exam. Part IVof the exam was designed to offer a ProfessionalRecognition Credit. Candidates who wish to ap-ply for the Professional Recognition Credit needto submit a registration form with a copy of thecertificate or letter from the sponsoring organiza-tion noting that the person has completed theexam requirements. The sponsoring organizationmay be contacted to verify the information sup-plied by the candidate.

For example, in the United States an individ-ual who is a certified public accountant, certifiedmanagement accountant, certified informationsystems auditor, or certified bank auditor is eligi-ble to receive Professional Recognition Credit forPart IV of the CIA examination. In Australia,Canada, and the United Kingdom, the charteredaccountant designation would receive Profes-

CELLER-KEFAUVER ANTI-MERGER ACT OF 1980


sional Recognition Credit by the Board of Re-gents.

The exam is nondisclosed. Individuals takingthe exam sign a statement indicating that theywill not disclose questions and answers subse-quent to taking the exam. The IIA considers dis-closure of the exam questions by a person whotook the examination to be a violation of the codeof ethics.

The passing score for the exam is 75 percent.In 1996 there were 4646 candidates; the averagepass rate by exam part is 45 percent. (Careers inAccounting 1997).

EXPERIENCE REQUIREMENT

In order to become a CIA, there is an experiencerequirement of twenty-four months of internalauditing or its equivalent. Representative equiv-alent experience can include quality assurance,internal control assessment, or external auditing.A master’s degree can be substituted for one yearof experience. The Board of Regents determinesthe acceptability of equivalent work experience.

More information is available from the Insti-tute of Internal Auditors at 249 Maitland Ave.,Altamonte Springs, Florida 32701-4201;(407)830-7600; or http://www.theiia.org.

(SEE ALSO: Institute for Internal Auditors)

BIBLIOGRAPHY

Careers in Accounting. (1997). Gainsville, FL: Gleim Publica-tions.

CHARLES H. CALHOUN

CERTIFIED MANAGEMENTACCOUNTANT (CMA)CERTIFIED IN FINANCIALMANAGEMENT (CFM)

The certified management accountant (CMA)and the certified in financial management (CFM)programs are designed to recognize the uniquequalifications and expertise of those professionalsengaged in management accounting and finan-cial management. These certifications provide

distinction in today’s economic climate and af-ford the opportunity to certify expertise in thebusiness areas that are critical to the decision-making process. The CMA and CFM certifica-tions, introduced by the Institute of ManagementAccountants (IMA) in 1972 and 1996, respec-tively, have global recognition and have receivedthe endorsement of approximately 200 corporateand academic organizations.

The CMA and CFM Programs have four ob-jectives:

● To establish management accounting and fi-nancial management as recognized professionsby identifying the role of the professional, theunderlying body of knowledge, and a courseof study by which such knowledge is acquired

● To encourage higher educational standards inthe management accounting and financialmanagement fields

● To establish an objective measure of an indi-vidual’s knowledge and competence in thefields of management accounting and financialmanagement

● To encourage continued professional develop-ment

The content of the certification examinationsrepresents the knowledge, skills, and abilities re-quired by business professionals in the fields ofmanagement accounting and financial manage-ment. The content is validated periodically by apractice analysis conducted by the IMA. The con-tent, covered in four examination parts for eachprogram, encompasses:

● Economics, finance, and management

● Financial accounting and reporting (CMA) orcorporate financial management (CFM)

● Management reporting, analysis, and behav-ioral issues

● Decision analysis and information systems

The Financial Accounting and ReportingExam is waived, upon request, for individualswho have passed the U.S. CPA Exam; this is notthe case, however, for the Corporate FinancialManagement Exam.

CERTIFIED MANAGEMENT ACCOUNTANT (CMA) CERTIFIED IN FINANCIAL MANAGEMENT (CFM)


Candidates for certification must meet thefollowing criteria to become a CMA or CFM:

● Education: Candidates must hold a baccalau-reate degree, in any area, from an accreditedcollege or university. Students attending ac-credited U.S. universities may take the exami-nations but must satisfy the education require-ment prior to certification. Degrees frominstitutions outside the United States must beevaluated by an independent agency. The edu-cation requirement may also be satisfied byholding a CPA license to practice or othercomparable professional qualification.

● Employment: Candidates must complete twocontinuous years of professional experience inmanagement accounting and/or financial man-agement. Qualifying experience consists ofpositions requiring judgments regularly madeemploying the principles of management ac-counting and financial management. This ex-perience may be completed prior to or withinseven years of passing the examination.

● Character references: The names of two char-acter references must be submitted at the timeof application.

● Ethics: Candidates for certification must agreeto comply with the Standards of Ethical Con-duct for Practitioners of Management Ac-counting and Financial Management.

● Membership: Candidates for certification mustbe a member of the IMA because the certifica-tion programs are a privilege of membership.

The CMA and CFM programs have been de-signed to meet the evolving needs of business andare focused on the dynamic roles that manage-ment accountants and financial managers play inbusiness, public, and government accounting.Certified professionals are more frequently iden-tified for promotion and have greater earningpotential than those professionals who are notcertified. To gather more information or to jointhe CMA/CFM programs, visit the IMAWeb siteat www.imanet.org or call (800)638-4427 for acertification information booklet.

PRISCILLA PAYNE

CERTIFIED PUBLICACCOUNTANT (CPA)

The designation certified public accountant(CPA) is conferred by a state or jurisdiction toindividuals to practice as a licensed certified pub-lic accountant. The licensing of CPAs protects thepublic from incompetent individuals performingsubstandard accounting work. In the UnitedStates, there are fifty-four states or jurisdictionswith laws and regulations on the requirementsand obligations of licensed CPAs. In 1896, NewYork State passed the first accountancy law to testthe qualifications of public accountants. This ledto the issuance of a state license to practice as acertified public accountant and the emergence ofaccounting as a profession with licensing require-ments, professional standards, and a code of pro-fessional ethics. Other states followed this lead,and eventually all of the fifty-four states and ju-risdictions enacted public accounting legislation.The Boards of Accountancy of each jurisdictionare responsible for licensing candidates and forcompliance with the state accountancy laws.

The Boards of Accountancy make licensuredecisions based on three factors: (1) the fulfill-ment of an educational requirement, (2) passinga Uniform CPA Examination and, (3) having anumber of years of work experience. The educa-tional and experience requirements vary amongthe fifty-four jurisdictions. All require at least abachelor’s degree; however, a majority of the ju-risdictions require one hundred and fifty semes-ter hours of coursework before a candidate cantake the CPA exam, which is typically a bache-lor’s degree, plus thirty hours of advanced study.The years of experience required vary among thejurisdictions from no experience to two or threeyears, depending on educational background. Asan example, in Texas candidates planning to takethe examination need to have one hundred andfifty semester hours of coursework and at leastone year of public accountancy experience. InFlorida candidates, since 1983, must complete atleast one hundred and fifty hours of coursework,but need no experience.

All the jurisdictions in the United States re-quire CPA candidates to pass a Uniform CPA

CERTIFIED PUBLIC ACCOUNTANT (CPA)


Examination that is prepared by the AmericanInstitute of Certified Public Accountants(AICPA) and graded by its Advisory GradingService. The objective of the examination is toprovide reasonable assurance to Boards of Ac-countancy that candidates passing the examina-tion possess the level of technical knowledge,skills, and abilities necessary to protect the publicinterest. The current Uniform CPA Examinationis a two-day paper and pencil linear examinationwith questions in a predetermined sequence to beanswered manually on paper answer sheets. Theexamination is offered semi-annually in May andNovember on a Wednesday and Thursday. Thecurrent examination covers four sections: (1)Auditing; (2) Financial Accounting and Report-ing; (3) Accounting and Reporting—Taxation,Managerial, and Governmental and Not-for-Profit Organizations; and (4) Business Law andProfessional Responsibilities. Since May 1996,the examination has been nondisclosed, meaningthat candidates are no longer allowed to retain orreceive their question booklets after the examina-tion or to reveal questions on the examination inany manner. The Board of Examiners of theAICPA maintains overall responsibility of exampreparation and issuance of grades to the stateboards. The examination is continually reviewedto maintain its currency and to reflect currentpractice. Future examinations will be computer-based examinations, which would permit the ex-amination to be given more frequently and to testan expanded range of knowledge and skills thatclosely reflect current practice.

Additional information on the Uniform CPAExamination is available from the AICPA Exami-nations Team, Harborside Financial Center, 201Plaza Three, Jersey City, New Jersey 07311-3881;http://www.aicpa.org. Information on state re-quirements may be obtained by contacting thestate board or the National Association of StateBoards of Accountancy, the organization that co-ordinates the activities of the fifty-four boards ofaccountancy, located at 150 Fourth AvenueNorth, Suite 700, Nashville, Tennessee 37219-2417; http://www.nasba.org.

(SEE ALSO: American Institute of Certified Public Ac-countants; National Association of Boards of Account-ancy; State Societies of Certified Public Accountants;Uniform Certified Public Accounting Examination)

BIBLIOGRAPHY

American Institute of Certified Public Accountants. (1998).Information for Uniform CPA Examination Candidates,15th ed. New York: Author.

Booker, Quinton, Brenner, Vincent C., and Blum, James D.(1998). ‘‘Brave New World for the CPA Exam.’’ Journalof Accountancy January:61-64.

Flesher, Dale L., Miranti, Paul J., and Previts, Gary John.(1996). ‘‘The First Century of the CPA.’’ Journal of Ac-countancy October:51-57.

ANTHONY T. KRZYSTOFIK

CHAIN DISCOUNTS(SEE: Pricing)

CHAIN OF COMMAND(SEE: Organizational Structure)

CHANGE PROCESS

Companies that are able to compete successfullyin today’s rapidly changing business environ-ment—characterized by globalization of theeconomy, exploding information technology,downsizing, restructuring, and new employer-employee relationships—must be ready to makesignificant changes in the way they operate.Changes can be realized in a number of areas;they can, for example, be observed in attitude orbehavior. Many major organizational changes,however, are technological ones. Sometimesthese changes are not intended to change behav-ior, but they almost always do in some respect.Another type of change is replacement of person-nel; when top management is impatient with thepace of productivity, they often replace key indi-viduals. Changes also occur in organizationalstructure, formal roles and jobs, control systems,

CHANGE PROCESS


work processes, and other elements of theorganization’s internal environment.

The motivation for change typically stemsfrom the fact that something isn’t working—forexample, continued negative feedback from cus-tomers, reduced profitability, threats of acquisi-tion, or other market pressures. For most organi-zations, a crisis is the catalyst for change. While acrisis may be sufficient to initiate a change, ittakes much more to successfully integrate thechange into the work processes. Managers musthave more than an extensive knowledge of themarketplace, how to compete in it, and whatinternal structures must be in place to make thecompany successful.

Every change effort should be accompaniedby an action plan. Once a compelling reason tochange has been identified, it is necessary to createa picture of what the change will require, how theorganization will effect it, and what the organiza-tion will look like when the change has beenimplemented. Although each action plan forchange will be unique, all plans should follow abasic structure: (1) identification of a course ofaction and allocation of resources to achieve theorganization’s change goals; (2) designation of theauthority, responsibility, and relationships thatwill drive the change efforts; (3) determination ofwho will lead the change effort and the specificroles and responsibilities of these individuals; (4) adescription of the procedures and processes thatwill expedite implementation of the change; (5)identification of the training that will be requiredto enable people to incorporate the change intotheir work processes; and (6) identification of theequipment, tools, ormachinery that will affect theway work is accomplished.

Many organizational changes are initiatedand implemented through the authority of toplevels of management. The problems are definedand solutions are developed by top-level manag-ers based on information that is gathered byothers with help from a limited number of peo-ple. Once a decision is made, the changes areoften communicated to people in the organiza-tion through memo, speech, policy statement, orverbal command. Since only a few people, usually

at the top, are involved in making the decisions,the change is usually introduced very rapidly.However, this strategy has proved to be largelyineffective in dealing with organizational changeprocesses, particularly for successful integration.A common misconception about carrying out achange is that it must be directed from the top.The foundation of successful change manage-ment lies in involving the people who will beaffected by the change.

Sharing responsibility for change is a processwhereby those at the top and those at lower levelsare jointly involved in identifying problems and/or developing solutions. Virtually continual in-teraction takes place between top and bottomlevels. The shared responsibility or participativeapproach can be addressed in several ways: (1)Top management defines the problem and usesstaff groups or consultants to gather informationand develop solutions. These identified solutionsare then communicated to lower-level groups inorder to obtain reactions. The feedback from thelower levels is then used to modify the solution,and the communication process starts again. Theassumption underlying this approach is that al-though involving others in the definition of theproblem or its solution may be impractical, thesolution can be improved and commitment ob-tained by involving lower levels. (2) Top manage-ment defines the problem but seeks involvementfrom lower levels by appointing task forces todevelop solutions. The task forces provide rec-ommendations to top management, where thefinal decision is made. These task forces are com-posed of people who will be affected by thechange and have some level of expertise in theareas that will be affected by the proposedchange. The assumption here is that those whohave the expertise to solve the problems are thosegroups that are closer to the situation. Also, thegroup’s commitment to the change may be madedeeper by this involvement. (3) Task forces com-posed of people from all levels are formed tocollect information about problems in the orga-nization and to develop solutions. The under-lying assumptions in this approach are that peo-ple at the top, middle, and lower levels are needed

CHANGE PROCESS


to develop quality solutions and that commit-ment must build at about the same rate at alllevels. These approaches emphasizing shared re-sponsibility usually take longer to implement butresult in more commitment from all levels of theorganization and more successful integration ofthe change into the work processes.

Understanding the factors that drive change,and how people react to change, is critical to thesuccessful implementation of change. It is part ofhuman nature to resist change; people prefer thesecurity of familiar surroundings and often don’treact well to changes in their work or socialenvironment. Resistance to change often takessome typical forms. One typical reaction is de-nial, which individuals use to protect themselves.If the change never really occurs, it won’t need tobe dealt with. Another common reaction is pas-sive resistance—individuals agree on the surfacewith the need for change but are quietly unsup-portive of it. Still others may respond with activeresistance by openly disagreeing with the pro-posed change, lobbying against it, and en-couraging others to do the same.

Many managers assume that if people thinkthe change is a good idea, they will not resist it.Why would the work force resist changes if thechanges will fix what they wanted fixed? Peoplemay want change—but not necessarily thechanges that have been identified in the plan.Workers may have their own ideas about whatshould change; and frequently the changes theythink ‘‘fix’’ the problem involve someone else’schanging, not them. In addition workers maythink the ways to make things better is simply toadjust and manipulate their work processes, notto implement the drastic changes identified in theproposed plan. Alternatively, workers may notthink that is wrong with the current way of work-ing. Often the process of changing looks toohard, looks like it will take too much energy, andseems confusing. A strictly structured changeprocess often ignores the ingrained human resis-tance to change. When that happens, people whoare affected by the change end up expendingmost of their time and energy figuring out how tostop the change or altering the change until it

looks like something they can live with. If thedesired change is not very desirable to the workforce, managers need to find out why. Insuffi-cient information about the driving force behindthe change and the benefits expected from it islikely to cause distress among those affected bythe change. People tend to act in their own per-ceived self-interest. Managers often think ofchange initiatives in broader terms; the workforce tends to think of it differently, in morenarrow terms of how the change will affect theirwork. Sometimes managers forget or overlookthis reaction to change. Effective strategies fororganizational change involve an understandingof the human beings in the work force.

Cultivating a sense of involvement and own-ership in all individuals affected by the proposedchange is critical. The more involved people feelin shaping their future, the less likely they are tocriticize the outcome. An essential factor in man-aging effective change is communication—noamount is too much. Managers should identifythe groups/individuals affected by the proposedchange in order to determine the best communi-cation methods to use. Newsletters, focus groups,bulletin boards, intranet pages, and lunchtimeseminars are all effective ways of communicatingto the work force. Managers need to be aware ofhow information flows through the organizationand which communication methods will be mosteffective.

Also crucial to successful integration ofchange in an organization is the level of supportfrom its leaders. Top levels of management mustbelieve that the proposed course of action is theright one for the future of the organization. At allphases of the change process, top-managementrepresentatives must strongly support the changeprocesses and communicate that support to thework force. During the planning phase, top-man-agement representatives should explain the busi-ness reasons for the changes and the costs of notchanging, tell employees what they can expect tohappen and when, and enlist the support of othersenior managers and stakeholders in the process.During the design phase, top-management repre-sentatives should listen and respond to feedback

CHANGE PROCESS


from the organization and provide updates onthe progress of the change. During the imple-mentation phase, top-management representa-tives should continue to listen to resistance andrespond to feedback, stay involved in the process,ensure that adequate resources and training areavailable, measure performance toward expectedresults, and reward role models.

Effective and efficient methods of communi-cation, education/training, and rewards/rein-forcements should be built into the implementa-tion plan. Appropriate training should beincorporated into the change plan to ensure thatthe work force can be productive with the newwork processes and systems. However, commu-nication and training may not be the only re-quired elements to help ensure effective changeimplementation. As the work force envisions thechange, managers may need to ensure that re-wards are in place for changing—in other words,identification of ‘‘what’s in it for me?’’ Recogni-tion is needed to reinforce changes in an organi-zation. Tangible and intangible rewards forchanged behavior, new attitudes, and enhancedskills can be effective both in building supportand advancing the changes.

Companies and people have no choice: Theymust change to survive. They do have a choice,however, in how they change. Understanding theforces that effect change, the process for change,and how to manage that process is critical to anorganization’s survival in today’s turbulentworld.

BIBLIOGRAPHY

BPR OnLine Learning Center http://www.prosci.com. 1999.

Brill, Peter L., andWorth, Richard (1997). The Four Levels ofCorporate Change. New York: AMACOM, AmericanManagement Association.

Harvard Business Review on Change. (1998). Boston: Har-vard Business School Press.

Hesselbein, Frances, Goldsmith, Marshall, and Beckhard,Richard, eds. (1997). The Organization of the Future. SanFrancisco: Jossey-Bass.

Nixon, Bruce. (1998). Making a Difference: Strategies andTools for Transforming Your Organization. New York:AMACOM, American Management Association.

CHERYL L. NOLL


The word channel might bring to mind a water-way such as the English Channel, where shipsmove people and cargo. Or it might bring tomind a passageway such as the Chunnel, therailroad tunnel under the English Channel. Ei-ther image implies the presence of paths or tracksthrough which goods, services, or ideas flow. Thisimagery offers a good starting point for under-standing channels of distribution.

The term marketing channel was first used todescribe trade channels that connected producersof goods with users of goods. Any movement ofproducts or services requires an exchange.Whenever something tangible (such as a com-puter) or intangible (such as data) is transferredbetween individuals or organizations, an ex-change has occurred. Therefore, marketing chan-nels make exchanges possible. How do they facil-itate exchanges? Perhaps the key part of anydistribution channel is the intermediary. Channelintermediaries are individuals or organizationswho create value or utility in exchange relation-ships. Intermediaries generate form, place, time,and/or ownership values between producers andusers of goods or services.

Marketing channels were traditionallyviewed as a bridge between producers and users.However, this traditional view fails to fully ex-plain the intricate network of relationships thatunderlie marketing flows—the exchanges ofgoods, services, and information. To illustrate,consider a prescription drug purchase. To getauthorization to purchase the drug, one mustvisit a physician to obtain a prescription. Then,one might acquire the drug from one of severalretail sources, including grocery store chains(such as Kroger’s), mass discounters (such asWal-Mart), neighborhood pharmacies, and evenvirtual pharmacies (such as Drugstore.com).



Each of these prescription drug outlets is a mar-keting channel. Pharmaceutical manufacturers,distributors, and their suppliers are all equallyimportant links in these channels of distributionfor pharmaceuticals. Sophisticated computer sys-tems track each pill, capsule, and tablet from itspoint-of-production at a pharmaceutical manu-facturer all the way to its point-of-sale in retailoutlets worldwide.

To appreciate the complexity of marketingchannels, exchange should be recognized as a dy-namic process. Exchange relationships them-selves continually evolve as new markets andtechnologies redefine the global marketplace.Consider, for example, that the World WideWeb’s arrival created a new distribution channelnow accounting for over $1.3 trillion in elec-tronic exchanges. It may come as a surprise thatthe fastest-growing segment of electronic com-merce involves not business-to-consumer,(called B2C in today’s Web language) but busi-ness-to-business (B2B) channels.

Whether these exchange processes occur be-tween manufacturers and their suppliers, retail-ers and consumers, or in some other buyer-sellerrelationship, marketing channels offer an impor-tant way to build competitive advantages in to-day’s global marketplace. This is so for two majorreasons:

● Distribution strategy lies at the core of all suc-cessful market entry and expansion strategies.The globalization of manufacturing and mar-keting requires the development of exchangerelationships to govern the movement ofgoods and services. As you sip your preferredcoffee blend at your neighborhood Starbucks,consider that consumers in China, Lebanon,and Singapore may be sipping that sameblend. Then consider how the finest coffeebeans from Costa Rica or Colombia get tothousands of neighborhood coffee shops, air-ports, and grocery stores around the world.

● New technologies are creating real-time (paral-lel) information exchange and reducing cycletimes and inventories. Take as an example DellComputer, which produces on-command, cus-tomized computers to satisfy individual cus-tomer preferences. At the same time, Dell is

able to align its need for material inputs (suchas chips) with customer demand for its com-puters. Dell uses just-in-time production capa-bilities. Internet-based organizations nowcompete vigorously with traditional suppliers,manufacturers, wholesalers, and retailers.Bricks-and-mortars (organizations having aphysical location) and clicks-and-mortars (or-ganizations having a virtual presence) are in avirtual face-off.

DEFINING MARKETING CHANNELS

The Greek philosopher Heraclitus wrote, ‘‘Noth-ing endures but change.’’ Marketing channels areenduring but flexible systems. They have beencompared to ecological systems. Thinking aboutdistribution channels in this manner points outthe unique, ecological-like connections that existamong the participants within any marketingchannel. All marketing channels are connectedsystems of individuals and organizations that aresufficiently agile to adapt to changing market-places.

This concept of a connected system suggeststhat channel exchange relationships are devel-oped to build lasting bridges between buyers andsellers. Each party then can create value for itselfthrough the exchange process it shares with itsfellow channel member. So, a channel of distri-bution involves an arrangement of exchange rela-tionships that create value for buyers and sellersthrough the acquisition (procurement), con-sumption (usage), or elimination (disposal) ofgoods and services.

EVOLUTION OF CHANNELS

Marketing channels always emerge from the de-mands of a marketplace. However, markets andtheir needs are always changing. It’s true, then,that marketing channels operate in a state ofcontinuous evolution and transformation. Chan-nels of distribution must constantly adapt in re-sponse to changes in the global marketplace. Re-member: Nothing endures but change.

At the beginning of the nineteenth century,most goods were still produced on farms. Thepoint-of-production had to be close to the point-of-consumption. But soon afterward, the Indus-



trial Revolution prompted a major shift in theAmerican populace from rural communities toemerging cities. These urban centers producedmarkets that needed larger and more diversebundles of goods and services. At the same time,burgeoning industrialization required a larger as-sortment of production resources, ranging fromraw materials to machinery parts. The transpor-tation, assembly, and reshipment of these goodsemerged as a critical part of production.

During the 1940s, the U.S. gross nationalproduct (GNP) grew at an extraordinary rate.After World War II ended, inventories of goodsbegan to stockpile as market demand leveled off.The costs of dormant inventories—goods notimmediately convertible into cash—rose expo-nentially. Advancements in production and dis-tribution methods now focused on cost-contain-ment, inventory control and asset management.Marketers soon shifted from a production to asales orientation. Attitudes like ‘‘a good productwill sell itself’’ or ‘‘we can sell whatever we make’’receded. Marketers confronted the need to ex-pand sales and advertising expenditures to con-vince individual customers to buy their specificbrands. The classic four Ps classification of mar-keting mix variables—product, price, promotionand place—emerged as a marketing principle.Distribution issues were relegated to the placedomain.

This new selling orientation inspired the de-velopment of new intermediaries as manufactur-ers sought new ways to expand market coverageto an increasingly mobile population. The sellingorientation required that more intimate access beestablished to a now more diversified market-place. In response, wholesale and retail interme-diaries evolved to reach consumers living in ruralareas, newly emerging suburbs and densely pop-ulated urban centers.

Pioneering retailers such as JohnWanamakerin Philadelphia and Marshall Field in Chicagoquickly sprouted as goliaths in this brave newretail world. Small retailers came of age, as well,offering specialized operations tailored to meetthe needs of a changing marketplace. Retailersand their channels evolved in lockstep with the

movements and needs of the consumer market-place. As always, marketing channels were evolv-ing in response to changing marketplace needs.

The impact of two remarkable innovationstaken for granted today—the car and the inter-state highway system—cannot be ignored. Thesetransforming innovations simultaneously stimu-lated and satisfied Americans’ desire for mobility.Manufacturers suddenly began selling their waresin previously inaccessible locations. Millions ofAmericans fled from the cities to the suburbs inthe 1950s and 1960s. Retailers quickly followed.Yet another channel phenonenom emerged, thisone involving groups of stores situated togetherat one site. The suburban shopping center wasborn. Its child, the mall, soon followed.

In 1951, the earth moved. That was the yearmarketers first embraced the marketing concept.The marketing concept decrees that customersshould be the focal point of all decisions aboutmarketing mix variables. It was accepted thatorganizations should only make what they couldmarket instead of trying to market whatever theycould make. This new perspective had a phenom-enal impact on channels of distribution. Suppli-ers, manufacturers, wholesalers, and retailerswere all forced to adopt a business orientationinitiated by the needs and expectations of eachchannel member’s customer.

The marketing concept quickly reinforcedthe importance of obtaining and then applyingcustomer information when planning produc-tion, distribution, and selling strategies. A sensi-tivity to customer needs became firmly embed-ded as a guiding principle by which emergingmarket requirements would be satisfied. Themarketing concept remained the cornerstone ofmarketing channel strategy for some thirty years.It even engendered the popular 1990s businessphilosophy known as total quality management.Small wonder, then, that in today’s Japan theEnglish word customer has become synonymouswith the Japanese phrase honored guest.

The customer focus espoused within themarketing concept has a broad, intuitive appeal.Yet the marketing concept implicitly suggeststhat information should flow unidirectionally



from customers to intermediaries, and from in-termediaries to manufacturers. This unnecessar-ily restrictive and reactive approach to satisfyingcustomers’ needs has been supplanted by therelationship marketing concept. As modern com-munication and information management tech-nologies emerged, channel members found theycould now establish and maintain interactive dia-logues with customers. Ideas and informationnow were exchanged—bidirectionally—in realtime between buyers and sellers. Channel mem-bers learned that success comes from anticipatingone’s customer’s needs before they do. The earthhad moved, again, as the relationship marketingphilosophy was widely adopted.

How important is a customer dialogue? So-phisticated database and interactive technologiesenable channel members to quickly identifychanges in customers’ preferences. This, in turn,allows manufacturers to modify product designsnimbly. Relationship marketing allows manufac-turers to mass-customize offerings and to reducefixed costs associated with production and distri-bution. Retailers and wholesalers make better-informed merchandising decisions. This is yetanother lesson in the costs of carrying unwantedproducts. Relationship marketing yields greatercustomer satisfaction with the products and ser-vices they acquire and consume. And why not?The customer’s voice was heard when the of-fering was being produced and distributed.

Relationship marketing is driven by twoprinciples having particular relevance to market-ing channel strategy:

● Long-term, ongoing relationships betweenchannel members are cost-effective. (Attractingnew customers costs more than ten timesmore than retaining existing customers.)

● The interactive dialogue between providersand users of goods and services is based onmutual trust. (The absence of trust imperils allrelationships. Its presence preserves them.)

THE ROLE OF INTERMEDIARIES

This progression from a production to a relation-ship orientation allowed many new channel in-termediaries to emerge because they created new

customer values. Intermediaries provide manyutilities to customers. The provision of con-tactual efficiency, routinization, assortment orcustomer confidence all create value in channelsof distribution.

One of the most basic values provided byintermediaries is the optimization of the numberof exchange relationships needed to completetransactions. Contactual efficiency describes anaspiration shared among channel members tomove toward the point where the quantity andquality of exchange relationships is optimized.Without channel intermediaries, each buyerwould have to interact directly with each seller.This would be extremely inefficient. Imagine itsimpact on the total costs of each exchange.

When only two parties participate in an ex-change, the relationship is a simple dyad. Ex-change processes become far more complicatedas the number of channel members increases.The number of exchange relationships that canpotentially develop within any channel equals:

3n − 2n+1 + 1

2

where n is the number of organizations in achannel. When n is 2, only one relationship ispossible. When n doubles to 4, up to 25 relation-ships can unfold. Increase n to 6, and the numberof potential relationships leaps to 301. The num-ber of relationships unfolding within a channelquickly becomes too large to efficiently managewhen each channel member deals with all othermembers. Channel intermediaries are thus neces-sary to facilitate contactual efficiency. But as thenumber of intermediaries approaches the num-ber of organizations in the channel, the law ofdiminishing returns kicks in. At that point, addi-tional intermediaries add little new value withinthe channel.

McKesson Drug Company, the nation’s larg-est drug wholesaler, acts as an intermediary be-tween drug manufacturers and retail pharmacies.About 600 million transactions would be neces-sary to satisfy the needs of the nation’s 50,000pharmacies if these pharmacies had to order on a



monthly basis from each of the 1000 U.S. phar-maceutical drug manufacturers. When our ex-ample is extended to the unreasonable possibilityof daily orders from these pharmacies, the num-ber of transactions required rises to more than 13billion. The number of transactions is nearly im-possible to consummate. However, introducing250 wholesale distributors into the pharmaceuti-cal channel reduces the number of annual trans-actions to about 26 million. This is contactualefficiency.

The costs associated with generating pur-chase orders, handling invoices, and maintaininginventory are considerable. Imagine the amountof order processing that would be necessary tocomplete millions upon millions of pharmaceuti-cal transactions. McKesson offers a computer-networked ordering system for pharmacies thatprovides fast, reliable, and cost-effective orderprocessing. The system processes each orderwithin one hour and routes the order to theclosest distribution system. Retailers are relievedof many of the administrative costs associatedwith routine orders. Not coincidentally, the sys-tem makes it more likely that McKesson will gettheir business as a result of the savings.

Routinization refers to the means by whichtransaction processes are standardized to im-prove the flow of goods and services throughmarketing channels. Routinization has severaladvantages for all channel participants. To beginwith, as transaction processes become routine,the expectations of exchange partners becomeinstitutionalized. The need to negotiate on atransaction-by-transaction basis disappears.Routinization permits channel partners to con-centrate more attention on their own core busi-nesses. Routinization clearly allows channel par-ticipants to strengthen their relationships.

Organizations strive to ensure that all marketofferings they produce are eventually convertedinto goods and services consumed by members oftheir target market. The process by which thismarket conversion occurs is called sorting. Inmarketing channels, assortment is often describedas the smoothing function. The smoothing func-tion relates to how raw materials are converted to

increasingly more refined forms until the goodsare acceptable for use by final consumers. Thenext time you purchase a soda, consider the roleintermediaries played in converting the originalsyrup to a conveniently consumed form. Coca-Cola ships syrup and other materials to bottlersthroughout the world. Independent bottlers car-bonate and add purified water to the syrup. Theproduct is then packaged and distributed to re-tailers. And we buy it. That’s assortment. That’swhat channels of distribution do. Two principaltasks are associated with the sorting function:

● Categorizing. At some point in every channel,large amounts of heterogeneous supplies haveto be converted into smaller homogeneouscategories. Returning to pharmaceutical chan-nels, the number of drugs available throughretail outlets is huge. More than 10,000 legaldrugs exist. In performing the categorizationtask, intermediaries first arrange this vastproduct portfolio into manageable therapeuticcategories. The items within these categoriesare then categorized further to satisfy the spe-cific needs of individual consumers.

● Breaking bulk. Producers want to produce inbulk quantities. Thus, it is necessary for inter-mediaries to break homogeneous lots intosmaller units. Over 60 percent of the typicalretail pharmacy’s capital is tied to the pur-chase and resale of inventory. The opportunityto acquire smaller lots means smaller capitaloutflows are necessary at a single time. Conse-quently, pharmaceutical distributors continu-ously break bulk to satisfy retailers’ lot-size re-quirements.

The role intermediaries play in buildingcustomer confidence is their most overlookedfunction. Several types of risks are associated withexchanges in channels of distribution, includingneed uncertainty, market uncertainty, and trans-action uncertainty. Intermediaries create value byreducing these risks.

Need uncertainty refers to the doubts thatsellers have regarding whether they actually un-derstand their customers’ needs. Usually neithersellers nor buyers understand exactly what is re-quired to reach optimal levels of productivity.Since intermediaries act like bridges linking



sellers to buyers, they are much closer to bothproducers and users than producers and users areto each other. Since they understand buyers’ andsellers’ needs, intermediaries are well positionedto reduce the uncertainty of each. They do this byadjusting what is available with what is needed.

Few organizations within any channel of dis-tribution are able to accurately state and ranktheir needs. Instead, most channel members haveneeds they perceive only dimly, while still otherfirms and persons have needs of which they arenot yet aware. In channels where there is a lot ofneed uncertainty, intermediaries generally evolveinto specialists. The number of intermediariesthen increases, while the roles they play becomemore complex and focused. The number of inter-mediaries declines as need uncertainty decreases.

Market uncertainty depends on the numberof sources available for a product or service.Market uncertainty is difficult to manage becauseit often results from uncontrollable environmentfactors. One means by which organizations canreduce their market uncertainty is by broadeningtheir view of what marketing channels can andperhaps should do for them. Channels must bepart of the strategic decision framework.

Transaction uncertainty relates to imperfectchannel flows between buyers and sellers. Whenconsidering product flows, one typically thinks ofthe delivery or distribution function. Intermedi-aries play a key role in ensuring that goods flowsmoothly through the channel. The delivery ofmaterials frequently must be timed to coincideprecisely with the use of those goods in the pro-duction processes of other products or services.Problems arising at any point during these chan-nel flows can lead to higher transaction uncer-tainty. Such difficulties could arise from legal,cultural, or technological sources. When transac-tion uncertainty is high, buyers attempt to securemultiple suppliers, although this option is notalways available.

Uncertainty within marketing channels canoften be minimized only through careful actionstaken over a prolonged period of exchange. Thefrequency, timing, and quantities of deliveriestypify the processes involved in matching chan-

nel functions to the need for efficient resourcemanagement within marketing channels. Chan-nel members are often unaware of their precisedelivery and handling requirement needs. Byminimizing transaction uncertainty, channel in-termediaries help clarify these processes. Natu-rally, as exchange processes become standard-ized, need, market, and transaction uncertainty islessened. As exchange relationships develop, un-certainty decreases because exchange partnersknow one another better.

WHERE MISSIONS MEET THE MARKET

The functions performed by marketing interme-diaries concurrently satisfy the needs of all chan-nel members in several ways. The most basic waythat market needs can be assessed and then satis-fied centers on the role channel intermediariescan perform in helping channel members reachthe goals mapped out in their strategic plans.Because they link manufacturers to their finalcustomers, channel intermediaries are instru-mental in aligning all organizations’ missionswith the market(s) they serve. Channel interme-diaries foster relationship-building activities andare indispensable proponents of the relationshipmarketing concept in the marketing channel.

Channels of distribution are not all there is tomarketing, but without them all the behaviorsand activities known as marketing become im-possible. Channels of distribution represent thefinal frontier within which most sustainable stra-tegic marketing advantages can be achieved.Channels of distribution are the instrumentsthrough which organizational missions meet—come face to face with—the marketplace. Strate-gic success or failure will take place there.

LOU E. PELTONDAVID STRUTTON

CHECKING ACCOUNTS

(SEE: Financial Institutions)

CHECKING ACCOUNTS


CHIEF FINANCIAL OFFICERSACT AND FEDERAL FINANCIALMANAGEMENT ACT

The Chief Financial Officer Act of 1990 (CFOAct) provided for tight financial control overagency operations and the central coordinationof financial management functions to support anefficient administration of the executive branch.It centralizes organization of federal financialmanagement, required long-term strategic plan-ning to sustain modernization, and began thedevelopment of projects to produce audited fi-nancial statements for the federal government. AsTitle IV of the Government Management ReformAct of 1994, the Federal Financial ManagementAct of 1994 extended the scope of the CFO Act byrequiring agency-wide financial statements and aconsolidated government-wide financial state-ment.

RATIONALE FOR CFO ACT

By the late 1980s, it was apparent that the finan-cial systems of the federal government were in adeplorable state. The savings and loan crisis haddeveloped undetected, financial scandals had oc-curred in the Department of Housing and UrbanDevelopment, numerous high-risk programs hadbeen identified, and seriously deficient systems ofinternal control were common.

Financial management systems were obsoleteand inefficient. Management, program funding,and revenue-generating activities were impaired.Hundreds of separate accounting systems mademonitoring, comparison, and auditing difficult.Enormous investments to upgrade financial sys-tems were failing to achieve the benefits of inte-gration because planning and coordination werelacking.

No one federal official or agency had statu-tory responsibility for coordination of federalfinancial management practices. Congress wasconcerned that management functions and inno-vations were being neglected as a result of thepreoccupation of the Office of Management andBudget (OMB) with the budget.

In 1990 the CFO Act was adopted to improvethe general and financial management practicesof the federal government by establishing a struc-ture for the central coordination of financialmanagement. The act provided for the imple-mentation of accounting systems and internalcontrols to produce reliable financial informa-tion and to deter waste, fraud, and abuse. Addi-tionally, the act required extensive changes inreporting to improve the information available toadministrators and to the Congress.

REQUIREMENTS OF THE CFO ACT AND ITS1994 EXPANSION

The CFO Act changed federal financial manage-ment in three ways: It created a new organiza-tional structure for financial management, it en-couraged the development of new andcompatible accounting systems, and it requirednew forms of reporting.

Three basic changes to organizational struc-ture were introduced in the CFO Act to providefor central coordination of financial manage-ment. In addition, a coordinating council wascreated. First, to heighten management prioritiesand centralize primary accountability, the actprovided for the statutory appointment by thepresident of a deputy director for management toreport directly to the director of OMB. This indi-vidual, one of two deputy directors at OMB, isthe chief financial officer of the United Stateswith responsibility for general management andfinancial management policies. His or her re-sponsibilities include guiding improvements ingovernment-wide financial systems, monitoringthe quality of financial management personnel,and working to ensure that the executive branchhas a financial structure capable of producingquality financial information.

The second component of organizational re-form was the creation within OMB of the Officeof Federal Financial Management under the con-trol of the deputy director for management. Acontroller, who functions primarily in the area offinancial management, heads this office andserves as principal adviser to the deputy directorfor management.

CHIEF FINANCIAL OFFICERS ACT AND FEDERAL FINANCIAL MANAGEMENT ACT


The final component of organizational re-form was the designation of CFOs and deputyCFOs for fourteen cabinet departments and eightmajor agencies of the executive branch. Account-ing, budgeting, and financial activities were con-solidated under agency CFOs who report directlyto agency heads. These positions were created tofoster organizational uniformity in managementoperations and to facilitate coordination of fed-eral financial management. Additionally, thechief financial officers council was created tocoordinate improvements in federal financialmanagement among agencies.

Under the CFO Act, the deputy director ofmanagement has overall responsibility for thedevelopment of management systems, includingsystems to measure performance. Each agencyCFO has specific responsibility to develop andmaintain integrated financial management sys-tems. These responsibilities include directing thedesign of agency financial management systemsand enhancement projects as well as overseeingassets management systems that encompass cashmanagement, debt collection, and inventorymanagement and control.

In creating new financial management sys-tems, the primary objective was to develop com-prehensive financial management systems thatwould integrate agency accounting, financial in-formation, and financial management systems.Priorities include the elimination of duplicatesystems and establishment of strong internalcontrols. With respect to accounting systems,conformity with applicable accounting principlesand standards were required. Integrated systemswere needed to support the production of finan-cial statements and to generate quality financialinformation for a variety of decision-makingpurposes.

To encourage the availability of sufficient re-sources to adequately support financial systems,the deputy director of management was requiredto review and monitor agency budgets for finan-cial systems and to assess the adequacy of agencypersonnel. The Office of Federal Financial Man-agement was funded under a separate and dis-tinct line item. And agency CFOs were empow-

ered with budget responsibility for financialmanagement functions.

The Federal Financial Management Act pro-vided for specific improvements in financialmanagement. To reduce the cost of disburse-ments, it required the use of electronic transfersin making wage, salary, and retirement pay-ments. To encourage debt collections, it providedthat agencies could retain a percentage of delin-quent debts collected. To promote internal mar-kets and competition, it established four fran-chise funds on a pilot basis. To reduceduplication, it empowered the OMB director toconsolidate and streamline management report-ing processes.

The CFO Act altered reporting by institutingfive-year strategic planning reports, the produc-tion of financial statements, and issuance of an-nual management reports. The director of OMBwas required to develop and annually to revisegovernment-wide plans with a five-year horizonfor improving the government’s financial man-agement systems. The director’s report is sup-ported by agency reports that identify changesneeded to achieve modern, integrated financialsystems. Deliberate long-range planning is in-tended to curb the proliferation of unique sys-tems and to provide for the common elementsnecessary for central reporting. The five-yearplans to improve financial management includedetails about the type and form of informationthat is to be produced: kinds of projects proposedto integrate systems, equipment, and personnelneeds, and the costs of implementation.

Under the CFO Act, all covered departmentsand agencies are required to prepare annual fi-nancial statements for trust funds, revolvingfunds, and commercial activities. A pilot projectprovided for the preparation of agency-widestatements in six agencies. A gradual pilot ap-proach was adopted with respect to the produc-tion of agency-wide financial statements becausefederal accounting standards were inadequate.The Federal Accounting Standards AdvisoryBoard (FASAB) was established one month be-fore the CFO Act was passed.



The production of agency-wide financialstatements and a consolidated government-widefinancial statement for the executive branch wasintended to strengthen accountability and to pro-vide the information needed for effective man-agement, including performance evaluation. Forexample, financial statements include informa-tion about the ways budgeted funds were spent,the proportion of taxes and other receivablescollected, the condition of physical assets, and theextent of financial obligations associated withvarious commitments.

Under the CFO Act, the director of the OMBis required to submit an annual financial man-agement report to Congress. This report analyzesthe status of financial management in the execu-tive branch; summarizes agency financial state-ments, audits, and audits reports; and reviewsreports on internal accounting and administra-tive controls. Also, government corporations arerequired to file an annual management report inaddition to financial statements, which have toinclude a statement about internal accountingand administrative controls. Management re-ports must include plans for correcting internalcontrol weaknesses.

RESPONSIBILITIES OF AUDITORS

The Federal Financial Management Act requiredthe production and audit of agency-wide finan-cial statements covering all accounts and activi-ties of the twenty-three CFO-covered agenciesand a consolidated government-wide financialstatement for the executive branch as a whole.Additionally, the Act provided that the directorof OMBmay require audited financial statementsof components of agencies such as the Depart-ments of the Army, Air Force, and Navy. Allfinancial statements produced under the CFOand Federal Financial Management Acts must beaudited in accordance with generally acceptedgovernment auditing standards.

The inspector general of an agency deter-mines who performs the audit. In the absence ofan inspector general, the agency head makes thisdetermination. The inspector general, certifiedpublic accountant (CPA) firms, or other quali-

fied parties may perform audits. Additionally, thecomptroller general may conduct the audit at hisor her discretion or at the request of Congress.The Federal Financial Management Act specifiesthat the comptroller general has responsibility forauditing the consolidated government-wide fi-nancial statements of the executive branch.

Special previsions apply to the auditing ofgovernment corporations. The CFO Act replaceda requirement that these corporations be auditedat least once every three years by the comptrollergeneral with a requirement of annual audits. Thecorporation was assigned responsibility for ar-ranging the audit, and the comptroller generalretained authority to review financial statementaudits performed by others. Additional informa-tion about the acts is available at http://www.financenet.gov.

(SEE ALSO: Government Accounting)

BIBLIOGRAPHY

Chief Financial Officers Act of 1990. (1990).U.S. Congressio-nal and Administrative News, 101st Congress 2nd Ses-sion, Vol. 3, Laws (Public Law 101-576). St. Paul, MN:West.

Chief Financial Officers Act of 1990. (1990).U.S. Congressio-nal and Administrative News, 101st Congress 2nd Ses-sion, Vol. 6, Legislative History (Public Law 101-576). St.Paul, MN: West.

Ewer, Sid R. (1997). ‘‘Federal Government Accountability.’’CPA Journal 67(3):22-27.

Government Management Reform Act of 1994. (1994). U.S.Congressional and Administrative News, 103rd Congress2nd Session, Vol. 3, Laws (Public Law 103-356). St. Paul,MN: West.

Government Management Reform Act of 1994. (1994). U.S.Congressional and Administrative News, 103rd Congress2nd Session, Vol. 3, Legislative History (Public Law 103-356). St. Paul, MN: West.

Hodsoll, Frank. (1992). ‘‘Facing the Facts of the CFO Act.’’Public Budgeting & Finance Vol. 12 (4):72-74.

Jones, L. R. (1993). ‘‘Counterpoint Essay: Nice ReasonsWhythe CFO Act May Not Achieve Its Objective.’’ PublicBudgeting & Finance Vol. 13 (1):87-94.

Jones, L. R. (1997). ‘‘Implementing the Chief Financial Offi-cers Act and the Government Performance and ResultsAct in the Federal Government.’’ Public Budgeting & Fi-nance Vol. 17 (1):35-55.



Jones, L. R., and McCaffery, Jerry L. (1992). ‘‘Federal Finan-cial Management Reform and the Chief Financial Offi-cers Act.’’ Public Budgeting & Finance Vol. 12 (4):75-86.

Jones, L. R., and McCaffery, Jerry L. (1993).‘‘Implementation of the Federal Chief Financial OfficersAct.’’ Public Budgeting & Finance Vol. 13 (1):68-76.

Kendig, William L. (1993). ‘‘The Evolution of Private SectorAccounting and its Relationship to The Federal ChiefFinancial Officers Act.’’ Government Accountants JournalVol. 42 (3)9-18.

Steinberg, Harold I. (1996). ‘‘The CFO Act: A Look atFederal Accountability.’’ Journal of Accountancy 181(3):55-57.

JEAN E. HARRIS

CIRCULAR FLOW

Circular flow describes how a market economyworks. A market economy is one in which indi-viduals influence directly what is produced, mar-keted, and consumed. Individuals do this byspending money on what they want. This thendirects producers to produce goods and servicesthat individuals will consume. The amount ofgoods and services that are made available isrelated to the laws of supply and demand.

A model that best depicts how goods andservices flow in exchange for money is called thecircular flow model, shown in Figure 1.

PARTICIPATION

The primary participants in the circular flow ofgoods and services are businesses and house-holds. Households are made up of individualswho both spend money and are the recipients ofmoney. Businesses do the same—they spendmoney and also receive money from households.It is important to note that the flow of goods andservices is in one direction in Figure 1, while theflow of money expenditures is in the oppositedirection. Both flows make a complete circle—hence, it is called the circular flow of goods andservice.

MARKETS

There are two types of markets in the circularflow of goods and services. The resource market is

where businesses purchase what they use to pro-duce goods and services. Resources are in theform of labor, natural resources, capital, and en-trepreneurship, all of which are supplied byhouseholds.

If, for example, a business wants to build asmall plant to produce electronic equipment, itmust have land on which to build the plant. Inthe process of building the plant, it uses humanlaborers who in turn use natural resources toconstruct the building. Capital to complete thebuilding comes ultimately from households, usu-ally by means of some type of financial institutionthat lends money to the entrepreneurs (who alsocome from households) to construct the elec-tronics plant.

Product markets are where goods and servicesare sold. In the case of the plant that produceselectronic equipment, the outlets for its productsmight be retail stores. Members of householdspurchase the equipment for their own use in thehousehold. Pieces of electronic equipment arepurchased by the households that also providedthe resources that made it possible to build theproduct. The outside circle of the process shownin Figure 1 has been completed.

In the reverse direction is the flow of spend-ing. Beginning with households, the individualstherein spend money for the purchase of goodsand services that are provided by businesses. Inour example, the purchase is of a finished piece ofelectronic equipment. The money that is spenton the equipment flows from households to thebusiness, making it possible for the business tosustain operations.

To sustain operations, the business must payworkers and purchase resources. Money contin-ues to flow through the business into the re-source markets. Bear in mind that one of the vitalresources for the operation of a business is hu-man resources, which are supplied by house-holds. Some of the money that passes through thebusiness goes back into the households as pay forthe use of the human resources. Once again, thecircular flow is complete: Money that came fromhouseholds through the purchase of electronic

CIRCULAR FLOW


Circular Flow of Goods and Services in a Market Economy

Resource Markets

Costs

Receipts

Money income from wages, rents,interest, and profits

Consumer Spending for Goods and Services

Businesses Households

Product Markets

Resources

Goods and Services

Labor, natural resources,capital, and entrepreneurship

Goods and Services

Figure 1

equipment passes back to households in the formof wages.

The money flow is more extensive than justwages, as shown in Figure 1. Households do notspend all their wages on goods and services. Someof the money goes into banks, financial invest-ments, real estate, and numerous other places.From those resources, households expect to re-ceive interest or rent as the resource is used.Banks and other financial institutions do notsimply hold the money that is deposited by thehouseholds—instead, they use it to provide capi-tal for building electronic plants and for numer-ous other reasons. The money flows back andforth through the circle.

The two flows of income and expendituresare equal. Expenditures on products are ulti-mately someone’s household income. Incomethat flows into households is expended in someway, either for goods and services or to purchasestock in companies, CDs, land, or another type ofinvestment.

LIMITATIONS

The circular flow model presented here is anaccepted way to show the flow of goods andservices in a market economy. In a mixed econ-omy, the government plays an important role aswell, but this is not shown in the circular flowmodel. Local, state, and federal governments alsoproduce, or cause the production of, goods andservices. Schools, highways, water-treatmentplants, parks, and other facilities are examples ofgovernment spending. Governments take part ofhousehold incomes in the form of taxes, but theyalso inject money back into households in theform of wages. Some of that money goes back tothe government in the form of taxes and stillmore goes into other places.

The government has considerable controlover the economy, which in turn affects produc-tion, employment, and economic growth. If in-terest rates go up, households will purchase fewergoods and services. If interest rates go down,households will spend more. This spending addsto or takes away from businesses’ operations and

CIRCULAR FLOW


the amount of goods and services being pro-duced.

Governments can influence the mix of goodsand services offered to households. Good exam-ples, although they might seem rather extreme,are when the government ordered the breakup ofthe Bell Telephone System and later of MicrosoftCorporation because it was determined that theyviolated antitrust legislation and had becomemonopolies. This kind of breakup affects busi-ness operations and households.

The model that is shown in Figure 1 couldalso be influenced by pricing factors—that is, thelaws of supply and demand. The model does nottake into consideration changes in prices or howprices are determined. Nor does it take into con-sideration how businesses choose the products orservices they produce and market.

Another limitation of the model as presentedhere is that not all the products and servicesoffered by businesses go to the households thatprovide the resources. For example, some of theelectronic equipment produced in the plant de-scribed earlier might be exported to anothercountry. In that case, the goods and services leavethe circular flow and the resources to pay for thegoods and services come from outside the circle.It might be easier to simplify the explanation andinclude all households and all businesses in theworld, but most economists would not agree withthat simplification.

While readers should be aware of the influ-ence that government, exporting and importing,and pricing and production has on businessesand households, it is not necessary to alter thecircular flow model. It remains a viable illustra-tion of what happens in a macroeconomic sensewithout microeconomic influences.

It is also considered by some to be a limita-tion when money leaves the circular flow to beinvested in savings, stocks, bonds, and other fi-nancial investments. However, the discussionhere assumes that the money that is invested doesnot really leave the circle, but rather is passed onas a resource to others. It is true that some moneydoes leave the circle because banks and otherfinancial institutions are required by law to

maintain a certain amount of money on deposit.And because some individuals in householdsdon’t trust banks or other financial institutions,they use the ‘‘coffee can’’ approach to saving theirmoney—they simply keep their savings at home.

SUMMARY

The circular flow of goods and services is a sim-plified illustration of basically two flows: the flowof incomes to households from businesses, andthe flow of resources to businesses from house-holds. This model excludes the more complexinfluences of microeconomic factors. In the mac-roeconomic perspective, resources flow fromhouseholds to businesses, which change the re-sources into goods and services for consumptionin the product markets. Households are re-warded for the resources they provide in the formof money. It is a circular process that flows inboth directions.

BIBLIOGRAPHY

Amacher, Ryan C., and Ulbrich, Holley, H. (1989).Principles of Economics. Cincinnati, OH: South-WesternCollege Publishing.

Gitman, Lawrence J., and McDaniel, Carl. (2000). The Fu-ture of Business. Cincinnati, OH: South-Western CollegePublishing.

McConnell, Campbell R., and Brue, Stanley L. (1999).Economics. New York: Irwin/McGraw-Hill.

ROGER L. LUFT

CIVIL RIGHTS ACT

In 1964, the United States passed one of its stron-gest civil rights laws in history, the Civil RightsAct. The act bans discrimination because of aperson’s color, race, national origin, religion, orsex; it primarily protects the rights of AfricanAmericans and other minorities. Major featuresof the Civil Rights Act include the freedom tovote and use hotels, restaurants, theaters, parks,and all other public places. The law also encour-aged the desegregation of public schools and au-thorized the withdrawal of federal funds fromprograms practicing discrimination. Other major

CIVIL RIGHTS ACT


President Lyndon B. Johnson (center, seated) at the signing of the Civil Rights Act.

features included the prohibition of job discrimi-nation and the creation of the Equal Employ-ment Opportunities Commission.

The Civil Rights Act was an attempt to im-prove the quality of life for African Americansand other minority groups. Historical momen-tum for civil rights legislation grew in the mid-1940s due to the extensive black migration to

northern cities. During this time, Congress be-came active in the pursuit of civil rights, with thejudicial branch of the government at its heels.Shortly afterwards, the Supreme Court joined thecivil rights forces and in doing so added to thehistorical pressure for the Civil Rights Act of1964. One of the most important and influentialSupreme Court decisions involving civil rights

CIVIL RIGHTS ACT


legislation was the 1954 ruling in Brown v. Boardof Education of Topeka, Kansas, which desegre-gated American public schools and paved the wayfor the civil rights movement.

The specific source of the Civil Rights Act of1964 was President John F. Kennedy. He begangaining support for it in a televised nationaladdress by urging Americans to take action toguarantee equal treatment for all. Kennedy thenproposed an act dealing with voting rights, publicaccommodations, desegregation of publicschools, and many more items on the civil rightsagendas. On July 2, 1964, President Johnsonsigned the bill that Kennedy had fought for,which created a major piece of civil rights legisla-tion. Although the Civil Rights Act did not re-solve all problems of discrimination, it did openthe door to further progress by lessening racialrestrictions on the use of public facilities, pro-viding more job opportunities, strengtheningvoting laws, and limiting federal funding of dis-criminatory programs.

BIBLIOGRAPHY

Congress Link Web Site. http://www.congresslink.org.

Western Area Power Administration Web Site. http://www.wapa.gov/CSO/eeo.eeomgr27.htm.

World Book Web Site. http://www.worldbook.com.

NIKOLE M. POGEMAN

CLASSICAL MANAGEMENT(SEE: Management)

CLASSIC BRANDS

Classic brands are a part of modern society thathave become so deeply ingrained into our every-day experiences that they have become unobtru-sive. A classic brand can be defined as one that,through careful and thorough advertising, mar-keting, and product positioning, has become syn-onymous with the product category of which it isa part. Additionally, a classic brand may also beone for which there is no other recognizable

competition within its product class. In thissense, a classic brand is one that has been raisedabove the commodity level, creating its ownproduct classification in the consumer’s mind.This is not to say that it is the only item of itstype, but rather that the other competing prod-ucts hold such a small market share that they areconsidered obscure, making the classic brand a‘‘category killer’’ within its market segment.

EXAMPLES OF CLASSIC BRANDS

Based on the aforementioned definition of whatconstitutes a classic brand, there are many prod-ucts and services that may be considered classic.Coca-Cola, (or Coke, as it is commonly referredto) is the undisputed leader in the soft-drinkindustry, so much so that a consumer in a restau-rant who wants a cola drink is programmed toask for a Coke, whether the establishment servesCoke, Pepsi, or any other brand. In the samesense, an adhesive bandage is better known as aBand-Aid, facial tissue is referred to as Kleenex,and Xerox has become a verb for the act ofphotocopying, as well as a noun used for what thephotocopy machine produces.

Household products such as Arm&HammerBaking Soda, Clorox Bleach, and Barbie dollsprovide strong examples of classic brands thathave no major market competition. Of coursethere are other baking sodas, bleaches, and dollson the market, but even a savvy consumer wouldbe hard-pressed to name them. This is true notonly of tangible products but of services as well.Service providers such as H & R Block and AAA(The American Automobile Association) areclassic brands whose names are synonymous withthe markets that they represent.

VISUAL IMPACT OF CLASSIC BRANDS

Much of the initial recognition of a classic brandstems not from its performance but from its vi-sual impact on the consumer’s memory.Granted, the product must perform superbly tomaintain its status; however, the initial impres-sion is often the result of a memorable logo.Classic brands generally have logos orbrandmarks that have changed little since the

CLASSIC BRANDS


inception of their product. The Coke bottleshape, the Golden Arches of McDonald’s, theyellow and red Arm and Hammer box—these areall brand identifiers that need no written wordsto explain what they represent. Consumers in-stantly recognize these symbols and associatethem with the brands that they depict. In thetwenty-first century, with Internet advertisingbecoming more and more prevalent, such simpleimages as these are a low-cost means of furtherperpetuating the brands’ success.

HISTORY OF A CLASSIC BRAND

Taking a brand from common to classic is nosmall task and does not happen overnight. Itinvolves strong commitment from many levels ofthe organization, along with a well-executed planfor remaining the leading player. A fine exampleof a classic brand through history is Coca-Cola,probably one of the best-known classics in theworld.

Coca-Cola was created by Dr. John SmythPemberton, an Atlanta pharmacist, in 1886 as abeverage served at his soda fountain. He de-scribed it to his patrons as ‘‘delicious and re-freshing,’’ a line still used in Coke’s advertising inthe twenty-first century. In 1892, Dr. Pembertonjoined forces with Asa G. Candler, an Atlantabusinessman who understood the power of ad-vertising, and registered the Coca-Cola trade-mark one year later. In order to create brandrecognition, Candler created a wide range of pro-motional memorabilia for soda fountains—clocks, fans, and other novelties, all depicting theCoca-Cola trademark.

In 1915, Candler introduced the contourbottle, which itself was granted trademark pro-tection in 1977—something not usually done forproduct packaging. The emergence of the con-tour bottle, along with bottling plants, allowedconsumers to enjoy Coca-Cola in their ownhomes. World War II had a major impact in thebuilding of the brand, since sixty-four of thesebottling plants supplied the armed forces withmore than five million bottles of Coke. It was alsoat this time that Coke became associated with theAmerican spirit of a can-do attitude and became

a global depiction of camaraderie and re-freshment.

After the war, Coca-Cola capitalized on thetechnology of radio and television to continue tospread its brand imagery. Its longstanding slo-gans and ad campaigns, such as ‘‘It’s the RealThing,’’ have permeated American life to thepoint that they are no longer just advertising;rather, they have become cultural icons. Coca-Cola’s commitment to quality advertising con-tinues in the modern day through its use of notone but five well-known creative agencies whoseprimary focus is to maintain Coke’s classic status.

This rich history, however, is not perfect. Inthe early 1980s, Coca-Cola tampered with per-fection and launched New Coke, a reformulatedversion of its product with a new taste and newpackaging design. Within weeks, consumers weredissatisfied with the change, and Coke movedswiftly to repair the damage that had been done.It quickly produced ‘‘Classic Coke,’’ which wasthe original formula that consumers had come toknow and love. This proved very costly to Cokenot only from the production and bottling sidebut also from the marketing side, where a correc-tive marketing plan had to be rapidly implemen-ted. Of course, Coca-Cola rebounded with aresounding success, and it continues to be themarket leader.

FORCES BEHIND CLASSIC BRANDS

The success stories of the countless other classicbrands read much the same as Coca-Cola’s.These classic brands all have one common threadthroughout their history—successful utilizationof the four Ps of marketing, which are product,placement, pricing, and promotion. It is the bal-ance of these four significant factors that takes abrand from a name to a classic.

First and foremost is product. Brands mustoutperform their competition in order to becomea classic. The best placement, pricing, and pro-motion will not raise a mediocre product to clas-sic status, regardless of how many marketing dol-lars are pumped into it. Before becoming a classicbrand, the product must taste better, go faster,

CLASSIC BRANDS


work harder, or last longer than other products itcompetes against.

Second, a product must be properly placed inthe market in order to overshadow the competi-tion. Its target market must be carefully decidedon and, in the case of most classic brands, berather broad. Most classic brands appeal to awide demographic range, rather than a small sliceof consumers. People from all walks of life usemost of the brands that have come to be consid-ered classics. Band-Aids, Coke, Levi’s, and Timexcan be found in just about any home in America,regardless of income, geographic region, educa-tion, or age.

Next, pricingmust be addressed. When look-ing at the cost of classic brands in comparison totheir competition, the classic brands generally fallin the median price range of the product cate-gory. While higher in price than the store housebrands and ‘‘generics,’’ they are not usually at thecostly end of the spectrum either. In part, this isbecause in order to be well received by themasses, the product must be neither overpricednor undervalued. There are many quality wrist-watches on the market, but Timex, one of theleast expensive, has made a name for itself as aclassic brand.

Lastly, a product must be adequately andappropriately promoted to become a classicbrand. Timex, for example, has created memora-ble television commercials over the years by us-ing the same premise over and over—‘‘Timextakes a licking and keeps on ticking.’’ The publichas grown accustomed to seeing what the wrist-watch can endure and remain functional. Such apromotional idea stems from a creative depart-ment committed to the success of the brandthrough consistent promotional processes. Pro-motion must also be constant. There must alwaysbe some kind of promotional vehicle in motionto keep the brand name in the forefront of theconsumer’s mind. Point-of-purchase displays,radio, television, print, and Internet advertising,corporate sponsorships, and contests are all used,often simultaneously, to maintain the public’sawareness of the brand.

These four traditional guidelines of productmarketing are crucially important for classicbrands, for the competition is generally aimeddirectly at them. Pepsi, for example, spends mil-lions of dollars a year targeting itself directlyagainst Coke. Coca-Cola cannot afford to rest onits classic brand status—they must be constantlyengaged in maintaining the perfect balance ofproduct, placement, pricing, and promotion, orrisk having its market share overtaken by thehungry competition.

Classic brands are not likely to change overthe next several generations. They will not disap-pear overnight or be swept away by increasingtechnology. Companies fortunate enough to haveclassic brands in their product lineup protecttheir esteemed place vigilantly through carefulmarketing, innovative ideas, and respect for theirplace in history.

BIBLIOGRAPHY

Battle, John D. (1999). ‘‘Brand Names, Durable and Ador-able.’’ Aftermarket Business June: 49.

Carmichael, Matt. (2000). ‘‘Coca-Cola’s No Brainer StillReinforces Brand.’’ Advertising Age. February 14: 56.

‘‘From Soda Fountain to American Icon.’’ (1999) Playthings.February 3.

KAREN J. PUGLISI

CLASSIC COKE

(SEE: Classic Brands)

CLAYTON ANTITRUST ACTOF 1914

(SEE: Antitrust Legislation)

CLIMATE IN ORGANIZATIONS

(SEE: Organizational Behavior and Development)

CLIMATE IN ORGANIZATIONS


CLOSED MANAGEMENTSYSTEMS(SEE: Management)

COGNITIVE DISSONANCE(SEE: Consumer Behavior)


Collective bargaining is ‘‘a process of negotiationbetween management and union representativesfor the purpose of arriving at mutually acceptablewages and working conditions for employees’’(Boone and Kurtz, 1999, pp. 424-425). Variousmethods may be used in the bargaining process,but the desired outcome is always mutual accep-tance by labor and management of a collectivebargaining agreement or contract.

THE BARGAINING PROCESS

The collective bargaining process begins whenthe majority of workers of an organization voteto be represented by a specific union. The Na-tional Labor Relations Board (see Labor Unions)then certifies the union. At this point, the man-agement of the organization must recognize theunion as the collective bargaining agent for all theemployees of that organization. Once this part ofthe process is completed, collective bargainingcan begin.

Bargaining always takes place between laborand management, but negotiations can includemore than one group of workers and more thanone employer. Single-plant, single-employeragreements are the most common. However, ifan employer has more than one plant or worksite, multiplant, single-employer agreements canbe bargained. Several different union groups rep-resenting the workers of the same employer canuse coalition bargaining. Industrywide bar-gaining involves one national union bargainingwith several employers of a specific industry.

Many different negotiation styles can be usedwhen union and labor representatives sit down atthe bargaining table. The two basic modes of

bargaining are traditional bargaining and part-nership bargaining, though there are many varia-tions of each style.

The traditional style of bargaining has beenused since collective bargaining began betweenmanagement and the early labor unions (see Lab-or Unions). It is an adversarial style of nego-tiating, pitting one side against the other withlittle or no understanding of, or education about,the other on the part of either party. Each sideplaces its demands and proposals on the table,and the other side responds to them with coun-terproposals. The process is negative and involvesa struggle of give-and-take on most issues. Evenwith its negative connotations, however, the tra-ditional style of negotiating is still used effectivelyin bargaining many union contracts.

The partnership style of bargaining is themore modern approach to negotiations. It strivesfor mutual understanding and common educa-tion on the part of both labor and management,and it focuses on goals and concerns common toboth parties. Because of its emphasis on eachside’s being aware of the issues concerning theother side, partnership-style bargaining is alsoknown as interest-based bargaining. In this pro-cess, labor and management each list and explaintheir needs, and the ensuing discussion revolvesaround ways to meet those needs that will be notonly acceptable but also beneficial to both par-ties. This style of bargaining is very positive andimparts a much more congenial atmosphere tothe negotiating process. Many modern union-management contracts are bargained very suc-cessfully using the partnership style.

A blending of the traditional and partnershipstyles is widely used in labor-management nego-tiations. The combination approach is used formany reasons, including the fact that manyunion and management leaders are more familiarwith the traditional style. However, with today’smore participatory relationship between laborand management in the workplace, the partner-ship style is becoming more accepted and is beingused more frequently. The negotiating processmay also include both styles of bargaining be-cause of the variety of issues being negotiated.

CLOSED MANAGEMENT SYSTEMS


The partnership style may be used to negotiatecertain issues, while the traditional style may beinvoked when bargaining other terms.

COLLECTIVE BARGAINING ISSUES

Labor unions were formed to help workersachieve common goals in the areas of wages,hours, working conditions, and job security.These issues still are the focus of the collectivebargaining process, though some new conceptshave become the subjects of negotiations. Table 1lists the issues most often negotiated in unioncontracts.

THE SETTLEMENT PROCESS

Union contracts are usually bargained to remainin effect for two to three years but may coverlonger or shorter periods of time. The process ofnegotiating a union contract, however, may takean extended period of time. Once the manage-ment and union members of the negotiatingteam come to agreement on the terms of thecontract, the union members must accept orreject the agreement by a majority vote. If theagreement is accepted, the contract is ratified andbecomes a legally binding agreement remainingin effect for the specified period of time.

If the union membership rejects the terms ofthe agreement, the negotiating teams from laborand management return to the bargaining tableand continue to negotiate. This cycle can be re-peated several times. If no agreement can bereached between the two teams, negotiations aresaid to have ‘‘broken down,’’ and several optionsbecome available.

Mediation is usually the first alternativewhen negotiations are at a stalemate. The twoparties agree voluntarily to have an impartialthird party listen to the proposals of both sides. Itis the mediator’s job to get the two sides to agreeto a settlement. Once the mediator understandswhere each side stands, he or she makes recom-mendations for settling their differences. Themediator merely makes suggestions, gives advice,and tries to get labor and management to com-promise on a solution. Agreement is still volun-tary at this point. The mediator has no power to

force either of the parties to settle the contract,though often labor and management do come toagreement by using mediation.

If mediation fails to bring about a settlement,the next step can be arbitration, which can beeither compulsory or voluntary. Compulsory ar-bitration is not often used in labor-managementnegotiations in the United States. Occasionally,however, the federal government requires unionand management to submit to compulsory arbi-tration. In voluntary arbitration, both sides agreeto use the arbitration process and agree that itwill be binding. As in mediation, an impartialthird party serves in the arbitration process. Thearbitrator acts as a judge, listening to both sidesand then making a decision on the terms of thesettlement, which becomes legally binding onlabor and management. Ninety percent of allunion contracts use arbitration if the union andmanagement can’t come to agreement (Booneand Kurtz, 1999).

SOURCES OF POWER

If the collective bargaining process is not workingas a way to settle the differences between laborand management, both sides have weapons theycan use to bolster their positions. One of themost effective union tactics is the strike or walk-out. While on strike, employees do not report towork and, of course, are not paid. Strikes usuallyshut down operations, thus pressuring manage-ment to give in to the union’s demands. Someemployees, even though allowed to belong tounions, are not allowed to strike. Federal employ-ees fall into this category. The law also prohibitssome state and municipal employees from strik-ing.

During a strike, workers often picket at theentrance to their place of employment. This in-volves marching, carrying signs, and talking tothe media about their demands. The right topicket is protected by the U.S. Constitution aslong as it does not involve violence or intimida-tion. Problems sometimes arise during strikesand picketing when management hires replace-ment workers, called scabs or strikebreakers, who



Collective Bargaining Issues

Wages Hours Working Conditions Job Security

Regular Compensation Regular Work Hours Rest Periods Seniority Overtime Compensation Overtime Work Hours Grievance Procedures Evaluation Incentives Vacations Union Membership Promotion Insurance Holidays Dues Collection Layoffs Pensions Recalls

Table 1

need to cross the picket line in order to do thejobs of the striking workers.

The boycott is another union strategy to putpressure on management to give in to the union’sdemands. During a primary boycott, not onlyunion members but also members of the generalpublic are encouraged to refuse to conduct busi-ness with the firm in dispute with the union.

Though it is rarely done, management mayuse the lockout as a tactic to obtain its bargainingobjectives. In this situation, management closesdown the business, thus keeping union membersfrom working. This puts pressure on the union tosettle the contract so employees can get back totheir jobs and receive their wages.

Management sometimes uses the injunctionas a strategy to put pressure on the union to givein to its demands. An injunction is a court orderprohibiting something from being done, such aspicketing, or requiring something to be done,such as workers being ordered to return to work.

GRIEVANCE PROCEDURES

Once a collective bargaining agreement is settledand a union contract is signed, it is binding onboth the union and management. However, dis-agreements with contract implementation canarise and violations of the contract terms canoccur. In these cases, a grievance, or complaint,can be filed. The differences that must be re-solved are usually handled through a step-by-stepprocess that is outlined in the collective bar-gaining agreement. The grievance procedure be-gins with a complaint to the worker’s immediatesupervisor and, if unresolved at that level, moves

upward, step by step, to higher levels of manage-ment. If no resolution is found at any of theselevels, the two parties can agree to have the griev-ance submitted to an impartial outside arbitratorfor a decision binding to the union and manage-ment.

Collective bargaining is a successful way forworkers to reach their goals concerning accept-able wages, hours, and working conditions. It al-lows workers to bargain as a team to satisfy theirneeds. Collective bargaining also allows manage-ment to negotiate efficiently with workers by bar-gaining with them as a group instead of with eachone individually. Though traditional bargainingcan be negative and adversarial, it does producecollective bargaining agreements between laborand management. Partnership bargaining canlead to increased understanding and trust be-tween labor and management. It is a positive,cooperative approach to collective bargainingthat also culminates in contracts between laborand management.

BIBLIOGRAPHY

Boone, Louis E., and Kurtz, David L. (1999). ContemporaryBusiness. Fort Worth, TX: Dryden Press.

Davey, Harold W. (1972). Contemporary Collective Bar-gaining. Englewood Cliffs, NJ: Prentice-Hall.

Miernyk, William H. (1965). The Economics of Labor andCollective Bargaining. Boston: Heath.

Voos, Paula B., ed. (1994). Contemporary Collective Bar-gaining in the Private Sector. Madison, WI: IndustrialRelations Research Association.




PAULA DEA LEE

COMMAND ECONOMIES(SEE: Economic Systems)

COMMON MARKET(SEE: Trading Blocs)


In the basic communication process, a senderputs a message in words and transmits it to areceiver who interprets the message. The me-dium the sender chooses to transmit the messageis called the communication channel.

Traditionally, it was thought that the wordschosen and way they were interpreted were solelyresponsible for a successful message. However,beginning in the 1960s with Marshall McLuhan,many came to believe that the medium was themessage. Today, with the help of media richnesstheory (Lengel and Daft 1998), most people real-ize that the appropriate choice of communicationchannel (medium) contributes significantly,along with the words, to the success of a message.Appropriate choice helps senders communicateclearly, saving them and their businesses timeand money. Therefore, examining various com-munication channels to understand their appro-priate use is important.

Media richness theory ranks communicationchannels along a continuum of richness, defininghighly rich channels as those handling multipleinherent cues simultaneously, such as using feed-back, nonverbal cues, and several senses. A face-to-face meeting, which employs feedback as wellas audio and visual senses, is considered ex-tremely rich. However, a newsletter or brochureis lean, involving only the visual sense and slowor no feedback. Several of these channels—

brochures, letters, e-mail messages, video e-mailmessages, telephone conversations, videoconfer-encing, and face-to-face meetings—will be re-viewed, along with some guides for appropriateuse.

BROCHURES

Writers usually create brochures to provide in-formation on a product or service. While oftenused for persuasive purposes, they are usuallypresented as routine informational documents.Writers lay out the information carefully, oftendesigning the visual layout as carefully as theycompose the text of the content. This lean chan-nel works effectively when one-way communica-tion in a visual medium is needed. In choosingthis channel, the sender is eliminating any extra-neous information a richer source might includein order to keep the content of the message clearand focused.

LETTERS

Letters are primarily printed, formal businessdocuments. They are best used today when onewants to convey important, nonroutine informa-tion, such as job offers or refusals, promotions,awards and honors, and other kinds of specialannouncements. Also, they are an appropriatechannel for certain attempts at persuasion, suchas soliciting contributions to a special cause, ask-ing someone to speak to a group, or proposingthe acceptance of an idea. Today print letters arestill used as advertising tools; however, the mosteffective ones are those that are individually cus-tomized, making them a special message.

E-MAIL MESSAGES

E-mail messages are widely used in business aswell as in personal life. While e-mail is a fast andefficient channel, it is considered lean because itallows for no eye contact and few nonverbal cues.Therefore, e-mail messages are primarily used inroutine contexts. The notes writers send to familyand friends are usually accounts of day-to-dayactivities, with more important, special messagescommunicated through richer channels. Businessusers, too, choose e-mail for conducting the rou-



Videoconferencing allows people in different locations to interact.

tine affairs of the business, leaving special ornonroutine messages for other channels.

VIDEO E-MAIL MESSAGES

A relatively new variant of e-mail is video e-mail.While much richer than text-based e-mail, videoe-mail is still a one-way communication channel.The lack of interactivity makes it appropriate formessages that need richness but not real-timefeedback. Even with today’s improved compres-sion technologies, video e-mail messages can bevery large files. For example, a thirty-secondvideo message might typically require aroundone megabyte—the upper limit of many e-mailsystems. Personal use of this channel might beappropriate for such situations as showing a newhaircut, introducing new friends, and even show-ing a new baby. On the other hand, business useof video e-mail is still evolving. Obviously, whenone needs to show something—say a new pack-age design—it would be a good choice. A shortsales message might be appropriate in some

contexts. At this time, the best use of this channelappears to be special messages.

TELEPHONE CONVERSATIONS

A somewhat richer channel is the telephone. Ittransmits sound rather than printed words andsound can enrich the message’s words with em-phasis and emotion. It also allows for immediatefeedback, qualifying it as a richer channel onewould use to get important, immediate re-sponses. The choice of this channel to transmit amessage is highly contextual. Some receivers viewthe telephone as invasive, relying on voice-mailsystems to get messages. Others view the tele-phone as an important way of doing business.These receivers often carry cell phones or pagersso they can get important messages whereverthey go. Knowing the importance of your mes-sage as well as the receiver’s preferred way ofdoing business is critical to choosing—or notchoosing—this channel.



VIDEOCONFERENCING

As a communication channel, videoconferencingis extremely rich. Its technology allows people indifferent locations to see and talk with one an-other interactively. Its users choose it for its con-venience as well as its cost-effectiveness. It isavailable in most large companies as well as inbusiness centers for use by smaller companiesand individuals. For example, a company mightwant to have the vice president for sales in on itsplanning meeting for a new product launch with-out asking that person to travel to its site for athirty-minute meeting. Or a company mightwant to screen job candidates and then bring inonly the top candidates for on-site interviews. Asa rule, this channel is best used when the com-munication needs are special, immediate, or oth-erwise expensive.

FACE-TO-FACE MEETINGS

Face-to-face meetings are ranked at the top of therichness scale because they allow complete use ofall senses and continuous feedback. Companiesfind such meetings to be a good choice fornonroutine business, such as planning new prod-ucts, analyzing markets and business strategy,negotiating issues, and solving or resolving prob-lems. Additionally, the face-to-face meetings ofteams often provide a synergistic effect that im-proves the outcome of their actions. The collabo-ration efforts face-to-face meetings evoke are of-ten worth the time and expense of using thischannel.

SUMMARY

While these channels are not the only ones avail-able, they clearly show that the sender of a mes-sage has range of choices from lean to rich. Tohelp ensure successful communication, thesender needs to select the channel appropriate forthe context. Additionally, in choosing an appro-priate channel, one needs to consider not onlyrichness but also other factors such as trainingand accessibility. For example, while a fax is rela-tively easy to send, some people may not haveeasy access to receiving it, while others could

easily have it forwarded to a pager or a wirelessphone wherever they are.

Appropriate choice of communication chan-nel leads to productivity increases and positivesocial effects. Understanding how the appropri-ate choice affects the success of a message helpssenders decide which communication channel touse.

BIBLIOGRAPHY

Donabedian, Baorji, McKinnon, Sharon M., and Burns,William J., Jr. (1998). ‘‘Task Characteristics, ManagerialSocialization, and Media Selection.’’ Management Com-munication Quarterly 11(3):372-400.

Lengel, Robert H., and Daft, Richard L. (1988). ‘‘The Selec-tion of Communication Media as an Executive Skill.’’The Academy of Management EXECUTIVE 2(3):236.

McLuhan, Marshall, and Fiore, Quentin. (1967). The Me-dium is the Message. New York: Random House.

MARIE E. FLATLEY

COMMUNICATIONS INBUSINESS

Communication, stated simply, is conveying amessage, through a channel, from one person toanother; that is, connecting or sharing thoughts,opinions, and intelligence. Communication is amechanism for all types of interaction and con-nectivity. It can instantaneously bring people to-gether. It can link ideas and things. It can delivernews and facts. It can impart knowledge. Becausecommunication can be expressed as words, let-ters, pictures, gestures, signals, colors, and soforth, it is credited with being the single elementthat has brought all corners of the world closertogether. In business, communication is the criti-cal backbone of an organization’s ability to oper-ate internally and externally as well as nationallyand internationally.

COMMUNICATION BASICS

Communication, in its most basic definition, in-volves a sender (encoder) and a receiver (de-coder). The sender encodes a message, decidingwhat content and relationship codes to use, and

COMMUNICATIONS IN BUSINESS


sends it via a communication channel (face toface, e-mail, telephone, etc.). The receiver (de-coder) takes the message and, in the decodingprocess, attempts to understand its content andrelationship meaning. After decoding, the re-ceiver then may respond, via a communicationchannel, to the sender with a new message basedon the receiver’s perception of what the messageimparted in terms of information and the rela-tionship with the sender. To be most effective,the feedback loop (the receiver’s decoded inter-pretation of the original message) should go for-ward; that is, the receiver should respond to thesender. This provides the sender with two vitalpieces of information: (1) whether the originalmessage was correctly understood as sent and (2)the new message. This allows for early correctionof incorrectly decoded messages. The decoding,encoding, and feedback loop continue as theparties communicate.

In the decoding of a message, miscommuni-cation and/or missed communication can occur.In the feedback loop, it is critical both that thesender provide the intended message, and thatthe receiver clarify how that message was per-ceived. The greater the number of people in-volved in the message exchange process and thegreater their differences in values, beliefs, atti-tudes, and knowledge of the subject matter, thegreater are the chances that the message will bedecoded improperly and a communicationbreakdown will occur.

Communication is most successful when it isunderstood by all persons involved in the pro-cess. That is, good communication is free fromsocial colloquialisms, intercultural mores, andgender-based styles. Because communicationmay be conveyed in many forms, it is frequentlydescribed in two general categories: verbal andnonverbal. Nonverbal communication includesbody language, gestures, and signals. In general,successful communication depends on how wella sender conveys a message to a receiver relyingon the six senses (seeing, hearing, speaking, smel-ling, touching, and tasting) and feedback.

COMMUNICATION RULES

There are several rules for successful communi-cation. The following checklist provides a guideto creating successful communication:

● Make messages clear, correct, comprehensive,and concise.

● Include an action step with deadlines in mes-sages that requires a response.

● Select correct channels of communicationbased on message content and relationshipcomponents.

● Structure the message so as not to overloadthe receiver with information.

● Develop sensitivity to the receiver’s communi-cation style and create the message accord-ingly.

● Be aware of how cultural patterns affect com-munication style and take this intoconsideration in sending and receiving mes-sages.

● Be aware that people operating in a secondlanguage may still code/decode messages basedon their first culture’s communication pat-terns.

● Enhance listening skills as an aspect of effec-tive use of the feedback loop.

● Recognize that all messages should be receivedwith a positive attitude.

COMMUNICATION TRANSMISSION MODES

Technology-mediated communication has be-come the norm in today’s worldwide businessenvironment. Messages are communicated regu-larly via e-mail, fax, and phones. People still meetface to face, but they also use express mail andcourier services, messaging and paging systems,caller identification and transfer/forwarding tele-phony (phone, telex, etc.) systems, and manyother combinations of message transfer and de-livery methods. Signaling, biometrics, scanning,imagery, and holography also have a place inbusiness communication. Additionally, manyprofessionals work in virtual groups using satel-lite uplink/downlinks, videoconferencing, andcomputer groupware. In using these technolo-gies, it is important to recognize the limits of the



channel of communication selected. For exam-ple, e-mail is efficient but does not convey thenuances of a message that can be gained fromfacial expressions or gestures. The use of multiplechannels of communication may be critical if thecontent is quite complex; thus, a verbal messagemay not be sufficient. The importance of usingthe feedback loop becomes more critical as thecontent and/or relational aspects of the messagesexpand. Also, as more workgroups operateglobally in a virtual medium, cultural patternsmust be considered in the quest for clear andeffective communication. The expansion ofglobal business combined with advances in tech-nology has created more cross-cultural opportu-nities. When working in a cross-cultural,multinational/multicultural environment, it isnecessary to understand that culture influencespeople’s behavior as well as their attitudes andbeliefs. We encode/decode messages with percep-tions learned from our cultural filters. In inter-cultural situations, the professional is careful touse the feedback loop to clarify understanding ofthe received message. Just because a message hasbeen received rapidly or with use of high-leveltechnology does not mean that the receiver hasdecoded it properly.

TYPES OF COMMUNICATION

Written communication usually takes the formof letters, memos, reports, manuscripts, personalcorrespondence, notes, forms, applications, re-sumes, legal and medical documents, and so on.

Spoken communication includes, amongother things, presentations, verbal exchange (e.g.,one-on-one, to a group), and voice messaging.Speaking distinctly, with appropriate speed, aswell as paying attention to voice inflection, tone,resonation, pitch clarity, and volume are impor-tant to the way a spoken message is received.Frequently, the way a spoken message is deliveredis as or more important than the content of themessage (a good example is a joke that has perfecttiming). More than 90 percent of what a messageconveys may actually be based on a positive atti-tude and nonverbal elements.

Nonverbal communication includes bodylanguage (e.g., facial expression, eye contact,body stance or sitting position, distance betweensender and receiver, gesturing), which can sendsignals to the receiver that are much strongerthan the message itself. If a picture truly speakslouder than a thousand words, communicationby means other than the spoken and writtenword—such as colors worn, signals or manner-isms reflecting personality or preferences, ges-turing—can make a big difference in the messagethat is conveyed.


Communication in a society, whether personal orbusiness, is critical. Individuals or organizationsdepend on it to function. Most businesses needboth internal and external communication to beproductive. Internal communication is commu-nication that is exchanged within an organiza-tion. Usually it is less formal than communica-tion that goes to those outside the business.Informal communication may range from chatsin the hallway and lunchroom, team and groupmeetings, casual conversations over the phone ore-mail, and memos and preliminary reports toteleconferencing, brainstorming idea sessions,department or division meetings, and draft docu-ments. Informal communication also includesthe grapevine, gossip, and the rumor mill; thesecommunication channels rely on people passingon messages to co-workers, friends, and others. Ifaccurate, they can be very effective.

External communication usually refers tomessages that extend beyond the business organi-zation. Because it reflects the organization’s im-age, external communication is usually more for-mal. External communication is an extension ofthe organization and can be an important chan-nel for marketing the company’s image, mission,products, and/or services.

COMMUNICATION PARAMETERS

The selection or type of business communicationtakes many factors into consideration, including(1) the nature of the business (e.g., government,commerce, industry, private or public organiza-



tion, manufacturing or marketing firm); (2) themission and the philosophy of the organization(open verses limited or closed communicationpatterns); (3) the way the business is organized(e.g., small or large company, branch offices, sub-sidiaries); (4) the leadership styles of the organi-zation’s managers and supervisors the (demo-cratic, authoritarian, dictatorial, pragmatic, etc.);(5) the number and types of personnel as well asthe levels of employees (hierarchy or status ofpositions, managerial or laborers, supervisors orteam leaders, etc.); (6) the proximity of workunits (closeness of departments, divisions, orgroups that depend on information from eachother); and (7) the need for communication(who needs to know what, when, why, and howfor informed decision making to take place).

COMMUNICATION SYSTEM

Every group (from an organization, to a family)has a communication system or network. Someare very effective and efficient while others arejust the opposite. Even if communication appearsto be (or is) nonexistent within an organizationor group, the group has a communication sys-tem. That is, poor or nonexistent communica-tion still conveys a message: no communicationis taking place or there is a lack of exchange ofinformation or messages within the group.

COMMUNICATION STYLES

Without realizing it, most people communicatewith others (verbally as well as nonverbally) ac-cording to a dominant style. Essentially, peoplecommunicate in one of four basic styles: (1) di-rectly or authoritatively (an in-charge person orone who is a driving force to get things done); (2)analytically or as a fact finder (a person whoplans, researches, and analyzes the facts andweighs the alternatives carefully); (3) amiably oras a coach (a supportive team builder who getspeople to work together toward a common goal);and (4) expressively or flamboyantly (a cheer-leader with a positive attitude who has lots ofideas and motivates others toward taking action).Communication styles are developed over timeand with practice. They may also reflect cultural

norms. It is important to understand one’s owncommunication style as well as those of others inorder to maximize one’s communication interac-tions.

BARRIERS TO COMMUNICATION

Effective communication relies in part on elimi-nating as many communication barriers as possi-ble. Some of the ways to avoid common barriersto communication include the following:

● Stay focused on the topic.

● If timing is important, adhere to the deadline.

● Be willing to use communication strategy ap-propriate to the situation; listen, negotiate,compromise, modify, and learn from feedback.

● Avoid relying on the grapevine as a source offacts even though it may have been an accu-rate communication channel in the past.

● Be sincere, empathetic, and sensitive to others’feelings; one’s voice, actions, and other non-verbal cues speak loudly.

● Seek out information about unknowns, espe-cially when cultural and gender differences areinvolved.

● Be tactful, polite, clear, prepared, and, aboveall, let a positive attitude guide all communi-cation.

SHARON LUND O’NEILD. GAYE PERRY

COMMUNISM(SEE: Economic Systems)

COMPARISON SHOPPING(SEE: Shopping)

COMPETITION

Competition is the battle between businesses towin consumer acceptance and loyalty. The free-enterprise system ensures that businesses makedecisions about what to produce, how to produce

COMMUNISM


it, and what price to charge for the product orservice. Competition is a basic premise of thefree-enterprise system because it is believed thathaving more than one business competing for thesame consumers will cause the products and/orservices to be provided at a better quality and alower cost than if there were no competitors. Inother words, competition should provide theconsumers with the best value for their hard-earned dollar.

ASPECTS OF COMPETITION

To be successful in today’s very competitive busi-ness world, it is important for businesses to beaware of what their competitors are doing and tofind a way to compete by matching or improvingon the competitors’ product or service. For ex-ample, if Pepsi-Cola offers a new caffeine-freesoda, Coca-Cola may offer a new caffeine-freesoda with only one calorie. By offering an im-provement on the competitor’s product, Coca-Cola is trying to convince soft-drink consumersto buy the new Coke product because it is animprovement on Pepsi’s product.

While being aware of the competition andmaking a countermove is important, it is alsovery important to pay attention to changing con-sumer wants, needs, and values and to make theneeded changes before the competition does. Do-ing research and development and being the firstto provide a new product or service can give acompany a competitive advantage in the market-place. Once consumers purchase a product orservice and are satisfied with it, they will typicallypurchase the same product again. Having acompetitive advantage means that a companydoes something better than the competition.Having a competitive advantage might mean in-venting a new product; providing the best qual-ity, the lowest prices, or the best customer ser-vice; or having cutting-edge technology. Todetermine an area where a company might have acompetitive advantage, a SWOT analysis is oftendone to identify the company’s internal Strengthsand Weaknesses and the external Opportunitiesand Threats. A SWOT analysis lets the companyknow in which area(s) it has a competitive ad-

vantage so it can concentrate on those areas inthe production and marketing of its product(s)or service(s).

In addition to staying on top of changingconsumer preferences, companies must con-stantly be looking for ways to cut costs and in-crease productivity. Companies must provideconsumers with the best-quality product at thelowest cost while still making a profit if they areto be successful competitors in the long run. Oneway to remain competitive is through the use oftechnology. Technology can help speed up pro-duction processes through the use of robots orproduction lines, move information more accu-rately and more quickly through the use of com-puter systems, and assist in research and develop-ment proceedings.

Global competition has made gainingconsumer acceptance an even tougher challengefor most businesses. Firms in other countriesmay be able to produce products and provideservices at a lower cost than American businesses.In order to compete, American businesses mustfind other ways to win consumers. One way forbusinesses to accomplish this is through compet-itive differentiation. Competitive differentiationoccurs when a firm somehow differentiates itsproduct or service from that of competitors.Competitive differentiation may be an actual dif-ference, such as a longer warranty or a lowerprice, but often the difference is only perceived.Difference in perception is usually accomplishedthrough advertising, the purpose of which is toconvince consumers that one company’s productis different from another company’s product.Common ways to differentiate a product or ser-vice include advertising a better-quality product,better service, better taste, or just a better image.Competitive differentiation is used extensively inthe monopolistic form of competition, discussedbelow.

FORMS OF COMPETITION

Although each form has many aspects, not all ofwhich can be considered here, competition cangenerally be classified into four main categories:perfect competition, monopolistic competition,

COMPETITION


oligopoly, and monopoly. (Table 1 summarizesthe basic differences among these four types ofcompetition.)

Perfect Competition Perfect competition (alsoknown as pure competition) exists when a largenumber of sellers produce products or servicesthat seem to be identical. These types of busi-nesses are typically run on a small scale, andparticipants have no control over the selling priceof their product because no one seller is largeenough to dictate the price of the product. In-stead, the price of the product is set by the mar-ket. There are many competitors in a perfectcompetition industry, and it is fairly easy to enteror leave the industry. While there are no idealexamples of perfect competition, agriculturalproducts are considered to be the closest examplein today’s economy. The corn grown by onefarmer is virtually identical to the corn grown byanother farmer, and the current market controlsthe price the farmers receive for their crops. Per-fect competition follows the law of supply anddemand. If the price of a product is high, con-sumers will demand less of the product while thesuppliers will want to supply more. If the price ofa product is low, the consumers will demandmore of the product, but the suppliers will beunwilling to sell much at such a low price. Theequilibrium point is where the supply and thedemand meet and determine the market price.For example, if the going market price for wheatis $5 a bushel and a farmer tries to sell wheat for$6 a bushel, no one will buy because they can getit for $5 a bushel from someone else. On theother hand, if a farmer offers to sell wheat for $4 abushel, the crop will sell, but the farmer has lostmoney because the crop is worth $5 a bushel onthe open market.

Monopolistic Competition Monopolistic com-petition exists when a large number of sellersproduce a product or service that is perceived byconsumers as being different from that of a com-petitor but is actually quite similar. This percep-tion of difference is the result of product differ-entiation, which is the key to success in amonopolistic industry. Products can be differen-

tiated based on price, quality, image, or someother feature, depending on the product. For ex-ample, there are many different brands of bathsoap on the market today. Each brand of soap issimilar because it is designed to get the user clean;however, each soap product tries to differentiateitself from the competition to attract consumers.One soap might claim that it leaves you with softskin, while another soap might claim that it has aclean, fresh scent. Each participant in this marketstructure has some control over pricing, whichmeans it can alter the selling price as long asconsumers are still willing to buy its product atthe new price. If one product costs twice as muchas similar products on the market, chances aremost consumers will avoid buying the more ex-pensive product and buy the competitors’ prod-ucts instead. There can be few or many competi-tors (typically many) in a monopolistic industry,and it is somewhat difficult to enter or leave suchan industry. Monopolistic products are typicallyfound in retailing businesses. Some examples ofmonopolistic products and/or services areshampoo products, extermination services, oilchanges, toothpaste, and fast-food restaurants.

Oligopoly An oligopoly (which is describedmore completely in another article) exists whenthere are few sellers in a certain industry. Thisoccurs because a large investment is required toenter the industry, which makes it difficult toenter or leave. The businesses involved in anoligopoly type of industry are typically very largebecause they have the financial ability to makethe needed investment. The type of products soldin an oligopoly can be similar or different, andeach seller has some control over price. Examplesof oligopolies include the automobile, airplane,and steel industries.

Monopoly A monopoly (which is describedmore completely in another article) exists when asingle seller controls the supply of a good orservice and prevents other businesses from enter-ing the field. Being the only provider of a certaingood or service gives the seller considerable con-trol over price. Monopolies are prohibited by lawin the United States; however, government-regu-

COMPETITION


Perfect Monopolistic Characteristics Competition Competition Oligopoly Monopoly

Number of competitors Many Few to many Very few No direct competition

Ease of entry or exit from Easy Somewhat Difficult Regulated by U.S. industry difficult government

Similarity of goods/services Same Seemingly Similar or No directly offered by competing firms different but different competing may be quite products similar

Individual firm's control over None (set by Some Some Considerable price the market) (in true monopoly) Little (in regulated one)

Examples Farmer Fast-food Automotive Power company restaurant manufacturer

Types of Competition

Table 1

lated monopolies do exist in some business areasbecause of the huge up-front investment thatmust be made in order to provide some types ofservices. Examples of monopolies in the UnitedStates are public utility companies that provideservices and/or products such as gas, water, and/or electricity.

BIBLIOGRAPHY

Boone, Louis E., and Kurtz, David L. (1999). ContemporaryBusiness, 9th ed. Orlando, FL: Harcourt Brace.

Bounds, Gregory M., and Lamb, Charles W., Jr. (1998).Business. Cincinnati, OH: South-Western College Pub-lishing.

Burnett, John, and Moriarty, Sandra. (1998). Introduction toMarketing Communication: An Integrated Approach. Up-per Saddle River, NJ: Prentice-Hall.

Clancy, Kevin J., and Shulman, Robert S. (1994).MarketingMyths That Are Killing Business: The Cure for Death WishMarketing. New York: McGraw-Hill.

French, Wendell L. (1998). Human Resources Management.New York or Boston: Houghton Mifflin.

Goldzimer, Linda Silverman, and Beckmann, Gregory, L(1989). ‘‘I’m First’’: Your Customer’s Message to You. NewYork: Rawson Associates.

Madura, Jeff. (1998). Introduction to Business. Cincinnati,OH: South-Western College Publishing.

Moore, James F. (1996). The Death of Competition: Leader-ship and Strategy in the Age of Business Ecosystems. NewYork: HarperBusiness.

Nickels, William G., McHugh, James M., and McHugh,SusanM. (1999).Understanding Business, 5th ed. Boston:Irwin-McGraw-Hill.

Pfeffer, Jeffery. (1994). Competitive Advantage Through Peo-ple. Boston, MA: Harvard Business School Press.

Pride, William M., Hughes, Robert J., and Kapoor, Jack R.(1999). Business, 6th ed. New York: Houghton Mifflin.

Zikmund, William G., Middlemist, Dennis R., and Mid-dlemist, Melanie R. (1995). Business: The American Chal-lenge for Global Competitiveness. Homewood, IL: Irwin.

MARCY SATTERWHITE

COMPILATION ANDREVIEW SERVICES

Public accountants are qualified to provide arange of services related to financial statements.Among the services are reviews and compila-tions, which are less comprehensive than audits,which are required for publicly owned compa-nies. Statements on Standards for Accountingand Review Services are issued by the Accountingand Review Services Committee, which is the se-

COMPILATION AND REVIEW SERVICES


nior technical committee of the American Insti-tute of Certified Public Accountants (AICPA)designated to issue pronouncements in connec-tion with the unaudited financial statements orother unaudited financial information of anonpublic entity.

NATURE OF ENGAGEMENTS CONTRASTEDWITH AN AUDIT

A review is less than an audit inasmuch as areview does not involve obtaining an under-standing of internal control, assessing controlrisk, testing accounting records, and obtainingcorroborating evidence to support the financialinformation shown in the financial statements.The public accountant provides limited assur-ance with a review. This type of assurance islimited in that the CPA firm states that it is notaware of any modifications that should be madeto the financial statements in order for them to bein accordance with generally accepted accountingprinciples (GAAP). While the CPA firm is notstating that the statements are in accordance withGAAP, it is noting that nothing came to its atten-tion to indicate that the statements are not inaccordance with GAAP. In order to express thistype of limited assurance, the CPA firm shouldperform more work than in a compilation, butless than in an audit.

A review requires that public accountantsmake inquiry and perform analytical procedures,which is a type of analysis that examines therelationships among data. For example, if CPAsnotice that a company’s reported sales are muchlarger than in the prior year, they should askmanagement why this is the case. However, theextent of investigation of this change would bemuch less than if the CPAs were performing anaudit. When CPAs issue a review report, thereport states explicitly that the procedures per-formed were much less stringent than whatwould be required to express an opinion on anaudit and that they do not express such an opin-ion.

A compilation offers no assurance that thefinancial statements are in accordance withGAAP. The word ‘‘compilation’’ is a good de-

scription of the type of service performed—theCPAs actually ‘‘compile,’’ or put together, theinformation supplied by the company’s manage-ment. While CPAs should be familiar with thepractices specific to the client’s industry, they donot have to perform the verification types ofprocedures associated with an audit. All the CPAsmust do is to make sure the financial statementsare free from obvious errors (e.g., the balancesheet should balance!) and make sure necessaryfootnote disclosures are included. In their compi-lation reports, CPAs state explicitly that they havenot performed a review or an audit and that theydo not express an opinion or offer any type ofassurance on the financial statements.

Accountants performing a compilationshould possess a level of knowledge of the ac-counting principles and practices of the industryin which the entity operates so that the financialstatements compiled will be appropriate in formfor a company operating in that industry. Thisdoes not mean accountants cannot accept anengagement to prepare a compilation for a com-pany in an industry with which they are unfamil-iar. However, accountants in this situation havethe responsibility to obtain the required level ofknowledge. There are many resources—including AICPA guides, industry publications,financial statements of other companies in theindustry, periodicals, and Web sites—that pro-vide the required background information.

To compile financial statements, accountantsshould have a general understanding of the na-ture of the company’s business transactions, thenature and extent of accounting records main-tained, the qualifications of the accounting per-sonnel responsible for the accounting process,and the accounting basis on which the financialstatements are to be presented, as well as the formand content of the financial statements. Account-ants are not required to make inquiries or per-form other procedures to verify, corroborate, orreview information supplied by the entity. How-ever, inquiries are likely to be needed in order tobecome acquainted with the entity’s accountingsystem.



REQUIREMENT FOR INDEPENDENCE

Another important difference among these ser-vices provided by the CPA is the level of indepen-dence required of the CPA who performs theservice. Independence is a state of separationbetween the CPA and the client. There are twotypes of independence mentioned in the stan-dards—independence in fact, which is an im-partial state of mind, and independence in appear-ance, which relates more to how others wouldperceive the relationship. For example, if theCPA were related to the client or served on thefirm’s board of directors, readers of the reportmight perceive it as biased. In order to provideany type of assurance, CPAs must be indepen-dent in fact and appearance. Therefore, both au-dits and reviews require independent CPAs.However, CPAs do not have to be independent toperform a compilation; but if they are not inde-pendent, they must disclose this to readers oftheir compilation report.

APPROPRIATE USE OF COMPILATIONSAND REVIEWS

So, what type of a client hires a CPA to perform acompilation or a review instead of a full-blownaudit? To understand this issue, it is first neces-sary to understand why some companies needaudits. If the management of the company isseparate from the suppliers of funding (i.e.,stockholders or banks), there is a ‘‘monitoring’’problem. Basically, banks or stockholders cannotbe sure the information provided is reliable, sothey charge the company a higher interest rate(or offer them a lower return on their invest-ment) because of the increased risk they face dueto this uncertainty. The management of the com-pany, therefore, hires an auditor to attest to thefact that the information is reliable in order tolower the company’s ‘‘cost of capital.’’

Now, picture the case of a small sole practi-tioner who is both the owner and manager of hercompany. It might be the case that she wantsfinancial statements prepared so that she canassess her own performance, but does not requirea great deal of assurance regarding the reliability

of the numbers because she is the one who pro-vided them to the CPA. In essence, the personproviding the information is also the user of thereport, so it would not be necessary to have anindependent auditor provide assurance on thereliability of the financial statements. In this case,the owner/manager would probably hire the CPAto perform a compilation because it would costless money and would be sufficient for her pur-poses.

Many banks want some form of assurancefrom small-business owners before lending themmoney but realize that an audit might be tooexpensive. They therefore require an indepen-dent CPA to provide a review report to give themlimited assurance that the financial statementsare fairly presented. This type of review is mostoften performed for nonpublic companies whosesecurities are not traded on an exchange.

Reviews are also performed for public com-panies. These companies are audited annually,but the Securities and Exchange Commission(SEC) also requires them to file quarterly finan-cial statements, which are unaudited. Publiccompanies often hire CPAs to perform a reviewof these interim financial statements. While a re-view is not required for quarterly reports, the BigFive international CPA firms in 1999 announcedthat they would not audit any public companythat would not allow them to review their quar-terly financial statements. They feel that this willprovide them with ongoing access to firms’ infor-mation and thus prevent any big audit surprisesat the end of the year. While this Big 5 agreementis not an official accounting standard, it is animportant development. Smaller accountingfirms have not disclosed whether they will alsofollow this practice of requiring reviews of quar-terly data, but it seems likely that a lot morereview reports will be issued in the near future.

SUMMARY

Audits require an independent CPA to perform asubstantial amount of work in order to providepositive assurance that the client’s financial state-ments are fairly presented in accordance withGAAP. A review requires an independent CPA to



perform more limited procedures to see if thefinancial statements seem reasonable enough toallow the CPA to provide negative assurance thatno problems were noted. To perform a compila-tion, the CPA does not have to be independentand does not provide any assurance as to whetheror not the financial statements are presented inaccordance with GAAP.

(SEE ALSO: Accounting)

BIBLIOGRAPHY

AICPA Professional Standards. New York: Author.

VICKY B. HOFFMAN

COMPLIANCE AUDITS(SEE: Auditing)

COMPUTER GRAPHICS

The basic building block of images on a com-puter screen is a dot of light called a pixel—theword created by combining the words ‘‘picture’’and ‘‘element.’’

The computer, because it can present thou-sands of pixels on a computer screen in millionsof different colors, can create shapes that thehuman eye recognizes as an image—a computergraphic.

It is hard now to imagine a world withoutcomputer graphics. Today’s children have grownup with video games, and graphic designers workalmost exclusively with computer programs tocreate images once laboriously drawn with pen,compass, ruler, and T-square on paper. Pilotslearn the latest techniques of flying in flight simu-lators; engineers and architects design everythingfrom aircraft to skyscrapers, making three-di-mensional models with their computers; TVweather maps display precipitation as it occurs;and doctors can look inside a patient’s bodywithout breaking the skin.

It was in the early 1960s that computer pio-neers at leading universities began developing

computers and the graphics programs that haverevolutionized the way we create visual images.The invention of the video display terminal, orcomputer monitor or screen, and its widespreaduse beginning in the 1970s, led to the revolutionin the way computers were put to use. Thisrevolution was accelerated by the introduction ofthe photocopier and the electronic spreadsheet tothe computer field.

The photocopier was invented by ChesterCarlson in 1940 and first produced commerciallyby Xerox Corporation in 1959. The photo-copier’s cousin, the desktop laser printer, alongwith software for desktop publishing (a termcoined in the early 1980s), made it possible foramateurs to create polished newsletters, flyers,party invitations, and other documents for mod-est-sized audiences. Now, with the use of scan-ners, individuals can produce documents con-taining color photos, original drawings, or anygraphic image from a publication or the Internetwith permission from the owners of those im-ages.

Electronic spreadsheets, which appeared in1978, incorporated mathematical formulas be-hind each element in a table of data. These for-mulas could refer to other elements of the table.Any change in one value would immediately af-fect the other cells, so business projections suchas sales, growth, or changes in interest rates couldbe manipulated to explore ‘‘what if’’ scenarios;the impact of every change would be instantlyapparent. Such tables can then be imported viacomputers into a text document to clarify andenhance the information in the document.

Computer memory and speed seem to ex-pand by the day, along with the sophistication ofgraphics programs, allowing individuals in theirown homes and offices to produce graphic mate-rials that match or exceed the capabilities of eventhe most advanced printing firms only a few yearsago.

To create a graphic image, a computer pro-gram will supply a series of instructions. Thoseinstructions will tell a computer how to connecttwo points to form a straight line, draw a circle,or form a letter in printed text. To accomplish

COMPLIANCE AUDITS


Computer airplane simulators used to help train pilots feature extensive graphics.

this, computer scientists have devised methods tobreak down complex drawing tasks to simplecomponents. The computer program then re-peats those drawing tasks over and over to form acomplete image.

Drawing an image of a brick wall by hand, forexample, would require an artist or draftspersonto draw hundreds or thousands of rectangles in-dividually. The computer, on the other hand,would draw one brick, then using the samemath-ematical formula it used to create the first brick,would duplicate it thousands of times almostinstantaneously.

Computers are excellent number crunchers.The thousands of calculations—even simple ad-dition or subtraction calculations—needed tocreate a computer image would be an immenselytime-consuming process without computers. Butwith these calculations written into a computergraphics program, the computer will quickly andprecisely light up the pixels needed to create thedesired graphic image on the video monitor.

Pixels are arranged in rows and columns on ascreen. The number of pixels in rows times thenumber of pixels in columns determines theirdensity, or resolution. Resolution is one compo-nent of the computer’s ability to form a distin-guishable image. A typical computer screen con-tains 640 pixels in a line and 480 pixels vertically.Multiplied, the number of pixels on a typicalscreen equals 307,200.

To draw the simplest graphics—those inblack and white—the computer program willassign the number 1 to those pixels that are to belighted and 0 to those that will remain unlit. Thecontrast created between lighted and unlighteddots forms the graphic image. Numbers writteninto computer programs likewise determine thecolor of each pixel in a color system.

Although the ability of computer hardwareand software to produce a dense or high-resolu-tion image is important to creating a quality im-age, their ability to duplicate colors is even moreimportant.

COMPUTER GRAPHICS


Primary colors—reds, greens, and blues—can be combined to produce full or true color.Their lightness or darkness—or values—as wellas their color create shapes, just as they would ina painting or drawing.

The number of pieces of information (bits)set aside for each pixel in a region of computermemory known as the video buffer determineshow many colors the screen can display at once.A true color system is capable of displaying morethan 16.7 million colors. However, because of thelimits of computer memory, ordinary computersemploy a 256-color system.

A program will command the use of one ofthe 256 colors from a color palette, which in turnwill transfer that color to a pixel. Determining thenumbers to achieve the desired color and value isthe core of the science of computer graphics.

By limiting the possible colors to 256, eachpixel cannot be illuminated with the perfectcolor. However, the computer, through a processcalled dithering, can fool the eye by blendingcolors among adjacent pixels. If a particular redcolor is not available from the color palette, thecomputer will spread its available red valuesaround adjacent pixels—giving more red valuesand fewer green and blue values to some whilegiving fewer red values and more green and bluevalues to others to achieve the desired overallcolor. The process of dithering starts at the im-age’s upper-left corner. In turn the computer willdither each pixel’s red, blue, and green colorvalues to make the image appear to the eye ascolor-accurate, ending at the lower-right cornerof the image.

In addition to dithering, a computer can re-produce a true color image, such as a photographcontaining thousands of colors, with accuracy byoptimizing the use of the 256 colors availablethrough the computer’s palette.

One such technique counts the number ofcolors in an image and gives priority to the onesused the most. But this leaves some colors un-represented and thus unavailable where needed.To solve this problem, a computer program willcarve up an image containing several thousandcolors into 256 equal ‘‘blocks’’ grouped accord-

ing to their intensity of color. It discards theblocks with no or few dots. The remaining pixelsare then divided up into 256 blocks with an equalnumber of pixels.

With color space divided up this way, theaverage of all the pixel values in each block repre-sents an optimal choice for a palette color.

When a computer graphics program draws aline or circle, it chooses which of the pixels toilluminate on a line from point A to point B, forexample, by a simple method of addition andsubtraction. First the computer illuminates thepixel at point A. Then the computer movestoward B one pixel closer. Should it illuminatethe pixel on the same row or one on the rowabove or below? A simple calculation shows thecomputer which of the two pixels lies closer tothe ideal line, and it illuminates that pixel.

In milliseconds, the program continues tomove along the line, calculating which pixel toilluminate until it reaches point B, creating a linethat is not strictly straight, but straight enough toappear so to the eye.

Just as with lines, the program will create anyshape—triangle, square, or polygon—using amathematical formula pertaining to that shape.Circles are created in much the same way. Theprogram will choose which pixel to illuminate bymeasuring its distance from the center of thecircle and calculating whether the one at thatpoint along the circumference will help create thecircle’s ideal shape. Again, the circle is not per-fectly circular, but the eye is somewhat deceivedbecause each pixel that is illuminated differs onlyslightly from its neighbor.

Because computer graphic images can re-quire large amounts of computer memory to bereproducible, techniques have been developed toreduce, or compress, the number of bits of mem-ory needed to store the image.

One such image compression technique isnamed run-length encoding (RLE). It usesmarkers that stand for runs of repeating numbersin a graphics file, reducing to two—one specify-ing the number and another the number of thatnumber in a run—in a file. For example, a filethat contains 50 identically colored red pixels

COMPUTER GRAPHICS


with a value of 200 can be substituted with thenumbers 50 and 200. With this process, the com-puter knows the image requires 50 characterswith a 200 red value, but it stores only those twocommands, a one-twenty-fifth reduction.

Another compression method, JPEG, takesits name from, the Joint Photographic ExpertsGroup, the organization that invented it. It usesmathematical formulas to segregate informationabout an image by its importance, and then dis-cards the less important information. The imagethat results after such compression will not ex-actly match the original, since some informationhas been lost in the process.

Another important file format is the Tagged-Image File Format (TIFF) which can be read ineither IBM-PC-compatible or Macintosh com-puters.

To create three-dimensional images, a com-puter uses a mathematical transformation calleda projection. Although the images are presentedon a two-dimensional screen, the computer,through using the principle of perspective—foreshortening, shading, and hidden surface re-moval—and through its ability to make quickcalculations, can portray the object so as to makeit appear to the human eye as a three-dimen-sional object. These techniques are the basis forcomputer-aided drafting and computer anima-tion.

Rapidly changing 3-D images on the com-puter screen creates the illusion of motion, oranimation. An animated movie will use slightlydiffering images on a filmstrip to create the illu-sion of motion. A computer acts much the sameway, although it cannot produce the twenty-fourfull-screen images per second typical in an ani-mated film.

The computer, however, will accomplish thesame effect by displaying one image on the screenwhile creating a new image in the backgroundand swapping the screen. This eliminates thetime between display of the images, creating theillusion of motion.

BIBLIOGRAPHY

Gates, Bill. (1995). The Road Ahead. New York: VikingPenguin.

Prosise, Jeff. (1994). How Computer Graphics Work. Em-eryville, CA: Ziff-Davis Press.

WALTER A. HAMILTON

COMPUTERS(SEE: Information Technology)

CONFLICT MANAGEMENT(SEE: Management Theories)

CONSUMER ADVOCACYAND PROTECTION

Consumer advocacy refers to actions taken byindividuals or groups to promote and protect theinterests of the buying public. Historically, con-sumer advocates have assumed a somewhat ad-versarial role in exposing unfair business prac-tices or unsafe products that threaten the welfareof the general public. Consumer advocates usetactics such as publicity, boycotts, letter-writingcampaigns, Internet ‘‘gripe sites,’’ and lawsuits toraise awareness of issues affecting consumers andto counteract the financial and political power ofthe organizations they target. Since even large,multinational businesses can be visibly woundedwhen their mistreatment of consumers or otherconstituencies arouses the ire of consumer advo-cacy organizations, it should be obvious to busi-ness owners that they can ill afford to engage inbusiness practices that could draw the attentionof consumer advocates.

Periods of vocal consumer advocacy aroundthe turn of the twentieth century and in the late1960s have left a legacy of federal legislation andagencies intended to protect consumers in theUnited States. The rights of consumers have ex-panded to include product safety, the legitimacyof advertising claims, the satisfactory resolutionof grievances, and a say in government decisions.

CONSUMER ADVOCACY AND PROTECTION


President Lyndon B. Johnson, surrounded by advisors and staff, signing a consumer bill.



In the early days of industry, companies couldafford to ignore consumers’ wishes because therewas so much demand for their goods and ser-vices. As a result, they were often able to com-mand high prices for products of poor quality.The earliest consumer advocates to point outsuch abuses were called ‘‘muckrakers,’’ and theirrevelations of underhanded business practicesspurred the creation of several federal agenciesand a flurry of legislation designed to curb someof the most serious abuses. At the same time,increased competition began to provide con-sumers with more choices among a variety ofproducts of higher quality. Still, some notablecases of corporations neglecting the public wel-fare for their own gain continued, and corporateinfluence in American politics enabled manybusinesses to resist calls for reform in advertising,worker or consumer safety, and pollution con-trol.

This situation led to the consumer move-ment of the 1960s. One of the country’s mostoutspoken and controversial consumer advo-cates, lawyer Ralph Nader, came to the forefrontduring this time. Nader’s effective and well-pub-licized denunciations of the American automo-bile industry included class-action lawsuits andcalls for recalls of allegedly defective products,and many of his actions served as a tactical modelfor future advocacy organizations.

The efforts of Nader and other activists led tothe formation of several federal agencies designedto protect consumer interests. The U.S. Office ofConsumer Affairs, created in 1971, investigatesand resolves consumer complaints, conductsconsumer surveys, and disseminates product in-formation to the public. The Consumer ProductSafety Commission, formed in 1973, sets nationalstandards for product safety and testing proce-dures, coordinates product recalls, and ensuresthat companies respond to valid consumer com-plaints. Other government agencies that benefitconsumers include the Better Business Bureauand state consumer agencies. The ConsumerFederation of America is the largest consumeradvocacy group in the United States, consistingof about two hundred twenty member organiza-

tions. The International Organization of Con-sumers Unions, based in the Netherlands, ac-tively promotes consumer interests on a globalscale.

CONSUMER ADVOCACY IN CYBERSPACE

In the early 1990s, the widespread use of homecomputers advanced consumer advocacy bymaking it easier for citizens to gather informa-tion and make their views known. And by the late1990s, the Internet had become one of the pri-mary weapons of consumer advocates. As of1998, according to Simon Reeve in the European,there were more than 8000 ‘‘so-called global‘gripe sites’ established by campaigners or dis-gruntled customers with the aim of harassing andharanguing large companies.’’

Before the advent of the World Wide Web, itwas difficult for individuals or small groups,which lacked the resources of major corpora-tions, to make their voices heard over their tar-gets’ advertising messages. ‘‘But the Internet hascreated a level playing field for advocacy,’’ Reevewrote. ‘‘With little more than a personal com-puter and a subscription to an Internet serviceprovider, anyone can open a site on the WorldWide Web and say more or less whatever theylike.’’ Current and potential customers of majorcorporations typically use common Internetsearch engines to access the companies’ carefullyprepared home pages. Yet these search enginesalso lead the customers to sites created by pro-testers that are filled with complaints and allega-tions against the companies, ranging from theuse of child labor to the exploitation of resourcesin less-developed countries. Thus, for consumeradvocates, ‘‘the Internet means a new freedom totake on the mightiest corporations, in an envi-ronment where massive advertising budgetscount for little,’’ Reeve stated.

For businesses, on the other hand, Internet‘‘gripe sites’’ pose a difficult problem. Althoughthe material posted on such sites might bedistorted, false, or even outright libelous, it canstill prove damaging to a company’s image.Moreover, few legal remedies exist as the lawstruggles to keep up with technology. It is often



difficult for companies to trace the operators ofgripe sites, for example, and suing the Internetservice providers that provide access to protestershas not proved successful. In addition, turning tothe law for help can turn into a public relationsdisaster for companies, making a small probleminto a much bigger one. ‘‘The Internet is anuncontrollable beast,’’ attorney Simon Hal-berstam told Reeve. ‘‘While legally the firm mayhave recourse to law, the reality is that they mayjust have to accept the problem and carry on withtheir business.’’

(SEE ALSO: Antitrust Legislation; Consumer Bill ofRights; Consumer Product Safety Act of 1972;Consumer Protest; Environmental Protection Agency;Fair Packaging and Labeling Act of 1966; Food andDrug Administration; Food, Drug, and Cosmetic Act;Price Fixing; Product Labeling)

BIBLIOGRAPHY

‘‘A Consumer Warning on New Ripoffs.’’ Money, March1992: 34.

Cook, Gareth G. (1995). ‘‘The Case for (Some) Regulation.’’Washington Monthly, March: 34.

‘‘Is Lawsuit Reform Good for Consumers?’’ Consumer Re-ports, May 1995, 312.

Kemper, Vicki. (1995). ‘‘A Citizen for All Seasons.’’Common Cause Magazine, Spring: 12.

Mayer, Robert N. (1989). The Consumer Movement: Guard-ians of the Marketplace. Boston: Twayne.

Reeve, Simon. (1998). ‘‘Web Attack.’’ European, January 26:20.

Saucer, Caroline. (1998). ‘‘Small Group, Big Impact.’’ Best’sReview, March: 50.

‘‘Unsafe at Any Megahertz: Ralph Nader Is Taking on BillGates. Is Consumerism Still a Force in America?’’Economist, October 11, 1997: 80.

LAURIE COLLIER HILLSTROM

CONSUMER ANDINDUSTRIAL GOODS

The classification of goods—physical products—is essential to business because it provides a basisfor determining the strategies needed to movethem through the marketing system. The two

main forms of classifications are consumer goodsand industrial goods.

CONSUMER GOODS

Consumer goods are goods that are bought fromretail stores for personal, family, or householduse. They are grouped into three subcategorieson the basis of consumer buying habits: conve-nience goods, shopping goods, and specialtygoods.

Consumer goods can also be differentiatedon the basis of durability. Durable goods areproducts that have a long life, such as furnitureand garden tools. Nondurable goods are thosethat are quickly used up, or worn out, or thatbecome outdated, such as food, school supplies,and disposable cameras.

Convenience Goods Convenience goods areitems that buyers want to buy with the leastamount of effort, that is, as conveniently as possi-ble. Most are nondurable goods of low value thatare frequently purchased in small quantities.These goods can be further divided into twosubcategories: staple and impulse items.

Staple convenience goods are basic items thatbuyers plan to buy before they enter a store, andinclude milk, bread, and toilet paper. Impulseitems are other convenience goods that are pur-chased without prior planning, such as candybars, soft drinks, and tabloid newspapers.

Since convenience goods are not actuallysought out by consumers, producers attempt toget as wide a distribution as possible throughwholesalers. To extend the distribution, theseitems are also frequently made available throughvending machines in offices, factories, schools,and other settings. Within stores, they are placedat checkout stands and other high-traffic areas.

Shopping Goods Shopping goods are pur-chased only after the buyer compares the prod-ucts of more than one store or looks at more thanone assortment of goods before making a deliber-ate buying decision. These goods are usually ofhigher value than convenience goods, bought in-frequently, and are durable. Price, quality, style,and color are typically factors in the buying deci-

CONSUMER AND INDUSTRIAL GOODS


sion. Televisions, computers, lawnmowers, bed-ding, and camping equipment are all examples ofshopping goods.

Because customers are going to shop forthese goods, a fundamental strategy in establish-ing stores that specialize in them is to locate nearsimilar stores in active shopping areas. Ongoingstrategies for marketing shopping goods includethe heavy use of advertising in local media, in-cluding newspapers, radio, and television. Adver-tising for shopping goods is often done coopera-tively with the manufacturers of the goods.

Specialty Goods Specialty goods are itemsthat are unique or unusual—at least in the mindof the buyer. Buyers know exactly what they wantand are willing to exert considerable effort toobtain it. These goods are usually, but not neces-sarily, of high value, and they may or may not bedurable goods. They differ from shopping goodsprimarily because price is not the chief consider-ation. Often the attributes that make themunique are brand preference (e.g., a certain makeof automobile) or personal preference (e.g., afood dish prepared in a specific way). Other itemsthat fall into this category are wedding dresses,antiques, fine jewelry, and golf clubs.

Producers and distributors of specialty goodsprefer to place their goods only in selected retailoutlets. These outlets are chosen on the basis oftheir willingness and ability to provide a highlevel of advertising and personal selling for theproduct. Consistency of image between the prod-uct and the store is also a factor in selectingoutlets.

The distinction among convenience, shop-ping, and specialty goods is not always clear. Asnoted earlier, these classifications are based onconsumers’ buying habits. Consequently, a givenitem may be a convenience good for one person,a shopping good for another, and a specialtygood for a third. For example, for a person whodoes not want to spend time shopping, buying apair of shoes might be a convenience purchase. Incontrast, another person might buy shoes onlyafter considerable thought and comparison: inthis instance, the shoes are a shopping good. Stillanother individual who perhaps prefers a certain

brand or has an unusual size will buy individualshoes only from a specific retail location; for thisbuyer, the shoes are a specialty good.

INDUSTRIAL GOODS

Industrial goods are products that companiespurchase to make other products, which theythen sell. Some are used directly in the produc-tion of the products for resale, and some are usedindirectly. Unlike consumer goods, industrialgoods are classified on the basis of their userather than customer buying habits. These goodsare divided into five subcategories: installations,accessory equipment, raw materials, fabricatedparts and materials, and industrial supplies.

Industrial goods also carry designations re-lated to their durability. Durable industrial goodsthat cost large sums of money are referred to ascapital items. Nondurable industrial goods thatare used up within a year are called expenseitems.

Installations Installations are major capitalitems that are typically used directly in the pro-duction of goods. Some installations, such asconveyor systems, robotics equipment, and ma-chine tools, are designed and built for specializedsituations. Other installations, such as stampingmachines, large commercial ovens, and comput-erized axial tomography (CAT) scan machines,are built to a standard design but can be modifiedto meet individual requirements.

The purchase of installations requires exten-sive research and careful decision making on thepart of the buyer. Manufacturers of installationscan make their availability known through adver-tising. However, actual sale of installations re-quires the technical knowledge and assistancethat can best be provided by personal selling.

Accessory Equipment Goods that fall into thesubcategory of accessory equipment are capitalitems that are less expensive and have shorterlives than installations. Examples include handtools, computers, desk calculators, and forklifts.While some types of accessory equipment, suchas hand tools, are involved directly in the produc-tion process, most are only indirectly involved.



The relatively low unit value of accessoryequipment, combined with a market made up ofbuyers from several different types of businesses,dictates a broad marketing strategy. Sellers relyheavily on advertisements in trade publicationsand mailings to purchasing agents and otherbusiness buyers. When personal selling is needed,it is usually done by intermediaries, such aswholesalers.

Raw Materials Raw materials are productsthat are purchased in their raw state for thepurpose of processing them into consumer orindustrial goods. Examples are iron ore, crudeoil, diamonds, copper, timber, wheat, and lea-ther. Some (e.g., wheat) may be converted di-rectly into another consumer product (cereal).Others (e.g., timber) may be converted into anintermediate product (lumber) to be resold foruse in another industry (construction).

Most raw materials are graded according toquality so that there is some assurance of consis-tency within each grade. There is, however, littledifference between offerings within a grade. Con-sequently, sales negotiations focus on price, de-livery, and credit terms. This negotiation plus thefact that raw materials are ordinarily sold in largequantities make personal selling the principalmarketing approach for these goods.

Fabricated Parts and Materials Fabricatedparts are items that are purchased to be placed inthe final product without further processing.Fabricated materials, on the other hand, requireadditional processing before being placed in theend product. Many industries, including the autoindustry, rely heavily on fabricated parts. Auto-makers use such fabricated parts as batteries, sunroofs, windshields, and spark plugs. They also useseveral fabricated materials, including steel andupholstery fabric. As a matter of fact, many in-dustries actually buy more fabricated items thanraw materials.

Buyers of fabricated parts and materials havewell-defined specifications for their needs. Theymay work closely with a company in designingthe components or materials they require, or theymay invite bids from several companies. In either

case, in order to be in a position to get thebusiness, personal contact must be maintainedwith the buyers over time. Here again, personalselling is a key component in the marketing strat-egy.

Industrial Supplies Industrial supplies are fre-quently purchased expense items. They contrib-ute indirectly to the production of final productsor to the administration of the production pro-cess. Supplies include computer paper, lightbulbs, lubrication oil, cleaning supplies, and of-fice supplies.

Buyers of industrial supplies do not spend agreat deal of time on their purchasing decisionsunless they are ordering large quantities. As aresult, companies marketing supplies place theiremphasis on advertising—particularly in theform of catalogues—to business buyers. Whenlarge orders are at stake, sales representatives maybe used.

It is not always clear whether a product is aconsumer good or an industrial good. The key todifferentiating them is to identify the use thebuyer intends to make of the good. Goods thatare in their final form, are ready to be consumed,and are bought to be resold to the final consumerare classified as consumer goods. On the otherhand, if they are bought by a business for its ownuse, they are considered industrial goods. Someitems, such as flour and pick-up trucks, can fallinto either classification, depending on how theyare used. Flour purchased by a supermarket forresale would be classified as a consumer good,but flour purchased by a bakery to make pastrieswould be classified as an industrial good. A pick-up truck bought for personal use is a consumergood; if purchased to transport lawnmowers for alawn service, it is an industrial good.

BIBLIOGRAPHY

Boone, Louis E., and Kurtz, David L. (1992). ContemporaryMarketing. IL: Dryden.

Diamond, William T. (1963). Distribution Channels for In-dustrial Goods. OH: Bureau of Business Research.

Eckles, Robert W. (1990). Business Marketing Management:Marketing of Business Products and Services. EnglewoodCliffs, NJ: Prentice-Hall.



Levy, Michael, and Weitz, Barton. (1992). Retail Manage-ment. IL: Irwin.

Reid, T. J. (1991).What Mother Never Told Ya About Retail.LA: Retail Resources Publications.

EARL C. MEYER

SHARON K. SLICK

CONSUMER BEHAVIOR

In September 1999, Polaroid Corparation intro-duced to the U.S. market a small, instant camerawith a cheap lens that produced fuzzy, postage-stamp-sized photographs that could double asstickers. Scientists and engineers at Polaroid,holding true to the company’s long-standing rep-utation for building high-quality, technologicallyinnovative products, were skeptical. They wor-ried that this new instant camera, called theI-Zone Instant Pocket Camera, would taint theirreputation. Before becoming one of I-Zone’s ar-dent supporters, Ed Coughlan thought the cam-era was crazy, ‘‘I’m an old engineer. I couldn’t forthe life of me figure out who’d buy it’’ (quoted inKlein, 2000, p. A1).

Figuring out not only who would buy it, butwhy they would buy it, where they would buy it,how often they would buy it, and how they woulduse it is the cornerstone of understanding con-sumer behavior. Consumer behavior is the studyof people: how we buy, consume and dispose ofproducts. There were 275 million people in theU.S. alone in 2000. Each of us is a consumer ofhundreds of products every day. As consumers,we can benefit from a better understanding ofhow we make our decisions so that we can makewiser ones. Marketers can benefit from an under-standing of consumer behavior so that they canbetter predict what consumers want and howbest to offer it to them. Trusting their under-standing of the changing consumer market, themarketing specialists at Polaroid convinced thecompany to launch the I-Zone. Less than threemonths after its launch, the I-Zone InstantPocket Camera became America’s number-one-selling camera (Klein, 2000).

There are two major forces that shape whowe are and what we buy. Our personal motives,attitudes, and decision-making abilities guide ourconsumption behavior. At the same time, ourfamilies, cultural background, the ads we see onTV, and the sites we visit on the Internet influ-ence our thoughts and actions (see Figure 1).

UNDERSTANDING CONSUMERS:INTERNAL FACTORS

Our consumption behavior is a function of whowe are as individuals. Our thoughts, feelings, atti-tudes, and patterns of behavior determine whatwe buy, when we buy it, and how we use it.Internal factors have a major impact on con-sumer behavior.

Consumer motivation. A marketer’s job is tofigure out what needs and wants the consumerhas, and what motivates the consumer to pur-chase. Motivation is the drive that initiates all ourconsumption behaviors, and consumers havemultiple motives, or goals. Some of these areovert, like a physiological thirst that motivates aconsumer to purchase a soft drink or the need topurchase a new suit for an interview. Other mo-tives are more obscure, like a student’s need totote a Kate Spade bookbag or wear Doc Martensto gain social approval. Most consumption activ-ities are the result of several motives operating atthe same time. Researchers specially trained inuncovering motives often use qualitative researchtechniques in which consumers are encouragedto reveal their thoughts (cognitions) and feelings(affect) through probing dialogue. Focus groupsand in-depth interviews give consumers an op-portunity to discuss products and express opin-ions about consumption activities. Trained mod-erators or interviewers are often able to tap intopreconscious motives that might otherwise goundetected. Sentence completion tasks (e.g., Menwho wear Old Spice are . . . ) or variants of theThematic Apperception Tests (TAT), in whichrespondents are shown a picture and asked to tella story surrounding it, are additional techniquesthat provide insight into underlying motives.

CONSUMER BEHAVIOR


Model of Consumer Behavior

Cognitive InputsIncluding

• Motivation• Information Processing• Attitudes

Social InputsIncluding

• Groups• Family• Culture• Subculture

Feedback

Decision Making Consumption Behavior

Feedback

Feedback

Figure 1

Consumer motives or goals can be repre-sented by the values they hold. Values are peo-ple’s broad life goals that symbolize a preferredmode of behaving (e.g., independent, compas-sionate, honest) or a preferred end-state of being(e.g., sense of accomplishment, love and affec-tion, social recognition). Consumers buy prod-ucts that will help them achieve desired values;they see product attributes as a means to an end.Understanding the means-end perspective canhelp marketers better position the product andcreate more effective advertising and promotioncampaigns.

Consumer information processing. The con-sumer information-processing approach aids inunderstanding consumptive behavior by focus-ing on the sequence of mental activities thatpeople use in interpreting and integrating theirenvironment.

The sequence begins with human perceptionof external stimuli. Perception is the process ofsensing, selecting, and interpreting stimuli inone’s environment. We begin to perceive an ex-ternal stimulus as it comes into contact with oneof our sensory receptors—eyes, ears, nose,

mouth, or skin. Perception of external stimuliinfluences our behavior even without our con-scious knowledge that it is doing so. Marketersand retailers understand this, and they createproducts and stores specifically designed to influ-ence our behavior. Fast-food chains paint theirwalls in ‘‘hot’’ colors, like red, to speed up cus-tomer turnover. Supermarkets steer entering cus-tomers directly into the produce section, wherethey can smell and touch the food, stimulatinghunger. A hungry shopper spends more money.

Close your eyes and think for a momentabout the hundreds of objects, noises, and smellssurrounding you at this very moment. In order tofunction in this crowded environment, wechoose to perceive certain stimuli while ignoringothers. This process is called selectivity. Selectivitylets us focus our attention on the things that pro-vide meaning for interpreting our environmentor on the things that are relevant to us, while notwasting our limited information-processing re-sources on irrelevant items. Did you even noticethat after you decide on, say, Florida, for yourvacation destination, there seems to be an abun-dance of ads for Florida resorts, airline promo-tions for Florida, and articles about Florida res-

CONSUMER BEHAVIOR


taurants and at t rac t ions everywhere?Coincidence? Not really. There are just as manynow as there were before, only now you areselectively attending to them, whereas you previ-ously filtered them out. Marketers continuouslystruggle to break through the clutter and grabconsumers’ attention. Advertising and packagingis designed to grab our attention through a hostof techniques, like the use of contrast in colorsand sound, repetition, and contextual placement.

Did you watch TV last night? You may havepaid attention to many of the ads you saw duringthe commercial breaks; you may even havelaughed out loud at a few of them. But howmanycan you recall today? Consumers’ ability to store,retain, and retrieve product information is criti-cal to a brand’s success. When information isprocessed, it is held for a very brief time (less thanone minute) in working, or short-term, memory.If this information is rehearsed (mentally re-peated), it is transferred to long-term memory; ifnot, the information is lost and forgotten. Oncetransferred to long-term memory, information isencoded or arranged in a way that provides mean-ing to the individual. Information in long-termmemory is constantly reorganized, updated, andrearranged as new information comes in, orlearning takes place. Information-processing the-orists represent the storage of information inlong-term memory as a network consisting ofnodes (word, idea, or concept) and links (rela-tionships among them). Nodes are connected toeach other depending on whether there is anassociation between concepts, with the length ofthe linkages representing the degree of the associ-ation. Figure 2 illustrates a network model oflong-term memory. When Edwin Land inventedthe first Polaroid instant camera, knowledgestructures for cameras changed to reflect the as-sociation between photography and instant out-put. Now, knowledge structures are changing toreflect the new I-Zone camera.

The complete network brought to mindwhen a product is activated is called the productschema. Knowing the set of associations that con-sumers retrieve from long-term memory about aparticular product or category is critical to a

successful marketing strategy. For new productsor services, marketers must first select the set ofassociations they want consumers to have. This iscalled positioning the product, or selecting thebrand image. Peak Freans’ unique positioning asan adult cookie was accomplished by establishinga link between the concept ‘‘serious’’ and‘‘cookie.’’ The brand position is then translatedinto clever ads, reinforced on product packaging,and integrated into all promotion and communi-cation strategies. Over time, a brand’s image canfade or become diluted. Sometimes consumersassociate concepts that are not favorable to abrand.When this occurs, marketers reposition thebrand, using advertising and other marketingtools to help consumers create new links to posi-tive association and discard links to the unfavor-able ones. In the mid-1990s, Hush Puppies shoesmade a comeback after decades of low sales. In-troducing exciting, vibrant colors, Hush Puppiesrepositioned their basic comfort shoe as fashion-able, youth-oriented, and ‘‘cool.’’ Strategies forsuccessful brand extensions also depend on thebrand schema. Generally speaking, a brand ex-tension is more likely to be successful if the set ofassociations for the extension matches the set ofassociations of the core product. Would Lifesav-ers brand toothpaste sell? Probably not, becausethe associations for Lifesavers (sweet, candy,sugar, fruity) are not the same as those for tooth-paste (mint, clean, noncandy). On the otherhand, a Lifesavers brand sugared children’s cerealwith colorful, fruity rings has a much bettermatch of associations.

Attitude formation and change. The set ofbeliefs consumers have stored in long-termmemory provides another critical function tomarketers: It provides the basis for a consumer’sattitude toward a brand or an ad. An attitude isan overall evaluation of an object, idea, or action.Attitudes can be positive or negative, and weaklyor strongly held. The statement ‘‘I love Ben &Jerry’s Vanilla Toffee Crunch’’ is a strong, posi-tively valenced attitude toward a product. Thestatement ‘‘I dislike the new Toyota ad’’ is a weak,negatively valenced attitude toward an advertise-ment. Marketers work hard to continuously

CONSUMER BEHAVIOR


Associative Network for Polaroid

PhotoCopier

Canon

InstantGratifi-cation

Camera

TraditionalPhoto-graphy

PhotoCopier

Film

Kodak

HighQuality

TraditionalProcessing

DelayedGratifi-cation

Polaroid

Insta-matic

Outdated

Izone CameraSticker Film

Youthful

Figure 2

monitor consumer attitudes toward their prod-ucts. Among other things, attitudes can indicateproblems with a product or campaign, successwith a product or campaign, likelihood of future

sales, and overall strength of the brand or brandequity.

A popular perspective is that attitude hasthree components: cognitive, affective, and co-

CONSUMER BEHAVIOR


native. The cognitive component reflects theknowledge and beliefs one has about the object(e.g., ‘‘Digital Club Network is an on-line livemusic Internet site.’’), the affective componentreflects feelings (e.g., ‘‘I like the Digital ClubNetwork site’’) and the conative component re-flects a behavioral tendency toward the object(e.g., ‘‘I will become a registered user of digi-talclubnetwork.com’’). Thus, attitudes are pre-dispositions to behave in a certain way. If youhave a favorable attitude toward a politician, youwill likely vote for him or her in the next election.Because of this, many marketers use attitudemeasures for forecasting future sales. It is impor-tant to note, however, that the link between atti-tudes and behavior is far from perfect. Con-sumers can hold positive attitudes towardmultiple brands but intend to purchase only one.External economic, social, or personal factorsoften alter behavioral plans.

Attitudes are dynamic, which means they areconstantly changing. As an individual learns newinformation, as fads change, as time goes on, theattitudes you once held with confidence may nolonger exist. Did you ever look at old photos ofyourself and wonder ‘‘What was I thinking wear-ing clothes like that? And look at my hairstyle!’’

UNDERSTANDING CONSUMERS:EXTERNAL FACTORS

In addition to the internal factors, consumerbehavior is also shaped to a large extent by socialfactors, such as culture, family relationships, andother aspects of the external environment.Awareness of these influences can help marketersto identify groups of consumers who tend tothink, feel, or act similarly and separate them intounique market segments. Aspects of the market-ing program—such as product design, advertis-ing, and pricing—can then be tailored to meetthe unique needs, values, and goals of these dis-tinct groups.

Group influences on individual consumer be-havior. Group influences on consumer behaviorcan impact motivation, values, and individual in-formation processing; they can come from

groups to which consumers already belong orfrom groups to which they aspire to belong (aspi-rational groups). Groups can exert a variety ofinfluences on individuals, including: (1)informational influences where the group acts as asource for expert opinions; (2) comparative influ-ences such that the group provides opportunitiesto manage the individual’s self-concept with re-spect to the group’s identity; and, (3) normativeinfluences, whereby the group specifies guidelinesand sanctions for appropriate or inappropriateindividual behaviors.

The influence of groups on consumer behav-ior tends to vary with a variety of group- andproduct-related factors. For example, the morethe group is perceived to be a credible, valuedsource of approval or disapproval to the con-sumer, the more likely that consumer is to con-form to group values. In addition, the more fre-quently group members interact, and the moreoutwardly visible use of the product is to groupand non-group members, the greater the group’sinfluence on individual consumption behavior.

Family influences on consumer behavior.Families have a particularly significant influenceon consumer behavior. For example, consump-tion behavior often changes substantially as fam-ily status changes over time. Thus, young unmar-ried adults, who are often focused on individualself-definition, tend to purchase products thatenhance or define their self-concepts. In contrast,couples with children may be more interested inpurchasing items or experiences that can beshared by all family members and, as a result,may spend less on individually oriented prod-ucts.

Family membership also leads to a greaterneed for joint rather than individual decisionmaking, further complicating consumer behaviorat the household level. For example, the personwho buys a product may not be the ultimateconsumer of the product. Or perhaps the hus-band and wife have differing levels of involve-ment with certain product decisions, leading todifferent types of separate decision processes thatmust be integrated before a choice is ultimatelymade. Understanding the dynamics involved in

CONSUMER BEHAVIOR


joint decision making and which family membersinfluence which types of decisions has importantimplications for marketers interested in directingmarketing efforts to the right person. Impor-tantly, these family dynamics and lifestyle transi-tions are complicated by the decline in traditionalhouseholds and the accompanying rise in non-traditional family structures, such as cohabitatingcouples or couples integrating families from pre-vious marriages.

Cultural and sub-cultural influences on con-sumer behavior. Culture comprises the commonmeanings and socially constructed values ac-cepted by the majority of members of a society orsocial group. It includes such things as sharedvalues, beliefs, norms, and attitudes, as well asaffective reactions, cognitive beliefs, and patternsof behavior. Typically, when we think of culture,we tend to think of differences among individualsfrom different countries or regions of the world.With the increasing globalization of the worldeconomy, understanding differences and similar-ities in consumer behavior across cultures be-comes increasingly meaningful, with importantimplications about the degree to which market-ing strategies can be standardized across coun-tries and cultures, or localized to reflect country-or region-specific cultural distinctions.

One important cultural difference is the de-gree to which the self is defined as independentfrom others versus interdependent with impor-tant others. Individualistic cultures, such as theUnited States, tend to foster an independentsense of self, with the self believed to be a set ofinternal attributes unique to each person.Collectivist cultures, however, such as China, fos-ter an interdependent sense of self, with the selfbelieved to be inseparable from others and thesocial context; person-specific attributes are lessimportant in self-definition than are interper-sonal relations. These differences in self-defini-tion affect a variety of consumer behaviors, in-cluding emotional reactions to advertisements,the degree to which information from others isvalued when making consumption decisions, andgift-giving behavior.

In addition to cultural differences that existacross countries, marketers are also increasinglyrecognizing the importance of cultural differ-ences within a society. Subcultures are distinctivegroups within a society that share commonmeanings. Subcultures can often be identifiedbased on demographic characteristics, such asgeographic location (e.g., the southern UnitedStates), ethnicity (e.g., Hispanic Americans), orage (e.g., baby-boomers). Polaroid’s I-Zone cam-era is targeted in the United States to appeal tothe teenage subculture.

Subcultures can also be identified based oncommon lifestyles. For example, a strong subcul-ture exists around Harley-Davidson motorcyclesand the Harley Owner’s Group (HOG). Mem-bers of this group share a core cultural value ofpersonal freedom, which is exemplified in boththe experience of using the product (taking to theopen road) and in the company’s marketingstrategy (e.g., the open-winged insignia[Schouten and Alexander, 1995]). Importantly,identification of lifestyle subcultures, and thecorresponding development of an inventory ofshared meanings, is typically more difficult thanthe development of such understanding of sub-cultures based on observable demographic char-acteristics.

Increasingly, Internet marketers have cometo realize the value of subculture segments andhave tailored product offerings and/or Web sitecontent to appeal to particular subcultures, mostoften demographically based, and to foster agreater sense of community and connectionamong subculture members. For example,iVillage.com features content of particular inter-est to women and offers forums for discussion ofissues relevant to its users. Similarly, His-panic.com aims to provide services and informa-tion to Hispanic Americans as well as to provide avirtual meeting space for Hispanic Americans tomeet and help one another. These represent earlyattempts to use the Internet to target and servesubculture populations. Future sites are likelyboth to target more narrowly defined subcultures(e.g., Hispanic Americans with an interest in

CONSUMER BEHAVIOR


gourmet cooking) and to focus on reaching morelifestyle-based subcultures.

THE CONSUMERDECISION-MAKING PROCESS

What consumers think and the social environ-ment they live in determine what they buy andhow that purchase decision is made. Typically,the decision process is described as a series of fivestages. The first stage, need recognition, occurswhen consumers perceive a difference betweentheir ideal and actual states. Need recognition isoften prompted by persuasive advertising. Con-sumers then begin the information search processby conducting an internal search of their ownknowledge structures, followed by an externalsearch for information from friends, family mem-bers, salespeople, and advertisements. This stepcan clarify the problem, providing criteria to usefor assessing product alternatives and resulting ina subset, or ‘‘consideration set,’’ of potentialchoices. These options are then assessed morecompletely in the third stage, alternative evalu-ation. In this stage, products in the considerationset are compared with one another. Sometimes asimple heuristic rule of thumb, such as ‘‘I’mgoing to buy the cheapest product’’ is used. Atother times a more complex strategy, such as aweighted-average model that compensates forproduct strengths and weaknesses, is used. Afterexamining each alternative, consumers are readyto purchase, the fourth step in the decision pro-cess. Finally, after buying, the consumers enterthe post-purchase phase of the process, duringwhich the performance of the chosen alternativeis evaluated in light of prior expectations. Con-sumers will be satisfied with the product if itmeets or exceeds expectations; dissatisfaction oc-curs if the product does not meet expectations.

This model of consumer behavior, while veryuseful, is highly simplified and does not alwaysaccurately reflect the decision process consumersfollow. Consumers may not always proceed lin-early through the five steps as described, andsometimes they may skip certain steps entirely.However, the model is a close approximation of

the process for most consumers for most pur-chase occasions.

We are all consumers. Understanding whywe behave as we do is integral to an efficienttransfer of goods and services in a market-driveneconomy.

BIBLIOGRAPHY

Klein, Alec. (2000). ‘‘On a Roll: The Techies Grumbled, butPolaroid’s Pocket Turned into a Huge Hit.’’ The WallStreet Journal May 2: A1.

Schouten, John W., and Alexander, James H. (1995). ‘‘Sub-cultures of Consumption: An Ethnography of the NewBikers.’’ Journal of Consumer Research 22 (June): 43-61.

Wilkie, William L. (1994). Consumer Behavior, 3rd ed. NewYork: Wiley.

LAUREN G. BLOCKPATTI WILLIAMS


Webster’s dictionary defines consumerism as ‘‘amovement for the protection of the consumeragainst defective products, misleading advertis-ing, etc.’’ Limited consumer protection was pres-ent until the 1950s and early 1960s. In the 1950s,a significant breakthrough occurred with the es-tablishment of the product-liability concept,whereby a plaintiff did not have to prove negli-gence but only had to prove that a defectiveproduct caused an injury. In his 1962 speech toCongress, President John F. Kennedy outlinedfour basic consumer rights, which later becameknown as the Consumer Bill of Rights. Later, in1985, the United Nations endorsed Kennedy’sConsumer Bill of Rights and expanded it to covereight consumer rights. Consumer protection canonly survive in highly industrialized countriesbecause of the resources needed to finance con-sumer interests.

Kennedy’s Consumer Bill of Rights includedthe right to be informed, the right to safety, theright to choose, and the right to be heard. Theright to be informed involves protection againstmisleading information in the areas of financing,advertising, labeling, and packaging. Several laws



of the 1960s and 1970s were aimed at this right.The Cigarette Labeling Act (1965), Fair Packag-ing and Labeling Act (1966), and the WholesomeMeat Act (1967) all addressed packaging. Thislegislation dealt with the accurate identificationof the content of the product and any dangersassociated with the product. The Truth-in-Lend-ing Act required full disclosure of all costs andthe annual percentage rate on installment loans.Prior to Truth-in-Lending, the actual cost washidden and confusing to calculate. Another sig-nificant piece of legislation, the Magnuson-MossWarranty Act, requires a warranty which statesthat a product will meet performance standardsand affirms that a warranty can be stated orimplied. Other regulation took place at the statelevel. Forty states have a cooling-off law, whichallows a consumer to change his or her mindwhen purchasing products from direct salespeo-ple.

The second consumer right, the right tosafety, is aimed at injuries caused by using prod-ucts other than automobiles. To address thisproblem, the government established the Con-sumer Product Safety Commission (CPSC) in1972. The CPSC has jurisdiction over thirteenthousand diverse products. The powers of theCPSC include the right to require warning labels,to establish standards of performance, to requireimmediate notification of a defective product,and to mandate product testing. However, itsgreatest power is product recall.

The right of consumer choice means the con-sumer should have a range of products fromvarious companies to choose from when makinga purchasing decision. To ensure these rights, thegovernment has taken a number of actions, suchas imposing time limits on patents, looking atmergers from the standpoint of limiting con-sumer choice, and prohibiting unfair price cut-ting and other unfair business practices.

The final consumer right is the right to beheard. Presently, no government agency is re-sponsible for handling consumer complaints.However, a number of government agencies doattempt to protect certain consumer rights. TheOffice of Consumer Affairs publishes a Con-

sumer’s Resource Handbook listing agencies thatwork in the area of consumer rights. In addition,a number of consumer groups issue complaintsto the government and industry groups.

The growth of consumerism in this countryhas not been without opposition. Although cor-porations have taken positive steps in manyareas, they have also opposed advancement ofsome consumer rights. Because corporations canhave deep pockets, they are able to appeal courtcases and slow down litigation. Today, however,because of past successes, the need for consumerprotection is not nearly as great as it was in previ-ous years.

BIBLIOGRAPHY

Alexander, Richard. ‘‘The Development of Consumer Rightsin the United States Slowed by the Power of CorporatePolitical Contributions and Lobbying.’’ 1999. Archivedat: http://consumerlawpage.com/article. 1999.

‘‘Consumer Rights.’’ Archived at: http://www.nolo.com.

‘‘Consumer Rights.’’ Archived at: http://www.consumer.gld.gov.

‘‘Consumer Rights.’’ Archived at: http://www.consumer.gld.gov.av/teacher.

‘‘Protection for the Consumer.’’ Archived at: http://www.hes.eku.edu.

MARY JEAN LUSHVAL HINTON

CONSUMERISM(SEE: Consumer Behavior)


The Consumer Price Index (CPI) provides astandardized method for comparing the averagelevel of prices faced by the consumers and house-holds of a nation over time. Price-level informa-tion is vital to a wide range of personal, govern-ment, and business decision makers. The CPIfocuses solely on the prices faced by consumersand does not attempt to reflect prices faced by allbuying entities in a country. Nevertheless, it is themost commonly used price-level indicator in a

CONSUMERISM


nation. It is the basis for the calculation of acountry’s inflation rate.

COMPUTATION

The Bureau of Labor Statistics (BLS) publishesCPI data monthly. BLS workers collect price dataon a set market basket of goods and services inselected cities across the country each month.The market basket includes hundreds of goodsand services typically purchased by consumers.The price data is then weighted to represent themix of goods and services typically purchased byconsumers. The mix of goods and services andthe weights are based on the Consumer Expendi-ture Survey, a national survey of the spendinghabits of 29,000 families (BLS, ‘‘How BLS Mea-sures’’). The decennial census of the populationis used for selection of the urban areas includedin the monthly surveys.

The CPI is computed by dividing theweighted price of the market basket in a timeperiod by the weighted price of the market basketin a designated base time period. The resultingratio times 100 yields an index with a value of 100for the base time period. CPI values above orbelow 100 indicate that the price level is higher orlower than it was during the base period. Forexample, an index value of 140 indicates that theaverage price level is 40 percent higher than it wasin the base year.

The prices of hundreds of goods and servicesare surveyed each month. The goods and servicesare organized into eight main groups: food andbeverage, housing, apparel, transportation, medi-cal care, recreation, education and communica-tion, and other goods and services.

Each month the BLS publishes numerousCPIs based on the data collected. The two mainCPI series are the CPI-U (Consumer Price Indexfor All Urban Consumers) and the CPI-W (Con-sumer Price Index for Urban Wage Earners andClerical Workers) Separate indices are publishedfor twenty-six selected urban areas and four geo-graphic regions of the country. There are alsoindices for three classes of cities (population ofover 1.5 million, mid-sized to small metropolitan

areas, and nonmetropolitan areas) and for cate-gories of goods and services.

MEASUREMENT ISSUES

The CPI provides a general approximation of theprice level faced by consumers in a given timeperiod. It is not designed to measure the exactprice level faced by any one consumer. The BLScollects data only in urban areas. Thus the CPIdoes not attempt to provide a measure of ruralprice levels. However, the CPI-U should be ser-viceable for approximately 87 percent of the U.S.population (BLS, ‘‘Guide to Available.’’) A two-week lag time exists between the completion ofdata collection and the publication of CPI data.The measure has limitations. The computationalmethodology has been gradually adjusted overtime to allow for more accurate measurement ofchanging price levels. Measurement issues in-clude index bias due to product innovation andquality changes that affect prices and consump-tion patterns, as well as uneven price changesacross retail outlets and geographic areas.

Historically, the CPI has been calculated as aLaspeyres index, or an index based on a fixedmarket basket of goods and services. This hasbeen criticized as an inaccurate approach becauseit does not allow for changing consumption pat-terns. Consumption patterns may change due tothe availability of new products, changing fea-tures of current products, changing consumerpreferences, or changes in the relative prices ofgoods and services. The impact of the availabilityof new products on purchasing patterns is exem-plified by products such as videocassette re-corders and microwave ovens, which were notavailable for consumer purchase until the late1970s but became common household purchasesin less than a decade. The emergence of audioCDs and CD players reduced purchases of audio-cassette tapes.

Price changes due to changes in productquality or features can be seen in the develop-ment of the manual typewriter, electric type-writer, and word processor. Adjustments aremade in the computation of the CPI for theimpact of quality changes on price. Also, periodic



adjustments in the market basket have beenmade every eight to twelve years to allow forchanging consumption patterns due to newproducts. This creates a situation in which price-level comparisons may be more accurate whenmade over relatively short periods of time ratherthan over many years or decades during whichthe nature and mix of goods and services in themarket basket changed considerably. The baseyear is also changed periodically. For example, inJanuary 1988 the CPI base year was changed from1967�100 to 1982-1984�100.

Beginning with January 1999 data, the BLSchanged to a geometric-mean-estimator methodof indexing. This method does not employ theLaspeyres fixed market basket; rather, it allowsconsumers to adjust purchases within broad cate-gories of goods and services due to changes in therelative prices of the goods or services withineach category. The consensus of experts was thatthe Laspeyres method led to a CPI which system-atically overestimated the price level actually paidby consumers, because consumers would substi-tute away from goods that increased in price infavor of similar goods with lower increases inprice. The geometric-mean-estimator methodwas adopted to reduce this overestimation. Aspart of this change, the BLS reports that CPIexpenditure weights are to be updated on a regu-lar two-year schedule (BLS, ‘‘Future Schedule’’).

During a year the prices of many goods andservices fluctuate because of seasonal factors,such as increases in supply affecting vegetableprices during harvest season. The BLS also pub-lishes monthly seasonally adjusted CPI measures,which factor out the monthly variation due to theseason of the year.

The CPI does not provide any explanationfor price-level changes, nor does it forecast futureprice levels. However, historical CPI data areused extensively by analysts in research on theseissues.

HISTORICAL TREND

The CPI tracks an ongoing trend of increasingprices in the United States. When making com-

parisons of the CPI over time, it is important tomake sure that all data use the same base year.

RELATED MEASURES

The CPI is not the only measure of price levelpublished by the government. Other commonprice indexes include a producer price index,which tracks the average prices producers pay forinputs, and the GDP deflator, which includes notonly consumer prices but also the prices paid byother purchasers such as investors and the gov-ernment.

Several other measures are based directly onthe CPI. A country’s inflation rate is the annualrate of change in its CPI. Also, purchasing powerindices are based on CPI data. Typically a pur-chasing power index is the reciprocal of a priceindex. In essence, the price index relates howmuch it would cost to purchase the same groupof goods and services compared to a base-timeperiod. A purchasing power index reflects thepercentage of the base-period group of goods andservices that could be purchased at current pricesif income were constant.

USES

Households, businesses, and governments useprice-level data in a variety of ways. One of themost common uses is to adjust other statistics forthe changes in price level. The resulting price-adjusted measures go by several terms including:real, in constant dollars, in (list base year) dollars,or deflated. For example, if an individual receiveda 10 percent raise while the CPI rose 3 percent,the individual would have a 7 percent increase inreal income. Data which are not adjusted forprice-level changes go by the descriptive termnominal. Real measures are commonly used inmedia reports and by decision makers. Other ex-amples of real measures are real gross domesticproduct, real interest rates, real exchange rates,and real government purchases.

Individuals and households rarely make di-rect use of the CPI, although they use CPI-basedinformation frequently. Examples of this includecomparisons of the cost of living in different cities,planning how much income will be needed to



provide a comparable standard of living in retire-ment, negotiating with employers for raises, anddetermining the real return received on savings.

Businesses use the CPI extensively in fore-casting future average price levels and consumerexpenditures. The expected price level also be-comes an important issue in negotiating escalatorclauses in long-term contracts. Labor contractsand pension plans may include cost-of-living-adjustment (COLA) clauses that tie wage or pen-sion increases to CPI increases. Internationalbusiness decision makers closely monitor differ-ences in the inflation rates of relevant countries.

Many branches of government use the CPI. Astable price level is one of the three main goals ofeconomic stability, and the CPI is the main mea-suring tool to assess a nation’s progress towardthis goal. Thus both fiscal and monetary policymakers use this statistic. Levels of many govern-ment expenditures, such as transfer payment lev-els and government employee salaries, are tied tochanges in the CPI. The legal system may inte-grate CPI adjustments into alimony or child-support agreements. In the 1980s the U.S. beganto index progressive income tax brackets to theinflation rate. Under an indexed income tax sys-tem, an individual will end up in a higher mar-ginal income tax bracket only if his or her incomerises more rapidly than the CPI.

BIBLIOGRAPHY

Bureau of Labor Statistics. ‘‘BLS to Maintain Current Refer-ence Base of 1982-84�100 for Most CPI Index series.’’Public Briefings on the 1998 CPI Revision. http://stats.bls.gov/cpibase1.htm. 1999.

Bureau of Labor Statistics. ‘‘Consumer Price Indexes.’’http://stats.bls.gov/epi0698c.htm. 1999.

Bureau of Labor Statistics. ‘‘Future Schedule for Expendi-ture Weight Updates in the Consumer Price Index.’’http://stats.bls.gov/cpiupdt.htm. 1999.

Bureau of Labor Statistics. ‘‘Guide to Available CPI Data.’’http://stats.bls.gov/cpifact8.htm. 1999.

Bureau of Labor Statistics. ‘‘How BLS Measures Changes inConsumer Prices.’’ http://stats.bls.gov/cpifact2.htm.1999.

Bureau of Labor Statistics. ‘‘Measurement Issues in the Con-sumer Price Index.’’ JEC Report: Quality and New Prod-ucts Bias. http://stats.bls.gov/cpigm697.htm. 1999.

Bureau of Labor Statistics. ‘‘Planned Change in the Con-sumer Price Index Formula April 16, 1998.’’ http://stats.bls.gov/epigm02.htm. 1999.

‘‘ESBR: Prices.’’ Economic Statistics Briefing Room.http://www.whitehouse.gov/fsbr/prices.html. 1999.

C. BETH HAYNES

CONSUMER PRODUCT SAFETYACT OF 1972

Congress passed the Consumer Product SafetyAct in 1972 to ‘‘assist consumers in evaluating thecomparative safety of consumer products; to de-velop uniform safety standards for consumerproducts and to minimize conflicting state andlocal regulations; and to promote research andinvestigation into the causes and prevention ofproduct related death, illnesses, and injuries.’’The act also established the Consumer ProductSafety Commission (CPSC) to ‘‘protect the pub-lic against unreasonable risks associated withconsumer products.’’ The CPSC has authority toset mandatory standards, ban products, order re-calls of unsafe products, and institute labelingrequirements.

The CPSC is an independent regulatoryagency charged with protecting consumers fromunreasonable risk of injury associated with con-sumer products. The most serious risks includeamputation, electrocution, burns, asphyxiation,and cancer. Examples of recent product liabilitylawsuits in which defendant companies lost in-clude breast implants that leaked silicone gel andfootball helmets that did not have enough pad-ding. The commission has jurisdiction overabout 15,000 types of consumer products, such asautomatic coffee makers, toys, furniture, cloth-ing, and lawn mowers. The CPSC works to re-duce the risk of injury and death from consumerproducts by:

● Developing voluntary standards with industry

● Issuing and enforcing mandatory standardsand banning consumer products if no feasiblestandard would adequately protect the public

CONSUMER PRODUCT SAFETY ACT OF 1972


A safety recall poster highlighting possible dangers to children.

CONSUMER PRODUCT SAFETY ACT OF 1972


● Obtaining the recall of products or arrangingfor their repair

● Conducting research on potential producthazards

● Informing and educating consumers throughthe media, state and local governments, andprivate organizations, and by responding toconsumer inquiries. (CPSC, 1999).

The CPSC has three key program areas:

1. The Office of Hazard Identification andReduction, which collects and analyzesconsumer injury and death data to deter-mine trends in consumer product haz-ards.

2. The Office of Compliance and Enforce-ment, which supervises compliance andadministrative activities related to the act.This office also reviews proposed stan-dards and rules with respect to their en-forceability.

3. The Office of Information and Public Af-fairs, which is responsible for thedevelopment, implementation, and evalu-ation of a comprehensive national infor-mation and public affairs program de-signed to promote product safety. (Fise,1998).

In recent years, the CPSC has been involvedin actions to protect children. In 1987, for exam-ple, the commission began to examine toys thatpose choking hazards. This led Congress to passthe Child Safety Protection Act of 1994. A sampleof child safety issues investigated by the commis-sion includes bicycle helmets, public play-grounds, upholstered furniture, walkers, draw-strings on children’s clothing, baseball protectiveequipment, and toys. More than 160 deaths fromtoys were reported between 1990 and 1997, andat least seventy-two different toys that posed asmall-parts hazard were recalled between Octo-ber 1996 and September 1997 by the CPSC.(Public Interest Research Group [PIRG], 2000).PIRG reports that in 1998 fewer toys posingchoking hazards appeared on shelves.

In addition, the commission has also writtenrules to establish performance, design, composi-tion, packaging, and construction standards formany products. Examples of products with man-datory safety standards include matchbooks,walk-behind power lawn mowers, residential ga-rage door openers, swimming pool slides, chain-saws, home-use pesticides, and cellulose insula-tion (Garman, 1997).

Consumers have benefited in the areas wherethe CPSC has taken action. The commission isconstantly challenged to keep abreast of newproducts and potential hazards that may be asso-ciated with them. The commission is usually ableto react, however, only after a consumer has beeninjured or died. The CPSC has changed the waymany products are designed and manufactured.Continuing education by consumer groups, themedia, and the CPSE has helped increase publicawareness of possible consumer safety hazards.The CPSC is an important consumer protectionagency, protecting consumers by assuring thatproducts they use every day are safe.

BIBLIOGRAPHY

Consumer Product and Safety Act (1972). Section 2051.

Consumer Product Safety Commission (CPSC). ‘‘Who AreWe—What We Do for You.’’ www.cpsc.gov/about/who.html. March 1999.

Fise, M. E. R. (1998). ‘‘Consumer Product Safety Regula-tion.’’ In Regulation and Consumer Protection: Politics,Bureaucracy and Economics, ed. K. J. Meier, E. T.Garman, and L. R. Keiser. Houston, TX: DAME Publica-tions.

Garman, E. T. (1997). Consumer Economic Issues in America,5th ed. Houston, TX: DAME Publications.

Public Interest Research Group (PIRG). ‘‘Trouble in Toy-land; Positive Signs in 1998.’’ www.pirg.org/consumer/products/toy/98/page6.htm. March 2000

PHYLLIS BUNN

CONSUMER PROTEST

The United States was built on the philosophy ofensuring citizens’ rights. Specifically, individualshave rights set forth in the Constitution and Bill

CONSUMER PROTEST


Consumer advocate Ralph Nader.

of Rights. Throughout history, American citizensand consumers have expended considerable en-ergy toward ensuring that organizations, retail-ers, and governments recognize and adhere tothese rights. Further, when citizens believe one ofthose rights has been overlooked or denied, theyjoin in protest to rectify the perceived injustice.

For example, even before the American Rev-olution, when they were still English subjects,colonists were disgruntled by the British Parlia-ment’s imposition of a tax on tea imports. OnDecember 16, 1773, to protest the tea tax (whichhad been implemented to help the poorly man-aged and corrupt East India Tea Company avoidbankruptcy), citizens donned Mohawk Indiandisguises, boarded three East India Tea Companyships docked in Boston harbor, and threw 342chests of Ceylon and Darjeiling tea overboard.

Since the Boston Tea Party, consumers’quests to attain and maintain their rights havecontinued as an undercurrent of resistance tounfair business and industry practices that di-

rectly affected consumers’ health, welfare, andsafety. However, during certain volatile times(the Progressive era of the late 1890s, the Depres-sion years of the 1930s, and the 1960s throughthe 1970s), consumer concerns have been morestrongly emphasized.

Further, women’s magazines (McClure’s andLadies’ Home Journal, for example) awakenedwomen to the activist movement as a way ofensuring safe products, achieving justice, and at-taining a level of equality (Nader, 1999). Womenhave been concerned about such issues as pricerigging, monopolies, dishonest labeling of medi-cines, and contaminated food. Outcomes of theseefforts have included both self-policing and ex-ternal policing by some business, industry, andgovernment agencies to protect the environmentand consumers.

Upton Sinclair’s 1906 novel The Jungle ex-posed unsanitary food-processing and meat-packing conditions. The graphic nature of thebook sparked a public outcry that led to thepassage of legislation by Congress, including thePure Food and Drug Act of 1906, which createdthe Food and Drug Administration (FDA).

When use of a liquid sulfur drug, Elixir Sulfa-nilamide, resulted in the deaths of more than 100people in 1937, the Pure Food and Drug Act wasproven to be inadequate. In 1938 the federalFood, Drug, and Cosmetic Act, became law; be-fore marketing new drugs, manufacturers wererequired by this law to prove their safety to theFDA.

Consumer concerns were minimized byWorld War II and did not retake the stage untilthe early 1960s. President John F. Kennedy, con-sidering consumer protection an important issue,suggested improvements in existing programsand also proposed two new consumer-protectionprograms: creation of the position of special as-sistant for consumer affairs (created by PresidentLyndon B. Johnson in 1964) and creation of anational oversight board made up of labor, coop-erative, and consumer groups, the ConsumerFederation of America (established in 1967).

Individuals have played, and continue toplay, integral roles in ensuring consumer protec-

CONSUMER PROTEST


tion. Ralph Nader, for instance, has led a crusadeto ensure consideration and enforcement of con-sumer rights for more than three decades. Naderand his advocacy groups, known as Nader’sRaiders, have investigated complaints, docu-mented harm, determined responsibility, dissem-inated information about consumer abuse, pro-posed alternatives, instigated reform, andcampaigned to provide the consumers’ viewpointto a wide range of audiences, including govern-ment and large corporations. Often these activi-ties not only resulted in important consumer vic-tories; they also resulted in positive changes inthe political climate and in the institution of self-regulation to ensure that regulations are met.

From the appearance of the automobile onthe American landscape through 1966, when afederal auto safety law was enacted, corporatedecision makers had determined the level ofsafety for their automobiles. From the first deathin 1899 until 1966, about 2 million automobile-related deaths occurred as well as about 100 mil-lion injuries, a figure three times greater thanU.S. combat losses in all military actions. Con-sumer advocates postulated that many of thosedeaths and injuries might have been avoided hadautomobile producers included certain safetyfeatures as part of the standard package. Con-sumers began to demand automobile safety fea-tures such as turn signals, seat belts, and air bags.

Nader began his first consumer campaign in1965 with his book Unsafe at Any Speed, whichdetailed Detroit automakers’ negligence and call-ing the Corvair ‘‘one of the nastiest handling carsever built (quoted in Watson, 1997). In 1969,after considerable consumer activism, Chevroletceased Corvair production. Later, in 1972, theDepartment of Transportation (DOT) tested theCorvair and found the handling ‘‘at least as goodas the performance of some contemporary vehi-cles, both foreign and domestic’’ (quoted in Wat-son, 1997); however, Nader contested the DOTfindings.

Another federal agency, the National High-way and Traffic Safety Administration (NHTSA),was established to ensure highway and automo-bile safety. It was responsible for setting minimal

safety standards for automobiles, as well as en-suring consumer notification of automobilesafety defects. NHTSA developed and issuedthirty standards in 1967 aimed at reducing crashpotential and resulting damage. However, con-sumers were generally not aware of these safetyrequirements, which included, among others, in-stallation of simple components that would re-duce head trauma (laminated windshields), pre-vent injury to the upper body (collapsiblesteering columns), and prevent occupants frombeing ejected from the car on impact (strongerdoor locks). Consumer rights are also protectedby local and state governments. For instance, es-tablishing minimum safety standards to ensurehighway safety is the responsibility of the individ-ual states; and consumer complaints against spe-cific businesses are often resolved with assistancefrom local consumer affairs offices.

Over the years, Nader and his associatesformed several consumer watchdog groups andinstigated activist movements. Included amongthese were the Critical Mass research project,which was directed at nuclear power’s negativeimpact on citizens’ health, and the Public InterestResearch Group (PIRG), which addressed bank-ing and corporate accountability as well as taxexemptions and government subsidies for bigbusiness.

Based on the initial successes of the PIRG,Nader formed the Public Citizen Tax ReformResearch Group in 1972. The tax group’s Peopleand Taxes was the first publication to explain themanipulation of the tax system to subsidize bigcorporations, thereby burdening the average tax-payer. In 1976, after many successful tax-reformactions, Tom Stanton, and his colleagues BobBrandon and Jonathan Rowe, published a suc-cinct, understandable tax analysis: Tax Politics:How They Make You Pay and What You Can DoAbout It.

Nader and his Raiders have played majorroles in addressing and resolving consumer mat-ters involving, among others, consumers’, work-ers’, and airline passengers’ rights; telecommuni-cations; education; banking; automobile safety;environmental protection; and legal issues. Their

CONSUMER PROTEST


campaigns, publications, and books have also re-sulted in the emergence of public opinion in sup-port of environmental protection. Additionally,John C. Esposito’s 1970 book, The Vanishing Air,presented the Clean Air Act of 1967 as havingfailed to initiate effective air pollution controls.At about the same time, the Environmental Pro-tection Agency increased its focus on environ-mental issues, and the Clean Water Act (1972)was passed, both resulting from public reactionto the publication of David Zwick’s WaterWasteland, which critiqued the failures of pollu-tion-control laws. Further, in response to statisti-cal findings in 1970 that worker deaths and disa-bilities totaled over 14,000 annually, Nadersponsored Joseph Page’s report Bitter Wages,which helped turn the public and political tidetoward enacting the Occupational Health andSafety Act legislation.

While OSHA has often been perceived byconsumer activists as being slow to act or react, ithas established standards that ensure businesscompliance with workplace safety mandates. Ad-ditionally, OSHA standards aid in reducing and,hopefully, minimizing cancer risks resulting fromuse of ordinary carcinogens, including industrialchemicals, such as benzene; pesticides, such asDBCP; ethylene oxide, a carcinogenic gas that isused for medical equipment sterilization; andformaldehyde, which is used in countless educa-tional and industrial environments. All thesestandards stemmed from the work (from 1974through 1983) of the Public Citizen Health Re-search Group headed by Dr. Sidney M. Wolfe.

Nader and his Raiders managed to pinpointand report dozens of consumer inequities, in-cluding ones involving such corporations as DuPont and Citicorp, but they have not been alonein the quest to establish and enforce consumerrights. Individuals and other traditional andnewly established groups (such as the RainforestAction Network, People for Ethical Treatment ofAnimals, Earth First) have used various means,including boycotts, to make their displeasureknown to business, industry, and governmententities. Manufacturers suffered from more than200 boycotts in 1990 (Rice, 1990), and the num-

bers have continued to increase as technology hasfacilitated ease of information access.

Friedman (1995) defines a consumer boycottas an action that deprives the organization ofsales, thus threatening its survival. Such action is‘‘an attempt by one or more parties to achievecertain objectives by urging individual con-sumers to refrain from making selected pur-chases in the marketplace.’’ (p. 199) Local, state,and international boycotts appear to be less com-mon than national boycotts, and the duration ofboycotts varies. Short-term boycotts usually lastthree months or less, whereas long-term boycottssometimes last more than a year. Friedman(1995) also noted that boycott characteristicsevolve over time. From the beginning announce-ment that a boycott is being considered, the levelof militancy builds, and many media-orientedboycotts combine the power of the media withtheir own actions to achieve the desired outcome.

In 1994, protesters boycotted dairy productsin an effort to prevent products from cows in-jected with BGH, a hormone to increase bovinemilk production, from being marketed. The hor-mone has potential to create other medical com-plications, which could result in potential healthrisks to consumers. The FDA affirmed that theconcerns expressed by boycott participants mightbe valid. Additionally, in response to the boycott,several national food distributors and grocerychains announced that they would not sell goodsfrom BGH-treated cows.

In 1996, Consumers Union of the U.S., Inc.,published its 60th anniversary article, which de-tailed consumer action victories over the preced-ing sixty years and affirmed the value of theirpublication Consumer Reports. This publication’smission is to detail the most urgent consumerissues. That article provided a listing of consumerissues perceived at that time to be most pressing:commercial clutter, health care, the informationage, economic insecurity, the environment, andconsumer rights.

As mentioned earlier, self-regulation throughcodes of ethical conduct and establishing, re-viewing, and maintaining product standards hasbecome essential for maintaining fruitful cus-

CONSUMER PROTEST


tomer/organizational interaction. Self-regula-tion, has engendered creation of such consumer-focused organizations, as Better Business Bu-reaus, the International Business Ethics Institute,and the Internet Law and Policy Forum, to namea few. Additionally, self-regulation programshave been created, such as the Chemical Manu-facturer Associations Responsible Care programand the standards of ethical conduct drafted bynumerous professional organizations (e.g.,American Bar Association, American MedicalAssociation, Institute of Electrical and ElectronicEngineers, and American Dental Association).While these self-regulation initiatives generallywere responses to consumer concerns in the earlydays of consumer protest, industries subse-quently began to self-regulate voluntarily andnow view it a matter of course and as a comple-ment to government regulation.

Today, the consumer movement continuespressuring for consumer protection against suchproblems as misleading advertising and defectiveproducts and for such benefits as safer food anddrugs, and affordable utilities. As the level ofactivism grows greater, challenges are generatedfor businesses and industries, for some com-plaints are costly to resolve. In the past, the sides(activist versus business) became polarized, re-sulting in delayed resolution. Wise business andindustry representatives, therefore, are not onlyproactively assuming responsibility for meetingactivist-generated challenges, but also taking anactive role in setting the public agenda for con-sumer concerns.

BIBLIOGRAPHY

‘‘America: History and Life.’’ (1980). http://serials.abc-clio.com/cgibin/nph-appframework/ABC-Clio.Serials.

American Civil Liberties Union. (1991).‘‘The Bill of Rights:A Brief History.’’ ACLU Briefing Paper. http://www.aclu.org/library/pbp9.html.

‘‘AnthemMergers Spark Protest.’’ (1997). Indianapolis Busi-ness Journal 18(42):7.

‘‘Bank-Bashing Goes Digital at Internet Gripe Sites.’’ (1999).American Banker 164(58):1-2.

Better Business Bureau. (1999). ‘‘Dow Brands and LeverBrothers Prove Industry Self-Regulation Works.’’http://www.bbb.org/advertising/nad/nadlever.html.

Bollier, D. ‘‘Corporate Abuses, Consumer Power.’’ (UK) InCitizen Action (Chapter 5). http://www.nader.org/history/bollier–chapter–5.html.

‘‘Boycotting BGH.’’ (1994). Environmental Action 26(1):9.h t t p : / / g w 4 . e p n e t . c o m / f u l l t e x t . a s p ? . ..mer%20protests&fuzzyTerm��FullText.

Brobeck, S. (1990). The Modern Consumer Movement: Refer-ences and Resources. G. K. Hall.

Consumer Bankers Association. (1999). http://www.cbanet.org/.

‘‘Consumer Rights.’’ http://www.nolo.com.

‘‘Consumer Rights.’’ http://www.consumer.gld.gov.

Fair Credit Reporting Act. http://www.moody.af.mil/wg/ja/fcra.htm.

Fair Debt Collection Practices Act (FDCPA). http://www.consumeraid.org/debt.htm.

Friedman, M. (1995). ‘‘On Promoting a Sustainable FutureThrough Consumer Activism.’’ Journal of Social Sciences51(4):197-215.

Furger, R. (1999). ‘‘Washington Tackles Internet Law.’’ PCWorld Online. http://www.pcworld.com/shared/printable–articles/0,1440,11862.00.html.

Garner, S. (1997). ‘‘Long March to Self-Regulation.’’Network World Today. http://www2.idg.com.au/nwwdb.NSF/8...666e54a2564de000eb51a?OpenDocument.

Historic Tours of America. (1999). ‘‘Boston Tea Party Shipand Museum.’’ http://historictours.com/boston/teaparty.htm.

Internet Law and Policy Forum. (1999). ‘‘ILPF AnnouncesSelf-Regulation Initiative.’’ http://www.ilpf.org/selfreg/announce.htm.

Jacob, J. A. (1997). ‘‘Consumer Protests Stall Blues Merger;Opposition Focuses on Loss of Charitable Assets.’’American Medical News 40(39):3-4.

King, A. and Lenox, M. (1999). ‘‘Industry Self-RegulationWithout Sanctions: The Chemical Industry’s Responsi-ble Care Program’’ (working paper abstract). http://www.stern.nyu.edu/om/aking/workingpaper3.htm.

Miller, J. C., III. (1985). ‘‘The FTC and Voluntary Standards:Maximizing the Net Benefits of Self-Regulation.’’ CatoJournal 4(3):897-903.

Massachusetts Nurses Association. (1996). More Than 1,000People Turn Out for Patients Not Profits Forum . . .Ralph Nader Encourages Nurses and Consumers to Be-come Allies for Quality Care. Nursing

Murphy, G. (1996). ‘‘The Bill of Rights Amendments 1-10 ofthe Constitution.’’ http://leweb2.loc.gov/const/bor.html.

CONSUMER PROTEST


Nader, Ralph. (1999). ‘‘Overcoming the Oligarchy.’’ (1999).The Progressive 63(1):58-61.

Noe, T. H., and Rebello, M. J. (1995). ‘‘Consumer Activism,Producer Groups, and Production Standards.’’ Journal ofEconomic Behavior & Organization, 69-85.

Nowlan, J. ‘‘Self-Regulation Only Way out of Budget Holeand Social Malaise.’’ http://jim.nowlan.nidus.net/selfgov.htm.

Office of Consumer Affairs. (1999). http://cher.eda.doc.gov/agencies/oca/index.html.

Pagan, R. D. (1989). ‘‘A New Era of Activism.’’ FuturistMay/June: 5.

‘‘Right to Protest, The.’’ (1999). http://www.geocities.com/SoHo/Workshop/1813/articles/daishowa.html.

‘‘Role of Litagation and Alternatives Thereto in ConsumerActivism, The.’’ (1991). Canada-United States Law Jour-nal 17:381-387.

Rotfeld, H. (1998). ‘‘Commentary: Misplaced Marketing—When Consumers or Society Are Not Satisfied.’’ Journalof Consumer Marketing 15(6):523-524.

Stoffer, H. (1997). ‘‘Mitsubishi Hit with Whale of a Prob-lem.’’ (1997). Automotive News 71(5725):1-6.

‘‘Six Key Issues: Then and Now.’’ (1996). Consumers Reports61(5)(May):6.

Stewart, T. A. (1989). ‘‘The Resurrection of Ralph Nader.’’Fortune (May): 106-111.

Watson, B. (1997). ‘‘Biggest Corvair Parts Supplier.’’ DailyHampshire Gazette. http://www.ziplink.net/users/mak/bac/articles/newspaper2.html.

Weidman, K. (1998). ‘‘Journalist-Turned-Educator UrgesMedia Self-Policing.’’ The Freedom Forum. http.//www.freedomforum.org/newseumnews/1998/8/4thornton.asp.

‘‘What’s in a name?’’ (1992). U.S. News & World Report112(10):17.

Worcester Polytechnic Institute. (1999). ‘‘Military Science:Boston Tea Party.’’ http://www.wpi.edu/Academics/Depts/MilSci/BISI/abs–bostea.html.

MARY JEAN LUSH

CONTEMPORARYMANAGEMENT THOUGHTS(SEE: Management)

CONTINGENCY MODEL(SEE: Management Styles)

CONTINUING PROFESSIONALEDUCATION(SEE: Professional Education)

CONTRACTS‘‘A contract is a promise or a set of promises for thebreach of which the law gives a remedy, or the per-formance of which the law in some way recognizes asa duty.’’

The freedom to contract has not existed through-out history. In medieval England, the courts didnot engage in the enforcement of agreementsbetween individuals. Rather, the feudal societythat ruled personal interaction was relied uponfor all forms of trade. As society evolved to em-phasize individual freedoms over social caste, theability to contract was viewed as a fundamentaltenet of individual liberty. Writers and economictheorists such as Adam Smith, David Ricardo,Jeremy Bentham, and John Stuart Mill ‘‘succes-sively insisted on freedom of bargaining as thefundamental and indispensable requisite of prog-ress; and imposed their theories on the educatedthought of their times.’’

Article I, Section 10 of the U.S. Constitutionprotects the individual right to contract by stat-ing that, ‘‘No State shall . . . pass any . . . lawimpairing the obligations of Contracts.’’ Manystate constitutions contain similar provisions.

Generally, the law of contracts does not comefrom statutes passed by Congress or by state leg-islatures, but rather is a product of the commonlaw, the continuing line of court decisions datingback to pre-colonial English courts. The com-mon law is living and constantly evolving, asmodern courts continue to analyze, revise andeven disagree on its application. The AmericanLaw Institute, a collection of legal scholars andpractitioners, attempted to catalogue the com-mon law of contracts in its Restatements of theLaw of Contracts in 1932. The Restatement, Sec-ond, of the Law of Contracts was published in1979. The Restatement, although it does not havethe force of law itself, is generally regarded as anexcellent source. The law of contracts is also sig-

CONTEMPORARY MANAGEMENT THOUGHTS


nificantly influenced by the Uniform Commer-cial Code (UCC), which has been adopted inforty-nine states. The UCC is an attempt to stan-dardize laws dealing with contracts and com-merce. The UCC is beyond the scope of thisarticle.

FORMATION OF A CONTRACT

A contract consists of one individual making anoffer, another accepting the offer, and the exis-tence of consideration between the contractingparties.

OFFER

An offer is the expression of a willingness to enterinto a bargain. An offer must be directed to aparticular offeree and be sufficiently clear so as tojustify another individual in the belief that accep-tance of the offer would constitute an agreement.Although an offer need not set forth all terms ofthe potential bargain (even the price may be leftto be later determined), a valid offer mustidentify the fundamental elements of the pro-posed agreement. An offer may be revoked at anytime before it is accepted or before it is reason-ably relied upon by another individual.

ACCEPTANCE

Acceptance of an offer is the communication bythe offeree of mutual assent, that is, the agree-ment to be bound by the terms of an offer. Anoffer may be accepted only by a person to whomthe offer was directed and only before the offerterminates or is revoked. A valid acceptance mustbe communicated to the offeror by the same orsimilar means under which the offer was com-municated, and must be unequivocal to make theagreement binding. At common law, it is gener-ally held that any deviation from the terms of theoffer is not an acceptance, but rather a rejectionand a counteroffer. If the offer identifies a specificmode of acceptance, such as form, date, time, orplace, that mode must be followed for an accep-tance to be valid. Generally, an acceptance is noteffective until it comes into the possession of theofferor, although some states employ themailboxrule, which makes acceptance sent by U.S. mail

effective upon its deposit in the mail. If an offerspecifically invites acceptance by performance ofa specified act, performance of that act by theofferee constitutes acceptance without notifica-tion of the offeror. Except in very limited circum-stances, such as where the parties have a patternof previous dealings or where it would be in-equitable to find otherwise, silence does not con-stitute acceptance.

CONSIDERATION

An offer and acceptance alone do not create avalid and binding contract. A third element,consideration, must exist. Consideration is abargained-for exchange, that is, the existence ofmutuality of obligation. Both parties must derivesome benefit—or, alternatively, both partiesmust experience some detriment or forbear-ance—for a contract to exist. Without consider-ation, an offer and acceptance represent merely anaked, unenforceable promise.

While the existence of consideration is criti-cal to the enforceability of a contract, the quan-tity or quality of consideration is immaterial.Generally, courts are not concerned with thevalue or adequacy of consideration and will notinterfere with a bargain entered into between theparties because of insufficient consideration. Cer-tain acts or forbearance cannot constitute consid-eration. A preexisting duty to perform or refrainfrom performing may not be consideration for acontract. Therefore, fulfilling an existing contrac-tual obligation or refraining from an unlawful actcannot constitute consideration. An exception tothis rule is that the agreement to pay a preexistingdebt may be consideration. A promise to make agift is not consideration, nor is a moral obliga-tion. A promise not to sue, so long as the right tosue actually exists, may be consideration.

DEFENSES

In its most basic form, a contract exists wherethere is an offer, an acceptance of the offer, andconsideration to support the contract. Despitethe existence of these three elements, enforce-ment of a contract may be denied if a sufficientdefense to the formation of a contracts is present.

CONTRACTS


In order for an individual to enter into acontract, that person must have the legal capacityto do so. At common law, minors, individualswho are mentally ill, persons under the influenceof alcohol or drugs and those under a legalguardianship lack legal capacity to contract. Therule as to minors is that a contract of a minor isvoidable, not void. That is, a minor has the optionto make a contract valid or not. However, if aminor enjoys the benefit of a contract, the minoris obligated either to repay the other party or tofulfill the minor’s obligations under the contract.In addition to capacity, an individual must havethe legal competency to enter a contract. Compe-tency is generally defined as the mental ability ofa party to contract. In other words, a legally com-petent person is one who possesses the ability torecognize and understand the contractual obliga-tions that will result. Courts will assume thatcapacity and competency exist until it is provedotherwise.

If the parties to a contract make a mutualmistake with regard to that contract, such as amutual misunderstanding, there is no mutualassent and therefore no contract. Clerical errors,known as scrivener’s errors, will generally be cor-rected by a court. That is, rather than finding thecontract invalid, the court will merely correct theerror.

A contract that is based on a fraudulent mis-representation of a material term is unenforce-able. A fraudulent misrepresentation is materialif the maker intended for the misrepresentationto induce the other party to enter the contractand if the misrepresentation would likely inducea reasonable person to so enter the contract.

Duress may make a contract unenforceable.Physical duress, or forcing a person to accept anoffer, invalidates the contract, while the threat ofphysical harm makes the contract voidable at theelection of the victim. Courts are divided onwhether economic duress is sufficient to deny theenforceability of a contract.

A contract that is entered into under undueinfluence is also voidable at the election of thevictim. Undue influence exists where one im-properly takes advantage of one’s relationship

with another to coerce the other person to enter acontract. Examples are the influence that an adultchild may have over an elderly parent who isdependent on the child for care, or the reliance ofan unsophisticated individual on a sophisticatedadviser, where the adviser is aware of the reliance.

As a general rule, an illegal bargain is void asa matter of law and may not be enforced. There-fore, a contract to commit murder, to rob a bank,or to steal a car is void as a matter of law.

A contract may be void because enforcementof the contract would be unconscionable. It isimportant to understand that mere dispropor-tionality of the benefits of a contract, no matterhow great, does not make the contract void asunconscionable. Unconscionability may befound only where there is grossly disproportion-ate bargaining power to the extent that one of theparties had virtually no choice in accepting theterms of the contract. Contracts are rarely foundto be unconscionable unless a significant publicpolicy issue is involved.

CONTRACT INTERPRETATION

An offer, acceptance, and consideration must bepresent to form a contract. The defenses to con-tract formation, as discussed above, may be usedto show that no contract exists. However, even ifit is shown that a contract does exist, questionsmay arise as to the content and meaning of thatcontract.

RULES OF CONSTRUCTION

In interpreting contracts, courts generally followcertain fundamental rules of construction. Underthe four corners rule, courts will restrict theiranalyses to the written terms of the agreementitself, wherever possible. Ambiguities will be con-strued against the drafter. Courts will generallyseek to harmonize the terms of a contract in amanner that makes those terms consistent.Courts will generally find that specifics in a con-tract will control over generalities. Words andphrases used in a contract are given their plainmeaning absent evidence to the contrary.

CONTRACTS


PAROL EVIDENCE RULE

The parol evidence rule provides that if the partiesto a contract intended for their contract to be acomplete integration, that is, if the parties in-tended that the written agreement be the fullextent of the understanding between them, thenevidence other than the contract itself may not beadmitted to contradict the written terms. There-fore, in interpreting a contract, the court shouldgenerally not look beyond the contract itself forinterpretation. The parol evidence rule permitsevidence intended to prove or disprove the legiti-macy of contract formation, such as evidenceshowing a party’s capacity or showing fraud ormutual mistake, but prohibits evidence intendedto vary, contradict, or change the terms of thewritten agreement. Of course, if a contract refersto another document, that other document maybe admitted to explain the terms of the contractat issue.

STATUTE OF FRAUDS

A common mistake is the belief that oral con-tracts are not enforceable. In fact, most oral con-tracts, if they fulfill all of the requirements of acontract, are indeed enforceable. However, thestatute of frauds requires that in certain specificcircumstances, contracts must be in writing.While the requirements vary from state to state,generally the statute of frauds requires the fol-lowing contracts to be in writing: contracts byexecutors, administrators, or other personal rep-resentatives; contracts in consideration of mar-riage; contracts for the sale of real estate; con-tracts for the sale of goods exceeding $500; andcontracts that will not be performed within oneyear of the making of the contract. The statute offrauds generally does not require any particularwritten form, and generally a contract will suf-fice so long as it identifies the parties, describesthe subject matter, states the essential and mate-rial terms, states that consideration exists, and issigned by the party against whom enforcementis sought.

REMEDIES AND DAMAGES

Throughout this article, reference has been madeto the court’s enforcement of a contract. This, ofcourse, begs the question of what course of actionmay be taken to enforce a contract, to repay thevictim of a breach of contract, or to punish thosewho breach.

Generally, the victim of a breached contractis entitled to be made whole, or put in the sameposition as that party would have been in had thecontract been fulfilled. Commonly, this is doneby forcing the breaching party to pay theaggrieved party compensatory damages. Compen-satory damages are intended to compensate thenonbreaching party for the actual damages suf-fered. Normally, compensatory damages aremeasured by the party’s expectancy, or what theparties should have reasonably foreseen as flow-ing from the breach. Expectancy damages are of-ten described as conferring the benefit of the bar-gain upon the nonbreaching party. Whereexpectancy damages are difficult to determine orotherwise impractical, a party may receive reli-ance damages, which are intended to compensatefor the losses incurred in relying on the breachingparty’s fulfillment of the contract. A third alter-native for compensation is restitution, where thebreaching party must compensate the victim forthe benefit conferred upon the breaching party.

Liquidated damages are a method used bycontracting parties to estimate the damages thatwill result in the event of a breach. Liquidateddamages may not serve as a penalty against thebreaching party, but so long as they are a reason-able estimate of the damages that would be suf-fered by the nonbreaching party, they will beenforced. A clause in an apartment rental con-tract that requires a breaching party to pay twomonths rent is a common form of liquidateddamages.

Punitive damages are those intended topunish the breaching party. Punitive damages areavailable only in very rare cases; they generallyare not awarded in contract disputes.

Finally, equitable relief is available tononbreaching parties where none of the aboveremedies would be sufficient. Under the concept

CONTRACTS


of equity, a court may take corrective actionother than by awarding money. In rare circum-stances where none of the above described com-pensatory damages would be sufficient, a courtmay order specific performance. That is, the courtwill order the parties to fulfill their obligationsunder the contract. This method is not favoredbecause of the practical difficulty of enforcement,but in some cases, such as the purchase of realestate, art, and the like, it is the only remedy thatis sufficient. Also available is an injunction, whichis a court order preventing a party from takingfurther action, such as a continued breach of acontract.

KEITH A. BICE

COOPERATIVE

A cooperative (also referred to as a co-op) is aform of business ownership that consists of agroup of people who have joined together toperform a business function more efficiently thaneach individual could do alone. The purpose of acooperative is not to make a profit for itself, butto improve each member’s situation. However,members of certain types of cooperatives domake a profit by selling their product and/orservice to customers who are not co-op mem-bers.

Cooperatives can take many forms. For ex-ample, a group of single parents may decide toband together to provide a child-care facility sothey will have reliable day care for their children.Each parent contributes a certain amount ofmoney and/or time, and in exchange they all havea safe place to leave their children. A credit unionis also a type of cooperative. The purpose of acredit union is not to make a profit for itself, butto help each member be more financially secure.By creating their own financial institution, mem-bers can receive a higher interest rate on themoney they have placed in savings and receive alower interest rate on loans. Retailers have alsostarted establishing co-ops. Ace Hardware, forexample, is a co-op of independent hardwarestore owners. By banding together, the hardware

owners can share advertising costs and receivediscounts for bulk ordering of materials and sup-plies. Sharing costs and discounts allows smallhardware stores to compete with large chainhardware stores.

While cooperatives can be found in manydifferent areas of the economy, they are mostcommonly found in the agricultural area. Agroup of farmers may band together to allowthemselves to be more competitive and to achievemore economic power. Agricultural cooperativesallow members to save money on materialsneeded to produce and market their product,which means a larger profit margin for all mem-bers. Ocean Spray Cranberries, Inc., for example,is a cooperative of several hundred cranberry andcitrus growers from all over the country. Otherwell known cooperatives include Blue Diamond,Sunkist, IGA (Independent Grocers Association),and Land-O-Lakes.

BIBLIOGRAPHY

Boone, Louis E., and Kurtz, David L. (1999). ContemporaryBusiness, 9th ed. Orlando, FL: Harcourt Brace CollegePublishers.



National Cooperative Business Association. http://www.ncba.org/index.cfm. 1999.

Nickels, William G., McHugh, James M., and McHugh,Susan M. (1999). Understanding Business, 5th ed. BostonIrwin-McGraw-Hill.

Pride, William M., Hughes, Robert J., and Kapoor Jack R.(1999). Business, 6th ed. New York: Houghton Mifflin.

MARCY SATTERWHITE

COOPERATIVE ADVERTISING

(SEE: Advertising)

COOPERATIVE


IGA employees. The Independent Grocers Association is one example of a cooperative business group.

COPYRIGHTS

A copyright gives the owner the exclusive right toreproduce, distribute, perform, display, or licenseoriginal material. Further, the owner also receivesthe exclusive right to produce or license the pro-duction of derivatives of that material. In essence,a copyright provides protection to the ownerguaranteeing that material cannot be copied

without the owner’s permission. Under the cur-rent law, materials are covered whether or not acopyright notice is attached and whether or notthe material is registered.

Yet an exception exists for the fair use of thematerial. The fair use of copyrighted material in-cludes such use as reproduction for purposes ofcriticism, comment, news reporting, teaching

COPYRIGHTS


The ACE Hardware name and logo are examples of copyrighted material.

(including multiple copies for classroom use),scholarship, or research and is not considered aninfringement of a copyright. Thus, fair use allowsan individual to reproduce the material for non-profit activities.

Originally, copyrights referred only to writ-ten materials. However, copyrights have been ex-tended to include: (1) literary materials; (2)musical materials, including any accompanyingwords; (3) dramatic materials, including any ac-companying music; (4) pantomimes and chore-ographic materials; (5) pictorial, graphic, andsculptural materials; (6) motion pictures andother audiovisual materials; (7) sound record-ings; and (8) architectural materials. Thus, mate-rial must be original and published in a concretemedium of expression to be covered by a copy-right. In other words, for material to be eligiblefor copyright protection, a tangible product mustexist. Consequently, copyright protection doesnot extend to any original material for ideas,procedures, processes, systems, methods of oper-

ation, concepts, principles, or discovery, regard-less of the form in which the material is de-scribed, explained, illustrated, or embodied.

The owner of a copyright has the right to doand authorize any of the following: (1) to repro-duce the copyrighted material in copies; (2) toprepare derivative materials based on the originalcopyrighted material; (3) to distribute copies ofthe copyrighted material to the public by sale orother transfer of ownership, or by rental, lease, orlending; (4) in the case of literary, musical, dra-matic, and choreographic materials, panto-mimes, and motion pictures and other audiovi-sual materials, to perform the copyrightedmaterial publicly; and (5) in the case of literary,musical, dramatic, and choreographic materials,pantomimes, and pictorial, graphic, or sculpturalmaterials, including the individual images of amotion picture or other audiovisual materials, todisplay the copyrighted material publicly.

The Berne Convention was a convention forthe protection of literacy and artistic materials

COPYRIGHTS


and the Universal Copyright Convention is a con-vention to provide for the adequate and effectiveprotection of the rights of authors and othercopyright proprietors in literary, scientific, andartistic materials, which includes writings; musi-cal, dramatic, and cinematographic materials;and paintings, engravings, and sculpture. As aresult, international guidelines for identifyingmaterials that were subject to copyright protec-tion were established, and those guidelines in-cluded an administrative process for redress if anauthor believed material to be reproduced with-out permission. Not only were the materials sub-ject to copyright protection expanded from writ-ten materials to audiovisual materials; pictorial,graphic, or sculptural materials; architecturalmaterials; collective materials; and compilationmaterials; but reproduction of materials was re-fined to include performing or displaying mate-rial as well as transmitting the work without theauthor’s permission. The United States joined theBerne Convention for the Protection of Literaryand Artistic Materials in 1989.

The federal agency charged with administer-ing the act is the Copyright Office of the Libraryof Congress. As previously mentioned, materialsare subject to copyright protection with or with-out copyright notice attached to the material. Toobtain a copyright for an original work, an appli-cation for copyright registration should be filedwith the Register of Copyrights in the CopyrightOffice of the Library of Congress. The applicationrequests the following information: (1) the nameand address of the author of the material; (2) inthe case of materials other than anonymous ofpseudonymous work, the name and nationalityor domicile of the author or authors and, if oneof more of the authors is deceased, the dates oftheir deaths; (3) if the work is anonymous orpseudonymous, the nationality or domicile of theauthor or authors; (4) in the case of materialmade for hire, a statement to that effect; (5) if thecopyright claimant is not the author, a brief state-ment of how the claimant obtained ownership ofthe copyright; (6) the title of the work, togetherwith any previous or alternative titles underwhich the material may be identified; (7) the year

in which creation of the work was completed; (8)if the work has been published, the date andnation of its first publication; (9) in the case of acompilation or derivative material, an identifica-tion of any preexisting material(s) that it is basedupon, and a brief, general statement of the addi-tional materials covered by the copyright claimbeing registered; and (10) in the case of publisheddocuments containing materials manufacturedin the United States, the names of the individualsor organizations who performed the manufactur-ing process and the location where the manufac-turing process was performed. Simply, an authorof an original work must file the required infor-mation and form to register the copyright withthe Register of Copyrights in the Copyright Of-fice of the Library of Congress. The appropriatefee must accompany the form to register thecopyright. In addition, the Copyright Office ofthe Library of Congress has been charged withoverseeing the copyright process and reviewingany reported violations. While this office has themajor responsibility for adjudicating any allegedcopyright violations, the U.S. Supreme Court andthe U.S. Circuit Courts of Appeals have bothrendered decisions affecting copyrights.

RANDY L. JOYNER

CORPORATE EDUCATION

Civilization has entered the Information Age,where business is knowledge-driven. Industrieswhose product lines either provide knowledge(e.g., software, information technology, and bio-technology) or process knowledge (e.g., telecom-munications, banking, and advertising) place anincreasing emphasis on speed, flexibility, techni-cal expertise, and innovation. Consequently, it isimperative to the survival of any business organi-zation to continually upgrade the knowledge baseand skill levels of its work force in order to keepup with the ever-changing demands of the globalmarketplace and advances in technology.

A corporation’s future is determined largelyby its involvement in the development of its in-tellectual resources. Enterprises are growing and

CORPORATE EDUCATION


A corporate outdoor training session in progress.

expanding the education segment of their busi-ness activity, realizing that without this input,they will quickly lose their competitive edge in ahighly competitive global economy. Not only iscontinuing education vital to the future successof any organization; it is of equal importance thatemployees remain adaptable and agile learners inorder to profit personally and professionallyfrom available opportunities generated by thisnew economy. Investing in the right program, forthe right people, at the right time will continue tobe a challenge for businesses as they strategicallyattempt to capitalize on the vast opportunitiesavailable to them in the twenty-first century.

Another important reason for the continuinggrowth of corporate education is that manyhighly competitive businesses are abandoning themultilayered hierarchical organization in pursuitof a structure that empowers front-line workerswith the authority to solve problems and makedecisions in areas that affect their realms of ex-pertise. Corporate restructuring, as well as high-

speed technological advances, gives employeesbroader responsibilities that require more skillsand training for self-managed, cross-functionalteams (Atkinson and Court, 1999).

TYPES OF CORPORATE EDUCATION

Independent Study Independent study is agrowing trend in corporate education gearedtoward providing employees with interactiveWeb-based training, also known as virtual class-rooms, from the comfort of their own desks. TheWeb reduces time and company costs by 50 per-cent over classroom training (Roberts, 1998).Employees are provided with the flexibility tolearn at their convenience, at their own pace, andfrom most locations. This method is beneficialfor those who lack the time to attend a regularlyscheduled class and for those who are uncom-fortable in traditional classroom situations wherethey would be expected to grasp concepts at thesame rate as fellow classmates.

CORPORATE EDUCATION


The value of an independent-study programis enhanced when used in conjunction with elec-tronic mail, live chatroom discussions, and desk-top videoconferencing. These additional toolsand resources allow employees to participate inelectronic discussion groups that serve to rein-force learning objectives. On-line learning via thevirtual classroom relies more on students’ learn-ing from collaborative discussions and team pro-jects than from lectures. As high-speed forms ofcommunication media become available, CEOsof many large corporations are encouraging thetraining of their work force in on-line skills (Ro-berts, 1998). In terms of public image, theseindustries project awareness and competency inleading-edge technology, winning the confidenceof customers and associates as well as command-ing respect from rivals.

Apprenticeships and On-the-Job TrainingApprenticeships are a form of on-the-job train-ing whereby individuals with little or no knowl-edge of certain trades are prepared for occupa-tions in skilled crafts and earn hourly wages asthey learn. Experienced workers train employeesto become, for example, accomplished electri-cians, machinists, operating engineers, and tool-and-die makers. Such programs incorporate acertain prescribed number of hours of relatedclassroom instruction. Examples of courseworkinclude safety, mathematics, schematic reading,and technical courses related to particular jobrequirements. ‘‘Statistics show that programgraduates earn higher wages, have more stablework records, and are promoted more often thanworkers who have not been trained through ap-prenticeship programs’’ (Texas Workforce Com-mission, 1999).

Other on-the-job training programs are cus-tomized for participants who have some job-related skills but need to become more knowl-edgeable and proficient in a particular trade. Aswith apprenticeships, employees benefit becausethey are paid to learn. In addition, employersbenefit from hosting on-the-job training pro-grams because they have the full-time services ofmotivated individuals who are training to fulfillspecific company needs. Participants also include

long-time employees who need to adapt to newtechnologies and procedures, ‘‘skills essential tothe full and adequate performance of the job’’(Texas Workforce Commission, 1999).

Traditional Classroom Instruction ‘‘Most or-ganizations equate employee development withclassroom training. Billions are spent providingclasses—mostly classroom-based lectures—toemployees at all levels. The material taught ismostly concepts, theories, approaches used byother organizations, and analysis of past events’’(Wheeler, 1999). Traditional classroom instruc-tion, however, is becoming obsolete. Whetherclasses are held in an on-site conference room orat an off-site facility, participants must attendregularly scheduled sessions that frequently in-terfere with work and personal obligations. Inaddition, the time spent in the classroom is oftenunproductive. Individuals who arrive at the spec-ified time may spend several minutes waiting forthe others in the class before the session com-mences. If the instructor is the only active partici-pant, the training objective of the course eludesthose required to attend. The lack of interactivelearning causes students to lose their focus on thecourse content, become passive, daydream, andwatch the clock.

Corporations with frequent employee turn-over, such as the hotel and resort industry, findtraditional classroom education to be inefficient,expensive, and pointless. This type of industrymust train its staff in order to properly anduniformly satisfy customer service requirements;however, employees are usually seasonal workers,making repeat training an exhausting necessity.Also, tight budgets limit the number of corporatetrainers available, creating additional problemsfor international chains. Lack of proper trainingprevents workers from doing their jobs well,which negatively impacts the business.

For the reasons explained above and manymore, organizations are shifting from traditionalclassroom instruction to Web-based interactivetraining that actively involves students in thelearning process. These programs are always ac-cessible from designated worldwide locations andare easily modified to reflect cultural and lan-

CORPORATE EDUCATION


guage differences. Students may participate fre-quently and at their own convenience.

Unconvent iona l Tra in ing ProgramsRegardless of the method used, the training andeducation department of an organization shouldbe designed to ‘‘maintain tighter ownership oflearning outcomes in order to better meet corpo-rate priorities’’ (Meister, 1999). Educationalpriorities are not always focused on implement-ing physical applications. Sometimes the purposeof training is to modify employee attitudes andwork ethics, thereby transforming the internalcorporate culture into one that is compatiblewith the corporation’s external image and direc-tion. Among the multitude of programs that maybe appropriate for this type of application areleadership development, team building, and con-flict resolution.

Corporate outdoor training, less conven-tional than the traditional classroom approach, isgaining in popularity with many internationalbusinesses as an informal yet meaningful methodof conveying corporate values across a diverserange of cultures. ‘‘The outdoors provides aunique learning environment for individual chal-lenge, personal development, and promotingbeneficial team behaviors’’ (Brooks, 2000). Activ-ities include ones such as canoeing, rafting, andclimbing that incorporate initiative and problem-solving skills. ‘‘Teams provide a vehicle for peo-ple to become involved, learn from each other,and work toward constant improvement. Learn-ing is most effective when it involves active par-ticipation’’ (Corporate Outdoor Training, 2000).

Another unconventional type of corporateeducation program emphasizes the usefulness ofhumor in the workplace. This program encour-ages employees, starting with upper manage-ment, to laugh and have fun, making work moreenjoyable for everyone. The motivation behindthis type of training is to create an atmosphere inwhich employees want to work, are proud oftheir contributions, and enjoy the company ofco-workers. Participating organizations benefitfrom a reduction in stress-related absenteeismand an increase in work-force creativity and in-novation. Many corporations have become suc-

cessful because they realized in the early stages oftheir development that a happy team is a winningteam and that ‘‘work can be play, and play can beextremely productive’’ (LeBrun, 2000).

ONGOING VALUE OFEDUCATING WORKERS

Corporations cannot afford to become compla-cent in the belief that they possess an abundanceof educated employees who are sufficiently famil-iar with existing technologies. As demonstratedthroughout the last century, continuous techno-logical developments altered the course of busi-ness from a process standpoint, outdating toolsand business practices that were once considereduseful, even state-of-the-art. As the world beginsits journey through the increasingly competitiveglobal economy of the twenty-first century, con-tinuous employee education remains a criticalcomponent in determining an industry’s abilityto survive. Evolving information systems and pe-ripheral equipment will further facilitate world-wide business communications and transactions,allowing instant access to many types of datafrom a variety of locations. Speed and proficiencyin the use of these systems, which are attainedmainly through continuous work-force educa-tion, will determine an industry’s status withinthe business community.

It is unlikely that this trend will reverse. Thehuman race is becoming accustomed to informa-tion-on-demand and, in the long run, technologyis cost-efficient. According to Ken Bryant, SeniorBusiness Specialist for Genicom Corporation, aVirginia-based printer manufacturer and net-work integration company, ‘‘With the growth oftechnology based businesses, especially withinthe burgeoning Internet marketplace, it is corpo-rate suicide not to actively encourage and pro-mote ongoing corporate training among staff.Technology companies have revolutionized mar-keting, customer service and many other facets ofbusiness, changing corporate culture and man-dating an increasing level of competence. Lack oftraining, whether through traditional classes,continuing education venues, or informal work(help) groups, puts companies at a distinct disad-

CORPORATE EDUCATION


vantage in global commerce’’ (personal commu-nication, January 27, 2000). The most importantgoal of any corporation is to increase profits.Without an ongoing commitment to work-forceeducation, businesses set themselves up for fail-ure. Complacency insures that organizationalgoals will never be attained.

BIBLIOGRAPHY

Atkinson, R. D., and Court, R. H. (1999, April). CorporateExpenditures on Training have Slightly Declined. The NewEconomy Index: Foundations for Future Growth.http://www.dlcppi.org/ppi/tech/neweconomy–site/section3–page18.html.

Brooks, C. Team Management Systems. Corporate OutdoorTraining: Teambuilding and Leadership Development.http://www.cot.com.au/cam.htm. January 28, 2000.

Corporate Outdoor Training. Company Profile. http://www.cot.com.au/profile.htm. January 28, 2000.

LeBrun, L. Humour: The Missing Link in the Chain of Com-mand. http://www.partnersinrenewal.com/humour.htm.January 28, 2000.

Meister, J. C. Innovators in Educating the Work Force. Corpo-rate Universities. http://www.fortune-sections.com/corporateuniversities/cu2.html. January 28, 2000.

Roberts, B. (1998, August). ‘‘://training via the desktop://.’’HR Magazine. http://www.shrm.org/hrmagazine/articles/0898tra.htm.

Texas Workforce Commission. (1999, November 1).Apprenticeship in Texas: A Career Opportunity that LetsYou Earn While You Learn. http://www.twc.state.tx.us/svcs/apprentice.html.

Texas Workforce Commission. (1999, July 1). On-the-Joband Customized Training. http://www.twc.state.tx.us/svcs/ojtcust.html.

Wheeler, K. (1999, September 1). If Developing People Is aRecruiting Strategy, What’s Wrong with Corporate Educa-tion? Corporate Universities and Human Capital.h t t p : / / w w w . g l r e s o u r c e s . c o m / c o l u m n s /if–developing–people–is–a.htm.

DIANE M. CLEVESY

CORPORATIONS

A business corporation is a legal entity permittedby law in every state to exist for the purpose ofengaging in lawful activities of a business nature.It is an artificial person created by law, with many

of the same rights and responsibilities possessedby humans. Corporations are widely prevalent inthe United States; today, virtually every large en-terprise is a corporation.

RIGHTS AND PRIVILEGES OFA CORPORATION

Within legal guidelines, corporations may issuestock, declare dividends, and provide ownerswith limited liability.

Stocks A corporation can issue and attemptto sell stock. Every share of stock owned repre-sents a share of the corporation’s ownership.

From the standpoint of stock sale, there aretwo kinds of corporations: public and private.With a public corporation, anyone can buyshares of stock, which may very well be traded ona stock exchange. With a private corporation,however, sale of stock may be limited to stipu-lated persons, such as members of the principalstockholder’s family.

A corporation can own ‘‘treasury stock’’; thatis, it may repurchase its own stock that it hadpreviously issued and sold.

A corporation may even give its stock awayfor any reason; for example, as a donation to acharity, or as a reward to employees for indus-trious service.

Dividends A corporate board of directors hasthe authority to declare and pay dividends in theform of cash or stock. Cash dividends are ordi-narily payable from current net income, althoughnet income ‘‘kept’’ from previous years may alsobe used. A common name for net income kept is‘‘retained earnings.’’ Recipients of stock divi-dends receive shares of stock in the corporation,thereby increasing the total number of sharesthey own. Stock dividends are declared from cap-ital stock that has been authorized but not issued.

Rules exist regarding eligibility for receipt ofa dividend. For example, assume that a cash divi-dend is declared on August 15, payable on Sep-tember 15. If Stockholder A owns the stock onAugust 15, he or she receives the dividend onSeptember 15. If Stockholder A sells the stock onAugust 27, Purchaser B buys it ‘‘ex-rights,’’

CORPORATIONS


meaning that on September 15 the dividend stillgoes to Stockholder A. Purchaser B would notreceive a dividend until the next one is declared,perhaps on November 15.

Recipients of cash dividends pay income taxas of the year the dividends are received. Incometax on stock dividends, however, is postponeduntil the recipients sell the stock.

Occasionally, corporations split their stock.However, this does not change the value of theshareholder’s shares on the corporation recordsor the corporation’s net worth.

A stock split is often a good sign as it is oftendone to reduce the price of a stock that has risento a point at which its marketability is impaired.

Limited Liability If a corporation suffers largefinancial losses or even terminates its existence,the shareholders might lose part or all of theirtotal investment. However, that is ordinarily theextent of their loss. Creditors cannot satisfy theirclaims by looking to the personal assets of corpo-rate shareholders as they can with a sole propri-etorship or an ordinary partnership.

Limited liability can be advantageous be-cause it encourages investment in thecorporation. With personal assets of $1.1 million,a potential investor might willingly invest$50,000 in a corporation knowing that no risksexist beyond the $50,000.

The limited liability advantage, however, canbe lost if the owners directly engage in the com-pany’s management and play an influential rolein causing corporate losses.

Addit ional Rights of a CorporationCorporations have the basic right to conduct abusiness in which they sell products or servicesand to engage in either a profit-seeking or a non-profit-seeking enterprise.

Corporations have the right to own, sell,rent, or lease real or personal property.

Corporations may sue other business en-tities, such as another corporation, a partnership,or a sole proprietorship.

Corporations may merge with other corpo-rations.

Example of Stock Split

Value of Smith's 2 for 1 Smith, A Shares on Stock Shareholder Corporation Records Split Owns Per Share Total Value

Before 100 shares $80 $8,000

After 200 shares $40 $8,000

Corporations may make contracts with ei-ther another business or a person.

Corporations may hire or discharge employ-ees of any rank, from entry-level employees to thechief executive officer (CEO).

Corporations may borrow money, and theyoften do so by issuing corporate bonds. Owning acorporate bond does not grant the bondholderany form of ownership in the company. Instead,corporate bondholders have actually loanedmoney to the corporation, virtually always with astated interest rate and with terms regardingdates and methods of repayment. Bondholdersmay ordinarily sell their bonds to other persons,most often through stockbrokers.

In addition to issuing bonds, corporationsmay borrow directly from any loan source, suchas banks. On occasion, corporations raise neededcash by authorizing and selling additional stock.

Corporations may make any lawful invest-ment. They often invest in the stock and/orbonds of other corporations, personal or realproperty, mutual funds, money market accounts,certificates of deposit, and government securities.

REQUIREMENTS OR LIMITATIONS OFA CORPORATION

Corporations are subject to risk, to suits, and toincome tax liabilities.

Risk By engaging in business activities, cor-porations are at risk, great or small. Profit-seek-ing corporations may very well find the largeprofits they seek. But they risk huge economiclosses and even bankruptcy.

CORPORATIONS


Suits Corporations may be sued by any busi-ness, including other corporations. And they maybe sued by individuals or groups of persons.

Income Tax Corporations must pay federaland state income taxes on the net profit theymake during a calendar or fiscal year. People whoreceive cash dividends must also pay income taxfor the year they are received. Thus it is often saidthat corporation profits are subject to doubletaxation. Corporations receive no deduction forany cash dividends that they pay. Recipients ofstock dividends, however, postpone payment ofincome tax on stock dividends until they sell thestock.

REGULATION OF CORPORATIONS

Corporations are subject to two kinds of regula-tion: (1) regulation by the state in which they areincorporated and (2) regulation by the individualcorporation’s articles of incorporation and by-laws.

State Regulation Corporations are regulatedby business corporation laws that exist in all fiftystates. Although the statutes prescribe what cor-porations may and may not do, they are writtenin broad and general language. In essence, then,the states permit articles of incorporation to bewritten in a manner that permits corporations toengage in business for almost any legal purpose.

Articles of incorporation are filed publiclyand are available to the public. They are subjectto amendment. Bylaws are not filed publicly.Consequently, they tend be more detailed thanarticles of incorporation.

Board of Directors Members of the board ofdirectors make the major decisions of the corpo-ration. When corporations are formed, they drawup Articles of Incorporation, usually for approvalby shareholders. The board of directors alsodraws up the initial and ensuing bylaws.

Board members are most often shareholdersand officers of the corporation. They are electedby the shareholders. They may be ‘‘internal’’ di-rectors or, for reasons of good public relations orof obtaining of expertise, may work on the ‘‘out-

side’’ and be selected on the basis of their promi-nent role in the community.

Policies made by the board of directors arecarried out by the corporation’s executives, whodirect the work of employees under their juris-diction.

CLASSES OF STOCK

Corporations ordinarily have two classes of stock:(1) common and (2) preferred. The two classesdiffer in many respects but both also share anumber of common characteristics. There is nolimit to how many classes of stock a corporationmay have.

Common Stock Common stockholders par-ticipate more in the governance of a corporationthan do preferred stockholders. This is accom-plished by giving common stockholders the rightto vote for members of the board of directors aswell as on major decisions (e.g., a merger withanother corporation). Common stock, however,can be issued without voting rights.

Cumulative voting, which permits share-holders to cast one vote for each share of com-mon stock owned in any combination, is preva-lent. In an election for members of the board ofdirectors, for example, a shareholder owning2000 shares of common stock could cast all 2000votes for one candidate or divide them in any wayamong candidates (e.g., 400 votes each for fivecandidates). Cumulative voting offers some pro-tection for smaller stockholders.

The market value of common stock tends tofluctuate more than that of preferred stock.

Preferred Stock Preferred stockholders arenot ordinarily granted the voting rights given tocommon stockholders. They cannot participatein elections for members of the board of directorsor in major decisions of the corporation.

However, preferred stockholders are almostalways given prior rights over common stock-holders in the matter of dividends.

Dividends for preferred stockholders are of-ten stated in advance and do not tend to fluctuateas much as those for common stock. Preferred

CORPORATIONS


dividends may be stated as a percentage of parvalue or as a dollar amount per share.

However, preferred dividends are not guar-anteed in the same sense as is bond interest.Neither preferred nor common stock dividendscan be paid without approval of the board ofdirectors. And boards may ‘‘skip’’ declaring divi-dends if the directors feel the financial situationso warrants.

Preferred stock is often ‘‘cumulative.’’ Withthis provision, a preferred stock dividend that isnot declared or paid is considered to be ‘‘owed.’’As long as the preferred dividend is ‘‘owed,’’ nocommon stock dividend may ordinarily be de-clared or paid. But even if the preferred stock isnot cumulative, a frequently applied policy is thatcommon stock dividends cannot be declared aslong as the preferred dividends are ‘‘in arrears.’’

Sometimes preferred stock is ‘‘convertible.’’Shareholders who own convertible preferredstock may, at a price announced when the stockis purchased, turn in their preferred stock andreceive common stock in its place. Assume, forexample, that an investor purchases preferredstock at $36.50 per share. The stock is convertiblefour years from its issuance at a ratio of 3:1; thatis, three shares of preferred stock can be traded atthe shareholder’s option for one share of com-mon stock. At the 3:l ratio, after discounting anyrelated transfer costs, the preferred stockholderwould find it profitable to convert if the commonstock value rises above $109.50 per share ($36.50� 3).

Preferred stock may be ‘‘callable.’’ At the op-tion of the corporation, callable preferred stockmay be surrendered to the corporation, usually ata price a little above par value (or a stated value).If the stated value is $50, the callable price on orafter a specified date might be $51.25. If thestock’s market value rises to, say, $55, it might beprofitable for the corporation to call for its sur-render.

Occasionally preferred stock is given theright to ‘‘participate’’ with common stock in be-ing granted dividends above a stated value. Forexample, assume the board of directors declares aregular preferred stock dividend at $3 per share

and a common stock dividend at $13 per share.With participating rights, it would have beenstipulated that preferred stockholders would re-ceive $1 per share more for every additional $5given to common stockholders.

If a corporation closes down its operation,preferred stockholders have prior claim overcommon stockholders upon dissolution of theassets. A sufficient amount of the corporation’sassets would need to be turned over to the pre-ferred stockholders before common stockholderscould claim any part of the assets. In practice,however, assets of a closed-down corporation arerarely sufficient to pay off the preferred share-holders in full.

RELATED FORMS OF BUSINESS OWNERSHIP

Five types of business entities have regulationssimilar to those of corporations.

Professional Corporations Professional cor-porations, organized under corporation laws oftheir respective states, involve incorporation bypersons engaged in professional practice, such asmedical doctors, lawyers, and architects. They aregranted limited liability against claims from theirclients, except for malpractice.

Not-for-Profit Corporations Not-for-profitcorporations, formed under the nonprofit laws oftheir respective states, have members instead ofstockholders. Any income made cannot be dis-tributed to the members.

Some apply to the Internal Revenue Servicefor tax-exempt status, becoming ‘‘501(c)(3)’’ or-ganizations, which permits donor gifts to be de-clared tax-deductible.

Closed Corporations Closed corporations,not permitted by statute in all states, limit share-holders to fifty. They permit the firm to operateinformally either by eliminating the board of di-rectors or curtailing its authority. Closed corpo-rations also restrict transferability of the owners’shares of stock.

Limited-Liability Companies Limited-liabilitycompanies enjoy the benefits of limited liabilitywhile being taxed like a general partnership.

CORPORATIONS


Owners’ net income is taxed at an individualpersonal rate rather than at the rate of a corpora-tion (taxation of both corporate net income anddividends).

Not all states permit formation of limited-liability companies. They are neither a partner-ship nor a corporation. They generally have alimited life span. Management must be by a smallgroup. States do not restrict the number or thetype of members. Unlimited transferability ofownership is not permitted.

S Corporations S corporations’ major benefitis that they are taxed like partnerships. The own-ers’ income tax is based on their share of thefirm’s total net income, whether or not it isdistributed to them. The second huge benefit islimited liability.

However, an S corporation is limited tothirty-five shareholders, none of whom can benonresident aliens. Only one class of stock maybe issued or outstanding. The S corporation mayown only 80 percent of a subsidiary businessfirm.

BIBLIOGRAPHY

Dicks, J. W. (1995). ‘‘Corporation.’’ In J. W. Dicks, TheSmall Business Legal Kit and Disk. Holbrook, MA: AdamsMedica Corporation.

Snifen, Carl R. J. (1995). The Essential Corporation Hand-book. Grants Pass, OR: Oasis Press/Psi Research.

G. W. MAXWELL

COST ACCOUNTING(SEE: Accounting)

COST ALLOCATION

A cost is generally understood to be that sacrificeincurred in an economic activity to achieve aspecific objective, such as to consume, exchange,or produce. All types of organizations—businesses, not-for-profits, governmental—incur costs. To achieve missions and objectives,an organization acquires resources, transforms

them in some manner, and delivers units ofproduct or service to its customers or clients.Costs are incurred to perform these activities. Forplanning and control, decisions are made aboutareas such as pricing, program evaluation, prod-uct costing, outsourcing, and investment. Differ-ent costs are needed for different purposes. Ineach instance, costs are determined to help man-agement make better decisions.

When incurred, costs are initially reviewedand accumulated by some classification system.Costs with one or more characteristics in com-mon may be accumulated into cost pools. Costsare then reassigned, differently for specified pur-poses, from these cost pools to one or more costobjects. A cost object is an activity, a unit ofproduct or service, a customer, another cost pool,or a segment of an organization for which man-agement needs a separate measurement and ac-cumulation of costs. Costs assigned to a costobject are either direct or indirect. A direct costcan be traced and assigned to the cost object in anunbiased, cost-effective manner. The incurrenceof an indirect cost cannot be so easily traced.Without such a direct relationship to the costobject, an indirect cost requires an in-betweenactivity to help establish a formula relationship.When the indirect cost is assigned through theuse of this formula, the cost is considered al-located. The activity used to establish the in-between linkage is called the basis of allocation.

TYPES OF ALLOCATIONS

Cost allocations can be made both within andacross time periods. If two or more cost objectsshare a common facility or program, the costpool of the shared unit is a common cost to theusers and must be divided or allocated to them.Bases of allocation typically are based on one ofthe following criteria: cause-and-effect, benefitsderived, fairness, or ability to bear. The selectionof a criterion can affect the selection of a basis.For example, the allocation of the costs of acommon service activity across product lines orprograms based on relative amounts of revenue isan ability to bear basis, whereas the same alloca-tion based on the relative number of service units

COST ALLOCATION


consumed by each product line or programwould reflect either the benefits derived or thecause-and-effect criteria. Cost allocation then isthe assignment of an indirect cost to one or morecost objects according to some formula. Becausethis process is not a direct assignment and resultsin different amounts allocated depending on ei-ther the basis of allocation or the method (for-mula) selected, some consider cost allocation tobe of an arbitrary nature, to some extent.

Costs of long-lived assets are allocated andreclassified as an expense across two or moretime periods. For anything other than land,which is not allocated, the reclassification of tan-gible assets is called depreciation (for anythingother than natural resources) or depletion (fornatural resources) expense. The bases for theseallocations are normally either time or volume ofactivity. Different methods of depreciation anddepletion are available. The costs of long-livedintangible assets, such as patents, are allocatedacross time periods and reclassified as amortiza-tion expense. The basis for these allocations isnormally time.

Cost allocations within a time period are typ-ically across either organizational segmentsknown as responsibility centers or across units ofproduct or service or programs for which a fullcost is needed. Allocations may differ dependingon whether a product or program is being costedfor financial reporting, government contract re-imbursement, reporting to governmental agen-cies, target pricing or costing, or life-cycle profit-ability analysis. Allocations to responsibilitycenters are made to motivate the centers’ manag-ers to be more goal-congruent in their decisionsand to assign to each center an amount of costreflective of all the sacrifices made by the overallorganization on behalf of the center. These allo-cations can be part of a price or transfers of costpools from one department to another.

ETHICAL CONSIDERATIONS

Allocations can involve ethical issues. Often thefederal government issues contracts to the privatesector on a cost-plus basis; that is, all the actualcosts incurred to complete a contract plus a per-

centage of profit is reimbursed to the contractorperforming the contract. A contractor complet-ing both governmental and private-sector con-tracts may select a formula that tends to allocatemore indirect costs to governmental contractsthan to nongovernmental ones. A contractor mayalso try to include in reimbursement requestscosts that are not allowable by the governmentalagency. A contractor may even try to double-count a cost item by including it as a direct costof the contract and as a part of an indirect costpool allocated to the contract. Lastly, a contractormay attempt to have a reimbursement coversome of the costs of unused capacity. Audits aremade of costs of government contracts to identifyinappropriate costs.

SERVICE FIRMS, NOT-FOR-PROFITORGANIZATIONS, AND MERCHANDISERS

Service and not-for-profit organizations allocatecosts, too. The cost object can be a unit of service,an individual client, or a cluster (category) ofclients. The costs of a service firm are typicallyprofessional labor and indirect costs in supportof the labor. The basis for allocating these indi-rect costs is often professional labor hours (eitherbillable or total) or the cost of such, reflective ofeither cause-and-effect or benefits-received crite-ria. For not-for-profit organizations, the propor-tions to be allocated are best figured in terms ofunits of the resource on hand, such as the num-ber of full-time equivalents, amount of squarefootage, or number of telephone lines. An impor-tant point to remember is that the principles ofallocation are the same for for-profit and not-for-profit organizations. The only difference is thatthe cost objects will be dissimilar.

Merchandisers, unlike most service and not-for-profit organizations, have inventory thatmust be costed for external and internal report-ing purposes. In these cases, the cost object is aunit of inventory. Incidental costs associated withthe acquisition and carrying of the inventory aremostly direct costs easily traceable clearly assign-able to the entire inventory, if not to individualunits.

COST ALLOCATION


MANUFACTURERS

Manufacturers need to cost the resources re-quired to complete their products. In costing aunit of product for inventory valuation, costs ofproduction are assigned. With the unit of prod-uct as the cost object, production costs are eitherdirect costs (traceable usage of materials and lab-or) or indirect costs (all of the other productioncosts, referred to as overhead). The indirect pro-duction costs are allocated. Traditionally, manu-facturers using labor-intensive technologies useda single basis of allocation based on labor, eitherin hours or in cost, associated with a single indi-rect cost pool. A manufacturer using a more capi-tal intensive technology might use a nonlaborbasis such as machine hours. Today many firmsproduce a varied set of products, using variedtechnologies with many levels of complexity.Such firms need a more refined cost assignmentsystem that uses multiple bases of allocation withmultiple indirect cost pools, such as activitybased costing.

While for product costing a unit of outputremains the final cost object, the technology aproducer uses can require a cost assignment to anintermediate cost pool (object) prior to an as-signment to a unit of output. For instance, abatch technology has a cost assignment first to anindividual job order (batch); the total cost as-signed to the job order is then unitized over theunits in the batch to determine cost of one unit ofoutput. Alternatively, for a given period in aprocess technology, costs are accumulated by (as-signed to) each production process; the total costassigned is then unitized across the total numberof (equivalent) units produced by that process tocost-out a unit of output.

Manufacturers also incur service departmentcosts (such as computer center costs) in supportof production departments. These service depart-ment costs are indirect to a unit of productionand for full costing must be allocated, first torespective production areas and then to the unitsof output. Such allocations are called service de-partment allocations, and the basis of allocationis normally an activity reflective of the nature of

demands made on the service department byother departments, both service and production.

JOINT PRODUCTION ALLOCATIONS

Allocations are also required in a joint produc-tion process. When two or more separately iden-tifiable final products initially share a commonjoint production process, the products are calledjoint products. The point at which they becomeseparately identifiable is referred to as the split-off point. Manufacturing costs incurred prior tothis split-off point are referred to as joint costsand need to be allocated across the different jointproducts for product costing purposes. The basesfor allocating the joint costs typically include (1)relative sales value at split-off, (2) net realizablevalue at split-off (as an approximation of thesales value at split-off), (3) final sales value at thecompletion of the production process, and (4)the number of physical units of the joint prod-ucts at split-off.

Many would consider this list of bases to bein an order of descending preference of use. Nor-mally there are additional production costs be-yond the split-off point. These additional costsare incurred in order to complete each jointproduct. For a given joint product, the net real-izable value at split-off is calculated by sub-tracting the additional costs to complete from thefinal sales value of the finished joint product.

SERVICE DEPARTMENT (RE)ALLOCATIONS

There are three basic methods to allocate servicedepartment costs to production departments orprograms in a not-for-profit: (1) the directmethod; (2) the step method; and (3) the recip-rocal method. The basis for allocation of servicearea costs should ideally be causally related to thedemands made on that area by other areas. Bothcause-and-effect and benefits-received criteriaare taken into account. If the service areas pro-vide service to each other (referred to as recipro-cal services), the reciprocal method is the mostaccurate, the step method next, and the directmethod the least accurate. With different serviceand production departments as cost objects, costsare initially accumulated on a department-by-

COST ALLOCATION


department basis. Departments working directlyon programs or units of product or service areproduction departments. The other departmentsare service departments. The allocation problemthen is to reassign service department costs toproduction departments or programs for bothperformance evaluation and product or programcosting. Within a production department, theseallocated service costs are then reallocated tounits of service or product according to the basesof allocation that each respective production de-partment uses for its indirect costs.

The direct method ignores reciprocal ser-vices. A service department’s costs are allocatedto the production departments according to theextent to which each production department uses(or, for budgeting purposes, intends to use) theservices of the service department. This ‘‘extent’’is determined on a percentage basis by either theamount of services actually provided by the ser-vice department to all the production depart-ments or by the amount of services the servicedepartment is capable of providing at normal orfull capacity. Variable and fixed costs may beallocated separately, resulting in a dual allocationprocess (for example, variable costs based on ac-tual usage and fixed costs based on budgetedusage).

The step method partially takes reciprocalservices into account by allocating service depart-ment costs to production departments on a se-quential basis. The service department that pro-vides the greatest amount of service to the otherservice departments is allocated first; the oneproviding the second greatest amount of serviceto the other service departments is allocated sec-ond; and so forth. The absolute dollar amountsof costs incurred within service departments canbe used to break a tie in usage, the larger amountallocated first. Once a service department hasbeen allocated, it is ignored for all subsequentallocations.

The reciprocal method takes into account allthe reciprocal services by setting up a set ofsimultaneous equations, one equation per servicedepartment. For any given service department,its equation is: Total allocable cost�direct costs

of the service department�costs allocated fromeach of the other service departments based onthis department’s use of the other service depart-ments. Once these equations are solved, the re-sultant allocable cost (sometimes referred to asthe reciprocal or artificial cost) is reallocatedacross all the other departments, service and pro-duction, according to the original percentage us-ages.

Two additional issues, fairness and acquiringthe service from the inside or from the outside,concern the allocation of a common cost. Theamount of common service cost allocated to ausing department may be greater that what itwould cost that department to obtain the sameservice from the outside. A variation of the recip-rocal method provides an analysis to help themanager of a using department decide whether toobtain the service from another departmentwithin the organization or to contract outside forthe service from another organization. Theamount of a particular service department’s costallocated to a using department may be depen-dent on the extent to which other departmentsalso use this service department. This does notseem to be fair.

(SEE ALSO: Accounting; Costs)

BIBLIOGRAPHY

Blocher, Edward J., Chen, Kung H., and Lin, Thomas W.(1999). Cost Management: A Strategic Emphasis. NewYork: Irwin/McGraw-Hill.

Brown, Clifford D. (1999). Accounting and Reporting Prac-tices of Nonprofit Organizations—Choices and Applica-tions. New York: American Institute of Certified PublicAccountants.

Horngren, Charles T., Foster, George, and Datar, Srikant M.(2000). Cost Accounting: A Managerial Emphasis. UpperSaddle River, NJ: PrenticeHall.

Ijiri, Yuji. (1975). Theory of Accounting Measurement. Sara-sota, FL: American Accounting Association.

Kaplan, Robert S., and Atkinson, Anthony A. (1989).Advanced Management Accounting. Englewood Cliffs, NJ:Prentice-Hall.

Statements on Management Accounting (4B): Allocation ofService and Administrative Costs. (1985). Montvale, NJ:National Association of Accountants.

COST ALLOCATION


Willson, James D., and Colford, James P. (1990).Controllership: The Work of the Managerial Accountant.New York: Wiley.

LAWRENCE A. KLEINCLIFFORD BROWN


Cost-benefit analysis is used for determiningwhich alternative is likely to provide the greatestreturn for a proposed investment. Sometimesreferred to as cost-effectiveness analysis, it is rele-vant to businesses as well as to not-for-profitentities and governmental units.

A business might find it helpful to use cost-benefit analysis to determine if additional fundsshould be invested in a facility in the home coun-try or in another country. A community not-for-profit organization that provides a variety of pro-grams for children might use cost-benefit analy-sis to assist management in determining whichactivities will provide the most services for thecosts specified. A federal governmental agencymight use cost-benefit analysis to determinewhich of several projects planned for the nationalparks is likely to be most used, given the costs, byinterested citizens.

Because resources such as money and timeare limited, an organization usually cannot un-dertake every project proposed. To decidewhether to undertake a project, decision makersweigh the benefits from the project against thecost of the resources it requires, normally ap-proving a project when its benefits exceed itscosts. Cost-benefit analysis provides the structureand support for making such decisions.

Benefits increase the welfare of the organiza-tion. Some benefits are monetary benefits, suchas the dollar amount of cash inflows from addi-tional sales of a product or the saving in cashoutflows that a project enables. Other benefits areimportant but harder to quantify. For example, aproject may increase customer satisfaction; in-creased customer satisfaction may increase futuresales, but the exact relationship between sales andsatisfaction is often hard to specify.

Costs are the outlays or expenditures made inorder to obtain a benefit. Many costs are mea-sured monetarily, such as the cost of buying anew machine or of hiring an additional em-ployee.

COST-BENEFIT ANALYSIS IN BUSINESS

A cost-benefit analysis is straightforward when allcosts and benefits are measurable in monetaryterms. Assume that Company A must decidewhether to rent an ice cream machine for thesummer for $900. The ice cream machine willproduce additional cash inflows of $1,000 duringthe summer. The benefit of additional cash in-flows ($1,000) exceeds the additional cost ($900),so the project should be undertaken. Not all cost-benefit analyses are this simple, however. If thebenefits and costs occur in different time periods,it may be necessary to discount the future cashflows to their equivalent worth today.

In another example, cost savings is a benefit.Assume that Company B makes about 100,000photocopies a year. Company B does not have itsown copy machine and currently pays 4 cents percopy, or $4,000 a year, to Copycat Copiers. Com-pany B can lease a copy machine for $2,500 ayear. It must also pay 2 cents per page for paperfor the leased machine, or $2,000. In this exam-ple, the cost of leasing the machine and buyingpaper ($2,500 � $2,000 � $4,500) exceeds thebenefit of saving the $4,000 normally paid toCopycat Copiers. Company B should continue touse Copycat Copiers for its photocopies. How-ever, Company B must have a pretty good esti-mate of the number of copies it needs to becomfortable with its decision. If Company Bneeds 150,000 copies this year instead of 100,000,the cost of the leasing the machine and buyingpaper ($2,500 � $3,000 � $5,500) is cheaperthan the $6,000 (150,000� $0.04) savings in feesto Copycat Copiers.

A third example involves a project with bene-fits that are difficult to quantify. Assume thatCompany C is deciding whether to give a picniccosting $50,000 for its employees. Company Cwould receive the benefit of increased employeemorale from the picnic. Better employee morale



might cause employees to work harder, increas-ing profits. However, the link between increasedmorale and increased monetary profits is tenu-ous. The decision maker must use his or herjudgment to compare the nonmonetary benefitto the monetary cost, possibly deciding that in-creased employee morale is worth the $50,000cost but would not be worth a $100,000 cost.

In the preceding examples, cost-benefit anal-ysis provided a framework for decision making.The range of objectivity related to measurementof the factors is typical. Techniques used in busi-ness as a basis for determining costs and benefits,such as return on investment, are generally quan-tifiable and thus appear to be objective. However,it is not uncommon for qualitative factors toenter into the decision-making process. For ex-ample, providing a product that individuals withlimited incomes will be able to purchase may notprovide the highest monetary return on invest-ment in the short run, but might prove to be asuccessful long-term investment. Careful deci-sion makers attempt to deal with a difficult-to-quantify factor in as objective a manner as possi-ble. However, cost-benefit analysis in most situa-tions continues to introduce measurement prob-lems.

COST-BENEFIT ANALYSIS INNONBUSINESS ENTITIES

Cost-benefit analyses are also common in non-business entities. Boards of not-for-profit organi-zations establish priorities for their programs,and such priorities often specify desired programoutputs. For example, assume a not-for-profitorganization is interested in reducing the level ofilliteracy among the citizens of a rural commu-nity in a state that has one of the lowest per-capita incomes in the United States. As alterna-tive programs for those who need to learn to readare considered, there will be cost-benefit analysesthat focus on a number of factors, including theextent to which a particular program can attractthose who are illiterate. A program in the down-town area of a small town might be consideredbecause a facility is available there at low cost—and that low cost is appealing. Focus on cost is

not sufficient, however. When benefits are con-sidered, it might become clear that those who areeager for such a program do not have cars andthat there is no public transportation from wherethey reside to the center of the small town. Fur-ther consideration of relevant factors and of al-ternatives, undertaken in good faith, should re-sult in cost-benefit analyses that provide valuableinformation as the agency makes decisions.

At all levels of government in the UnitedStates, cost-benefit analyses are used as a basis forallocating resources for the public good to thoseprograms, projects, and services that will meetthe expectations of citizens. For example, deci-sion makers at the federal level who have policyresponsibility for environmental standards, air-quality rules, or services to the elderly often findinformation from cost-benefit analyses to be crit-ical to the decision-making task.

CONTINUING EFFORTS TO QUANTIFYCOST-BENEFIT FACTORS

As possibilities for the use of funds increase, thereis motivation for better measurement of bothcosts and benefits as well as for speedier ways ofaccomplishing analyses for alternatives that areappealing. All types of entities—businesses, not-for-profit organizations, and governmentalunits—strive to improve the measurments usedin cost-benefit analyses. The capabilities of elec-tronic equipment provide promising assistancein accumulating data relevant for analyses. Wiseuse of resources is an important goal in everyorganization; cost-benefit analyses make a keycontribution to this goal. Therefore, attention isgiven to improving both the effectiveness andefficiency of such analyses.

BIBLIOGRAPHY

Boardman, Anthony, E. (1996). Cost-Benefit Analysis: Con-cepts and Practice. Upper Saddle River, NJ: Prentice-Hall.

Nas, Tevik F. (1996). Cost-Benefit Analysis: Theory and Ap-plication. Thousand Oaks, CA: Sage Publications.

MARY MICHEL

MARY ELLEN OLIVERIO



COST OF LIVING INDEX(SEE ALSO: Consumer Price Index)

COSTS

The word cost appears in many terms, some withsubtle distinctions in meaning, used in account-ing, economics, and business. The single wordcost rarely has a clear meaning. (Neither does theword value have a clear meaning. Avoid usingvalue without a modifying adjective, such asmarket or present or book.) The word cost, with-out modifying adjectives, typically means the sac-rifice, measured by the price paid or required tobe paid, to acquire goods or services. Hence, thesingle word cost often carries the meaning moreprecisely represented by the following.

acquisition cost. historical cost. Net priceplus all expenditures to ready an item forits intended use at the time the firm ac-quired the item. The other expendituresmight include legal fees, transportationcharges, and installation costs.

Accountants can easily measure acquisitioncost, but economists and managers often find itless useful in making decisions. Economists andmanagers more often care about some measureof current costs, which accountants find harderto measure.

current cost. Replacement cost or net real-izable value.

replacement cost. Acquisition cost at thedate of measurement, typically the present,in contrast to the earlier date of acquisi-tion.

net realizable value. The amount a firm cancollect in cash by selling an item, less thecosts (such as commissions and deliverycosts) of disposition.

When accountants use a notion of currentcost, they most often refer to fair value.

fair value. Price negotiated at arm’s lengthbetween willing buyers and willing sellers,

each acting rationally in their own self-in-terest. Sometimes measured as the presentvalue of expected cash flows. [See the entryTime value of money.]

Accountants often contrast (actual) histori-cal cost with standard cost.

standard cost. An estimate of how muchcost a firm should incur to produce a goodor service. This measurement plays a rolein cost accounting, in situations wheremanagement needs an estimate of costs in-curred before sufficient time has elapsedfor computation of actual costs incurred.

The following terms desegregate historicalcost into components.

variable cost. Costs that change as activitylevels change. (The term cost driver refersto the activity that causes cost to change.)Strictly speaking, variable costs are zerowhen the activity level is zero. Carefulwriters use the term semivariable costs tomean costs that increase strictly linearlywith activity but have a positive value atzero activity level. Royalty fees of 2 percentof sales are variable; royalty fees of $1,000per year plus 2 percent of sales aresemivariable.

fixed cost. A cost that does not change asactivity levels change, at least for sometime period. In the long run, all costs canvary.

In accounting for the costs of product orservices or segments of a business, accountantssometimes desegregate total costs into those thatbenefit a specific product and those that benefitall products jointly produced.

traceable cost. direct cost. A cost the firmcan identify with a specific product, suchas the cost of a computer chip installed ina given personal computer, or with someactivity.

common cost. joint cost. indirect cost. A costincurred to benefit more than one productor activity, such as the cost of rent of a

COSTS


factory building in which the firm makesseveral different kinds of personal comput-ers or the cost of a steer from which thefirm manufactures leather and hamburger.Some restrict the term common cost to sit-uations such as the first, where the firmchooses to produce products together,while restricting joint costs to situations,such as the second, where the firm mustincur the cost simultaneously. The majorproblem in cost accounting is allocation ofcommon and joint costs to individualproducts. Managers and regulators (e.g.,the Securities and Exchange Commissionand the IRS) often insist on such alloca-tions, while economists and some account-ants recognize that such allocations do notaid decision making.

Virtually all costs recorded by accountantsrequire a cash outlay at some time. Analystssometimes need to distinguish between costs as-sociated with current or future cash expendituresand those where the expenditure already oc-curred.

out-of-pocket cost. outlay cost. cash cost. Anitem requiring a current or future cash ex-penditure.

book cost. sunk cost. A cost incurrencewhere the cash expenditure has already oc-curred, such as the cost of depreciation fora machine purchased several years ago. (Inaccounting, depreciation is an allocation ofa previous expenditure, while in economicsdepreciation represents a decline in currentvalue.)

In decision making, the cost concepts aboveoften get further refined, as follows.

incremental cost. marginal cost. differentialcost. avoidable cost. The firm will incur(save) incremental costs if it carries out (orstops) a project. These four terms tend tohave the same meaning, except that theeconomist restricts the term marginal costto the cost of producing one more unit.Thus the next unit has a marginal cost; the

next week’s output has an incrementalcost. If a firm produces and sells a newproduct, the related new costs would prop-erly be called incremental, not marginal. Ifa factory is closed, the costs saved are in-cremental, not marginal.

unavoidable cost. inescapable cost. sunk cost.Unavoidable costs will occur whether thedecision is made to go ahead or not, be-cause the firm has already spent, or com-mitted to spend, the cash. Not all unavoid-able costs are book costs; consider a salarypromised, but not yet earned, that the firmwill pay if it makes a no-go decision. Sunkcosts are past costs that current and futuredecisions cannot affect and, hence, are ir-relevant for decision making (aside fromincome tax effects). For example, the ac-quisition cost of machinery is irrelevant toa decision of whether to scrap the ma-chinery. In making such a decision, oneshould consider only the sacrifice of con-tinuing to own it and the cost of, say, theelectricity to run the machine, both incre-mental costs. Sunk costs become relevantfor decision making when the analysis re-quires taking income taxes (gain or loss ondisposal of asset) into account, since thecash payment for income taxes depends onthe tax basis of the asset. Avoid using theambiguous term sunk costs. Consider, forexample, a machine costing $100,000 withcurrent salvage value of $20,000. Somewould say that $100,000 is ‘‘sunk’’; otherswould say that only $80,000 is ‘‘sunk.’’Those who say $100,000 have in mind agross cost, while those who say $80,000have in mind a net cost—original amountreduced by current opportunity cost.

In deciding which employees to reward,management often cares about desegregating ac-tual costs into those that are controllable andthose not controllable by a given employee ordivision. All costs can be affected by someone inthe firm; those who design incentive schemes at-tempt to hold a person responsible for a cost only

COSTS


if that person can influence the amount of thecost.

A firm incurs costs because it perceives that itwill realize benefits. Careful usage of cost termsdistinguishes between incurrences where the firmwill enjoy the benefits in the future from thosewhere the firm has already enjoyed the benefits.Accounting distinguishes costs that have futurebenefits by calling them assets and contrastingthem with costs whose benefits the firm has al-ready consumed, by calling them expenses. Otherpairs of terms involving this distinction areunexpired cost versus expired cost and product costversus period cost.

Economists, managers, and regulators makefurther distinctions between cost concepts, as fol-lows.

fully absorbed cost versus variable cost. Fullyabsorbed costs refer to costs where thefirm has allocated fixed manufacturingcosts to products produced or divisionswithin the firm as required by generally ac-cepted accounting principles. Variablecosts, in contrast, may be more relevantfor making decisions, such as in settingprices or deciding whether a firm haspriced below cost for antitrust purposes.

fully absorbed cost versus full cost. In fullcosting, the analysis allocates all costs,manufacturing costs as well as central cor-porate expenses (including financing ex-penses), to products or to divisions. In fullabsorption costing, the firm allocates onlymanufacturing costs to product. Only infull costing will revenues, expenses, and in-come summed over all products or divi-sions equal corporate revenues, expenses,and income.

opportunity cost versus outlay cost. Oppor-tunity cost refers to the economic benefitforgone by using a resource for one pur-pose rather than another. If the firm cansell a machine for $200,000, then the op-portunity cost of using that machine inoperations is $200,000 independent of its

outlay cost or its book cost or its historicalcost.

future cost versus past cost. Effective deci-sion making analyzes only present and fu-ture outlay costs, or out-of-pocket costs.Optimal decisions result from using futurecosts, whereas financial reporting uses pastcosts.

short-run cost versus long-run cost. For agiven configuration of plant and equip-ment, short-run costs vary as output va-ries. The firm can incur long-run costs tochange that configuration. This pair ofterms is the economist’s analogy of the ac-counting pair, above, variable and fixedcosts. The analogy is inexact because someshort-run costs are fixed, such as propertytaxes on the factory.

imputed cost versus book cost. Imputedcosts do not appear in the historical costaccounting records for financial reporting.The actual cost incurred is recorder and iscalled a book cost. Some regulators calcu-late the cost of owners’ equity capital, forvarious purposes; these are imputed costs.Opportunity costs are imputed costs andare relevant for decision making.

average cost versus marginal cost. This isthe economic distinction equivalent to fullyabsorbed cost of product and variable costof product. Average cost is total cost di-vided by number of units. Marginal cost isthe cost to produce the next unit (or thelast unit).

differential cost versus variable cost.Whether a cost changes or remains fixeddepends on the activity basis being consid-ered. Typically, but not invariably, analyststerm costs as variable, or fixed, with respectto an activity basis such as changes in pro-duction levels. Typically, but not invari-ably, analysts term costs as incremental, ornot, with respect to an activity basis, suchas the undertaking of some new venture.Consider the decision to undertake theproduction of food processors, rather than

COSTS


food blenders, which the manufacturer hasbeen making. To produce processors re-quires the acquisition of a new machinetool. The cost of the new machine tool isincremental with respect to a decision toproduce food processors instead of foodblenders, but, once acquired, becomes afixed cost of producing food processors.Consider a firm that will incur costs of di-rect labor for the production of food pro-cessors or food blenders, whichever thefirm produces. Assume the firm cannotproduce both. Such labor is variable withrespect to production measured in units,but not incremental with respect to the de-cision to produce processors rather thanblenders. This distinction often blurs inpractice, so a careful understanding of theactivity basis being considered is necessaryfor understanding of the concepts beingused in a particular application.

Analysis of operating and manufacturing ac-tivities uses the following subdivisions of fixed(historical) costs. Fixed costs have the followingcomponents:

Fixed capacity programmed costs costs costs

semifixed fixed standby enabling costs portions costs costs of semi- + variable costs "pure" fixed costs

+

= +

Capacity costs (committed costs) give a firmthe capability to produce or to sell, whileprogrammed costs (managed costs, discretionarycosts), such as for advertising or research, may benonessential, but once the firm has decided toincur them, they become fixed costs. The firmwill incur standby costs even if it does not useexisting capacity; examples include propertytaxes and depreciation on a building. The firm

can avoid enabling costs, such as for a securityforce, if it does not use capacity. A cost fixed overa wide range but that can change is a semifixedcost or ‘‘step cost.’’ An example is the cost of raillines from the factory to the main rail line, wherefixed cost depends on whether there are one ortwo parallel lines but are independent of thenumber of trains run per day. Semivariable costscombine a strictly fixed component cost plus avariable component. Telephone charges usuallyhave a fixed monthly component plus a chargerelated to usage.

(SEE ALSO: Cost Allocation; Cost-Benefit Analysis)

BIBLIOGRAPHY

Buchanan, James. M., and Thirlby, G. F. (1973). L.S.E.Essays on Cost. London: Weidenfeld and Nicholson.

Horngren, Charles T., Foster, George, and Datar, Srikant M.(2000). Cost Accounting: A Managerial Emphasi, 10th ed.Upper Saddle River, NJ: Prentice-Hall.

Maher, Michael W., Stickney, Clyde P., and Weil, Roman L.(1997). Managerial Accounting: An Introduction to Con-cepts, Methods, and Uses, 6th ed. Ft. Worth, TX: DrydenPress.

Stickney, Clyde P., and Weil, Roman L. (2000). FinancialAccounting: An Introduction to Concepts, Methods andUses, 9th ed. Ft. Worth, TX: Dryden Press.

ROMAN L. WEIL

COST-VOLUME-PROFITANALYSIS

Cost-volume-profit analysis (CVP), or break-even analysis, is used to compute the volumelevel at which total revenues are equal to totalcosts. When total costs and total revenues areequal, the business organization is said to be‘‘breaking even.’’ The analysis is based on a set oflinear equations for a straight line and the separa-tion of variable and fixed costs.

Total variable costs are considered to bethose costs that vary as the production volumechanges. In a factory, production volume is con-sidered to be the number of units produced, butin a governmental organization with no assemblyprocess, the units produced might refer, for ex-



ample, to the number of welfare cases processed.There are a number of costs that vary or change,but if the variation is not due to volume changes,it is not considered to be a variable cost. Exam-ples of variable costs are direct materials anddirect labor. Total fixed costs do not vary asvolume levels change within the relevant range.Examples of fixed costs are straight-line deprecia-tion and annual insurance charges. Total variablecosts can be viewed as a 45� line and total fixedcosts as a straight line. In the break-even chartshown in Figure 1, the upward slope of line DFCrepresents the change in variable costs. Variablecosts sit on top of fixed costs, line DE. Point Frepresents the breakeven point. This is where thetotal cost (costs below the line DFC) crosses andis equal to total revenues (line AFB).

All the lines in the chart are straight lines:Linearity is an underlying assumption of CVPanalysis. Although no one can be certain thatcosts are linear over the entire range of output orproduction, this is an assumption of CVP. Tohelp alleviate the limitations of this assumption,it is also assumed that the linear relationshipshold only within the relevant range of produc-tion. The relevant range is represented by thehigh and low output points that have been previ-ously reached with past production. CVP analysisis best viewed within the relevant range, that is,within our previous actual experience. Outside ofthat range, costs may vary in a nonlinear manner.The straight-line equation for total cost is:

Total cost � total fixed cost � total variable cost

Total variable cost is calculated by multiply-ing the cost of a unit, which remains constant ona per-unit basis, by the number of units pro-duced. Therefore the total cost equation could beexpanded as:

Total cost � total fixed cost � (variable cost perunit � number of units)

Total fixed costs do not change.

A final version of the equation is:

Y � a � bx

where a is the fixed cost, b is the variable cost perunit, x is the level of activity, and Y is the totalcost. Assume that the fixed costs are $5,000, thevolume of units produced is 1,000, and the per-unit variable cost is $2. In that case the total costwould be computed as follows:

Y � $5,000 � ($2 � 1,000) Y � $7,000

It can be seen that it is important to separatevariable and fixed costs. Another reason it isimportant to separate these costs is because vari-able costs are used to determine the contributionmargin, and the contribution margin is used todetermine the break-even point. The contribu-tion margin is the difference between the per-unit variable cost and the selling price per unit.For example, if the per-unit variable cost is $15and selling price per unit is $20, then the contri-bution margin is equal to $5. The contributionmargin may provide a $5 contribution toward thereduction of fixed costs or a $5 contribution toprofits. If the business is operating at a volumeabove the break-even point volume (above pointF), then the $5 is a contribution (on a per-unitbasis) to additional profits. If the business isoperating at a volume below the break-evenpoint (below point F), then the $5 provides for areduction in fixed costs and continues to do sountil the break-even point is passed.

Once the contribution margin is determined,it can be used to calculate the break-even point involume of units or in total sales dollars. When aper-unit contribution margin occurs below afirm’s break-even point, it is a contribution to thereduction of fixed costs. Therefore, it is logical todivide fixed costs by the contribution margin todetermine how many units must be produced toreach the break-even point:

Break-even�

total fixed costsin units contribution margin per unit

Assume that the contribution margin is thesame as in the previous example, $5. In this ex-ample, assume that the total fixed costs are in-creased to $8,000. Using the equation, we deter-mine that the break-even point in units:



Break-Even Chart

Total dollars

Volume

D

A

F

B

C

E

Break-even point

$32,000

1600

Loss

Figure 1

Break-even point in units �$8,000

$5

� 1,600 units

In Figure 1, the break-even point is shown asa vertical line from the x-axis to point F. Now, ifwe want to determine the break-even point intotal sales dollars (total revenue), we could multi-ply 1600 units by the assumed selling price of $20and arrive at $32,000. Or we could use anotherequation to compute the break-even point intotal sales directly. In that case, we would firsthave to compute the contribution margin ratio.This ratio is determined by dividing the contri-bution margin by selling price. Referring to ourexample, the calculation of the ratio involves twosteps:

$20 (selling price) −15 (variable cost) $ 5 (contribution margin)

Contribution�

contribution marginmargin ratio selling price

�520

� 25%

Going back to the break-even equation andreplacing the per-unit contribution margin withthe contribution margin ratio results in the fol-lowing formula and calculation:

Break-even in�

total fixed coststotal sales contribution margin ratio

�$8,000

.25

� $32,000

Figure 1 shows this break-even point, at$32,000 in sales, as a horizontal line from point Fto the y-axis. Total sales at the break-even pointare illustrated on the y-axis and total units on thex-axis. Also notice that the losses are representedby the DFA triangle and profits in the FBC trian-gle.

The financial information required for CVPanalysis is for internal use and is usually availableonly to managers inside the firm; informationabout variable and fixed costs is not available tothe general public. CVP analysis is good as ageneral guide for one product within the relevantrange. If the company has more than one prod-uct, then the contribution margins from all prod-ucts must be averaged together. But, any cost-averaging process reduces the level of accuracy ascompared to working with cost data from a singleproduct. Furthermore, some organizations, suchas nonprofit organizations, do not incur a signifi-cant level of variable costs. In these cases, stan-dard CVP assumptions can lead to misleadingresults and decisions.

(SEE ALSO: Accounting; Costs)

G. STEVENSON SMITH

COTTAGE INDUSTRIES

‘‘Cottage industries’’ is a term that was usedprevalently during the eighteenth and nineteenthand centuries to describe the home-based systemof manufacturing. This term is also used today torefer to goods or services that are produced athome. Sewing, craft production, sales and mar-

COTTAGE INDUSTRIES


Women working in a cottage industry at the beginning of the twentieth century.

keting, typing, bookkeeping, and auto repair arejust a few examples of home-based employment.

HISTORY

Rural families were some of the first to becomeinvolved in the cottage industry. They added totheir agricultural income by making products athome. Merchants provided the raw materials tothe families, collected and marketed the finishedproduct, and then paid the family a percentage ofthe price charged to the end consumer. Some ofthe items made by these at-home workers werecloth and clothing, shoes, cigars, and hand-deco-rated items.

Cottage industries developed in cities around1870, resulting in the harsh tenement housingsystem. Immigrant families lived and worked inthese crowded, unsafe apartment buildings. Theyworked for extremely low wages, usually makinggarments. This system lasted until around 1920,when better management of factories madehome-produced goods less competitive.

Hand-decorating of items, sewing, and otherhighly specialized activities still operate as cottageindustries today. Economists point to the rise of anew type of cottage industry whereby people canstay at home to perform work on their computersthat formerly had to be done at the office. ‘‘Tele-commuters’’ is another term used more fre-quently today to refer to home-based employ-ment. Many jobs that used to require workers’physical presence in the office can now be per-formed from home. Running a business fromhome today requires only a couple of phone lineswith call forwarding and call waiting, a computerwith e-mail and a modem, a fax machine, acopier, and office supplies. For executives on thego, a cell phone and laptop computer can keepthem up and running from just about any loca-tion.

HOME EMPLOYMENT BENEFITS

There are many reasons that people choose towork from their homes. They can be experienced

COTTAGE INDUSTRIES


or inexperienced, young or elderly, healthy orphysically challenged, single or married, with orwithout children.

Many mothers and/or fathers of young chil-dren find it more productive, more cost-effective,and safer to keep their children with them whilethey work at home. They can have the flexibilityof arranging their job around their family’sneeds. Many parents enjoy being able to spendtime with their children during the day. Parentsmaintain responsibility for the safety of their ownchildren and can keep abreast of how much theyare learning, know who they are playing with,and save money on day-care expenses at the sametime.

Another reason people choose to work fromhome is that they don’t have to commute to andfrom their workplace. By not commuting towork, they can save on wear and tear of theirvehicle, get lower insurance rates, and spend lessmoney on gas.

Working from home also saves money thatwould normally be spent on a workplace ward-robe. Much more informal clothing can be wornwhen working at home. Not spending money onuniforms, suits, and/or dresses provides moremoney for other expenses.

Home employment gives control of one’s lifeto oneself. There is freedom and flexibility insetting work schedules. Parents can be home fortheir children, there are no commuting hassles,and no one looks over shoulders or determinesbreak time. The individual, not the employer,determines the work schedule. A parent has theflexibility of scheduling work flow around schoolactivities such as field trips and sports activities.

DECISIONS TO MAKE

Despite all the benefits listed above, home em-ployment is not for everyone. For example, thosewho start their own business must be able togenerate work. There are advertising costs in-volved in getting the company name out to thegeneral public. Careful consideration should begiven to the possible advertising avenues to use.Advertising can be very expensive and may notgenerate enough business if it does not reach po-

tential customers. People who do good work butcannot get others to recognize this or cannot dowell in promoting themselves may be spendingmore than they are earning.

Detailed record keeping is a must for the self-employed as well as the work-at-home person.Some deductions are available only if the busi-ness is making a profit, while others are usedyearly to determine expenses. Depending on thetype of business a person wishes to become in-volved in, start-up costs need to be consideredand information gathered on the best equip-ment/tools necessary. Some businesses may re-quire a starting inventory, while others do not.When considering start-up costs, one shouldshop wisely and consider purchasing used equip-ment and supplies. This will save money for otherexpenses, and the depreciation on these itemswill be more reasonable. Advertising, mileage ex-penses, cost of supplies, phone, electricity, andentertainment are just some of the expenses forwhich records must be maintained. Tax laws canand do change frequently. The person who isunsure about what records need to be keptshould contact a tax adviser for detailed and up-to-date information.

Another factor to consider before deciding towork from home is motivation. One must be ableto set one’s own schedule and follow through onit. If a person is used to working for someone elseand having supervision and direction provided, itcan be very easy to let work slide. Setting goalsand following through on them is a necessitywhen working for oneself.

Finally, one should check local authoritiesbefore starting a home-based business as townsvary greatly in their local ordinances. They willexplain any rules the town has established regard-ing home-based businesses and give guidance inthe necessary paperwork or approval process.

HOME EMPLOYMENT RESOURCES

For those people who wish to become self-em-ployed and work out of their home, there areseveral organizations available to help get started.

One major resource for the self-employed isan association called SCORE (Service Corps of

COTTAGE INDUSTRIES


Retired Executives). SCORE is a nonprofit groupsponsored by the U.S. Small Business Adminis-tration that has provided successful, free businesscounseling since 1964. SCORE matches volun-teer counselors with clients needing their expertadvice. It also maintains a national skills roster tohelp identify the best counselor for a particularclient. SCORE is made up of more than 13,000retired or active executives and has more than400 chapters nationwide. These executives volun-teer their time, skills, and experience to help theself-employed get started in their own business orhelp those who are already in business when theyhave problems or need advice. SCORE also offersmany seminars and workshops and posts thisinformation at its local chapters. Since its incep-tion, SCORE has advised, counseled, andmentored more than 300,000 small businesses,helping nearly 4 million Americans with face-to-face counseling, e-mail counseling, and training.For more information on SCORE, contact a localchapter personally or visit its Web site athttp://www.score.org/.

Home Employment Resource is an organiza-tion dedicated to helping people who want towork at home. It provides information on com-panies nationwide that hire people to work fromhome. A partial listing of jobs that have beenavailable to the home-employed include typists,graphic artists, auto appraisers, editors, reporters,financial analysts, cartoonists, claims processors,photographers, proofreaders, recruiters, andwriters. There are many jobs available for home-based workers if one knows where to look. Thisorganization assists in contacting the companiesthat hire work-at-home people. The Web site forHome Employment Resource is http://www.home-employment.com/.

The Independent Homeworkers Alliance(IHA) is an organization dedicated to helpingpeople who want to work from home. The IHAoffers its members valuable benefits that are de-signed specifically for the work-at-home person.Included in its database are more than 43,000 joblistings. Membership and maintenance fees thatare charged to members are applied directly tothe organization itself to improve, enhance, and

add to the existing services provided to its mem-bers, who number more than 27,000. More infor-mation about Independent Homeworkers Alli-ance is available through their Web site athttp://www.homeworkers.org/.

There are also home study schools that offertraining in fields such as medical billing andclaims processing, medical transcription, book-keeping, and paralegal work. For more informa-tion on home-study schooling, contact At-HomeProfession . . . America’s First Home StudySchool for Work-at-Home Careers, 2001 LoweStreet, Fort Collins, CO 80525.

BIBLIOGRAPHY

Home Employment Resource. http://www.home-employment.com/.

Independent Homeworkers Alliance. http://www.homeworkers.org/.

SCORE, Johnson City, Tennessee. http://farad.xtn.net/virtual/mainmenu/newjc/chamber/scoreindex.html.

‘‘The SCORE Association Marks Milestones. Carolina-Up-state Business Journal. http://www.carolina-upstate.com/journal/page20.htm.

The World Book Encyclopedia. (1997) Chicago: WorldBook.

JULIE A. WATKINS

COUPONS(SEE: Promotion)


Until the 1920’s, consumer purchases in theUnited States were made primarily in one of twoways: cash or personal check. But in that decade,a new means of payment was introduced—thecredit account. While credit transactions hadbeen common for a long time in business tobusiness dealings, they were new to the consumermarket. The credit account allowed a consumerto defer payment on a purchase made today tosome time in the future: thus, the expression‘‘buy now, pay later’’ was born. Evidence of the



credit account typically took the form of a card—the credit card.

Since the 1920’s, different types of creditcards have emerged. In addition, related types ofcards have also appeared on the consumer scene:the debit card, as well as the ATM card and thesmart card, and the travel card and charge card.Each type of card will be defined and explained inthis entry.

CREDIT CARDS

A credit card is a pocket size, plastic card thatallows the holder to make a purchase on a creditaccount that will be repaid at some time in thefuture. Repayment may be in a single amount orin a series of amounts. At a minimum, the creditcard will include identification of the user byname, account number, and signature.

The earliest issuance of credit cards in theUnited States was by gasoline companies andretail stores. Thus, it was quite common in thefirst half of the twentieth century to carry a creditcard from Esso, Sears, and/or a local departmentstore. These early cards were issued by the privatecompany itself based on the credit policy of thatcompany. Many of the accounts were expected tobe paid in the month following purchase. Otherswere revolving charge accounts in which partialpayment was expected every month, with acharge for interest on amounts not paid promp-tly.

If the balances of the credit accounts werenot paid, the issuing firm took the loss. Thus,deciding to issue a credit card was a thoughtfulprocess on the part of the firm. Often, the threeC’s of credit were applied to a credit applicant:character, capacity, and capital. Character re-ferred to the record of the applicant in payingprevious accounts—his or her credit history. Ca-pacity meant the earnings potential (salary) ofthe applicant. Capital referred to the net assets(assets minus liabilities) of the person. Obtaininga credit card was far from an automatic process.

Major changes in the nature and types ofcredit cards occurred in the 1950’s. Two types ofcredit cards emerged in that decade: the charge

card and the bank credit card. The charge card isdiscussed as a travel card later in this entry.

The bank credit card expanded the idea of acredit card company to a much broader usage—virtually every merchant and service providerworldwide. The 1959 BankAmericard from theBank of America in California is today the VISAcard. The 1970’s saw the birth of Master Charge,today’s MasterCard. These cards are issued bybanks, so one applies to a bank for the creditcard. A preset credit limit is assigned to the carduser. After an item is charged at a firm, the firmreceives payment from the bank. The bankcharges a fee to the firm, pays the firm the netamount, and then collects from the consumer.The consumer usually pays an annual fee to thebank and is charged interest on the unpaid bal-ance at the end of each month. Credit cards mayalso be used to make a cash advance from thebank. However, it should be remembered thatinterest rates on cash advances using a credit cardcan be much higher than the rates for credit cardpurchases. Thus, the cash advance feature shouldbe used wisely.

While at one time it was difficult to earncredit, the process is far easier at the present time.Banks compete for customers for their creditcards and often solicit college students with lim-ited capital and offer them credit cards. Telemar-keting of credit cards is frequent. Low creditlimits are relatively easy to obtain at present.Demonstrating a solid payment record andgrowth in earnings then leads to higher limits.

Managing one’s credit becomes important tothe consumer. It is critical never to get into aposition in which one has so many credit cardsand so many high balances that the credit billsnever get paid off. For example, if you have abank credit card with a balance of $1,000 and aninterest rate of 18% a year or 1 1⁄2% a month(18% divided by 12 months), the interest for thecurrent month will be $15 ($1,000� .015). If thepayment made on the account this month is only$25, then the first $15 is for interest; the remain-ing $10 ($25-$15) reduces the principal of $1,000to $990 for the next month. In other words, morehas been paid for interest than for what was



purchased; the situation in the following monthwill change very little. At this rate of payment, itcould be several years before the balance is re-duced to zero. In the meantime, if the card hasbeen used for more purchases, the cycle of re-maining in debt continues. Credit card manage-ment is critical to a consumer. In fact, one whohas difficulty in dealing with credit cards mightbe better off with debit cards.

DEBIT CARDS

A debit card is also issued by a bank and lookslike a credit card, but it works very differently.When one uses a debit card, the amount spent isdeducted immediately from the user’s bank ac-count. It is as if one is paying by check withouthaving to write a check. There will be no unpaidfuture bills, for the payment is made at the timeof the expenditure. For example, many peopletoday purchase groceries with the debit card byrunning it through the card reader at the grocerystore check out counter. In addition, people oftenget extra cash while paying for the groceries withthat debit card.

It is helpful to know how a bank accountworks from the bank’s point of view to fullyunderstand the debit card. When an amount isadded to a bank account, such as by a deposit, theindividual’s account is ‘‘credited;’’ when anamount is subtracted from that bank account,such as by writing a check, the account is‘‘debited.’’ Thus, the term debit card states whathappens to the bank account when the card isused—an immediate subtraction.

A common function of the debit card is as anATM card. ATM stands for the Automated TellerMachine that so many use today. ATMs allow for24-hour banking. The card holder is able to makedeposits, find out bank balances, transfer moneyfrom account to account, and make a loan pay-ment. The ATM/debit card can also be used toobtain cash; the amount withdrawn is subtractedimmediately from the bank account; thus it isanother use of a debit card.

The user of the debit card must take particu-lar care in keeping records of expenditures withthe debit card. Unlike the check that usually is

recorded at the time of payment, the debit cardexpense has its record in the form of a sales slip, aregister receipt, or a record of an ATM with-drawal or deposit. Debit card expenditures mustbe deducted from the bank account balance bythe user in a regular accurate manner to avoidlosing track of the account balance.

A variation on the debit card is the smartcard. While the debit card uses a magnetic strip,the smart card typically uses an embedded semi-conductor to store and maintain information.Smart cards have many uses, but in general areused for prepayment of an expense, such as whena phone card is purchased. The phone card has somany dollars in it that have been paid for inadvance of use. As the card is used, money valueis deducted. Other applications of the smart cardare for the payment of tolls and for the purchaseof gasoline. In both cases, the card can be wavedat a reader that will record the toll or the pur-chase of gasoline. Food plans at colleges andtransit cards on subway systems are other uses ofthe smart card. Using a smart card saves thatsudden search for change to pay a toll or to makea phone call.

TRAVEL CARDS

Travel cards, also called travel and entertainmentcards, fall into two categories. The first is thecharge card mentioned earlier. A charge card isissued by a firm whose main product is creditgranting in order to purchase a service. The firsttwo companies in this field were Diners’ Club,Inc. and American Express Company. In bothcases, one is issued a card based on a credit checkand then uses the card at designated establish-ments and with designated types of firms to payfor services or products. Payment is made not toa store nor to a bank, but rather to Diners’ Clubor to American Express. Diners’ Club cards areused primarily at eating establishments. Ameri-can Express cards are used for airlines, hotels,and other travel-related activities. No credit lim-its are established for charge cards, but paymentis expected in full within the next billing periodto maintain one’s credit record. However, a cur-rent change in the approach to the charge card



has been made by American Express to allowmonthly payments, just as if it were a bank creditcard account.

A second type of travel card is issued byairlines or hotel chains. This card does not havedirect money use, but serves instead as an up-graded service provider. Thus, included in thiscategory are such cards as frequent flyer cards,with which airline mileage is accumulated, to belater used for upgraded or free flights. In addi-tion, services are provided to the cardholder suchas early boarding of flights and/or other amenit-ies. Also included in this category are hotel chaincards that accumulate services at hotels in thatchain. Room upgrades, speedy check in andcheck out, and help with reservations are amongthe benefits of this type of card. Furthermore,many hotels are partners with airlines, so moneyspent at a hotel can result in additional miles onthe airline mileage account.

A growing trend among the airlines is theissuance of airline MasterCards or VISA cards.The airlines work with a bank to issue standardbank credit cards with one modification: everydollar spent using that credit card is turned intoairline mileage. Thus, the benefit of the bankcredit card is joined with the value of the airlinetravel card.

SUMMARY

From a time when what was bought was paid foron the spot, ‘‘plastic’’ has changed the way thatconsumers do business and handle personal fi-nancial functions. Credit cards allow a purchasenow with payment in the future. Debit cardsresult in an immediate deduction from a bankaccount without writing a check. Smart cards al-low for prepayment of expenses to aid in conve-nience when the expense needs to be paid. Travelcards permit charging of travel related expensesand the accumulation of travel services and bene-fits. All of these items are part of what seems to bearriving in the fairly near future—a paperless fi-nancial society accessed by cards of various types.In fact, it is possible that the day of cards will atsome point end and another means will be foundto connect the individual with those purchases

needed for functioning. Until then, given themany ways to purchase, wise consumerism isneeded to result in the correct choice of cards foran individual.

BURTON S. KALISKI

CREDIT UNIONS(SEE: Financial Institutions)

CRIME AND FRAUD

Both individuals and businesses commit manycriminal activities that cost businesses, con-sumers, government agencies, and stockholdersconsiderable sums of money each year. Businesscrime is not new; in fact, fraudulent activitieshave been a common part of business operationsfor thousands of years. For instance, in 360 B.C.in Syracuse, Sicily (then a Greek colony),Xenothemis and a shipowner, Hegestratos, per-suaded a customer to advance cash by claimingthat a vessel was fully laden with corn. Maritimetrade was at that time very risky, and manyvessels were subsequently lost at sea. Hegestratosintended to exploit this risk of loss at sea threedays after the ship sailed from port by sinking it.When the other passengers discoveredHegestratos’ plot, he panicked, jumpedoverboard, and drowned. This early example il-lustrates that criminal, and especially fraudulent,activities have existed within the world of busi-ness for some time and, unfortunately, will prob-ably continue to do so.

Under modern law, for a crime to have oc-curred, an illegal act must have been committedand intent to commit the act must be shown. Acrime is a violation of local, state, or federal lawand is punishable by the appropriate governmentauthority. Criminal activities are usually definedas applying to a specific type of behavior oraction. Embezzlement and fraud are two com-mon business-related crimes. Embezzlement oc-curs when a person has the right to possess busi-ness property or money but then converts that

CREDIT UNIONS


property or money to personal possession or use.Fraud is often thought of as intentional decep-tion of another person in order to deprive thatperson of property or to injure that person insome other way. Criminal activities can be com-mitted by individuals against a business as well asby businesses through the actions of their em-ployees against consumers, the general public,and/or stockholders.

INDIVIDUAL CRIMES AGAINST BUSINESS

Business-related individual criminal activities arenormally broken down into two categories: inter-nal and external.

Internal Crimes Internal crime occurs whenan employee steals from or commits some otheroffense against the business. For example, de-pending on their jobs, employees may have ac-cess to business files, records, or sensitive finan-cial information. The dishonest employee couldthen use this information to commit a crimeagainst the business. Generally, the higher in thebusiness the employee, the greater the potentialfor serious criminal activities against the firm.

A number of internal crimes are frequentlycommitted against a business. Among the mostcommon are abuse of power, accounting embez-zlement, misuse of business time, computer andelectronic information manipulation, intellectualproperty theft, supply and equipment pilferage,travel expense abuse, and vandalism and sabo-tage.

Abuse of Power. One form of employee crimi-nal activity is making inappropriate financial de-cisions on behalf of the business that are reallyintended to benefit the employee. An example ofthis activity may be seen when an employee isempowered to sign purchase contracts on behalfof the employer with the objective of getting thelowest price available from outside vendors. In-stead of doing this, an employee could sign con-tracts with more expensive outside vendors andreceive a kickback in return. Acceptance of kick-backs is an abuse of power and, depending on thesize of the contracts, may cost a business a con-siderable amount of money.

Accounting Embezzlement. One of the mostcommon internal criminal activities is the ma-nipulating of accounting records to steal businessfunds. An employee who is well trained in ac-counting techniques may be able to devise so-phisticated schemes to cover his or her connec-tion to the stolen business funds. Such criminalaccounting violations have and can go on foryears and end up costing a business many thou-sands of dollars. These criminal accounting prac-tices can be detected through a variety of meth-ods, such as changes in accounting procedures,co-worker concerns, and regular internal and/orexternal audits.

Accounting crimes are very serious mattersthat have adverse consequences for a business.The stealing of funds hurts the business’s profitmargin and, in turn, stockholders. Stock value ishurt because of the reduced profits showing onthe books, which, in turn, can cost a business thelost value of its securities. Such internal account-ing crimes must be reported to the appropriatelaw enforcement agencies, making the embezzle-ment part of the business’s public record. Thusthe business faces the embarrassment associatedwith having been a victim of accounting crimes,possibly weakening its image and public confi-dence in it. An employee who gets caught com-mitting such crimes faces severe penalties if con-victed. Depending on the amount of fundsstolen, an employee could be charged with andconvicted of a felony and face a long prisonsentence. In addition, once convicted of such acrime, it will be next to impossible for a person toget another job in the business world.

Misuse of Business Time. Employees who per-form non-work-related functions while at workare involved in fraudulent activities because theyare getting paid to do work for the business but inreality are not performing those functions. Anexample of this practice is an employee who surfsthe Internet for several hours a day for personalreasons, depriving the business of employee pro-duction during that time. A few hours of losttime here and there may not seem like much toan employee, but the aggregate loss of work time

CRIME AND FRAUD


in the business as a whole can add up to a sizableloss.

Computer and Electronic Information Manipu-lation. The advent of modern technology has pro-vided more opportunities for employees to com-mit computer or electronic fraud. One of themost common forms of embezzlement involvesthe electronic manipulation of business funds soas to deposit them into personal or other third-party accounts. Once the rerouted business fundsare deposited into such an account, the employeeis free to withdraw and spend them at will. Ini-tially, such electronic fraud might seem easy tocarry out, but computers leave behind clues thatwill lead auditors to the final destination of thefunds and to the dishonest employee.

Intellectual Property Theft. One of the fastest-growing areas of business-related criminal activ-ity is the theft of cutting-edge technology by aworker from the employing business. Typically,the dishonest employee will sell the stolen tech-nological knowledge to a competing firm. Crimi-nal activity in this area can be extremely damag-ing to any business. One reason is that mostbusinesses invest considerable sums of money inresearch and development to improve or createnew technology. The theft and resale of this in-formation to competitors could easily cost a busi-ness many thousands of dollars in lost profits.Another is that the business’s competitors canstay competitive for only a fraction of the priceand thus reap even larger profits. In response tothis serious issue, businesses have tightened secu-rity and have asked law enforcement to vigor-ously prosecute anyone involved with this type ofcriminal behavior.

Supply and Equipment Pilferage. Another ex-ample of internal employee criminal activity isthe theft of business supplies and office equip-ment. Businesses are concerned with employeeswho steal supplies and office equipment, such aslaptop computers, paper, paper clips, pens,printers, and so forth. The theft of such businessproperty reduces business profits and, if its stockis publicly traded, earnings for its stockholders.The consequences for dishonest employees who

are caught engaging in these activities include jobtermination and criminal prosecution.

Travel Expense Abuse. Employees who travelfor a business as part of their jobs often commitfraud by putting personal items on the firm’sexpense account. For example, employees mayinclude higher amounts on their expense voucherthan were actually paid. This practice is commonwhen reporting the amount paid in the form of atip, as usually no receipt is involved. Individually,the funds embezzled by one employee in this waymight not add up to much, but collectively thistype of crime could cost a business many thou-sands of dollars each year.

Vandalism and Sabotage. Another type of in-ternal crime is an employee’s intentional destruc-tion of business property or equipment. Theemployee does not receive any monetary benefitfrom destroying business property; rather, it isdone to get back at a business or a supervisor fora myriad of reasons, such as being passed over forpromotion, a pending layoff, or a poor perform-ance evaluation. Traditional employee vandalisminvolves destruction of physical property, includ-ing computer equipment, office furniture, busi-ness vehicles, or other business property. Physicaldestruction of business property can be deterredby the use of surveillance equipment and thevisible presence of adequate security staff.

The real threat to modern businesses is theeffort to sabotage computer systems. An em-ployee with extensive knowledge of a business’scomputer system could create a computer virusor some other highly technical method to inca-pacitate some or all of the business’s computersystem. The destruction or failure of a business’scomputer system would cause enormous troublefor the business. In addition, if business files wereto be damaged or erased, it could cost the busi-ness a considerable amount of time and resourcesto fix them, not to mention the lost sales or poorcustomer service that might occur as a result.Since the computer security issue is so important,businesses normally discontinue computer accessfor employees who are going to be separatedfrom the firm. In addition, business security typi-

CRIME AND FRAUD


cally monitors employees who have exhibitedstrong negative feelings toward the business or asupervisor.

External Crimes Among the more commonexternal crimes committed against a business areburglary, robbery, shoplifting, and walk-in office/factory thefts.

Burglary. While burglary has been describedin many ways, it is usually thought of as breakinginto a place of business with the intent of com-mitting a felony or simply stealing something.Although any business may be burglarized, indi-viduals who commit burglary tend to target thosefirms where they are likely to receive a highmonetary return for their efforts. Financial insti-tutions, such as banks, are often targeted becausethey normally have large amounts of cash orvaluable securities on hand. Almost every majorfinancial business uses a variety of elaborateantiburglary devices to deter potential burglaries.Financial institutions also use extensive networksof electronic equipment to notify law enforce-ment when burglaries do occur. Most majorbusinesses now employ a wide variety ofantiburglary strategies in order to provide maxi-mum security to their offices and employees.

Robbery. Robbery is committed when a crimi-nal attempts to steal from a business by use offorce or threat of force—usually with a weapon,such as a gun or knife—during its normal oper-ating hours. Robberies are very serious because oftheir potential to inflict bodily injury on employ-ees and/or customers who are on the premises atthe time of the robbery. Moreover, any propertyor money that is stolen also hurts the businessfrom a profit-and-loss point of view. The mostcommon example of a robbery would be a crimi-nal attempting to steal money from a store dur-ing business hours.

Shoplifting. One of the most prominentthreats to any retail business is shoplifting, whichcosts businesses millions of dollars in lost salesand stolen merchandise each year. Unfortu-nately, the cost associated with this type of crimi-nal activity is passed on to honest consumers in

the form of higher prices. Because of the highcosts associated with shoplifting, many retailbusinesses use sophisticated electronic surveil-lance systems in order to deter shoplifting and tocatch those who commit the crime. In fact, mostretailers have adopted a zero-tolerance policy rel-ative to shoplifting and prosecute anyone caughtstealing regardless of the amount. The combina-tion of strong antitheft measures and vigorousprosecution of those caught has resulted in fewernumbers of shoplifting cases.

Walk-In Office/Factory Thefts. Some individu-als commit thefts by simply walking into an officeand attempting to steal something of value. Thecriminal then walks out of the office or factorywith the item and tries to resell the product.Individuals who commit such crimes normallyuse a disguise (i.e., a delivery person) in order toget past business security.

CRIMES COMMITTED BY BUSINESS

Occasionally, businesses are sources of crimeagainst consumers, the general public, govern-ment, and/or stockholders. Examples of crimescommitted by businesses include fraudulent re-porting, price fixing, and product misrepresenta-tion.

Fraudulent Reporting A business might par-take in fraudulent activities by manipulating ormisrepresenting business accounting records,profit information, sales data, or other pertinentfinancial information. This type of behavior isusually on attempt to hide serious financial prob-lems in order to prevent the general public, regu-latory agencies, or stockholders from gettingpoor status reports. Unfavorable financial infor-mation can be devastating to a business’s stockvalue, which, in turn, will likely cause the busi-ness to lose a considerable amount of money inbusiness equity. For example, business X mightintentionally misreport higher profits than wereactually accrued to maintain the stock price andvalue of the business. If the actual lower profitshad been reported, then the stock would almostsurely go down, causing a decrease in the value ofthe business. Another reason a business might

CRIME AND FRAUD


report inaccurate financial data is because mostcorporate officers have some form of stock op-tions, and a serious drop in the stock price mightbe very costly on a personal basis. This type offraud is usually carried out at the top levels of thebusiness.

When this type of crime is committed by abusiness through its officers, serious conse-quences accrue to both. Once the crime is uncov-ered, regulatory and law enforcement agencies atboth the federal and state levels may begin aninvestigation of the alleged fraudulent activities.If the criminal activities are substantiated andconvictions occur, the business, at a minimum,faces large fines, while the officers face longprison terms. In addition, the business faces ahumiliating defeat in the arena of public opinionthat will, in turn, hurt future sales.

Price Fixing Businesses may engage in an-other type of crime known as ‘‘price fixing,’’ orconspiring with competitors to charge a mini-mum price for their products. This practiceforces consumers to pay more for a particularproduct than would be charged in a ‘‘non-pricefixing’’ competitive environment. Businesses arerewarded with higher profit margins because thispractice does not force them to conform to mar-ket forces. Price fixing is a violation of the Sher-man Anti-Trust Act of 1890, which was passed toensure that a competitive free market exists,which results in competitive pricing. The FederalTrade Commission (FTC) and the United StatesDepartment of Justice have primary jurisdictionover businesses that engage in violations of theSherman Anti-Trust Act. When a business and itsofficers are prosecuted for price fixing, the busi-ness often faces large fines while individual offi-cers usually go to prison.

Product Misrepresentation When a businessknowingly produces a defective or substandardproduct and sells it to the public anyway, the firmhas committed product fraud. Product fraud isextremely serious because consumers depend onsafe products in every aspect of daily life. Defec-tive or unsafe products can cause serious harm toboth the individual consumer and the general

public. An example of product fraud would bewhen an automobile manufacturer produces andmarkets a vehicle that has shown, in presale trials,to be unsafe. For instance, a vehicle may beunsafe when hit from behind or from the side,causing the gas tank to explode because of designflaws. The obvious results of such flaws in vehicledesign are the severe injury and/or death of peo-ple. Naturally, responses to product fraud in-clude numerous lawsuits and lack of public trustin businesses that knowingly release defective orpoorly designed products.

SUMMARY

Business-related criminal activity is not new. Infact, crimes in business, such as fraud, can betraced by thousands of years. Crimes can be com-mitted both by and against a business. Commoncrimes that influence the health of businesses andtheir customers include burglary, embezzlement,fraud, robbery, and shoplifting. Since crimes,both by and against businesses, are so costly,elaborate measures have been put in place todecrease the likelihood of their occurrence.

BIBLIOGRAPHY

Anderson, R. A., Fox, I., and Twomey, D. P. (1980). BusinessLaw, 11th ed. Cincinnati, OH: Southwestern Publishing

Company.

Clarke, M. (1990). Business Crime—Its Nature and Control.New York: St. Martin’s Press.

Coleman, J. W. (1985). The Criminal Elite. New York: St.Martin’s Press.

Comer, Michael J. (1998). Corporate Fraud, 3d ed. Brook-field, VT: Gower.

Loewy, A. H. (2000). Criminal Law in a Nutshell, 3d ed. St.Paul, MN: West.

Mann, R. A., and Roberts, B. S. (1998). Essentials of BusinessLaw and the Legal Environment, 6th ed. St. Paul, MN:

West.

ALLEN D. TRUELLMICHAEL MILBIER

CRIME AND FRAUD


Money traders at work.

CURRENCY EXCHANGE

Money is any medium that is universally acceptedin an economy by sellers of goods and services aspayment and by creditors as payment for debts.Money serves as a medium of exchange; indeed,without money, we would have to resort to barterin doing business. Barter is simply a direct ex-change of goods and services for other goods andservices. For instance, a wheat farmer who wantsa pair of eyeglasses must find an optician who, atexactly the same time, wants a dozen bushels ofwheat; that is, there must be a double coincidenceof wants, and the elements of the desired trademust be of equal value. If there isn’t a doublecoincidence of wants, the wheat farmer must gothrough several trades in order to obtain the de-sired eyeglasses; for example, this might involvetrading wheat for a computer, then the computerfor several lamps, then the lamps for the desiredeyeglasses.

The existence of money means that individu-als do not need to hold a diverse collection ofgoods as an exchange inventory. Money allowsthem to specialize in any area in which they havea comparative advantage and to receive moneypayments for their labor. Money can then beexchanged for the fruits of other people’s labor.The use of money as a medium of exchangepermits individuals to specialize and promotesthe economic efficiencies that result from special-ization.

In the same way that money facilitates ex-change in a single economy, exchange of currenc-ies facilitates the exchange of goods and servicesacross the boundaries of countries. For instance,when you buy a foreign product, such as a Japa-nese car, you have dollars with which to pay theJapanese carmaker. The Japanese carmaker, how-ever, cannot pay workers in dollars. The workersare Japanese, they live in Japan, and they needJapanese yen to buy goods and services in that

CURRENCY EXCHANGE


country. There must be some way of exchangingdollars for the yen that the carmaker will acceptin order to facilitate trade. That exchange occursin a foreign-exchange market, which in this casespecializes in exchanging yen for dollars.

The particular exchange rate between yenand dollars that would prevail depends on thecurrent demand for and supply of yen and dollars(see Figure 1). If one cent per yen is the equilib-rium price of yen, then that is the foreign-ex-change rate determined by the current demandfor and supply of yen in the foreign-exchangemarket. A person going to the foreign-exchangemarket would need one hundred yen (1/.01) tobuy one dollar or one dollar to buy one hundredyen.

SUPPLY AND DEMAND FORFOREIGN CURRENCY

Suppose you want to buy a Japanese car. To doso, you must have Japanese yen. You go to theforeign-exchange market (or your Americanbank). Your desire to purchase the Japanese carcauses you to offer (supply) dollars to the foreign-exchange market. Your demand for Japanese yenis equivalent to your supply of U.S. dollars to theforeign-exchange market. Indeed, every U.S. im-port leads to a supply of dollars and a demand forsome foreign currency. Likewise, every U.S. ex-port leads to a demand for dollars and a supply ofsome foreign currency by the purchaser.

For the moment assume that only two goodsare being traded—Japanese cars and U.S. steel.Thus, the U.S. demand for Japanese cars creates asupply of dollars and a demand for Japanese yenin the foreign-exchange market. Similarly, theJapanese demand for U.S. steel creates a supply ofyen and a demand for dollars in the foreign-exchange market. The equilibrium exchange ratewill tell us how many yen a dollar can be ex-changed for (the dollar price of yen) or howmany dollars a yen can be exchanged for (the yenprice of dollars).

The demand for and supply of foreign-ex-change determine the equilibrium foreign ex-change rate. For the moment, ignore any specula-tive aspects of foreign exchange; that is, assume

that there are no individuals who wish to buy yensimply because they think that the price of yenwill go up in the future.

The idea of an exchange rate is similar to theidea of paying a market-determined price forsomething you want to buy. If you like soda, youknow you have to pay about fifty cents a can. Ifthe price went up to one dollar, you would prob-ably buy fewer sodas. If the price went down totwenty-five cents, you might buy more. In otherwords, the demand curve for soda, expressed interms of dollars, slopes downward, following thelaw of demand.

The demand curve for Japanese yen alsoslopes downward. Suppose it costs you one centto buy one yen—this would be the exchange ratebetween dollars and yen. If tomorrow you had topay two cents for a yen, then the exchange ratewould have changed. Looking at such an increasewith respect to the yen, we would say that therehas been an appreciation in the value of the yen inthe foreign-exchange market. But this increase inthe value of the yen means that there has been adepreciation in the value of the dollar in the for-eign-exchange market. When one currency ap-preciates, the other currency depreciates.

DETERMINANTS OF THE VALUE OFFOREIGN EXCHANGE

Supply and demand in the foreign-exchangemarket are determined by changes in many mar-ket variables, including relative price levels, realinterest rates, productivity, product preferences,and perceptions of economic stability.

Different countries have different rates of in-flation, which are an important factor in deter-mining exchange rates. Purchasing power parity(PPP) is one widely used theory of the determi-nation of exchange rates. PPP exists between anytwo currencies whenever changes in the exchangerate exactly reflect relative changes in price levelsin two countries. In the long run, the averagevalue of exchange rates depends on their pur-chasing power parity because in that way therelative prices in the two countries will stay thesame (when measured in a common currency).That is, changes in the relative values of the two

CURRENCY EXCHANGE


Demand Supply

100 125 150 Billions of Yen per Year

.012

.010

Pric

e pe

r Yen

(in

$)

Equilibrium

Figure 1

currencies compensate exactly for differences innational exchange rates. The PPP theory seems towork well in the long run when the differences ininflation rates between two countries are rela-tively large. When differences in inflation ratesare relatively small, other market-oriented forcesmay dominate and often distort the picture.

A factor that may affect equilibrium currencyprices is the interest rate of a country. If the U.S.interest rate, corrected for people’s expectationsof inflation, abruptly increased relative to interestrates in the rest of the world, international inves-tors elsewhere would increase their demand fordollar-denominated assets, thereby increasingthe demand for dollars in foreign-exchange mar-kets. An increased demand in foreign-exchangemarkets, other things held constant, would causethe dollar to appreciate and other currencies todepreciate.

Another factor affecting equilibrium is achange in relative productivity. If one country’sproductivity increased relative to another’s, theformer country would become more competitivein world markets. The demand for its exportswould increase, and so would the demand for itscurrency.

Changes in consumers’ tastes also affect theequilibrium prices of currencies. If Japan’s citi-zens suddenly developed a taste for a U.S. prod-

uct, such as video games, this would increase thedemand for U.S. dollars in foreign-exchangemarkets.

Finally, economic and political stability affectthe supply of and demand for a currency, andtherefore the equilibrium price of that currency.If the United States looked economically andpolitically more stable than other countries, moreforeigners would want to put their savings intoU.S. assets than in assets of another country. Thiswould increase the demand for dollars.

FIXED- VERSUS FLEXIBLE-EXCHANGE-RATESYSTEMS

Under the flexible-exchange-rate system describedabove, the equilibrium exchange rate reflects thesupply and demand for the currency. Under afixed-exchange-rate system a country’s centralbank intervenes by buying or selling its currencyto keep its foreign-exchange rates from changing.As with most systems in which the price of a goodor service is fixed, the only way that it can remainso is for the government to intervene. Considerthe two-country example above. Suppose thatthere were an increase in the prices of all goodsand services made in the United States, includingsteel. The Japanese yen would now buy less steelthan before. The Japanese would supply feweryen to the foreign-exchange market and demandfewer dollars at the fixed exchange rate. But sup-pose Americans continued to demand Japanesecars. In fact, they would demand more Japanesecars because, at the fixed exchange rate, the rela-tive price of Japanese cars would fall. Americanswould now supply more dollars to the foreign-exchange market and demand more yen. In theabsence of intervention by a central bank, theexchange rate would change. In order to main-tain the foreign-exchange price of the yen, theJapanese central bank would buy (demand) dol-lars and sell (supply) yen.

If the central bank didn’t act to support thestated foreign-exchange rate, then too much ortoo little of one currency would be supplied ordemanded. This lack of balance (i.e., disequilib-rium) in the foreign-exchange market would im-pede trade between the two countries and could

CURRENCY EXCHANGE


potentially result in a black market (i.e., under-ground market or illegal trade) in the two cur-rencies.

CURRENCY CRISES

The only way for the United States to support theprice of the dollar is to buy up excess dollars withforeign reserves—in our case, with Japanese yen.But the United States might eventually run out ofJapanese yen. If this happened, it would nolonger be able to stabilize the price of the dollar,and a currency crisis would result. A currencycrisis occurs when a country can no longer sup-port the price of its currency in foreign-exchangemarkets under a fixed-exchange-rate system.Many such crises have occurred in the past sev-eral decades when countries have attempted tomaintain a fixed exchange rate that was in dis-equilibrium.

One alternative to a currency crisis or tocontinuing to try to support a fixed exchange rateis to devalue unilaterally. Currency devaluation isequivalent to currency depreciation, except thatit occurs under a fixed-exchange-rate regime.The country officially lowers the price of its cur-rency in foreign-exchange markets; this is a delib-erate public action by a government following afixed-exchange-rate policy. Revaluation is theopposite of devaluation. This occurs when, undera fixed-exchange-rate regime, there is pressure ona country’s currency to rise in value in foreign-exchange markets. Unilaterally, that country candeclare that the value of its currency in foreign-exchange markets is higher than it has been in thepast. Currency revaluation is the equivalent ofcurrency appreciation, except that it occurs un-der a fixed exchange rate regime and is mandatedby the government. Managed exchange rates,sometimes referred to as dirty float, occur when acentral bank or several central banks intervene ina system of flexible exchange to keep the ex-change rate from undergoing extreme changes.

SUMMARY

Thus, a well-functioning foreign-exchange mar-ket is vital for worldwide trade. In a flexible-exchange-rate system, supply of and demand for

a currency determine the exchange rate. In afixed-exchange rate system, a government im-poses the exchange rate; given the mandated ex-change rate, consumers determine how much ofthe currency they wish to supply or demand. In amanaged-exchange-rate system, the exchangerate is determined through the markets, but thecentral bank will intervene by buying and sellingthe currency in order to influence the price.

DENISE WOODBURY

CUSTOMER SERVICE

A growing number of organizations are givingincreased attention to customer service. Financialinstitutions, hospitals, public utilities, airlines, re-tail stores, restaurants, manufacturers, andwholesalers face the problem of gaining and re-taining the patronage of customers. Buildinglong-term relationships with customers has beengiven a high priority by the majority of America’smost successful enterprises. These companies re-alize that customer satisfaction is an importantkey to success. Customer service can be defined asthose activities that enhance or facilitate the pur-chase and use of the product. Today’s emphasison customer satisfaction can be traced to a mana-gerial philosophy that has been described as themarketing concept.

EVOLUTION OF THEMARKETING CONCEPT

What is the ‘‘marketing concept’’? When a busi-ness firm moves from a product orientation to acustomer orientation, we say it has adopted themarketing concept. This concept springs from thebelief that the firm should dedicate all its policies,planning, and operation to the satisfaction of thecustomer.

The marketing era in the United States beganin the 1950s. J. B. McKitterick, a General Electricexecutive, is credited with making one of theearliest formal statements indicating corporateinterest in the marketing concept. In a paperwritten in 1957 he observed that the principalmarketing function of a company is to determine

CUSTOMER SERVICE


what the customer wants and then develop theappropriate product or service. This view con-trasted with the prevailing practice of that period,which was to develop products and then buildcustomer interest in those products.

The foundation for the marketing concept isa business philosophy that leaves no doubt in themind of every employee that customer satisfac-tion is of primary importance. All energies aredirected toward satisfying the consumer. L. L.Bean, the Freeport, Maine, mail-order firm, pro-vides a good example of a company that hasembraced the marketing concept. This well-known supplier of outdoor products offers thecustomer an unconditional guarantee of satisfac-tion that has been in place since the company wasfounded in 1912. If you are unhappy with an L. L.Bean product, simply request replacement or arefund (Comarow, 1999).

We have entered the age of boundless com-petition, triggered in large part by an expandingglobal economy. Multinational competition hasincreased dramatically in recent years, and thismeans a one-world market exists for productsranging from cars to computers. To competesuccessfully in markets where products are thesame or very similar, and prices are basically thesame, service is often the only competitive advan-tage available.

WINNING CUSTOMER SERVICE STRATEGIES

According to the marketing concept, an organi-zation must determine what customers want anduse this information to create satisfying productsand services (Pride and Ferrell, 1997). FederalExpress redefined mail service by providing over-night, door-to-door delivery of packages and let-ters. The company discovered a need for speed,reliability, and courteous service by well-trainedemployees. The marketing concept is a manage-ment philosophy guiding all the organizationalactivities, including production, personnel, fi-nance, distribution, and marketing.

Excellent customer service is achieved by athree-dimensional process (see Figure 1) that in-cludes a well-conceived service strategy, cus-tomer-driven systems, and customer-friendly

The Service Triangle

TheServiceStrategy

TheSystems

TheCustomer

ThePeople

Figure 1

people (Albrecht and Zemke, 1985). Each dimen-sion must reflect the important needs and wantsof the customer. The ‘‘service triangle’’ can bedeveloped for any type of business. Each piece ofthe triangle is explained in the following sections.

SERVICE STRATEGY

A well-conceived service strategy includes threeimportant elements: market research to discoverthe customers’ needs and wants; a clear vision ofthe firm’s ‘‘reason for being’’; and clearly statedbeliefs and values that guide the enterprise(Albrecht and Zemke, 1985).

Many organizations are creating a writtenvision or mission statement that directs the en-ergies of the company and inspires employees toachieve greater heights. Ortho Biotech, based inRaritan, New Jersey, begins its vision statementwith a bold prediction: ‘‘We will be the best inour business by providing customers with inno-vative solutions to significant medical problemsthrough biotechnology and related science’’(quoted in Lee, 1993, p. 27). Senior managersmust serve as ‘‘cheerleaders’’ to unify employeesbehind the vision.

The creation of a sound set of beliefs andvalues can give stability to an organization. Cus-tomer service priorities also become clearer. Ben

CUSTOMER SERVICE


Edwards, chairman of A.G. Edwards and Sons,Inc., the seventh-largest securities firm in the na-tion, says following the Golden Rule is still thebest way to achieve success in business (Kegley,1990). This attitude has had a positive influenceon the company’s 7400 employees.

CUSTOMER-FRIENDLY SYSTEMS

Service systems are made up of all the variouspractices and procedures that personnel can useto meet customer needs. When you check intothe Hyatt Regency Crown Center in Kansas City,Missouri, you are given a card that says, ‘‘Call 50for a response to any concern within five min-utes’’ (Manning and Reece, 1998). MBNA, a Wil-mington, Delaware, financial services companywants every phone call answered within tworings. Employees achieve this goal nearly 100percent of the time (Reece and Brandt, 1999). Ifyou have a problem with your Dell computer,you can check the detailed troubleshooting guideprovided by the company or get help from amember of the technical support staff. These ex-amples are typical of the steps being taken bycompanies that want to meet, and in some casesexceed, the expectations of their customers.

Customer-friendly systems are designed tomake things easy for customers. Complaintsshould be handled in a timely fashion. Returningor exchanging products should not be difficult.Requests for assistance should be handled in acourteous and efficient manner. Customer-friendly systems add value and build customerloyalty.

CUSTOMER-FRIENDLY FRONTLINE PEOPLE

In many cases, the customer’s first impression ofan organization comes during contact withfrontline people. The cashier at the supermarket,the receptionist at the doctor’s office, and thefront-desk clerk at the hotel often have the firstopportunity to serve the customer. Unfortu-nately, too often these employees earn low pay,receive little formal training, and are given little

recognition for the important duties they per-form. The best frontline employees are bothcompetent and caring. They have a certain levelof maturity and possess the social skills needed tobuild customer loyalty.

SUMMARY

The ultimate purpose of every business should beto satisfy the customer. Increased levels of com-petition require a greater commitment to cus-tomer service. Firms that invest the time, energy,and money needed to achieve excellent customerservice will be the ones that thrive and grow.

BIBLIOGRAPHY

Albrecht, K., and Zemke, R. (1985). Service America!Home-wood, IL: Dow Jones-Irwin.

Carlzon, Jan. (1987). Moments of Truth. Cambridge, MA:Ballinger.

Comarow, A. (1999). ‘‘Broken? No Problem.’’ U.S. Newsand World Report January 11:68-70.

Fromm, Bill, and Schlesinger, Len. (1994). The Real Heroesof Business . . . and Not a CEO among Them. New York:Currency Doubleday.

Kawasaki, Guy. (1999). Rules for Revolutionaries. New York:Harper Business.

Kegley, G. (1990). ‘‘Broker with a Difference: A. G. Edwards,Chairman.’’ Roanoke Times World News April 13:B-6.

Lavington, Camille. (1997). You’ve Only Got Three Seconds.New York: Doubleday.

Lee, C. (1993). ‘‘The Vision Thing.’’ Training February27:27.

Manning, G. L., and Reece, B. L. (1998). Selling Today:Building Quality Partnerships. Upper Saddle River, NJ:Prentice-Hall.

Peppers, Don, and Rogers, Martha. (1999). The One to OneFieldbook. New York: Currency Doubleday.

Pride, W. M., and Ferrell, O. C. (1997). Marketing. BostonHoughton Mifflin.

Reece, B. L., and Brandt, R. (1999). Effective Human Rela-tions in Organizations. Boston: Houghton Mifflin.

Sewell, Carl. (1998). Customers for Life. New York: PocketBooks.

BARRY L. REECE

CUSTOMER SERVICE


DATABASES

With the rise of business data-processing systemson a very large scale during the 1960s and 1970scame the development of databases and databasemanagement systems. Databases are large collec-tions of interrelated data stored on computerdisk systems from which they can be immediatelyaccessed and revised. Database management sys-tems are large computer programs that ‘‘manage’’or control the databases.

Data is normally defined as ‘‘facts’’ fromwhich information can be derived. For example,‘‘Janene Clouse lives at 1411 Sycamore Avenue’’is a fact. A database may contain millions of suchfacts. From these facts the database managementsystem can derive information in the form ofanswers to questions such as ‘‘How many peoplelive on Sycamore Avenue?’’ The popularity ofdatabases in business is a direct result of thepower of database management systems in deriv-ing valuable business information from large col-lections of data.

RELATIONAL DATABASES

Most modern databases are relational, meaningthat data are stored in tables, consisting of rowsand columns, and that data in different tables arerelated by the meanings of certain common col-umns. (The tables in a database are sometimescalled ‘‘files,’’ the rows are called ‘‘records,’’ andthe columns are called ‘‘fields.’’ However, this isan older terminology, left over from the early

days of business computer systems.) The follow-ing is an example of a simple relational databaseconsisting of three tables—one for customers,one for products, and one for sales:

Customers

Customer_no name address phone

1001 Jones 320 Main 555-88111002 Smith 401 Oak 555-88221003 Brown 211 Elm 555-88331004 Green 899 Maple 555-8844

Products

product_no description price

25 Ring 3.2533 Gasket 1.2345 Shaft 4.55

Sales

sale_no date customer_no product_no

841 3/11 1002 45842 3/12 1001 25843 3/12 1002 45844 3/13 1004 33845 3/14 1003 25846 3/15 1002 33

Suppose we want to know the customer’sname for sale number 845. We look in the cus-tomer number column of the Sales table, and wesee that it was customer 1003. Next, we refer tothe Customers table and find customer 1003.Here we see the customer’s name is Brown. So,Brown was the customer for sale number 845.

D

227

STRUCTURED QUERY LANGUAGE

The foregoing is a simple example of a databasequery. In a modern database, queries are ex-pressed in a query language, which requires aparticular format that can be recognized andinterpreted by the database management system(DBMS). The standard query language for rela-tional databases, as adopted by the AmericanNational Standards Institute (ANSI), is SQL,which is generally understood to be an abbre-viation for ‘‘Structured Query Language.’’ Let uslook at a few examples of queries expressed inSQL.

Query: Which products have a price over $2?

SQL Solution: Select product_no, description

From ProductsWhere price � 2.00

Result: product_no description

RingShaft

This query’s SQL solution illustrates the SQLformat. In general, SQL ‘‘statements’’ have a Se-lect ‘‘clause,’’ a From ‘‘clause,’’ and a Where‘‘clause.’’ The Select clause lists the columns thatare to be shown in the result, the From clause liststhe database tables from which data is to betaken, and the Where clause gives the conditionto be applied to each row in the table. If a rowsatisfies the condition, then it is selected, and thevalues in that row for the columns listed in theSelect clause are included in the result.

Query: When have we sold product number 45 tocustomer 1002?

SQL Solution: Select dateFrom SalesWhere product_no = 45and customer_no = 1002

Result: date

3/113/12

In this example you can see that the condi-tion in the Where clause includes the connector‘‘and,’’ which indicates that both conditions(product–no � 45 and customer–no � 1002)must be fulfilled. In our sample database thereare two rows that satisfy this condition, and thequery’s result yields the dates from those tworows.

Our next query gives the SQL solution to theoriginal query we discussed above.

Query: What is the customer's name for salenumber 845?

SQL Solution: Select nameFrom Customers, SalesWhere sale_no = 845 and

Sales.customer_no =Customers.customer.no

This query illustrates how we can query morethan one table at once in SQL. First, we list alltables needed to answer the query. In this casethen, we list the Customers and the Sales tables.Then in the Where clause we give two conditions:

sale–no � 845 and

Sales.customer–no �Customers.customer–no

The first condition indicates that the sale–nocolumn must have a value of 845. Since there isonly one row in the Sales table having that value,we have limited our query to that single row. Thesecond condition indicates that we want only thatrow in the Customers table which has the samevalue for its customer–no column as the Salesrow has for its customer–no column. This condi-tion then limits our result to the joining togetherof one row from the Sales table and one row fromthe Customers table. Finally, the Select clause,

Select name

tells us that we should give the value from thename column as our result. As we showed before,the resulting customer name is ‘‘Brown.’’

Queries can also be used to perform calcula-tions:

DATABASES


Query: What is the average price of our products?

SQL Solution: Select Avg (price)From Products

Result: 3.01

SQL also provides statements that can be used tomake changes to data in the database. For exam-ple, let’s suppose we want to increase the price ofour products by 3 percent. Then we can use thefollowing statement:

Update Products

Set price � 1.03 * price

This statement will cause the price of every prod-uct in our Products table to be increased by 3percent. Note that it doesn’t matter whether wehave 3 products, as shown in our sample data-base, or 300,000 products. A single statement willupdate the prices of all products. Of course, if weonly want to change the prices of selected prod-ucts we can do that, too:

Update Products

Set price � 1.03 * price

Where product–no � 33

This statement will only change the price ofproduct number 33. SQL also provides state-ments to Insert new rows into tables and toDelete rows from tables.

These queries show only a very small numberof the capabilities of SQL. The Where clause canbe used to select rows based on where names arein the alphabet, whether dates are before or aftercertain other dates, based on averages, and basedon many other conditions.

SMALL AND LARGE DATABASES

Databases can be single-user or multi-user. A sin-gle-user database exists on a single computer andis accessible only from that computer. Many sin-gle-user databases exist, and there are a numberof commercial DBMSs that address this market.A multi-user database may exist on a single ma-chine, such as a mainframe or other powerful

computer, or it may be distributed and exist onmultiple computers. Multi-user databases are ac-cessible from multiple computers simulta-neously. With the rise of the Internet, manydatabases are publicly accessible. For example,the holdings of university libraries are main-tained on databases that can be browsed fromremote locations. A person interested in locatinga book in a library can enter the book’s title,author, or subject, and a database query will beautomatically performed. Information on the de-sired book or list of books will be returned to theperson’s computer.

SELECTING A DATABASE SYSTEM

A person or business seeking to purchase a data-base management system for use in managing adatabase should consider the following factors:

Relational: Virtually all major commercialdatabase management systems are rela-tional, since the desirability of relationaldatabases is well-accepted in the databasecommunity.

SQL: In addition, since the American Na-tional Standards Institute has adopted SQLas it standard for relational databases, thedesired DBMS should support SQL.

Capacity: As noted above, database man-agement systems are designed for a varietyof environments. Some are designed to besingle-user systems, others are designed formedium-sized businesses, while still othersare designed for large businesses. The sys-tem chosen should naturally be one thathas been shown to be successful in and ap-propriate for the environment it is chosenfor.

Disaster recovery capability: More sophisti-cated systems are more capable of recov-ering from power outages, computer hard-ware failure, and the like than are thesingle-user systems. They use sophisticatedlogging and database locking facilities thatmake such recovery possible. Often, thesefacilities are unnecessary for single-usersystems.

DATABASES


SUMMARY

Databases and database management systems arecentral to modern business information systems.Relational databases using the SQL language pro-vide substantial logical power to help businessesmake informed decisions based on their owndata. Database systems can be small and handledby a single user, or they can be large and availableto multiple users. They are even publicly avail-able through the Internet. Database managementsystems can be sophisticated and expensive, andconsequently their purchase requires careful, in-formed consideration.

BIBLIOGRAPHY

Dunham, Jeff. (1998). Database Performance Tuning Hand-book. New York: McGraw-Hill.

Groff, James R. and Weinberg, Paul N. (1999). SQL: TheComplete Reference. Berkeley: Osborne/McGraw-Hill.

Hansen, Gary W. and Hansen, James V. (1996). DatabaseManagement and Design, 2d ed. Upper Saddle River, NJ:Prentice Hall.

Kroenke, David M. (2000). Database Processing, 7th ed.Upper Saddle River, NJ: Prentice Hall.

Rob, Peter and Coronel, Carlos. (2000). Database Systems:Design Implementation, and Management, 4th ed. Cam-bridge, MA: Course Technology.

GARY HANSEN

DECA

DECA is a national student organization for indi-viduals preparing for marketing, management,and entrepreneurship careers. With 180,000members, DECA serves as the companion tomarketing education programs within secondaryand post-secondary schools across all fifty statesof the United States, its territories, and Canada.As a co-curricular organization, DECA is an inte-gral part of classroom instruction—a vehiclethrough which students learn marketing andmanagement, and are motivated to succeed.

In partnership with businesses throughoutthe country, DECA offers learning experiencesthat contribute to the integration of academicand career-focused instruction, resulting in

heightened student achievement and student rec-ognition. For example, each year more than60,000 student members participate in a compet-itive events program, culminating in state andnational secondary and post-secondary CareerDevelopment Conferences that allow membersto demonstrate academic and marketing excel-lence.

Organized in 1946, DECA meets the needs ofmarketing (then, distributive) education studentsseeking professional and personal growth. Theassociation is governed by a board of directors.Until July 1991, DECA was referred to as theDistributive Education Clubs of America. Al-though that continues to be the legal name, theorganization uses the commonly recognized ac-ronym, DECA, along with the tag line, An Asso-ciation of Marketing Students.’’ The official logoof DECA is a diamond, whose four points em-phasize civic consciousness, leadership develop-ment, vocational understanding, and social intel-ligence. DECA is advised by a national advisoryboard, consisting of business representatives, anda congressional advisory board, comprised offederal legislators.

The official publications of DECA are theDECA Advisor, Dimensions, Chi Connection,Highwired.Net, and the DECA Guide. Such schol-arships as the Harry A. Applegate, J. C. Penney,and Sears Scholarships are available to supportthe academic endeavors of members. More infor-mation is available from DECA at 1908 Associa-tion Dr., Reston, Virginia 20191; (703)860-5000:or http://www.deca.org.

BIBLIOGRAPHY

Berns, Robert G. (1996). DECA: A Continuing Tradition ofExcellence. Reston, VA: DECA.

Cahill, Julie, and Brady, Kathleen. (1999). ‘‘Sweetening theDeal.’’ Techniques, March:26-28.

Distributive Education Clubs of America DECA: An Associ-ation of Marketing Students. http://www.deca.org/.1999.

JEWEL E. HAIRSTONROBERT G. BERNS

DECA


DECISION MAKING

Decision making, also referred to as problemsolving, is the process of recognizing a problemor opportunity and finding a solution to it. Deci-sions are made by everyone involved in the busi-ness world, but managers typically face the mostdecisions on a daily basis. Many of these deci-sions are relatively simple and routine, such asordering production supplies, choosing the dis-count rate for an order, or deciding the annualraise of an employee. These routine types ofdecisions are known as programmed decisions, be-cause the decision maker already knows what thesolution and outcome will be. However, manag-ers are also faced with decisions that can drastic-ally affect the future outcomes of the business.These types of decisions are known asnonprogrammed decisions, because neither theappropriate solution nor the potential outcome isknown. Examples of nonprogrammed decisionsinclude merging with another company, creatinga new product, or expanding production facili-ties.

Decision making typically follows a six-stepprocess:

1. Identify the problem or opportunity

2. Gather relevant information

3. Develop as many alternatives as possible

4. Evaluate alternatives to decide which isbest

5. Decide on and implement the best alter-native

6. Follow-up on the decision

In step 1, the decision maker must be sure heor she has an accurate grasp of the situation. Theneed to make a decision has occurred becausethere is a difference between the desired outcomeand what is actually occurring. Before proceedingto step 2, it is important to pinpoint the actualcause of the situation, which may not always beobviously apparent.

In step 2, the decision maker gathers as muchinformation as possible because having all thefacts gives the decision maker a much better

chance of making the appropriate decision.When an uninformed decision is made, the out-come is usually not very positive, so it is impor-tant to have all the facts before proceeding.

In step 3, the decision maker attempts tocome up with as many alternatives as possible. Atechnique known as ‘‘brainstorming,’’ wherebygroup members offer any and all ideas even ifthey sound totally ridiculous, is often used in thisstep.

In step 4, the alternatives are evaluated andthe best one is selected. The process of evaluatingthe alternatives usually starts by narrowing thechoices down to two or three and then choosingthe best one. This step is usually the most diffi-cult, because there are often many variables toconsider. The decision maker must attempt toselect the alternative that will be the most effec-tive given the available amount of information,the legal obstacles, the public relations issues, thefinancial implications, and the time constraintson making the decision. Often the decisionmaker is faced with a problem for which there isno apparent good solution at the moment. Whenthis happens, the decision maker must make thebest choice available at the time but continue tolook for a better option in the future.

Once the decision has been made, step 5 isperformed. Implementation often requires someadditional planning time as well as the under-standing and cooperation of the people involved.Communication is very important in the imple-mentation step, because most people are resistantto change simply because they do not understandwhy it is necessary. In order to ensure smoothimplementation of the decision, the decisionmaker should communicate the reasons behindthe decision to the people involved.

In step 6, after the decision has been imple-mented, the decision maker must follow-up onthe decision to see if it is working successfully. Ifthe decision that was implemented has correctedthe difference between the actual and desiredoutcome, the decision is considered successful.However, if the implemented decision has notproduced the desired result, once again a deci-sion must be made. The decision maker can

DECISION MAKING


decide to give the decision more time to work,choose another of the generated alternatives, orstart the whole process over from the beginning.

STRATEGIC, TACTICAL, ANDOPERATIONAL DECISIONS

People at different levels in a company have dif-ferent types of decision-making responsibilities.Strategic decisions, which affect the long-term di-rection of the entire company, are typically madeby top managers. Examples of strategic decisionsmight be to focus efforts on a new product or toincrease production output. These types of deci-sions are often complex and the outcomes uncer-tain, because available information is often lim-ited. Managers at this level must often depend onpast experiences and their instincts when makingstrategic decisions.

Tactical decisions, which focus on more inter-mediate-term issues, are typically made by mid-dle managers. The purpose of decisions made atthis level is to help move the company closer toreaching the strategic goal. Examples of tacticaldecisions might be to pick an advertising agencyto promote a new product or to provide anincentive plan to employees to encourage in-creased production.

Operational decisions focus on day-to-day ac-tivities within the company and are typicallymade by lower-level managers. Decisions madeat this level help to ensure that daily activitiesproceed smoothly and therefore help to move thecompany toward reaching the strategic goal. Ex-amples of operational decisions include sched-uling employees, handling employee conflicts,and purchasing raw materials needed for produc-tion.

It should be noted that in many ‘‘flatter’’organizations, where the middle managementlevel has been eliminated, both tactical and oper-ational decisions are made by lower-level man-agement and/or teams of employees.

GROUP DECISIONS

Group decision making has many benefits as wellas some disadvantages. The obvious benefit isthat there is more input and therefore more pos-

sible solutions to the situation can be generated.Another advantage is that there is shared respon-sibility for the decision and its outcome, so oneperson does not have total responsibility formaking a decision. The disadvantages are that itoften takes a long time to reach a group consen-sus and that group members may have to com-promise in order to reach a consensus. Manybusinesses have created problem-solving teamswhose purpose is to find ways to improve specificwork activities.

BIBLIOGRAPHY



Clancy, Kevin J., and Shulman, Robert S. (1994).MarketingMyths That are Killing Business: The Cure for Death WishMarketing. New York: McGraw-Hill.

French, Wendell L. (1998). Human Resources Management.New York: Houghton Mifflin.


Nickels, William G., McHugh, James M., and McHugh,SusanM. (1999).Understanding Business, 5th ed. Boston:Irwin McGraw-Hill.

Pride, William M., Hughes, Robert J., and Kapoor, Jack R.(1999). Business, 6th ed. New York: Houghton Mifflin.

MARCY SATTERWHITE

DEFLATION

(SEE: Economic Cycles)

DELEGATION

(SEE: Mangement: Authority and Responsibility)

DEMAND(SEE: Supply and Demand)

DEFLATION


DEMAND CURVES(SEE: Supply and Demand)

DEPARTMENTALIZATION(SEE: Organizational Structure)

DEPRESSION(SEE: Economic Cycles)

DEREGULATION

Most societies rely on competitive markets tohandle the allocation of scarce resources to theirhighest and best uses. Yet markets are not with-out their shortcomings. For this reason, govern-ments sometime institute regulatory control. In1887, the first regulatory agency, the InterstateCommerce Commission, was created to regulatemonopolistic pricing policies of railroads.

When private firms gain monopoly power,usually because of economies of scale, they are ina position to restrict production and raise pricewith little worry of competition; these are knownas natural monopolies. The government maypermit a single producer (e.g., of natural gas orelectricity) to exist in order to gain lower produc-tion costs but simultaneously empower a regula-tory agency to set the firm’s prices.

A second reason for regulation stems fromthe fact that society declares certain activities ille-gal. Prostitution, gambling, and certain drugs areeither not permitted or allowed only under cer-tain conditions. Through a licensing system, gov-ernment agencies control who enters such indus-tries, their prices, and their methods ofoperation.

Another reason for government regulationarises because society establishes standards forparticular professions, such as medicine, law, ac-counting, and real estate. The government guar-antees compliance with these standards by im-posing tests and other requirements. Thosefailing to meet these standards are not permitted

to engage in that business. Hundreds of agenciesadminister tests and police the professions, alldone ostensibly in the interest of protecting theconsumer. Interestingly, license holders oftenpush for even higher licensing requirements, of-ten grandfathering in all current license holders,because higher salaries are possible when thenumber of competitors is restricted.

Many government regulations are designedto protect people from the negative consequences(i.e., externalities) of buyers and sellers who havelittle incentive to look out for the welfare of thirdparties. For example, slaughterhouses may havethe freedom to kill animals for sale to their cus-tomers in grocery stores without taking into ac-count obnoxious odors or sounds emanatingfrom the slaughterhouse. Neighborhood resi-dents, however, incur externality costs. Throughagencies such as the Environmental ProtectionAgency (EPA), the government controls whatslaughterhouses can and cannot do in order tolessen the negative effects on the population.

Although government regulation is pervasivefor the reasons presented above, it is apparentthat regulation may not achieve the lofty goals setout in the initial effort to regulate. Governmentscan also fail, and government failure often aggra-vates the problems it sets out to solve. Publicchoice economists have identified several specificcauses of government failure. Voters are oftenrationally ignorant about many things, and theyvote for political candidates who are uninformedor misinformed. Also, politicians are often in-debted to their financial supporters, some ofwhom are regulated industries, and will oftenenact laws favorable to their supporters regard-less of the negative impact on the public. Politi-cians may even be willing to sacrifice the futurefor the sake of short-term benefits for their finan-cial supporters. Recognition of such limitationsto government regulation has caused Congress torethink regulation, especially as it relates to cer-tain industries.

Beginning in the mid-1970s, increased dis-satisfaction with the burdens of regulation, espe-cially the costs imposed on consumers, led to thederegulation of a number of industries, including

DEREGULATION


Protesters at a deregulation rally.

the airlines (Airline Deregulation Act of 1978),natural gas (Natural Gas Policy Act of 1978),trucking (Motor Carrier Act of 1980), and bank-ing (Depository Institutions Deregulation andMonetary Control Act of 1980).

In 1997 some states began deregulating theproduction and sale of electricity. New technolo-gies now permit small companies to produceelectricity at reduced costs. Under the new system(much like the system in the telephone industry),local utilities must permit competitors to usetheir electric lines for a fee.

Benefits from deregulation include reducedprices and increased choices for consumers.Competition among long-distance telephonesuppliers is keen, no longer requiring govern-ment regulation, and is demonstrated by the factthat from 1985 to 1998 prices declined by 72percent. Expanded service and reduced priceshave occurred in both airlines and trucking.Eleven thousand new trucking lines started up

within three years of deregulation, and savingsmay be as high as $50 billion per year.

Some concerns have arisen about deregu-lation, however. The airline industry has becomemore concentrated since deregulation. In 1978eleven carriers handled 87 percent of the traffic,while in 1995 seven carriers handled 93 percentof the traffic. Although some feared reducedsafety, that has not materialized. Some of thebank failures in the 1980s were attributed toderegulation; yet depositors receive higher inter-est. On balance, deregulation effects have beenpositive.

A significant change in direction has alsotaken place with regard to government regulationof industries producing externalities. Many ex-ternalities arise because of the lack of propertyrights; consequently there is greater emphasis onestablishing clearly defined property rights,which allows the market to automatically inter-nalize the cost to buyers and sellers, makinggovernment regulation costly and unnecessary.

DEREGULATION


The EPA now depends less heavily on its com-mand-and-control approach and more heavilyon tradable permits, reducing the overall level ofpollution and allowing firms to avoid pollutionin a more cost-effective way.

Although Congress has deregulated specificindustries, social regulation designed to ‘‘protect’’consumers has expanded. Through such agenciesas the Occupational Safety and Health Adminis-tration, the Consumer Product Safety Commis-sion, the Food and Drug Administration, theEqual Employment Opportunity Commission,and the EPA, the government is attempting toprovide safer products, better health care, faireremployment practices, and a cleaner environ-ment. Government at federal, state, and locallevels has also continued to increase license re-quirements for numerous occupations and pro-fessions.

Many economists wonder if the benefits arehigh enough to warrant the cost of regulation. Inaddition to regulatory-imposed limits on con-sumer freedom, product prices rise, administra-tive costs are high, and some firms are driven outof business, thereby reducing competition. Tofurther complicate things, many special-interestgroups use such laws to increase their wealth atthe expense of others. It has been estimated thatfederal regulation costs each household $6000per year. Clearly the issues surrounding regula-tion/deregulation will continue to be discussedinto the twenty-first century.

BIBLIOGRAPHY

Kahn, Alfred E. (1988). The Economics of Regulation: Princi-ples and Institutions. Cambridge, MA: MIT Press.

Teske, P., Best, S, and Mintrom, M., (1995). DeregulatingFreight Transportation. Lavergne, TN: AEI Press.

Winston, C. (1993). ‘‘Economic Deregulation’’ Journal ofEconomic Literature September: 1263-1289.

JAMES R. RINEHARTJEFFREY J. POMPE

DERIVATIVES

Derivative instruments are used as financial man-agement tools to enhance investment returns andto manage such risks relative to interest rates,exchange rates, and financial instrument andcommodity prices. Several local and interna-tional banks, businesses, municipalities, andothers have experienced significant losses withthe use of derivatives. However, their use hasincreased as efforts to control risk in complexsituations are perceived to be wise strategic deci-sions.

SFAS 133’S DEFINITION OF ADERIVATIVE INSTRUMENT

In 1998, the Financial Accounting StandardsBoard (FASB) issued Statement on Financial Ac-counting Standards No. 133 (SFAS 133),Accounting for Derivative Instruments and Hedg-ing Activities, which is effective for companieswith fiscal years beginning after June 15, 2000.SFAS 133 establishes new accounting and report-ing rules for derivative instruments, includingderivatives embedded in other contracts, and forhedging activities. Derivatives must now be re-ported at their fair values in financial statements.Gains and losses from derivative transactionsmust be reported currently in income, exceptfrom those transactions that qualify as effectivehedges.

According to Statement on Financial Ac-counting Standards (SFAS) 133, a derivative in-strument is defined as a financial instrument orother contract that represents rights or obliga-tions of assets or liabilities with all three of thefollowing characteristics:

● It has (1) one or more underlyings and (2)one or more notional amounts or paymentprovisions or both. Those terms determine thesettlement amount of the derivative. Anunderlying is a variable (i.e., stock price) orindex (i.e., bond index) whose market move-ments cause the fair value market or cashflows of a derivative to change. The notionalamount is the fixed amount or quantity thatdetermines the size of the change caused bythe change in the underlying; possibly a num-

DERIVATIVES


ber of currency units, shares, bushels, pounds,or other units specified in the contract. Apayment provision specifies a fixed or deter-minable settlement to be made if the under-lying behaves in a specified manner.

● It requires no initial net investment or an ini-tial net investment that is smaller than wouldbe required for other types of similar instru-ments.

● Its terms require or permit net settlement.[SFAS 133, paragraph 6]

USERS OF DERIVATIVES

The derivatives market serves the needs of severalgroups of users, including those parties who wishto hedge, those who wish to speculate, and arbi-trageurs.

● A hedger enters the market to reduce risk.Hedging usually involves taking a position ina derivative financial instrument, which hasopposite return characteristics of the item be-ing hedged, to offset losses or gains.

● A speculator enters the derivatives market insearch of profits, and is willing to accept risk.A speculator takes an open position in a de-rivative product (i.e. there is no offsetting cashflow exposure to offset losses on the positiontaken in the derivative product).

● An arbitrageur is a speculator who attempts tolock in near riskless profit from price differ-ences by simultaneously entering into the pur-chase and sale of substantially identical finan-cial instruments.

Other participants include clearinghouses orclearing corporations, brokers, commodity fu-tures trading commission, commodity pool op-erators, commodity trading advisors, financialinstitutions and banks, futures exchange, and fu-tures commission merchants.

TYPES OF DERIVATIVE INSTRUMENTS

Derivative instruments are classified as:

● Forward Contracts

● Futures Contracts

● Options

● Swaps

Derivatives can also be classified as eitherforward-based (e.g., futures, forward contracts,and swap contracts), option-based (e.g., call orput option), or combinations of the two. A for-ward-based contract obligates one party to buyand a counterparty to sell an underlying asset,such as foreign currency or a commodity, withequal risk at a future date at an agreed-on price.Option-based contracts (e.g., call options, putoptions, caps and floors) provide the holder witha right, but not an obligation to buy or sell anunderlying financial instrument, foreign cur-rency, or commodity at an agreed-on price dur-ing a specified time period or at a specified date.

Forward Contracts Forward contracts are ne-gotiated between two parties, with no formalregulation or exchange, to purchase (long posi-tion) and sell (short position) a specific quantityof a specific quantity of a commodity (i.e., cornand gold), foreign currency, or financial instru-ment (i.e., bonds and stock) at a specified price(delivery price), with delivery or settlement at aspecified future date (maturity date). The price ofthe underlying asset for immediate delivery isknown as the spot price.

Forward contracts may be entered intothrough an agreement without a cash payment,provided the forward rate is equal to the currentmarket rate. Forward contracts are often used tohedge the entire price changed of a commodity, aforeign currency, or a financial instrument. irre-spective of a price increase or decrease.

Futures Contracts Futures are standardizedcontracts traded on a regulated exchange to makeor take delivery of a specified quantity of a com-modity, a foreign currency, or a financial instru-ment at a specified price, with delivery or settle-ment at a specified future date. Futures contractsinvolve U.S. Treasury bonds, agricultural com-modities, stock indices, interest-earning assets,and foreign currency.

A futures contract is entered into through anorganized exchange, using banks and brokers.These organized exchanges have clearinghouses,which may be financial institutions or part of thefutures exchange. They interpose themselves be-

DERIVATIVES


tween the buyer and the seller, guarantee obliga-tions, and make futures liquid with low creditrisk. Although no payment is made upon enter-ing into a futures contract, since the underlying(i.e. interest rate, share price, or commodityprice) is at-the-market, subsequent value changesrequire daily mark-to-marking by cash settle-ment (i.e. disbursed gains and daily collectedlosses). Similarly, margin requirements involvedeposits from both parties to ensure any financialliabilities.

Futures contracts are used to hedge the entireprice change of a commodity, a foreign currency,or a financial instrument since the contract valueand underlying price change symmetrically.

Options Options are rights to buy or sell. Forexample, the purchaser of an option has the right,but not the obligation, to buy or sell a specifiedquantity of a particular commodity, a foreigncurrency, or a financial instrument, at a specifiedprice, during a specified period of time (Ameri-can option) or on a specified date (Europeanoption). An option may be settled by taking de-livery of the underlying or by cash settlement,with risk limited to the premium.

The two main types of option contracts arecall options and put options, while some othersinclude stock (or equity) options, foreign cur-rency options, options on futures, caps, floors,collars, and swaptions.

● American call options provide the holder withthe right to acquire an underlying product(e.g., stock) at an exercise or strike price,throughout the option term. The holder paysa premium for the right to benefit from theappreciation in the underlying.

● American put options provide the holder withthe right to sell the underlying product (e.g.,stock) at a certain exercise or strike price,throughout the option term. The holder gainsas the market price of the underlying (stockprice) falls below the exercise price.

● An interest rate cap is an option that allows acap purchaser to limit exposure to increasinginterest rates on its variable-rate debt instru-ments.

● An interest rate floor is an option that allows afloor purchaser to limit exposure to decreasinginterest rates on its variable-rate investments.

Generally, option contracts are used to hedgea one-directional movement in the underlyingcommodity, foreign currency, or financial instru-ment.

Swaps A swap is a flexible, private, forward-based contract or agreement, generally betweentwo counterparties to exchange streams of cashflows based on an agreed-on (or notional) princi-pal amount over a specified period of time in thefuture.

Swaps are usually entered into at-the-money(i.e. with minimal initial cash payments becausefair value is zero), through brokers or dealerswho take an up-front cash payment or who ad-just the rate to bear default risk. The two mostprevalent swaps are interest rate swaps and for-eign currency swaps, while others include equityswaps, commodity swaps, and swaptions.

● Swaptions are options on swaps that providethe holder with the right to enter into a swapat a specified future date at specified terms(stand-alone option in a swap) or to extendor terminate the life of an existing swap (em-bedded option on a swap).

Swap contracts are used to hedge entire pricechanges (symmetrically) related to an identifiedhedged risk, such as interest rate or foreign cur-rency risk, since both counterparties gain or loseequally.

RISK CHARACTERISTICS OF DERIVATIVES

The main types of risk characteristics associatedwith derivatives are:

● Basis Risk This is the spot (cash) price of theunderlying asset being hedged, less the priceof the derivative contract used to hedge theasset.

● Credit Risk Credit risk or default risk evolvesfrom the possibility that one of the parties toa derivative contract will not satisfy its finan-cial obligations under the derivative contract.

DERIVATIVES


● Market Risk This is the potential financial lossdue to adverse changes in the fair value of aderivative. Market risk encompasses legal risk,control risk, and accounting risk.

BIBLIOGRAPHY

Hull, John. (1998). Introduction to Futures and Options Mar-kets, 3rd ed. Upper Saddle River, NJ: Prentice Hall.

Kolb, Robert. (1995). Futures, Options and Swaps, 2nd ed.London: Blackwell.

Statement of Financial Accounting Standards (SFAS) No. 133,Accounting for Derivatives Instruments and Hedging Ac-tivities. (1998). Norwalk, CT: Financial Accounting Stan-dards Board (FASB).

PATRICK CASABONA

DESKTOP PUBLISHING

Desktop publishing, or DTP, is the term applied tothe process of creating and publishing profes-sional-looking documents using microcom-puters. DTP systems can produce many types ofdocuments, from simple to sophisticated, includ-ing business cards, letterhead stationery, bro-chures, newsletters, flyers, maps, coupons, pos-ters, invitations, business graphics, annualreports, proposals, and magazines. For such pro-jects, a company would need photography equip-ment, photo-editing software, illustration soft-ware, and page-layout software.

For example, creating a brochure wouldrequire photographs of people or products.Photo-editing software would be used to edit,combine, and give special treatment to the pho-tographs. Illustration software would be neededto create line drawings or other special effects.And page-layout software would be needed toarrange all the text and graphic elements. Thefollowing sections review the history, systemcomponents, design process and guidelines, fea-tures, and management guidelines pertaining toDTP.

HISTORY

Historically, the creation and publication of pro-fessionally designed documents involved a vari-ety of separate processes and people. To create a

brochure, for example, a designer would developthe overall idea and create a drawing of the fin-ished document. A writer would create the text, atypesetter would type the text in the desiredfonts, an illustrator would draw needed line art, aphotographer would shoot photos, and a servicebureau would develop the film and create colorseparations from the photos for color work. Thedesigner would then create the final comprehen-sive, pasting text, illustrations, and other ele-ments on a board for filming. The comprehen-sive would be photographed, after which photonegatives would be cut out and placed on a sheetfrom which printing plates would be made. Theplates would then be mounted on a printer, andthe final document would be printed, cropped,folded, and bound as necessary.

Today’s DTP technology automates many ofthese steps and enables just one person with acomputer and DTP software to become a stand-alone publishing business. Photos can be takenwith digital cameras, bypassing the film-develop-ment stage required of traditional film-type pho-tography. Photo-editing software enables photosto be cropped, scaled, and edited. Word-process-ing software is used to capture and process text,and illustration software is used to create draw-ings. Finally, page-layout software is used to as-semble all the components and print output fromwhich printing plates are made. The final docu-ment is then printed on a computer printer or ona large commercial press. Alternately, electronicdocuments can be published on the Internet,making them available to a worldwide audience.

SYSTEM COMPONENTS

DTP system hardware requires a fast computerwith a high-capacity hard disk, scanner, high-resolution printer, modem or other connectionto the Internet, large amount of random-accessmemory (RAM), and digital camera. In addition,the system must have word-processing software,illustration software, photo-editing software,page-layout software, Internet-publishing soft-ware, clip art, and multiple type fonts. DTP peri-odicals can be helpful in selecting appropriatehardware and software.

DESKTOP PUBLISHING


DESIGN PROCESS AND GUIDELINES

Being successful at desktop publishing requiresmore than just learning how to operate all theDTP hardware and software. One must first de-velop a design, which requires creativity andknowledge of design principles, and then use thehardware and software to make the design a real-ity. The first phase of document creation involvesplanning. This phase focuses on identifying thegoals of the publication. For example, to design abusiness card, the designer will want to give thecustomer the information needed to contact thebusiness and to make a good impression on thecustomer.

The second step is to analyze the audience,the people who will be using and reading thedocument. If a newsletter focuses on mountainbiking, for example, the audience might be pri-marily younger outdoor enthusiasts. Additionalaudience research would provide additional in-formation about mountain biker characteristics.

The third step is to develop a strategy, ortheme. A total communication line for a moun-tain biking retail business might include an Inter-net Web site, brochures, business cards, letter-head and envelopes, forms, and informationsheets. To achieve unity, a carefully selected con-cept or theme should be carried throughout allthese items. For example, all the documentsmight carry a common theme of a knobby bicyclewheel as the company logo, the same typeface fortext and headings, and the same color scheme.Repetition of document characteristics and ele-ments is a key characteristic of effective docu-ments.

The final step in the planning phase is todevelop a prototype of documents to be devel-oped. Designers usually create numeroussketches and then gradually refine the more pre-ferred sketches until a final selection is made. Thefinal design must include appropriate emptyspace, called white space, so the document doesnot look too crowded. Obviously, the greatestrequirement of the final design is that it willappeal to and persuade the intended audience.

After the planning phase, the document iscreated. Creation requires writing appropriate

text, called copy, and choosing the appropriatefonts (typefaces, type styles, and type sizes) forthe various parts of the text. To achieve a harmo-nious appearance, the fonts must complementthe graphic styles. The text must be skillfully or-ganized for easy reading, and the wording mustbe understandable and meaningful to the in-tended audience.

Graphics also have to be obtained, either il-lustrations or photographs. Professional artistscan be hired to create needed illustrations, andphotographers can be hired to shoot the desiredphotographs. Alternately, a person can take aphotograph with a digital camera or with a regu-lar camera, and afterward use a scanner to insertthe image into the DTP software. Illustrations ofmany types can be created using illustration soft-ware, or commercially prepared clip art and clipphotos can be purchased for use in business doc-uments. As allowed by software-licensing agree-ments, graphic software can be used to manipu-late or combine these graphics to produce thefinal desired graphic.

The graphics and text must then be assem-bled on the page, using page-layout software, sothat all elements contribute to a pleasing andeffective product. Principles of color, size, posi-tion, shape, pattern, and other contrast tech-niques must be applied so that documents willattract readers’ attention. Documents should alsobe attractively balanced on the left and right sidesof a page. Symmetrical balancemeans that the leftand right sides of the page are visually similar.Asymmetrical balance means that the left andright sides are visually different. Asymmetricalbalance is less formal and usually attracts readers’attention better; symmetrically balanced docu-ments convey a message of formality and stabil-ity.

Elements of the document should be appro-priately aligned with other parts of thedocument, rather than being randomly posi-tioned. For example, a block of text and its re-lated graphic could be aligned by the top, bot-tom, left, or right sides. Using a page grid(guidelines dividing a page into rectangular rowsand columns) will help to achieve a good layout.

DESKTOP PUBLISHING


In addition to alignment, related items should begrouped and placed more closely together, whileunrelated items should be separated. Extra whitespace or borders can be used to divide or frameelements.

After the document is designed and created,it can then be published. Publishing can includedesktop printers, photocopy machines, or largecommercial presses. If commercial printers areused, document designers should confer with thepress personnel regarding special procedures andfile formats required in creating the document.In addition to being published as paper docu-ments, documents can also be electronically pub-lished on the Internet for viewing by a worldwideaudience.

FEATURES

The features typically found in page-layout soft-ware include the following:

Alignment guidelines: places nonprintingalignment lines on the computer screen foreasy alignment of graphics and text

Automatic threading: links various parts ofrelated text segments throughout multipagepublications, such as magazines, and con-nects them with appropriate text, such as‘‘continued on page x’’ and ‘‘continuedfrom page x’’

Color separation printing: enables the print-ing of different printing plates required incolor offset printing

Frames: creates rectangular or circularboxes to contain graphics or text

Graphic cropping: provides the ability tocut, or crop, unwanted portions of photo-graphs

Grid lines: displays multiple borders on thescreen for consistent positioning of textand graphics

Imposition: arranges long publications, likebooklets, books, and magazines, for print-ing and subsequent folding into the properpage sequence

Independent text and graphic placement: en-ables the placement of text and graphicobjects anywhere on the page without hav-ing nearby text and graphics affect them

Indexing: provides automatic generation ofindexes and tables of contents

Layers: provides the ability to stack text orgraphics on top of one another

Master pages: provides automatic layout,pagination, headers and footers, andgraphic elements for multiple pages

Object grouping: enables various graphicand text objects to be combined so theycan be moved as a single object

Page-size flexibility: gives the ability to cre-ate documents in a wide variety of pagesizes

Printer’s marks: prints crop marks and reg-istration marks needed by commercialprinters when running color jobs

Spacing: manipulates the amount of whitespace on a page, including leading,kerning, tracking, margins, indentations,and column and paragraph borders

Spell checking: provides automatic spellchecking for text

Styles: automatically adds appropriate typo-graphical and layout attributes to text andgraphics

Text curving and rotation: enables text tobe angled or curved

Typography: manipulates all aspects oftype, such as typeface, height, width, color,and dropped capitals

MANAGEMENT GUIDELINES

Not every organization needs to have a fullyequipped DTP system. The decision regardingwhat elements to purchase should be based on arealistic needs analysis. Several questions shouldbe answered in making this decision, such as (1)what documents are being planned for the orga-nization? (2) can existing word-processing soft-ware be used to create most of the documents the

DESKTOP PUBLISHING


company needs? (3) does the organization havetrained personnel to design and create profes-sional documents? and (4) how much will anoutside agency charge to produce the documentsthe firm is wants to publish?

After a careful needs and resource analysis, afirm might decide to develop in-house DTP de-sign and software expertise. If such a decision ismade, the firm can hire someone who is alreadytrained in DTP, or the organization can sendcurrent employees to DTP seminars or enrollthem in formal classes at a local college. Also,high-quality periodicals provide useful designguidelines as well as information on cutting-edgetechnology and product comparisons. In addi-tion, helpful Web sites give useful learning tips,and numerous DTP books offer additional assis-tance in document design.

BIBLIOGRAPHY

Conover, Theodore E. (1995). Graphic Communications To-day, 3d ed. St. Paul, MN: West Publishing Company.

Devall, Sandra Lentz. (1998).Desktop Publishing Style Guide.Albany, NY: Delmar Publishers.

Parker, Roger C. (1997). Looking Good in Print. ResearchTriangle Park, NC: Ventana Communications Group.

Shushan, Ronnie, Wright, Don, and Lewis, Laura. (1996).Desktop Publishing by Design. Redmond, WA: MicrosoftPress.

WILLIAM H. BAKER

DIRECT MAIL ADVERTISING(SEE: Advertising)

DISCOUNT STORES

A discount store is a departmentalized retail op-eration that sells at prices substantially lower thanconventional retailers. To offset the lower prices,expenses are kept down by minimizing free cus-tomer services, maximizing the use of self-ser-vice, and using inexpensive fixtures, decorations,and displays. In addition, improvement of opera-tional efficiency is continually sought to control

costs. Modern discount stores typically sell a mixof hard goods (e.g., refrigerators, televisions) andsoft goods (e.g., apparel) and other general mer-chandise.

Discount stores evolved from a series of re-tailing changes that began in the United States inthe late nineteenth century. Following the CivilWar, the development of mass-production pro-cesses and a mass-distribution system, along withpopulation increases, paved the way for a newapproach to retailing—mass merchandising. Thefirst type of mass-merchandising operation wasthe department store. The second was the chainstore, which included variety stores and ‘‘juniordepartment stores.’’ The third was the mail-orderhouse. These patterns for mass merchandisingremained relatively constant through the 1920s.

The Great Depression of the 1930s and theaccompanying economic hardships set the stagefor another retailing change and the beginning ofdiscount operations. Grocery supermarkets, thefourth type of mass-merchandising operation,appeared in 1930. Supermarkets were compre-hensive grocery stores that were designed for self-service and consumer accessibility. Their size andlow-cost facilities enabled them to operate on lowmargins and sell below the competition. Theirinventories were quickly expanded to includenonprescription drugs. Drugstores, in turn,added variety merchandise, and variety stores ex-panded their mix while keeping prices relativelylow. The starting point for the fifth type of massmerchandising, discount stores, is often traced tothe opening of a radio and appliance store by theMasters brothers in Manhattan in 1937.

Price competition among supermarket, drug,and variety chains in the 1930s also broughtabout legislative constraints in several states toprotect small retailers. These resale-price-main-tenance, or ‘‘fair-trade,’’ laws provided that man-ufacturers could establish retail prices for prod-ucts that carried their brand name, thus legallyfixing prices. In 1937, these laws were strength-ened by the Miller-Tydings federal legislation.Even though the laws were difficult to enforce,they would present a major challenge to discountmerchandisers over the years to come.

DISCOUNT STORES


0

10

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sWal-Mart Net Sales

1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

$1.2 $1.4 $2.1 $3.2

$4.6

$6.4

$8.4

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$15.9

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$55.5

$67.3

Year

Figure 1SOURCE: Stone, Kenneth E. (1995). Competing with the Retail Giants: How to Survive in the New Retail Landscape. New York: Wiley.

By the early 1940s, a significant number ofretail operations called discount houses had beenestablished in several major cities. These discoun-ters carried nationally advertised hard goods suchas cameras and appliances. They targeted specificgroups, such as teachers and labor unions, andsold from catalogues or samples. They were ableto offer goods at exceptionally low prices becausethey bought directly from manufacturers andkept expenses down through low inventories,low-cost facilities (often in office buildings), andno credit/no delivery policies.

After World War II, discount merchandisinggrew rapidly. This explosion in growth was fueledby consumer bargain-hunting in the face of rising

prices, the pent-up demand for goods created bywartime shortages, and the establishment ofhomes and families by returning GIs. Discountstores sprang up across the country to satisfy thedemand for consumer goods, including televi-sion sets and other new products. Many of thesenew discounters sold their merchandise out ofother existing businesses or set up in low-costfacilities such as abandoned factories and lofts.Despite these often makeshift origins, the mod-ern discount industry was beginning to takeshape.

Sparked by increased consumer confidencein discount stores and increased availability ofgoods from manufacturers, discounting contin-

DISCOUNT STORES


0

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1988 1989 1990 1991 1992 1993

$25.9 $27.7

$28.1

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Figure 2SOURCE: Stone, Kenneth E. (1995). Competing with the RetailGiants: How to Survive in the New Retail Landscape. New York:Wiley.

ued to grow rapidly during the 1950s and becamean important part of the retail landscape. Newchains were drawn to the field, and establishedchains opened new outlets. Variety stores, spe-cialty retailers, traditional department stores, andsupermarkets were looking into discounting and,in some cases, launching ventures.

The look of discount stores also began tochange in the 1950s as leading discounters (e.g.,Masters, Two Guys, Korvettes) took on a depart-ment store-like appearance by adding householdgoods, apparel, and other soft goods. ‘‘Mill store’’discount operations further contributed to thischange as they began to surface with their base ofsoft goods.

In addition to the national and regionalchains that entered the industry in the 1950s,several others opened their doors in the early1960s. Many of the new additions were inexperi-enced and underfinanced, but among the newentries were four that would become the giants ofthe industry—K-Mart, Woolco, Target, andWal-Mart. All four began their operation in1962.

K-Mart was formed by Kresge, one of thenation’s leading chain stores, in response to com-petition from drugstores, supermarkets, and thenew discount stores. Kresge’s new venture was

0

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1983 1985 1987 1989 1991 1993

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Figure 3SOURCE: Stone, Kenneth E. (1995). Competing with the RetailGiants: How to Survive in the New Retail Landscape. New York:Wiley.

unique in two respects. First, the marketing planwas based on the idea of offering quality mer-chandise—predominantly national brands—atdiscounted prices. Second, the location strategywas to ‘‘surround’’ cities with their stores.

Woolco was organized by Woolworth, an-other longtime leader among variety stores.Faced with the same problem as Kresge, they alsoresponded by shifting their efforts to dis-counting. Their strategy was built around carry-ing department store merchandise, auto partsand accessories, and soft goods, all at discountprices.

Target was a spin-off of the Dayton Corpora-tion, a Minneapolis-based regional departmentstore chain. It was conceived as a chain of re-gional upscale discount stores designed to attractaffluent suburbanites. The product lines werehigher quality and higher priced, with an empha-sis on furniture and household appliances.

Wal-Mart was started from scratch by SamWalton, the owner of a group of Ben Franklinvariety stores in the south-central states.Walton’s strategy was to establish stores only insmall and medium-size towns so that he couldcapture a substantial part of the total local mar-ket. His key policy was to sell at ‘‘everyday lowprices,’’ rather than hold periodic sales.

DISCOUNT STORES


In addition to their marketing innovations,these four industry leaders played a major role insetting the pattern for other aspects of the indus-try. In particular, they established large facilitieswith standardized layouts in or near shoppingcenters. Their merchandise lines included bothhard and soft goods. And, once they were estab-lished, they reduced the number of leased depart-ments to a minimum.

Many discount businesses failed in 1962 and1963 because of the fierce competition broughton by the proliferation of new discounters andthe experimentation of other retailers in dis-counting in the early 1960s. Many were marginaloperators that had expanded too quickly; otherswere well-established chains.

In spite of the failures, the industry contin-ued to expand in the mid-1960s, both in terms ofnumber of stores and amount of sales. The largerchains, especially, were expanding through ac-quisition of closing operations as well as openingnew units. By 1966, discount stores were attract-ing approximately 60 percent of the nation’sshoppers (1969).

By the late 1960s, Woolco had openedninety-two stores (1968), Target had eleven(1968), and Wal-Mart had reached thirteen(1969). At this time, K-Mart had grown to morethan 300 stores.

The 1970s were a decade of expansion for thesuccessful chains. Woolco and K-Mart focusedon national expansion, and by 1974 K-Mart hadbecome the first truly national chain with storesin the forty-eight contiguous states. Wal-Martexpanded into the Southeast and Midwest. AndTarget established a strong presence in the Mid-west. Some chains were forced into bankruptcyby the recessions of the 1970s, but their storeswere bought up by the major chains and others.The decade also witnessed the end of federal‘‘fair-trade’’ laws and the adoption of retailingtechnologies such as computerized cash registers,point-of-sale (POS) checkout scanning, and sat-ellite communications.

Acquisitions and failures were still commonat the beginning of the 1980s, reaching a highpoint in 1982. Most notably, Woolco closed dur-

ing that year, while several others filed Chapter11 bankruptcy and closed shortly thereafter.Other well-known chains folded in the years thatfollowed. As in the previous decades, these fail-ures provided the opportunity for quick expan-sion by survivors.

Two distinct trends were underway as thediscount industry entered the 1990s. One was thebankruptcy of several remaining discounters.The other was the spectacular growth of the(now) three major players: Target, K-Mart, andWal-Mart. Target sales more than doubled be-tween 1987 and 1993. K-Mart sales grew by morethan $8.3 billion during the period 1988-1993.Meanwhile, in 1991, Wal-Mart passed Sears tobecome the nation’s largest retailer. Their com-bined sales had increased by more than $46.7billion during the period 1988-1993. As a resultof these trends, the industry fragmented into foursegments: the three major chains and a group ofregional operators.

Along with the departure of large numbers ofdiscounters and the acquisition of others bystronger chains, new kinds of discounters haveemerged. They include membership warehouses,specialty discounters, factory mall outlets, andspecialty mail-order houses.

Based on the trends of the 1990s, continuedgrowth and consolidation as well as new applica-tions are safe predictions for discounting at thebeginning of the twenty-first century. In addi-tion, deep discounting promises to providestrong competition for others in the industry.And all indications are that e-commerce discountretailing will grow, rapidly changing the shape ofdiscounting and impacting the current industrymembers.

BIBLIOGRAPHY

‘‘Discounting: Chronicles of its Evolution (30 Years of Dis-counting).’’ (1992). Discount Store News September:49-50.

Liebeck, Laura. (1994). ‘‘Deja Vu: K-Mart to Remake Itself.’’Discount Store News September: 54-55.

Lisanti, Tony. (1999). ‘‘It’s Time to Look Ahead.’’ DiscountStore News December: 8.

DISCOUNT STORES


Stone, Kenneth E. (1995). Competing with the Retail Giants:How to Survive in the New Retail Landscape. New York:Wiley.

Vance, Sandra S., and Scott, Roy V. (1994). Wal-Mart: AHistory of Sam Walton’s Retail Phenomenon. New York:Twayne.

EARL C. MEYER

WINIFRED L. GREEN

DISPLAYS(SEE: Promotion)

DISPOSABLE INCOME(SEE: Income)

DISTRIBUTION(SEE: Channels of Distribution)

DIVERSITY INTHE WORKPLACE

Diversity in the workplace is a reality for allemployers. Managing that diversity is an ideawhose time has come. Employers of all kinds areawakening to the fact that a diverse work force isnot a burden, but a potential strength.

OUR CHANGING FACE

One of the reasons for this awakening is theincreasing diverse marketplace. Today, when youcall many airlines to make flight reservations, theautomated attendant asks if you would feel morecomfortable talking to a Spanish-speaking cus-tomer service representative. Who can best un-derstand and serve this changing market? It takesa diverse work force at all levels.

Changing demographics is an urgent reasonfor the increased interest in managing diversity inthe workplace. The growing numbers in the U.S.labor force and its customer base will be com-posed largely of women, minorities, and immi-grants. This group will constitute about 85 per-

cent of the new entrants into the work force,according to the landmark Hudson InstituteStudy. With more diversity come varied expecta-tions of service as well as language barriers. Cus-tomer service training consultants are adding di-versity to their curriculum because customershave varied backgrounds and expect customizedservice. Employers realize they must attract, re-tain, and promote a full spectrum of people to besuccessful. So great is their need that advice onmanagement of diversity has become a growthindustry.

Progressive employers have developed spe-cialized programs to deal with the work-forcediversity issue. Some of these programs, knownas ‘‘valuing differences programs,’’ are geared tothe individual and interpersonal level. Their ob-jective is to enhance interpersonal relationshipsamong employees and to minimize blatant ex-pressions of racism and sexism. Often these pro-grams focus on the ways that men and women orpeople of different races or cultures have uniquevalues, attitudes, behavior styles, and ways ofthinking. These educational sessions can vary inlength from one day to several days or they canoccur on an ongoing basis. They usually concen-trate on one or several of the following generalobjectives:

● Fostering awareness and acceptance of humandifferences

● Fostering a greater understanding of the na-ture and dynamics of individual differences

● Helping participants understand their ownfeelings and attitudes about people who aredifferent from themselves

● Exploring how differences might be tapped asassets in the workplace

HARASSMENT

The Equal Employment Opportunity Commis-sion (EEOC) is the federal agency responsible forenforcing antidiscrimination efforts. The EEOChas identified what constitutes unlawful harass-ment: It is verbal or physical conduct that deni-grates or shows hostility or aversion toward anindividual because of his or her race, color, reli-



President Bill Clinton speaks to corporate leaders about diversity.

gion, gender, national origin, age, or disability orthat of his or her friends, relatives, or associates.It must also create a hostile work environment,interfere with work performance, and affect one’semployment opportunities. Some states, cities,and employers have also included sexual orienta-tion in their antidiscrimination policies.

Examples of harassment include epithets,slurs, negative stereotyping, or threatening actstoward an identified person or group. Other ex-amples include written or graphic materialplaced on walls, bulletin boards, or elsewhere onthe employer’s premises that denigrates or showshostility or aversion toward an individual orgroup. Included in this definition are acts thatpurport to be pranks but in reality are hostile ordemeaning.

To be illegal, harassment must be sufficientlysevere or pervasive to alter the conditions of em-ployment and create an intimidating or abusivework environment. Although courts do not usu-

ally hold employers liable for violations based onisolated derogatory remarks in the workplace,many recognize that in the right context one slurcan effectively destroy a working relationship andcan create a hostile environment, particularly ifthe comment is made by a supervisor.

At the organizational level, employers mustbe sensitive to a wide array of both state andfederal regulations that address all types of dis-crimination in employment. With today’s diverseworkplace, the goal is to increase the chances ofequal opportunity for all workers and mutualrespect in the workplace.

EMPLOYER RESPONSIBILITIES

Providing a workplace free from harassment isone of the basic responsibilities of an employer.Although sexual harassment has received most ofthe public attention, harassment can take manyforms. As employers add staff from a variety ofethnic, religious, age, and cultural groups, main-



taining a harmonious workplace is critical. Givenour increasing litigious society, it is inevitablethat court decisions related to other forms ofharassment will increase.

Senior citizens, immigrants, and employeeswith disabilities are being employed in all levelsof positions. They might suffer from a hostileenvironment because of their differences. Toavoid future litigation, prudent managers need tocreate a hospitable environment.

A major challenge for all employers is toassimilate a variety of employees into themainstream of corporate life. Women and mi-norities are sometimes excluded from social ac-tivities or left out of informal communicationsnetworks. The result appears to be a sense ofisolation, lower organizational commitment, andultimately a decision to seek employment in amore welcoming environment. For example, awoman feeling left out may think that two muchemphasis is placed on getting along with others insenior management: ‘‘As a woman, I do not fitinto the group of males who go to lunch togetherand play golf together. These are the guys who getthe promotions.’’

As work-force diversity increases, exclusionand isolation may disappear. In the meantime, afew organizations are encouraging women’s sup-port groups, black caucuses, and other ways tohelp subgroups tie into social and communica-tions networks. More importantly, organizationsare becoming more sensitive to sponsoring socialactivities that will allow full participation by allemployees.

DISCRIMINATION

Making prejudgments is part of human naturebecause we cannot anticipate every event freshlyin its own right. Although prejudgments helpgive order to our daily living, our minds have ahabit of assimilating as much as they can intocategories, which can cause irrational judgments.A person acts with prejudice because of his or herpersonality, which has been formed by family,school, and community environments.

Prejudice has been defined as an attitude, notan act—an opinion based partly on observation

and partly on ignorance, fear, and cultural pat-terns, none of which have a rational basis. Aprejudiced person tends to think of all membersof a group as being the same, giving little consid-eration to individual differences. This kind ofthinking gives rise to stereotypes. Stereotypes,like prejudices, are based partly on observationand partly on ignorance and tradition. For exam-ple, a person who assumes that all women areoverly emotional is subscribing to a widely heldbut false stereotype of women.

Stereotypes are difficult to overcome becausethey usually develop over long periods of time.Some stereotypes are shared bymany people, giv-ing them an illusion of rationality. However,many people today are trying to rid themselves ofstereotyped thinking about others. This effort re-flects a growing consciousness that people areindividuals and can and should be treated assuch.

The basis of prejudice toward a subgroup ofsociety is often found in economic or psychologi-cal factors. Most free-market countries have adiversity of social groups. The social mobilityconcept postulates that as one subgroup movesup in economic terms, it is replaced by a lessfortunate subgroup that is seeking a better way oflife.

Since the mid-1800s, various ethnic groupshave immigrated to the United States in waves.Tension between subgroups is often a result ofeconomic competition for jobs, shelter, and so-cial status. When physical differences, religiousbeliefs, ethical values, and traditions differ,subgroups can feel threatened and can sometimestake inappropriate actions.

Unfortunately, there is macroeconomic gainfor employers in aiding and abetting discrimina-tion in the workplace. Competition for jobsamong workers can help employers lower wagesand neglect working conditions. Employers oftenthreaten striking workers with the prospect ofbeing replaced, since there are usually membersof minority groups who are willing to take jobsthat pay lower wages because they previously hadlittle or no chance of being hired at all.



As the United States becomes more involvedin international markets, business managers arebecoming aware that discrimination can make adisastrous impression on potential buyers andsellers. When we preach democracy but practicediscrimination, our credibility is lost. Establish-ing oil trade with African countries, for example,becomes more complex when Africans see theU.S. establishment discriminating against AfricanAmericans.

RACIAL PREJUDICE

From its beginnings, the United States was di-vided by racial tensions. White settlers drove outNative Americans and, in the South, set up a sys-tem of labor based on slavery. Racism towardblacks and Native Americans is still with us to-day.

Minority groups come from subcultures thatoften have their own norms and values, which arenot always understood by the majority group.For example, African Americans’ social relationsare sometimes characterized by an outlook theydescribe as ecosystem distrust. Ecosystem distrustsubsumes such phenomena as lower interper-sonal trust and suspicion of authority figures.When this type of outlook is brought into atraditional white, middle-class work environ-ment, there can be misunderstandings and mis-trust. Lack of awareness of these phenomena caneasily lead to false assumptions by managementabout the worker. Due to cultural differences,many employers are conducting cross-culturaltraining for employees from both majority andminority groups.

GENDER ISSUES

Many women have felt discriminated against inthe workplace. Advancement into managementpositions for women has been difficult. In thepast decade, more and more woman have notonly entered the work force but also have beenpromoted into management positions. Somewould argue that men and women influence theworkplace differently. Women exercise leader-ship through strong interpersonal skills, produc-ing positive results. Male leadership can be more

direct, impersonal, and focused on results. Be-cause of the individual strengths of both men andwomen, a diverse leadership team incorporatingdifferent styles of leadership will do more to helpemployers succeed in today’s marketplace.

Traditionally, women have been discrimi-nated against in terms of pay. The wage gapcontinues to narrow, however. For various rea-sons, women’s pay is gaining parity with men’s.For example, many high-paying manufacturingjobs have disappeared, forcing many men intojobs in lower-paying service industries.

Organizations that continue to exclude somesegments of the population from their work forcerisk sending the subtle message that some em-ployees and perhaps some customers are less val-ued, less important, and less welcome. This willhave a negative effect on the bottom line.

BIBLIOGRAPHY

Champagne, Paul, McAfee, Bruce, and Moberg, Phillip.(1992). ‘‘A Workplace of Mutual Respect.’’HRMagazineOctober: 78-81.

Rosen, Benson, and Lovelace, Kay. (1994). ‘‘Fitting SquarePegs into Round Holes.’’ HR Magazine January: 86-88.

Smith, Vernita. (1993). ‘‘Glass Ceiling: Take Two.’’ HumanResources Executive October: 30-33.

PATRICK J. HIGHLAND

DIVISION OF LABOR

In the early 1900s, Max Weber, one of the pio-neers of modern sociology, designed a perfectlyrational organizational form, called a bureau-cracy. Among the characteristics of this ‘‘ideal’’organization were specialization, division of lab-or, and a hierarchical organizational design.

Division of labor is a form of specialization inwhich the production of a product or service isdivided into several separate tasks, each per-formed by one person. According to Weber’s de-sign, inherent within the specialization and divi-sion of labor is knowledge of the precise limit ofeach worker’s ‘‘sphere of competence,’’ and theauthority to perform individual tasks withoutoverlapping others.’

DIVISION OF LABOR


Sociology pioneer Max Weber.

Adam Smith, an early economist, suggestedthat productivity would rise significantly whenthe division of labor principle was used. Outputper worker would be raised while costs per unitproduced would be reduced. Division of laborwas applied, for example, in manufacturingplants that incorporated mass production tech-niques. In organizations that used mass produc-tion, each worker specialized in completing onespecialized task; the combined work of severalspecialized workers produced the final product.For example, in manufacturing an automobile,one worker would assemble the dashboard, an-other would assemble the wheels, and yet anotherwould paint the exterior.

Since the time of Adam Smith, division oflabor has been perceived as a central feature ofeconomic progress. Two aspects of labor exist.First is the division of labor within firms; thisconcerns the range of tasks performed by workerswithin a particular firm. Second is the division of

labor between firms; this concerns the range ofproducts or services the firm produces.

CURRENT APPLICATION OF DIVISIONOF LABOR

Fred Luthans (1998) describes the bureaucraticmodel proposed by Max Weber as an ‘‘historicalstarting point’’ for organizational analysis. Citing‘‘complex, highly conflicting relationships, ad-vanced information technology, and empoweredemployees,’’ Luthans (p. 519) discusses the func-tional and dysfunctional consequences of special-ization uncovered in several research studies. Forexample, although specialization has enhancedproductivity and efficiency, it has also led to con-flict between specialized units, hindering achieve-ment of the overall goals of the organization.Further, specialization can impede communica-tion among units, as highly specialized units tendto ‘‘withdraw into themselves and not fully com-municate with other units above, below, or hori-zontal to it: (Luthans, p. 519). In addition, highlyspecialized jobs can lead to employee boredomand burnout.

Given these concerns, a significant change isunder way in management of work in organiza-tions. According to Richard Walton (1991), thework force can be managed in two ways, onebased on control and the other based on commit-ment. Key factors that differ between the controland commitment approaches are job design prin-ciples, performance expectations, managementorganization (structure, systems, and style), com-pensation policies, employment assurances, em-ployee input in policies, and labor-managementrelations (Walton, 1991).

The control-oriented approach is based onthe classic bureaucratic principles of specializa-tion and division of labor. In the control-ori-ented environment, worker commitment doesnot flourish. Division of labor can ultimatelyreduce productivity and increase costs to pro-duce units. Several reasons are identified ascauses for reduction in productivity. For exam-ple, productivity can suffer when workers be-come bored with the monstrous repetition of atask. Additionally, productivity can be affected

DIVISION OF LABOR


when workers lose pride in their work becausethey are not producing an entire product theycan identify as their own work. A breakdown inthe mass production line can bring an entire pro-duction line to a standstill. And, with highly spe-cialized jobs, worker training can be so narrowlyfocused that workers cannot move among alter-nate jobs easily. Consequently, productivity cansuffer when one key worker is absent. Finally,discontent with control is increasing in today’swork force, further hindering the long-term suc-cess of the classic bureaucratic application of spe-cialization and division of labor.

In contrast to the control-oriented approach,the commitment-oriented approach proposesthat employee commitment will lead to enhancedperformance. Jobs are more broadly designedand job operations are upgraded to include moreresponsibility. Control and coordination dependon shared goals and expertise rather than onformal position. The control and commitment-oriented approaches are only one way to view theconcepts of division of labor and specialization.These concepts influenced organizations in thelate 1990s by a complex array of organizationaldynamics.

In response to such complex organizationaldynamics as intense competitive pressures, orga-nizations were being restructured. Hierarchieswere becoming flatter, meaning that fewer levelsof management existed between the lowest levelof worker and top management. In some organi-zations, web-like and network organizationalstructures were replacing traditional hierarchicalorganizations (Kerka, 1994). In these redesignedorganizations, the shift was away from depart-ments that focused on traditional organizationalfunctions such as production, administration, fi-nance, design, and marketing (Lindbeck andSnower, 1997).

In these redesigned organizations, the shiftwas away from highly-specialized jobs towardworkers performing a multitude of tasks withinrelatively small autonomous customer-orientedteams. In these working groups, workers weregiven a broad task specification by managementand within those loose constraints, the teams

were allowed to organize, to allocate roles, toschedule tasks, and so forth (Bessant, 1991).With this design, traditional occupational bar-riers and clear-cut specialized job descriptionsbegan evaporating as workers were empoweredto define their own job tasks; this movementresulted in a decrease of the division of labor andspecialization within firms.

As a consequence of these changes, duringthe 1990s, increased division of labor betweenfirms was often accompanied by a reduction inthe division of labor within firms. In other words,while firms were becoming more specialized inthe products and services they offered, individualworkers within firms were handling an increasingrange and depth of job responsibilities. As men-tioned earlier, this work was often completed inautonomous teams.

EFFECTS OF SIZE, COST, ANDPERFORMANCE ON DIVISION OF LABOR

In some organizations, division of labor and thedegree of specialization are being reduced, whilein other organizations, division of labor and spe-cialization are increasing. A number of factorscan influence this discrepancy among organiza-tions.

For example, the degree of specialization anddivision of labor can be related to the size of theorganization; typically, small and mid-sized em-ployers are not able to cost justify specializeddivision of labor. Lindbeck and Snower (1997)report that, as the costs of communicationamong workers declines, the degree of specializa-tion, and consequently, division of labor withinorganizations, may rise. Some literature reportsthat, as the size of the market increases, it sup-ports more division of labor. The degree of divi-sion of labor within firms can also depend on thedegree to which performance on particular tasksis measurable, and the degree to which wagesaffect task performance. Implementation of tech-nology can also have a profound influence on thedivision of labor in organizations.

DIVISION OF LABOR


EFFECTS OF TECHNOLOGY ON DIVISIONOF LABOR

Computerization has enabled organizations toincrease the variety of tasks performed by work-ers, consequently reducing specialization and di-vision of labor. For example, information tech-no l o g y—flex i b l e mach in e t oo l s andprogrammable multipurpose equipment—canreduce the division of labor within firms as work-ers transfer their knowledge from task to taskmore easily. Information and manufacturingtechnology can also enable individual workers orwork teams to combine different tasks morereadily to meet a customer’s needs while en-hancing productivity. For example, customer in-formation gained from production activities canbe used to improve financial accounting prac-tices, and employee information gained fromtraining activities can be used to improve workpractices.

Eric Alsene (1994) reported that increasedintegration of computer databases has the poten-tial to profoundly alter task and functional as-signments in organizations, consequently affect-ing division of labor and specialization.Originally, the purpose of integrating computersinto organizations was to merge the various func-tions of labor. Computer integration was de-signed to restructure businesses around theircore business processes, outsourcing some activi-ties to specialized external organizations andstrengthening partnerships with suppliers andsubcontractors. In the new culture shaped bycomputer integration, every worker was to have abroader view of the organization. Workers wereexpected to work in teams with enhanced com-munication, participation, teamwork, and an en-hanced sense of belonging and continuous learn-ing. In this new organizational model enabled bytechnology, the classic bureaucratic mass pro-duction model in which workers performedfunctions separately and sequentially was elimi-nated.

The computer integration model was de-signed to ultimately lead to the dismantling ofvertical and horizontal barriers while supervisorycontrol concentrated increasingly on work meth-

ods rather than on final products (Child, 1987).In other words, the new design enabled organiza-tions to focus on how products and services weredelivered rather than on what products or ser-vices were delivered. This design facilitated con-tinuous improvement in the organization. Thenew technologies assisted in blurring the bound-aries among departments while informationflowed freely throughout the organization,thereby disregarding the traditional bureaucratichierarchy. As work groups and task forces wereformed, units no longer worked in isolation.

The new model enabled by technology callsinto question the traditional division of labor inorganizations. For example, flexible manufactur-ing systems eliminate the barrier between main-tenance and production. This increased automa-tion supports the movement described earlier ofwork becoming more diversified, independent,intellectual, and collective.

SUMMARY

The classic principles of division of labor andspecialization still exist; however, their applica-tion produces both functional and dysfunctionalconsequences in the increasingly complex orga-nizations of the twenty-first century. A numberof factors affect the modern application of divi-sion of labor. Along with other complex organi-zational and market dynamics, these factors in-clude information technology, workerempowerment, human factors, communicationsystems, organizational size, competitive pres-sures, and organization structure.

BIBLIOGRAPHY

Alsene, Eric. (1994). ‘‘Computerization Integration and Or-ganization of Work in Enterprises.’’ International LaborReview. 133(5-6) 657-676.

Bessant, J. (1991).Managing Advanced Manufacturing Tech-nology: The Challenge of the Fifth Wave. Oxford, Black-well.

Child, J. (1987). ‘‘Organizational Design for AdvancedMan-ufacturing Technology,’’ in T.D. Wall, C.W. Clegg, andN.J. Kemp eds. The Human Side of Advanced Manufac-turing Technology. Chichester: Wiley.

Kerka, Sandra. (1994). ‘‘New Technologies and EmergingCareers. Trends and Issues Alerts.’’ Columbus, OH:

DIVISION OF LABOR


ERIC Clearinghouse on Adult, Career, and VocationalEducation.

Lindbeck, Assar, and Snower, Dennis J. (1997). ‘‘The Divi-sion of Labor Within Firms.’’ Stockholm, Sweden: Insti-tute for International Economic Studies, University ofStockholm.

Luthans, Fred. (1998). Organizational Behavior. Boston,MA: Irwin McGraw-Hill.

Walton, Richard E. (1991). ‘‘From Control to Commitmentin the Workplace: In Factory After Factory, There Is aRevolution Under Management of Work.’’ Readings onLabor-Management Relations. Washington, DC: Bureauof Labor-Management Relations and Cooperative Pro-grams.

DONNA L. MCALISTER-KIZZIER

DOCUMENT PROCESSING

Document processing involves the equipment,software, and procedures for creating, for-matting, editing, researching, retrieving, storing,and mailing documents. A document is any writ-ten, printed, or electronically prepared businesscommunication that conveys information. Themost common types of documents are those thatcomprise correspondence: letters, memos, re-ports, forms, statistical tables, and e-mail.

Document processing can be viewed as anintegral part of information resource manage-ment (IRM), which includes the management of(1) a broad range of information resources, suchas printed materials, electronic information, andmicroforms; (2) the various technologies andequipment that manipulate these resources; and(3) the people who generate, organize, and dis-seminate those resources. The overall purpose ofIRM is to increase the usefulness of informationto both internal users and external customers.

Information resource management is a phil-osophical and practical approach to managinginformation. Because information is a valuableresource to be managed like other resources, IRMcontributes directly to accomplishing organiza-tional goals and objectives. It provides an inte-grated approach to managing the entire life cycleof information—from creation, to dissemina-

tion, to archiving or destruction—so as to maxi-mize the overall usefulness of information.

DOCUMENT ORIGINATIONAND PREPARATION

The procedures for creating a document includeformatting the layout of a document, inputtingand editing it, and proofreading it.

SETTING FORMATS

In correspondence, formats are selected that areappropriate for the type of document (e.g., letter,memorandum, or report). Format settings in-clude margins (left, right, top, and bottom ofpage), tab settings, page length, line spacing,header and footers, page numbering, type style(font typeface and size)

INPUTTING DOCUMENTS

Documents are most often keyed into a com-puter so that they can be stored, revised asneeded, and updated and reused when appropri-ate. Sometimes voice-recognition software—which keys in words that appear on a computermonitor as one dictates material—is used.

EDITING DOCUMENTS

A document may be edited, or changed, severaltimes before it is finished. Sometimes certainkinds of formatting are done after a documenthas been initially keyed in, including alignment(e.g., centering or justifying); and such for-matting enhancements as bold face or italic type,underscoring, bulleted lists, and tables. Editingfunctions include copy and move, cut and paste,search and replace, insert and delete, merge, andsave, among others.

PROOFREADING

After a document is keyed, checks are made forerrors, such as keying errors, spelling errors, andgrammatical errors. Many software packageshave tools that check for spelling and grammarerrors. These tools enhance, but do not replace,careful proofreading.

DOCUMENT PROCESSING


COMPOSITION OFBUSINESS CORRESPONDENCE

The essentials of effective communication arecourtesy, clarity, completeness, and conciseness.Business correspondence includes memos, min-utes of meanings, agendas, e-mail messages, andletters. Electronic technology has increased theuse of written communications in the office,which often take the form of an interofficememos or e-mail; employees of a large corpora-tion may send hundreds of thousands of pieces ofe-mail every month. Interoffice memos ande-mail can be in a more casual form than tradi-tional letters.

Because many businesses have offices aroundthe world, it is important to understand interna-tional business communications and to accom-modate cultural differences. Customs, values, re-ligion, decision-making processes, and manners,vary from country to country; international cor-respondence should reflect an understanding ofthese differences. International correspondenceis often more formal than domestic correspon-dence.

Tone is an important part of a message be-cause it reflects the attitude of the writer; a posi-tive tone—which includes tact and courtesy—encourages a positive reaction from the reader.Letters should have a natural style, with shortsentences and active verbs. Typical business com-munications include cover letters, reference let-ters, ‘‘good news’’ and ‘‘bad news’’ letters, re-minders, acknowledgments, and letters ofintroduction. A variety of business reports, rang-ing from briefing reports to comprehensive re-search reports, are also typical business commu-nications.

Business correspondence can also includeforms, such as invoices, purchase requisitions,and purchase orders. Document processing alsoincludes the creation, distribution, and use ofsuch forms.

DESKTOP PUBLISHING

Desktop publishing is a method for using a com-puter, a laser printer, and various software pro-

grams to prepare and print documents rangingfrom a single page of text to flyers, advertise-ments, pamphlets, books, and magazines. Desk-top publishing became possible for small busi-nesses on a broad scale around 1985, with theintroduction of the first relatively inexpensivelaser printer able to produce ‘‘letter-quality’’ typeand visuals when used with a personal computer.

A basic desktop publishing system, besidesproviding a variety of type fonts and sizes, canalso create graphics as well as use art and photo-graphs stored in sources inside the computer.

HISTORY OF DOCUMENT PROCESSING

Documents have been processed in businesssince the beginning of formal systems of writing.Prior to the invention of the typewriter, docu-ments were handwritten, and the particular styleof penmanship preferred by businesses was stud-ied. The manual typewriter was introduced intobusinesses after its invention in the 1870s, fol-lowed by the electric typewriter. In the early1960s, IBM introduced the Selectric typewriter,with a golf-ball type element that tilted androtated to transfer characters onto paper. Thisinnovation, by eliminating the movable carriage,allowed for faster document production. In 1964,IBM introduced the Magnetic Tape SelectricTypewriter (MT/ST). The magnetic tape storedkeystrokes electronically, so that text could thenbe edited. The MT/ST is considered to be a ‘‘first-generation’’ automated document processor. Of-fice equipment manufacturers then began to de-velop and market word-processing or document-processing hardware and software, which in-cluded the addition of a cathode-ray tube (CRT),to view text and provide additional flexibility inmanipulation of the text copy and format priorto printing. The storage media was expanded toinclude not only magnetic tape and cards but alsofloppy disks, hard disks, and mainframe comput-ers.

REPROGRAPHICS

Reprographics, which is the multiple reproduc-tion of images, today involves the use of twoprimary types of equipment: copiers and duplica-

DOCUMENT PROCESSING


tors. Copiers use an image-forming process simi-lar to a camera to create copies directly fromexisting originals. Duplicators make copies frommasters on specially prepared paper.

Copying, printing, and distributing informa-tion has been with us for thousands of years. Formuch of that time, it was a largely manual taskperformed by scribes. The first major success inautomation was by Gutenberg’s invention ofmovable type in the fifteenth century, a milestonein the history of printing, duplicating, and copy-ing, methods. Reprographics can be tracedthrough four basic historical periods: printing(letterpress; 1500 to present), duplicating (offset,spirit, and stencil; 1900 to present), copying(photochemical, thermofax, dye transfer, elec-trofax, xerography, and liquid toner transfer;1940 to present), and electronic printing (intelli-gent copier/printers, ink jet, magnetography,thermography, and laser xerography; 1976 topresent).

COMPUTERIZED RECORDS MANAGEMENT

The processing capabilities and storage capacityof computers have made electronic storage andretrieval of information a common practice inbusiness. Computer-generated document man-agement, records-management software, and im-aging systems assist businesses with large vol-umes of records. Imaging systems convert alltypes of documents to digitized electronic datathat can be easily stored and retrieved. Thesesystems include scanners that convert paper doc-uments to a digitized form, processors that com-press the image, storage media that retain theimage, retrieval mechanisms to convert the imagefor viewing on a monitor, and output devices thatprocess the image into hard-copy format. Laseroptical disks are well suited for high-volume rec-ord management because of their high capacityand durability.

Micrographics is the process of creating, us-ing, and storing images and data in microform.The most common type of microform is micro-film. Images, reduced in size, are stored on reels,in cartridges, on cassettes, on aperture cards, onmicrofiche, and in jackets. Information stored in

a computer can be converted to microfilm. Com-puter-output microfilm (COM) is imaged di-rectly from magnetic media. The electrical im-pulses on the media are converted to visualimages and stored on microfilm. Computer-in-put microfilm (CIM) can be converted to electri-cal impulses, stored on magnetic media, and usedas input. CIM can be used to introduce informa-tion from a large microfilm file, such as censusdata, into a computer for processing. Computer-assisted retrieval (CAR) systems are used forhigh-speed microform indexing and retrieval.

For many businesses, however, manual rec-ords-management systems are still the norm.Businesses use one or more of the five basic filingmethods—alphabetic, subject, numeric, geo-graphic, and chronological—to store records invertical and lateral files, open-shelf files, and ro-tary files. Good records-management practicesinclude establishing complete archives, develop-ing retention schedules, and using timelines fortransferring records to permanent storage.

SEARCHING FOR INFORMATION ONTHE INTERNET

The ease and availability of using the Internet tofind information has added another dimensionto document processing. A search engine is asoftware program that is used to find Web sites,Web pages, and Internet files. Examples includeAltaVista, Excite, Yahoo!, HotBot, Lycos, andInfoseek. Single or multiple keywords can be en-tered into a search engine, which will search in-dices to return a list of hits, which can numberfrom zero to more than a million. The hits areWeb pages that contain information relevant tothe search criteria. Users must beware that thequality of the sites may differ; some sites may bethose of Fortune 500 companies, while othersmay be those of a 10-year-old child.

The Internet contains Web sites, composedof multiple related Web pages, connected byhyperlinks. A hyperlink, also called a link, is abuilt-in connection to another related Web page.These links allow information to be obtained inthe order desired by the user, not necessarily inthe linear fashion provided in books. Informa-

DOCUMENT PROCESSING


tion found on the Web can be easily copied andpasted into other documents or used alone, withonly minor editing.

BIBLIOGRAPHY

Academic American Encyclopedia (Grolier Multimedia Ency-clopedia Version). (1995). Danbury, CT: Grolier.

Blass, Gary D., et al. (1991). ‘‘Finding Government Informa-tion: The Federal Information Locator System (FILS)’’Government Information Quarterly 8 (1):11-32.

Boldt, Dennis, and Groneman, Nancy. (1998). ‘‘InternetUse in Document Processing and Computer Applica-tion.’’ In Dennis LaBonty (ed.), Integrating the Internetinto the Busines Curriculum (1998 NBEA Yearbook, No.36) (pp. 117-127). Reston, VA: National Business Educa-tion Association.

Shelly, Gary, Cashman, Thomas, Vermaat, Misty, andWalker, Tim. (1999). Discovering Computers; 2000 Con-cepts for a Connected World. Cambridge, MA: CourseTechnology.

Stallard, John J., and Terry, George R. (1984). Office SystemsManagement. Homewood, IL: Irwin.

Swanson, Marie L. Reding, Elizabeth Eisner, Beskeen, DavidW., and Johnson, Steven M. (1997). Microsoft Office 97,Professional Edition—Illustrated, A First Course. Cam-bridge, MA: Course Technology.

Tilton, Rita Sloan, Jackson, J. Howard, and Rigvy, SueChappell. (1996). The Electronic Office: Procedures &Administration. Cincinnati, OH: South-Western Educa-tional Publishing.

LINDA J. AUSTINDEBBIE HUGHES

DOUBLE-ENTRY ACCOUNTING(SEE: Accounting)

DOW-JONES INDEX(SEE: Stock and Bond Issues)

DURABLE GOODS(SEE: Goods and Services; Shopping)

DURABLE GOODS


ECONOMIC ANALYSIS

Economic forces affect decisions made in per-sonal business activities, as well as within busi-ness organizations, government entities, andnonprofit organizations. Changes in economicconditions affect and are affected by supply anddemand, strength of buying power and the wil-lingness to spend, and the intensity of competi-tive efforts. These changes propel fluctuations inthe overall state of the economy and influencecourses of action and the timeliness of actions.Nonprofit organizations, for example, may findthat fund-raising efforts fueled by personal con-tributions are more successful during periods ofeconomic prosperity. A first-time home buyermay be more inclined to purchase a house wheninterest rates are low and prices are likely toincrease in future months. Since decision makerscannot control economic forces, a concerted ef-fort should be made to monitor such forces. Allbusiness executives know that it is important togain some idea of what general business condi-tions will be in the months or years ahead. For-tunately, certain economic indicators or indicesenable decision makers to forecast oncomingchanges in economic forces. Since both individ-uals and organizations operate in a dynamiceconomic environment, losing sight of what isgoing on can be disastrous for either.

THE BUSINESS CYCLE

Fluctuations in the economy tend to follow ageneral pattern that is commonly referred to asthe business cycle. The business cycle, in thetraditional view, consists of four stages—each ofwhich may vary in terms of duration and inten-sity. The four stages are prosperity, recession,depression, and recovery.

Up-to-date charts, tabulations, and measuresof relevant economic indicators are published bythe Bureau of the Census in the monthly report,Business Cycle Developments. Economic indica-tors are predictors or gauges that signal cyclicalmovement of the economy within each stage ofthe business cycle or from one stage to another. Afew examples of economic indicators include av-erage workweek in manufacturing, new buildingpermits for private housing, new orders for dura-ble goods, and changes in consumer installmentdebt. While various government agencies collectand report monthly, quarterly, semi-annual, andannual measures of numerous economic indica-tors, economists representing various industriesand other decision makers analyze and interpretthe data.

Timing is everything when it comes to mak-ing good business cycle-sensitive decisions. Justas a truck driver starts braking before reaching anintersection with a flashing red light, decisionmakers need to make appropriate plans beforethe business cycle passes from one stage to thenext. Prosperity, a period characterized by low

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unemployment and relatively high incomes, isfollowed by recession, a period during which un-employment rises and total buying power de-clines, leading to decreased spending by businessfirms and consumers. A production managershould make appropriate cutbacks prior to theonset of a recession. Failure to do so, in the faceof decreasing sales, leads to bloated inventoriesand idle productive resources. On the otherhand, when a period of recession (during whichunemployment is extremely high and wages arevery low), gives way to a period of recovery(characterized by increases in employment andincome), a production manager should begin toplan for increased outputs. Just as the truckdriver saw the red light and recognized it as asignal to start braking, decision makers must seechanging economic conditions and make appro-priate responses.

THE PROCESS OF CONDUCTING ANECONOMIC ANALYSIS

Conducting an economic analysis requires theapplication of scientific methods to break downeconomic events into separate components thatare easier to analyze. The remainder of this articlediscusses the steps included in this process.

Step 1—Identify Appropriate Economic Indi-cators The first step in the process of conductingan economic analysis is to identify appropriateeconomic indicators for specific economic fore-casts or trends. While various indicators may beselected, they are usually classified as indicatorsthat lead, lag, and/or are coincident with eco-nomic conditions. Measures of data derived fromeconomic indicators yield valuable informationfor the identification of economic trends and thepreparation of specific economic forecasts.

Step 2—Collect Economic Data Once theidentification of indicators has been completed,the second step, which is the collection of eco-nomic data yielded by the indicators, can begin.Data collection is accomplished through observa-tion and/or by reviewing measures of economicperformance, such as unemployment rates, per-sonal income and expenditures, interest rates,

business inventories, gross product by industry,and numerous other economic indicators or in-dices. Such measures of economic performancemay be found in secondary sources such as busi-ness, trade, government, and general-interestpublications. The Bureau of Economic Analysis(BEA), contained in the U.S. Department ofCommerce, provides economic information vianews releases, publications, diskettes, CD-ROMs,and the Internet. The information may be ac-cessed through the Bureau’s Web site(http://www.bea.doc.gov), on recorded tele-phone messages, and in printed Bureau of Eco-nomic Analysis Reports. Such economic data arealso available online through STAT-USA’s Eco-nomic Bulletin Board.

Step 3—Prepare or Select an Economic Fore-cast Of course, simply gathering informationabout economic indicators is not enough. Deci-sion makers must use the data to identify trendsand project forecasts. Decision makers know thatit is important to gain some idea of what eco-nomic conditions will be in months or yearsahead. As a result, they either use the collecteddata to prepare their own forecasts or they useeconomic forecasts that have been prepared byexperts who monitor economic activity. Regard-less of its origin, the forecast itself is essential ifthe decision maker is to recognize opportunitiesand threats posed by the economic environment.Thus, using economic data to predict the futureis the third step in the process.

Economic forecasting can be and often is acomplicated process. While accurate, relevantdata are the basis for predictions, forecastersmust be careful not to gather so much data thatsheer volume makes analyzing impossible. Fore-casts may be classified as short term (with spansor distances to the target period of up to one ortwo years), intermediate (two to five years), andlong term (relating to more persistent develop-ments and distant occurrences). Because of thepossibility of unforeseen events occurring over along interval, short-term forecasts are usuallymore accurate than long-range ones. There arefour principal techniques used to forecast:

ECONOMIC ANALYSIS


● Judgmental forecasting is the oldest and stillthe most important method of forecasting thefuture. Judgmental forecasters often blend sev-eral forecasters’ judgments together to producea forecast. This may be a complicated process,since various ‘‘Delphic’’ methodologies areused to integrate inputs from people experi-enced in forecasting.

● Indicator forecasts are nearly as old as judg-mental forecasts. This technique requires thateconomic indicators be used to estimate thebehavior of related variables. The index ofleading indicators published by the CommerceDepartment is the best-known overall mea-sure, but decision makers can use many otherindicators for their own purposes.

● Time-series techniques use trend projectionsof past economic activity to extend into thefuture. Projecting is done by plotting data forthe past years on a chart and, from the latestdata, extending a line into future time periodsthat follows the pattern of prior years.

● Structural models of the economy try to cap-ture the interrelationships among many vari-ables, using statistical analysis to estimate thehistoric patterns. Large models of the U.S.economy, used by major forecasting firms andthe government, may have up to a thousandinterlinked equations. Simple models used byindividual organizations, however, can have asfew as one equation.

These four methods are not mutually exclu-sive. Combinations of methodologies are perhapsmore commonly used in formulating forecaststoday.

Step 4—Interpret the Economic Data Thefourth step requires decision makers to examine,assess, and interpret the economic data collectedand the subsequent forecast generated from theeconomic data. Decision makers evaluate thedata and forecast for accuracy, try to resolve in-consistencies in the information, and—if it iswarranted—assign significance to the findings.By analyzing economic data and forecasts, deci-sion makers should be able to recognize andidentify potential opportunities and threatslinked to economic changes and developments.As a result, they are better able to understand the

influence that the economy is exerting and betterprepared to make decisions and plan strategy.The process, however, should not be viewed in anoversimplified manner. Today’s global economiclinks make economic forecasting and analysis es-pecially complex.

Step 5—Monitor Intervening Forces Then,too, intervening forces can and do influence eco-nomic activity. Such forces can shift or alter eco-nomic performance and trends and must be an-ticipated by decision makers. Thus, anticipatingand monitoring the government’s manipulationof two powerful sets of economic instruments,fiscal policy and monetary policy, becomes thefifth step in the process. Fiscal policy is the gov-ernment’s combined spending and taxation pro-gram, while monetary policy represents actionsby the Federal Reserve System that affect thesupply and availability of money and credit. Thetwo arms of policy can work to supplement eachother when powerful stimulus or restraint issought. Or they can work in beneficial or damag-ing opposition, when one or the other is drivenoff-course into excessive stimulation or excessiverestraint. Observers can often anticipate the gov-ernment’s implementation of fiscal and/or mon-etary policies based on prevailing economic con-ditions. The outcomes of such implementationsmust be considered by analysts.

Step 6—Use the Economic Analysis for Deci-sion Making Finally, decision makers use the re-sults of an economic analysis for decision mak-ing. Astute decision makers recognize thateconomic forces are uncontrollable and that cur-rent strategies may need to be adjusted to copewith or overcome obstructing economic changes.They approach with caution opportunities andthreats discovered as a result of economic scan-ning and analysis. They pursue a proactive ap-proach, however, knowing that an economicanalysis enables them to choose from alternativeapproaches how to employ scarce or uncommonresources and achieve objectives in the most effi-cient and cost effective manner.

ECONOMIC ANALYSIS


BIBLIOGRAPHY

Cross, Wilbur. (1995). Encyclopedia of Business Terms Dic-tionary. Englewood Cliffs, NJ: Prentice Hall.

Economic Information Systems Incorporated. http://econ-line.com/.

Economic Statistics Briefing Room. http://www.whitehouse.gov/fsbr/esbr.html.

FEDSTATS. http://www.fedstats.gov.

Geahigan, Priscilla Cheng, ed. (1994). American BusinessClimate and Economic Profiles. Detroit, MI: Gale Re-search.

Maddison, Angus. (1995). Explaining the Economic Perform-ance of Nations: Essays in Time and Space. Brookfield,VT: Edward Elgar Publishing.

Office of Economic Analysis Main Page. http://www.oea.das.state.or.us/welcome.html.

Rao Tummola, V. M. (1973). Decision Analysis with BusinessApplications. New York: Intext Educational Publishers.

Schumpeter, Joseph A. (1954). History of Economic Analysis.New York: Oxford University Press.

STAT-USA Internet. http://www.stat.usa.gov.

Trueman, Richard E. (1981). Quantitative Methods for Deci-sion Making in Business. Dryden Press.

RALPH D. WRAY

ECONOMIC CYCLES

Economic cycles, more commonly called busi-ness cycles, are the recurring expansion and con-traction of the national economy. This is aphenomenon that is unique to a private or free-enterprise economic system, also called a capital-ist economy. Other systems do experience someof the same characteristics of the free-enterpriseeconomy; however, business/economic cycles inthe capitalistic economy are the focus of atten-tion in this discussion.

The individual who is most famous for re-search on the business/economic cycle is WesleyMitchell. He defined the business cycle as follows:

Business cycles are a type of fluctuation found in theaggregate economic activity of nations that organizetheir work mainly in business enterprises; a cycleconsists of expansions occurring at about the sametime in many economic activities, followed by simi-larly general recessions, contractions, and revivalswhich merge into the expansion phase of the next

cycle; this sequence of changes is recurrent but notperiodic; in duration business cycles vary from morethan one year to ten or twelve years; they are notdivisible into shorter cycles of similar character withamplitudes approximately their own. (Burns andMitchell, 1946, p. 3)

This definition illustrates Mitchell’s pointthat business/economic cycles occur in private-enterprise but not other systems. He also pointedout that business cycles are not unique to a singlefirm or industry; they affect an entire economy.Although all cycles follow the same basic pattern,they differ in many ways, such as longevity andseverity. Mitchell also points out that an eco-nomic cycle can last from one to twelve years.

UNDERSTANDING THE BUSINESS CYCLE

Business/economic cycles go through increasesand decreases while reaching peaks and troughs.To begin thinking about a cycle, think about atrough, or the low flat part of the cycle, whichmoves to a peak and then to a terminatingtrough. In order to determine and isolate a spe-cific cycle, it is necessary to determine the dates ofthe initial trough and the terminal trough. Mostcycles are measured from cycle to cycle regardlessof length or magnitude.

Cycle Divisions Every business/economic cy-cle goes through divisions. The period from theinitial trough to the peak is called expansion. Thedeclining period of the cycle is called contraction.Within the expansion period there are twophases, which are called recovery and prosperity.After the cycle reaches its peak and contractionbegins, the cycle goes through crisis anddepression. Another term used for a mild depres-sion is recession.

The business cycle is often further dividedinto nine stages. Stage I is centered at the time ofthe initial trough; Stage V is at the time of thepeak; and Stage IX is centered at the terminaltrough. Stages II through IV are equally dividedinto thirds across the expansion period, andStages VI through VIII are equally divided intothirds across the contraction period. These divi-

ECONOMIC CYCLES


Men waiting for job openings during the Great Depression of the 1930s.

sions are made so economists can more easilyanalyze date and time periods for the cycles.

Cycle Terminology There is considerable ter-minology that is related to business/economiccycles, terms such as expansion, contraction,depression, recession, and others. To better under-stand business cycles, it is important to under-stand the terminology.

Expansion: When the economy is growingand businesses in general are doing well, theperiod is known as expansion. There are severalways in which economic growth is measured.One way is gross domestic product (GDP), whichis the total value of all goods and services that areproduced in a country in a specific time period,such as a month, a quarter, or a year. If produc-tion is increasing, this is an indicator that theeconomy is growing.

Another measure of economic expansion ispersonal income. If workers have increasing in-come, the indications are that the economy is

growing and workers can be paid more. Likewise,if unemployment rates are declining or remainlow, this means that people who want to work arefinding jobs and the economy is expanding. Onefear is that the economy will expand too rapidly,leading to inflation.

Inflation: In simplest terms, inflation meansthat there is too much money in the economyand not enough goods and services to purchase.Inflation is a general rise in the prices of goodsand services. In economics, this relates to supplyand demand. If consumers have high demandsfor goods and services, but the supply of thesegoods and services doesn’t increase to meet thedemands, producers can raise prices and con-sumers will still be willing to purchase the goodsand services at higher prices. There is consider-able competition for limited resources. Inflationis measured using the Consumer Price Index(CPI). The CPI is a market basket of goods andservices that consumers regularly buy. As theprices of these goods and services rise, so do the

ECONOMIC CYCLES


Consumer Price Index and all prices in general.This explains why the shoes that cost $50 last yearnow cost $55.

Contraction: The economy will reach a pointwhere expansion first slows and then stops. Theremight be a period of stagnation during whichthere is no growth or even a decline in economicactivity. An economic decline, or contraction,typically follows this period. This is the result ofbusiness activity slowing, less money being spent,unemployment rising, and wages and salaries de-clining or remaining stable.

Recession: If there are two consecutive quar-ters of decline in economic activity as measuredby a decrease in GDP, the economy is said to bein a recession. During a recession, prices fall,consumers don’t buy as many products (espe-cially high-priced items), and businesses begin tofail. A recession has severe consequences for theeconomy, highlighted by high unemploymentand an overall drop in living standards. When thefear of a recession begins to surface, the federalgovernment expends considerable effort tochange the course of activities. Those activitieswill be discussed later.

Depression: A depression is a very severe re-cession. History books talk about the Great De-pression of the 1930s in the United States, one ofthe most severe in the history of the U.S. andworld economies. Depressions are characterizedby extremely high unemployment, low wages,business failures due to little money to purchasegoods and services, and appalling living stan-dards.

Deflation: The opposite of inflation, deflationmeans that prices are going down. The CPI goesdown because the prices of the goods and servicesthat are used to measure it are in general decline.Deflation often follows inflation but normally isshorter in length and of a lesser magnitude.

Stagnation: Stability in growth is a goal of theprivate-enterprise system. This means that therearen’t any drastic changes in prices and the econ-omy is moving forward at an acceptable rate.However, stability can lead to stagnation, a timewhen there is too much complacency, which in

turn leads to a decline in new-product develop-ment and marketing. If this occurs, consumersbecome dissatisfied with what is available andspending slows down, followed by a decline inthe economy. For example, if consumers arespending at a steady rate and they are willing topay reasonable prices for goods and services,manufacturers don’t feel the need for innovationand growth in new areas. This causes stagnation,which leads to decline.

Stagflation: The term stagflation is sometimesused to describe a situation in which there is slowto zero growth in real output, high inflationexists, and unemployment is higher than normal.This situation usually begins with rising prices attimes when production is declining. Because ofdeclining production, unemployment also in-creases. All three of these factors combined causestagflation—stagnation in production and em-ployment together with increasing inflation.

HISTORICAL PERSPECTIVE

The economies of the United States and of theworld generally have been through numerouseconomic cycles. This discussion will not be anextensive one, but rather an overview to show theeffects and relationships of the economy andbusiness cycles.

The First Cycle Following the end of TheRevolutionary War in 1783, the U.S. economyexperienced rapid development and growth. Thiswas a period when the population was growingrapidly and there was expansion to the West.Even though the manufacturing and agriculturalprocesses were primitive by today’s standards,the country was full of new activities. There werenew outlets for goods and services, and tradeopportunities were enhanced. This new growthand expansion lasted until the beginning of theCivil War.

The Second Cycle Rapid growth in economicactivity continued in the period between the be-ginning of the Civil War and the start of WorldWar I. This was caused in part by the steadyincrease in population growth, with immigrantsarriving in the United States virtually daily. Dur-

ECONOMIC CYCLES


ing this time, manufacturing became more domi-nant and replaced agriculture as the primary in-dustry. At the beginning of this period, about 30percent of production in the United States wasfrom agriculture; and at the end of the period, ithad declined to about 20 percent.

This period wasn’t without setbacks, how-ever. In 1873 a major depression began thatlasted until the middle of 1879. This depressionresulted from a financial panic that caused banksto call for repayment of many of their loans. Veryfew banks failed, but in the wake of the panicmany businesses were affected and did fail.

The Third Cycle The third cycle of economicactivity began in 1914 and lasted through 1950.This period was one of major economic varia-tions. Following World War I, demand for goodsand services was high, so the economy flourished.Manufacturing continued to flourish and grow,and mechanization in agriculture increased theefficiency of production and reduced the demandfor labor. People who were farm laborers becamelaborers in the manufacturing sector, especiallyafter the introduction of the gasoline-poweredtractor.

In 1929, signs of a troubled economy beganto surface. The stock market was greatly affectedbecause investors were borrowing large amountsof money to purchase stocks. In late October, thestock market crash had a profound effect on allbusiness activity. Business activity continued todecline through 1932. This was the Great Depres-sion—a worldwide depression. In 1933, a recov-ery began that lasted until 1937. There was againa decline in economic activity and a recession,which lasted until late in 1938.

The United States entered World War II inDecember 1941. Because of military operations,the demand for goods and services rose dramati-cally, employment levels increased, and con-sumers had more money to spend. The economywas on the mend but rising too rapidly, causingfears of inflation. These fears caused the govern-ment to set price ceilings on some products andto ration others. Following the war, the countryconverted from wartime to peacetime produc-

tion, causing many industries to slow down; butthe economy continued to grow.

The Fourth Cycle This period, which beganwith 1950, has been characterized by many eco-nomic cycles. The first twenty years of this periodsaw satisfactory economic growth. The Koreanconflict and the Vietnam War greatly influencedthe economy. There were some downturns in theeconomy, but they were minimal. These occurredin 1953, 1957, and 1960. During this period, un-employment was becoming a problem becausethe demand for unskilled labor was decreasingand the labor force was growing at a rate fasterthan the demand for employees.

In more recent years, the economy has grownand prospered. There has been a shift to a serviceeconomy, which has largely resulted from rapidchanges in technology. In this last cycle, therehave been recessions that have been relativelyshort but have caused hardships for some busi-ness sectors. There was a period of recession from1973 to 1975, in 1980, and again in late 1981.Inflation was a severe problem in 1981, and re-covery didn’t start again until late in 1982. Then,in late 1987, the stock market crash caused prob-lems for many businesses and investors. In addi-tion to those events, there have been severalsmaller cycles.

CONCLUSION

This overview of business/economic cycles hasprovided some insight to the cause of changes inthe U.S. economy, highlighting terminology thatit is important to understand. The role of the U.S.government in controlling changes in economicactivity could not be discussed for reasons oflength.

(SEE: Fiscal policy, Monetary policy)

BIBLIOGRAPHY

Burns, Arthur, and Mitchell, Wesley. (1946). MeasuringBusiness Cycles. New York: National Bureau of EconomicResearch.

Dolan, Edwin G., and Lindsey, David E. (1991). Economics.Chicago: Dryden Press.

ECONOMIC CYCLES


Griffin, Ricky W., and Ebert, Ronald. (1999). Business. Up-per Saddle River, NJ: Prentice-Hall.

Nickels, William G., McHugh, James M., and McHugh,Susan M. (1998). Understanding Business. Chicago: Rich-ard D. Irwin.

Sherman, Howard J., and Kolk, David X. (1996). BusinessCycles and Forecasting. New York: HarperCollins.

Valentine, Lloyd M. (1987). Business Cycles and Forecasting.Cincinnati: South-Western Publishing.

PAULA LUFT


Economic development, generally speaking, is aprocess of change that is focused on the better-ment of the community, state, and/or nation.Defining economic development can be difficult.The first term in this phrase—‘‘economic’’—refers to an accepted paradigm for organizingthe business and financial and even to some ex-tent the governmental sectors of a nation. Eco-nomics is viewed as the foundation for buildinga prosperous society. However, it is the secondterm—‘‘development’’—over which there isconsiderable debate. People’s perceptions of de-velopment vary. For some, development has theappearance of successful commercial enterprise;for others, the face of development is one ofeconomic equality. Nevertheless, the concept of‘‘economic development’’ has the attention ofgovernment, the business sector, and the citi-zenry. We pursue economic development as oneof the goals of a successful country, state, or city.It captures the attention of the news media andimpacts, as well as is impacted by, politicalobjectives.

MEASUREMENT OFECONOMIC DEVELOPMENT

Economic development in a community can takemany forms. However, before we can discuss theprocess of economic development, we must firstunderstand how economic development hasbeen measured, particularly at the national level.It is within this framework that communitieshave pursued their goal of improving the local

economic environment. In fact, standardizedmeasures of economic development are beingused throughout the world, not just in the UnitedStates.

Standardized measures of economic develop-ment are used to identify the status of one’scountry, state, or local community. We use thesemeasures for a number of different purposes, in-cluding identifying trends and understandingpatterns of economic development in communi-ties that face different resource opportunities andconstraints.

One of the most common methods of mea-suring economic growth is by calculating thegross national product of a country. Gross na-tional product (GNP) is the value of goods andservices produced by an economy’s factors in agiven period of time (e.g., the value of all goodsand services produced by U.S. operationsthroughout the world in a given year). Grossdomestic product (GDP), on the other hand, isthe value of goods and services produced in aneconomy in a given period of time (e.g., the valueof goods and services produced in the UnitedStates in a given year). When these measures areadjusted for inflation, we correct for any changesin the GNP or GDP that are due simply to in-creases in the price level in the economy. RealGDP, for example, is the value of goods andservices produced in an economy adjusted forchanges in the price level. This is particularlyimportant when comparing across differenteconomies because changes in price levels willnot necessarily be uniform from one country tothe next.

The general purpose of using measures suchas real GNP or real GDP is to collect and analyzeinformation related to a country’s economictransactions. Real GNP or real GDP providesanalysts with an indication of how quickly thebusiness sector of the economy is growing in acountry. It also serves as a guidepost for localcommunities as they address economic develop-ment issues at a local level.

Trends in national economic developmentreflect changes occurring at the state and locallevels and can impact local economic develop-



Economic development in Portland, Oregon.

ment planning. For instance, if the real GD of acountry has increased, then we conclude that thecountry has experienced economic growth andthe economy has improved. This informationsends a signal to local economies suggesting thatthe national economy is in the growth phase ofthe business cycle. Communities can use this in-

formation to identify their position relative to thecurrent trend and to plan future economic devel-opment. If, however, real GNP has declined, thenthe economy is thought to have experienced aneconomic downturn and a community can usethis information to anticipate the impact of fu-ture economic downturns.



TRENDS IN ECONOMIC DEVELOPMENT INTHE UNITED STATES

Positive trends in growth at the national level donot guarantee that individual communities are orwill be successful in developing their local econo-mies. The needs of local communities havechanged as the patterns of growth at the locallevel have changed. Thus the rules of local eco-nomic development as they relate to attractingnew business in order to promote economicgrowth also have changed. As communities com-pete with each other to attract new businessesand hence jobs to the local environment, they arediscovering that the traditional methods of taxabatement and low-interest loans, coupled withjob training, are not sufficient to guarantee a levelof development that improves the economic baseof the community. In fact, communities are look-ing for ways to ensure that they will get morefrom the investment than it will cost them interms of tax abatements and infrastructure costs.

As firms increasingly engage in multilocationoperations, communities are finding that, in ad-dition to attracting new businesses, encouraginglocal firms to develop is a valuable economicdevelopment tool. The community’s view of itsresources has expanded beyond providing thetraditional tax incentives to expand a commu-nity’s economic resources to include factors suchas a well-educated work force and adequate pub-lic services. Communities are now more likely totarget the type of firm that is ‘‘right’’ for thecommunity. The emphasis on locating manufac-turing enterprises has diminished as communi-ties look to ‘‘healthy’’ businesses that fit thechanging needs of the work force and infrastruc-ture. Explicit consideration of the impact of thenew business on economic equity in the commu-nity is also becoming more important, andgrowth and equity are increasingly recognized ascomplementary rather than opposing goals.

Many of these changes can be summarized inthe phrase ‘‘sustainable development.’’ The caseof sustainable development is appearing moreand more frequently in discussions of commu-nity economic development. What is ‘‘sustain-able development’’? Sustainable development is a

process of development that ‘‘ensures the needsof the present are met, without compromisingthe ability of future generations to meet theirown needs.’’ (World Commission on Environ-ment and Development, 1987, p. 9) The vision ofsustainable development is one of developingwithin the capacity of our resources an ability toreplenish themselves; by analogy to the financialsector, it means living off of the interest as op-posed to the capital of our investment.

In the sustainable development context, eco-nomic development is managed and controlledin a way that recognizes the dynamic nature ofsocial, political, technological, and economic fac-tors in a local community. Ultimately, the pro-cess of economic development is changed fromone of identifying incentives for business growthto one of comprehensive planning to address so-cial, economic, and environmental concerns. Thethemes of economic development also change.Traditional local economic development policiespursue increases in economic activity and thus inthe income levels of local residents. A larger taxbase and lower levels of unemployment areequated with business expansion. Sustainable de-velopment means that growth occurs alongsidecommunity goals of increased self-sufficiencyand improved environmental quality. In fact, dif-ferent forms of growth are encouraged. The sus-tainable development initiative is not opposed togrowth but rather focuses its efforts on answeringthe question, ‘‘How do we grow?’’

Successful economic development has beenachieved in many communities pursing a sus-tainable development approach. Among the suc-cess stories is Kansas City, Missouri. This cityfaced one of the most urgent economic develop-ment problems of urban areas—urban sprawl.From 1960 to 1990, the population in the metro-politan area grew by less than one-third while theland area developed more than doubled. Thecity’s population was moving to the suburbswhile the inner city was slowly being abandoned.As a result, the jobs moved with the population,and the communities in the outer ring of the cityused traditional economic development tools,such as tax incentives, to attract new business.



The central city attempted to compete by pro-viding additional incentives. The burden, how-ever, was clearly felt by taxpayers, as this in-creased over this period.

Recently, however, a Metropoli tanDevelopment Forum was formed to address thecommunity development issues associated withurban sprawl. The forum has been successful inmany areas: they have identified regional trans-portation needs, achieved agreement on the roleof tax incentives in the region as a whole, createda metropolitan greenway, and created local initi-atives for economic development planning.

One community that has achieved long-termsuccess is Portland, Oregon. Portland has chan-neled the economic growth in the city such thatemployment in the formerly dying downtownarea grew from 50,000 jobs in 1975 to 105,000jobs in 1998. This strategy has been successfulbecause they focused the development of busi-ness in areas that are close to developed transitsystems, limited commuter parking, and con-trolled the expansion of growth into the ruralareas.

Kansas City and Portland are only two ofmany examples of successful sustainable develop-ment initiatives across the country. As a commu-nity’s needs change and as development is morebroadly defined to include social as well as eco-nomic indicators of progress, sustainable devel-opment and planned growth initiatives will con-tinue to take hold. There are many opportunitiesahead for local economies to grow and prosper inways that recognize the importance of improvingthe quality of life as well as the economy’s overallproductivity and income levels.

BIBLIOGRAPHY

Parkin, Michael. (1998). Macroeconomics, 4th ed. Addison-Wesley.

Shaffer, Ron. (1998). ‘‘Playing by New Rules in Local Eco-nomic Development.’’ Community Economics Newsletter,No. 263. Center for Community Economic Develop-ment, University of Wisconsin-Madison.

Shaffer, Ron. (1995). ‘‘Sustainable Community EconomicDevelopment.’’ Community Economics Newsletter, No.224. Center for Community Economic Development,University of Wisconsin-Madison.

Thomas, Margaret G. (1999). ‘‘Strategies for SustainableEconomic Development.’’ Community Economics News-letter, No. 267. Center for Community Economic Devel-opment, University of Wisconsin-Madison.

World Commission on Environment and Development.(1987). Our Common Future. Oxford: Oxford UniversityPress.

ELLEN JEAN SZARLETA

ECONOMICS

Economics is often described as a body of knowl-edge or study that discusses how a society tries tosolve the human problems of unlimited wantsand scarce resources. Because economics is asso-ciated with human behavior, the study of eco-nomics is classified as a social science. Becauseeconomics deals with human problems, it cannotbe an exact science and one can easily find differ-ing views and descriptions of economics. In thisdiscussion, the focus is an overview of the ele-ments that constitute the study of economics,that is, wants, needs, scarcity, resources, goodsand services, economic choice, and the laws ofsupply and demand.

Every person is involved with making eco-nomic decisions every day of his or her life. Thisoccurs when one decides whether to cook a mealat home or go to a restaurant to eat, or when onedecides between purchasing a new luxury car or alow-priced pickup truck. People make economicdecisions when they decide whether to rent orpurchase housing or where they should attendcollege.

WANTS, NEEDS, AND SCARCITY

As a society, and in economic terms, people haveunlimited wants; however, resources are scarce.Don’t confuse wants and needs. Individuals oftenwant what they don’t need. In the automobileexample used above, someone might want todrive a large luxury car, but a small pickup truckmay be more suited to the purchaser’s needs if heor she must have a vehicle for hauling furniture.Economic decisions must be made.

ECONOMICS


Robert Mundell, 1999 Nobel Economics winner.

A resource is scarce when there is not enoughof it to satisfy human wants. And human wantsare endless. Because of unlimited wants and lim-ited resources to satisfy those wants, economicdecisions must be made. This problem of scarcity(limited resources) must be addressed, whichleads to economics and economic problems.

Figure 1 illustrates the relationships that existrelative to wants and scarcity. Many elementsinfluence economic decisions. To better under-stand economics, it is critical to understand whatis shown in this Figure.

RESOURCES

Economic resources, often called factors of pro-duction, are divided into four general categories.They are land, labor (sometimes referred to ashuman resources), capital, and entrepreneurship.

Land. Land describes the ground that mightbe used to build a structure such as a factory,school, home, or church, but it means muchmore than that. Land is also the term used for the

Relationship of Economic Tenets

ECONOMIC PROBLEM

Unlimited Wants

LimitedResources

Specialization

Interdependence Resulting from Specialization

LandLaborCapital

Entrepre-neurship

What goods will be

produced?

How will production

occur?

How much should be produced?

Who will be the

recipients?

Figure 1

resources that come from the land. Trees areproduced by the land and are used for lumber,firewood, paper, and numerous other products,so they are referred to as land. Minerals thatcome from the ground, such as oil that is used tomake gasoline or to lubricate automobile en-gines, or gold that is used to make jewelry, orwheat that is grown on the land and is used in theproduction of bread and other products, or sheepthat are raised for the wool they produce that isused to make sweaters are all described as land.

Labor (Human Resources). Labor is the gen-eral category of the human effort that is used forthe production of goods and services. This in-cludes physical labor, such as harvesting trees forlumber, drilling for oil or mining for gold, grow-ing wheat for bread, or raising the sheep thatproduce wool for a sweater. In addition to physi-cal labor, there is mental labor, which is necessaryfor such activities as planning the best ways toharvest trees and making decisions about whichtrees to harvest. Labor is also involved when adoctor or surgeon analyzes and diagnoses (men-tal labor) before performing a medical proce-

ECONOMICS


dure, then performs the procedure (physical lab-or).

Capital. Capital is input that is often viewedin two ways, much as is labor. Capital might beviewed as human capital—the knowledge, skills,and attitudes that humans possess that allowthem to produce. The other type of capital isphysical capital, which includes buildings, ma-chinery, tools, and other items that are used toproduce goods and service. Traditionally, physi-cal capital has been a prerequisite for humancapital; however, because of rapid changes intechnology, today human capital is less depen-dent on physical capital.

Entrepreneurship. One special form of hu-man capital that is important in an economicsetting is entrepreneurship (often thought of asthe fourth factor of production). Entrepreneurialabilities are needed to improve what we have andto create new goods and services. An entrepre-neur is one who brings together all the resourcesof land, labor, and capital that are needed toproduce a better product or service. In the pro-cess of doing this, the entrepreneur is willing toassume the risk of success and failure.

Many people associate entrepreneurship withcreating or owning a new business. That is onedefinition of entrepreneurship but not the onlyone. An entrepreneur might create a new marketfor something that already exists or push the useof a natural resource to new limits in order tomaximize efficiency and minimize consumption.See ‘‘entrepreneurship’’ for a more general dis-cussion as it relates to business ownership.

GOODS AND SERVICES

It takes land, labor, and capital that are used byan entrepreneur to produce goods and servicesthat will ultimately be used to satisfy our wants.Goods are tangible, meaning they are somethingthat can be seen or touched. The production ofgoods requires using limited resources to pro-duce in order to satisfy wants. An example mightbe a farmer who grows grain. The farmer usesfarm equipment manufactured from resources;ground is a natural resource that is used to grow

the grain; and because the growth of grain de-pletes the nutrients in the soil, the farmer mustuse fertilizers to restore the nutrients. Limitedresources are used to produce natural or chemi-cal fertilizers, but they are necessary for cropproduction. Water might be used to irrigate thecrop and enhance production. When the crop isready for harvest, the farmer uses additional re-sources to complete the process—equipment,gasoline, labor, and so on—which results in agood that can be used or sold for use by others.

Services are provided in numerous ways andare an intangible activity. There is no doubt thatone can often see someone providing a service,but the service is not something that someonecan pick up and take home to use. An example ofa service is a ride in a taxi through a crowded city.It takes resources for the owner or driver to pro-vide the service, and a passenger is consciouslyaware of riding in a taxi. When the ride is com-pleted and the provider has been paid, the pas-senger doesn’t have anything tangible to holdexcept the receipt. However, resources have beenused to provide the service. The automobile usedas the cab, the fuel used to operate the cab, andthe labor of the driver are all examples of re-sources being used to provide a service that willsatisfy a want.

It is important to understand that becausegoods and services utilize resources that are lim-ited, goods and services are also scarce. Scarcityresults when the demand for a good or service isgreater than its supply. Remember that societyhas unlimited wants but scarce resources. It isscarcity, then, that causes consumers to have tomake choices. If individuals can’t have everythingthey want, they must decide which of the goodsand services are most important and which theycan do without.

ECONOMIC CHOICE

Opportunity Cost. When one makes eco-nomic decisions, it is because of limited re-sources. Alternatives must be considered. Peoplemake such decisions based on expecting greaterbenefits from one alternative than another. Thereis an opportunity cost involved in the choice. Op-

ECONOMICS


portunity cost is the benefit forgone from the bestalternative that is not selected: Individuals give upan opportunity to use or enjoy something inorder to select something else.

Opportunity costs can’t always be measured,because it might be satisfaction that is lost. Atother times, however, opportunity cost can bemeasured. Here are examples of each. Perhaps astudent is studying hard for a final examinationin a difficult course because a good exam score iscritical to achieve the desired grade. Friends callto invite the student out for the evening. Thealternatives are to study or to have fun. Beingwise, the student selects studying instead of goingout. It is difficult to measure the opportunity costof having fun with friends. In the second exam-ple, the same studying student is asked to helpsomeone clean a garage. If the person offers topay the student $50 to clean the garage and thestudent chooses to study, the opportunity cost iseasily measured at $50. In both these examples,opportunity cost is directly related to what wasgiven up, not any other benefits that might resultfrom the decision.

Circumstances also play a role in opportunitycost. Sometimes people are forced into a decisionbecause of circumstances and the results may notalways be optimal. For example, if someone isplanning to relocate to a new city to start a newjob and wants to sell a house before the move inorder to be able to purchase a new house in thenew location, the person may sell the house forless than the market price in order to completethe process. The opportunity cost is the value ofwhat was given up in order to be able to purchasea new home. Every time a choice is made, oppor-tunity costs are assumed.

Production. Another economic choice thatmust be made is related to production. This isillustrated in Figure 1. All four of the decisionsmust be made: What goods will be produced?How will production occur? How much shouldbe produced? Who will be the recipients? All aredecisions that influence production efficiency.

Efficiency is the primary element in decidingwhat to produce and how to go about the pro-duction process. Efficiency is producing with the

least amount of expense, effort, and waste, butnot without cost. If you take something awayfrom a person to satisfy another person, one willbe less happy and the other will be more happy. Ifa way can be found to make one person morehappy without making the other person lesshappy, this would be efficient.

An example of economic efficiency might bethe following. Assume someone owns a car and afriend doesn’t own a car but does drive. Thefriend needs transportation regularly for a week.It happens to be a time when the car owner willbe away on a business trip and therefore won’t beusing the car. It makes no sense for the friend tobuy a car to use for such a short period of time, sothe owner loans the friend the car for that week.The car owner is no worse off and the friend isbetter off. Economic efficiency has occurred inthis situation. If the car owner had not loaned thecar to the friend, there would have been wastebecause the friend would have had to buy or renta car. It is wasteful to fail to take advantage ofopportunities in which there is no loss of satisfac-tion to either party.

Production efficiency is a situation in which itis not possible to produce any more units of agood without giving up the opportunity to pro-duce another good unless a change occurs inavailable productive resources. If a farmer isgrowing wheat to be sold for the production ofbread, there is a point at which adding additionalfertilizer to the soil would do no good. If thefertilizer were used on an oat crop in a differentfield, production could be increased for thatcrop. The way to increase the wheat production isto find different resources to make the crop bet-ter, such as irrigating the land to provide moremoisture.

In the above example, it was suggested thatdifferent or additional resources might be used toincrease production. This is necessary only afterefficiency has been achieved. Additional re-sources would have to come from land, labor,capital, or entrepreneurship. It is most commonthat capital will be used most often to increaseproduction. Capital is productive input that isincreased by people. This is known as invest-

ECONOMICS


ment. Investment involves giving up what mightpresently be consumed in favor of producingsomething to consume in the future. If thefarmer wants to increase wheat production in thefuture, something will have to be given up now inorder to increase the resources available for fu-ture production.

Increasing human capital is critical to in-creasing production. This does not mean thatmore people must be produced, but rather thatthe knowledge and skills of humans must beincreased. This can happen because of improve-ments in technology and new ways of satisfyingwants. This involves the entrepreneurial factorthat was described previously—the human ele-ment that figures out ways to improve and ex-pand the resources that already exist.

Product Distribution. Getting goods into thehands of those who want them involves manychoices. The economic system must decide howto divide the products that are produced amongthe potential recipients. Sometimes products canbe divided equally among recipients, but nor-mally this is not the situation. It must then bedetermined how the division will take place. In acapitalistic economic system, distribution is oftendetermined by wealth. If two people have thesame wants, the person who can most affordsomething will be able to acquire it.

THE LAWS OF SUPPLY AND DEMAND

Production decisions are made based on demandfor goods and services. Supply of goods andservices is dependent upon demand for the same.Why do movies that are much more popular stayat theaters longer than those that aren’t as popu-lar? Demand for the movie causes the theateroperators to supply the showings that the con-sumer wants. Why does the room rate in a con-vention hotel go down on weekends? There is lessdemand on weekends because most convention-goers leave on Friday or Saturday and othersdon’t arrive until Monday, so the supply of avail-able rooms goes up. Hotel operators try to createmore demand for their vacant weekend rooms bylowering prices and offering attractive amenities.

The law of demand states that during a spe-cific time period the quantity of a product that isdemanded is inversely related to its price, as longas other things remain constant. The higher theprice, the lower the demand; the lower the price,the higher the demand. Don’t confuse demandwith wants. Consumers have unlimited wants, aswas established at the beginning of this discus-sion. Nor are demands and wants the same asneeds. A consumer may need to have a crown puton a tooth but may not want to have it donebecause of the high cost. At some point, thesuffering patient may demand the services beprovided regardless of the price.

Often when prices are too high and demandfor a product or service lessens, it is becauseconsumers have found a suitable substitute. Sub-stitution happens all the time as a result of eco-nomic decisions that are made by consumers. Forexample, if someone needs a winter coat and likesone with a designer name and a price that reflectsthat name, the purchase may not be made. In-stead, the person finds a similar coat that doesnot have a designer label and purchases it insteadat a much lower cost.

Demand for goods or services determines theamount that will be supplied. The law of supplystates that the greater the demand, the more thatwill be supplied; the lower the demand, the lessthat will be supplied. The amount that will besupplied by a producer of the good or service isbased on capacity and willingness to supply theproduct at a specific price. A producer will notsupply goods and services just because there isdemand for them—price for the good or serviceis an important consideration.

If consumers are willing to pay more for agood or service, the producer will likely be willingto shift more resources in order to increase thesupply of the demanded product. If a rancher israising prime beef cattle and there is high de-mand for this good and consumers are willing topay more for high-quality beef, then the ranchermight be willing to supply more even if it isnecessary to shift resources or acquire additionalresources to be able to do so.

ECONOMICS


Demands change, supplies change, andprices change. So how does a producer know howmuch is enough and what price to charge for thegoods and services? Very simply, the demand forand supply of goods and services can be plottedon graphs using different prices. The supply anddemand for a good or service intersect on thegraph at what is called the equilibrium price, orthe price where all of what is supplied will bedemanded. If the price is below equilibrium,there will be a shortage of the good or service,and if the price is above equilibrium, there will bea surplus of the good or service. For a moredetailed explanation on this aspect of economics,see the discussion of supply and demand.

SUMMARY

Economics is a complex topic that is studiedconstantly and thoroughly. This article has givenan overview of some of the main tenets of eco-nomics; however, there is much that was not evenintroduced. There are other topics throughoutthis encyclopedia, such as macroeconomics andmicroeconomics, that will further define and ex-pand the topic of economics.

BIBLIOGRAPHY

Dolan, Edwin G., and Lindsey, David E. (1991). Economics.Chicago: Dryden.

Heilbroner, Robert L., and Thurow, Lester C. (1987).Economics Explained. New York: Simon & Schuster.

Lipsey, Richard G., Steiner, Peter O., Purvis, Douglas D.,and Courant, Paul N. (1990). Economics. New York:Harper & Row.

McEachern, William A. (1991). Economics: A ContemporaryIntroduction. Cincinnati, OH: South-Western Publish-ing.

ROGER L. LUFT

ECONOMICS: A HISTORICALPERSPECTIVE

Economics has been around since the beginningof time, but the study of economics dates backonly a few hundred years. Since the beginning ofhuman history, people have had to confront the

problem of scarce resources and unlimited wants.The study of economics will continue until theend of time because each day uncovers new evi-dence that supports or revolutionizes economictheory.

THE DEVELOPMENT OFECONOMIC SYSTEMS

The United States has a capitalistic economicsystem. Sometimes this system is called the free-enterprise system because that term is more ac-ceptable to certain individuals. A capitalistic sys-tem includes a market society, or market sys-tem—a system of mercantilism in whichparticipants react freely to the opportunities andchallenges of the marketplace. This is in contrastto systems in which participants follow traditionor the commands of others. In a market system,anyone can buy land or sell it of his or her ownfree will or produce products and/or services thatare sold at a market price. In earlier societies,participants responded not to the demands of themarketplace but to the demands of tradition orlaw as well as the threat and fear of punishment.

The factors of production, key to a capital-istic system, are the result of historical changesthat made labor a key to creating wealth, madereal estate out of land that had been in familiesfor generations, and made capital out of posses-sions. Capitalism, a free-market system, was thecause of much unrest and insecurity, but it alsogave birth to progress and, ultimately, fulfill-ment. There have been several key individualswhose work and economic writing help to clarifycurrent thought about economic systems. Theideas of four are presented here.

ADAM SMITH (1723–1790)

Perhaps the best known and one of the mostrevered economists, Adam Smith wrote TheWealth of Nations in 1776, the same year theDeclaration of Independence was signed. In thisfamous work, Smith explained how an indepen-dent society works. He answered several ques-tions that people had at the time regarding theconcepts of a free-market system.

ECONOMICS: A HISTORICAL PERSPECTIVE


Of primary concern was the question of howthose consumed with greed might be controlledso they wouldn’t take over society. Smith intro-duced the concept of competition. Anyone benton bettering only him- or herself with no regardfor others will be confronted by others with thesame goals. In this new system, those who arebuying or selling are forced to meet the pricesoffered by competitors.

Smith also illustrated that a market systemalso has another important function. That func-tion is to produce goods and services that societywants, and in quantities that society wants. Agood example of this is when products such ashula-hoops, cabbage patch dolls, or beanie babiesbecame the rage, there weren’t enough being pro-duced to satisfy all the potential buyers. As aresult, the manufacturers had to increase produc-tion and were also able to increase prices becausethe demand for the products was so great andbuyers were willing to pay higher prices. In fact,many buyers bought quantities they didn’t needprecisely so they could, in turn, sell the high-demand products to others who were willing topay the higher price. That is the capitalistic mar-ket system.

Smith was extremely visionary and foresawthat if a free market is to grow and prosper, theremust be little government intervention. He sawthat a free market must be self-regulating inorder to become wealthy and robust. He made itclear that it was truly individuals’ greed and de-sire for profits that would create a working free-enterprise system that is self-regulating.

KARL MARX (1818–1883)

The mere mention of Karl Marx might be dis-turbing to some; however, his thoughts and writ-ings on economics have stirred many to moreintense economic analysis. His role in economichistory is quite different from that of AdamSmith. Smith was the visionary regarding theorderly processes and growth of capitalism whileMarx diagnosed its disorderliness and eventualdemise. Marx believed that growth is fraughtwith crises and pitfalls.

Karl Marx stressed the instability of capitalism.

Marx was the first economic theorist to stressthe instability of capitalism, maintaining thateconomic growth is wavering and uncertain. Hepointed out that even though accumulation ofwealth is primary in a free-market system, it maynot always be possible. Marx believed that in-creasing instability would occur until the systemcollapsed.

Marx discussed how the size of businesseswould continue to grow because of the inherentinstability and demise of smaller, noncompetitivebusinesses. Failing businesses would be boughtby successful ones; hence, the growth cycle wouldcontinue. He realized that a trend toward largerbusinesses is typical in a capitalistic system.

Marx also speculated that there would be aclass struggle in a capitalistic society. He thoughtthat as small businesses were forced out of themarketplace and acquired by larger businesses,the social structure would also evolve into twoclasses. He predicted that there would be oneclass of wealthy property owners and another



class of propertyless workers. There are argu-ments for and against Marx’s economic beliefs,but he has more critics than supporters in capi-talistic countries.

JOHN MAYNARD KEYNES (1883–1946)

John Maynard Keynes was the father of a ‘‘mixedeconomy’’ in which the government plays a cru-cial role. Many believe that government shouldnot have a role in a capitalistic system, viewingsuch a role with considerable distrust and suspi-cion. As a result, many find Keynes’s theories tobe as offensive as those of Marx.

One of the main tenets of Keynes’s theory—in conflict with both Smith and Marx—is thateconomic problems in a capitalistic society arenot self-correcting and that economies cannotkeep growing indefinitely. He believed that ifthere is nothing to support capital growth, adepressed economy requires outside interventionor a substitute for business capital spending. Key-nes believed that only government interventioncould get a country out of a depression and theeconomy back on track.

ALFRED MARSHALL (1842–1924)

Alfred Marshall was a mathematician who ap-plied his mathematical training to his explana-tion of economics. Marshall’s economic theories,although very elaborate, have been viewed aseclectic and lacking in internal consistency. Hewas noted for taking a series of formal economicthoughts and analyses and linking them. Hethought that his writings would present a detailedpicture of economic reality.

His complex thoughts are much too detailedto go into here, but he did develop theories ofvalue and distribution that combine marginalutility with real cost. The forces behind bothsupply and demand determine value. Behind de-mand is marginal utility, which is reflected in theprices at which given quantities will be demandedby buyers. Marshall stated that behind supply ismarginal effort and sacrifice, reflected in theprices at which given quantities will be produced.

J. Maynard Keynes, father of the ‘‘mixed economy.’’

SUMMARY

There are, of course, many other noted econo-mists who have influenced the study of econom-ics. Many contemporary economic theorists haveused the writings of the early economists to fur-ther develop economic thought. Economics is acontinually evolving study, and its history will beconstantly changing.

BIBLIOGRAPHY

Blaug, Mark, ed. (1990). The History of Economic Thought.Brookfield, VT: Elgar.

Deane, Phyllis. (1978). The Evolution of Economic Ideas. NewYork: Cambridge University Press.

Galbraith, John Kenneth. (1987). Economics in Perspective: ACritical History. Boston: Houghton Mifflin.

Heilbroner, Robert L., and Thurow, Lester C. (1987).Economics Explained. New York: Simon and Schuster.

Heimann, Eduard. (1964).History of Economic Doctrines: AnIntroduction to Economic Theory. New York: Oxford Uni-versity Press.



Rostow, W. W. (1990). Theorists of Economic Growth fromDavid Hume to the Present With a Perspective on the NextCentury. New York: Oxford University Press.

ROGER L. LUFT

ECONOMIC SYSTEMS

The fundamental economic problem in any soci-ety is to provide a set of rules for allocatingresources and/or consumption among individu-als who can’t satisfy their wants, given limitedresources. The rules that each economic systemprovides function within a framework of formalinstitutions (e.g., laws) and informal institutions(e.g., customs).

In every nation, no matter what the form ofgovernment, what the type of economic system,who controls the government, or how rich orpoor the country is, three basic economic ques-tions must be answered. They are:

What and how much will be produced? Lit-erally, billions of different outputs could beproduced with society’s scarce resources.Some mechanism must exist that differen-tiates between products to be producedand others that remain as either un-exploited inventions or as individuals’unfulfilled desires.

How will it be produced? There are manyways to produce a desired item. It may bepossible to use more labor and less capital,or vice versa. It may be possible to usemore unskilled labor to substitute forfewer units of skilled labor. Choices mustbe made about the particular input mix,the way the inputs should be organized,how they are brought together, and wherethe production is to take place.

For whom will it be produced? Once a com-modity is produced, some mechanismmust exist that distributes finished prod-ucts to the ultimate consumers of theproduct. The mechanism of distributionfor these commodities differs by economicsystem.

MARKET VS. COMMAND SYSTEMS

One way to define economic systems is to classifythem according to whether they are market sys-tems or command systems. In a market system,individuals own the factors of production andindividually decide how to use them. The cumu-lative decisions of these individuals are reflectedin constantly changing prices, which result fromthe supply and demand for different commodi-ties and, in turn, impact that supply and demand.The prices of those commodities are signals toeveryone within the system indicating relativescarcity and abundance. Indeed, it is the signalingaspect of the price system that provides the infor-mation to buyers and sellers about what shouldbe bought and what should be produced.

In a market system the interaction of supplyand demand for each good determines what andhow much to produce. For example, if the highestprice that consumers are willing to pay is lessthan the lowest cost at which a good can beproduced, output will be zero. That doesn’t meanthat the market system has failed. It merely im-plies that the demand is not high enough inrelation to supply to create a market; however, itmight be someday.

In a market economy the efficient use ofscarce inputs determines how output will be pro-duced. Specifically, in a market system, the least-cost production method will have to be used. Ifany other method was used, firms would be sacri-ficing potential profit. Any firm that fails to em-ploy the least-cost technique will find that otherfirms can undercut its price. That is, other firmscan choose the least-cost or any lower-cost pro-duction method and be able to offer the productat a lower price, while still making a profit. Thislower price will induce consumers to shift pur-chases from the higher-priced firm to the lower-priced firm, and inefficient firms will be forcedout of business.

In a market system, individuals make thechoice about what is purchased; however, abilityto pay, as well as the consumer’s willingness topurchase the good or service, determine thatchoice.Who gets what is determined by the distri-bution of money income. In a market system, a

ECONOMIC SYSTEMS


consumer’s ability to pay for consumer productsis based on the consumer’s money income.Money income in turn depends on the quantities,qualities, and types of the various human andnon-human resources that the individual ownsand supplies to the marketplace. It also dependson the prices, or payments, for those resources.When you are selling your human resources aslabor services, your money income is based onthe wages you can earn in the labor market. Ifyou own non-human resources—capital andland, for example—the level of interest and rentsthat you are paid for your resources will influencethe size of your money income, and thus yourability to buy consumer products.

Critics commonly argue that in a marketsystem the rich, who begin with a disproportion-ately large share of resources, tend to becomericher while the poor, who begin with a dispro-portionately small share of resources, tend tobecome poorer. They further argue that a gov-ernment, which is designed to protect private-property rights, will tend to be exploited by thosein power, which tends to be the economicallywealthy. These critics argue that a market econ-omy leads to selfish behavior rather than sociallydesirable outcomes.

In contrast, a command system is one inwhich decision making is centralized. In a com-mand system, the government controls the fac-tors of production and makes all decisions abouttheir use and about the consumption of output.The central planning unit takes the inputs of theeconomy and directs them into outputs in asocially desirable manner. This requires a carefulbalancing between output goals and available re-sources.

In a command system the central plannersdetermine what and how much will be producedby first forecasting an optimal level of consump-tion for a future period and then specifically al-locating resources projected to be sufficient tosupport that level of production. The ‘‘optimal’’level of production in a command economy isdetermined by the central planners and is consis-tent with government objectives rather than be-ing a function of consumer desires.

As a part of the resource allocation process,the central planners also determine how produc-tion will take place. This process could focus onlow-cost production or high quality productionor full-employment of relatively inefficient re-sources or any number of other governmentalobjectives.

Finally, the command system will determinefor whom the product is produced. Again, thefocus is on socially-desirable objectives. Theproduct can be allocated based on class, on aqueuing process, on a reward system for out-standing or loyal performance, or on any othersocially-desirable basis for the economy.

Critics commonly argue that becauseplanned economies cannot effectively process asmuch relevant information as a market does,command economic systems cannot coordinateeconomic activity or satisfy consumer demand aswell as market forces do. For example, consideran economic planning board of twenty people,that must decide how many coats, apartmentbuildings, cars, trains, museums, jets, grocerystores, and so forth should be built in the nextfive years. Where should these planners begin?How would they forecast the future need for eachof these? Critics argue that, at best, plannerswould make a guess about what goods and ser-vices would be needed. If they guess wrong, re-sources would be misallocated and too much ortoo little production would take place. These crit-ics argue that private individuals, guided by ris-ing and falling prices and by the desire to earnprofits, are better at satisfying consumer demand.

CAPITALISM

Under a capitalist economic system, individualsown all resources, both human and non-human.Governments intervene only minimally in theoperation of markets, primarily to protect theprivate-property rights of individuals. Free mar-kets in which suppliers and demanders can enterand exit the market at their own discretion arefundamental to the capitalist economic system.The concept of laissez-faire, that is, leaving thecoordination of individuals’ wants to be con-trolled by the market, is also a tenet of capitalism.

ECONOMIC SYSTEMS


What and how much will be produced? Howwill it be produced? For whom will it be produced?In a capitalist system, individuals own resources,either through inheritance or through industry.The individual receives compensation for the useof resources by others. This, combined with in-herited wealth of the person, determines an indi-vidual’s spending power. The accumulatedspending power and the willingness of individu-als to allocate resources to consumption deter-mine demand. The availability and costs of re-sources, together with the potential for profits offirms, determine supply. In a market system thedemand of consumers combined with the supplyof producers determine what and how much willbe produced.

Because of the economic competitiveness ofthe market system, the lowest-cost productionmethod will be used. If anything other than thelowest-cost production method was being used, acompeting firm would have an incentive to enterproduction to earn a greater profit and couldafford to sell at a lower price, thus driving theoriginal firm out of production. Consumerscould then purchase more of the product at alower price, allowing their limited resources topurchase more.

Production will be allocated to those withavailable resources and a willingness to purchasethe output of production. These purchases thenbecome information for suppliers in determiningwhat and how much to produce in the future.

Thus, pure capitalism is an economic systembased upon private property and the market inwhich—in principle—individuals decide how,what, and for whom to produce. Under capital-ism, individuals are encouraged to follow theirown self-interests, while the market forces of sup-ply and demand are relied upon to coordinateeconomic activity. Distribution to each individ-ual is according to his or her ability, effort, andinherited property. Typically the economies ofCanada, the United States, and Western Europeare considered to be capitalist.

SOCIALISM

Under a socialist economic system, individualsown their own human capital and the govern-ment owns most other, non-human resources—that is, most of the major factors of productionare owned by the state. Land, factories, and majormachinery are publicly owned.

What and how much will be produced? Howwill it be produced? For whom will it be produced?A socialist system is a form of command econ-omy in which prices and production are set bythe state. Movement of resources, including themovement of labor, is strictly controlled. Re-sources can only move at the direction of thecentralized planning authority. Economic deci-sions about what and how much, how, and forwhom are all made by the state through its centralplanning agencies.

In theory, socialism is an economic systembased upon the individual’s good will towardothers, rather than a function of his or her ownself-interest. Socialism attempts to influence in-dividuals to take other people’s needs into ac-count and to adjust their own needs in accord-ance with what’s available. In socialist economies,individuals are urged to consider the well-beingof others; if individuals don’t behave in a sociallydesirable manner, the government will intervene.In practice, socialism has become an economicsystem based on government ownership of themeans of production, with economic activitygoverned by central planning. The economies ofSweden and France are examples of a socialisteconomic system.

COMMUNISM

Under a communist economic system, all re-sources, both human and non-human, areowned by the state. The government takes on acentral planning role directing both productionand consumption in a socially desirable manner.

What and how much will be produced? Howwill it be produced? For whom will it be produced?Central planners forecast a socially beneficial fu-ture and determine the production needed to

ECONOMIC SYSTEMS


obtain that outcome. The central planners makeall decisions, guided by what they believe to begood for the country. The central planners alsoallocate the production to consumers based ontheir assessment of the individual’s need. Basichuman needs and wants would be met accordingto the Marxist principle, ‘‘From each accordingto his ability to produce, to each according to hisneed.’’

The economies of China, the former SovietUnion, and the former East Germany are exam-ples of communist economies.

MIXED ECONOMIC SYSTEMS

In practice, most economies blend some ele-ments of both market and command economiesin answering the three fundamental economicquestions: What and how much will be produced?How will it be produced? For whom will it beproduced? Furthermore, within any economy, thedegree of the mix will vary.

The economy of the United States is gener-ally considered to be a free market or capitalisteconomic system. However, even in the UnitedStates the government has determined a ‘‘mini-mum wage,’’ has set rules and regulations forenvironmental protection, has provided pricesupports for agricultural products, restricts theimports of items that might compete with localproduction, restricts the exports of sensitive out-put, provides for public goods such as a parksystem, and provides health and retirement ser-vices through Medicaid and Medicare. All ofthese detract from the essential nature of a capi-talist economy. However, most decisions con-tinue to be left to free markets, leaving the UnitedStates as a mixed economy that leans heavilytoward the capitalist economic system.

In contrast, the economy of the former So-viet Union is generally considered to be commu-nist. However, the strict controls of the centralplanning unit of the country tended to be moreintensely focused on heavy industry, includingthe defense and aerospace industries, than onagricultural industries. Farmers often had signifi-cant freedom to produce and sell (or barter) whatthey wished.

SUMMARY

Countries have scarce resources. The economicsystems of countries are designed to allocatethose resources, through a production system, toprovide output for their citizens. The fundamen-tal questions that these systems answer are:

● What and how much will be produced?

● How will it be produced?

● For whom will it be produced?

Market economies leave the answers to thesequestions to the determination of the forces ofsupply and demand while command economiesuse a central planning agency to direct the activi-ties of the economy. Pure capitalist economiesare market economies in which the role of gov-ernment is to ensure that the ownership of theresources used in production are privately held.Socialist economies are primarily commandeconomies where most non-human resources areowned by the state but human capital is ownedby the individual. Communist economies are alsocommand economies but all resources, both hu-man and non-human, are owned by the state.

In practice, all economies are actually mixedeconomies, incorporating some facets of bothmarket and command economies. The relativeimportance of the particular economic system inthe country is the determinant of the type ofeconomic system that it is generally considered tobe.

DENISE WOODBURY

EDUCATION(SEE: Corporate Education; Training and Develop-ment)

ELECTRONIC COMMERCE

‘‘No single force embodies our electronic trans-formation more than the evolving mediumknown as the Internet. Internet technology ishaving a profound effect on the global trade inservices,’’ according to a White House paper in

EDUCATION


These Carnegie Mellon University students were among the first to graduate with a Master of Science in ElectronicCommerce.

1997. Electronic commerce is estimated to havebeen in the range of $63 billion in 1999 and isexpected to soar to $1,444 trillion by 2003 (For-rester Research, 1999). Electronic commerce is abroad term describing business activities with as-sociated technical data that are conducted elec-tronically. It is an entire set of different, digitally

enabled activities that are progressively replacingthe more traditional brick-and-mortar commer-cial functions. While the wider phenomenon of‘‘electronization of economic activities’’ encom-passes the digitalization of all processes of eco-nomic wealth generation—including economicanalysis, production, storage, information provi-

ELECTRONIC COMMERCE


Electronization of Business

Payment

Delivery

Auditing

Sale

Inventory

Purchasing

Manufacturing

Pre-sale-care

Marketing

Advertising

E-care

Web-based Cash register

Shopping carts Click paths E-Catalog

Web-based Credit card

E-cash Micropayments

Tracking

Tracking

E-Catalog

Bitable Non-bitable

Continuous Automatic Confirmation

VRS Auto Responder

Continuous ERPSs

New ParadigmsTech support Lead follows Help desk

Web advertising Customization

Banners

B2B Purchasing Open EDI Extranets

Individual targeting Spamming

Virtual communities Customer party lines

Figure 1

sioning, marketing, and so on—it is the area ofsales and related processes facilitated by elec-tronic media that have been popularly termed‘‘electronic commerce.’’ Consequently within themore general phenomenon of digitalization ofmodern life, we find its most important compo-nent electronic commerce.

NEW WAYS OF DOING BUSINESS

Corporate, not-for-profit, and governmental sys-tems are incorporating many increasingly digital-ized processes that are leading to astoundingproductivity gains in the world economy becausethese processes are becoming less expensive, lesstime consuming, and more useful (‘‘Why theProductivity Revolution,’’ 2000). For example, adirectory-assistance call formerly required an op-

erator, look-up in paper-based directories, and alocalized search. Now it involves a national (orinternational) computer database, voice synthe-sis, and automatic connection. Furthermore, theprocess has been expanded; one can do reversesearches through the Internet that will point tothe owner of a telephone number, link this toone’s telephone bill, and not involve any individ-ual as the service provider. Thousands of ‘‘systemprocesses’’ are undergoing this type of mutation,leading to cheaper, less time-consuming, and ex-panded types of services. Figure 1 shows severalcomponents of the business process (e.g., mar-keting) and electronic commerce tools (e.g., Webbanners) that are structurally changing ways ofdoing business.

The marketing, advertising, and care triadare the core of the phenomenon. One-to-one

ELECTRONIC COMMERCE


0

5

10

15

20

25

30

35

Bill

ion

s o

f D

olla

rs

Automobiles Hardware Consumer Health AppliancesFeedApparelTravel

Sectors

Series1

Series2

Series3

Series4

Sector and E-Commerce by 2004

Figure 2

marketing (whereby large customer databaseslink much information about clients, thus creat-ing very efficient leads) is linked to very tailoredadvertising: The firm knows the client when he orshe is connected to the Internet, and it fires off aseries of individually targeted banners cateringvery closely to the client’s needs. These advertis-ing banners can explore the geography of theclient at that moment (for example, if in a car, theclosest gas station, drug store, or sports bar),linkages among products or recent purchase(bought a computer, needs parts and software),personal factors (getting married, needing adress, birthday, death in the family), and otherfactors. The e-care part of the triad is the emerg-ing process of the new organization. Technologi-cally rich products need superior, technologicallybased support. E-care—a mix of e-mail, Web-based support, and, when essential, phone sup-port—is cheaper and more powerful if properlydone than the traditional means. Organizationsare finding that the same stringent standards oftraditional care must be applied in thee-organization.

The electronic commerce revolution is in itsinitial phases and will progressively take over allprocesses either directly or indirectly. The dis-tinction between ‘‘snail’’ commerce ande-commerce will disappear, with all processes be-coming either digital or aided by digital support-ing processes. The pace of this transformation iswhat differentiates winning from losing competi-tors, industries, and investors. The intrinsic na-ture of the product and processes, as well as thedynamics and resistance to change of corpora-tions and industries, will determine the pace ofchange and the gains in productivity. Togetherwith the telephone, railroads, and electricity, theInternet is one of the major agents of change ofmodern life.

Two major factors affect the speed of changein terms of product: (1) bitability and (2)e-commoditization. A product is bitable or not.If it can be transmitted over the Internet, theproduct (or service) is bitable. Software, infor-mation, remote support services, banking, bro-kerage, and insurance, for example, fall into thiscategory. If a product is bitable it does not ulti-mately have to be physically delivered, although

ELECTRONIC COMMERCE


Technology World Wide Web

Services Delivery Escrow

Price Comparisons

Business Model E-Catalog Auctions

Name your price

The Three Factors and Illustrations

Figure 3

it may take some time to acquire sufficient band-width or get consumers used to the idea. Thee-commoditization factor is more complex. Ane-commodity is an item that one does not needto touch, see, try on, try out, taste, or squeezebefore buying. Clearly high-fashion clothes, cars,foods, meats, vegetables, and girlfriends tend notto fall into this category. On the other hand, thisis very much a question of attitude and need.Busy executives will forgo the examination offood items for the convenience of having them athome when they arrive there. Once a teenager hastried on an item of brand-name clothing for size,it becomes a commodity, since sizes tend to bequality controlled. A buyer who lives in a veryremote location may consider an item to be acommodity because the cost of its examinationdoes not warrant extensive travel—and, in thecase of clothes, they can be altered. Ultimately,bitable goods and bitable commodity goods pres-ent the highest potentials for e-commerce.

Research predicts that there will be a widerange of business expansion on the Internet. Thisis reflected on Figure 2, which incorporates aseries of predictions from four different organi-zations.

Travel and apparel are expected to be thelargest B2C (business to consumer) areas. At thesame time, the volumes of B2B (business to busi-ness) trade are expected to be six to ten times

larger than B2C, but with much narrower mar-gins.

EMERGING PRINCIPLES OFELECTRONIC COMMERCE

An entirely new set of principles of commerce isemerging. First is the realization that aMalthusian physical world is giving way to aplace where information is abundant and eyeballslimited. Second is the realization that paradoxesexist because of technology, and that givingthings away for free, not protecting softwareagainst privacy, and paying for visitors, may bethe paradigms of the e-world. Third, the meaningof the words competitor and industry are chang-ing. In the faceless world of the Internet, one’scurrent and future customers and suppliers areboth one’s competitors and one’s allies. Fourth,industries are blending and changing, and affilia-tion agreements allow for the creation of entireproduct cycles without the ownership of inven-tory or production facilities. Finally, pricingmodels are changing; hybrids of fixed pricing,auctions, variable pricing, contingent pricing,and name-your-price pricing are emerging andcreating new business models. While technologygets most of the credit, actually successes areusually based on the triad of: (1) technology, (2)business model innovation, and (3) a family offacilitating (profitable) services. (See Figure 3)

The B2B sector of e-commerce will presentboth vertical and horizontal models. In the verti-cal model, the firm will focus on an industry anddevelop great industry expertise in order to de-velop its markets. In the horizontal model thefirm will focus on one type of product or serviceand offer it across industries (e.g., Internet pay-roll services). The B2B sector is intrinsically dif-ferent from B2C. Buyers are well informed, pos-sess many resources and can negotiate based onvolume. Brand name is much less of a consider-ation than price, quality, delivery time, and reli-ability. Three different models have emerged forB2B transactions: (1) the e-catalog model forsituations in which there are many differentitems at distributed locations and the price isfixed (e.g., auto parts); (2) the auction model, in

ELECTRONIC COMMERCE


which products are not standardized and thereare great differences in the perceptions of value(e.g., auctions of used capital plant products);and (3) the commodity auction model, in whichthere are not too many variations on the type ofproduct and there are large buyers and sellers(e.g., natural gas, pork bellies, coffee, etc.).

Electronic commerce is progressively and ir-reversibly changing the face of many businessesbecause of three dominant phenomena: (1) dis-intermediation, whereby one party to a transac-tion is eliminated (e.g., brokers in on-line trad-ing); (2) re-intermediation, whereby a new elec-tronic intermediary comes between the seller andthe buyer (e.g., electronic booksellers that takeorders and farm them out to providers that havethe book in stock); and (3) cannibalization,whereby businesses progressively give up theirtraditional brick-and-mortar ventures for the su-perior electronic model (e.g., traditional phar-macies opening on-line drug stores).

PROBLEMS IN SEARCH OF SOLUTIONS

The e-commerce juggernaut is not without itsdangers and shortcomings. It is drastically affect-ing traditional firms that cannot continue to dobusiness according to the traditional economicmodel. For example, a stock brokerage firm thaton average charged $90 per trade cannot competewith $10 on-line trades; if any adaptations meetwith strong resistance, the organization could bedooming itself to extinction. The security weak-nesses of the e-commerce infrastructure havebeen well publicized: Viruses, security intrusions,and inability to provide services because of vol-ume attacks are not phenomena that will disap-pear. A continuous struggle is evolving amongfacilitating technologies, intrinsic technologicaldangers, and the management of these factors.

Privacy issues present a different set of chal-lenges. The same technology that facilitates busi-ness activities and provides wonderful services isalso a major threat to individual freedom. Largedatabases linking information about economicactivity from different sources (purchases, bank-ing activity, medical records) provide great eco-nomic advantages by making marketing more ef-

ficient, loans more targeted, and medicalinformation ubiquitous. They also create greatdangers for privacy potentials for abuse. Dou-bleclick.com, a marketing analysis technologyfirm, tracks customer activities in Web sites. Itsclick-path analysis allows firms to understandcustomer behavior and improve their offerings.However they have 11,000 clients, and linkingtogether the buyers’ profiles from these sites isconsidered to be far too intrusive by many peo-ple. Complaints have been filed with the FederalTrade Commission and boycotts proposed. As aresponse, Doubleclick lured bigger profile ‘‘pri-mary’’ officers for its board.’’

Solutions, however, are not as straightfor-ward as they might seem. Making certain actionsillegal can actually create arbitrage opportunitiesand extraordinary advantages for Internet play-ers. Because gambling rules are strict in theUnited States, electronic casinos are created incooperative havens in the Bahamas: A legal ob-stacle in the United States is a business opportu-nity for another country. When restrictions areplaced on the use and content of databases inGermany, offshore database havens appear im-mediately. When Web-site censorship appears inChina, free-Chinese Web sites are constructed.Telephone systems are monitored and taxed byPTTs, supranational satellite telephone networksare being created.

Consequently, easy fixes are not possible andnew methods of establishing order, efficiency,and decency will have to be created. Because theInternet is truly a supranational entity, nationsneed to band together to maintain order andefficiency and reasonableness in cyberspace. Thesame economic factors that allow for arbitragecan also be used for self-policing and monitoringof the e-commerce environment. To benefit fullyfrom this medium, companies/entities andnations must have payment-clearing solutions,customs solutions, and access to the large mar-kets of the economy. Rogue countries can beexcluded from the payment-clearing chains;rogue companies behaving in unacceptable wayscan be boycotted and excluded from any affilia-tion and linking deals. Self-policing seals such as

ELECTRONIC COMMERCE


the American Institute of Certified Public Ac-countants’ (AICPA) Web Trust and SysTrustproducts, inspections, and certificates can beused for monitoring and supervision. Interna-tional information structures, involving manycooperating organizations, can be on the alert forrogue behavior and spearhead a drive to createreasonable and unbiased rules. Technology canbe used to monitor and detect money laundering,illegal product flows, and information trafficking.But such monitoring must be carefully conceivedand supervised, because it could turn into a ‘‘BigBrother’’ type of behavior. Most important of allis not to succumb to the easy temptation of creat-ing restrictive and ill-thought-out laws of the sortthat legislators tend to create when some localscandal occurs.

BIBLIOGRAPHY

American Institute of Certified Public Accountants and Ca-nadian Institute of Chartered Accountants. (1999).SysTrust (TM/SM) Principles and Criteria for Systems Re-liability.

American Institute of Certified Public Accountants. (up-dated annually). CPA WebTrust: Practitioner’s Guide forBusiness to Consumer Electronic Commerce.

Forrester Research. (1999, November).

Kilmer, William E. (1999). Getting Your Business Wired:Using Computer Networking and the Internet to Growyour Business. New York: AMACOM.

Rosen, Anita. (2000). The e-Commerce Question and AnswerBook: A Survival Guide for Business Managers. New York:American Management Association.

U.S. Government’s Framework for Electronic Commerce,The. (1997, July 1). The White House, http://www.ecommerce.gov/framewrk.htm�BACKGROUND.

‘‘Why the Productivity Revolution Will Spread.’’ (2000).Business Week. February 14. http://www.businessweek.com.

MIKLOS A. VASARHELYI

E-MAIL

Electronic mail, or e-mail, is a method of com-municating whereby an individual uses a com-puter or other electronic device to compose andsend a message to another individual. Messages

may be sent through computer systems linked bya network, through modems using telephonelines, or, in some cases, through wireless trans-missions.

While some systems provide links onlywithin a company’s particular e-mail system, theprevailing trend is for e-mail users to be able tosend e-mail to anyone in the world. In order tosend an e-mail message, each party must have ane-mail address. The address is composed of anidentifying name, an @ sign, the name of thefileserver where the account is located, and a do-main name. Typical domain names are com(commercial), gov (government), edu (schools),and org (organization). An example of an e-mailaddress would be [email protected] order to send a message outside the companye-mail system, the complete address must beused.

Address book: Most electronic mail systemsoffer an address book feature. The address bookprovides a place to store e-mail addresses, whichcan often be complex and difficult to remember.The address book can also be used to developmailing lists. For example, if six friends fre-quently communicate, a user might list all theiraddresses in a folder in the address book. Thefolder would have a name such as ‘‘My Friends.’’Then the user could quickly send a message to allsix friends at one time by addressing the messageto ‘‘My Friends’’ rather than to each individualuser.

Attachments: While the majority of e-mailmessages are composed of text, e-mail users aresending increasingly complex messages with ac-companying attachments. Users can send docu-ments by using an attachment feature of thee-mail package. The attachment feature allowsthe user to specify where an electronic file—suchas a text document, a spreadsheet, or a graphicspresentation—is located and then to send a copyby e-mail. Attachments can also be sent to a list ofpeople in one e-mail message. This feature hasgreatly enhanced the ability of people at a dis-tance to work together. For example, if two peo-ple are planning a presentation at a conference,they can attach outlines of the presentation as

E-MAIL


well as slides of the actual presentation and trans-mit them for revision or review.

Photographs can also be attached to e-mailmessages, in the same way as another file can.One caution is that multimedia files includingphotos can be quite large and take a longer timeto send. With the additional use of digital cam-eras and/or scanners, photographs that are valu-able to business are easier to send than everbefore.

Deleting a message: After reading an incom-ing e-mail message, the reader may decide thatthe message does not need to be saved. All e-mailsystems have a feature to allow for quick deletionof messages. However, many systems convey thedeleted message to a trash file that will allow themessage to be recalled. To delete the messagefrom the individual computer, the message in thetrash file must also be deleted. Even after thisdouble deletion, the message may still be accessi-ble. Large computer systems periodically back upall mail, so the message may be floating around inthe organization’s computer memory backup fora much longer time.

Forwarding a message: At times, the reader ofa message may decide to forward a message to athird party. The person sending e-mail has nocontrol over what the receiver will do with themessage. The receiver can easily forward the mes-sage to one individual or a list of individuals.

Replying to a message: If the reader wishes torespond to an e-mail message, the reply featureprovides a quick way to answer the message with-out keying in the e-mail address of the personwho sent it. There is a common e-mail faux pas,however, that should be avoided. If a message hasbeen sent to a list and one reader replies to theperson who sent the message by using the replyfeature, that reply may be sent to everyone on thelist. For example, a conference coordinator sendsa reminder message to a list of 500 people whowill be attending a conference. One of the re-spondents has a question about whether his orher registration has arrived and replies to themessage using the reply feature. Since the originalmessage was sent to a list, it is quite possible thatusing the reply feature will result in that individ-

ual’s message being transmitted to all 500 peopleon the list instead of only to the original sender.This is a common violation of ‘‘netiquette,’’ aterm that refers to using courtesy on the Internet.

Netiquette: Using the correct etiquette helpspeople respond correctly in their environment.For example, eating peas with a knife, interrupt-ing a speaker, and not introducing people areexamples of poor etiquette. Poor etiquette canalso exist in the electronic environment. A fewthings that could be considered violations ofnetiquette are flaming (sending an immediate,angry overreaction to an e-mail message), shout-ing (typing a message in all capital letters), for-warding personal messages without permission,and sending a personal message to an entire list.Other problems include preparing a list that in-cludes individuals who have no interest in thetopic and bombarding them with e-mail, sendinge-mail messages that criticize others, and usingemoticons (typed symbols to indicate expres-sions) in business e-mail. Just as an understand-ing of good manners helps one move effectivelyin society, so an understanding of netiquettehelps one perform effectively in electronic com-munication.

Privacy of e-mail: One of the controversiessurrounding electronic mail has been the issue ofprivacy. The term ‘‘mail’’ seems to imply thesame safeguards that one has when using the U.S.Postal Service. These safeguards include the rightto open your own mail and legal protection fromthose who would tamper with your mail. Elec-tronic mail, however, may not include these safe-guards.

Courts have upheld the right of corporationsto review the e-mail of employees who use com-pany resources such as hardware, software, and/or company time to compose and send e-mailmessages. It is the court’s position that a com-pany has the right to read the e-mail of employ-ees is especially strong for those companies whohave an e-mail policy in place.

Employees should be judicious in their use ofe-mail and should not put in electronic writinganything they would not write on paper for pub-lic distribution. Both individuals and companies

E-MAIL


have seen their e-mail communications comeback to haunt them in the media and in court.For example, some plaintiffs in sexual harass-ment cases have used negative e-mail messagessent by company employees to establish the legaldefinition of a hostile working environment.Others have seen their e-mail admitted in courtas proof of their beliefs and actions that maydisagree with their sworn testimony.

Electronic mail policy: Many organizationshave implemented e-mail policies in theworkplace. A good policy clearly defines an em-ployer’s expectations about how e-mail should beused by employees. If personal e-mail is accept-able, conditions for its use are outlined in thepolicy. In addition, a process should be devel-oped so employees can indicate their under-standing of the e-mail policy in place.

Volume of electronic mail messages: A concernfor many employees is the large number of e-mailmessages that they receive and are expected torespond to on a daily basis. Some e-mail systemsallow the sender to assign a priority rating to themessage. In this way priority messages are flag-ged. Other systems rely on the subject line. Forthat reason, a concise subject line that clearlydefines the message is an asset when a readerreviews the message. The subject line will help thereader decide when the message should be read.A message from an unknown sender with nosubject line may not be evaluated very quickly.

Organizing electronic mail messages: As e-mailmessages arrive, the reader can reply, forward, ordelete them. The reader can also save or storemessages. E-mail systems allow the reader to setup filters to organize incoming messages andfolders to organize messages that should bestored. The reader then merely transfers the mes-sage to the appropriate folder. This action willclear the inbox of messages and provide a logicalarrangement to locate messages by sender or bytopic.

Response speed: Just as it is easier to send ane-mail message than to mail a letter or, in manycases, to attempt to phone someone, the amountof time allowed for a response has also decreased.While a letter may take two to three days to travel

to its destination, an e-mail message is transmit-ted almost instantaneously. Few would expect ananswer to a letter within a week of sending it.However, the tolerance for a slow e-mail re-sponse has dwindled. Seldom would a personsending an e-mail message expect to wait two tothree days for a response. If the first e-mail mes-sage elicits no response, the sender may send fol-low-up messages or attempt some other means ofcommunication if a timely response is not re-ceived.

Junk mail or spam: Junk mail, or spam, canarrive in the inbox in the form of chain letters,unsolicited advertisements, warnings (usuallynot founded in fact) about viruses or files, andother nonbusiness information. The differencebetween the junk mail received via the U.S. PostalService and the junk mail received throughe-mail is that the former can be quickly dis-carded. The junk mail received via e-mail, how-ever, is more difficult to get rid of and ties up thecompany’s resources as well. Some corporationsuse procedures to block junk mail, or spam, fromentering their e-mail systems. Some users findthat friends or acquaintances can be the worstviolators and are too willing to pass along unnec-essary information they have found on the Inter-net.

BIBLIOGRAPHY

Bicknell, David. (1999). ‘‘E-Mails That Could Cost Mil-lions.’’ Computer Weekly January 28:26.

Flynn, Nancy, and Flynn, Tom. (1998). Writing EffectiveE-Mail: Improving Your Electronic Communication.Menlo Park, CA: Crisp Publications.

Gleeson, Kerry. (1998). The High-Tech Personal EfficiencyProgram: Organizing Your Electronic Resources to Maxi-mize Your Time and Efficiency. New York: Wiley.

Hartman, Diane B., and Nantz, Karen. (1996). The 3 R’s ofE-Mail: Risks, Rights, and Responsibilities. Menlo Park,CA: Crisp Publications.

Levin, John R., and Baroudi, Carol. (1997). E-Mail for Dum-mies, 2d ed. Foster City, CA: IDG Books Worldwide.

Mead, Hayden, and Hill, Brad. (1997). The On-Line/E-MailDictionary. New York: Berkley Publishing Group.

Overly, Michael R. (1999). E-Policy: How to Develop Com-puter, E-Policy, and Internet Guidelines to Protect Your

E-MAIL


Company and Its Assets. AMACOM. Boulder, CO: NetLibrary, Inc.

Schwartz, Alan, and Ferguson, Paula. (1998). ManagingMailing Lists. Cambridge, England: O’Reilly and Associ-ates, Inc.

Tuten, Tracy L., Urban, David J., and Gray, George. (1998).‘‘Electronic Mail as Social Influence in Downsized Orga-nizations.’’ Human Resource Management 37(3,4):249-261.

MARSHA L. BAYLESS

EMPLOYEE ASSISTANCEPROGRAMS

The term employee assistance program (EAP) re-fers to a program that provides business andindustry with the means of identifying employeeswhose job performance is negatively affected bypersonal or job-related problems. The EAP ar-ranges for structured assistance to solve thoseproblems, with the goal of reestablishing the em-ployee’s effective job performance. The servicesof an EAP may be contracted, or the programmay be an employer’s own creation, designed tofit the unique needs of a company. EAPs typicallyprovide professional, confidential, no- or low-cost assistance for employees with personal prob-lems.

EAPs help employers by identifying troubledworkers, by either supervisory referrals or self-referrals. Each referred employee is assessed, anda plan of action is designed to suit his or herneeds. The ability to uncover the employee’s pri-mary problem is required. The goal is to enablethe employees to work again at peak levels. Aneffective EAP requires a knowledge of resourcesavailable in the community.

HISTORY

No one knows when the first employer offeredcounseling and social work services to its em-ployees. But in 1917 Macy’s, the New York Citydepartment store, opened an office specificallydevoted to helping employees deal with personalproblems. Metropolitan Life Insurance Companyand Western Electric were also pioneers in the

field, but it was not until the years immediatelyfollowing World War II that a limited form ofEAP became relatively common.

In those days, Alcoholics Anonymous was anew organization gaining widespread attention.For the first time, alcohol abuse was perceived bybusiness to be a workplace problem, and manycompanies started alcoholism programs for theirworkers. These programs were usually staffed byrecovering alcoholics who trained supervisors tospot alcoholics by looking for such symptoms asshaking hands, bloodshot eyes, and alcohol onthe breath. These early programs produced grat-ifying results, but they were severely limited be-cause they identified only late-stage problems.Alcoholics in the early stage whose hands did notshake and who did not drink on the job did notreceive help.

Today, most EAPs pay close attention to thespecific needs of clients. For example, until re-cently few EAPs dealt with gambling-related is-sues; but now counselors are being trained todeal with gambling addiction and related prob-lems. A number of companies also have EAPsthat offer financial and legal referrals to employ-ees with consumer credit or bankruptcy prob-lems and legal concerns. These services are inaddition to assistance offered for emotional, fam-ily, work, and substance-abuse problems.

Another area that EAPs frequently deal withis critical incident intervention—helping work-ers handle deaths, suicides, hostage situations,major accidents, and natural disasters, includingfires, earthquakes, mudslides, floods, and hurri-canes. Employees often need assistance in dealingwith the emotional and physical trauma of thesenatural disasters.

MODERN PROGRAMS

Organizational development, managed care,workers’ compensation, child care, and cata-strophic disasters are just a few of the issues thatare expanding the scope of today’s EAPs. Thechanges going on in corporate America are tre-mendous. As a result, the role and scope of thecompany’s employee assistance program hasevolved with the times. Some EAPs offer workers



In 1917, Macy’s department store in New York City opened an office to help employees deal with personalproblems.

professional organizational counseling. This ser-vice runs the gamut from counseling work-groupmembers who are having problems getting alongwith one another to counseling survivors ofdownsizing on how to handle stress.

Managers may have to terminate good em-ployees as well as difficult ones. Besides the emo-tional effects, there is also a practical side to

letting workers go: There is documentation and aprocedure to follow. Human resources staffmembers are stretched to the limit in some cases.

Many EAPs provide disability managementservices. Companies today want to complementthe traditional disability arrangement with awhole-person approach. In many cases workers’self-esteem is tied to their jobs. As workers sit at



home recuperating from injuries or disabilities,they may become bored and depressed. In somecases their disabilities may put financial strainson their families. Therefore, there is a need tosupplement the medical care a person is receivingwith counseling on issues he or she is facing. Thegoal is to keep the worker connected to theworkplace.

Today’s EAPs have grown in size and sophis-tication. In some businesses EAPs are operatedthrough employee associations. Sometimes pro-fessional groups or similar businesses and smallindustries unite to form a consortium. Althoughall EAPs aim to help both management and em-ployees, there are differences in how they do it.Boiled down to the essentials, these differencescome under two headings: who is helped andhow that help is provided.

SINGLE-ISSUE PROGRAMS

Single-issue programs aim to help only employ-ees impaired by a specific problem. Their focus isclear, and they are generally small enough to costthe employer relatively little. A disadvantage ofsingle-issue programs is that they may becomestigmatized because of the negative connotationsof terms such as addiction and alcoholism. Somepeople may be afraid to use the program for fearof being labeled ‘‘drunks’’ or ‘‘addicts.’’ Since theper-person cost of an EAP decreases with thenumber of people who use it, this stigmatizationis an important issue to consider. Furthermore,supervisors tend to look only for symptoms ofabuse instead of concentrating on declining jobperformance.

The greatest weakness of single-issue pro-grams is their lack of preventative power. Late-stage alcoholics and addicts have the highest re-lapse rate and the least chance for permanentrecovery. Single-issue programs tend to findthese late-stagers, but recognizing those in theearly stages for whom help can be most effectiveis much more difficult.

BROAD-BRUSH EAPS

Broad-brush EAPs offer help to employees suf-fering from all kinds of problems, including

chemical dependency. For example, a broad-brush program may provide crisis-managementservices for those whose problems can be dealtwith over the short term. Sometimes all that isneeded is a chance to talk a problem over with asympathetic listener. The great advantage ofbroad-brush programs is their ability to uncoverdrug and alcohol problems in their early stages.Often early-stagers come to their EAP presentingproblems that make no mention of alcohol ordrugs. At first clients complain about financialtrouble, a stressful marriage, or abuse of problemchildren. It is only after working with a skilledcounselor that the truth is revealed: cocainebankrupting an executive; a marriage in troublebecause the wife drinks and the husband enablesher; children acting out because they cannot getthe nurturing they need from addicted parents.

One disadvantage of broad-brush programsis that they are usually more expensive than sin-gle-issue programs. There are, however, ways tominimize costs by designing a program cus-tomized to specialized businesses. Costs can bereduced when multiple businesses form an EAPalliance. In the long run, EAPs can save busi-nesses money by making themmore efficient andproductive, by reducing accidents, by reducingemployee absenteeism/turnover, by raising em-ployee morale and decreasing grievances, and bycutting back on the number of unnecessary in-surance claims.

MODES OF SERVICE

Today’s EAPs differ from their predecessors inthe mode of service they deliver. It would beimpossible to describe all variations that exist,but a short description of several of the mostcommon varieties will provide some insight.

Some EAPs are just a hotline. Employees areencouraged to call a particular number and askfor help. The EAP provides the names and num-bers of local public service agencies that may beable to address employees’ personal problems.Alone, this just barely qualifies as employee assis-tance. However, a hotline in conjunction withother services may prove helpful in attractingfearful employees for whom anonymity is essen-



tial. And hotlines can be extremely beneficialwhen depression is a serious problem.

Other EAPs amount to no more than a singleindividual in the personnel department or themedical office who can direct an employee off-site on the basis of his or her problem. This is notmuch better than the hotline, and employees maynot go near the office for fear of being labeled.Employees required to report to this office be-cause of poor performance evaluations and fearof losing their livelihoods may complain aboutthe lack of confidentiality.

A few very large companies have elaborateon-site EAP divisions with full staffs, includingdoctors and nurses. Or several geographicallyclose companies with similar concerns or prod-ucts may join together to form an EAP consor-tium that contracts with a consulting EAP orga-nization to provide services to employees fromeach site.

Most EAP providers emphasize the confiden-tial nature of their services and will give theemployer numerical information only, withoutdivulging names of EAP-assisted employees.Otherwise, many employees would be hesitant, ifnot totally unwilling, to admit a personal prob-lem for fear that it would jeopardize their jobstatus or chances for promotions.

However, there may be situations in whichan employer may need to know certain types ofinformation. For example, when an employee isengaged in dangerous duties, supervisory person-nel may need to know general information aboutthe employee’s condition for safety reasons.Therefore, the employer’s promise of confiden-tiality and privacy to employees is extremely im-portant. Whatever level of confidentiality the em-ployer establishes must be maintained; noticemust be given to employees and consent ob-tained for variances. Also, it is important that anemployer give employees clear warnings thatsuch disclosures are permitted. Specific state pri-vacy laws may affect the availability of such infor-mation.

Some EAP programs provide services togroups of employees during a crisis. For example,a team of counselors from an EAPmay work with

an entire department affected by a violentworkplace incident.

EAPS CAN DETER VIOLENCE

Stress at home or on the job, burnout, or rela-tionships that have soured can result in violentacts at work. Experts estimate that more than100,000 incidents of workplace violence occurannually in the United States. The typicalworkplace killer is a middle-aged man, mostlikely a loner frustrated by problems on the jobwith few personal contacts outside the workplace.One study showed men were responsible for 98percent of all violence committed at work. Theaverage age was 36, and firearms were used 81percent of the time. Following workplace homi-cides, one-fourth of the murderers killed them-selves.

Workplace violence, whether it involves ha-rassment, threats, or physical attack, is a seriousand growing problem for employers. Lack of at-tention to the issue can mean lost lives, discon-tent, and fear among employees, as well as tre-mendous cost to companies.

Corporations without preventative measuresare particularly subject to lawsuits and highercosts. The best way to prevent workplace violenceis to have an effective employee assistance pro-gram. Other precautions companies can take toprevent violence are establishing clear guidelineson appropriate behavior, screening applicantscarefully, training employees to identify warningsigns, and setting up procedures for managers torespond to cries for help. Companies also shouldlook closely at the procedures they use when theyterminate employees. Perhaps most important ismaintaining a healthy work environment. It re-ally boils down to one person’s relationship withanother and whether or not the environmentfosters mutual respect.

EXTERNAL PROVIDERS

A unique feature of employee assistance pro-grams is the dual responsibility that its profes-sionals have toward both the companies theywork for and the individual workers in those or-ganizations who require assistance. The special



responsibilities toward the organization go be-yond those that social workers have toward theiragencies because the occupational setting also is aclient to which they have service obligations. Attimes this dual responsibility creates ethical di-lemmas for practitioners. The very existence of awell-functioning EAP is a major source of assis-tance to the organization as a whole, not just theindividual clients who receive direct services.

Both managers and employee clients expectstaff members of in-house EAPs to be especiallyadept in matching an employee’s needs with re-sources that provide prompt and effective inter-vention. The depth and thoroughness of the as-sessment is a means of increasing the probabilitythat key problems will be identified and priori-tized accurately. Failure to meet these expecta-tions can adversely affect the credibility of theEAP. As a result, most EAPs devote a significantpart of program resources to locating, evaluating,and updating their network of providers. Thereferral function is distinct from the proceduresgoverning the internal services. Referring is theprocess of locating one or more providers exter-nal to the employer to supply ongoing services todeal with employee concerns. These external re-sources may assume responsibility for all of aclient’s needs or they may be ancillary to thework being done in-house by an EAP counselor.

Most employees are not well informed abouttreatment programs, community agencies, oreven self-help groups. EAPs must educate themabout available services, their relative benefits,and how these resources are viewed in the com-munity. In addition, clients often need to be en-couraged to assume a consumer orientation re-garding referral sources. Having to apply for anykind of help is intimidating, and it is difficult forthe uninitiated to recognize appropriate or inap-propriate requirements. Clients should be toldthat if they decide a resource is not acceptablethey may return to the EAP for other options.

PERSONAL PROBLEMS

People thrive on things they do well. Often it istheir work. A happy, healthy worker is likely to bea productive one. Conversely, personal problems

can hamper an employee’s performance. Some-times problems can be alleviated quickly, but of-ten the problems extend over long periods oftime. The impact on the employee will vary, butthere will usually be noticeable change in behav-ior and attitude. Personal problems are signifi-cant hurdles that every person living in today’scomplex society will confront in one fashion oranother.

Employees’ personal problems can havemany sources. Most can be categorized into oneof the following categories: substance abuse,health related, family related, and financial.Almost every adult will deal with one or more ofthese problems. It is how individuals deal withthese problems, and the level of support theyreceive in addressing the issue, that will deter-mine the intensity of the problem’s impact.

BIBLIOGRAPHY

Browning, Darrell. ‘‘Stamping Out Violence.’’ Human Re-sources Executive. 1994: 22-25.

PATRICK J. HIGHLAND

EMPLOYEE BENEFITS

Employee benefits are compensations given to em-ployees in addition to regular salaries or wages.These compensations are given at the entire orpartial expense of the employer. Benefit packagesusually make up between 30 and 40 percent of anemployee’s total compensation for employment,which makes them an important aspect of theterms of employment. While some employeebenefits are required by law, many employersoffer additional benefits in order to attract andretain quality workers and maintain morale.Some types of benefits are also used as incentivesto encourage increased worker productivity.

LEGALLY REQUIRED BENEFITS

While some benefits are offered as incentives toattract workers, some are legally required. Forexample, employers must provide workers’ com-pensation insurance, which pays the medical bills

EMPLOYEE BENEFITS


Target stores offer employees a 10 percent discount on merchandise.

for job-related injuries and provides an incomefor employees who become disabled because of ajob-related injury. Social Security must be paidby the employer (in addition to the amountsdeducted from employee’s pay) to help meet em-ployees’ retirement needs, and employers mustpay for unemployment insurance to compensateworkers in the event that their job is eliminated.The Family and Medical Leave Act, passed byCongress in 1993, requires large employers toprovide workers with unpaid leave for family ormedical emergencies (up to 12 weeks of unpaid,job-protected leave per year). Under this law,employees are guaranteed that they can return tothe same or a comparable position and that theirhealth care coverage will be continued during theleave.

TRADITIONAL TYPES OFEMPLOYEE BENEFITS

Because of continually rising health care costs,one of the most desirable types of benefits for

employees to have is a health insurance plan.These plans can be set up to cover the individualworker and, in many cases, the worker’s family aswell; they may or may not include such optionsas dental, eye, chiropractic, hospital, and othertypes of health care. Health insurance plans maybe provided at no cost to employees, or they maybe made available at a more desirable rate thanemployees could get on their own. The healthinsurance aspect of a benefit package is often themajor deciding factor in whether a person ac-cepts a position with a company. The degree ofhealth insurance is often more important to apotential employee than the salary level; espe-cially when children are an issue.

Most benefit plans also include a certainnumber of paid sick days, personal days, and/orvacation days. Many companies are finding waysof increasing the flexibility of employee benefits.One way to increase flexibility is to group sick,vacation, and personal days into a certainamount of paid time off (PTO). PTO allows em-

EMPLOYEE BENEFITS


ployees to take days off—for example, to care fora sick child, observe a religious holiday, or go onvacation—without having to explain why. ThePTO benefit helps employees because their timeis more flexible, and it helps employers by main-taining morale and reducing unanticipated ab-senteeism.

Life insurance and retirement options areanother type of benefit many companies offertheir employees. These types of benefits oftenencourage employees to remain with the samecompany because they do not want to cash intheir life insurance or retirement plans. Thistends to make employees more loyal to the com-pany because their future is invested with thecompany. It also gives the employee a feeling ofpower by having some control over planning forretirement.

EXPANDED TYPES OF EMPLOYEE BENEFITS

While health care, paid time off, and retirementplans are the most common types of benefitsemployees receive, some companies offer evenmore types of benefits to help attract and retainemployees as well as increase employee moraleand improve job performance. One example ofthis type of benefit is tuition reimbursement,which allows employees to further their educa-tion while working. Motivating employees to bet-ter themselves at the employer’s expense, helpsthe company keep knowledgeable employees.

With the growing number of single parentsand dual-career couples in the work force, manycompanies have opened day-care facilities in theworkplace where employees can feel safe aboutleaving their children. On-site child care is obvi-ously a very desirable benefit for parents becauseit allows them to check up on the children, cutdown on travel time, and be available in case ofan emergency. However, some childless workersfeel that this benefit discriminates against thembecause they get no use out of the day-care facil-ity. One way many companies are handling thistype of concern is through a cafeteria plan. Whilethere are several different ways to set up a cafete-ria plan, such as setting aside pre-tax dollars formedical expenses, one of the most useful ways is

to give employees many different benefit optionsto choose from. Each employee is given a setallowance that can be used toward any benefit theemployee chooses, allowing the employees topick the options that will most benefit them. Thecafeteria plan is one fair way to handle benefitsfor everyone concerned.

Another characteristic of the work force is itsincreasingly older age. As a result, there are anincreasing number of workers with aging parentswho need care. Many companies recognize theneed for elder care and are providing benefits tohelp, such as referral services for quality nursinghomes and flexible work hours and/or days off soemployees can care for aging parents.

Other benefits provided by some employersinclude credit unions to help employees with fi-nancial needs, gym facilities to allow employeesto fit exercise into their busy schedules, cafeteriasthat sell reduced price meals to working employ-ees, and on-site laundry services where employ-ees can have laundry done while they are at work.Making the work environment seem more like afamily helps boost employee morale and improveworking relationships. Many companies provideuniforms for their employees, so that workers donot have to worry about ruining their own cloth-ing. The uniforms also help with the feeling ofunity because everyone in the company is dressedsimilarly. Because transportation can often be aproblem for employees, some companies areeven providing transportation options as a bene-fit to employees. Disney World, in Orlando, Flor-ida, has a shuttle that picks employees up fromtheir living quarters and takes them to work.Corn detasslers meet in a central location and abus takes them to the site. Sales people are oftenprovided with a company car.

While these types of benefits are meant toattract and retain employees as well as create apositive work environment, some types of em-ployee benefits are used to encourage increasedperformance. The following are the four maintypes of benefits used as incentives to encourageemployees to exhibit superior performance:

1. Profit sharing gives the employee a por-tion of the company profits. Profit

EMPLOYEE BENEFITS


sharing is often done through makingshares of company stock part of the em-ployee benefit package. Employees receivea certain number of shares of stock eachyear, which provides employees an incen-tive to help the company succeed. Thismight also be accomplished through ayearly profit-sharing bonus.

2. Gain sharing rewards employees for ex-ceeding a predetermined goal by sharingthe extra profits. If profits exceed thegoal, employees share in the extra profits.

3. Lump-sum bonuses are a one-time cashpayment based on performance. Lump-sum bonuses may be an annual reward,such as a Christmas bonus, where thepurpose is to share profits with the em-ployees, and thus motivate them.

4. Pay for knowledge rewards employees forcontinuing their education and/or learn-ing new job tasks. The more education orexperience an employee has, the higherhe/she moves up on the pay-for-knowl-edge pay scale. Pay for knowledge is anincentive for employees to continue theireducation because it results in immediaterewards on the job.

PERKS

In addition to what we typically think as em-ployee benefits, many employers also offer‘‘perks’’ to their employees. Typically limited toemployees in management positions, these perksinclude such benefits as country club or healthclub memberships, a company car, special park-ing privileges at work, tickets for sporting events,first-class travel accommodations, and generousexpense accounts. However, certain types ofperks are also being extended to employees inmany different types of positions. One type ofperk that is common in many retail stores is anemployee discount on merchandise bought fromthe place of employment. For example, DaytonHudson’s Target stores offer a 10 percent dis-count to employees and their immediate familieswhen purchasing merchandise from any Target

store. Employees of local movie theaters oftenreceive free movie tickets as a perk, while manyrestaurant employees receive free or reduced-price meals. By offering employees such perks,the company is providing a strong incentive foremployees to continue working there.

FLEXIBLE WORK PLANS

A flexible work plan is another type of employeebenefit that has been proven to have a positiveinfluence on employee productivity, attendance,and morale. A flexible work plan allows employ-ees to adjust their working conditions withinconstraints set by the company and may includesuch options as flex-time, a compressed work-week, job sharing, and home-based work. Flex-time involves adjusting an employee’s daily timeschedule; it can be as simple as allowing a workerto come into work an hour earlier and leave anhour earlier than the normal 8-to-5 workday.Usually there are some time constraints set up bythe company, but employees who work withinthose constraints can basically set their ownschedules. A compressed workweek involvesworking longer hours each day for fewer daysthan the normal Monday-through-Friday work-week. For example, at many businesses employ-ees work ten-hour days, four days a week.

Job sharing allows two or more people todivide the tasks of one job. It allows the sameconsistency as a full-time person, because thework is simply divided among the people whoshare the job responsibility. Job sharing is popu-lar among people who only want to work parttime but want a job with full-time responsibili-ties. These types of people include older workers,retirees, students, and working parents. Home-based work programs allow employees to per-form their jobs at home instead of in an officesetting. These people are often know as tele-commuters, because they ‘‘commute’’ to workthrough electronic mail, faxes, and other types oftelecommunications. Home-based work is popu-lar with disabled workers, elderly workers, par-ents with small children, and workers who havehad to relocate far away from the workplace be-cause of a spouse’s job change. Through home-

EMPLOYEE BENEFITS


based work, all of these types of employees areable to take care of personal and family responsi-bilities while maintaining and enjoying their joband/or career.

CONCLUSION

Finally, it should be noted that the various typesof benefits offered to employees can dependgreatly on the size and type of the business as wellas its geographic location. For example, a smallbusiness might be unable to afford to providecomplete health care coverage for employees be-cause there are not enough employees to dividethe risk. This would cause the cost of the insur-ance to be high. On the other hand, a largecompany may not want to give all 1,000 employ-ees a turkey for Thanksgiving because of theenormity of the undertaking. A video store wouldbe more likely to give employees free movierentals, while a restaurant would offer employeesfree or reduced-price meals. Employee benefitsmay be the major deciding factor for many peo-ple when choosing a company for employment.In order to attract and retain the best-qualityemployees, companies must be willing to offerflexible and extensive types of benefits to meetvarious employee needs.

BIBLIOGRAPHY



French, Wendell L. (1998). Human Resources Management.New York: Houghton Mifflin.

Jenks, James M., and Zevnik, Brian L. P. (1993). EmployeeBenefits Plain and Simple. New York: Macmillan.


Nickels, William G., McHugh, James M., and McHugh,SusanM. (1999).Understanding Business, 5th ed. Boston,MA: Irwin-McGraw-Hill.

Pfeffer, Jeffery. (1994). Competitive Advantage Through Peo-ple. Boston, MA: Harvard Business School Press.

Pride, William M., Hughes, Robert J., and Kapoor Jack R.(1999). Business, 6th ed. New York: Houghton Mifflin.

MARCY SATTERWHITE


In exchange for job performance and commit-ment, an employer offers rewards to employees.Adequate rewards and compensations potentiallyattract a quality work force, maintain the satisfac-tion of existing employees, keep quality employ-ees from leaving, and motivate them in theworkplace. A proper design of reward and com-pensation systems requires careful review of thelabor market, thorough analysis of jobs, and asystematic study of pay structures.

There are a number of ways of classifyingrewards. A commonly discussed dichotomy isintrinsic versus extrinsic rewards. Intrinsic re-wards are satisfactions one gets from the jobitself, such as a feeling of achievement, responsi-bility, or autonomy. Extrinsic rewards includemonetary compensation, promotion, and tangi-ble benefits.

Compensation frequently refers to extrinsic,monetary rewards that employees receive in ex-change for their work. Usually, compensation iscomposed of the base wage or salary, any incen-tives or bonuses, and other benefits. Base wage orsalary is the hourly, weekly, or monthly pay thatemployees receive. Incentives or bonuses are re-wards offered in addition to the base wage whenemployees achieve a high level of performance.Benefits are rewards offered for being a memberof the company and can include paid vacation,health and life insurance, and retirement pen-sion.

A company’s compensation system must in-clude policies, procedures, and rules that provideclear and unambiguous determination and ad-ministration of employee compensation. Other-wise, there can be confusion, diminished em-ployee satisfaction, and potentially costlylitigation.



DETERMINANTS OF COMPENSATION

Fair and adequate compensation is critical tomotivating employees attracting high-potentialemployees, and retaining competent employees.Compensation has to be fair and equitableamong all workers in the same company (internalequity). Internal equity can be achieved when payis proportionate to the individual employee’squalifications and contributions to a company.On the other hand, compensation also has to befair and equitable in comparison to the externalmarket (external equity). If a company pays itsemployees below the market rate, it may losecompetent employees. In determining adequatepay for employees, a manager must consider thethree major factors: the labor market, the natureand scope of the job, and characteristics of theindividual employee.

Potential employees are recruited from a cer-tain geographic area—the labor market. The ac-tual boundary of a labor market varies dependingon the type of job, company, and industry. Forexample, an opening for a systems analyst at IBMmay attract candidates from across the country,whereas a secretarial position at an elementaryschool may attract candidates only from the im-mediate local area of the school.

Pay for a job even within the same labormarket may vary widely because of many factors,such as the industry, type of job, cost of living,and location of the job. Compensation managersmust be aware of these differences. To help com-pensation managers understand the market rateof labor, a compensation survey is conducted. Acompensation survey obtains data regardingwhat other firms pay for specific jobs or jobclasses in a given geographic market. Large com-panies periodically conduct compensation sur-veys and review their compensation system toassure external equity. There are professional or-ganizations that conduct compensation surveysand provide their analysis to smaller companiesfor a fee.

Several factors are generally considered inevaluating the market rate of a job. They includethe cost of living of the area, union contracts, andbroader economic conditions. Urban or metro-

politan areas generally have a higher cost of livingthan rural areas. Usually, in calculating the realpay, a cost-of-living allowance (COLA) is addedto the base wage or salary. Cost-of-living indexesare published periodically in major businessjournals. During an economically depressed pe-riod, the labor supply usually exceeds the de-mand in the labor market, resulting in lowerlabor rates.

The characteristics of an individual employeeare also important in determining compensation.An individual’s job qualifications, abilities andskills, prior experiences, and even willingness towork in hardship conditions are determining fac-tors. Within the reasonable range of a marketrate, companies offer additional compensation toattract and retain competent employees.

In principle, compensation must be designedaround the job, not the person. Person-based payfrequently results in discriminatory practices,which violates Title VII of the Civil Rights Act,and job-based compensation is the employer’smost powerful defense in court. For job-basedcompensation, management must conduct a sys-tematic job analysis, identifying and describingwhat is happening on the job. Each job must becarefully examined to list the necessary tasks andactions, identify skills and abilities required, andestablish desirable behaviors for successful com-pletion of the job.

With complete and comprehensive dataabout all the jobs, job analysts must conduct sys-tematic comparisons of them and determinetheir relative worth. Numerous techniques havebeen developed for the analysis of relative worth,including the simple point method, job classifica-tion method, job ranking method, and the factorcomparison method.

Information resulting from the comprehen-sive job analysis will be used for establishing payor wage grades. Assume that twenty-five jobsrange from 10 to 50 points in their job scoresbased on the job point method. All twenty-five ofthese jobs are reviewed carefully for their relativeworth and plotted on Figure 1. The x-axis repre-sents job points and the ordinate (y-axis) repre-sents relative worth or wage rates. Once a man-



Wage CurveBASED ON THE JOB POINT METHOD

10 20 30 40 50

5.0

5.5

6.0

6.57.0

7.5

8.0

8.5

9.0

*

* * *

*

* *

* ***

*

*

**

* **

****

*

*

Points

HourlyPayRate

Figure 1

ager can identify fair and realistic wages of two ormore jobs, desirably top and bottom ones, thenall the rest can be prorated along the wage curvein the diagram.

In order to simplify the administration of awage structure, similar jobs in the approximatecluster are grouped together into a class or gradefor pay purpose. Figure 2 shows how twenty-fivejobs are grouped into five pay grades. Employeesmove up in their pay within each grade, typicallyby seniority. Once a person hits the top pay in thegrade, he or she can only increase the pay bymoving to a higher grade. Under certain unusualcircumstances, it is possible for an outstandingperformer in a lower grade to be paid more thana person at the bottom of the next-highest level.

INNOVATIONS INCOMPENSATION SYSTEMS

As the market becomes more dynamic and com-petitive, companies are trying harder to improveperformance. Since companies cannot afford tocontinually increase wages by a certain percent-age, they are introducing many innovative com-pensation plans tied to performance. Several ofthese plans are discussed in this section.

Incentive Compensation Plan. Incentive com-pensation pays proportionately to employee per-formance. Incentives are typically given in addi-

Pay Ranges within Grades ESTABLISHED BASED ON THE JOB POINT METHODS

10 20 30 40 50

5.0

5.5

6.0

6.57.0

7.5

8.0

8.5

9.0

Points

HourlyPay

Rates

Figure 2

tion to the base wage; they can be paid on thebasis of individual, group, or plant-wide per-formance. While individual incentive plans en-courage competition among employees, group orplant-wide incentive plans encourage coopera-tion and direct the efforts of all employees towardachieving overall company performance.

Skill-Based or Knowledge-Based Compensa-tion. Skill-based pay is a system that pays employ-ees based on the skills they possess or master, notfor the job they hold. Some managers believe thatmastery of certain sets of skills leads to higherproductivity and therefore want their employeesto master a series of skill sets. As employees gainone skill and then another, their wage rate goesup until they have mastered all the skills. Similarto skill-based pay is knowledge-based pay. Whileskill-based pay evolved in the manufacturingsector, pay-for-knowledge developed in the ser-vice sector (Henderson, 1997). For example,public school teachers with a bachelor’s degreereceive the lowest rate of pay, those with a mas-ter’s degree receive a higher rate, and those with adoctorate receive the highest.

Team-Based Compensation. As many compa-nies introduce team-based management practicessuch as self-managed work teams, they begin tooffer team-based pay. Recognizing the impor-



tance of close cooperation and mutual develop-ment in a work group, companies want to en-courage employees to work as a team by offeringpay based on the overall effectiveness of the team.

Performance-Based Compensation. In the tra-ditional sense, pay is considered entitlement thatemployees deserve in exchange for showing up atwork and doing well enough to avoid being fired.While base pay is given to employees regardlessof performance, incentives and bonuses are extrarewards given in appreciation of their extra ef-forts. Pay-for-performance is a new movementaway from this entitlement concept (Milkovichand Newman, 1996). A pay-for-performanceplan increases even the base pay—so-called meritincreases—to reflect how highly employees arerated on a performance evaluation. Other incen-tives and bonuses are calculated based on thisnew merit pay, resulting in substantially moretotal dollars for highly ranked employee per-formance. Frequently, employees also receive anend-of-year lump sum bonus that does not buildinto base pay.

EXECUTIVE COMPENSATION

Recently, people have been concerned with theexcessively high level of executive compensation.According to Business Week’s annual executivepay survey, in 1997 Sanford Weill, CEO of Trav-elers Group, collected $7.5 million in salary andbonuses plus $223.2 million for long-term com-pensation, totaling $230.7 million. In the sameyear, Roberto Goizueta, CEO of Coca-Cola,earned a total of $111.8 million, including annualsalary, bonuses, and long-term compensation.Compensations of the twenty highest-paid exec-utives ranged from $28.4 million to $230 million.

Frequently, executive compensation be-comes controversial. Are these compensationsexcessive? What justifies such a large compensa-tion for executives? Justification of such a largesum of compensation is linked to the company’sperformance. In fact, a significant portion of ex-ecutive compensation results from exercisingstock options, which were quite valuable in therecent ‘‘bull’’ market. And yet ordinary working-

class Americans are outraged by the shockingcontrast in pay raises: Annual executive pay atlarge companies rose 54 percent in 1996, whereasthe pay raises of most working-class people werein the 3 percent to 5 percent range during thesame period.

An executive compensation package is typi-cally composed of (1) base salary, (2) annualincentives or bonuses, (3) long-term incentives(e.g., stock options), (4) executive benefits (e.g.,health insurance, life insurance, and pensionplans), and (5) executive perquisites. Consider-ing the high turnover rate of competent execu-tives, offering a competitive salary is crucial inattracting the top candidates.

Frequently, annual bonuses play a more im-portant role than base salary in executive com-pensations. They are primarily designed to moti-vate better performance. In order to underscorethe importance of financial performance, usuallymeasured by the company’s stock price, top exec-utives are offered stock options. Sometimes, ex-ercising stock options yields more cash benefitsto executives than do annual salaries.

In addition to monetary compensation, exec-utives enjoy many different types of perquisites,commonly called ‘‘perks.’’ Such executive perksinclude the luxurious office with lush carpets, theexecutive dining room, special parking, use of acompany airplane, company-paid membershipin high-class country clubs and associations, andexecutive travel arrangements. Many companieseven offer executives tax-free personal perks, in-cluding such things as free access to companyproperty, free legal counseling, free home repairsand improvements, and expenses for vacationhomes or boats.

Another perk that became popular recently isthe so-called golden parachute—a protectionplan for executives in the event that they areforced out of the organization. Such severancefrequently results from a merger or hostile take-over of the company. The golden parachute pro-vides either a significant one-time sum to thedeparting executive or a guaranteed executiveposition in the newly merged company.



BIBLIOGRAPHY

Henderson, Richard I. (1997). Compensation Managementin a Knowledge-Based World, 7th ed. New York: Prentice-Hall.

Henderson, Richard I. (1994). Compensation Management:Rewarding Performance, 6th ed. New York: Prentice Hall.

Klein, Andrew L. (1996). ‘‘Validity and Reliability for Com-petency-Based Systems: Reducing Litigation Risks.’’Compensation and Benefits Review 28(4): 31-37.

Milkovich, George T., and Newman, Jerry M. (1996).Compensation, 5th ed. Chicago: Irwin.

Pauline, George B. (1997). ‘‘Executive Compensation andChanges in Control: A Search for Fairness.’’Compensation and Benefits Review 29 (March/April):30-40.

Reingold, Jennifer, and Borrus, Amy. (1997). ‘‘Even Execu-tives Are Wincing at Executive Pay.’’ Business Week, May12: 40-41.

Reingold, Jennifer, and Melcher, Richard A. (1998). ‘‘Execu-tive Pay.’’ Business Week, April 20: 64-68.

LEE W. LEE

EMPLOYEE DISCIPLINE

Discipline refers to the actions imposed by anorganization on its employees for failure to fol-low the organization’s rules, standards, or poli-cies. Traditional approaches to discipline, basedon punishment, are known to promote adver-sarial relationships between leaders and fol-lowers. A more effective approach now beingused by many companies recognizes good per-formance and encourages employee commit-ment to the organization and its goals. Onceemployees see the discrepancy between actualand expected performance, the burden is on theemployee to change. Even with more positiveapproaches to discipline, organizations still needto have some form of disciplinary procedure,whether formal or informal, that carries succes-sively stiffer penalties for repeated or more seri-ous offenses.

ESTABLISHING AND COMMUNICATINGWORK RULES

A first step in the disciplinary procedure is toestablish work rules that are in line with the

organization’s goals or objectives. These workrules become the basis for disciplinary actionswhen the rules are broken. They are generallyestablished jointly by management, the organiza-tion’s human resources unit, and employees, whoshould have an opportunity for input to ensurethat rules are fair and can reasonably be followed.Work rules are directly related to work behaviorand productivity. Employees who continually vi-olate the rules are candidates for a disciplinaryprocedure.

Employees must know the rules that havebeen established. Even though employees mighthave had input in the development of the rules, itis the employer who creates the final version. Theorganization’s work rules should be presented ina printed format, and each employee should begiven a copy. This is usually accomplished in theform of an employee handbook. The handbookmay have other information, but the work rulesare a critical part of it.

In some organizations, these work rules arediscussed at meetings, seminars, or training ses-sions. Employees with long tenure in the organi-zation typically review the rules periodically.Work rules should be reviewed from time to timeand, if necessary, revised. If an organizationmakes major changes in the way it operates be-cause of new equipment, expansion or contrac-tion, or new ownership, it will need to revise itswork rules accordingly. Small companies withonly a few employees also need to have writtenwork rules. Such companies may not have anemployee handbook, but it is still wise for therules to be written down and presented to eachemployee. Additionally, these rules may beposted in a spot where all employees can readthem easily.

EVALUATING EMPLOYEES

In the employee evaluation process, either formalor informal, behaviors requiring disciplinary ac-tions are often revealed. Informal evaluationmight occur at all times as supervisors monitoremployees. Formal evaluations of each employeeshould be completed regularly so that deficien-cies can be discovered and discussed with the

EMPLOYEE DISCIPLINE


employee. When employees violate work rules, achange of behavior is sought. Although smallcompanies with only a few employees may notuse a formal written evaluation, it is still impor-tant that employees be evaluated regularly. Smallcompanies may find it easier to take correctiveactions than large companies because of thecloseness of the supervisor to each of the worksituations. In contrast, a supervisor in a largeorganization might be responsible for fifty, ahundred, or more workers.

When employees break the rules of the orga-nization, they often need assistance to changetheir behavior so as to operate within the estab-lished parameters. Counseling and coachingcould be a part of this process, but they usuallytake place prior to disciplinary actions. If em-ployees change their behavior as a result of disci-plinary actions and conform to the establishedwork rules, there is no need for further discipline.If a change in behavior does not occur, then aharsher disciplinary procedure will need to beimplemented.

The need to resort to disciplinary proceduresmay be lessened by (1) smart hiring, using back-ground checks and extensive interviews; (2) per-formance evaluations with clear goals and objec-tives; (3) training and development to improveskills and increase performance; and (4) re-warding performance and goal achievement.

USING THE DISCIPLINARY PROCEDURE

Although most employees do follow the organi-zation’s rules and regulations, there are timeswhen the employer must use the discipline pro-cedure. Frequent reasons for using the procedureinclude the following:

Absence from work

Absenteeism

Abusing customers

Abusive language toward supervisor

Assault and fighting among employees

Causing unsafe working conditions

Damage to or loss of machinery or materi-als

Dishonesty

Disloyalty to employer (includes competingwith employer, conflict of interest)

Falsifying company records (including timerecords, production records)

Falsifying employment application

Gambling

Horseplay

Incompetence (including low productivity)

Insubordination

Leaving place of work (including quittingearly)

Loafing

Misconduct during a strike

Negligence

Obscene or immoral conduct

Participation in a prohibited strike

Possession or use of drugs or intoxicants

Profane or abusive language (not towardsupervisor)

Refusal to accept a job assignment

Refusal to work overtime

Sleeping on the job

Slowdown

Tardiness

Theft

Threat to or assault of management repre-sentative

A formal disciplinary procedure usually be-gins with an oral warning and progresses througha written warning, suspension, and, ultimately,discharge. Formal disciplinary procedures alsooutline the penalty for each successive offenseand define time limits for maintaining records ofeach offense and penalty. For instance, tardinessrecords might be maintained for only a six-month period. Tardiness prior to the six monthspreceding the offense would not be considered inthe disciplinary action. Less formal proceduresgenerally specify the reasons for disciplinary ac-tion as being for just or proper cause.

EMPLOYEE DISCIPLINE


Preventing the disciplinary procedure fromprogressing beyond the oral warning stage is ob-viously advantageous to both the employee andmanagement. Discipline should be aimed at cor-rection rather than punishment. If the behaviorcan be corrected by a friendly talk between thesupervisor and the employee, there is less chancethat the problem will become a source of bitter-ness. Formal oral or written warnings are lesslikely to cause animosity than would a suspen-sion. Of course, the most costly and least accept-able form of discipline is discharge. Disciplinaryprocedures should be viewed as a means of en-couraging employees to abide willingly by therules and standards of the organization.

The importance of having a procedurallycorrect performance evaluation system receivesconstant emphasis. There is a need to adoptprocedural due process for performance evalu-ation systems in order to rate employee job per-formance accurately because those ratings mightbe challenged. Legal problems regarding em-ployee disciplinary measures can be prevented bymaking sure that these measures follow pre-scribed guidelines, such as these:

● Employees are given advance notice of disci-plinary action.

● Disciplinary rules are reasonable.

● Offenses are properly investigated.

● Investigations are conducted objectively.

● Rules are enforced equally.

● Penalties are related to the severity of offenses.

LABOR UNION INVOLVEMENT

Numerous employees in the United States arerepresented by labor unions. In a unionized orga-nization, the supervisor is the primary link be-tween the organization and union members. Thesupervisor’s first responsibility is to uphold theinterests of management. At the same time, thesupervisor must fulfill the contractual obligationsof management and see that the union fulfills itsobligations. Collective bargaining between man-agement and the union determines terms ofworker contracts, legal documents that cover aspecified period of time. Union contracts include

provisions for a worker grievance and disciplin-ary procedures. For example, the union contractmay stipulate that an employee can be disciplinedfor just cause. To fulfill this provision, manage-ment must develop a system of discipline thatsupervisors must follow.

FEATURE OF AN EFFECTIVEDISCIPLINARY PROCESS

A disciplinary procedure is directed against theworker’s behavior rather than the person. Keyfeatures of an effective process include the fol-lowing principles of disciplining workers.

1. The length of time between the miscon-duct and the discipline should be short. For disci-pline to be most effective, it must beadministered as soon as possible, but withoutmaking an emotional, irrational decision.

2. Disciplinary action should be preceded byadvance warning. Noting rule infractions in anemployee’s record is not sufficient to supportdisciplinary action. An employee who is not ad-vised of an infraction is not considered to havebeen given a warning. Noting that the employeewas advised of the infraction and having the em-ployee sign a discipline form are both valid em-ployment practices. Failure to warn an employeeof the consequences of repeated violations of arule is a frequently cited reason for overturning adisciplinary action.

3. Consistency in the discipline procedure iskey. Inconsistency lowers morale, diminishes re-spect for the supervisor, and leads to grievances.Consistency does not mean that an absence ofpast infractions, long length of service, a goodwork record, and other mitigating factors shouldnot be considered when applying discipline.However, an employee should feel that underessentially the same circumstances any other em-ployee would have received the same punish-ment/penalty.

4. Supervisors should take steps to ensureimpartiality when applying discipline. The em-ployee should feel that the disciplinary action is aconsequence of behavior, not of personality orrelationship to the supervisor. The supervisorshould avoid arguing with the employee and

EMPLOYEE DISCIPLINE


should administer discipline in a straightforward,calm manner. Administering discipline withoutanger or apology and then resuming a pleasantrelationship aid in reducing the negative effectsof discipline.

5. Ordinarily, the supervisor should adminis-ter discipline in private. Only in the case of grossinsubordination or flagrant and serious rule vio-lations is a public reprimand desirable. Then apublic reprimand helps the supervisor regaincontrol of a situation. Even in such situations,however, the supervisor’s objective should be toregain control, not to embarrass the employee.

6. The supervisor should warn the employeeof the result of repeated violations. Sometimessuggestions to the employee on ways to correctbehavior are beneficial. Supervisors should bevery reluctant to impose disciplinary suspensionsand to discharge workers. Usually, discipline ofthis degree is reserved for higher levels of man-agement. However, even though supervisors usu-ally lack the power to administer disciplinarysuspensions or to discharge workers, they arenearly always the ones who must recommendsuch action to higher management.

7. Finally, it is necessary to document theaction taken and inform others in the organiza-tion. Any time an organization takes disciplinaryaction, it must consider the possibility of anEqual Employment Opportunity complaint. Thedocumentation should be sufficiently detailedthat another manager at a similar level in theorganization would come to the same conclu-sions or least see clearly why the decision wasmade. Sufficient documentation does not meanthat every detail of an individual’s work needs tobe recorded. Rather, the manager should keepaccurate records of those elements that signifi-cantly contribute to or hamper the work effort.In addition, this information, both positive andnegative, should be communicated to the em-ployee either orally or in writing.

SUMMARY

If a company is to have a successful employeedisciplinary procedure, both the organizationand the manager have important roles to play. In

practice, companies assume the responsibility ofestablishing rules, communicating them to em-ployees, and developing a penalty system for en-forcing them. The manager’s role in the disciplin-ary procedure is distinct from that of theorganization, yet the two overlap and supporteach other. Managers are responsible for imple-menting the organization’s discipline procedure.This requires them to do several things: Theymust compare their organization’s rules with em-ployee behavior to determine whether a rule hasbeen broken; they must determine whether theyhave sufficient proof that the employee did in-deed break the rule; they must decide what cor-rective action should be taken and then take it;and they must document whatever action istaken. To the extent that all managers performthese steps effectively, the disciplinary procedurewill be effective and there is a very good chancethat employee behavior on the job can be signifi-cantly improved.

BIBLIOGRAPHY

Benton, Douglas A. (1998). Applied Human Relations. Up-per Saddle River, NJ: Prentice-Hall.

Champagne, Paul J., and McAfee, R. Bruce. (1989).Motivating Strategies for Performance and Productivity.New York: Quorum Books.

Greenberg, Jerald. (1999). Managing Behavior in Organiza-tions: Science in Service to Practice. Upper Saddle River,NJ: Prentice-Hall.

Hersey, Paul, Blanchard, Kenneth H., and Johnson, DeweyE. (1996). Management of Organizational Behavior. Up-per Saddle River, NJ: Prentice-Hall.

Rue, Leslie W., and Byars, Lloyd L. (1990). Supervision: KeyLink to Productivity. Homewood, IL: Irwin.

Whetten, David A., and Cameron, Kim S. (1995).Developing Management Skills. New York: HarperCol-lins.


Yukl, Gary. (1994). Leadership in Organizations. EnglewoodCliffs, NJ: Prentice-Hall.

MARCIA ANDERSON

EMPLOYEE DISCIPLINE


EMPLOYEE MOTIVATION(SEE: Motivation)

ENTREPRENEURSHIP

A subject taught in many high schools and col-leges, entrepreneurship is actually defined as ‘‘thestate of being an entrepreneur.’’ An entrepreneuris an individual who owns, organizes, and man-ages a business and, in so doing, assumes the riskof either making a profit or losing the invest-ment. According to the Small Business Adminis-tration (1999), the total number of businesses inthe United States in 1995 was somewhere be-tween 16 million and 24 million, of which ap-proximately 15,000 were large. In 1997, therewere an estimated 8.5 million businesses ownedby women.

For any business to be successful, an ade-quate level of funding must be furnished. Theamount needed varies according to the scope andnature of the business. Another key factor in thesuccess of an entrepreneurial organization isplanning, including planning for the marketing,management, and financial aspects of the busi-ness.

From a personal perspective, becoming anentrepreneur is not a simple task. It certainly hasits drawbacks. However, it can also be quite re-warding.

BENEFITS AND DRAWBACKSOF ENTREPRENEURSHIP

Choosing to create a new business, or even topurchase an existing one, is a decision that has afar-reaching impact. Long hours, poor pay, andan unclear future are only three of the challengesa budding entrepreneur must face. And, ofcourse, losing everything one invests in a busi-ness is a very real risk. In fact, while 885,416 ‘‘newemployer firms’’ were created in 1997, as re-ported by the U.S. Department of Labor, 857,073businesses were terminated during the same year,with 53,826 of these being bankruptcies and83,384 being failures. Failures and bankruptcies

Computer entrepreneur Bill Gates.

are business closures that occur while the busi-ness owes debts.

However, the potential rewards are unlim-ited. Business owners can profit greatly. Many ofthe wealthiest people on earth are entrepreneurs,including William Henry Gates III, the world’srichest person and co-founder, chairman, andCEO of Microsoft Corporation. Another rewardentrepreneurs tend to appreciate is indepen-dence. However, entrepreneurs’ time is not nec-essarily their own. The work of the business mustbe completed, and often the entrepreneur is theone who must perform the most complex tasks ofthe business. Although others may work for theowner and manager of the business, it is ulti-mately the responsibility of the entrepreneur tomake sure that the work gets done. Other re-wards cited by entrepreneurs include personalsatisfaction gained while performing the duties ofthe business and the resulting prestige.

ENTREPRENEURSHIP


BUSINESS PLAN

Planning is a key ingredient in the success of anentrepreneur. A business plan helps to guide thedecision making needed to operate a business.The first decision is to choose what sort of busi-ness to own. The business may be:

● a retail business that markets a tangible prod-uct (such as clothing, houses, food)

● a wholesale business that acquires goods froma producer and distributes requested quan-tities to retailers

● a service business that offers an intangibleproduct (such as insurance, haircuts, consul-tant services, construction, financial services)

● a manufacturing business that produces aproduct

Of course, a business may perform more thanone of these functions. The scope of the businesswill also be dependent on the breadth and depthof the products or services offered as well as thegeographic region served.

One option available to someone interestedin purchasing a business is a franchise. A fran-chise is a license to organize a business thatmarkets products manufactured or owned by aparent company, such as a Kwik Copy, Sleep Inn,McDonald’s, Play It Again Sports, or other busi-nesses.

Another early decision involves choosing thelegal form of ownership. Three options are soleproprietorship, partnership, and corporation. Ina sole proprietorship, a single person owns andoperates the business. The owner assumes allrisks and responsibilities for the business, includ-ing debts. Two or more individuals may form apartnership and serve as co-owners of the busi-ness. If the partnership is a general partnership,all partners assume unlimited liability. However,if the partnership is a limited partnership, one ormore of the partners assumes unlimited liabilitywhile the remaining partner(s) do(es) not. In-stead, they may lose up to the amount of theirinvestment, while having limited involvement inthe business.

The third form of ownership is the corpora-tion. A corporation is a group of individuals who

obtain a charter giving the organization formedby the group legal rights and privileges. This or-ganization can perform such functions as buyingand selling, as well as owning property, as if thegroup were an individual person. The corpora-tion is actually owned by individuals who pur-chase stock. A major advantage of this form ofownership is that the stockholders themselveshave limited liability, thus minimizing financialrisks.

The Small Business Administration (1999)reports that in 1996, according to the InternalRevenue Service, 16,471,000 sole proprietorships,1,679,000 partnerships, and 5,005,000 corpora-tions filed nonfarm business tax returns.

A business plan often contains three majorsections: the marketing plan, the managementplan, and the financial plan.

Marketing Plan Marketing is a process inwhich the decisions of the business are basedupon the goals of the organization. One of thesegoals is usually that of satisfying the needs andwants of potential customers or a target market.Potential customers can be divided into specificmarket segments that represent groups based onspecified characteristics. For example, a businessmay strive to serve those in their late teens andearly twenties who live primarily in large cities.Narrowing the segment even further, the busi-ness may offer goods or services for those interes-ted specifically in sports—both as active playersand as spectators or fans. Thus the business maysell athletic shoes and clothing, sports equip-ment, and ‘‘how-to’’ books. The owner(s) wouldlocate this business in an area with a large num-ber of people in that age group. Other factors toconsider when defining a target market includesuch demographic factors as income level, sex,marital status, and ethnic group, and such geo-graphic factors as climate and region of the coun-try.

Part of the marketing plan is the marketingmix. A marketing mix has four basic compo-nents: product, place, price, and promotion.

Product: The product is the goods and/orservices offered by the business. A travel agentmay offer the service of arranging any type of trip

ENTREPRENEURSHIP


to anywhere in the world or may specialize spe-cifically in cruises. Choosing products is depen-dent on the market segment the business intendsto serve. Other considerations include theamount of physical space available for storing theproduct, the amount of funds needed to purchasethe product from the wholesaler or manufac-turer, and the profitability potential of offeringthe product. Another important consideration isthe product’s life cycle. A life cycle has four sec-tions: introduction, growth, maturity, and de-cline. When a new product is introduced to themarket, it is in the introduction phase. Over time,it may grow in popularity and sales, reaching apoint of maturity. Maturity is then followed bydecline. An entrepreneur must be careful to avoidoffering products or services that are in decline.That is one of the reasons for continually moni-toring the sales of products and adjusting theproduct mix to reflect such changes in the prod-uct life cycle.

Place: Another factor in the marketing mix isplace. Marketers often say that the success of abusiness is dependent upon ‘‘location . . . loca-tion . . . location.’’ Choosing the location of thebusiness is an important decision that must takeinto consideration such factors as the chosen tar-get market, traffic patterns, parking availability,population trends, competitive businesses, rentalcosts, and other expenses. The place function alsoincludes business activities that involve physicaldistribution, such as transporting goods, han-dling the goods, storing the goods, and keepingtrack of the goods (inventory).

An increasing number of businesses are lo-cating on the Internet. Entrepreneurs createWorld Wide Web pages on which they promotetheir offerings. Consumers may either telephonethe business to order the product or service oruse a credit card to purchase the item over theInternet. The actual location of the business isless important since the Web is availablethroughout the country and, indeed, the world.However, the location still must be consideredrelative to business expenses (e.g., rent, utilityprices) and transportation prices (e.g., cost of

transporting products purchased on the Internetfrom the business to the customer).

Businesses can also be located in the home; infact, home-based businesses represent a largeportion of businesses in the United States. Manyentrepreneurs begin their businesses in the homeand eventually outgrow the space available there,at which point the owner usually seeks an outsidefacility.

Price: Price is the third component of themarketing mix. A pricing structure must be de-veloped that includes specific goals and reflectspolicies of the business. A goal may reflect anintended image of the business or a particularprofit margin that is sought. Factors to considerwhen identifying goals and policies related toprice are: the amount of sales that are sought,pricing policies of competitors, profits that areprojected, supply of the product that is availableand projected demand for that product, the loca-tion of the business, and the expenses of thebusiness.

Promotion: The fourth component of themarketing mix is promotion—the activities ofthe business that are intended to inform potentialcustomers about the product or service and per-suade them to purchase it. Methods include per-sonal selling, advertising, visual merchandising(the coordination of all physical elements in abusiness such as displays, counters, offices, win-dows, signs, fixtures, lighting, and such), andpublicity. The effectiveness of promotional strat-egies must be monitored so that promotionaldollars are spent on strategies that are contribut-ing to the achievement of business goals.

Management Plan Another major section of abusiness plan is the management plan. The fourbasic functions of management are planning, or-ganizing, directing, and controlling.

Planning involves the determination of goalsand objectives for the business, including the ac-tual results sought by the firm. A set of policiesand procedures are determined that guide theidentification of specific activities that will lead tothese goals. Planning does not end with the cre-ation of a business plan, however; it continuesthroughout the life of the business.

ENTREPRENEURSHIP


To implement the plan, the entrepreneur or-ganizes the personnel and other resources of thebusiness. An organizational chart is created thatshows the hierarchy of the people working in thebusiness. After the number of employees andtheir qualifications are determined, applicantsare recruited and, once hired, are trained. Othertypes of resources that are organized by manage-ment are facilities, equipment, materials, andsupplies.

The third management function is directing.Managers direct the work of the business byapplying leadership and management skills. Theymodel desired behavior while supervising, moti-vating, and evaluating their employees. Finally,comparing the plan with the actual results iscalled ‘‘controlling.’’ By observing and studyingfinancial statements, managers can understandthe status of the business and adjust activitieswhere necessary to contribute toward theachievement of the business goals. The control-ling function also includes evaluation of employ-ees.

Financial Plan The financial aspects of thebusiness must also be planned. The financial planincludes several financial statements. One ofthese statements is the ‘‘statement of financialrequirements,’’ which identifies the projected ex-penses and the assets they will create for a speci-fied time period. Among the expenses listed arethose for rent, insurance, telephone, and inven-tory. The entrepreneur also needs money to meetpersonal expenses as the business grows. Theseexpenses are also included in this statement. Theexpenses are used to create assets. Assets areitems of value that are owned by the business. Forexample, if a business purchases land upon whichto place a facility for the business, the moneyneeded for the purchase is an expense that thencreates the asset of land.

The financial plan also includes the source(s)of the funds needed to meet the financial require-ments. Sometimes an entrepreneur will alreadyhave all the funds needed; more often these mustbe acquired from family members, private lend-ing agencies, and/or governmental loan pro-grams.

Another statement included in the financialplan is the income statement, which may bereferred to as a profit-and-loss statement or oper-ating statement. This statement is a projection ofthe sales expected in a given period of time, thecost of the merchandise that will be sold, and theoperating expenses of the business. From thisinformation, projected profits or losses are deter-mined.

A financial plan also includes a beginningbalance sheet. This form provides a list of theassets, liabilities, and net worth of a business on agiven day. Assets are tangible items that areowned by the business, liabilities are the debts ofa business, and net worth is the amount of invest-ment that the owner(s) has in the business.

The financial plan also includes a cash-flowanalysis and a break-even analysis. The cash-flowanalysis identifies the cash generated after ex-penses and loan principal payments are de-ducted. This projection is calculated for severalyears into the future. The break-even analysisidentifies the break-even point, which is the levelof sales and expenses, including loan principalpayments, at which a business has no profit andno loss.

RESOURCES

Information that can help the budding entrepre-neur is available from people, printed material,and the Internet. All entrepreneurs need peoplethey can go to for advice. Accountants and attor-neys are especially important. An accountant notonly provides the financial data and statementsfor the business but also interprets the informa-tion for the entrepreneur. This is important be-cause business decisions must be based on avariety of considerations, including financialones. Attorneys provide legal advice throughoutthe process of purchasing or creating a businessand owning and managing it.

Other sources of information include finan-cial institutions, the Chamber of Commerce, ed-ucational institutions, insurance agents, and sup-pliers of products used in the business.Publications provide up-to-date information:Books from major publishers, magazines such as

ENTREPRENEURSHIP


Entrepreneur and Inc., and newsletters and jour-nals offered by associations are available. Manytypes of businesses are served by trade associa-tions such as the American Hotel and Motel As-sociation, which is comprised of owners and op-erators of lodging businesses throughout thecountry. Along with providing publications,these organizations hold conferences and work-shops and provide networking opportunities.Various government agencies are also availablefor advice, such as the Small Business Adminis-tration and the Internal Revenue Service.

The Internet provides information from avariety of people and organizations. Although theInternet is a valuable resource, the informationavailable on it is not screened for accuracy. Rele-vant Web sites can be located by use of searchengines that pinpoint specification on categoriesand topics.

Although it is important that the entrepre-neur seeks advice throughout the planning andoperation of a business, the ultimate decisionmaker on matters related to the business is theentrepreneur.

SUCCESSFUL ENTREPRENEURS

Successful entrepreneurs can be found in justabout every community in the country. Fromsmall businesses employing only a few persons tomegabusinesses employing thousands, successfulentrepreneurs abound. The following successfulentrepreneurs represent a few of those at the highend of success as measured by wealth:

William (Bill) H. Gates is the co-founder,chairman, and CEO of Microsoft Corpora-tion, the world’s leading provider of soft-ware for personal computers. Gates was astudent at Harvard when he developedBASIC, a programming language for thefirst microcomputer. He founded Microsoftin 1975 with a childhood friend, Paul Al-len. According to Microsoft Corporation,Gates’s determination to develop Microsoftstemmed from his belief that the personalcomputer would be a valuable tool for ev-

ery home and office; thus he began devel-oping software for personal computers.

Mary Kay Ash launched Mary Kay Cos-metics on September 13, 1963. Mary Kay,Inc. reports that, with a life savings of$5000, Ash launched what is now the larg-est direct seller of skin care products andthe best-selling brand of skin-care andcolor cosmetics in the United States. MaryKay Cosmetics originated from an idea ofwriting a book to help women survive inthe male-dominated business world. Fromthere, Ash inadvertently created the mar-keting plan for Mary Kay Cosmetics.

Gozi Samuel Oburota founded the GoziSamuel Oburota Certified Public Account-ancy Corporation (GSO) in 1994. Accord-ing to the GSO Corporation, before found-ing the company, Oburota had served as asenior accountant at IBM, trusted withworldwide accounting responsibility for theDASD 3390 mainframe computer projectfrom product development through manu-facturing and general availability. GSO is afull service certified public accounting firmwith offices in San Jose, Los Angeles, andWashington, D.C. By 1999, GSO was oneof the fastest-growing professional firmsheadquartered in Silicon Valley. GSO is100 percent minority owned.

(SEE ALSO: Factors of Production)

BIBLIOGRAPHY

Ely, Vivien K., Berns, Robert G., and Popo, Debbi. (1990).Entrepreneurship. New York: Glencoe/McGraw-Hill.

Entrepreneur Magazine 2392 Morse Avenue, Irvine, Califor-nia 92614.

GSO Corporation. http://www.gsocorp.com. 1999.

Kent, Calvin A., ed. (1990). Entrepreneurship Education Cur-rent Developments, Future Directions. Westport, CT:Quorum Books.

Inc. 477 Madison Ave., New York, New York 10022.

Longenecker, Justin G., Moore, Carlos W., and Petty, Bill(1997). Small Business Management: An EntrepreneurialEmphasis. Cincinnati, OH: South-Western College Pub-lishing.

ENTREPRENEURSHIP


Mary Kay, Inc. http://www.marykay.com. 1999.

Meyer, Earl C., and Allen, Kathleen R. (1994).Entrepreneurship and Small Business Management. NewYork: Glencoe.

Microsoft Corporation. http://www.microsoft.com. 1999.

Moorman, Jerry W., and Halloran, James W. (1996).Contemporary Entrepreneurship. Cincinnati, OH: South-Western Educational Publishing.

U.S. Association for Small Business and Entrepreneurship.Entrepreneurial Theory and Practice. Waco, TX: BaylorUniversity.

U.S. Small Business Administration. http://www.sba.gov.1999.

ROBERT G. BERNSJEWEL E. HAIRSTON

ENVIRONMENTALPROTECTION AGENCY

In December 1970, the U.S. Environmental Pro-tection Agency (EPA) was established as an inde-pendent agency. Reorganization Plan �3 of 1970consolidated fifteen components from five agen-cies for the purpose of grouping all environmen-tal regulatory activities under a single agency.Most of these functions were housed in the De-partment of the Interior, Department of Agricul-ture, and the Department of Health, Educationand Welfare.

The purpose of the EPA is to ensure that allAmericans and the environment in which theylive are safe from health hazards. The EPA has anumber of goals: clean air, clean and safe water,safe food, preventing and reducing pollution, wa-ter management and restoration of waste sites,redirection of international pollution, and credi-ble deterrents to pollution. Also, the EPA engagesin education about pollution and its environ-mental risks.

The first four goals deal with the immediateenvironment of people: clean air; clean and safewater; safe food; and preventing pollution andreducing risks in our environment. The remain-ing goals deal with education, the clean-up ofexisting pollution, and efforts in the global arena.They involve better water management, the re-duction of cross-border environmental risks, the

expansion of Americans’ right to know abouttheir environment, sound service, improved un-derstanding of environmental risks, credible de-terrents to pollution, and greater compliancewith the law and effective management.

In addition to these goals, the EPA hasadopted a number of principles to guide manage-ment in establishing priorities. These guidelinesare to reduce environmental risks, to prevent pol-lution, to focus on children’s health, to establishpartners with local governments, to maximizepublic participation, to emphasize community-based solutions, to work with Indian tribes, andto choose cost-effective solutions. The EPA also isengaged in ongoing educational programs, whichemphasize the community’s right to know aboutits environmental risks.

The EPA has to enforce fifteen or more stat-utes or laws, including the Clean Air Act; theClean Water Act; the Federal Food, Drug, andCosmetic Act; the Endangered Species Act; thePollution Prevention Act; and the Federal Insec-ticide, Fungicide, and Rodenticides Act. The EPAalso enforces other laws dealing with pollutionand toxic substances.

The EPA has had some major successes sinceits inception. In the area of air quality: (1) Morethan half of the large cities now meet air-qualitystandards; (2) emissions of common air pollu-tants have dropped by an average of 24 percent;and (3) blood lead levels in children have de-clined by 75 percent. In the area of water quality:(1) 60 percent of the nation’s waterways are safefor fishing and swimming; (2) ocean dumpinghas been banned; and (3) standards for wastewa-ter have been established for fifty industries. Inthe area of toxic and pesticide management: (1)DDT has been banned; (2) safer pesticides havebeen introduced; and (3) toxic emissions havebeen reduced by 39 percent. Finally, the EPA hasbeen able to set many standards covering a widerange of pollutants. More information is avail-able from the EPA at 401 M Street SW, Washing-ton, D.C. 20460-0003; (202)260-2090; orhttp://www.epa.gov.

ENVIRONMENTAL PROTECTION AGENCY


American Electric Power, in Beverly, Ohio, was named in a lawsuit by the Environmental Protection Agency.

BIBLIOGRAPHY

Environmental Protection Agency (EPA). ‘‘EPA’s Mission.’’Archived at: http://www.epa.gov/epahome. 1999.

EPA. ‘‘Frequently Asked Questions.’’ Archived at:http://www.epa.gov.gov/history. 1999.

EPA. ‘‘Research Programs.’’ Archived at: http://www.epa.gov/epahome. 1999.

EPA. ‘‘Twenty-Five Years of Environmental Progress at aGlance.’’ Archived at: http://www.epa.gov/25years. 1999.


EQUAL EMPLOYMENTOPPORTUNITY ACT

The Equal Employment Opportunity Act of 1972(Public Law 92-261) instituted the federal EqualEmployment Opportunity program, which is de-signed to ensure fair treatment to all segments ofsociety without regard to race, religion, color,national origin, or sex. The goal of this law and

program is to make discrimination in employ-ment illegal. Equal Employment Opportunityprograms include affirmative action for employ-ment as well as processing of and remedies fordiscrimination complaints. All employees, in-cluding supervisors, managers, former employ-ees, and applicants for employment, regardless ofgrade level or position, are covered under thislegislation. The Equal Employment OpportunityAct of 1972, which amended the Civil Rights Actof 1964 to include public employees, grantedenforcement authority to the Civil Service Com-mission (now the Office of Personnel Manage-ment) to ensure nondiscrimination in human re-sources actions and to establish affirmativeemployment measures.

Equal Employment Opportunity (EEO)means fair treatment in employment, promotion,training, and other personnel actions without re-gard to the previously mentioned factors. Themain misconception about the EEO is that itapplies is only to selected groups, but the EEO

EQUAL EMPLOYMENT OPPORTUNITY ACT


Black Males for Justice campaign for Equal Employment Opportunity.

applies to everyone because it is the law. How-ever, the EEO program is not a guarantee ofemployment for anyone. Under the EEO law,only job-related factors can be used to determinewhether an individual is qualified for a particularjob.

The development of the EEO policies andlaws can be dated back to the Civil Rights Act of1883, which prohibited political favoritism infederal employment. In 1940, Executive Order0948 prohibited discrimination in federal agen-cies based on race, creed, or color. In 1961, Exec-utive Order 10955 required that positive steps betaken to eliminate workplace discrimination inagencies. The next landmark influencing equalemployment opportunity was the Equal Pay Actof 1963, which prohibited the payment of differ-ent wage rates to workers for substantially similarwork on the basis of sex. Title VII of the CivilRights Act of 1964, which prohibited discrimina-tion based on race, color, sex, religion, or na-tional origin and established the Equal Employ-

ment Opportunity Commission (EEOC), wasanother very influential piece of legislation forthe EEO movement. Executive Order 11246 in1965 was also influential because it named theprocess for achieving equal employment oppor-tunity—affirmative action. Other importantmilestones were Executive Order 11375 in 1967,which prohibited discrimination based on sexand required affirmative action employment tohelp women, and the Age Discrimination in Em-ployment Act of 1967, which prohibited discrim-ination against persons between the ages of 40and 70. The final piece of legislation that influ-enced the Equal Employment Opportunity Act of1972 was Executive Order 11478 of 1969, whichmandated that equal employment opportunitiesbe a part of every aspect of human resourcespolicy and practice in the employment, develop-ment, advancement, and treatment of civilianemployees of the federal government.

In addition to the Equal Employment Op-portunity Act of 1972, two other pieces of legisla-

EQUAL EMPLOYMENT OPPORTUNITY ACT


tion dealing with equal employment opportuni-ties have been passed. The Equal EmploymentOpportunity Act of 1995 is one of these morerecent laws. This act prohibits discrimination onfourteen grounds: (1) impairment, (2) maritalstatus, (3) political belief or activity, (4) race, (5)religion, (6) sex, (7) societal status as a person,(8) age, (9) role in business dealings, (10) lawfulsexual activity, (11) physical features, (12) preg-nancy, (13) position or past positions held asemployment, and (14) association with a personwho is identified by reference to any of the thir-teen other listed grounds. The act also prohibitssexual harassment, which applies to both em-ployers and employees. The other piece of legisla-tion dealing with equal employment opportunityis the Further Amendment to Executive Order11478, Equal Employment Opportunity in theFederal Government. The order provides a uni-form policy for the federal government to use inprohibiting discrimination based on sexual ori-entation in the federal civilian work force, inaddition to race, color, religion, sex, nationalorigin, physical disabilities, or age for which dis-crimination is prohibited in Executive Order11478.

BIBLIOGRAPHY

African American Internetwork Web Site. http://www.afamnet.com/NationalPage/Politics/052998/–eeo.htm.

Defense Supply Center Web Site. http://www.dscr.dla.mil/eeo/Web-Project-WIP/DCSR-EEO-Terms.htm.

Law Institute of Victoria Web Site. http://liv.asn.au/public/general/employ/employ-Equal.html.

National Archives and Records Administration Web Site.http://www.nara.gov.nara.eeo.html�program.

U.S. Equal Employment Opportunity Commission WebSite. http://www.eeoc.gov

Western Area Power Administration Web Site. http://www.wapa.gov/CSO/eeo.eeomgr27.htm.

NIKOLE M. POGEMAN

EQUAL PAY ACT

The Equal Pay Act of 1963, which is an amend-ment to the Fair Labor Standards Act of 1938, is a

federal law that requires employers to pay allemployees equally for equal work, regardless oftheir gender. In other words, the act prohibitsunequal pay for equal or substantially equal workperformed by men and women in the same estab-lishment who are performing under similarworking conditions. Enforced by the Equal Em-ployment Opportunity Commission, the EqualPay Act also bars employers from reducing thewages of either sex in order to comply with thelaw. The act makes no provisions as to wagediscrimination based on race or national origin,addressing only the issue of sex-based wage dis-crimination and covering only situations involv-ing substantially equal work. The Equal Pay Actapplies to all employees covered by the Fair LaborStandards Act, which means that virtually all em-ployees are covered. However, in addition to theemployees covered by the Fair Labor StandardsAct, the Equal Pay Act covers professional em-ployees such as executives and managers and in-cludes administrators and teachers in elementaryand secondary schools.

In order to fully understand the Equal PayAct, it is important to determine the definition of‘‘equal work.’’ Jobs do not have to be identical forthem to be considered equal. The courts haveruled that two jobs are equal for the purposes ofthe Equal Pay Act when both require equal levelsof skill, effort, and responsibility and are per-formed under similar conditions. Although thereis a lot of room for interpretation, the focus ofequal work should be on only the duties per-formed. Job titles, classifications, and descrip-tions may weigh into the determination, but theyare not all that is considered.

Significant legal history of employment dis-crimination began to appear in the early 1960s.The Equal Pay Act of 1963 was established to fixpay contingent upon the job. The act has almostalways been applied to situations in whichwomen are being paid less than men for doingsimilar jobs. Indeed, the law was passed to helprectify the problems faced by women workersbecause of sex discrimination in employment.The Equal Pay Act was closely followed by TitleVII of the Civil Rights Act of 1964, which pro-

EQUAL PAY ACT


President Clinton speaks on Equal Pay.

hibits discrimination in employment. However,the Equal Pay Act provides two advantages overTitle VII of the Civil Rights Act. First, a lawsuitcan be filed under the Equal Pay Act without firstfiling a complaint with the Equal EmploymentOpportunity Commission. In addition, unlikeTitle VII, the Equal Pay Act does not requireproof that the employer acted intentionally whendiscriminating, which makes an Equal Pay Actcase easier to win.

When a worker establishes a pay disparitybetween a male and a female worker performingsubstantially equal jobs, the burden of proofshifts to the employer to justify its actions. Em-ployers can defend themselves in one of fourways. The defenses that can be used are to showthat the pay disparity was based on (1) a senioritysystem, (2) a merit system, (3) a system that de-termines wages based on the quantity or qualityof work produced, or (4) some factor other thansex. However, an investigation occurs only if theemployee can prove that the male and female are

working in the same place, doing equal work, andreceiving unequal pay because of their genders.In the event the employer is found guilty ofviolating the Equal Pay Act, back pay can bedoubled if the employer’s violation is determinedto be willful.

BIBLIOGRAPHY

Law for All. http://www.nolo.com.

National Partnership for Women and Families. http://www.nationalpartnership.org.

U.S. Equal Employment Opportunity Commission WebSite. http://www.eeoc.gov/laws/epa.html.

Western Area Power Administration Web Site. http://www.wapa.gov/CSO.eeo.eeomgr27.htm.

NIKOLE M. POGEMAN

EQUILIBRIUM(SEE: Supply and Demand)

EQUILIBRIUM


EQUITY THEORY(SEE: Motivation)

ERGONOMICS

Ergonomics is the science of fitting the job to theworker and adapting the work environment tothe needs of humans. An overall goal ofergonomics is to promote health and safety andto optimize productivity.

The term ergonomics comes from the Greekwords ergon, meaning ‘‘work’’, and nomos, mean-ing ‘‘laws’’—thus, laws of work. The study ofergonomics as a way to reduce human error be-gan in the military during the Korean War. Inplanes used for pilot training, the eject buttonwas poorly placed and pilots sometimes acciden-tally ejected themselves—often at too low an alti-tude for their parachutes to open. The button’slocation was changed and fewer lives were lost.

Principles of ergonomics are now applied tothe design of many elements of everyday life,from car seats to garden tools. Many differentoccupations are involved in implementing these‘‘human factor’’ principles in the workplace, suchas human factors/ergonomics specialists; safetyengineers; industrial hygienists, engineers, de-signers; human resource managers; occupationalmedicine physicians and therapists; and chiro-practors. Research in ergonomics is ongoing.

Knowledge of basic ergonomics principles isimportant for both workers and employers be-cause both share responsibility for a safe workenvironment. One can easily imagine the poten-tial hazards in manufacturing settings whereequipment is operated and heavy materials arehandled, but hazards exist in other environ-ments, too. And technology (especially computeruse) has brought about widespread changes inhow work is accomplished.

Attention to ergonomics principles helps toreduce workplace injuries and illnesses that resultin workers’ compensation costs, medical claims,and lost work time. Many disorders and injuriesare preventable when work conditions are de-signed for human safety and comfort. People

need training in how to recognize hazards andsafety problems as well as how to control theirown behaviors for maximum comfort and health.

One of the key considerations in ergonomicsis adjustability of physical elements. People comein all shapes and sizes, and the ‘‘average’’ work-station configuration will not fit everyone. Mak-ing changes during a workday in the physicalsetup of equipment, such as adjusting chairheight, can alleviate discomfort and fatigue.Work surfaces should be at comfortable heightsin relationship to a chair or to a standing posi-tion. Equipment and related items should be ar-ranged conveniently.

Whenever a mismatch occurs between thephysical requirements of a job and the physicalcapacity of a worker, musculoskeletal disorderscan result. People working with intense concen-tration or at high speeds often work with poorposture. Cumulative trauma disorders (alsocalled repetitive strain injuries) are caused byrepeating the same motion in awkward positionsor with noticeable force, such as in lifting heavyobjects. Carpal-tunnel syndrome, a disorder af-fecting nerves in the wrist that has the potentialto permanently disable, is a condition affectingpeople in a variety of occupations frommeatpackers to musicians. Wrist pain can be se-vere, with treatment involving wrist splints, anti-inflammatory drugs, or even surgery. And peoplewho use a computer extensively are especiallyprone to developing carpal-tunnel syndrome.Computer use often contributes to vision prob-lems, too.

Posture in standing and in seated positions isimportant to avoid musculoskeletal disorders.The natural curve of the spine should be main-tained, with the head balanced over the spine.When a person is seated:

● Feet should rest on the floor, with legs andbody forming 90� to 110� angles.

● The body should be straight, with the neckupright and supporting the head balanced onthe spine (not forward or twisted to thesides).

● Upper arms should be perpendicular to thefloor; forearms should parallel the floor.

ERGONOMICS


Ergonomic keyboards help ease the strain on computer users’ hands and wrists.

Symptoms of musculoskeletal disorders canbegin as numbness or stiffness in joints or tin-gling, aching sensations in muscles. Pain or burn-ing sensations may be evident, too. Often symp-toms progress gradually, becoming more severewith prolonged exposure to the conditioncausing them. Damage to nerves, tendons, joints,or soft tissue can result.

With computer use so prevalent, poor workhabits will contribute to musculoskeletal disor-ders formany peoplewho spend long hours seatedat a computer. These include the following:

● Wrists misaligned or excessive force used witha keyboard

● Poor posture used with an incorrect seatingheight

ERGONOMICS


● A monitor incorrectly positioned, resulting ineye strain and vision problems

● Inappropriate lighting, causing glare on moni-tors and other work surfaces

● High concentration, causing infrequent breaks

The following paragraphs provide a fewguidelines for working conditions when using acomputer.

Chair: A well-designed chair with easy-to-implement adjustability is essential. A user canvary angles of back support and the seat pan tocontrol the degree of pressure on the thighs andback. Weight should be evenly distributed, withno extreme pressure points. An upright posture isa little easier to achieve if the seat pan is tiltedslightly forward of horizontal. When a person isseated, feet should rest on the floor and the chairseat pan should be even with the back of the knee,ranging from 13 to 19 inches above the floordepending on an individual’s height. A foot restmay be used to relieve pressure on the thighs.Both lumbar and mid-level back support areneeded. Arm rests, adjustable for height, arehelpful to many people. The chair should have afive-point base for stability and casters for easymovement.

Keyboard: The keyboard provides the pri-mary means of interacting with a computer. Thekeyboard should be in a comfortable position,and wrists should ‘‘float’’ over the keyboardwhen keying with a light touch so wrists andforearms remain straight. Although wrist padsare helpful for resting when not keying, they canactually create problems when a user keeps wristson them when keying because the wrists canbend down. Different opinions exist on the ap-propriate angle of the keyboard; some peopleprefer a flat position while others find a reverseincline more comfortable. Split and curved key-boards are available, too. However, the most im-portant part of keyboard use is keeping the wristsstraight in line with the forearm and not bent tothe side. When voice-recognition technology be-comes commonly used, dependency on the key-board will be reduced.

Mouse: A mouse should be positioned next tothe keyboard, reachable without extending thearm in an awkward position. Again, a light touchis needed and users should avoid gripping orsqueezing the mouse. A wrist support or adjust-able mouse platform may be helpful if a userbegins to develop wrist problems. A variety ofshapes are available for these pointing devices,and a trackball can be used for the same purpose.

Monitor: A monitor should be directly infront of the user, with the top of the screen at orbelow the line of sight, 18 to 30 inches away fromthe eyes, and tiltable to avoid glare from overheadlighting and windows. If necessary, antiglare fil-ters can be added. Screen size should be largeenough for easy reading of screen character sizeswith a screen refresh rate fast enough to avoid avisible flicker. An individual can experience blur-red vision or fatigue from a poor monitor view-ing angle, reflected glare, or a low-quality moni-tor. Because glands in the eyelids produce tearsthat cleanse eyes as the eyelids blink and the eyesmove, irritated eyes can develop because one’sblink rate tends to decrease when one is concen-trating.

To avoid neck and eyestrain, an individualshould do the following:

● Use a copyholder positioned near the monitorto support material used with computer work.

● Use lower levels of lighting to reduce glare onmonitors. Many older offices have high illumi-nation levels that are necessary for paper-in-tensive tasks—but are too highly lighted forcomputer work. Softer overall, or ambient,lighting should be used, with task lightingadded to surfaces as needed for more illumi-nation.

● Relax eye muscles by shifting focus from thecomputer screen to distant objects for a fewseconds every 5 to 10 minutes.

● Take microbreaks to stretch the neck, shoul-ders, hands, wrists, back, and legs as well as torest the eyes. Stretching exercises can be sim-ple neck rotations, shoulder shrugs, fistsclenched and then released, or arms hangingdown naturally for a few moments. Get upand move around about every 30 minutes.Take a brisk walk if possible. Exercises with

ERGONOMICS


hand weights will help with stretching and willgive the body isometric exercise.

While it may be ideal to have individuallyadjustable temperature controls, this is not feasi-ble in many work situations. For business offices,most people are comfortable with temperaturelevels at 68� to 72� in the winter and 72� to 76� inthe summer. Humidity levels should be main-tained between 40 to 60 percent not only forcomfort but also for proper functioning of officeequipment. Indoor air quality involves morethan heating and cooling—air should becleansed of pollutants (bacteria, dust, fumes,etc.), with fresh air added before circulation.Many factors affect the efficiency of HVAC (heat-ing, ventilation, and air conditioning) systems.These systems must be designed for the numberof people and the equipment to be used in eacharea because computers and other devices canproduce almost as much heat as a human bodyproduces.

Another important concept is adjustability ofwork pace. Jobs may require redesign to allowworkers to accomplish tasks at varying speeds orto enable workers to rotate to different tasks or touse a variety of work methods that permit differ-ent movements. Rest breaks are important, too,and microbreaks can be taken to interrupt in-tense situations, to rest arms and wrists, or to resteyes.

Much ergonomics information is available inprint and on the Internet, published by organiza-tions such as the Occupational Safety and HealthAdministration (OSHA), the National Instituteof Occupational Safety and Health (NIOSH), theNational Safety Council, the Human Factors andErgonomic Society, and others. OSHA is devel-oping ergonomics program standards that wereto be published in 2000 (OSHA 1999). Consul-tants can provide technical expertise to help withall phases of ergonomics assessment and the im-plementation of corrective measures and/ortraining programs.

BIBLIOGRAPHY

‘‘Occupational Safety and Health Administration.’’http://www.osha�slc.gov/SLTC/ergonomics/. 1999.

PAT R. GRAVES


Ethics in accounting is of utmost importance toaccounting professionals and those who rely ontheir services. Certified Public Accountants(CPAs) and other accounting professionals knowthat people who use their services, especially de-cision makers using financial statements, expectthem to be highly competent, reliable, and objec-tive. Those who work in the field of accountingmust not only be well qualified but must alsopossess a high degree of professional integrity. Aprofessional’s good reputation is one of his or hermost important possessions.

The general ethical standards of society applyto people in professions such as medicine andaccounting just as much as to anyone else. How-ever, society places even higher expectations onprofessionals. People need to have confidence inthe quality of the complex services provided byprofessionals. Because of these high expectations,professions have adopted codes of ethics, alsoknown as codes of professional conduct. Theseethical codes call for their members to maintain alevel of self-discipline that goes beyond the re-quirements of laws and regulations.

CODES OF ETHICS

By joining their professional organizations, peo-ple who work in the field of accounting agree touphold the high ethical standards of their profes-sion. Each of the major professional associationsfor accountants has a code of ethics. The Code ofProfessional Conduct of the American Instituteof CPAs (AICPA), the national professional asso-ciation for CPAs, sets forth ethical principles andrules of conduct for its members. The principlesare positively stated and provide general guide-lines that CPAs (or any professionals, for thatmatter) should strive to follow. The rules of con-duct are much more explicit as to specific actions



that should or should not be taken. The Instituteof Management Accountants (IMA) Standards ofEthical Conduct applies to practitioners of man-agement accounting and financial management,and the Institute of Internal Auditors (IIA) Codeof Ethics applies to its members and to CertifiedInternal Auditors (CIAs).

ETHICAL RESPONSIBILITIES

A distinguishing mark of professions such asmedicine and accounting is acceptance of theirresponsibilities to the public. The AICPA Code ofProfessional Conduct describes the accountingprofession’s public as consisting of ‘‘clients,credit grantors, governments, employers, inves-tors, the business and financial community, andothers who rely on the objectivity and integrity ofCPAs to maintain the orderly functioning ofcommerce.’’ Many, but not all, CPAs work infirms that provide accounting, auditing, andother services to the general public; these CPAsare said to be in public practice. Regardless ofwhere CPAs work, the AICPA Code applies totheir professional conduct, although there aresome special provisions for those in public prac-tice. Internal auditors, management accountants,and financial managers most commonly are em-ployees of the organizations to which they pro-vide these services; but, as professionals, they,too, must also be mindful of their obligations tothe public.

The responsibilities placed on accountingprofessionals by the three ethics codes and therelated professional standards have many simi-larities. All three require professional compe-tence, confidentiality, integrity, and objectivity.Accounting professionals should only undertaketasks that they can complete with professionalcompetence, and they must carry out their re-sponsibilities with sufficient care and diligence,usually referred to as due professional care or duecare. The codes of ethics of the AICPA, IMA, andIIA all require that confidential informationknown to accounting professionals not be dis-closed to outsiders. The most significant excep-tion to the confidentiality rules is that accountingprofessionals’ workpapers are subject to sub-

poena by a court; nothing analogous to attorney-client privilege exists.

INDEPENDENCE

Maintaining integrity and objectivity calls foravoiding both actual and apparent conflicts ofinterest. This notion is termed independence. Be-ing independent in fact and in appearance meansthat one not only is unbiased, impartial, andobjective but also is perceived to be that way byothers. While applicable to all accounting profes-sionals, independence is especially important forCPAs in public practice. The AICPA’s rules per-taining to independence for CPAs who performaudits are detailed and technical. For instance, aCPA lacks independence and thus may not audita company if he or she (or the spouse or depen-dents) owns stock in that company and/or hascertain other financial or employment relation-ships with the client.

ETHICS ENFORCEMENT

To a large extent, the accounting profession isself-regulated through various professional asso-ciations rather than being regulated by the gov-ernment. The AICPA, the IMA, and the IIA haveinternal means to enforce the codes of ethics.Furthermore, the professional organizations forCPAs in each state, known as state societies ofCPAs, have mechanisms for enforcing their codesof ethics, which are usually very similar to theAICPA Code. Violations of ethical standards canlead to a person’s being publicly expelled fromthe professional organization. Because of the ex-treme importance of a professional accountant’sreputation, expulsion is a strong disciplinarymeasure. However, ethical violations can lead toeven more adverse consequences for CPAs be-cause of state and federal laws.

The state government issues a CPA’s licenseto practice, usually through an organizationknown as the state board of accountancy. Sincestate laws governing the practice of accountancytypically include important parts of the AICPACode, the Code thus gains legal enforceability.Consequently, ethical violations can result in thestate’s revoking a CPA’s license to practice on a



temporary or even permanent basis. Because alicensed CPA is also likely to belong to the AICPAand the state society of CPAs, investigations ofethics violations may be carried out jointly by theAICPA, the state society, and the state board ofaccountancy.

CPAs in public practice who audit the finan-cial statements of public corporations are subjectto federal securities laws and regulations, includ-ing the Securities Exchange Act of 1934. TheSecurities and Exchange Commission (SEC),which administers these laws, has broad powersto regulate corporations that sell their stock tothe public. One important SEC requirement isthat these corporations’ financial statements beaudited by an independent CPA. The SEC has theauthority to establish and enforce auditing stan-dards and procedures, including what constitutesindependence for a CPA. The SEC has largelydelegated standard setting to the private sectorbut retains oversight and enforcement responsi-bilities. In 1998 the SEC and the AICPA jointlyannounced the creation of the IndependenceStandards Board (ISB), a private-sector bodywhose mission is to improve auditor indepen-dence standards. In announcing the formation ofthe ISB, the SEC reaffirmed the crucial impor-t a n c e o f t h e CPA ’ s i n d e p e nd e n c e :‘‘[M]aintaining the independence of auditors offinancial statements . . . is crucial to the credibil-ity of financial reporting and, in turn, to thecapital formation process’’ (SEC Release FRR-50,1998).

(SEE ALSO: American Institute of Certified Public Ac-countants; Institute of Internal Auditors; Institute forManagement Accountants; State Societies of CPAs)

BIBLIOGRAPHY

AICPA Code of Professional Conduct. (1988). Jersey City,NJ: American Institute of Certified Public Accountants.

IMA. (1997). Statements on Management Accounting: Objec-tives of Management Accounting, Statement No. 1B. NewYork: Institute of Management Accountants.

IIA Code of Ethics. (1988). Altamonte Springs, FL: Instituteof Internal Auditors.

MARY BRADY GREENAWALT

ETHICS IN ECONOMICS

As might be suspected, early writings on ethicswere centered not on economics or business, butpersonal beliefs and actions. It becomes readilyapparent from early discussions of ethics thatphilosophers and writers viewed ethics as a mat-ter of choice. Individuals must make choices intheir lives. This is important to note—businessesdon’t make choices. Choices are made and/orimplemented by individuals within the economicenterprise. People in government make choices,people in educational institutions make choices,people in businesses make choices, people withchurches make choices; everyone is forced tomake choices, and even the choice not to chooseis a decision.

ETHICS IN ORGANIZATION

Velasquez (1982) illustrated some importantpoints regarding organizations and their acts rel-ative to individuals in the organization. Hestated:

I. A corporate organization ‘‘exists’’ only if(1) there exist certain human individualsplaced in certain circumstances and (2)our linguistic rules lay down that whenthose kinds of individuals exist in thosekinds of circumstances, they shall countas a corporate organization.

II. A corporate organization ‘‘acts’’ only if(1) certain human individuals in the or-ganization performed certain actions incertain circumstances and (2) our linguis-tic rules lay down that when those kindsof individuals perform those kinds of ac-tions in those kinds of circumstances, thisshall count as an act of their corporateorganization. (p. 16)

Linguistic rules are the rules of either writtenor spoken language. In the above quote, it ispointed out that individuals make up the corpo-ration or business and that the corporation actswhen these individuals carry out their assignedduties within the scope of the corporate author-ity. However, since it is human individuals on

ETHICS IN ECONOMICS


whom the corporation depends, it is these indi-viduals who are seen to be responsible for moralduties and issues.

Businesses are the most significant institu-tion in the economic structure. As such, busi-nesses are expected to produce goods and ser-vices that are demanded by members of society,and once produced, these goods and servicesmust be distributed to the numerous societalgroups. Decisions are made within the businessstructure about who will produce, howmuch willbe produced, how production will be implemen-ted, how the work will be organized, and how thefinished good or service will be made available tothe consuming members of society. All these de-cisions are necessary in the day-to-day operationof an economic institution, and all these choicesare made by people. It could be argued that com-puter models are used to make decisions, but itcan be further counter-argued that computermodels are developed by people and people arethe ones who implement recommendationsmade by computer modeling.

In order for people in all institutions to makechoices, there must be some guidelines or princi-ples upon which the choices are based. Theseguidelines are often referred to as values. Every-one develops a set of values, or preferences, be-ginning in early childhood—or perhaps even im-mediately from birth. These values stem fromhow people are raised, where they live, theirancestry, and all the other factors that influenceeveryone’s lives. If everyone has a value system,everyone must have an ethical system uponwhich to base judgments and choices. Stemmingfrom this personal set of values will come policiesand procedures that will guide all organizationswithin the economic structure.

Boulding (1968) argued that individuals havea ‘‘real’’ personal ethic, which can be deducedfrom a person’s actual behavior, and a ‘‘verbal’’ethic, which can be deduced from a person’sstatements. Boulding found that it is basically auniversal phenomenon that a person will talkabout one set of ethical principles but act accord-ing to another. The old statement ‘‘Do as I say,

not as I do’’ seems to reflect an accurate percep-tion of reality.

Ethics, from an economist’s perspective, is amatter of choice. Economics is a matter of choice.There are several alternatives from which achoice must be made. A business owner or man-ager might have to decide between producingweapons for military use or firearms for use byprivate individuals who pursue the sport of wildgame hunting. These decisions are not alwayseasy, especially when guided by the need for theorganization to make a profit. The choice that isultimately made is based on a value system thatinfluences policies and procedures in the organi-zation. In an economic environment, the deci-sion is often made based on values that have beendetermined to be most important or that areranked on a scale of best to worst.

A dilemma that faces all decision makers,especially when group decision making is used, isthe different value systems that are held by indi-viduals. While organizations have policies andprocedures, not every option from which tochoose is necessarily easily defined or clearlyunderstood. Many organizations have mecha-nisms through which those affected by the deci-sion can appeal it for further consideration. Inthe case of a university student who receives afailing grade but thinks the grade was undeservedbecause of a conflict with the professor, an appealby the student might be heard and a decisioncould be made to overturn the professor’s deci-sion. Or the decision might be made in favor ofthe professor and the student’s appeal denied.Such a decision is based on value systems thatguide ethical behaviors.

Decisions made by economic institutions donot always match what the general populacethinks is correct. When this happens, the resultcan be new laws or rules that are passed to try tocontain those who are perceived as violating thepublic trust. For example, many laws have beenpassed to curb problems with pollution. An-tipollution laws are designed to reduce the harm-ful effects of pollution; when a business does notfollow the laws, it can be severely penalized. Insome cases, the new laws force the closure of

ETHICS IN ECONOMICS


business enterprises because conformity to thelaws is cost-prohibitive. This was the case whenlaws went into effect requiring underground gas-oline tanks at service stations to meet Environ-mental Protection Agency requirements. Manybusinesses couldn’t meet the requirements be-cause of the expenses involved and they closedtheir doors.

At other times, businesses choose to violatethe laws in order to save money. In the long run,this can cost more than the business would havehad to pay had the changes been made to complywith the laws. This occurred when a chemicalmanufacturing company was caught dumpinghazardous waste into an Illinois River. The com-pany was told to stop the dumping and was fineda large sum of money. But during the time theenvironmental inspectors were on the premises,the company chose to dump more waste into theriver, saying that if they hadn’t done it, therecould have been a fatal accident in the plant.They were fined an additional sum. These exam-ples illustrate choices that must be made—not bybusinesses in economic systems, but by individu-als in the businesses.

It was stated earlier that businesses are themost significant institution within the economicstructure. It should also be noted, however, thatbusinesses are not the only institutions within aneconomic structure. There are many other im-portant groups, such as the family, government,churches, and schools. All these institutions playan important role in developing value systemsand the moral influences on individuals in busi-nesses.

Because many other institutions influencethe thinking of individuals in organizations, dif-ferent value systems are developed. Some valuesystems are inconsistent with what is necessaryfor successful business operations and become athreat to a business and economic system. Anexample of that is honesty. An individual whosevalue system does not include complete honestybecomes a threat to successful business opera-tions. Because of threats like these to economicentities, rules are established to deal with thosewho have different value systems. The rules are

called laws, and the government is the largestenforcer of laws.

Governments are important to successfulbusiness and economic operations. Governmentshelp to assure fair trade and commerce within acountry and internationally. A good example ofthis is when the U.S. government ordered thebreakup of the Bell Telephone System severalyears ago. It was felt that the system had growntoo large and that fair competition wasn’t possi-ble. When companies become monopolies, theycan set prices and control supplies of goods andservices in ways that might not be fair to con-sumers. A government can intervene to assurefair trade practices. Many laws have been writtento influence fair economic trade.

SETTING BUSINESS ETHICAL STANDARDS

Businesses make decisions that influence con-sumers, employees, and society in general. It ispeople who make up the businesses, and it ispeople who must set the standards for ethicalconduct. The process for setting standards needsto be a top-down approach—management mustdevelop and support an ethical code. Employeesmust understand what is expected of them inorder to follow the codes. Managers and employ-ees must be trained to interpret and consideralternatives relative to established ethical codes.In larger businesses, compliance offices are oftenestablished to assure that ethical codes are fol-lowed.

People outside the business must also knowwhat ethical standards are being followed, andthey must know that individuals within the com-pany who do not follow the prescribed ethicalcodes will be dealt with in a manner appropriateto the violation. This illustrates the need to en-force the ethical codes. If a business establishes anethical code but does not enforce it, the code willnot be followed.


Closely related to ethical codes are responsibili-ties that economic enterprises have to society.This is known as social responsibility. This is adifficult element of business operations because it

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normally means additional costs to the business.Social responsibility could mean making contri-butions to charitable organizations. An examplemight be a corporation donating land it is notusing to a conservation group for the develop-ment of a nature preserve.

Social responsibility also includes internalconsiderations, such as hiring minorities, estab-lishing on-site child-care facilities, controllingpollution, ensuring safe working conditions, pro-viding substance-abuse programs for employees,and manufacturing safe products. These are alleconomic decisions that have social effects bothwithin and outside the business.

Businesses that are concerned about socialresponsibility will conduct social audits. This is asystematic evaluation of the organization’s prog-ress toward implementing socially responsibleprograms. This is not a precise science and de-pends on interpretations of what is socially re-sponsive behavior. Again, these decisions must bemade by individuals within the business. Socialaudits do illustrate that a business is at least con-cerned about the social impact it has.

SUMMARY

Ethics is not easy for any business, and there willalways be individuals and/or groups who ques-tion the behaviors of institutions in our eco-nomic system. Our discussion has focused onbusinesses in the economic system, but othersystems such as churches, schools, and govern-mental agencies are also subjected to critical ethi-cal scrutiny. Ethics and social responsibility arethe concern of everyone, and it is up to individu-als to establish ethical codes and to follow them.

BIBLIOGRAPHY

Baylis, Charles A. (1958). Ethics: The Principles of WiseChoice. New York: Henry Holt.

Boulding, Kenneth E. (1968). Beyond Economics: Essays onSociety, Religion, and Ethics. Ann Arbor; MI: Universityof Michigan Press.

Bowne, Borden P. (1895). The Principles of Ethics. New York:Harper & Brothers.

Brandt, Richard B. (1979). A Theory of the Good and theRight. Oxford: Clarendon Press.

Facione, Peter A., Scherer, Donald, and Attig, Thomas.(1991). Ethics and Society. Englewood Cliffs, NJ: PrenticeHall.

Velasquez, Manuel G. (1982). Business Ethics: Concepts andCases. Englewood Cliffs, NJ: Prentice-Hall.

ROGER L. LUFT

ETHICS IN FINANCE

Ethics in general is concerned with human be-havior that is acceptable or ‘‘right’’ and that is notacceptable or ‘‘wrong’’ based on conventionalmorality. General ethical norms encompasstruthfulness, honesty, integrity, respect forothers, fairness, and justice. They relate to allaspects of life, including business and finance.Financial ethics is, therefore, a subset of generalethics.

Ethical norms are essential for maintainingstability and harmony in social life, where peopleinteract with one another. Recognition of others’needs and aspirations, fairness, and cooperativeefforts to deal with common issues are, for exam-ple, aspects of social behavior that contribute tosocial stability. In the process of social evolution,we have developed not only an instinct to care forourselves but also a conscience to care for others.There may arise situations in which the need tocare for ourselves runs into conflict with the needto care for others. In such situations, ethicalnorms are needed to guide our behavior. AsDemsey (1999) puts it: ‘‘Ethics represents the at-tempt to resolve the conflict between selfishnessand selflessness; between our material needs andour conscience.’’

Ethical dilemmas and ethical violations infinance can be attributed to an inconsistency inthe conceptual framework of modern financial-economic theory and the widespread use of aprincipal-agent model of relationship in financialtransactions. The financial-economic theory thatunderlies the modern capitalist system is basedon the rational-maximizer paradigm, whichholds that individuals are self-seeking (egoistic)and that they behave rationally when they seek tomaximize their own interests. The principal-

ETHICS IN FINANCE


agent model of relationships refers to an arrange-ment whereby one party, acting as an agent foranother, carries out certain functions on behalf ofthat other. Such arrangements are an integralpart of the modern economic and financial sys-tem, and it is difficult to imagine it functioningwithout them.

The behavioral assumption of the modernfinancial-economic theory runs counter to theideas of trustworthiness, loyalty, fidelity, steward-ship, and concern for others that underlie thetraditional principal-agent relationship. The tra-ditional concept of agency is based on moralvalues. But if human beings are rational maxi-mizers, then agency on behalf of others in thetraditional sense is impossible. As Duska (1992)explains it: ‘‘To do something for another in asystem geared to maximize self-interest is foolish.Such an answer, though, points out an inconsis-tency at the heart of the system, for a system thathas rules requiring agents to look out for otherswhile encouraging individuals to look out onlyfor themselves, destroys the practice of lookingout for others’’ (p. 61).

The ethical dilemma presented by the prob-lem of conflicting interests has been addressed insome areas of finance, such as corporate gover-nance, by converting the agency relationship intoa purely contractual relationship that uses a car-rot-and-stick approach to ensure ethical behaviorby agents. In corporate governance, the problemof conflict between management (agent) andstockholders (principal) is described as an agencyproblem. Economists have developed an agencytheory to deal with this problem. The agencytheory assumes that both the agent and the prin-cipal are self-interested and aim to maximizetheir gain in their relationship. A simple examplewould be the case of a store manager acting as anagent for the owner of the store. The store man-ager wants as much pay as possible for as littlework as possible, and the store owner wants asmuch work from the manager for as little pay aspossible. This theory is value-free because it doesnot pass judgment on whether the maximizationbehavior is good or bad and is not concernedwith what a just pay for the manager might be. It

drops the ideas of honesty and loyalty from theagency relationship because of their incompati-bility with the fundamental assumption of ratio-nal maximization. ‘‘The job of agency theory is tohelp devise techniques for describing the conflictinherent in the principal-agent relationship andcontrolling the situations so that the agent, actingfrom self-interest, does as little harm as possibleto the principal’s interest’’ (DeGeorge, 1992).The agency theory turns the traditional conceptof agency relationship into a structured (contrac-tual) relationship in which the principal can in-fluence the actions of agents through incentives,motivations, and punishment schemes. The prin-cipal essentially uses monetary rewards, punish-ments, and the agency laws to command loyaltyfrom the agent.

Most of our needs for financial services—management of retirement savings, stock andbond investing, and protection against unfore-seen events, to name a few—are such that theyare better entrusted to others because we haveneither the ability nor the time to carry them outeffectively. The corporate device of contrac-tualization of the agency relationship is, however,too difficult to apply to the multitude of financialdealings between individuals and institutionsthat take place in the financial market every day.Individuals are not as well organized as stock-holders, and they are often unaware of the agencyproblem. Lack of information also limits theirability to monitor an agent’s behavior. Therefore,what we have in our complex modern economicsystem is a paradoxical situation: the ever-in-creasing need for getting things done by otherson the one hand, and the description of humannature that emphasizes selfish behavior on theother. This paradoxical situation, or the inconsis-tency in the foundation of the modern capitalistsystem, can explain most of the ethical problemsand declining morality in the modern businessand finance arena.

ETHICAL VIOLATIONS

The most frequently occurring ethical violationsin finance relate to insider trading, stakeholderinterest versus stockholder interest, investment

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management, and campaign financing. Businessin general and financial markets in particular arereplete with examples of violations of trust andloyalty in both public and private dealings.Fraudulent financial dealings, influence peddlingand corruption in governments, brokers notmaintaining proper records of customer trading,cheating customers of their trading profits, unau-thorized transactions, insider trading, misuse ofcustomer funds for personal gain, mispricingcustomer trades, and corruption and larceny inbanking have become common occurrences.

Insider trading is perhaps one of the mostpublicized unethical behaviors by traders. Insidertrading refers to trading in the securities of acompany to take advantage of material ‘‘inside’’information about the company that is not avail-able to the public. Such a trade is motivated bythe possibility of generating extraordinary gainwith the help of nonpublic information (infor-mation not yet made public). It gives the traderan unfair advantage over other traders in thesame security. Insider trading was legal in someEuropean countries until recently. In the UnitedStates, the 1984 Trading Sanctions Act made itillegal to trade in a security while in the posses-sion of material nonpublic information. The lawapplies to both the insiders, who have access tononpublic information, and the people withwhom they share such information.

Campaign financing in the United States hasbeen a major source of concern to the publicbecause it raises the issue of conflict of interestfor elected officials in relation to the people orlobbying groups that have financed their cam-paigns. The United States has a long history ofcampaign finance reform. The Federal ElectionCommission (FEC) administers and enforces thefederal campaign finance statutes enacted by theCongress from time to time. Many states havealso passed lobbying and campaign finance lawsand established ethics commissions to enforcethese statutes.

ETHICAL CODES

Approaches to dealing with ethical problems infinance range from establishing ethical codes for

financial professionals to efforts to replace therational-maximizer (egoistic) paradigm thatunderlies the modern capitalist system by one inwhich individuals are assumed to be altruistic,honest, and basically virtuous.

It is not uncommon to find established ethi-cal codes and ethical offices in American corpo-rations and in financial markets. Ethical codes forfinancial markets are established by the officialregulatory agencies and self-regulating organiza-tions to ensure ethically responsible behavior onthe part of the operatives in the financial markets.

One of the most important and powerfulofficial regulatory agencies for the securities in-dustry in the United States is the Securities andExchange Commission (SEC). It is in charge ofimplementing federal securities laws, and, assuch, it sets up rules and regulations for theproper conduct of professionals operating withinits regulatory jurisdiction. Many professionalsplay a role within the securities industry, amongthe most important of which are accountants,broker-dealers, investment advisers, and invest-ment companies. Any improper or unethicalconduct on the part of these professionals is ofgreat concern to the SEC, whose primary respon-sibility is to protect investor interests and main-tain the integrity of the securities market. TheSEC can censure, suspend, or bar professionalswho practice within its regulatory domain forlack of requisite qualifications or unethical andimproper conduct. The SEC also oversees self-regulatory organizations (SROs), which includestock exchanges, the National Association of Se-curity Dealers (NASD), the Municipal SecuritiesRulemaking Board (MSRB), clearing agencies,transfer agents, and securities information pro-cessors. An SRO is a membership organizationthat makes and enforces rules for its membersbased on the federal securities laws. The SEC hasthe responsibility of reviewing and approving therules made by SROs.

Other rule-making agencies include the Fed-eral Reserve System, the Federal Deposit Insur-ance Corporation (FDIC), and state finance au-thorities. Congress has entrusted to the FederalReserve Board the responsibility of implementing

ETHICS IN FINANCE


laws pertaining to a wide range of banking andfinancial activities, a task that it carries outthrough its regulations. One such regulation hasto do with unfair or deceptive acts or practices.The FDIC has its own rules and regulations forthe banking industry, and it also draws its powerto regulate from various banking laws passed byCongress.

In addition to federal and state regulatoryagencies, various professional associations settheir own rules of good conduct for their mem-bers. The American Institute of Certified PublicAccountants (AICPA), the American Institute ofCertified Planners (AICP), the Investment Com-pany Institute (ICI), the American Society ofChartered Life Underwriters (ASCLU), the Insti-tute of Chartered Financial Analysts (ICFA), theNational Association of Bank Loan and CreditOfficers (also known as Robert Morris Associ-ates), and the Association for Investment Man-agement and Research (AIMR) are some of theprofessional associations that have well-publi-cized codes of ethics.

TOWARD A PARADIGM SHIFT

There has been an effort to address the ethicalproblems in business and finance by reexaminingthe conceptual foundation of the modern capital-ist system and changing it to one that is consis-tent with the traditional model of agency rela-tionship. The proponents of a paradigm shiftquestion the rational-maximizer assumption thatunderlies the modern financial-economic theoryand reject the idea that all human actions aremotivated by self-interest. They embrace an al-ternative assumption—that human beings are tosome degree ethical and altruistic—and empha-size the role of the traditional principal-agentrelationship based on honesty, loyalty, and trust.Duska (1992) argues: ‘‘Clearly, there is an extentto which [Adam] Smith and the economists areright. Human beings are self-interested and willnot always look out for the interest of others. Butthere are times they will set aside their interests toact on behalf of others. Agency situations werepresumably set up to guarantee those times.’’

The idea that human beings can be honestand altruistic is an empirically valid assumption;it is not hard to find examples of honesty andaltruism in both private and public dealings.There is no reason this idea should not be em-braced and nurtured. As Bowie (1991) pointsout: ‘‘Looking out for oneself is a natural, power-ful motive that needs little, if any, social rein-forcement. . . . Altruistic motives, even if they tooare natural, are not as powerful: they need to besocially reinforced and nurtured’’ (p. 19). If thefinancial-economic theory accepts the fact thatbehavioral motivations other than that of wealthmaximization are both realistic and desirable,then the agency problem that economists try todeal with will be a nonproblem. For Dobson(1993), the true role of ethics in finance is to befound in the acceptance of ‘‘internal good’’(‘‘good’’ in the sense of ‘‘right’’ rather than in thesense of ‘‘physical product’’), which, he adds, iswhat classical philosophers describe as ‘‘vir-tue’’—that is, the internal good toward which allhuman endeavor should strive. He contends: ‘‘Ifthe attainment of internal goods were to becomegenerally accepted as the ultimate objective of allhuman endeavor, both personal and profes-sional, then financial markets would becometruly ethical’’ (p. 60).

BIBLIOGRAPHY

Bowie, Norman E. (1991). ‘‘Challenging the Egoistic Para-digm.’’ Business Ethics Quarterly. 1. 1-4.

Bowie, Norman E., and Freeman, Edward R., eds. (1992).Ethics and Agency Theory: An Introduction. New York:Oxford University Press.

DeGeorge, Richard T. (1992) ‘‘Agency Theory and the Eth-ics of Agency.’’ In Norman E. Bowie and Edward R.Freeman, eds. Ethics and Agency Theory: An Introduction.New York: Oxford University Press.

Dempsey, Mike. (1999). ‘‘An Agenda for Window-Dressingor for Radical Change?’’ http://panopticon.csustan.edu/cpa99/html/dempsy.html.

Dobson, John. (1993). ‘‘The Role of Ethics in Finance.’’Financial Analysis Journal. November-December: 57-61.

Duska, Ronald R. (1992). ‘‘Why Be a Loyal Agent? A Sys-tematic Ethical Analysis.’’ In Ethics and Agency Theory:An Introduction. Norman E. Bowie and Edward R. Free-man, eds., New York: Oxford University Press.

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Frowen, S.F. and McHugh, F.P., eds. (1995). ed. FinancialDecision-Making and Moral Responsibility. New York:Macmillan.

Goodpaster, Kenneth E. (1991). ‘‘Business Ethics and Stake-holder Analysis.’’ Business Ethics Quarterly. 1. 53-71.

Nadler, Paul S. (1989). ‘‘Ethics and the Financial Commu-nity.’’ Secured Lender. January-February.

ANAND G. SHETTY

ETHICS ININFORMATION PROCESSING

New technologies in information processing of-ten raise ethical concerns, resulting from theircreating new possibilities for human action.Computer ethics can be defined as moral philoso-phy concerning the ethical dilemmas involved inareas of information processing, including theo-ries, approaches in decision-making situations,and methods of increasing awareness of ethics.These ethical and moral issues are among themost socially important aspects of informationprocessing. There are two major problems in thearea: (1) unethical behavior leading to immoralacts such as virus creation and software piracyand (2) lack of awareness about informationtechnology security and information technology-related crimes (Siponen and Kajava, 1999).

Ethics in information processing is consid-ered so important that the Computer Ethics In-stitute developed the following Ten Command-ments of Computer Ethics.

Thou shalt not use a computer to harmother people.

Thou shalt not interfere with other peo-ple’s computer work.

Thou shalt not snoop around in otherpeople’s computer files.

Thou shalt not use a computer to steal.

Thou shalt not use a computer to bearfalse witness.

Thou shalt not copy or use proprietarysoftware for which you have not paid.

Thou shalt not use other people’s com-puter resources without authorization orproper compensation.

Thou shalt not appropriate other people’sintellectual output.

Thou shalt think about the social conse-quences of the program you are writing orthe system you are designing.

Thou shalt always use a computer in waysthat ensure consideration and respect foryour fellow humans.

INFORMATION-PROCESSING ETHICSAND BUSINESS

Ethical issues raised by information processing inbusiness include confidentiality of data, softwarepiracy, hacking, and stealing the property ofothers. In order to determine the ethical knowl-edge and behavior of young people, a survey of780 high school and university business studentswas conducted (Vincent and Meche, 1998). Theethical knowledge survey was made up of nine-teen questions, six of which were the informa-tion-processing questions shown in Table 1.

All of the actions in Table 1 are unethical.The responses shown in the table demonstratethat ethical problems exist among young people.As can be seen, some do not recognize ethicaldilemmas, and many would participate in uneth-ical behavior regardless. For instance, revealingconfidential information, stealing the ideas ofothers, copying software, and punching the timeclock from home are unethical behaviors. Unau-thorized copying of software—software piracy—is stealing. Besides being strictly illegal in manycountries, it is morally wrong, because it violatesthe right of the owners of the software to receivepayment for the use of their invention. Illegalsoftware amounts to more than 90 percent of allsoftware used in some Asian countries, at least 75percent in Eastern Europe, and less than 33 per-cent in the United States (Siponen and Kajava,1999) . Add i t i ona l l y , a c co rd ing to aComputerworld survey of 255 information sys-tems professionals in corporate America, 53 per-cent have made unauthorized copies of commer-

ETHICS IN INFORMATION PROCESSING


Use of Information

1. You are the payroll clerk and know what everyone's salary is. A raise will be given next month. You feel that it would be OK to tell a few of your closest friends what they will be getting.

2. Your job is in jeopardy because you have displayed very little initiative. You need this job because you have a family to support. You use a colleague's computer and see a proposal for a new product. You write it up as your own.

3. Today is the third day you have had trouble getting to work on time. You can punch in by computer from your home. You do it "just for today" so that you do not lose your job.

4. You work for the phone company and have access to private/unlisted numbers. A friend calls you, saying he must make an emergency call; and he needs to know a number that is unlisted. You give your friend the number.

5. A really nice word processing program is on the computer in your office. You would like to have it on your home computer, so you copy it.

6. You work in a bank and have access to all bank account records. Out of curiosity, you check to see what your friends' bank balances are.

% Ethical % Would You Do It?

High High School Univ School Univ Yes Yes Yes Yes

0.36 0.27 0.54 0.29

0.15 0.12 0.25 0.15

0.15 0.10 0.48 0.35

0.17 0.17 0.39 0.42

0.33 0.33 0.59 0.56

0.10 0.13 0.23 0.21

Table 1

cial software (‘‘Results of a Survey,’’ 1995). Thetypical reason given was to try it out before buy-ing it.

Hacking and virus creations are seriouscrimes that must be treated just like other crimi-nal offenses. Generally speaking, hacking isbreaking into other people’s property; it is animmoral action that cannot be justified underany circumstances. One of the most popularhackers’ arguments is that ‘‘electrons are free—they do not belong to anybody.’’ This premise isinvalid; there is no reason why electrically com-mitted crimes should be treated differently fromphysical crimes (Siponen, 1997).

Information on the Net, including thousandsof databases and more than four hundred maga-zines, is extremely hard to control. Search en-gines or robots have been designed to search forspecific information in this immense collectionof data. When a search engine filters or controlsall the information that a person accesses, there isthe danger that the person’s view of the topic will

become narrowed (Pedersen, 1996). This offersthe designers of search engines an opportunity tomanipulate people’s minds by controlling the in-formation they receive. Additionally, onlineshopping creates the possibility of disclosure offinancial information, such as credit card infor-mation, to unauthorized parties.

Questions have arisen concerning computergraphics. For example, should graphical re-crea-tions of incidents such as automobile accidentsbe allowed to be used in courtrooms? Is it rightfor an individual to electronically reproduce andthen alter an artistic image originally created bysomeone else. It is apparent that there should beclear rules and regulations concerning cyberspace(Johnson, 1994).

INFORMATION-PROCESSING ETHICSAND ETIQUETTE

Courtesy in information processing is often re-ferred to as Netiquette—or etiquette on the In-ternet. E-mail and chat room etiquette is central



to courtesy in cyberspace. In both situations peo-ple should follow the Golden Rule: ‘‘Do untoothers as you would have them do unto you.’’

Regarding e-mail, one should respondpromptly to e-mail messages; think twice beforesending personal information and private letterson business systems; not send flame mail (mailwritten in anger); not send duplicate copies ofprivate e-mail without letting the recipient knowwho else is getting it; and not send unsolicitedmail, such as pyramid schemes, chain letters, andjunk mail.

Schools and employers should establishe-mail policies, present them in writing, and havetraining sessions for all involved. Lack of ane-mail policy creates legal risks. Often, the com-pany is responsible for the e-mail of its employ-ees. Additionally, e-mail is not a secure medium.Many company policy statements say that e-mailis owned or co-owned by the company and thatthe company has a right to inspect it. The federalElectronic Communication Privacy Act of 1986prohibits the interception of any wire, oral, orelectronic communication, but there is a businessexception to the law that allows employers tointercept such communications that are deemedwork-related.

Chat room etiquette involves communicat-ing with others over the Internet. The same eti-quette used in personal conversation should beobserved here. Anonymity does not excuse badbehavior.

INFORMATION-PROCESSING ETHICSAND PORNOGRAPHY

Currently computer pornography means de-piction of actual sexual contact (hard-core) anddepiction of nudity or lewd exhibition (soft-core). The courts and numerous U.S. statutesconcur with the distinction between hard-coreand soft-core pornography. Not all pornographymeets the legal test for obscenity, however, norare all depictions of sexual activity deemed por-nographic (Albee, 1999). Pornography and ob-scenity certainly raise a few moral questions: Arepornographic materials morally objectionable ornot? Is it right for the state to regulate access to

pornographic material by consenting adults? Inall the confusion one point should be made: Por-nography degrades human beings.

Feminists consider pornography to be de-meaning to women, contributing to their beingseen as objects of desire and control for men.Some religious leaders maintain that pornogra-phy ought to be banned because it is morallywrong. Meanwhile pornography continues to bea huge force in the social and personal context(Albee, 1999).

CODES OF ETHICS ININFORMATION PROCESSING

The following guidelines should be consideredwhen developing codes of ethics for schools andbusinesses:

1. Identify prevailing social values before ad-dressing current issues in the school orworkplace. Examples of ethical values im-portant to society might include trustwor-thiness, responsibility, respect, empathy,fairness, and citizenship.

2. In composing the code of ethics, give ex-amples of behaviors that reflect eachvalue.

3. Have key members of the organizationreview the code and provide input.

4. Review any rules or values incorporatedinto the code to assure that they adhereto relevant laws and regulations; this en-sures that the school or organization isnot breaking any of them.

5. Indicate that all employees are expectedto conform to the values stated in thecode of ethics.

6. Announce and distribute the new code ofethics to all involved.

7. Update the code at least once a year.

Examples of topics typically addressed incodes of ethics include: dressing appropriately;avoiding illegal drugs; following the instructionsof superiors; being reliable and prompt; main-taining confidentiality; not accepting personalgifts from stakeholders; avoiding discrimination



based on race, gender, age or sexual orientation;avoiding conflicts of interest; complying withlaws and regulations; not using the organization’sproperty for personal use; and reporting illegal orquestionable activity (McNamara, 1998).

TEACHING INFORMATIONPROCESSING ETHICS

In direct and indirect ways people begin to learnethical values from birth. While the family andreligious institutions are assigned the primary re-sponsibility for ethical education, schools havetraditionally been charged with teaching and re-inforcing moral values, especially those directlyrelated to school behaviors. Since many of theethical issues that surround technology deal withschool behaviors, they are an appropriate andnecessary part of the school curriculum. Schoolsmust create technology environments that helpstudents avoid temptations. Computer screensthat are easily monitored, use of passwords, andlogging in and out of secure network systems,along with videotaping of lab areas, all help re-move the opportunities for technology misuse inthe media center or classroom.

Teachers and leaders of student groups whowant to promote good ethical behavior can usemethods such as creating codes of ethics, usingstories of good or bad ethical behavior as exam-ples in discussions, inviting speakers, and usingcase studies, role playing, games, simulations,and mock trials. Of primary importance is theteacher’s or student leader’s own behavior, whichshould be exemplary. Technology privilegesshould not be given to students until they havedemonstrated that they know and can apply ethi-cal standards and school policies.

Finally, measures should be taken to improvethe solutions to the ethical dilemmas that arise ininformation processing. There is a need for morespecific professional guidelines and codes of eth-ics; research on ethical problems; education andtraining; and cooperation among all who are in-volved with information-processing ethics, in-cluding, but not limited to, theologians, philoso-phers, computer scientists, educators, businesspeople, and attorneys.

BIBLIOGRAPHY

Albee, Reid D. ‘‘Ethical Dimensions: Ethical Considerationsof Pornography.’’ http://www/umm.maine.edu/BSED/students/ReidAlbee/ra360.html. 1999.

Johnson, Deborah G. (1994). Computer Ethics, 2nd. ed.Englewood Cliffs, NJ: Prentice Hall.

McNamara, Carter. ‘‘Complete Guide to Ethics Manage-ment: An Ethics Toolkit for Managers.’’ http://www.mapnp.org/library/ethics/ethxgde.htm�anchor41892.1998.

Pedersen, Christian H. (1996). ‘‘Agents Searching Informa-tion from Networks.’’ Magazine of Science.

‘‘Results of a Survey of Information Systems Professionals inthe United States.’’ [1995]. Computerworld May 2:p. 1.

Siponen, Mikko T. (1997). ‘‘The Applicability of EthicalTheories to Computer Ethics—Selected Issues.’’ Unpub-lished manuscript.

Siponen, Mikko T., and Kajava, Jorma. ‘‘Computer Ethics—The Most Vital Social Aspect of Computing: SomeThemes and Issues Concerning Moral and Ethical Prob-lems in Information Technology.’’ http://www/ifi.uio.no/isis20/proceedings/12.htm. 1999.

Vincent, Annette, and Meche, Melanie. (1998). ‘‘Knowledgeof Ethics Among Teens and Young Adults.’’ Ethics andCritical Thinking December:Part 1, Section 4, pp. 1-11.

ANNETTE VINCENTMELANIE A. MECHE


This article deals with ethical problems in law inthe context of business operations. A lawyer isprofessionally qualified to give businesspersonsadvice on what the law is; judges are authorizedto decide what the law is; and legislatures, withinthe limits of the Constitution, may make the law.Religious organizations and other organizationsmake many statements about what is ethical, butunless the ethical norms are written into law, theyare not enforceable and, to some extent, remain amatter of personal opinion.

This article is intended to raise issues of eth-ics in law for business that may be discussed anddebated. It also provides a framework from Aris-totle to aid in the discussion of determining themost ethical course. In each case questions maybe asked as follows:



1. What are the ethical choices in makingthis decision?

2. Does the law require the businesspersonto make ethical choices?

3. Should the law require the businesspersonto make ethical choices?

WHAT IS LAW?

Law for business consists of a set of requirednorms of behavior. The essence of law is that itcommands behavior under threat of punishmentor sanction. Tax law requires the payment ofmoney to the government; there is no choice.Contracts are entered into voluntarily, but onceentered into they may be enforced through thecourts. Many laws have no particular ethical con-tent. Many laws require ethical behavior, and, inrare cases, some laws may require unethical be-havior. Frequently the law allows the business-person the choice to be either ethical or unethi-cal. In those cases the question arises: Should thelaw require ethical behavior?

WHAT IS ETHICS?

The Greek word ethos means ‘‘habit.’’ The Greekphilosopher Aristotle taught that the ethical per-son is one who has virtuous habits. Among thevirtues are courage, temperance, honor, goodtemper, truthfulness and justice. Virtues can belearned through education and practice. Aristotlebelieved virtue and consequent ethical behaviorcan be learned. He went on to say that we all seek‘‘the good life,’’ which comes when we live in asociety of ethical persons—that is, those whobehave virtuously. This philosophy can serve as amodel for our discussion. We must decide whatthe elements of ‘‘the good life’’ are (wealth, secu-rity, freedom, opportunity). Next, what in a givenbusiness situation would be ethical (virtuous be-havior), and does the law require or should thelaw require ethical behavior? In the followingparagraphs areas of business law that have ethicalissues are considered. The reader is invited toexamine the issues in light of the above ethicalmodel.

CONTRACTS AND ETHICS

Business is about making and selling productsand exchanging goods and services. When a con-tractor orders a load of bricks to build a houseand then in turn sells the house or hires a worker,it is a constant process of making and fulfillingcontracts. A contract is a promise to do some-thing. It may be to deliver goods, to perform aservice (say, to paint a house), or possibly toemploy or be employed by another. The veryprocess of business is making and fulfilling con-tracts. Without contracts, no business would bepossible. There are many ethical issues involvedin making contracts.

For most legal purposes, a person becomesan adult at age eighteen. Before that, a minor maydisaffirm an otherwise legal agreement, a provi-sion that exists to protect minors from abuse byoverreaching adults. What should the rights andresponsibilities of minors be? What about adultswho are mentally incompetent or insane?

What about adults of normal intelligence andcapacity? Suppose a loan is made on the follow-ing terms: ‘‘Here is a loan of $20. You will giveme $21 back in a week.’’ This is an interest rate of5 percent a week, which is 5 percent� 52, or 260percent a year. This contract is illegal in moststates. Suppose a fast-talking but honest sales-person sells goods on credit in the buyer’s home.Buyers must be told in writing that they havethree days to change their minds. Is this ethical?

Under the law of contract, when a transac-tion is completed, it is final. Suppose a personbuys a set of green towels and then decides acouple of days later that red towels would lookbetter. The store could legally say, ‘‘you boughtthem, there’s nothing wrong with them; they areyours.’’ If a sign in the store said ‘‘All returnsmust be made within 30 days,’’ that sign becomespart of the contract. Frequently signs warn ‘‘Noreturns on prom and party dresses.’’ This reinfor-ces what the contract already is. A good returnpolicy is simply good business, but the law leavesthe ethics of returns up to the store. What returnpolicy is the most ethical for business?



WARRANTIES

A warranty is part of a business contract. It isessentially a binding promise that the product isfit for its intended purposes, is free of defects, andworks. Most products of any complexity comewith a ‘‘limited warranty,’’ which most com-monly warrants parts and labor for one year. Alsocommon these days are the sales of extendedwarranties that extend the one-year warranty upto three or even five years. This allows manufac-turers and sellers to write warranties in almostany fashion. The ethical questions are: To whatextent should a company stand behind its prod-ucts? At what point is it ethically correct for thecustomer to accept the risk of a defective prod-uct?

The way warranties are written can raise ethi-cal problems. In an automobile, tires and batte-ries wear out and are subject to very limitedwarranties; however, a modern automobile con-sists of thousands of parts—any one of whichmay give out or be defective. Warranty descrip-tions, even when plainly written, can be confus-ing as to what is included and what is excluded.What, then, is an ethical automobile warranty?

ADVERTISING

Everyone is aware that there is much criticism ofthe ethics of advertising. False advertising isagainst the law, and all would agree it is unethi-cal. Famous cases involve a product that was ben-eficial in many ways but was falsely claimed toprevent colds. In another case, an aspirin com-pany claimed its aspirin was more effective thanothers.

If a store advertises ‘‘apples—5 pounds for$2.50,’’ it must have a ‘‘reasonable quantity’’ onhand; it is considered good business practice togive ‘‘rain checks,’’ but doing so is not legallyrequired. It is also against the law to advertise aproduct at a very low price with the intention oftrying to talk customers into higher-priced prod-ucts. This is known as ‘‘bait and switch.’’

The law allows what is known as sales ‘‘puf-fery.’’ This is an emphasis on subjective qualities,such as that a car is beautiful and will make you

‘‘feel good,’’ or that a high-fat food ‘‘tastes good’’without mentioning the health risks of excess fat.It is easy to look at advertisements and identifysales puffery and half-truths. What is the ethicalline?

It is against the law to advertise illegal prod-ucts, such as controlled substances. But whatabout legal products that are harmful? Cigarettesmay not now be advertised on television or onbillboards. Should the ban be extended to adver-tising in magazines?

Truthful advertising is part of freedom ofspeech. What other restrictions, if any, should bepart of law? What about advertisements for alco-hol?

EMPLOYMENT LAW

Few areas of law mix law and ethics as much asemployment law. Surely employment is criticalto our welfare and thus is of keen interest andsubject to much emotional debate.

Employment-at-Will While government em-ployees and unionized workers enjoy more jobprotection, most employees in the United Statesare employed at will. The law allows them to befired for cause or for no cause. A boss, under thelaw, may fire even a long-term employee simplybecause the boss does not like the person. In mostother industrialized countries employees, after aprobationary period, can be fired only for cause(e.g. they are incompetent or steal companyproperty). American law seems to be less ethical.What arguments can be made for American law?

Employment Discrimination Law The UnitedStates made a major commitment to putting eth-ics into law through the Civil Rights Act of 1964,which forbids employment discrimination basedon race, religion, creed, national origin, or sex.Other categories, including age and disability sta-tus, have been added since then. Most peopleagree that the United States had great problemsof employment discrimination and that today,despite substantial progress, many problems re-main. There are many ethical questions. Virtuallyeveryone would agree that it is unethical to dis-criminate both because it is wrong and because it



violates the law. Should the law compel busi-nesses to be ethical and not discriminate?

Jobs Overseas Since almost everyone agreesthe American civil rights laws serve an ethicalpurpose, should American business voluntarilyimplement these laws as policy in their opera-tions in foreign countries that do not have similarlaws?

Wages are substantially lower in many coun-tries, such as Mexico, than in the United States.Many companies have moved all or part of theiroperations to Mexico. The law allows this. Whatethical obligation does a company have to Ameri-can workers who in many cases will not findcomparable employment? What do managersethically owe to workers and what to the share-holders or owners? What, then, are the ethicalobligations to potential Mexican workers whomay be eager to take the jobs even though thepay, benefits, and protection are well below U.S.standards? This, in fact, is a whole area of ethicaldiscussion. What standards of employment (pay,benefits, job protection) should American com-panies and consumers demand when we make orbuy goods produced in a foreign country?

ENVIRONMENT

Along with civil rights, the environmental move-ment has been another great crusade. The pur-pose of environmentalism is to protect the planetnot only for ourselves but also for those whocome after us. Compliance with environmentallaw would seem a basic ethical norm. How farshould environmental law go? Chemical compa-nies that make products we all use everyday, bythe nature of their business, pollute the environ-ment. What is the ethical position of a chemicalcompany in spending money lobbying the publicand Congress on new laws and enforcement ofexisting ones? Automobiles still pollute the atmo-sphere, although much less than in the past.Gasohol is a motor fuel made in part from etha-nol, which is made from corn, but it is moreexpensive than gasoline. What are the ethical is-sues surrounding ethanol?

Global warming is an important environ-mental issue. According to some, our planet isgradually growing warmer due to pollutants. Thiscould end or radically change life on earth.Others say that the earth naturally warms andcools and that there is no evidence to suggest thatthere has been any significant change because ofpollution. What should be the ethical position ofcitizens, especially companies that stand to eitherlose or gain by governmental measures taken?

As with civil rights law, many countries haveless stringent laws than the United States regard-ing environmental issues. American companieswith operations in these countries can pollutemuch more than in the United States. It is alsoan important point that pollution does not re-spect national borders. What are the ethicalnorms that a company should consider in mak-ing its policy?

CONCLUSIONS

Aristotle said that deciding what is the best ethi-cal course is not easy. Reasonable people willdisagree on what is right. This article is intendedto raise questions, not to provide answers. Manymore issues of ethics in law for business could beconsidered. The ultimate, overreaching questionsare: What is an ethical company and to whatextent should law require ethics?

BIBLIOGRAPHY

Bagley, Constance E. (1999). Managers and the Legal Envi-ronment, 3d ed. St. Paul, MN: West Publishing Com-pany.

Charley, Robert N. (1996). The Legal and Regulatory Envi-ronment of Business, 10th ed. New York: McGraw Hill.

Cheeseman, Henry R. (1997). Contemporary Business Law,2d ed. Upper Saddle River, NJ: Prentice-Hall.

Mann, Richard A., and Roberts, Barry S. (1999). Smith andRoberson’s Business Law, 11th ed. St. Paul, MN: WestPublishing Company.

McGuire, Charles. (1998). The Legal Environment of Busi-ness, 3d ed. Dubuque, IA: Kendall/Hunt PublishingCompany.

CARSON VARNER




Managers in today’s business world increasinglyneed to be concerned with two separate but inter-related concerns—business ethics and social re-sponsibility.

BUSINESS ETHICS

Perhaps the most practical approach to view eth-ics is as a catalyst that causes managers to takesocially responsible actions. The movementtoward including ethics as a critical part of man-agement education began in the 1970s, grew sig-nificantly in the 1980s, and is expected to con-tinue growing. Hence, business ethics is a criticalcomponent of business leadership. Ethics can bedefined as our concern for good behavior. Wefeel an obligation to consider not only our ownpersonal well-being but also that of other humanbeings. This is similar to the precept of theGolden Rule: Do unto others as you would havethem do unto you. In business, ethics can bedefined as the ability and willingness to reflect onvalues in the course of the organization’s deci-sion-making process, to determine how valuesand decisions affect the various stakeholdergroups, and to establish how managers can usethese precepts in day-to-day company opera-tions. Ethical business leaders strive for fairnessand justice within the confines of sound manage-ment practices.

Many people ask why ethics is such a vitalcomponent of management practice. It has beensaid that it makes good business sense for manag-ers to be ethical. Without being ethical, compa-nies cannot be competitive at either the nationalor international levels. While ethical manage-ment practices may not necessarily be linked tospecific indicators of financial profitability, thereis no inevitable conflict between ethical practicesand a firm’s emphasis on making a profit; oursystem of competition presumes underlying val-ues of truthfulness and fair dealing.

The employment of ethical business practicescan enhance overall corporate health in threeimportant areas. The first area is productivity.The employees of a corporation are stakeholders

who are affected by management practices. Whenmanagement considers ethics in its actionstoward stakeholders, employees can be positivelyaffected. For example, a corporation may decidethat business ethics requires a special effort toensure the health and welfare of employees.Many corporations have established employeeadvisory programs (EAPs) to help employeeswith family, work, financial, or legal problems, orwith mental illness or chemical dependency.These programs can be a source of enhancedproductivity for a corporation.

A second area in which ethical managementpractices can enhance corporate health is by posi-tively affecting ‘‘outside’’ stakeholders, such assuppliers and customers. A positive public imagecan attract customers. For example, a manufac-turer of baby products carefully guards its publicimage as a company that puts customer healthand well-being ahead of corporate profits, as ex-emplified in its code of ethics.

The third area in which ethical managementpractices can enhance corporate health is in min-imizing regulation from government agencies.Where companies are believed to be acting un-ethically, the public is more likely to put pressureon legislators and other government officials toregulate those businesses or to enforce existingregulations. For example, in 1990 hearings wereheld on the rise in gasoline and home heating oilprices following Iraq’s invasion of Kuwait, in partdue to the public perception that oil companieswere not behaving ethically.

A CODE OF ETHICS

A code of ethics is a formal statement that acts asa guide for how people within a particular orga-nization should act and make decisions in anethical fashion. Ninety percent of the Fortune 500firms, and almost half of all other firms, haveethical codes. Codes of ethics commonly addresssuch issues as conflict of interest, behaviortoward competitors, privacy of information, giftgiving, and making political contributions. Ac-cording to a recent survey, the development anddistribution of a code of ethics within an organi-zation is perceived as an effective and efficient



means of encouraging ethical practices within or-ganizations (Ross, 1988).

Business leaders cannot assume, however,that merely because they have developed anddistributed a code of ethics an organization’smembers have all the guidelines needed to deter-mine what is ethical and will act accordingly.There is no way that all situations that involveethical decision making an organization can beaddressed in a code. Codes of ethics must bemonitored continually to determine whetherthey are comprehensive and usable guidelines formaking ethical business decisions. Managersshould view codes of ethics as tools that must beevaluated and refined in order to more effectivelyencourage ethical practices.

CREATING AN ETHICAL WORKPLACE

Business managers in most organizations com-monly strive to encourage ethical practices notonly to ensure moral conduct but also to gainwhatever business advantage there may be inhaving potential consumers and employees re-gard the company as ethical. Creating, distrib-uting, and continually improving a company’scode of ethics is one usual step managers can taketo establish an ethical workplace.

Another step managers can take is to create aspecial office or department with the responsibil-ity of ensuring ethical practices within the orga-nization. For example, management at a majorsupplier of missile systems and aircraft compo-nents has established a corporate ethics office.This ethics office is a tangible sign to all employ-ees that management is serious about en-couraging ethical practices within the company.

Another way to promote ethics in theworkplace is to provide the work force with ap-propriate training. Several companies conducttraining programs aimed at encouraging ethicalpractices within their organizations. Such pro-grams do not attempt to teach what is moral orethical but, rather, to give business managerscriteria they can use to help determine how ethi-cal a certain action might be. Managers then canfeel confident that a potential action will be con-

sidered ethical by the general public if it is consis-tent with one or more of the following standards:

1. The Golden Rule: Act in a way you wouldwant others to act toward you.

2. The utilitarian principle: Act in a way thatresults in the greatest good for the great-est number.

3. Kant’s categorical imperative: Act in sucha way that the action taken under the cir-cumstances could be a universal law, orrule, of behavior.

4. The professional ethic: Take actions thatwould be viewed as proper by a disinter-ested panel of professional peers.

5. The TV test: Always ask, ‘‘Would I feelcomfortable explaining to a national TVaudience why I took this action?’’

6. The legal test: Ask whether the proposedaction or decision is legal. Establishedlaws are generally considered minimumstandards for ethics.

7. The four-way test: Ask whether you cananswer ‘‘yes’’ to the following questionsas they relate to the decision: Is the deci-sion truthful? Is it fair to all concerned?Will it build goodwill and better friend-ships? Will it be beneficial to all con-cerned?

Finally, managers can take responsibility forcreating and sustaining conditions in which peo-ple are likely to behave ethically and for minimiz-ing conditions in which people might be temptedto behave unethically. Two practices that com-monly inspire unethical behavior in organiza-tions are giving unusually high rewards for goodperformance and unusually severe punishmentsfor poor performance. By eliminating such fac-tors, managers can reduce much of the pressurethat people feel to perform unethically. They canalso promote the social responsibility of the orga-nization.


The term social responsibility means differentthings to different people. Generally, corporate



social responsibility is the obligation to take ac-tion that protects and improves the welfare ofsociety as a whole as well as organizational inter-ests. According to the concept of corporate socialresponsibility, a manager must strive to achieveboth organizational and societal goals. Currentperspectives regarding the fundamentals of socialresponsibility of businesses are listed and dis-cussed through (1) the Davis model of corporatesocial responsibility, (2) areas of corporate socialresponsibility, and (3) varying opinions on socialresponsibility.

A model of corporate social responsibilitydeveloped by Keith Davis (1975) provides fivepropositions that describe why and how busi-nesses should adhere to the obligation to takeaction that protects and improves the welfare ofsociety and the organization:

Proposition 1: Social responsibility arisesfrom social power.

Proposition 2: Business shall operate as anopen system, with open receipt of inputsfrom society and open disclosure of its op-eration to the public.

Proposition 3: The social costs and benefitsof an activity, product, or service shall bethoroughly calculated and considered indeciding whether to proceed with it.

Proposition 4: Social costs related to eachactivity, product, or service shall be passedon to the consumer.

Proposition 5: Business institutions, as citi-zens, have the responsibility to become in-volved in certain social problems that areoutside their normal areas of operation(pp. 20-23).

The areas in which business can become in-volved to protect and improve the welfare ofsociety are numerous and diverse. Some of themost publicized of these areas are urban affairs,consumer affairs, environmental affairs, and em-ployment practices. Although numerous busi-nesses are involved in socially responsible activi-ties, much controversy persists about whethersuch involvement is necessary or appropriate.

There are several arguments for and against busi-nesses performing socially responsible activities.

The best-known argument supporting suchactivities is that because business is a subset ofand exerts a significant impact on society, it hasthe responsibility to help improve society. Sincesociety asks no more and no less of any of itsmembers, why should business be exempt fromsuch responsibility? Additionally, profitabilityand growth go hand in hand with responsibletreatment of employees, customers, and the com-munity. However, studies have not indicated anyclear relationship between corporate social re-sponsibility and profitability (Aupperle, Caroll,and Hatfield, 1985; McGuire, Sundgren, andSchneeweis, 1988).

One of the better known arguments againstsuch activities is advanced by the distinguishedeconomist Milton Friedman. Friedman (1989)argues that making business managers simulta-neously responsible to business owners for reach-ing profit objectives and to society for enhancingsocietal welfare represents a conflict of interestthat has the potential to cause the demise ofbusiness. According to Friedman, this demisealmost certainly will occur if business continuallyis forced to perform socially responsible behaviorthat is in direct conflict with private organiza-tional objectives. He also argues that to requirebusiness managers to pursue socially responsibleobjectives may be unethical, since it requiresmanagers to spend money that really belongs toother individuals.

Regardless of which argument or combina-tion of arguments particular managers mightsupport, they generally should make a concertedeffort to perform all legally required socially re-sponsible activities, consider voluntarily per-forming socially responsible activities beyondthose legally required, and inform all relevantindividuals of the extent to which their organiza-tion will become involved in performing sociallyresponsible activities.

Federal law requires that businesses performcertain socially responsible activities. In fact, sev-eral government agencies have been establishedto develop such business-related legislation and



to make sure the laws are followed. The Environ-mental Protection Agency has the authority torequire businesses to adhere to certain sociallyresponsible environmental standards. Adherenceto legislated social responsibilities represents theminimum standard of socially responsible per-formance that business leaders must achieve.Managers must ask themselves, however, how farbeyond the minimum they should attempt togo—a difficult and complicated question thatentails assessing the positive and negative out-comes of performing socially responsible activi-ties. Only those activities that contribute to thebusiness’s success while contributing to the wel-fare of society should be undertaken.

Social Responsiveness Social responsiveness isthe degree of effectiveness and efficiency an orga-nization displays in pursuing its social responsi-bilities. The greater the degree of effectivenessand efficiency, the more socially responsive theorganization is said to be. The socially responsiveorganization that is both effective and efficientmeets its social responsibilities without wastingorganizational resources in the process. Deter-mining exactly which social responsibilities anorganization should pursue and then decidinghow to pursue them are perhaps the two mostcritical decision-making aspects of maintaining ahigh level of social responsiveness within an or-ganization. That is, managers must decidewhether their organization should undertake theactivities on its own or acquire the help of outsid-ers with more expertise in the area.

In addition to decision making, various ap-proaches to meeting social obligations are an-other determinant of an organization’s level ofsocial responsiveness. A desirable and socially re-sponsive approach to meeting social obligationsinvolves the following:

● Incorporating social goals into the annualplanning process

● Seeking comparative industry norms for socialprograms

● Presenting reports to organization members,the board of directors, and stockholders onprogress in social responsibility

● Experimenting with different approaches formeasuring social performance

● Attempting to measure the cost of social pro-grams as well as the return on social programinvestments

S. Prakash Sethi (1975) presents three man-agement approaches to meeting social obliga-tions: (1) the social obligation approach, (2) thesocial responsibility approach, and (3) the socialresponsiveness approach. Each of Sethi’s threeapproaches contains behavior that reflects asomewhat different attitude with regard to busi-nesses performing social responsible activities.The social obligation approach, for example,considers business as having primarily economicpurposes and confines socially responsible activ-ity mainly to conformance to existing laws Thesocial responsibility approach sees business ashaving both economic and societal goals. Thesocial responsiveness approach considers busi-ness as having both societal and economic goalsas well as the obligation to anticipate upcomingsocial problems and to work actively to preventtheir appearance.

Organizations characterized by attitudes andbehaviors consistent with the social responsive-ness approach generally are more socially respon-sive than organizations characterized by attitudesand behaviors consistent with either the socialresponsibility approach or the social obligationapproach. Also, organizations characterized bythe social responsibility approach generallyachieve higher levels of social responsivenessthan organizations characterized by the socialobligation approach. As one moves from the so-cial obligation approach to the social responsive-ness approach, management becomes more pro-active. Proactive managers will do what isprudent from a business viewpoint to reduceliabilities whether an action is required by law ornot.

Areas of Measurement To be consistent, mea-surements to gauge organizational progress inreaching socially responsible objectives can beperformed. The specific areas in which individualcompanies actually take such measurements



vary, of course, depending on the specific objec-tives of the companies. All companies, however,probably should take such measurements in atleast the following four major areas:

1. Economic function: This measurementgives some indication of the economiccontribution the organization is makingto society.

2. Quality of life: The measurement of qual-ity of life should focus on whether theorganization is improving or degradingthe general quality of life in society.

3. Social investment: The measurement ofsocial investment deals with the degree towhich the organization is investing bothmoney and human resources to solvecommunity social problems.

4. Problem solving: The measurement ofproblem solving should focus on the de-gree to which the organization deals withsocial problems.

The Social Audit: A Progress Report A socialaudit is the process of taking measurements ofsocial responsibility to assess organizational per-formance in this area. The basic steps in conduct-ing a social audit are monitoring, measuring, andappraising all aspects of an organization’s sociallyresponsible performance. Probably no two orga-nizations conduct and present the results of asocial audit in exactly the same way. The socialaudit is the process of measuring the sociallyresponsible activities of an organization. It moni-tors, measures, and appraises socially responsibleperformance.

BIBLIOGRAPHY

Aupperle, K. E., Caroll, A. B., and Hatfield, J. D. (1985). ‘‘AnEmpirical Examination of the Relationship BetweenCorporate Responsibility and Profitability.’’ Academy ofManagement Journal June:446-463.

Davis, L. (1975). ‘‘Five Propositions for Social Responsibil-ity.’’ Busisiness Horizons June:19-24.

Friedman, M. (1989). ‘‘Freedom and Philanthropy: An In-terview with Milton Friedman.’’ Business and Society Re-view Fall:11-18.

McGuire, J. B., Sundgren, A., and Schneeweis, T. (1988).‘‘Corporate Social Responsibility and Firm FinancialPerformance.’’ Academy of Management Journal Decem-ber:854-872.

Ross, T. (1988). Ethics in American Business. New York:Touche Ross and Co.

Sethi, S. P. (1975). ‘‘Dimensions of Corporate Social Per-formance: An Analytical Framework.’’ California Man-agement Review Spring:58-64.

THOMAS HAYNES

ETHICS IN MARKETING

Ethics are a collection of principles of right con-duct that shape the decisions people ororganizations make. Practicing ethics in market-ing means deliberately applying standards of fair-ness, or moral rights and wrongs, to marketingdecision making, behavior, and practice in theorganization.

In a market economy, a business may beexpected to act in what it believes to be its ownbest interest. The purpose of marketing is to cre-ate a competitive advantage. An organizationachieves an advantage when it does a better jobthan its competitors at satisfying the product andservice requirements of its target markets. Thoseorganizations that develop a competitive advan-tage are able to satisfy the needs of both cus-tomers and the organization.

As our economic system has become moresuccessful at providing for needs and wants, therehas been greater focus on organizations’ adheringto ethical values rather than simply providingproducts. This focus has come about for tworeasons. First, when an organization behaves eth-ically, customers develop more positive attitudesabout the firm, its products, and its services.When marketing practices depart from standardsthat society considers acceptable, the market pro-cess becomes less efficient—sometimes it is eveninterrupted. Not employing ethical marketingpractices may lead to dissatisfied customers, badpublicity, a lack of trust, lost business, or, some-times, legal action. Thus, most organizations arevery sensitive to the needs and opinions of their

ETHICS IN MARKETING


Tobacco marketing has been the target of government regulation.

customers and look for ways to protect theirlong-term interests.

Second, ethical abuses frequently lead topressure (social or government) for institutionsto assume greater responsibility for their actions.Since abuses do occur, some people believe thatquestionable business practices abound. As a re-sult, consumer interest groups, professional asso-

ciations, and self-regulatory groups exert consid-erable influence on marketing. Calls for socialresponsibility have also subjected marketingpractices to a wide range of federal and stateregulations designed to either protect consumerrights or to stimulate trade.

The Federal Trade Commission (FTC) andother federal and state government agencies are

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charged both with enforcing the laws and creat-ing policies to limit unfair marketing practices.Because regulation cannot be developed to coverevery possible abuse, organizations and industrygroups often develop codes of ethical conduct orrules for behavior to serve as a guide in decisionmaking. The American Marketing Association,for example, has developed a code of ethics(which can be viewed on its Web site at www.ama.org). Self-regulation not only helps a firm avoidextensive government intervention; it also per-mits it to better respond to changes in marketconditions. An organization’s long-term successand profitability depends on this ability to re-spond.

Several areas of concern in marketing ethicsare explored in the remainder of the article.

UNFAIR OR DECEPTIVEMARKETING PRACTICES

Marketing practices are deceptive if customersbelieve they will get more value from a productor service than they actually receive. Deception,which can take the form of a misrepresentation,omission, or misleading practice, can occur whenworking with any element of the marketing mix.Because consumers are exposed to great quan-tities of information about products and firms,they often become skeptical of marketing claimsand selling messages and act to protect them-selves from being deceived. Thus, when a prod-uct or service does not provide expected value,customers will often seek a different source.

Deceptive pricing practices cause customersto believe that the price they pay for some unit ofvalue in a product or service is lower than it reallyis. The deception might take the form of makingfalse price comparisons, providing misleadingsuggested selling prices, omitting important con-ditions of the sale, or making very low price offersavailable only when other items are purchased aswell. Promotion practices are deceptive when theseller intentionally misstates how a product isconstructed or performs, fails to disclose infor-mation regarding pyramid sales (a sales tech-nique in which a person is recruited into a planand then expects to make money by recruiting

other people), or employs bait-and-switch sellingtechniques (a technique in which a business of-fers to sell a product or service, often at a lowerprice, in order to attract customers who are thenencouraged to purchase a more expensive item).False or greatly exaggerated product or serviceclaims are also deceptive. When packages are in-tentionally mislabeled as to contents, size, weight,or use information, that constitutes deceptivepackaging. Selling hazardous or defective prod-ucts without disclosing the dangers, failing toperform promised services, and not honoringwarranty obligations are also considered decep-tion.

OFFENSIVE MATERIALS ANDOBJECTIONABLE MARKETING PRACTICES

Marketers control what they say to customers aswell as and how and where they say it. Whenevents, television or radio programming, or pub-lications sponsored by a marketer, in addition toproducts or promotional materials, are perceivedas offensive, they often create strong negativereactions. For example, some people find adver-tising for all products promoting sexual potencyto be offensive. Others may be offended when apromotion employs stereotypical images or usessex as an appeal. This is particularly true when aproduct is being marketed in other countries,where words and images may carry differentmeanings than they do in the host country.

When people feel that products or appealsare offensive, they may pressure vendors to stopcarrying the product. Thus, all promotional mes-sages must be carefully screened and tested, andcommunication media, programming, and edi-torial content selected to match the tastes andinterests of targeted customers. Beyond the targetaudience, however, marketers should understandthat there are others who are not customers whomight receive their appeals and see their imagesand be offended.

Direct marketing is also undergoing closerexamination. Objectionable practices range fromminor irritants, such as the timing and frequencyof sales letters or commercials, to those that areoffensive or even illegal. Among examples of

ETHICS IN MARKETING


practices that may raise ethical questions are per-sistent and high-pressure selling, annoying tele-marketing calls, and television commercials thatare too long or run too frequently. Marketingappeals created to take advantage of young orinexperienced consumers or senior citizens—including advertisements, sales appeals disguisedas contests, junk mail (including electronic mail),and the use and exchange of mailing lists—mayalso pose ethical questions. In addition to beingsubject to consumer-protection laws and regula-tions, the Direct Marketing Association providesa list of voluntary ethical guidelines for compa-nies engaged in direct marketing (available attheir Web site at www.the-dma.org).

ETHICAL PRODUCT ANDDISTRIBUTION PRACTICES

Several product-related issues raise questionsabout ethics in marketing, most often concerningthe quality of products and services provided.Among the most frequently voiced complaintsare ones about products that are unsafe, that areof poor quality in construction or content, thatdo not contain what is promoted, or that go outof style or become obsolete before they actuallyneed replacing. An organization that marketspoor-quality or unsafe products is taking thechance that it will develop a reputation for poorproducts or service. In addition, it may be put-ting itself in jeopardy for product claims or legalaction. Sometimes, however, frequent changes inproduct features or performance, such as thosethat often occur in the computer industry, makeprevious models of products obsolete. Suchchanges can be misinterpreted as planned obso-lescence.

Ethical questions may also arise in the distri-bution process. Because sales performance is themost common way in which marketing represen-tatives and sales personnel are evaluated, per-formance pressures exist that may lead to ethicaldilemmas. For example, pressuring vendors tobuy more than they need and pushing items thatwill result in higher commissions are tempta-tions. Exerting influence to cause vendors to re-duce display space for competitors’ products,

promising shipment when knowing delivery isnot possible by the promised date, or paying ven-dors to carry a firm’s product rather than one ofits competitors are also unethical.

Research is another area in which ethical is-sues may arise. Information gathered from re-search can be important to the successful market-ing of products or services. Consumers, however,may view organizations’ efforts to gather datafrom them as invading their privacy. They areresistant to give out personal information thatmight cause them to become a marketing targetor to receive product or sales information. Whendata about products or consumers are exagger-ated to make a selling point, or research ques-tions are written to obtain a specific result, con-sumers are misled. Without self-imposed ethicalstandards in the research process, managementwill likely make decisions based on inaccurateinformation.

DOES MARKETING OVERFOCUSON MATERIALISM?

Consumers develop an identity in the market-place that is shaped both by who they are and bywhat they see themselves as becoming. There isevidence that the way consumers view themselvesinfluences their purchasing behavior. This iden-tity is often reflected in the brands or productsthey consume or the way in which they lead theirlives.

The proliferation of information about prod-ucts and services complicates decision making.Sometimes consumer desires to achieve or main-tain a certain lifestyle or image results in theirpurchasing more than they need or can afford.Does marketing create these wants? Clearly, ap-peals exist that are designed to cause people topurchase more than they need or can afford.Unsolicited offers of credit cards with high limitsor high interest rates, advertising appeals toutingthe psychological benefits of conspicuous con-sumption, and promotions that seek to stimulateunrecognized needs are often cited as examplesof these excesses.

ETHICS IN MARKETING


SPECIAL ETHICAL ISSUES IN MARKETINGTO CHILDREN

Children are an important marketing target forcertain products. Because their knowledge aboutproducts, the media, and selling strategies is usu-ally not as well developed as that of adults, chil-dren are likely to be more vulnerable to psycho-logical appeals and strong images. Thus, ethicalquestions sometimes arise when they are exposedto questionable marketing tactics and messages.For example, studies linking relationships be-tween tobacco and alcohol marketing with youthconsumption resulted in increased public pres-sure directly leading to the regulation of market-ing for those products.

The proliferation of direct marketing and useof the Internet to market to children also raisesethical issues. Sometimes a few unscrupulousmarketers design sites so that children are able tobypass adult supervision or control; sometimesthey present objectionable materials to underageconsumers or pressure them to buy items orprovide credit card numbers. When this happens,it is likely that social pressure and subsequentregulation will result. Likewise, programming forchildren and youth in the mass media has beenunder scrutiny for many years.

In the United States, marketing to children isclosely controlled. Federal regulations place lim-its on the types of marketing that can be directedto children, and marketing activities are moni-tored by the Better Business Bureau, the FederalTrade Commission, consumer and parentalgroups, and the broadcast networks. Theseguidelines provide clear direction to marketers.

ETHICAL ISSUES IN MARKETINGTO MINORITIES

The United States is a society of ever-increasingdiversity. Markets are broken into segments inwhich people share some similar characteristics.Ethical issues arise when marketing tactics aredesigned specifically to exploit or manipulate aminority market segment. Offensive practicesmay take the form of negative or stereotypicalrepresentations of minorities, associating the

consumption of harmful or questionable prod-ucts with a particular minority segment, and de-meaning portrayals of a race or group. Ethicalquestions may also arise when high-pressureselling is directed at a group, when higher pricesare charged for products sold to minorities, oreven when stores provide poorer service in neigh-borhoods with a high population of minoritycustomers. Such practices will likely result in abad public image and lost sales for the marketer.

Unlike the legal protections in place to pro-tect children from harmful practices, there havebeen few efforts to protect minority customers.When targeting minorities, firms must evaluatewhether the targeted population is susceptible toappeals because of their minority status. The firmmust assess marketing efforts to determinewhether ethical behavior would cause them tochange their marketing practices.

ETHICAL ISSUES SURROUNDING THEPORTRAYAL OF WOMEN IN

MARKETING EFFORTS

As society changes, so do the images of and rolesassumed by people, regardless of race, sex, oroccupation. Women have been portrayed in avariety of ways over the years. When marketerspresent those images as overly conventional, for-mulaic, or oversimplified, people may view themas stereotypical and offensive.

Examples of demeaning stereotypes includethose in which women are presented as less intel-ligent, submissive to or obsessed with men, un-able to assume leadership roles or make deci-sions, or skimpily dressed in order to appeal tothe sexual interests of males. Harmful stereotypesinclude those portraying women as obsessed withtheir appearance or conforming to some ideal ofsize, weight, or beauty. When images are consid-ered demeaning or harmful, they will work to thedetriment of the organization. Advertisements, inparticular, should be evaluated to be sure that theimages projected are not offensive.

CONCLUSION

Because marketing decisions often require spe-cialized knowledge, ethical issues are often more

ETHICS IN MARKETING


complicated than those faced in personal life—and effective decision making requires consis-tency. Because each business situation is differ-ent, and not all decisions are simple, many orga-nizations have embraced ethical codes of conductand rules of professional ethics to guide manag-ers and employees. However, sometimes self-reg-ulation proves insufficient to protect the interestof customers, organizations, or society. At thatpoint, pressures for regulation and enactment oflegislation to protect the interests of all parties inthe exchange process will likely occur.

BIBLIOGRAPHY

American Marketing Association. (1998). American Market-ing Association Code of Ethics. New York: Author.

Barnett, Tim, Bass, Ken, Brown, Frederick, and Hebert, J.(1998). ‘‘Ethical Ideology and the Ethical Judgments ofMarketing Professionals.’’ Journal of Business EthicsMay:715-723.

Berman, Barry, and Evans, Joel R. (1998). Retail Manage-ment: A Strategic Approach, 7th ed. New York: PrenticeHall.

Bone, Paula F., and Corey, Robert J. (1998). ‘‘Moral Reflec-tions in Marketing.’’ Journal of Macromarketing Fall:104-114.

‘‘Federal Trade Commission Deception Policy Statement.’’http://www.webcom.com.lewrose/deceptionpol.html.1983.

Ferrell, O. C., Hartline, Michael D., and McDaniel, StephenW. (1998). ‘‘Codes of Ethics Among Corporate ResearchDepartments, Marketing Research Firms, and Data Sub-contractors: An Examination of a Three-CommunitiesMetaphor.’’ Journal of Business Ethics April: 503-516.

‘‘FTC Guides Against Deceptive Pricing.’’ http://www.ftc.gov/bcp/guides/decptprc.htm. 1998.

Gustafson, Robert, Popovich, Mark, and Thomsen, Steven.(1999). ‘‘The ‘Thin’ Ideal.’’ Marketing News March 15:22.

Jones, Thomas M., and Ryan, Lori V. (1998). ‘‘The Effect ofOrganizational Forces on Individual Morality: Judg-ment, Moral Approbation, and Behavior.’’ Business Eth-ics Quarterly July: 431-445.

Koehn, Daryl. (1999). ‘‘Business Ethics Is Not a Contradic-tion.’’ San Antonio Business Journal 12(49) (January): 38.

Kotler, Philip, and Armstrong, Gary. (1999). Principles ofMarketing, 8th ed. New York: Prentice-Hall.

Mahoney, Ann I. (1999). ‘‘Talking About Ethics.’’Association Management March: 45.

Murphy, Patrick E. (1998). ‘‘Ethics in Advertising: Review,Analysis, and Suggestions.’’ Journal of Public Policy andMarketing Fall: 316-319.

Murphy, Patrick E. (1999). ‘‘Character and Virtue Ethics inInternational Marketing: An Agenda for Managers, Re-searchers, and Educators.’’ Journal of Business Ethics Jan-uary: 107-124.

Rallapalli, Kuman C. (1999). ‘‘A Paradigm for Developmentand Promulgation of a Global Code of Marketing Eth-ics.’’ Journal of Business Ethics January: 125-137.

Rieck, Dean. (1998). ‘‘Balancing Ethics and Profitability.’’Direct Marketing October: 53-56.

Rose, Gregory M., Bush, Victoria D., and Kahle, Lynn.(1998). ‘‘The Influence of Family Communication Pat-terns on Parental Reactions Toward Advertising: ACross-National Examination.’’ Journal of AdvertisingWinter: 71-85.

Russell, J. Thomas, and Lane, W. Ronald. (1999). Kleppner’sAdvertising Procedure, 14th ed. New York: Prentice Hall.

Self-Regulatory Guidelines for Children’s Advertising. (1997).New York: Children’s Advertising Review Unit of theCouncil of Better Business Bureaus.

Sirgy, M. Joseph, Lee, Dong-Jin, Kosenko, Rustan, and Lee,H. (1998). ‘‘Does Television Viewership Play a Role inthe Perception of Quality of Life?’’ Journal of AdvertisingSpring: 125-142.

United States Code, Title 15, Section 45. http://www4.law.cornell.edu/uscode/15/45.text.html.

JOHN A. SWOPE

ETHICS OVERVIEW

Ethics is the study of questions of morality, thesearch to understand what is right, wrong, good,and bad. It is the branch of philosophy that sys-tematically studies moral ideals and goals, mo-tives of choice, and patterns of good and badconduct. Ethics is derived from the Greek ethikos,meaning ‘‘character.’’ Issues of personal charac-ter, and the search for the best patterns for living,were at the core of Greek ethical philosophy. Incontrast,moral is from the Latinmore (MOR-ay).The Romans used this term to describe the cus-tomary ways that people tended to act. Thus,though the two terms are often used interchange-ably today, morality has evolved to mean thesocial norms that people are taught and condi-tioned to follow, while ethics has come to refer to

ETHICS OVERVIEW


Greek philosopher Socrates was a pioneer in virtue-ethical thinking.

ETHICS OVERVIEW


the rational investigating and questioning ofthese norms. This view of ethics is said to benormative, since it assumes the existence of atleast some universal moral principles and stan-dards.

Ethics tends to be a cross-disciplinary field ofstudy. Theologians study ethics and morality inlight of religious teachings and divine com-mands. Psychologists seek to understand howpeople’s values influence their thinking, behav-ioral motivations, and personal development. So-ciologists attempt to identify and explain varyingcultural norms and practices. Business educatorstry to help companies, employees, and profes-sionals avoid expensive and counterproductiveethical misdeeds. However, the study of norma-tive ethics has historically been dominated byphilosophers, who have applied rules of reasonand logic to find answers to humanity’s per-plexing moral questions.

One apparent obstacle to this process is thatlogical reasoning, at least at first glance, does notseem to lead different people to the same ethicalconclusions and answers. If people, ideally, usedreason correctly, what would it tell us about eth-ics? This search for the best, most logical princi-ples to follow is the realm of general ethics. Theend results of this search are ethical systems ortheories—groups of systematically related ethicalprinciples that attempt to describe and prescribehuman morality. Scholars in applied ethics thentake these ethical systems and principles and ap-ply them to contemporary moral questions, di-lemmas, and life-situations. Examples of specificstudies in applied ethics include business, gov-ernment, and professional ethics (medical, legal,etc.).

RELIGIOUS AND PHILOSOPHICAL ETHICS

Perhaps the greatest continual struggle related toethics throughout history has been between fol-lowers of religious ethics and proponents of phil-osophical ethics. Religious ethics gives preemi-nence to divine authority. Actions that conformto the will or teachings of this authority areconsidered good or right; actions that do notconform are seen as bad, wrong, or evil. It is

believed that people can find or discover thisdivine will through sacred scriptures, the teach-ings of religious leaders, prayer, and personalrevelation. On the other hand, philosophical eth-ics places its primary emphasis on rationalthought and the rules of logic. This view assumesthat individuals can use reason to find answers tomoral questions, making religious authority un-necessary.

This conflict can reach critical proportions.Many philosophers who have challenged the reli-gious authorities of their times have beenbranded as dangerous heretics. Foreshadowingthe pattern that would repeat itself for centuries,the central charge leading to the conviction andeventual execution of Socrates was that he ques-tioned the gods of Athens and taught others to dothe same. However, it is also worth noting thatsome of history’s most influential ethical thinkershave argued that this perceived conflict betweenreason and faith may only be illusionary; thatfaith and reason need not be adversaries, but cansupport and even validate each other.

ETHICAL SYSTEMS

There have been about as many different philo-sophical viewpoints on ethics as there have beenpeople thinking about them. But these can beroughly grouped into three main families of ethi-cal systems. The first are virtue-ethics theories,founded on the teachings of the three great lightsof ancient Greek philosophy—Socrates (469-399B.C.), Plato (427?-347? B.C.), and Aristotle (384-322 B.C.). Most attempts to chronicle Westernethical thinking begin with these three men be-cause of their emphasis on reason and logic asessential tools for finding answers to ethical ques-tions. This assumption has been the cornerstoneof philosophical thinking ever since. The centralfocus in virtue-ethics is personal character. Theancient Greeks believed it was a mandate fromnature itself that the purpose of life for humanswas to achieve happiness and fulfillment. Thegoal of ancient Greek ethics, then, was the searchfor ‘‘the good life,’’ the pattern of specific charac-ter traits (virtues) that people should integrateinto their lives to make happiness and fulfillment

ETHICS OVERVIEW


most likely. Plato and Aristotle wrote that thevirtues of wisdom, courage, temperance, and jus-tice were the most logical choices to help peopleachieve this goal.

One evidence of the profound influence ofthese Greek thinkers is that so many other philos-ophers have adopted and adapted their approach.Cicero (106-43 B.C.), the most well known of theRoman intellectuals, leaned heavily on Aristotle’sprinciples and concepts. The Catholic theologianThomas Aquinas (1225?-1274) took Aristotle’swritings about the essential roles of reason andnature in ethics and integrated them with medi-eval Roman Catholic dogma. In doing so, hehelped to usher in the Enlightenment, revolu-tionizing Catholic thinking and doctrine in waysstill evident today. Aquinas’s ethical system(natural law) remained the most influential viewthroughout much of the Middle Ages, supportedin no small part by the power of the Church. Thisdomination continued until the seventeenth andeighteenth centuries, when philosophers beganattempting to restore the preeminence of reasonover religious authority, perhaps the most signifi-cant event in the development of ethical thinkingsince the time of Plato.

One early leader was the British philosopherJohn Locke (1632–1704). Locke stretched naturallaw’s tenets to include the assumption that allhumans are endowed by nature (or God) withcertain basic human rights. This fact gives peoplea clear moral duty to respect the rights of others.Thus, violating the rights of others becomes theonly real moral wrong, and all actions that do notviolate the rights of other persons must be ethi-cally permissible. Among the most ardent sup-porters of Locke’s natural rights system were thefounders of the United States, who viewed hisprinciples and assumptions as the moral bedrockof their new republic. These principles, evidentthroughout the Declaration of Independence andConstitution, remain at the heart of the Ameri-can legal system.

The second family of ethical sytems is madeup of deontology theories. These approaches sharethe view that ethics should be based primarily onmoral duty. This approach is probably best ex-

emplified by the writings of the great Germanphilosopher and writer Immanuel Kant (1724–1804). Kant maintained that at the heart of ethicslies the moral duty to obey the dictates of reason.People can know what reason commandsthrough intuition and moral reason. Kant’s cen-tral ethical principle is the categorical imperative,which says that the only moral actions are thoseconsistent with the moral standards that wewould want everyone else to follow. For example,Kant argued that lying is always wrong, since norational person would want lying to become themoral standard for everyone. (Kant recognizedno exceptions, arguing that even lying to save alife was immoral.) A corollary to this principle isKant’s respect for persons, the maxim that it isalways wrong to exploit others. People, he ar-gued, must be treated as ends (goals) in them-selves, not merely as means to our own ends.

The third major family of ethical systemscomprises the utilitarian theories. This approachsees the proper goal of ethics as producing good,pleasure, or happiness. Early proponents of utili-tarianism were the British philosophers JeremyBentham (1748–1832) and John Stuart Mill(1806–1873). According to utilitarian reasoning,the morally right (or best) action is the one thatproduces the greatest possible happiness for thegreatest possible number. Thus, behaviors arenot always moral or always immoral. Instead mo-rality is based on specific variables unique to eachsituation. In some situations, lying might pro-duce more overall good than telling the truth(e.g., deceiving a kidnapper to save a child). Inother situations, truth would clearly producemore good.

BUSINESS AND PROFESSIONAL CODESOF ETHICS

These classical ethical systems are expressed andaffirmed in contemporary society in many ways.Codes of ethics are practical examples. A code ofethics is a written document intended to serve asa guideline to those who would follow it. Mostlarger businesses and corporations have codes ofethics for their employees, as do most professionsfor their members. Professional codes are usually

ETHICS OVERVIEW


written by members of the profession through acentral national organization. For example, it isgenerally understood that American doctors aresubject to the American Medical Associationcode of ethics, and American lawyers follow theirbar association codes. But many other profes-sions have codes of ethics as well, including suchdiverse fields as journalism, pharmacy, businessmanagement, education, accounting, engineer-ing, nursing, law enforcement, and psychology.Even the best codes of ethics cannot guaranteeethical behavior. Indeed, many codes do not evencontain methods of enforcement, but merely ex-press the ideals and values of their respective cor-porations and professions. The decision to actethically or unethically is, as it has been throughthe ages, up to the individual.

BIBLIOGRAPHY

DeGeorge, Richard T. (1990). Business Ethics, 3rd ed. NewYork: Macmillan.

Frost, S. E., Jr. (1989). Basic Teachings of the Great Philoso-phers. New York: Anchor.

Goree, Keith. (1996). Ethics in American Life. Cincinnati,OH: South-Western ITP.

Gorlin, Rena A. (1991). Codes of Professional Responsibility,2nd ed. Washington, DC: Bureau of National Affairs.

Holmes, Robert L. (1993). Basic Moral Philosophy. Belmont,CA: Wadsworth.

Peterfreund, Denise. (1992). Great Traditions in Ethics, 7thed. Belmont, CA: Wadsworth.

Richardson, Michael, and Baker, Emily. (1999). Ethics Ap-plied, ed. 3.0. New York: Pearson.

Ruggiero, Vincent R. (1992). Thinking Critically About Ethi-cal Issues, 3rd ed. Mountain View, CA: Mayfield.

Shaw, William H. (1991). Business Ethics. Belmont, CA:Wadsworth.

Wagner, Michael E. (1991). An Historical Introduction toMoral Philosophy. Englewood Cliffs, NJ: Prentice-Hall.

KEITH GOREE

EUROPEAN UNION

The European Union is an ever-evolving allianceof fifteen European countries designed to fostereconomic cooperation among its members. With

its roots stretching back to just after World WarII, this alliance has the ultimate goal of unifyingthe economic interests of these countries in orderto reduce the chance of widespread armed con-flict returning to the European continent.

HISTORY

In the early 1950s, Germany and France spear-headed the establishment of the European Coaland Steel Community. At this time, West Ger-many was in the process of rebuilding its war-ravaged steel industry under the direction of theUnited States and Great Britain. This was anunderstandable source of concern for France, asGerman industrial might had been used againstthe French in the two world wars earlier in thecentury. Consequently, a federation that wouldgovern these important economic resources wonthe approval of both the French and Germans.They were also joined by Italy, Belgium, Luxem-bourg, and the Netherlands as the original sixfounding nations of what would eventually be-come the European Union.

The European Coal and Steel Communitywas later followed by the establishment of theEuropean Economic Community under theTreaty of Rome, which was signed by the same sixcountries in 1957. This treaty established theframework for the six member countries topursue an economic and monetary union bycreating a single market to further their eco-nomic development. The European EconomicCommunity established a customs union for re-moving trade barriers, such as tariffs and quotas,between member countries over a period of sev-eral years. Also, common external tariffs werephased in for goods entering the union.

The single market established by the Euro-pean Economic Community also opened thedoor for the free movement of workers, busi-nesses, and capital throughout the community.Border stops and customs checks were elimi-nated, companies expanded across national bor-ders, and financial institutions expanded withthem.

EUROPEAN UNION


Romano Prodi (right), president of the European Union Commission.

THE EURO

To further facilitate trade within this single mar-ket, European leaders felt a single currencyshould be created to eliminate foreign-exchangehurdles encountered by companies doing busi-ness across European borders. After several inter-vening rounds of negotiations and agreements,the Treaty on European Union was signed in

Maastricht in December 1991. The EuropeanUnion was formally established as the successorto the European Economic Community, and thetreaty laid the groundwork for the completion ofthe economic and monetary union by calling fora new European currency.

The European Union introduced this newcurrency on January 1, 1999, christening it the

EUROPEAN UNION


‘‘euro.’’ Like many other changes implementedby the European Union, the euro was notlaunched without difficulties. By the time theeuro was introduced in 1999, nine more coun-tries had joined the original six members. TheEuropean Union had added Denmark, Ireland,and the United Kingdom to its ranks in 1973;Greece in 1981; Portugal and Spain in 1986; andAustria, Finland, and Sweden ratified member-ship in 1995. During the launch of the euro, theUnited Kingdom, Sweden, and Denmark allchose to ‘‘opt out’’ of participation due to politi-cal pressures in each country. One other mem-ber, Greece, failed to satisfy the economic criteriafor convergence, which required members of the‘‘euro zone’’ to meet targets for price stability,long-term interest rates, government budget def-icits, and government debt. Consequently, theconversion to the euro was initiated in onlyeleven of the fifteen member states in 1999.

Transactions in member states beginning in1999 could be denominated in euros. The actualeuro currency and coins will begin circulation in2002. In the ‘‘interim period,’’ transactions canbe carried out in either euros or the formernational currencies of the member states.

GOVERNANCE

The governance of the European Union is quitecomplex. The European Commission, based inBrussels, introduces legislation and negotiates alltrade agreements between the European Unionand other countries. The five largest countries inthe union appoint two members and other coun-tries one member to the European Commission.The European Parliament, which is the onlyelected body, also has legislative and veto author-ity in some specific areas. The Council of Minis-ters, comprised of civil servants from each coun-try, acts on the legislation proposed by theEuropean Commission. Most decisions are by amajority vote, but some require unanimity.

Monetary policy in the countries adoptingthe euro is governed by the European CentralBank. The primary mission of this independentinstitution is to maintain stable prices. It is alsoresponsible for foreign-exchange operations and

managing foreign reserves in the euro zone. Al-though it is a relatively new currency, the eurohas joined the U.S. dollar and Japanese yen as areserve currency held by central banks.

INTERNATIONAL TRADE

The fifteen members of the European Union in1999 have a combined population 40 percentlarger than that of the United States, creating anattractive business marketplace without internaltrade barriers. Many American companies—from Ford, which sells 15 million vehicles a yearin Europe, to Coca-Cola, Inc., which serves 209million of its beverages to European customersevery day—have a long-established presence inEurope. Other companies, such as software giantMicrosoft, have entered the European market inrecent years and been successful in the EuropeanUnion’s single market. If the European Unioncontinues to add new members, it may be only amatter of time before the European marketplacebegins to challenge the United States as the pre-mier business market in the world.

European companies, with their enhancedsize due to expansion across Europe, have also settheir sights across the Atlantic. The purchases ofChrysler by Daimler-Benz and Amoco by BritishPetroleum in the late 1990s were but two of themany examples of large European companiesstrengthening their positions in the Americanmarketplace. With the majority of foreign invest-ment in the United States coming from membersof the European Union, economic interests havecontinued to become more intertwined as multi-national companies now operate on both sides ofthe Atlantic.

FUTURE EXPANSION

In the future, the size of the European Union willlikely expand because numerous other countries,primarily in Central and Eastern Europe, haveexpressed an interest in joining the union. Manyof these countries are in the process of makingthe structural changes needed to meet the criteriafor membership in the European Union. Ad-mitting these countries would add to the Euro-pean Union’s stature in global trade negotiations,

EUROPEAN UNION


further the cause of social stability in the region,and add yet another chapter to the story of thisdynamic union.

BIBLIOGRAPHY

Dinan, Desmond, ed. (1998). Encyclopedia of the EuropeanUnion. (1998). Boulder, CO: Lynne Rienner.

How Does the European Union Work?, 2d ed. (1998). Luxem-bourg: Office for Official Publications of the EuropeanCommunities.

Leonard, R. L. (1998). The Economist Guide to the EuropeanUnion. London: The Economist in association with Pro-file.

Redmond, John, and Rosenthal, Glenda G., eds. (1998). TheExpanding European Union: Past, Present, Future. Boul-der, CO: Lynne Rienner.

DAVID MCGRADY


(SEE: Employee Compensation)

EXPECTANCY THEORY

(SEE: Motivation)

EXPORT-IMPORT BANK

(SEE: Financial Institutions; International Trade)

EXPORTS

(SEE: International Trade)




Facsimile reproduction means making an exactcopy of anything imprinted on paper by usingelectronic devices such as copiers, fax machines,and scanners. Material may be reproduced elec-tronically on a computer’s monitor (soft copy),or reproduced on paper (hard copy). In repro-ducing information either electronically or onpaper, one wants a quality copy that will beacceptable for the task at hand.

HISTORICAL PERSPECTIVE

The first method used to make a printed copywas carbon paper. Although a Britain named J.W. Swan invented carbon tissue paper coatedwith gelatin about 1862, it didn’t come into gen-eral use for office work until the mid-1920s. Itprovided a somewhat less than perfect copy oftyped material. At that time one could choosebetween very messy carbon paper that made sev-eral copies or single-use carbon paper that wasmuch easier to use. The first reverberations of thedeath knell for carbon paper occurred in 1937when Chester Carlson invented the xerographyprocess of duplication.

In the late 1890s the mimeograph machinebegan to be used to produce copies. This processinvolved typing on a lightly oiled surface called a‘‘master,’’ which involved retyping a preexistingoriginal—a very time-consuming process. Astime passed, however, the mimeograph machine

was improved enough to permit masters to bereused if stored properly.

In 1906 the Haloid Company was founded tosell photographic paper for its early version oftoday’s copier. This early piece of reprographicequipment was hardly an office tool—it was veryexpensive, very cumbersome, and very difficult touse. Trained operators were scarce.

In 1913 Edouard Belin invented theBelinograph, a portable facsimile machine capa-ble of using ordinary telephone lines.

In the 1920s, the Gestetner office duplicatingmachine was considered to be one of the firstmodern examples of efficient industrial design.

In 1937 an electrostatic copying processknown as ‘‘xerography’’ was invented by anAmerican law student named Chester Carlson.This process, which involved the effect of light onphotoconductivity, led to the unprecedented suc-cess of the ‘‘Xerox’’ commercial copy machine,introduced in 1959. The major problem with thiscopier was that it was heat-sensitive and resultedin paper scorching.

After World War II, 3M and Eastman Kodakintroduced the Thermo-Fax and verifax copiersinto the workplace. The copies were of poor qual-ity and continued to darken long after havingbeen pulled from the machine. Although theseoffice machines were relatively inexpensive andeasy to use, they required special paper that wasextremely expensive.

F

349

Chester Carlson invented the xerography process.



As computer use continued to develop, addi-tional copying methods such as fax, Ditto, andMimeograph appeared.

In 1971 dot-matrix printers were introduced,providing a reasonably efficient way to reproducecomputer-generated information on paper.

In 1974 the first international fax standardwas set by the United Nations, allowing for faxmessages to be transmitted at a rate of one pageevery six minutes. Special paper was required forthese early fax machines. Today’s fax equipmentwill accept either special fax paper of a greatly-improved quality or plain paper. In 1990 facsim-ile machines (commonly called fax machines)that could transmit in color became available.

In 1975 IBM introduced the first laserprinter. Using light lasers in the process of copy-ing greatly improved both the process and theproduct.

Today’s evolving technology provides repro-graphic-related equipment. Scanners are used inconjunction with digital cameras to reproducepictures, sounds, and other images electronicallyand on paper.

COPIERS TODAY

Today’s copiers are advancing rapidly, consistentwith continuing advances in technology. Al-though using a copier today is a simple process,choosing one is not. Training is required, alongwith knowledge of what is best in an individualsituation. Cost is a major factor in determiningthe most appropriate copier to use, as is the typeof material that is to be reproduced.

COPIER FEATURES

Copiers are sold by a variety of vendors who offeran array of products to meet individual needs.When selecting a copier for possible lease or pur-chase, individual features and individual needsshould be studied and matched carefully. Doingso can save time and money in the long run.

Copy Speed: The number of copies that canbe produced in a minute is an important feature.Most copiers can make from twelve to fifty copiesper minute, depending on the model. Most oftoday’s copiers are also capable of creating trans-

parencies, address labels, and letterheads. How-ever, the quality of paper is important becausepoor-quality paper can cause jamming.

Paper Trays: Only specified amounts of papercan be loaded at one time into today’s copiers.Paper can be loaded from the front using either aspecified tray or a ‘‘bypass’’ tray. A bypass traypermits two-sided copies or copies on specialpaper stock or paper sizes to be made by pro-gramming the size individually.

Enlargement Options: Copiers today oftencome with a choice of preset enlargement ratios.For example, one copier’s enlargement ratios arepreset at 65, 77, 129, and 155 percent. Othermodels allow one to reduce or enlarge from 65 to165 percent in 1 percent increments. This featurecan save time and money if one has predeter-mined the common enlargement needs andpreset the ratio to assist in copying.

Book Copying: Copiers with a book-copyingfeature allow copying from books or bound doc-uments without distortion of copy.

Sorting: Copiers are available that can sortwith a variety of bin configurations. As papermoves through the copier, it can be sorted into abin and then stacked, collated, and stapled. Thisoption can save immense time.

Control Panel and Servicing: The easy-to-readcontrol panels on today’s copiers permit copyingdecisions to be made easily. Copiers are oftendesigned with a front opening that allows unob-structed access for easy servicing, includingchanging toner for the copier. An increasingnumber of copiers are now designed so that theyuse toner cartridges, a feature that eliminatesmessy, time-consuming toner changes.

COPIER COSTS

The cost of a copier is determined by the modelselected and the options desired. Prices rangefrom a few hundred dollars to more than$100,000. One modern copier has a suggested listprice of $120,000 for the standard configurationand $137,500 for a model equipped with addi-tional options. These options include digital ser-vice capabilities such as permitting taking of a



photo, putting it on a scanner, bringing it up onthe computer and sending out copies.

The Xerox 5800 is suited for use in generaloffice copy rooms, an application encouraged byits user-friendly touch-screen control panel. Ad-ditional trays are available that automaticallycombine a variety of different paper stocks, in-cluding full-color offset pages, color covers, spe-cialty stocks, mylar tabs, and heat-sensitive mate-rials in a single document.

It also includes an exclusive computer-basedservice capability called Xerox Sixth Sense. Thisremote service system uses leading-edge commu-nications technology and specially developedsoftware to enable rapid diagnosis and resolutionof equipment service needs. A copier of this typeis truly state of the art.

SCANNERS

A scanner is a small machine that makes a photo-copy of virtually any printed matter or illustra-tion and stores it in a computer.

Scanners have a wide variety of applications.For personal use, for example, they can be usedfor copying photographs and sending them tofriends and relatives over the Internet.

Businesses make extensive use of scanners.They are used in doctors’ and dentists’ offices tophotocopy patients’ health insurance data forstorage in their computer. Manufacturers mayuse a scanner to store copies of technical matterin a computer for later retrieval. Lecturers mayuse scanners not only to provide illustrations forbrochures advertising their appearance but alsoto enhance overhead transparencies they may useduring their lectures. People who use communi-cations a great deal in their work find scannersinvaluable in enriching the e-mails they transmit.

Selection of a scanner should involve consid-eration of the ease of placing the image into theuser’s application. One begins the operation ofsome scanners by merely pressing a button;others require drawing a box around a prelimi-nary scan. Some scanners automatically make thecorrect setting by recognizing the difference be-tween a photograph and printed material; othersrequire the setting to be done by the operator.

Some scanners automatically select the correctfile type for the software program being used;others must have this procedure handled by theoperator.

Image quality is another criterion to be stud-ied when selecting a scanner. It is important tohave good resolution and bit-depth. But addi-tional factors are large lenses, good optics, andstrong light sources. Some scanners have auto-matic functions that bring these good results;others require considerable adjustments orrescanning of the image.

Image quality can also be observed in colorline art. Some scanners leave uneven color line-art halftones; others correct automatically forsuch a deficiency. In working with black-and-white line art, some scanners bring about perfectedges automatically. Other scanners must resortto rescanning.

Another factor to take into considerationwhen purchasing a scanner is the manufacturer.What is the manufacturer’s reputation? If a ques-tion arises about a scanner, it is easy to get asatisfactory answer quickly from technical sup-port? And is prompt service available in the eventof a problem?

Finally, thought must be given to resolution.It is not true that the larger the number of dotsper inch (dpi), the higher the quality of the im-age. Rather, the dpi must be appropriate for thescanning project. Most scanning projects requireless than 300 dpi. If you could scan an image at9600 dpi, only a small portion would show on acomputer monitor.

Judging a scanner involves studying its easeof operation, the quality of the image, the reputa-tion of the manufacturer, and the resolution ofthe image.

BIBLIOGRAPHY

‘‘Carbons to Computers.’’ www.educate.si.edu/scitech/carbons/copiers/.html. March 3, 1999.

‘‘HP Scanjet Scanners, Hewlett Packard.’’ www.scanjet.com/products/shoppinglist.html. March 15, 1999.

DOROTHY MAXWELL




Land, labor, capital, and entrepreneurship: Theseare four generally recognized factors of produc-tion. Of course, in a literal sense anything con-tributing to the productive process is a factor ofproduction. However, economists seek to classifyall inputs into a few broad categories, so standardusage refers to the categories themselves as fac-tors. Before the twentieth century, only three fac-tors making up the ‘‘classical triad’’ were recog-nized: land, labor, and capital. Entrepreneurshipis a fairly recent addition.

The factor concept is used to constructmodels illustrating general features of the eco-nomic process without getting caught up ininessential details. These include models pur-porting to explain growth, value, choice of pro-duction method, income distribution, and socialclasses. A major conceptual application is in thetheory of production functions. One intuitivebasis for the classification of the factors of pro-duction is the manner of payment for their ser-vices: rent for land, wages for labor, interest forcapital, and profit for entrepreneurship. A dis-cussion of each of the factors follows.

LAND

This category sometimes extends over all naturalresources. It is intended to represent the contri-bution to production of nonhuman resources asfound in their original, unimproved form.

For the French physiocrats led by FrancoisQuesnay in the 1750s and 1760s, land was theonly factor yielding a reliable gain to its owner. Intheir view, laborers and artisans were powerlessand in excess supply, and hence they earned onaverage only a subsistence-level income; and inthe same way what they produced outside ofagriculture fetched enough to cover only theirwages and input costs with no margin for profit.Only in agriculture, due to soil fertility and other‘‘gifts of nature,’’ could a laborer palpably pro-duce more than required to cover subsistenceand other costs, so only in agriculture could pro-prietors collect surplus. Thus the physiocrats ex-plained land rent as coming from surplus pro-

Joseph Schumpeter contrasted the entrepreneur fromthe capitalist.

duced by the land. They recommended taxes onland as the only sound way to raise revenue andland-grabbing as the best means to increase thegovernment’s revenue base.

In 1821 David Ricardo, in The Principles ofPolitical Economy and Taxation, stated what cameto be known as the classical view: that rent re-flects scarcity of good land. The value of a cropdepends on the labor required to produce it onthe worst land under cultivation. This worst landyields no rent—as long as some of it remainsunused—and rent collected on better land issimply its yield in excess of that on the worstland. Ricardo saw rent as coming from differ-ences in land quality (including accessibility) andscarcity. The classical economists assumed onlyland—understood as natural resources—couldbe scarce in the long term.

Marginalism, as expounded in 1899 by JohnBates Clark in The Distribution of Wealth, takes adifferent approach. It declares that rent reflectsthe marginal productivity of land—not, as with



Ricardo, the productivity of good versus mar-ginal land. Marginal productivity is the extraoutput obtained by extending a constant amountof labor and capital over an additional unit ofland of uniform quality. Marginalists held thatany factor of production could be scarce. Theirtheory is based on the possibility of substitutingamong factors to design alternative productionmethods, whereby the optimal productionmethod allocates all the factors to equalize theirmarginal productivity with their marginal costs.

Long thought of as a self-sustaining input,land might depreciate just like produced assetsdo. In 1989 Herman Daly and Jonathan Cobb, inFor the Common Good, distinguished betweennonrenewable resources that are consumed ordepreciate irretrievably, and renewable resourceswhere the rate of natural renewal is important.One consequence of this work in environmentaleconomics is that natural resource accounting in-creasingly resembles capital accounting.

LABOR

The classical ‘‘labor theory of value’’ was an inno-vative theory in response to the physiocratic doc-trine that only land could yield surplus. In 1776Adam Smith, in The Wealth of Nations, observedthat with expansion of production and trade,enterprises were making profits over long periodsof time, although they either had nothing to dowith agriculture or else as agricultural enter-prises. Classical economists tried to answer thequestion: Where does profit come from? Theiranswer was that it came from labor. At prevailingprices, labor can yield a surplus over subsistencecosts in many industries.

The question arises of why proprietors, butnot laborers, earn profit. Ricardo arrived at oneanswer: Technical innovation increases laborproductivity. Owners of innovative equipment,until its general adoption, get the premium fromreduced costs. In 1867 Karl Marx in Capital,added that wages reflect the cost of subsistence,not what laborers can produce, and that profit isthe difference between the two. Even withoutinnovation proprietors would reap surpluses,

Marx held, since laborers lack market power andcannot afford their own equipment.

Why do wages differ for different types oflabor? Marx’s answer was that higher wages covercosts, beyond personal subsistence, of trainingand cultivation of skills, acknowledging that onekind of ‘‘equipment,’’ now known as human cap-ital, was available at least to some laborers.

Marginalist economists noticed the advanceof technology, which according to classical andMarxist views made labor ever more productive,continually throws laborers out of work. This ledthem to attribute productivity to equipmentrather than only to labor. Referring to equipmentas capital, they developed production functionsfeaturing labor and capital as substitutes for eachother. Choice among production techniques in-volving different combinations of labor and capi-tal became a major theme in marginalist growththeory.

CAPITAL

This most controversial of factors is variously de-fined as produced equipment; as finance used toacquire produced equipment; as all finance usedto begin and carry on production, including the‘‘wage fund’’; and as the assessed value of thewhole productive enterprise, including intangi-bles such as ‘‘goodwill.’’ In 1960 Piero Sraffa, inProduction of Commodities by Means of Commod-ities, showed that capital in the sense of producedequipment can fail to behave as expected in mar-ginalist production functions when an entireeconomy is modeled. Specifically, equipmentadopted to replace labor after wages rise from alow level, relative to interest on capital, may beabandoned again in favor of labor as wages risestill higher. This counterintuitive ‘‘reswitching’’can happen because the equipment used is itself aproduct of labor and equipment, and because theratio of labor to equipment varies for differentproducts.

Frequently capital is treated as finance, asso-ciated with the payment of interest. Yet the con-nection with equipment, in spite of Sraffa’s dem-onstration, has never been severed entirely. Onestill studies capital depreciation, distinguishing



wear-and-tear from obsolescence, and from thepresent value of investments in capital. Increas-ingly, theory has come to treat any investment asa capital investment. Furthermore, acquired skills(as opposed to ‘‘know-how,’’ an attribute of soci-ety rather than individuals) have come to beviewed as analogous to physical equipment, ca-pable of yielding their owners a return. Thisanalogy suggests their current designation as hu-man capital. Thus capital is a concept still miredin confusion, and care must be taken in its use tobe sure what it means.

ENTREPRENEURSHIP

Until the twentieth century, this function wasassigned to the capitalist and frequently conflatedwith capital. In the classical view, profit ratherthan interest was attributed to ownership of capi-tal. In the marginalist view, capital earned inter-est, and profit was a mere residual after all thefactors of production were compensated. In hisPrinciples of Economics, first published in 1890,Alfred Marshall made extensive references to‘‘organization’’ and ‘‘management,’’ referring tothe coordination function of entrepreneurshipbut to neither risk-assuming nor innovation. Butin 1912 Joseph Schumpeter, in The Theory ofEconomic Development, featured the revolution-ary role of organizer and innovator and con-trasted it with that of the conservative financier,thus vividly distinguishing the entrepreneur fromthe capitalist. The entrepreneur’s role in this viewis not merely that of manager and risk-taker, butalso of visionary—someone who seeks as muchto destroy the old order as to create somethingnew. Since innovation usually requires destroy-ing old ways of doing things, Schumpeter gave itthe name ‘‘creative destruction.’’ Profit is nowassigned to entrepreneurship, to innovation.With the rise of ‘‘venture capitalists’’ and otherfinanciers willing to take on more risk and domore for innovation in the hope for supernormalreturns, the distinction between capitalist and en-trepreneur has again become fuzzier. Now thereare entrepreneurial financiers as well as entrepre-neurial producers and distributors.

Although in business usage stock dividendsare distributed profits, in economic analysis theyfigure as returns to capital, a kind of interestpayment, since they are a return to financerather than to entrepreneurship. The fact thatstocks are legally equity rather than debt sharesis thereby ignored. Similarly, salaries of corpo-rate executive officers are treated as profit, a re-turn to entrepreneurship, rather than as wagesfor labor services.

BIBLIOGRAPHY

Clark, John Bates (1899/1966). The Distribution of Wealth.Clifton, NJ: Augustus M. Kelley.

Daly, Herman E., and Cobb, Jonathan. (1989). For the Com-mon Good: Redirecting the Economy Toward Community,the Environment, and a Sustainable Future. Boston: Bea-con Press.

Marshall, Alfred. (1920). Principles of Economics. New York:Macmillan.

Marx, Karl. (1867/1977). Capital, vol. I. New York: VintageBooks.

Ricardo, David. (1821/1965). The Principles of Political Econ-omy and Taxation. London: Everyman’s Library.

Schumpeter, Joseph. (1934/1912). The Theory of EconomicDevelopment. Cambridge, Mass.: Harvard UniversityPress.

Schumpeter, Joseph. (1954). History of Economic Analysis.New York: Oxford University Press.

Smith, Adam. (1776/1965). An Inquiry into the Nature andCauses of the Wealth of Nations. New York: ModernLibrary.

Sraffa, Piero. (1960/1963). Production of Commodities byMeans of Commodities. London: Cambridge UniversityPress.

MICHAEL BRUN

FADS

The Hula Hoop, Pet Rock, and Cabbage PatchKid were all crazes known as fads. These prod-ucts, like most fads, entered the market quickly,created a consumer obsession, sold millions ofunits in a short amount of time, and declined justas rapidly. Their special product life cycle ofquick, dramatic sales and a sharp, drastic declinediffers from the five stage product life cycle con-

FADS


Hula Hoopers enjoy one of the current fads of their day.

cept of product development, introduction,growth, maturity, and decline. Fads have a lim-ited following and tend to die quickly becausethey do not satisfy a strong consumer need.

THE PRODUCT LIFE CYCLE

The course that a product’s sales and profits takeover its lifetime is the product life cycle (PLC).

Marketers know that all products will have sometype of life cycle, but the shape and length is notknown in advance. In the first stage of the cycle,product development, an idea for a product isformulated and development of the product be-gins. During this stage sales are zero, consumerresearch begins, and promotion consists of pub-lic relations.

FADS


The next stage, introduction, is characterizedby a period of slow sales growth, but no profitsare made because of the high initial investmentand promotional costs. The company begins toinform consumers about the product throughadvertising, and distribution of the product isselective.

The third stage of the PLC, growth, is a timeof rapid market acceptance and increasing pro-fits. Product distribution becomes more wide-spread, and advertising shifts from being infor-mative to being persuasive. Realizing theopportunity for profit, competitors will enter themarket, creating market expansion. Promotionalspending remains the same or increases slightly.Prices may be lowered during the growth stage toattract new customers.

The fourth stage of the PLC, maturity, is aperiod of slow sales growth and leveling-off ordeclining profits. Most potential buyers havebeen reached, so no new customers are buyingthe product. This stage presents the greatest chal-lenges to marketers. To prevent entering the de-cline stage, research and development depart-ments may make product modifications to meetthe changing needs of consumers, distributionbecomes selective again, and advertising becomescompetitive because of the number of competi-tors who have entered the market.

Sales slow and profits drop in the declinestage, usually because of advances in technol-ogy, a shift in consumer taste, or increasedcompetition. Distribution becomes exclusive,and sales promotions are developed. Productsin the decline stage should have their sales,market share, costs, and profit trends regularlyreviewed so that managers can decide whetherto maintain the product, harvest the product(reduce various costs associated with the prod-uct), or drop the product from the productline. Now let’s examine and discuss the productlife cycle of fads.

THE PRODUCT LIFE CYCLE OF FADS

The Hula Hoop has been called the ‘‘greatest fadof them all.’’ Developed in 1957 by Wham-Ocreators Richard Knerr and Arthur ‘‘Spud’’

Melin, it was modeled after an Australian toy. Aprototype was developed and tested on U.S. play-grounds and was found to have the longest ‘‘playvalue.’’ After only four months on the market, 25million Hula Hoops had been sold. In less than ayear, sales had almost completely stopped andcompetition was increasing, so Wham-O enteredforeign markets and its success continued. Col-lectively, toy manufacturers made $45 million offthe Hula Hoop.

The life cycle of the Hula Hoop was nottypical of most products. A prototype was devel-oped and tested during the product developmentstage, but the Hula Hoop bypassed the introduc-tion stage and, with rapid sales, the toy quicklyentered the growth stage. Again, the Hula Hoopskipped the maturity stage and went directly intothe decline stage, with sales coming to an almostimmediate halt. Other fads’ life cycles have fol-lowed this model.

Gary Dahl created the Pet Rock in the 1970s,complaining that dogs, cats, and other pets weretoo messy, misbehaved, and expensive. Instead,Dahl had a pet rock that was easy to care for andcheap; it also had a great personality. Dahl wrotethe Pet Rock Training Manual and created the PetRock out of a Rosarita Beach Stone that cost hima penny. In October 1975, Dahl packaged the PetRock in a gift box shaped like a pet carrying case,included the training manual, and sold it for$3.95. Within a few months, Dahl had sold amillion rocks and became an instant millionaire.By the next February, sales had stopped.

Unlike the Hula Hoop, the Pet Rock was nottested during the product development stage.Dahl had the idea for the product and quicklyproduced it with no market testing. Similar to theHula Hoop, the Pet Rock caught on quickly withconsumers, reached its life-cycle peak at thegrowth stage, and dipped down into the declinestage in a very short period of time.

Artist Xaiver Roberts created Cabbage PatchKids, originally called ‘‘Little People,’’ in 1977.The cloth doll was ‘‘delivered’’ at BabyLand Gen-eral Hospital, a former medical clinic in Cleve-land, Georgia, where Roberts had his employeesdress in white nurses’ and doctors’ uniforms.

FADS


Sales of the dolls were termed ‘‘adoptions,’’ andeach doll came with a birth certificate and adop-tion papers. Roberts sold 250,000 dolls at pricesranging from $125 to $1000. National CabbagePatch mania struck when Roberts signed a con-tract with Coleco in 1982, and $25 models startedselling all over the United States. Approximately2.5 million Cabbage Patch Kids were sold in thefirst year on the market. But, like the fads beforeit, the Cabbage Patch Kid had lost its dominatingposition in the market by 1985.

The Cabbage Patch Kid had a standard prod-uct development stage, but its introduction stagewas short. Shortly after hitting the toy storeshelves, sales skyrocketed and the product en-tered the growth stage with full force. It enteredthe maturity stage when sales starting leveling offand the supply was greater than the demand. Inan effort to prevent the product from enteringthe decline stage, marketers at Coleco experi-mented with product extensions—but to noavail. Eventually, profits began to drop and theCabbage Patch Kid fell into the decline stage.Figure 1 shows the product life cycle of fads.

Fads are generally mysterious both to theircreators and to the public. Although their prod-ucts were unique, Wham-O, Dahl, and Robertshad no idea they would experience such rapidsuccess. Past fads have included the Rubik Cube,Beanie Babies, and Furbee. Most fads never reallycompletely die, but they never regain their initialpopularity. To understand consumer obsessionswith fads, marketers must understand consumerbuying behavior.

CONSUMER BUYING BEHAVIOR

There are four types of buying behavior: complexbuying behavior, dissonance-reducing buyingbehavior, habitual buying behavior, and variety-seeking buying behavior. Complex buying behav-ior occurs when the consumer is purchasingsomething expensive or risky, such as a personalcomputer. The consumer must learn about theproduct line, is highly involved in the buyingprocess, and perceives significant differencesamong brands. Marketers must differentiate theirproducts’ features from other brands. Disso-

Product Life Cycle of Fads

Time

Sal

es

Figure 1

nance-reducing buying behavior occurs when anexpensive or risky purchase is being made, butthe consumer perceives no difference in brands.They may purchase the brand that offers the bestprice or that is the most convenient to buy. Ha-bitual buying behavior involves low consumerinvolvement and little concern for brand differ-ences. Variety-seeking buying behavior is charac-terized by low consumer involvement but signifi-cant differences in brands. Consumers displayingthis type of buying behavior often switch brandsto experience variety rather than because of dis-satisfaction.

Fad purchasers display variety-seeking buy-ing behavior. Buyers of Beanie Babies are loyal tothe Ty brand; they will not buy competingbrands. Many consumers who buy Beanie Babiesswitch to the next craze when it hits the shelves.PokeMon became the latest fad in 2000, and thevariety-seekers shifted again to this latest trend.Until consumer demands and obsessions cease toexist, fads are here to stay.

FADS


BIBLIOGRAPHY

Armstrong, Gary and Kotler, Philip. (1999). Principles ofMarketing. 8th ed. Upper Saddle River, NJ: Prentice-Hall.

Baig, Edward C. (1983). ‘‘The Billion-Dollar Cabbage Patchin Cleveland, Georgia.’’ Fortune December 26: 108.

Friedrich, Otto. (1983). ‘‘The Strange Cabbage Patch Craze;Troubled Coleco is Cashing in Big On the Year’s HottestToy.’’ Time December 12: 122.

Rakstis, Ted J. (1985). ‘‘Cabbage Patch Takes Sudden SalesPlunge.’’ Playthings June: 83.

JENNIFER L. JENNESS

FAIR PACKAGING ANDLABELING ACT OF 1966

Many consumer problems have been, and insome instances still are, caused by incorrect andeven fraudulent information disclosure on prod-ucts and through advertising. The Fair Packagingand Labeling Act of 1966 was passed during theJohnson administration to ensure that con-sumers have the information they need to choosewisely among competing products. The act di-rects businesses to disclose necessary informationtruthfully. Product labels must include such basicinformation as ingredients and contents, quan-tity, and maker of the product. Therefore, anybusiness engaged in producing and distributingconsumer products must comply with the FairPackaging and Labeling Act of 1966. This actcomes under the consumer-protection charge ofthe Federal Trade Commission, which bears theprimary responsibility for making sure that la-beling is not false and misleading. Textiles andfood products are two examples of products reg-ulated under this act, which not only preventsconsumer deception but also provides consumerswith the opportunity to compare value.

Amendments to the Fair Labeling and Pack-aging Act of 1966, passed in 1992 and enforcedbeginning in 1994, require labels to include con-version of quantities into a metric measurementin addition to the customary U.S. system ofweights and measures. There was a great deal ofopposition to this act from both private and

public-sector manufacturers that sold their prod-ucts only in the United States. For example, somepaint manufacturers said that labeling contentsin pints and gallons should be sufficient sincetheir paint was sold only in the United States. Theminimum federal penalty for not including met-ric measurements was established at $10,000.State regulators have the authority to removeproducts from store shelves if they were not com-pliant with the established guidelines.

Under the Bush administration, the Nutri-tion Labeling and Education Act of 1990 waspassed, which requires detailed information onlabels and standardized descriptive phrases suchas ‘‘low fat’’ and ‘‘light.’’ Manufacturers had tocomply with this act by 1994. Since the passage ofthe Nutrition Labeling and Education Act, peopleare better satisfied with the information printedon food and drug labels (Kristal et al., 1998).While manufacturers were initially opposed tothe new nutrition labeling, mainly because ofcost, it was predicted that consumer health bene-fits would exceed the cost.

In 1993 the Food and Drug Administrationissued additional regulations to the Nutrition La-beling and Education Act, stating that restaurantmenus must comply with regulations for nutrientand health claims that appear on signs,placecards, and menus. The rule was finalized in1996, establishing criteria under which restau-rants must provide nutrition information formenu items. Thus healthier or ‘‘low-fat’’ menuchoices must be highlighted with claims such as‘‘no more than 5 grams of fat per serving.’’ Res-taurants are getting excellent customer re-sponse—better than expected—to providinghealthy food choices. Consumers today are de-manding higher quality. Fair labeling and pack-aging help assure consumers that they are gettingthe high quality they are demanding.

BIBLIOGRAPHY

Kristal, A. R., Levy, L., et al. (1998). ‘‘Trends in Food UseAssociated with New Labeling Regulations.’’ AmericanJournal of Public Health 88(8):1212-1216.

Kurtzweil, P. (1997). ‘‘Today’s Special Nutrition Informa-tion.’’ FDA Consumer 31(4):21-26.

FAIR PACKAGING AND LABELING ACT OF 1966


Litvan, L. M. (1994). ‘‘Sizing Up Metric Labeling Rules.’’Nation’s Business 82(11):62.

PHYLLIS BUNN


To promote the development of a sound econ-omy and a reliable banking system, Congresspassed, and President Woodrow Wilson signed,the Federal Reserve Act on December 23, 1913.The act was a response to the recurring bankfailures and financial panics that had plagued thenation.

After much disagreement, but eventual com-promise, all parties to the discussions—the gov-ernment, banks, other financial institutions, anda few business and labor leaders—agreed that acentral U.S. bank was essential for the economichealth of the country. Starting with the goal ofstabilizing the nation’s monetary and financialsystem, the Federal Reserves System (Commonlycalled the Fed) has undertaken a number of re-sponsibilities that are described later in thisarticle.

STRUCTURE OF THE SYSTEM

Designed by Congress and subject to congressio-nal authority, the Fed is a politically independentand financially self-sufficient federal agency. Itconsists of the following components:

1. A central bank, sometimes called the gov-ernment’s bank, located in Washington,D. C.

2. Twelve regional Reserve Banks, located inthe following cities: Atlanta, Boston, Chi-cago, Cleveland, Dallas, Kansas City,Minneapolis, New York, Philadelphia,Richmond, San Francisco, and St. Louis.Each Reserve Bank relies on advisorygroups for information and suggestions.Some of the more important ones con-cern operations, small business and agri-culture, and thrift institutions (savingsbanks, savings and loan associations, andcredit unions). Reserve Bank officials also

meet periodically to discuss mutual prob-lems. These groups include the Confer-ence of Presidents, the Conference ofFirst Vice Presidents, the Conference ofChairmen, and the Financial Services Pol-icy Committee.

3. Twenty-five branch banks, located withindefined areas of the Reserve Banks. Forexample, branch banks within the SanFrancisco Reserve Bank area are locatedin Los Angeles, Portland (Oregon), SaltLake City, and Seattle.

4. Member banks, located throughout thecountry. Some are national banks (all ofwhich are commercial banks) charteredby the federal government and, by law,are members of the Fed. Others are statecommercial banks that have chosen to bemembers. Of the more than 9000 com-mercial banks in the country, more than3700 are members of the Fed. Other de-pository institutions, including nonmem-ber commercial banks and thrift institu-tions, are subject to many of the Fed’srules and regulations. A member bank isrequired to purchase stock from its Re-serve Bank in an amount equal to 3 per-cent of its combined capital and surplus.However, this investment does not repre-sent control of or a financial interest inthe Reserve Bank. In return for its invest-ment, however, a member bank receives a6 percent annual dividend and the rightto vote in elections of directors of its Re-serve Bank.

GOVERNANCE OF THE SYSTEM

These are three basic components in the gover-nance structure of the Fed:

1. The Fed’s primary policy-making group isthe seven-member Board of Governors.Appointed by the president and con-firmed by the Senate, members serve forone fourteen-year term only. A memberwho is appointed to fill an unexpiredterm may be appointed for an additional



The Federal Reserve building.

full term. From among the seven mem-bers, the Board’s chairman and vicechairman are also appointed and con-firmed by the president and the Senatefor four-year terms.

2. There are three advisory groups that aidthe Board of Governors:

a. Federal Advisory Council, consistingof one member from each ReserveBank. Its major concerns involvebanking and economic issues.

b. Consumer Advisory Council, consist-ing of thirty specialists in consumerand financial matters.

c. Thrift Institutions Advisory Council,consisting of people representing thriftinstitutions. This Council is concernedwith issues affecting those institutions.

3. The Federal Open Market Committee(FOMC) consists of the seven-memberBoard of Governors, the New York Fed-

eral Reserve Bank president, and an addi-tional four Reserve Bank presidents whoserve on a one-year rotating basis. By tra-dition, the Committee elects the Board ofGovernors chairman as its chairman andthe New York Reserve Bank president asits vice chairman. Although all twelve Re-serve Bank presidents attend the FOMC’seight-times-a-year formal meetings, onlythe Board, the New York Reserve Bankpresident, and the four rotating presi-dents are voting members.

ACTIVITIES AND RESPONSIBILITIES OF THEFEDERAL RESERVE SYSTEM

In conjunction with the FOMC and the twelveReserve Banks, the Board of Governors’ mainconcern is the development of monetary policy,which it carries out through three means:

1. The establishment of reserve-level rates;that is, amounts that member banks must



Woodrow Wilson created the Federal Reserve.

set aside to be reserved against deposits.These amounts depend on the nation’seconomic activity status, with emphasisplaced on price levels and the volume ofbusiness and consumer expenditures. Bythe lowering of the required reserve-levelrate, banks can increase the proportion offunds they are able to lend to customers.By raising the required reserve-level rate,the opposite effect takes place. Thus, theFed can influence such factors as eco-nomic activities, the money supply, inter-est rates, credit availability, and prices.However, a change in a reserve-level rateusually causes banks to change their stra-tegic plans. In addition, a reserve-levelrate increase is costly to banks. Conse-quently, changes in reserve-level rates areuncommon.

2. The approval of discount rates (interestrates at which member banks may bor-row short-term funds from their Reserve

Bank). When inflation threatens, a dis-count-rate increase tends to dampen eco-nomic activity because then banks chargehigher interest rates to borrowers. On theother hand, a discount-rate decrease isdesigned to stimulate business activity.The term ‘‘discount window’’ is oftenused when describing a Reserve Bank fa-cility that extends credit to a memberbank.

Another rate, the federal funds rate, isan important factor affecting day-to-daybank operations. This is the rate chargedby one depository institution to anotherfor the overnight loan of funds. This hap-pens when one bank is short of fundswhile another has a surplus. The rate isnot fixed; it may change from day to dayand from bank to bank.

3. Open-market operations (the purchaseand sale of U.S. government securities inthe open market). These activities areconducted by the FOMC, of which theBoard of Governors comprises the major-ity. The Fed buys and sells U.S. govern-ment securities such as Treasury billsfrom banks and others several times aweek. As a result, the amounts bankshave available to lend to borrowers areaffected. For example, when the Fed buyssecurities, banks have more funds, so in-terest rates tend to drop. The oppositeoccurs when the Fed sells its securities.By and large, open-market operationscomprise the most powerful tool the Fedhas to influence monetary policy.

Other activities and responsibilities of theFederal Reserve System include the following:

1. Supervision of the twelve Reserve Banksand their branches. With regard to thelatter, the Board of Governors, throughthe Reserve Banks, uses both on- and off-site examinations to maintain awarenessof each member bank’s activities. Theseactivities include the quality of loans, cap-ital levels, and the availability of cash.



2. Cooperative efforts of the U.S. Treasuryand the Fed. For example, the Fed acts asthe Treasury’s fiscal agent by putting pa-per money and coins into circulation,handling Treasury securities, and main-taining a checking account for the Trea-sury’s receipts and payments.

3. Oversight of banking organizations, suchas bank holding companies (companiesthat own or control one or more banks).

4. Provision of an efficient payments system;for example, check collections and elec-tronic transactions. With billions ofchecks in circulation each year, the Fedplays a major role in assuring their effi-cient processing. By arrangements amongthe Reserve Banks, member banks andnonmember banks, checks are credited ordebited (added to or subtracted from) todepositors’ accounts speedily and accu-rately. Electronic methods are being usedincreasingly to transfer funds (and securi-ties, too). One such method, involvingvery large sums, is called ‘‘Fedwire.’’ An-other is the Automated Clearinghouse(ACH), which is used by the government,businesses, and individuals for the receiptor payment of recurring items, such asSocial Security.

5. Enforcement of consumer credit protec-tion laws. These laws include the Com-munity Reinvestment Act, which pro-motes community credit needs; the EqualCredit Opportunity Act, which prohibitsdiscrimination in credit transactions onthe basis of marital status, race, sex, andso forth; the Fair Credit Reporting Act,which allows consumers access to theircredit records for the purpose of correct-ing errors; and the Truth in Lending Act,which enables consumers to determinethe true amount they are paying forcredit.

6. Establishment of banking rules and regu-lations.

7. Determination of margin requirements(the amount of credit granted investorsfor the purchase of securities, such asshares of stock). The borrowed funds areusually secured from a bank or a broker-age firm (a company that sells stocksand/or bonds). Margin requirements thatare too liberal can damage the stock mar-ket and the economy.

8. Approval or disapproval of applicationsfor bank mergers (two or more banksjoining together to form one new bank).The Fed also acts if the new bank is tobecome a state member bank of the Fed-eral Reserve System.

9. Approval and supervision of the Edge Act(named for Senator Walter Edge of NewJersey) and ‘‘agreement corporations.’’Both cases involve corporations that arechartered to engage in international bank-ing. Edge Act corporations are charteredby the Fed, while ‘‘agreement corpora-tions’’ secure their charters from thestates. The latter are so named becausethey must agree to conform to activitiespermitted to Edge Act corporations. TheFed is also responsible for approving andregulating foreign branches of memberbanks and for developing policies regard-ing foreign lending by member banks.

10. Issuance and redemption of U.S. savingsbonds. Regardless of how the bonds arepurchased—for example, through an em-ployer savings plan or a bank—it is theFed that processes the applications andsends the bonds.

SUMMARY

Since it holds substantial U.S. government secu-rities, the Federal Reserve System earns sufficientinterest to operate without government appro-priations. Consequently, it is both a financiallyself-sufficient and politically independent agencythat exerts great influence on the nation’s econ-omy. It bolsters domestic consumer confidence



and is a major player in global economic activi-ties.

(SEE ALSO: Financial Institutions)

BIBLIOGRAPHY

Federal Reserve System. http://www/federalreserve.gov.Federal Reserve System Structure and Functions. (1992).Atlanta: Federal Reserve Bank of Atlanta.

Feinman, Joshua N. (June 1993). ‘‘Reserve Requirements:History, Current Practice, and Potential Reform.’’Federal Reserve Bulletin 79:569-589.

The Federal Reserve System: Purposes and Functions. (1994)Washington, DC: Board of Governors of the FederalReserve System.

MELVIN MORGENSTEIN

FEDERAL TRADE COMMISSIONACT OF 1914

The Federal Trade Commission Act of 1914 pro-hibits unfair methods, acts, and practices of com-petition in interstate commerce. It also createdthe Federal Trade Commission, a bipartisancommission of five presidential appointees, con-firmed by the Senate, to police violations of theact. The Federal Trade Commission’s (FTC)function is to counter deceptive acts and prac-tices and anticompetitive behavior by businesses.The FTC enforces the Clayton and Federal TradeCommission Acts as well as a number of otherantitrust and consumer-protection laws. TheFTC’s rulemaking authority enables it to issuerules interpreting the antitrust laws that governeither all members of industry or apply to specificbusiness practices. When a rule is violated, theFTC can initiate civil proceedings in a federaldistrict court to obtain injunctive relief and civildamages.

The FTC (and the provisions of the antitrustacts that preceded it) promotes free and fair tradecompetition by investigating and preventing vio-lations of the law. Key areas covered by the Fed-eral Trade Commission Act of 1914, as well asother antitrust laws, include the following:

Price fixing: There are two types of pricefixing: vertical and horizontal. Verticalprice fixing occurs when manufacturersmake express or implied agreements withtheir customers obligating them to resell ata price dictated by the manufacturer. Man-ufacturers can suggest retail prices but notfix them by agreement. Few sellers arecaught vertically fixing prices; instead, theyintimidate retailers by cutting off sales(Garman, 1997). Horizontal price fixingoccurs when competitors make directagreements about the quantity of goodsthat will be produced, offered for sale, orbought. According to Garman (1997), inone case, an agreement by major oil re-finers to purchase and store the excessproduction of small independent refinerswas found to be illegal because the pur-pose of the agreement was to affect themarket price for gasoline by artificially lim-iting the availability of supply. The govern-ment can take action, civil and/or criminal,in cases of price fixing.

Unfair competition: The FTC and antitrustpolicies that preceded it are in agreementon concepts of unfair competition. Exam-ples of unfair competition are larger busi-nesses using their size or market power togain lower prices from suppliers or a man-ufacturer granting discounts for the sameproducts sold to larger firms withoutgranting similar discounts to smaller busi-nesses when selling costs do not vary.

Merger prohibition: A merger is the acquisi-tion of one company by another. The FTCestablished guidelines and criteria thatchallenge mergers that lessen competition.The judgment of the courts is that a re-straint of trade occurring through a mergermust be undue and unreasonable before itis held illegal.

Deceptive practices: False advertising is oneexample of deceptive practice. The FTCconsiders an advertisement deceptive if itcontains misrepresentation or omission

FEDERAL TRADE COMMISSION ACT OF 1914


that is likely to mislead consumers actingreasonably under the circumstances totheir detriment.

Even though there are differences of opinionas to the effectiveness of antitrust policy, every-one—consumers, competitors, and prospectivebusiness owners—benefits from amore competi-tive economy. Thus, antitrust policy is an impor-tant element in public policy regarding business.Unfortunately, there are limits to what is accom-plished mainly because the amount of funds pro-vided by Congress for antitrust issues has a signif-icant impact on enforcement. One case, such asthe 1999 Microsoft case, can make a major dentin the FTC budget.

(SEE ALSO: Antitrust Legislation)

BIBLIOGRAPHY

Garman E. T. (1997). Consumer Economics Issues in America,5th ed. Houston, TX: DAME Publications.

Meier, K. J., Garman, E. T., and Keiser, L. R. (1998).Regulation and Consumer Protection: Politics, Bureaucracyand Economics, 3d ed. Houston, TX: DAME Publica-tions.

PHYLLIS BUNN

FEEDBACK(SEE: Operations Management)

FINANCE

Corporate or Business Finance is basically themethodology of allocating financial resources,with a financial value, in an optimal manner tomaximize the wealth of a business enterprise.There are three major decisions to be made inthis allocation process: capital budgeting, financ-ing, and dividend policy. Capital budgeting is thedecision regarding the choice of which invest-ments are to be made with the resources thathave been brought into the business or earnedand retained by the business. The choice dependson the returns to be made from the investmentexceeding the cost of capital. The method used to

do this is the discounted time-value of money ofthe cash flow from the investment. This value isthe internal rate of return (IRR), a measure ofreturn on investment. When the IRR exceeds therequired return, which is equal to the cost of thefunds invested—see weighted average cost of capi-tal, below—then the investment should be made.If such a required return is used as the discountrate, then that is the same as saying the invest-ment will yield a positive net present value (NPV).If there are two or more investments that can bemade, but they are mutually exclusive, then theymust be ranked; and the one with the highestNPV should be chosen. If there is a limitedamount of funds to be invested, then somebankers or advisers who obtain additional fundsfor a business may require that the businesschoose among the investments so as not to ex-ceed the limited level of funds available. Thisselection process, which is called capital ra-tioning, should be done in a similar manner torank the projects by selecting the combination ofinvestments that do not exceed the total fundsavailable and that yield the maximum total netpresent value.

Financing is the decision of which resourcesor funds are to be brought into the business fromexternal investors and creditors in order to beinvested in profitable projects. The first externalsource of finance is debt, which includes loansfrom banks and bonds purchased by bond-holders. The debt creditors take less risk ofnonrepayment because the business must repaythem if there are funds available to do so whenthe debt becomes due. The second externalsource of finance is equity, which includescommon stock and preferred stock. The equity in-vestors in the business take more business riskand may not receive payment until the creditorsare repaid and the management of the businessdecides to distribute funds back to the investors.The goal of the financing decision is to obtain allthe resources necessary, to make all the invest-ments that yield a return in excess of the cost ofthe funds invested or the required rate of return,and to obtain these funds at the lowest averagecost, so as to reduce the required rate of return

FINANCE


and increase the net present value of the projectsselected.

Dividend policy is the decision regardingfunds to be distributed or returned to the equityinvestors. This can be done with common stockdividends, preferred stock dividends, or stock repur-chase by the business of its own stock. The aim ofthis decision is to retain the resources in thebusiness that are required to run the business ormake additional investments in the business, aslong as the returns earned exceed the requiredreturn. In theory, management should return ordistribute all resources that cannot be invested inthe business at levels in excess of the requiredreturn. In practice, however, dividends are oftenmaintained at or changed to certain levels inorder to convey the proper signals to the inves-tors and the financial markets. For example, divi-dends can be maintained at moderate levels todemonstrate stability, maintained at or reducedto low levels to demonstrate the growth opportu-nities for the business, or increased to higherlevels to demonstrate the restoration of a strongfinancial (capital) structure (debt and equity cap-ital) for the business.

Capital is the total of financial resourcesinvested in the business. In terms of the sources,there are two types of capital: interest-bearingdebt funds, such as loans, bonds, short-termnotes, and interest-bearing payables to trade sup-pliers; and equity, such as common and preferredstock and the earnings retained in the businessthat add to stockholders’ share of the entities. Interms of uses, there are also two types of capital:net working capital, such as operating cash, inven-tory, and receivables, less interest-free payables totrade suppliers; and fixed capital, such as prop-erty, plant and equipment. Capital is managed tomaximize wealth by maximizing the rates of re-turn on investments of capital and thus maximiz-ing the total net present value of the business.This can be done by minimizing the amount ofcapital used for given business investments withgiven business returns.

Weighted average cost of capital is theweighted average of the returns on investment orfuture dividends for the stockholders and interest

rates on debt for the creditors. This average re-turn should be used as the required return forinvestments, as mentioned earlier, because it rep-resents the weighted average of the required re-turns of all the different debt creditors and equityinvestors. It also represents the weighted averageof the costs that can be saved by the business ifthe resources or financial funds are returned tothe creditors and investors instead of being usedfor investments within the business.

Capital structure is represented by the typesof sources of capital funds invested in the busi-ness. A common measure of sources is the per-centage of debt relative to equity that appears ona company’s balance sheet. Usually, the cost orrequired returns for the debt is much less thanthe equity, especially on an after-tax basis. Thus,the total cost of capital declines when some debtfunds from creditors are substituted for equityfunds from investors. Yet as more debt is added,the business becomes riskier because of thehigher amount of fixed payments that must bemade to creditors, whether or not the business isgenerating adequate funds from earnings; andthen the costs of both the debt and equity fundsare increased to the point where the weighted-average cost increases.

Acquisitions, which are purchases of otherbusinesses, are merely another type of capitalbudgeting investment for a business. Such pur-chases should be evaluated in the samemanner asany other capital investment, as outlined earlier,to obtain the maximum positive net presentvalue, though the issues and data are often morecomplex to analyze.

Price/earnings ratio is often used in makingacquisitions as an abbreviated measure of valua-tion. This ratio is of the value or price of abusiness or its stock to its earnings. Yet the actualdecision to make an acquisition is a capital bud-geting decision; the resultant determination ofprice or net present value can then be describedin relative terms to the earnings in the price/earnings ratio.

Returns for any business or particular debt orinvestment made in the business are merely thecash flows that will ultimately be earned by the

FINANCE


business or particular creditors and stockholders.These can be expressed in dollar terms or as per-centages, with the latter being the average annualpercentage of the cash flows relative to the overallinvestment in the business or the particularamounts of debt or stock involved. For debt in-struments, these percentage rates are calledinterest rates. For specific investment decisions,the returns used should be those that are incre-mental of the specific investment.

Return/interest rates are based on three com-ponents: pure return for the investor or creditorproviding funds; coverage of inflation rates, sothat the purchasing power of the proceeds ismaintained apart from the true return; and addi-tional return for additional risk, such as an equityinvestment in a risky business as opposed to abond from the U.S. government. These compo-nents are then compounded with each other,rather than merely added together, to obtain theoverall interest rate or required return on equityinvestment. When calculating return or interestrates, any additional up-front money, such asclosing costs, must also be added to the invest-ment; this amount increases or reduces the re-turn, depending on who pays for it.

Residual values are a portion of the returns tobe earned in an investment that is returned to thebusiness when the investment is sold or theproject is terminated. This can be most impor-tant in the liquidation of inventory and receiva-bles when operations of a portion of a businessare terminated or when real estate ceases to berequired and thus can be sold, for example, whena factory is closed or when a lease term is com-plete.

Maturities of debt instruments, such asbonds, loans, or notes payable, are the amountsof time outstanding before the debt becomes due.The financial management rule with respect tomaturities is to match the duration of the fundsbeing borrowed by the debtor, or invested by thecreditor, with the timing of his or her own busi-ness needs for funds in the future. Thus, thefinancing of a new business—with the likely fu-ture expansions of property, plant, equipment,inventory, and receivables—can be done with

longer-term debt funds. Yet the financing of aspecific shorter-term need, such as the outlays ona construction project before completion pay-ments are made, should be comparably shorter inmaturity. Similarly, the investment of temporaryexcess cash should be in shorter-term instru-ments, such as short-term CDs or Treasury bills.If maturities are not matched, then the additionaltime before the debt becomes due from or to youbecomes a period of speculation on the rise or fallof future interest rates.

International finance is concerned with thesame methodology of allocating financial re-sources, but with modifications or areas of em-phasis required by the restrictions of currencyand capital movements among countries and thedifferences in the currencies used in differentcountries. The following paragraphs representsome of the major changes to the basic financialdecisions:

1. Foreign capital budgeting requires the useof foreign cash flows and local tax rates,but U.S. inflation rates and U.S. dollars atthe current exchange rates can be used.The required return or cost of capitalthen need only be adjusted, as with anyinvestment, for the greater or lesser riskof the project in which the investment ismade, which includes the greater or lesserrisk of the country in which the invest-ment is being made.

2. Foreign capital markets are a source forboth debt and equity funds, for both for-eign subsidiary operations and the generalneeds of the overall business. Foreign sub-sidiary capital structures often utilize morelocal debt when legally and practicallyavailable in order to reduce the risk ofblockages of earned funds from repa-triation to the parent company in anothercountry. In addition, local-currency debtreduces the risk for the parent companyif the exchange rates for the local cur-rency change adversely.

3. Foreign-exchange rates can change dra-matically and therefore pose a significant

FINANCE


risk for the value of assets held in or fu-ture payments from foreign countries.These exposures may be in dealings withthird parties or within a company’s ownforeign subsidiaries. Forward currency con-tracts or currency options, instrumentsused to purchase one currency for an-other currency in the future at guaran-teed exchange rates, can be used to pro-tect against such risk. While thesecontracts are often also used to makeprofits by managers who believe the ex-change rates will change in a manner dif-ferent from the expectations implicit inthe overall currency market, such useshould be viewed as risky speculation.

4. Personal finance is concerned with thesame methodology of allocating resources,but with a greater emphasis on allocatingsome of them to obtain the maximumconsumption satisfaction at the lowestcost, as opposed to earning income andcash flow returns on the investments.

5. Budgeting and financial planning are theprocesses used by financial managers toforecast future financial results for a busi-ness, a person, or a particular investment.Usually, the major components of earn-ings, cash flow, and capital are projectedin the form of forecasted income state-ments, cash-flow statements, and balancesheets. The latter show where the capitalfunds are invested in the components offixed and working capital, as well as thesources of these capital funds in terms ofthe debt, stock, and retained earnings.

ISSUES IN APPLIED CORPORATE FINANCEAND VALUATION

Estimation of the Cost of Capital. In recentdecades, theoretical breakthroughs in such areasas portfolio diversification, market efficiency,and asset pricing have converged into compellingrecommendations about the cost of capital to acorporation. The cost of capital is central tomodern finance, touching on investment and di-

vestment decisions, measure of economic profit,performance appraisal, and incentive systems.Each year in the United States, corporations un-dertake more than $500 billion in expenditures,so how firms estimate the cost is not a trivialmatter. A key insight from finance theory is thatany use of capital imposes an opportunity cost oninvestors; namely, funds are diverted fromearning a return on the next-best equal risk in-vestment. Since investors have access to a host offinancial market opportunities, corporate use ofcapital must be benchmarked against these capi-tal market alternatives. The cost of capital pro-vides this benchmark. Unless a firm can earn inexcess of its cost of capital, it will not create eco-nomic profit or value for investors. A recentsurvey of leading practitioners reported the fol-lowing best practices:

● Discounted cash flow (DCF) is the dominantinvestment-evaluation technique.

● Weighted average cost of capital (WACC) isthe dominant discount rate used in DCF anal-yses.

● Weights are based on market, not book, valuemixes of debt and equity.

● The after-tax cost of debt is predominantlybased on marginal pretax costs, as well asmarginal or statutory tax rates.

● The capital asset pricing model (CAPM) is thedominant model for estimating the cost of eq-uity.

Discounted cash flow valuation models. Theparameters that make up the DCF model arerelated to risk (the required rate of return) andthe return itself. These models use three alterna-tive cash-flow measures: dividends, accountingearnings, and free cash flows. Just as DCF andasset-based valuation models are equivalent un-der the assumption of perfect markets, dividends,earnings, and free cash-flow measures can beshown to yield equivalent results. Their imple-mentation, however, is not straightforward. First,there is inherent difficulty in defining the cashflows used in these models. Which cash flows andto whom do they flow? Conceptually, cash flowsare defined differently depending on whether the

FINANCE


valuation objective is the firm’s equity or thevalue of the firm’s debt plus equity. Assumingthat we can define cash flows, we are left withanother issue. The models need future cash flowsas inputs. How is the cash-flow stream estimatedfrom present data? More important, are currentand past dividends, earnings, or cash flows thebest indicators of that stream? These pragmaticissues determine which model should be used.Although the dividend model is easy to use, itpresents a conceptual dilemma. Finance theorysays that dividend policy is irrelevant. The model,however, requires forecasting dividends to infin-ity or making terminal value assumptions. Firmsthat presently do not pay dividends are a case inpoint. Such firms are not valueless. In fact, high-growth firms often pay no dividends, since theyreinvest all funds available to them. When firmvalue is estimated using a dividend discountmodel, it depends on the dividend level of thefirm after its growth stabilizes. Future dividendsdepend on the earnings stream the firm will beable to generate. Thus, the firm’s expected futureearnings are fundamental to such a valuation.Similarly, for a firm paying dividends, the level ofdividends may be a discretionary choice of man-agement that is restricted by available earnings.When dividends are not paid out, value accumu-lates within the firm in the form of reinvestedearnings. Alternatively, firms sometimes pay div-idends right up to bankruptcy. Thus, dividendsmay say more about the allocation of earnings todifferent claimants than valuation. All three DCFapproaches rely on a measure of cash flows to thesuppliers of capital (debt and equity) to the firm.They differ only in the choice of measurement,with the dividend approach measuring the cashflows directly and the others arriving at them inan indirect manner. The free cash-flow approacharrives at the cash-flowmeasure (if the firm is all-equity) by subtracting investment from operatingcash flows, whereas the earnings approach ex-presses dividends indirectly as a fraction of earn-ings.

The capital asset pricing model. This is a set ofpredictions concerning equilibrium expected re-turns on risky assets. Harry Markowitz estab-

lished the foundation of modern portfolio theoryin 1952. The CAPM was developed twelve yearslater in articles by William Sharpe, John Lintner,and Jan Mossin. Almost always referred to asCAPM, it is a centerpiece of modern financialeconomics. The model gives us a precise predic-tion of the relationship that we should observebetween the risk of an asset and its expectedreturn. This relationship serves two vital func-tions. First, it provides a benchmark rate of re-turn for evaluating possible investments. For ex-ample, if we are analyzing securities, we might beinterested in whether the expected return weforecast for a stock is more or less than its ‘‘fair’’return given its risk. Second, the model helps usto make an educated guess as to the expectedreturn on assets that have not yet been traded inthe marketplace. For example, how do we pricean initial public offering of stock? How will a newinvestment project affect the return investors re-quire on a company’s stock? Although the CAPMdoes not fully withstand empirical tests, it iswidely used because of the insight it offers andbecause its accuracy suffices for many importantapplications. Although the CAPM is a quite com-plex model, it can be reduced to five simple ideas:

● Investors can eliminate some risk (unsystema-tic risk) by diversifying across many regionsand sectors.

● Some risk (systematic risk), such as that ofglobal recession, cannot be eliminated throughdiversification. So even a basket with all of thestocks in the stock market will still be risky.

● People must be rewarded for investing in sucha risky basket by earning returns above thosethat they can get on safer assets.

● The rewards on a specific investment dependonly on the extent to which it affects the mar-ket basket’s risk.

● Conveniently, that contribution to the marketbasket’s risk can be captured by a single mea-sure—‘‘beta’’—that expresses the relationshipbetween the investment’s risk and the market’srisk.

Finance theory is evolving in response to innova-tive products and strategies devised in the finan-

FINANCE


cial market-place and in academic research cen-ters.

(SEE ALSO: Financial Institutions; Financial Markets;Securities and Exchange Commission)

BIBLIOGRAPHY

Bodie, Zvi, Kane, Alex, and Marcus, Alan J. (1999).Investments. New York: Irwin-McGraw-Hill.

Bruner, Robert F. (1998). Case Studies in Finance: Managingfor Corporate Value Creation, New York: Irwin McGraw-Hill.

Bruner, Robert F. and Eades, Kenneth M., Harris, Robert S.,and Higgins, Robert C. (1998). ‘‘Best Practices’’ in Esti-mating the Cost of Capital: Survey and Synthesis.’’Journal of Financial Practice and Education Spring.

Kaushik, Surendra K., and Krackov, Lawrence M. (1989).Multinational Financial Management. New York: NewYork Institute of Finance.

Krackov, Lawrence M., and Kaushik, Surendra K. (1988).The Practical Financial Manager. New York: New YorkInstitute of Finance.

Stein, Jeremy. (1996). ‘‘Rational Capital Budgeting in anIrrational World.’’ The Journal of Business (October).

White, Gerald I., Sondhi, Ashwinpaul C., and Fried, Dov.(1998). The Analysis and Use of Financial Statements.New York: Wiley.

SURENDRA K. KAUSHIKLAWRENCE M. KRACKOVMASSIMO SANTICCHIA


Corporate finance, which is the acquisition anduse of funds by business entities, has evolved asthe scope of business enterprises has changed andas American society has become increasingly suc-cessful in achieving its economic goals. The his-tory of finance in the United States is a story thatbegan with rudimentary, unregulated means ofsecuring funds in the early years of the newlyestablished nation and reached in the closingdecades of the twentieth century, a level of ad-vanced innovation that made the United Statesthe financial leader in the global community. Thesuccess of the finance function in corporateAmerica is the result of a combination of busi-

ness innovation in the design and strategies ofsecuring funds and of governmental regulationsthat assure integrity in financial markets. Signifi-cant aspects in this development are discussed inthe sections that follow.

EARLY AMERICAN FINANCE

In the colonial United States, businesses were, forthe most part, small and self-financed. However,the first settlers, who had been British subjects,were well acquainted with the corporate form oforganization. As Davis (1917) noted, ‘‘before theend of the colonial period a considerable numberof truly private corporations had been establishedfor ecclesiastical, education, charitable, and evenbusiness purposes’’ (p. 4).

Many of these early efforts were unsuccessful,and those individuals who invested in them oftenlost their total contributions. The nature of fi-nancing problems in these early efforts is illus-trated by the story of an organization called TheSociety for Establishing Useful Manufacturers. InNovember 1791, the legislature of New Jerseypassed an act incorporating this enterprise, whichlikely manufactured various products includingpaper, textiles, pottery, and wire. Davis (1917)identified this company as ‘‘one of the pioneerindustrial corporations of the United States andthe largest and most pretentious of these’’(p. 349). Plans for the new corporation werepublicly announced, including the much-criti-cized strategy of raising capital by issuing publicstocks. The emphasis on developing domestic in-dustry and reducing dependence on imports wasappealing to potential investors, and private citi-zens were getting encouragement from the newlyformed federal government to undertake busi-ness activity on a broader scale than had beencommon at the time. At the time the prospectusfor this new enterprise was being circulated,Alexander Hamilton, the secretary of the Trea-sury, presented his Report on Manufacturers,which was prepared in response to PresidentWashington’s direction ‘‘to prepare and report tothe House, a proper plan for the encouragementand promotion of such manufactories as will

FINANCE: HISTORICAL PERSPECTIVES


tend to render the United States independent ofother nations’’ (quoted in Davis, 1917, p. 362).

The requisite capital was indeed raised, withmost of the subscriptions secured in New York.Shortly thereafter, panic ensued because the newenterprise was not progressing as intended. Theleading offices and directors were deeply involvedin the speculative boom that was widespread atthe time and had not given attention to the actualbusiness of the new enterprise. Thereafter, theleaders, who were in possession of most of thepaid-in funds, went bankrupt. This story revealsthe lure of becoming wealthy quickly and ofgeneral incompetence among leadership. Therewere virtually no rules to restrain the behavior ofthe leaders, and they appropriated the funds fortheir own personal use.

The society was saved by a loan of $10,000from the Bank of New York, and there is evidencethat the secretary of Treasury was critical in se-curing this financing. However, there continuedto be serious finance problems, throughout theperiod when facilities for the envisioned textilemills were being constructed. The newlyappointed treasurer was supposed to be bonded,but he refused. He continued in the positionnonetheless. When he retired in 1796, the trea-surer’s books and the funds were supposed to beleft with the deputy-governor. The books,though, were never recovered. It is not clearwhether all the funds were recovered. The opera-tions were unprofitable and were discontinued inthe same year.

FINANCE IN THE 1800s

On the brink of the nineteenth century theUnited States had a dismal record of successfulcorporations, as illustrated by the effort in NewJersey discussed above. The country was a worldof small mercantile businesses. As of 1790, forexample, there were only three banks, threebridge companies, a few insurance associations,and a dozen canal companies (Williamson,1951). However, some businesspeople began tosee the value of the corporation: The risks ofmanufacturing made the limited liability of thecorporation appealing. Several states enacted

useful laws. In 1811 New York enacted a law thatallowed for the incorporation of certain kinds ofmanufacturing concerns with less than $100,000of capital. Connecticut, in 1817, and Massachu-setts, in 1830, granted limited liability, which wasthe first step in movement for general incorpora-tion acts. The intent of such acts was to encour-age the financing of entities through the corpo-rate structure and to protect the public thatmight be inclined to invest in these new enter-prises. In the same period, the government wassignificantly involved in the financing of busi-nesses. As Cochran (1966) noted:

The capital needs of banking and transportationbrought state participation in business organization.Few such pioneer enterprises seemed possible withoutsubstantial state, county, or municipal purchases ofstocks and bonds. The credit of the state was gener-ally substituted in part for that of the private com-pany by issuance of state bonds and use of theproceeds to buy the company’s securities. (p. 219)

At the same time, Cochran (1966) notedsome of the serious drawbacks of the new owner-ship:

Free and secret transferability of corporate ownershipencouraged grave abuses on the part of unscrupulousfinanciers. It was possible for managing groups toprofit personally by ruining great companies andthen selling out before the situation became known.(p. 219)

However, there were conscientious men whowere interested in productive efficiency as well asthe quest for wealth. Among the individualsCochran (1966) identified was Nathan Appleton:

Nathan Appleton . . . turning from mercantile pur-suits in 1813, joined with some of the Lowells andJacksons, put his capital into large-scale textile man-ufacture. . . . Appleton came to be looked upon as thebusiness leader of Massachusetts. . . . By 1840 he andhis Boston associates had created in eastern Massa-chusetts a miniature of the corporate industrial soci-ety of the twentieth century. They controlled bank-ing, railroad, insurance, and power companies aswell as great textile mills scattered all over the state.It was the large ‘‘modern’’ corporation controllableby strategically organized blocs of shares, and virtu-ally self-perpetuating boards of directors that made



this concentration of power possible, but it must beremembered that it was also this device for gatheringtogether the savings of thousands of small investorsthat had produced the great development. (p. 220)

There had been remarkable developmentsthroughout the 1800s. Baskin and Miranti(1997), for example, pointed out that the ‘‘lastquarter of the eighteenth century saw the start ofa great economic expansion that changed corpo-rate finance in fundamental ways’’ (p. 127). Itwas during this period that there was extensivedevelopment of railroads, which independentlybecame strong bastions of finance capitalism.During this period, preferred stock and debt be-came popular means of financing corporations.During the final decades of the 1800s, relativelywidely distributed financial journals and newspa-pers began to appear.

THE ROLE OF BANKS FROM THE LATE1800s THROUGH THE 1920s

Bankers are critical to economic development.Schumpeter, in his theory of economic develop-ment, highlighted the role of bankers as thesource of funds for enterpreneurs, who them-selves often lack financial resource. Schumpeter(1934) noted: ‘‘In an economy without develop-ment there would be no such money market . . .the kernel of the matter lies in the credit require-ments of new enterprises . . . thus, the main func-tion of the money or capital market is trading incredit for the purpose of financing development’’(p. 122-127).

Schumpeter undoubtedly was fully aware ofthe U.S. experience and the influence of Ameri-can bankers in the impressive growth of theAmerican economy from the mid-1800s throughthe early decade of the twentieth century. Possi-bly the most impressive of the bankers were theMorgans. As Chernow (1990), in his history ofthe Morgans, concluded: ‘‘The old pre-1935House of Morgan was probably the most formi-dable financial combine in history. It financedmany industrial giants, including U.S. Steel, Gen-eral Electric, General Motors, Du Pont, andAmerican Telephone and Telegraph’’ (p. xi).

At the end of the 1800s, banks were thecritical source of funds for U.S. enterprises. Theirrole, however, changed during the twentieth cen-tury, as businesses became larger and the types offinancial institutions increased.

CHANGES IN FINANCIAL STRUCTURE

The financial structure in the United Stateschanged during the twentieth century. Gold-smith’s (1969) study provided a comparison ofthe main types of U.S. financial institutions in1900 and 1963, shown in Table 1.

As Table 1 shows, in 1900, 62.9 percent oftotal assets of all the financial institutions wereheld by commercial banks; by 1963 that percent-age was 32.2. While thrift institutions, includingmutual savings banks, savings and loan associa-tions, credit unions, and postal savings systems,maintained approximately the same percentageof total assets (18.2 percent in 1900; 16.9 percentin 1963), mutual savings banks held 15.1 percentof total assets in 1900 but only 5.1 percent in1963. Savings and loan associations, which had3.1 of total assets in 1900, held 10.9 percent in1963. In 1900 a group of institutions identified as‘‘miscellaneous’’ included only mortgage compa-nies and security dealers. By 1963, the ‘‘miscella-neous’’ category included those that had existedin 1900, plus finance companies, investmentcompanies, land banks, and government lendinginstitutions (Goldsmith, 1969).

Goldsmith’s analysis revealed that financialsuperstructure grows more rapidly than the in-frastructure of national product and nationalwealth. He noted that in less than two hundredyears within the world community there haddeveloped what he identified as a financial systemof the modern type, characterized by:

the existence of several basic forms of financial insti-tutions (banks of issue and deposit, savings banks,mortgage banks, and insurance companies) and offinancial instruments (scriptural [nonmetallic]money, bills of exchange, accounts receivable andpayable, bank deposits and loans made by financialinstitutions, life insurance and pension contracts,mortgages, government and corporate bonds, andcorporate stock.) (Goldsmith, 1969, 99. 10-11)



1963 1900 % %Federal Reserve Banks 5.9 ---Commercial banks 32.2 62.9 Mutual savings banks 5.1 15.1 Savings and loan associations 10.9 3.1Credit unions 0.8 ---Postal savings system 0.1 ---Insurance organizations 32.0 13.8 Miscellaneous institutions 13.0 5.1 Total 100.0 100.0

Type of institution Distribution of total assets of financial institutions

Financial Institutions in 1900 and 1963

Table 1SOURCE: Goldsmith, Raymond. (1969). Financial Structure andDevelopment. New Haven: Yale University Press.

A parallelism between economic and finan-cial development is observable if periods of sev-eral decades are considered. Goldsmith’s (1969)data showed that ‘‘as real income and wealthincrease, in the aggregate and per head of thepopulation, the size and complexity of the finan-cial superstructure grow’’ (p. 48).

Shares of assets held by banks and thrift insti-tutions continued to decline. While the two typesof financial institutions held 55.0 percent of totalassets in 1963, the two types held only 22.7 per-cent by the end of 1999, as reported by theFederal Reserve Board.

IMPETUS FOR REGULATION OF SECURITIESIN THE UNITED STATES

Prior to 1929, there was little support for federalregulation of securities markets in the UnitedStates. The optimism of the post-World War Iperiod, with promises of easy credit and instantwealth, was not a time of restraints imposed byregulation. As noted by the Securities and Ex-change Commission (SEC), ‘‘During the 1920s,approximately 20 million large and small share-holders took advantage of post-war prosperityand set out to make their fortunes in the stockmarket. It is estimated that of the $50 billion innew securities offering during this period, halfbecame worthless.’’ (SEC, www.sec.gov/)

Public confidence shifted dramatically withthe stock market crash of 1929. For the economyto recover, the public’s faith in the capital mar-kets needed to be restored. The outcome was thepassage of two acts by Congress, the SecuritiesAct of 1933 and the Securities Exchange Act of1934. These laws were established to providestructure in the functioning of financial marketsand to provide government oversight.

THE SECURITIES ANDEXCHANGE COMMISSION

The Securities Exchange Act of 1934 included theestablishment of the Securities and ExchangeCommission, which was charged with enforcingthe newly passed securities laws, promoting sta-bility in the markets, and protecting investors.

The Securities and Exchange Commissionoperates on the premise that all investors shouldhave access to certain basic facts about invest-ments prior to purchase. The key means ofachieving this is through requiring that all pub-licly owned companies disclose relevant financialand other information to all citizens.

The SEC oversees key participants in the fi-nancial world, including stock exchanges, bro-ker-dealers, and investment advisers. Through itsenforcement authority, the SEC brings civil en-forcement actions against individuals and com-panies that violate securities laws. Typical infrac-tions relate to insider trading, accounting fraud,and providing false or misleading informationabout securities and the companies that issuethem.

THE ROLE OF STOCK EXCHANGES

Stock exchanges have played a significant role inthe financing of U.S. business enterprisesthrough providing a means of buying and sellingsecurities. The first stock exchange in the UnitedStates was established in 1790 in Philadelphia.Two years later, in 1792, the New York StockExchange was formed when twenty-fourstockbrokers signed an agreement to trade withone another beneath a buttonwood tree outsidewhat is now 68 Wall Street. The New York Stock



Exchange (NYSE) is the largest stock exchange inthe world.

The NYSE’s first client, in 1792, was the Bankof New York, and its first office, set up in 1817,was a rented room at 40 Wall Street. It achievedits first million-share day on December 15, 1886,and its first billion-share day on October 28,1997.

A study of all securities markets by the SECin 1961 revealed that the over-the-counter secu-rities market was fragmented and obscure, lead-ing the SEC to propose to the National Associa-tion of Securities Dealers, that it develop anautomated over-the-counter securities system.Such a system was completed and began opera-tions in February 1971; it is known as the Na-tional Association of Securities Dealers Auto-mated Quotation—or NASDAQ—system. Theworld’s first electronic stock market, by the endof 1999 it ranked second, below the New YorkStock Exchange, among the world’s securitiesmarkets in terms of dollar volume.

CLOSING DECADES OF THETWENTIETH CENTURY

With the passage of new laws, the financial indus-try is being restructured. The scope of servicesprovided by type of institution is not as limited aswas the case earlier.

The impact of technology. As the twenty-firstcentury got under way, the ways in which stockswere bought and sold began to receive intensiveattention. Stock markets, including the regionalones in the United States, began considering theways in which current and emerging technologieswould affect how they function.

The Federal Government also became in-volved in assessing the implications of electroniccommerce during the final years of the twentiethcentury. Hearings were held by committees inboth the House of Representatives and the Sen-ate. Among those making presentations at hear-ings of the Senate Banking Committee were lead-ers of banks and stock exchanges. Traditionalfirms in these industries assured the members ofsuch committees that they could meet the chal-

lenges of the new technology and continue to beviable players in the financial marketplace.

One example of the appeal of electronic com-merce in financial services is the extent of suchcommerce as of mid-2000. On-line spending infinancial services, primarily the buying andselling of securities, was 28.9 percent of all expen-ditures in this category. A year earlier, the extentof such transactions was 14.6. (as reported in TheWall Street Journal, July 17, 2000. ‘‘Clicks andMortar.’’ William M. Bulkeley, p.R4. Source wascited as Boston Consulting Group).

There is considerable interest in developingthe rules and regulations to enhance the effective-ness and efficiency of financial transactions elec-tronically. An important new ruling fore-commerce that will allow on-line signatureswas passed by Congress in June 2000 and willtake effect as of October 1, 2000.

Continuing development of the theory of fi-nance. In the final third of the twentieth century,there were impressive developments in the theoryof finance. Although the Nobel Prize was firstawarded in 1901, the category ‘‘economic sci-ence’’ was not added until 1969. Several leadingtheorists in the field of finance have been amongthe recipients of the Nobel Prize in economicscience.

The globalization of financial activity. Thetransformation of capital markets from the na-tional level to the global level increased consider-ably during the final decade of the twentiethcentury, fueled by economic progress and sup-ported by rapidly developing technological capa-bilities. Leadership was provided by an associa-tion of the world’s securities regulators, theInternational Organization of Securities Com-missions (IOSCO), which was organized in theearly 1970s. The IOSCO in 1993 described a coreset of standards that would be needed to providea comprehensive body of accounting principlesfor companies undertaking cross-border securi-ties offerings. In May 2000, the IOSCO approvedthe core standards developed by the InternationalAccounting Standards Committee (IASC). In themeantime, the International Accounting Stan-



dards Committee designed a new structure for aninternational accounting standard-setting body,which was accepted by the membership in May2000 with implementation anticipated in January2001.

These developments are promising for thedevelopment of a functioning global financialmarketplace.

(SEE ALSO: Finance)

BIBLIOGRAPHY

Baskin, Jonathon Barron, and Miranti, Paul J., Jr. (1997). AHistory of Corporate Finance. New York: Cambridge Uni-versity Press.

Bulkeley, WilliamM. (2000). ‘‘Clicks and Mortar.’’ TheWallStreet Journal. July 17: p.R4.

Chernow, Ron. (1990). The House of Morgan: An AmericanBanking Dynasty and the Rise of Modern Finance. NewYork: Atlantic Monthly Press.

Cochran, Thomas C. (1966). ‘‘Business Organization andthe Development of an Industrial Discipline.’’ InThomas C. Cochran and Thomas B. Brewer, eds. Viewsof American Economic Growth: The Agricultural Era. NewYork: McGraw-Hill.

Davis, Joseph Stancliffe. (1917). Essays in the Earlier Historyof American Corporations. vol. 1. Cambridge, MA: Har-vard University Press.

Goldsmith, Raymond. (1969). Financial Structure and De-velopment. New Haven, CT: Yale University Press.

National Association of Securities Dealers Automated Quo-tation. www.nasdaq.com/.

New York State Exchange. www.nyse.org.

Schumpeter, Joseph A. (1934). The Theory of EconomicDevelopment: An Inquiry into Profits, Capital, Credit,Interest, and the Business Cycle. cambridge, MA: HarvardUniversity Press.

Securities and Exchange Commission (SEC). www.sec.gov

Williamson, Harold F. (1951). Growth of the American Econ-omy. 2nd ed. Englewood Cliffs, NJ: Prentice-Hall.

MARY ELLEN OLIVERIO


The United States has a longstanding tradition ofaccounting standards being set by the privatesector (as opposed to the government). Although

the federal government’s Securities and ExchangeCommission (SEC) has the legal authority to es-tablish accounting standards for public compa-nies, the SEC has historically looked to the pri-vate sector to set accounting standards.

The first two standard-setting organizationsin the United States were the Committee on Ac-counting Procedure (CAP), which was estab-lished in 1938, and the Accounting PrinciplesBoard (APB), which replaced the CAP in 1959.Both organizations were committees of theAmerican Institute of Certified Public Account-ants (AICPA) and included approximatelytwenty representatives of the accounting profes-sion who served on a part-time basis. Pronounce-ments issued by those two bodies are still consid-ered to be generally accepted accountingprinciples (GAAP) today unless they have beenspecifically amended or replaced by a subsequentpronouncement.

Largely as a result of criticisms concerningthe perceived lack of independence of the APBand the part-time involvement of its members, amajor reconsideration of the standard-settingstructure in the United States occurred in theearly 1970s. This led to the creation in 1973 of anew standard-setting body designed to be inde-pendent of all other business and professionalorganizations. That new group was the FinancialAccounting Standards Board (FASB).

The FASB is funded by revenues from thesales of its publications and by voluntary contri-butions, primarily from public accounting firmsand corporations. The board consists of sevenfull-time members. The usual composition of theboard is three members with extensive publicaccounting experience, two from a corporatebackground, one academic, and one financial an-alyst.

The three pillars on which the FASB was builtare independence, openness (or ‘‘sunshine’’), andneutrality. Although independence can never betotally assured, the FASB charter did attempt toprotect the board from as much external pressureas possible. The charter gives the FASB exclusiveauthority to set its own agenda and establish ac-counting standards. Board members are insu-

FINANCIAL ACCOUNTING STANDARDS BOARD


lated from external pressures by fixed five-yearterms (with a two-term maximum), by the re-quirements to end all past employment relation-ships, and by disclosure of (and certain limita-tions on) investments and outside activities thatmight create a conflict of interest.

‘‘Sunshine’’ characterizes the open processthat the board follows. It means that all its techni-cal business is conducted in meetings that areannounced in advance and are open to the pub-lic. Because the board’s Rules of Procedure re-quire a supermajority of five votes to approve theissuance of any new standard, no more than fourboard members can meet privately to discusstechnical issues.

Neutrality means that accounting standardsshould be designed to provide the best possibleinformation for economic decision making with-out regard to how that information may affecteconomic, political, or social behavior. Putting itanother way, accounting standards should not beintentionally biased for the purpose of promot-ing either private special interests or governmentpolicy goals. Neutrality has been reinforced byadoption and adherence to a broad set of princi-ples called the conceptual framework. Thatframework was designed to produce standardsthat result in neutral information that is useful indecision making.

An independent group, the Financial Ac-counting Foundation, oversees the activities ofthe FASB. It is responsible for selecting membersof the FASB, raising money to fund the FASB’soperations, and providing general oversight ofthe FASB to assure that it is performing its mis-sion. The foundation is composed of a sixteen-member board of trustees that represent the ma-jority of the groups interested in, or affected by,the accounting standard-setting process.

The FASB has the authority to establishGAAPs but has no authority to enforce its stan-dards. The SEC and the AICPA are the organiza-tions that provide the enforcement mechanism.The SEC requires compliance with FASB stan-dards by all public companies, that is, thosewhose securities are traded in public markets—on stock exchanges or over-the-counter. The

AICPA requires public accounting firms that au-dit either public or private companies to expressan opinion as to whether those companies’ finan-cial statements conform with GAAPs.

STANDARD-SETTING PROCESS

Within this overall structure, the FASB has devel-oped an extensive structure of due process toconduct its standard-setting activities. The pro-cess usually starts by determining what financialreporting issues are sufficiently pervasive and im-portant that they warrant consideration by theboard.

The FASB has a professional staff of approxi-mately forty-five persons; once a project is addedto the agenda, staff members are assigned tobegin research on the topic. On most larger pro-jects, a task force of outside advisers is appointed;they assist in the staff’s research and the board’sdeliberations by providing expertise, a diversityof viewpoints, and a mechanism for communica-tion with those who may be affected by the pro-posed standard.

The FASB sometimes asks for written com-ments from constituents during the researchphase through the issuance of a DiscussionMem-orandum. Such a document analyzes the prob-lem in depth, delineates the issues, identifies al-ternative solutions, and discusses the merits ofthose solutions in an objective way. Or the boardmay issue what is known as a Preliminary Viewsdocument, which includes tentative decisions ona few basic issues and again seeks input fromconstituents.

After completion of initial research by thestaff and consideration of comments on a Discus-sion Memorandum or Preliminary Views, if oneof those documents is issued, the board membersbegin deliberating the issues in earnest. This pro-cess can take anywhere from a few months toseveral years, depending on the number andcomplexity of the issues involved as well as thestrength of the convictions of individual boardmembers. Once at least five board members agreeon an overall answer, the board issues an Expo-sure Draft (ED) of a proposed standard for public



comment. The comment period is at least ninetydays.

While the ED is out for public comment, theFASB will often conduct a field test, which isdesigned to test the application of the proposedstandard using actual financial information pro-vided by volunteering companies.

The number of comment letters received onan ED can range from a few dozen to more than athousand, depending on how pervasive and howcontroversial the proposal is. Comment lettersare received primarily from corporations, largepublic accounting firms, government regulators,academics, and financial analysts, although anyinterested party is free to express his or her views.After reading the letters, the board redeliberatesall the issues in the ED and any additional issuesthat may have arisen in the comment and field-test processes. At the end of those deliberations,the board again votes; if there is sufficient sup-port among the board members, it issues a finalStatement of Financial Accounting Standards.

The steps described above are just an overalloutline of the process. Throughout a project’slife, discussions are held with the FASB’s advisorycouncil, the project task force, and various otherinterested parties. In addition, the process doesnot end with the issuance of a Statement. TheFASB monitors the application of a Statement toensure that it is working as planned. Should thestandard not work in practice, then the boardmay consider amending it to provide clarifica-tion, issuing additional interpretive guidance, ortaking some other action to address problemsthat arise.

Most FASB projects are controversial. Forexample, pronouncements on topics such as ac-counting for employee stock options,postretirement health care benefits, and deriva-tive financial instruments were strongly opposedby many corporations and other affected parties.The board does its best to consider the reasonablearguments expressed by all parties. But in thefinal analysis, the FASB endeavors to act in thepublic interest by issuing accounting standardsthat will result in the most informative and unbi-ased financial statements possible. Thus inves-

tors, creditors, and all others who use financialstatements in making economic decisions cantake comfort in the fact that the FASB puts thegeneral public interest above any concerns of in-dividual corporations or other self-interestedparties.

Despite disagreement over some specific pro-nouncements, the board’s various constituentsremain generally supportive. They know thattheir views are carefully weighed during theFASB’s deliberations, but they also recognize thatthe ultimate determinant of a new standard mustbe the board’s judgment. As the FASB’s missionstatement states, ‘‘The FASB is committed tofollowing an open orderly process for standardsetting that precludes placing any particular in-terest above the interests of the many who rely onfinancial information.’’

COMMUNICATING WITH THE FASB

In addition to the Statements, EDs, DiscussionMemoranda, and Preliminary Views documentsreferred to above, the FASB publishes a variety ofother documents that provide guidance on finan-cial accounting and reporting. For example, itsEmerging Issues Task Force (EITF) develops con-sensus positions on accounting matters that de-mand prompt solutions. EITF materials andother FASB publications can be ordered by indi-vidual item or through a variety of subscriptionprograms that the organization offers. Specialdiscounts on publications are available to partieswho make voluntary contributions to supportthe overall work of the FASB.

More information on publications or anyother related matters is available from the FASBat 401 Merritt 7, Norwalk, CT 06856; (203)847-0700; or at http://www.fasb.org.

BIBLIOGRAPHY

Miller, Paul B. W., Redding, Rodney J., and Bahnson, PaulR. (1998). The FASB—The People, the Process, and thePolitics. New York: Irwin/McGraw-Hill.



Van Riper, Robert. (1994). Setting Standards for FinancialReporting—FASB and the Struggle for Control of a CriticalProcess. Westport, CT: Quorum Books.

DENNIS R. BERESFORD

FINANCIAL FORECASTSAND PROJECTIONS

Business entities need to plan for the future; theymust also consider alternative management strat-egies and prepare capital and operating budgets;they must also consider alternative funding andcash budget possibilities. An important part ofthe planning process is the preparation of pro-spective financial statements that attempt to pre-dict the outcome of the business entity’s activitiesin future periods.

Financial forecasts and financial projectionsare prospective financial statements that presentan entity’s expected financial position, results ofoperations, and cash flows in future periods un-der two different conditions. Financial forecastsassume that the entity will continue to functionin the manner in which it is currently function-ing. For example, if the entity is a retail storechain, that it will continue to do business in themanner in which it is currently engaged. Thefinancial forecast presents the predicted resultsfor the next year. Financial projections, on theother hand, make one or more hypothetical as-sumptions about an entity’s future course of ac-tion. For example, if the retail store chain wereconsidering a Web site at which it would also sellmerchandise—in addition to the merchandisesold in the stores—a financial projection wouldprovide expected results. Financial forecasts andprojections should be distinguished from proforma financial statements, which show the effectof a hypothetical future event on the historicalfinancial statements results.

PREPARATION OF PROSPECTIVEFINANCIAL STATEMENTS

The preparation of prospective financial state-ments requires considerable knowledge of theentity’s business and the factors that are likely to

determine its future results. The following keyfactors related to future results must be consid-ered in the preparation of such statements:

● Factors related to the specific entity

● Factors related to the industry

● Factors related to the market

● Factors related to the economy

Factors Related to the Specific Entity. Theprincipal cost elements of the entity’s doing busi-ness must be considered. Depending on the en-tity, these elements may include such costs aspayroll and benefits, needed employees, raw ma-terials, products the entity sells, freight or ship-ping, and advertising.

Another consideration is the availability ofresources. For example, are the expert, special-ized, or skilled workers available to meet theneeds of the entity under the plan as initiallyproposed? Are the raw materials and/or productsfor resale available? Can the delivery system beorganized to accomplish the task? Are the com-pany’s physical facilities sufficient for the usesand for the capacities contemplated?

Factors Related to the Industry. Factors re-lated to the industry in which the entity is operat-ing must be considered. Is the industry one inwhich companies are very competitive? Are com-petitive industries emerging? Is obsolescenceemerging within the industry? Are there regula-tory considerations and requirements? Is newtechnology being introduced into the industry?What are the economic conditions within theindustry?

Factors Related to the Market. Market factorsmust be considered. What are the trends in busi-ness or consumer demand related to the servicesor goods being sold by the entity? Are competi-tive companies emerging, perhaps with new ordifferent products? Is unique marketing re-quired? Are there pricing developments to be fac-tored into the forecast?

Factors Related to the Economy. Numerousfactors related to the economy must be consid-ered. What are the economic conditions in the

FINANCIAL FORECASTS AND PROJECTIONS


country? What are critical economic trends? Isthe economy inflationary, deflationary, or stable?What is the trend with regard to labor availabil-ity? What are the financing considerations inrelation to the economy? What are interest rates?Are there significant factors related to long-termversus short-term financing? Is a public stockoffering a possible financing option?

ATTESTATION SERVICES PROVIDED FORFINANCIAL FORECASTS ANDFINANCIAL PROJECTIONS

Forecasts and projections are important in anorganization. They are also of great interest tofinancial analysts and others in the business envi-ronment who make decisions about future busi-ness behavior. Because of outsider interest, pub-lic accountants are engaged to provideprofessional services. There are three types ofengagements that a certified public accountantmay undertake in relation to financial forecastsand projections:

1. Examination: An accountant evaluates thepreparation, underlying support, and pre-sentation of the financial statements, andexpresses an opinion on them.

2. Applying agreed-upon procedures: Usersestablish the nature and scope of the en-gagement, and only the results of theprocedures performed are provided.

3. Compilation: An accountant prepares theprospective statements from informationand assumptions provided, and no assur-ance is given.

Examination. The American Institute of Cer-tified Public Accountants (AICPA) has preparedguidelines for prospective financial statementsengagements. The person or persons who pre-pare the financial statements, called the responsi-ble party, are usually the management of thecompany but may be outsiders, such as the man-agement of an entity considering acquiring thecompany. The accountants who examine suchstatements must consider whether the sources ofinformation used by the client are sufficient to

support the assumptions reflected in the prospec-tive statements. For example, external sourcesthat should be considered include industry andgovernment publications; reports on new infor-mation; digital, electronic, and mechanical tech-nology; reports on new scientific developments;micro and macroeconomic forecasts; and reportson present and proposed legislation. Examples ofinternal sources that accountants consider in-clude strategic plans, budgets, contractual agree-ments, purchase and sale agreements and com-mitments, intellectual property rights such ascopyrights and patents, royalty and commissionagreements, employee contracts and labor agree-ments, and financing and debt agreements.

When the examination is of a financial pro-jection, the accountants must determine whetherthe hypothetical condition or course of action(which will not necessarily occur) is consistentwith the purpose of the projection. The account-ants must evaluate the support underlying as-sumptions in the same manner as is done for aforecast.

Upon completion of a financial forecast ex-amination, assuming the accountants have col-lected sufficient evidence to provide a reasonablebasis for the standard report to be issued, thatreport will state in part:

In our opinion, the accompanying forecast is pre-sented in conformity with guidelines for presentationof a forecast established by the American Institute ofCertified Public Accountants, and the underlying as-sumptions provide a reasonable basis for manage-ment’s forecast.

Upon completion of a financial projectionexamination, the standard report would includea description of the hypothetical assumption andthe opinion would state that the underlying as-sumptions provide a reasonable basis for man-agement’s forecast assuming the occurrence ofthe hypothetical assumption. The report willstate in part:

In our opinion, the accompanying projection is pre-sented in conformity with guidelines for presentationof a projection established by the American Instituteof Certified Public Accountants, and the underlying



assumptions provide a reasonable basis for manage-ment’s projection [then the hypothetical assumptionwould be described and assumed to have occurred,for example, ‘‘assuming the establishment of a Website which will . . .’’]

Financial forecasts are considered general-purpose financial statements that may be distrib-uted to any interested party, whereas financialprojections are considered limited-purpose fi-nancial statements only to be used by the respon-sible party who prepared the statements or byknowledgeable third parties. In both forecastsand prospective financial statement opinions, awarning must be included in the opinion that theprospective results may not be achieved.

If, in the accountants’ opinion, the prospec-tive financial statements depart from AICPAguidelines, or one of the significant assumptionsdoes not provide a reasonable basis for the pro-spective statements, or the accountants could notapply some procedures that were considered nec-essary, the report would have to be modified.

Applying Agreed-Upon Procedures. Anothertype of engagement that certified public account-ants may undertake is to apply only some proce-dures, which have been specified by the users, tothe financial forecast or projection. An exampleof such an engagement might be to review theforecast in regard to sales, or payroll costs, orboth. Limiting the procedures to only one item,or some of the items, on the prospective financialstatements does not enable the accountants toprovide an overall opinion. Because of the limita-tion in regard to the procedures performed, thereport is restricted to the users who specified theprocedures to be applied.

The standard applying agreed-upon proce-dures report will state in part:

At your request, we have performed certain agreed-upon procedures, as enumerated below,. . .we makeno representation regarding the sufficiency of theprocedures described . . . [a list of the proceduresperformed and related findings would be stated] . . .we do not express an opinion on whether the prospec-tive financial statements . . . provide a reasonablebasis for the presentation.

Compilation. A compilation of prospectivefinancial statements by certified public account-ants involves only the service of preparing thestatements in whole or part from informationand significant assumptions provided by the re-sponsible party, usually a member of manage-ment. Because such an activity does not envisionan examination or even applying agreed-uponprocedures, no assurance is provided.

The standard compilation report on a fore-cast would state in part:

We have not examined the forecast and, accordingly,do not express an opinion or any other form ofassurance on the accompanying statements or as-sumptions.

IMPORTANCE OF FORECASTSAND PROJECTIONS

Forecasts and projections have assumed extraor-dinary significance in U.S. business. The releaseof corporate managers’ earnings forecasts has be-come common. Management forecasts have be-come an important source of information forfinancial analysts and investors. Stock pricesshow significant movements after the release ofinformation that shows earnings will be higher orlower than current expectations.

However, some skepticism in regard to theseforecasts exists on the part of financial analystsand governmental agencies, such as the Securitiesand Exchange Commission, because of the fearthat forecasts may be biased at times in order toinfluence capital markets or may simply be inac-curate. In addition, prospective financial infor-mation is considered vital in relation to mergersand acquisitions as well as to such business entitymanagement activities as budgeting. In these cir-cumstances, it would appear advisable to obtaincertified public accountant examinations and re-ports before the public release of prospective fi-nancial information.

(SEE ALSO: Assurance Services; Auditing)

BIBLIOGRAPHY

AICPA Professional Standards. Attestation Standards, Finan-cial Forecasts and Projections. (1999). New York:



American Institute of Certified Public Accountants(published annually).

Coller, and Maribeth, and Yohn, Teri Lombardi, (1998).‘‘Management Forecasts: What DoWe Know?’’ FinancialAnalysts Journal (January/February): 58-62.

Guide for Prospective Financial Information. (1999). NewYork: American Institute of Certified Public Account-ants.

Hirst, D. Eric, Koonce, Lisa, and Miller, Jeffrey. (1999).‘‘The Joint Effect of Management’s Prior Forecast Accu-racy and the Form of Its Financial Forecasts on InvestorJudgment.’’ Journal of Accounting Research 37 (Supple-ment): 101-124.

BERNARD H. NEWMAN


A financial institution is one that facilitates allo-cation of financial resources from its source topotential users. There are a large number of dif-ferent types of financial institutions in the UnitedStates, creating a rich mosaic in the financial sys-tem. Some institutions acquire funds and makethem available to users. Others act as middlemenbetween deficit and surplus units. Still others in-vest (manage) funds as agents for their clients.The key categories of financial institutions are thefollowing: deposit taking; finance and insurance;and investment, pension, and risk management.There are also government and government-sponsored institutions that carry out regulatory,supervisory, and financing functions. Histori-cally, each type has performed a specialized func-tion in financing and investment management.

DEPOSIT TAKING

Deposit-taking institutions take the form of com-mercial banks, which accept deposits and makecommercial and other loans; savings and loanassociations and mutual savings banks, which ac-cept deposits and make mortgage and other typesof loans; and credit unions, which are coopera-tive organizations that issue share certificates andmake member (consumer) and other loans. Alto-gether there are more than 15,000 deposit takinginstitutions with more than 100,000 branchesspread across the economy.

The U.S. commercial banking system prac-ticed competition through a large number offirms in the industry from 1776 to 1976. It wasdesigned to be a unit-banking system in whichstate charters of banks allowed only one-officebanking. The system also encouraged thrift anduse of local savings for investment in the localeconomy. The unit-banking system not onlyforced competition among existing and newbanks in a given banking market; it deliberatelyavoided the emergence of monopolies in the in-dustry. The founding fathers in the original thir-teen states understood the harm monopoliescould inflict on the economic and financial sys-tems. In due course the U.S. Congress passed theSherman Antitrust Act of 1890, making monop-oly and monopolistic practices unacceptable andtherefore illegal.

The commercial banking industry domi-nated the U.S. financial industry from the begin-ning to the 1970s, when financial product inno-vation and the resulting business and consumerfinancial choices exploded to create competitionacross financial services industries. The commer-cial banking industry and its limited productofferings on both sides of the balance sheet werethe only choices available to the general public.This is because the commercial banks specializedin taking checking account deposits on the liabil-ity side and making commercial loans on theasset side. They relied for safety of their opera-tions on maturity-based hedging of mostly short-term liabilities with short-term self-liquidatingcommercial loans assets. This also meant thathouseholds, farmers, students, and other groupsdid not have access to financial capital.

Savings and loan associations, mutual sav-ings banks and credit unions, and money marketmutual funds are other deposit-taking institu-tions. Savings and loan associations take savingsdeposits and primarily make mortgage loansthroughout the country. They have providedfunds to create millions of housing units in thecounty. Their key function is maturity interme-diation when they accept short-term deposit andmake long-term mortgage loans. Mutual savingsbanks exist mainly in the eastern part of the



United States. Like savings and loan associations,they, too, accept short-maturity deposits andmake long-term mortgage loans. They also issueconsumer and other loans, making then some-what more diversified and therefore less risky interms of loan defaults. Credit unions specialize inmember savings and loans, although they alsomake mortgage-type loans and other investmentssimilar to other deposit-taking institutions.

FINANCE AND INSURANCE INSTITUTIONS

Finance (credit) companies are different fromdeposit-taking banking institutions in that theirsources of funds are not deposits. They acquirefunds in the market by issuing their own obliga-tions, such as notes and bonds. They, however,make loans on the other side of the balance sheetin full competition with deposit-taking and othertypes of financial institutions, such as insurancecompanies. Finance companies specialize in busi-ness inventory financing, although they alsomake consumer loans, mostly indirectly throughmanufacturers and distributors of goods and ser-vices. Some of the finance companies are hugeand operate in domestic as well as foreign mar-kets. Several are bigger than most of the commer-cial banks in the United States.

Insurance companies provide the dual ser-vices of insurance protection and investment.There are two types of insurance companies: lifeinsurance companies and casualty and propertyinsurance companies. Insurance companies’sources of funds are primarily policy premiums.Their uses of funds range from loans (thus com-peting with finance companies, commercialbanks, and savings and loan associations) to cre-ation of investment products (thus competingwith investment companies). Life insurancecompanies match their certain mortality-basedneeds for cash outflows with longer-term riskierinvestments such as stocks and bonds. Casualtyand property insurance companies have moreuncertainty of cash outflows and their timing.Therefore they have more conservative invest-ment policies in terms of maturity and credit riskof their investments.

INVESTMENT, PENSION, ANDRISK MANAGEMENT

Investment companies pool together funds andinvest in the market to achieve goals set forvarious types of investments, matching liquidity,maturity, return, risk, tax, and other preferencesof investors on the one hand and users of fundson the other. Investment companies are orga-nized as open-end or closed-end mutual funds.Open-end funds accept new investments and re-deem old ones, while closed-end funds acceptfunds at one time and then do not take in newfunds. Investment companies have become verypopular with investors in recent decades, andthus they have mobilized trillions of dollars.

Another investment type of company is in-vestment banks, which provide investment andfund-raising advice to potential users of funds,such as commercial, industrial, and financialcompanies. They also create venture capital fundsor companies. Some of them also have brokerageand dealerships in securities. Many of them un-derwrite securities and then place them in themarket or sell them to investors.

Pension funds in the private and the govern-ment sectors collect pension contributions andinvest them according to goals of the employeesfor their funds. Increasingly, employees are ableto indicate their personal preferences for risk andreward targets with respect to their own andsometimes their employers’ contributions.

Other institutions that are significant parts ofthe financial system are the stock, bond, com-modity, currency, futures, and options ex-changes. The various types of exchanges makepossible not only creation and ownership of fi-nancial claims but also management of liquidityand risk of price changes and other risks in un-derlying commodities in the market. They greatlyexpand investment opportunities for savers andaccess to funds by small, medium, and largebusiness enterprises. They have deepened andbroadened markets in financial products and ser-vices, helped manage price risk, and improvedallocation efficiency in financial markets whereevery attribute desired in a financial product hasa counter party to trade with. The banking and



investment intermediaries have extended theirservices to the global saver-investor with thecross-border flow of funds and trading of finan-cial products facilitated by cross-border invest-ing, listing, and trading of securities in home andforeign markets in home and foreign currencies.

HISTORICAL DEVELOPMENT OF THE U.S.FINANCIAL SYSTEM

Specialization and division of labor, identified assources of creativity and efficiency by AdamSmith, led to the creation of other specializeddeposit-taking and investment-type financial in-stitutions that began to meet the demand notfulfilled by the commercial banking industry.Similar institutions were created to finance agri-culture and housing in rural areas, public works,and education. Laws and regulations recognizedand strengthened the separation, and thus spe-cialization, of the financial function different in-termediaries performed in the financial system.

The system was further strengthened by es-tablishing government and semi-governmentintermediaries to increase liquidity in the market,manage maturity risk, and broaden the sharing ofthe market (price) risk through secondary mar-kets for mortgages, agency (government andsponsored) securities, and other asset-based se-curities. Examples of institutions are: Commod-ity Credit Corporation, Farm Credit Banks, FarmCredit Financing Assistance Corporation, Farm-ers Home Administration, Federal Home LoanMortgage Corporation (FEDMAC), Federal Fi-nancing Corporation, Federal National MortgageAssociation (FNMA), Federal Housing Adminis-tration (FHA), Federal Home Loan Banks, Gov-ernment National Mortgage Association(GNMA), Resolution Funding Corporation,Small Business Administration, and StudentLoan Marketing Association (SLMA).

THE MONETARY SYSTEM

The U.S. monetary system is based on credit. TheU.S. currency is issued by its central bank, theFederal Reserve System, as a liability on itself.The value of the currency is based on its purchas-ing power in the economy and around the world

and has not been linked to or defined in terms ofany particular commodity or an index since 1968.The issuance of currency was tied to the U.S. goldholdings prior to 1968. The U.S. money supplyconsists of currency and coins and checkablepublic deposits in the banking system. The mea-sures of money are M1, M2, M3, and L.

The Federal Reserve System, created in 1913,was established to furnish elastic currency to theeconomy and to supervise the banking system.Prior to 1913 there had been financial crises thatwere due to absence of a systematic way to pro-vide money and credit in the economy. Therehad also been large bank failures due to fraud andmismanagement, as well as economic fluctua-tions and boom and bust in commodity prices.

The Federal Reserve System consists of theBoard of Governors of the Federal Reserve andthe twelve regional or district Federal Reservebanks. The Board of Governors in Washington isthe central decision point organization in a de-centralized system. The board has seven mem-bers who are nominated by the president andconfirmed by the Senate. Each board member hasa fourteen-year appointment so as to make theboard immune from political influence of anyadministration in office. The board is set up as anindependent agency; it does not report to thepresident, but it does report to Congress. How-ever, it actively coordinates its research and anal-ysis with the White House and the Treasury Sec-retary in formulating policy. The regional FederalReserve banks’ Board of Directors is also struc-tured to represent banking, industry and com-merce, and the general public. There is a formalstatutory requirement to have three directorsfrom the three groups in the area on the board.

The monetary policy-making body withinthe Federal Reserve is the Federal Open MarketCommittee (FOMC), which meets regularly(generally eight times a year). Its voting membersare the seven governors of the Board of Gover-nors and five presidents of the regional banks.The president of the Federal Reserve Bank ofNew York is a permanent member of FOMC, andthe other four serve on annual rotation fromamong four groups formed from the remaining



eleven regional banks. The regional banks arelocated in Boston, New York, Philadelphia, Rich-mond, Atlanta, Cleveland, Chicago, Dallas, St.Louis, Kansas City, Minneapolis, and San Fran-cisco. These cities were chosen because they rep-resented the hub of the regional economy of eacharea of the United States in 1913. It was thoughtat the time that the regional economies had dif-ferent characteristics in terms of the type andlevel of economic activity, so they needed differ-ent accommodation with respect to supply ofmoney and finance, rediscounting mechanisms,and interest rates. In other words, it was thoughtthat there were twelve different money marketsin the U.S. economy, so each one needed specialattention for its needs. This structure of the Fed-eral Reserve System continues to this day, but themoney market has become one market due toinstitutional and technological advancements.Now there are truly national financial institu-tions, not just in terms of their national charter,with interstate deposit taking and lending ofcommercial and numerous other types of loansto businesses and households.

The Federal Reserve policy serves the needsof the entire economy and all its parts by takinginto account economic and financial informationconcerning all economic segments and activitiesin the U.S. economy. There are many advisorycommittees, such as the Federal Advisory Com-mittee representing the interests of the bankingindustry, the Consumer Advisory Committeerepresenting consumer interests, and similarother committees representing interests of othersegments to the Federal Reserve System. Legisla-tive, regulatory, monetary policy, and day-to-dayoperations of the central bank consider relevantdetails in their deliberations and policy decisions,including research from a wide variety of sources,private and public, about the economy.

LEGAL AND REGULATORY STRUCTURE

The key laws governing the U.S. financial institu-tions are: National Bank Act of 1863; FederalReserve Act of 1913; McFadden Act of 1927;Banking Act (Glass-Steagall) of 1933 and 1935;Securities Act of 1933; Securities Exchange Act of

1934; Federal Credit Union Act of 1934; Invest-ment Advisors Act of 1940; Investment CompanyAct of 1940; Bank Holding Company Act of 1956and Douglas Amendment of 1970; Bank MergerAct of 1966; Employment Retirement Income Se-curity Act of 1974; Depository Institutions De-regulation and Monetary Control Act of 1980;Depository Institutions (Garn-St. Germain) Actof 1982; Competitive Equality in Banking Act of1987; Financial Institutions Reform, Recovery,and Enforcement Act of 1989; Federal DepositInsurance Corporation Improvement Act of1991; Interstate Banking and Branching Effi-ciency Act of 1994; and Financial ModernizationAct of 1999.

The federal agencies that regulate depositoryinstitutions are: Office of the Comptroller of theCurrency, Federal Reserve System, Federal De-posit Insurance System, National Credit UnionAdministration, and Office of Thrift Supervision.The Securities and Exchange Commission, Com-modity Futures Trading Commission, and theJustice Department monitor and enforce relevantlaws and regulations concerning securities andfutures markets. State authorities regulate, moni-tor, and enforce laws concerning depository, in-surance, finance companies and other financialinstitutions. The laws and regulations on finan-cial institutions in the United States have madethem competitive, efficient, fair, safe and sound,and transparent with the use of both carrots andsticks.

FINANCIAL SERVICES MODERNIZATIONACT 1999

The U.S. financial system in the twenty-first cen-tury has evolved into the largest, most developed,most efficient, and most sophisticated financialsystem in the world. The financial system hasgrown enormously since the founding of the firstinsurance company by Benjamin Franklin, asPhiladelphia Contributionship, in 1752. The firstbanks in the United States were the Bank of NewYork, founded by Alexander Hamilton in 1784;Bank of Boston, also founded in 1784; and theFirst Bank of the United States, chartered in1791. The economic structures and forces that



have made this success possible are the concepts(or the foundation stones) of competition, spe-cialization, thrift, entrepreneurial zest, and inno-vation. These concepts were just as well under-stood and vigorously practiced in the Americancolonies as they were expounded on by AdamSmith in Scotland in 1776 in An Inquiry into theNature and Causes of the Wealth of Nations, hissynthesis of a competitive market system. TheUnited States has structured its economic andfinancial systems on Smith’s economic modelsince its founding in 1776.

Some of the key concepts that have been thefoundation stones of this financial architectureare: competition, efficiency, entrepreneurial cul-ture, financial capital, innovation, regulation/de-regulation/liberalization, reform, risk manage-ment, savings, specialization, and thrift.

The Financial Services Modernization Act,signed into law by the president on October 12,1999, removes many of the restrictions on thebanking and securities institutions imposed inthe 1920s and 1930s. For example, financial con-glomerates will again be able to organize com-mercial banking, insurance business, investmentbanking, securities underwriting, and other fi-nancial services under the umbrella of a holding/parent company. The McFadden Act and theGlass-Steagall Act are now in the history books.Financial innovation made possible by computerand communications technologies and spawnedby competition and deregulation has broughtU.S. financial institutions and the entire financialsystem to the exciting financial structure of thetwenty-first century.

(SEE ALSO: Capital Markets; Finance)

BIBLIOGRAPHY

Blackwell, DavidW., Kidwell, D., and Peterson, R. L. (2000).Financial Institutions, Markets, and Money, 7th ed. FortWorth, TX: Dryden Press, Harcourt College Publishers.

Dymski, Gary A., Epstein, G., and Pollin, R. (1993).Transforming the U.S. Financial System: Equity and Effi-ciency for the 21st Century. Armonk, NY: M.E. Sharpe.

Federal Deposit Insurance Corporation, Division of Re-search and Statistics. (1998). Statistics on Banking: AStatistical Profile of the United States Banking Industry.

Washington, DC: Federal Deposit Insurance Corpora-tion.

Federal Reserve System. (1994). Purposes and Functions, 8thed. Washington, DC: Board of Governors of the FederalReserve System.

Hayes, III, Samuel L., ed. (1993). Financial Services: Perspec-tives and Challenges. Boston: Harvard Business SchoolPress.

Kaufman, George G. (1995). The U.S. Financial Systems:Money, Markets and Institutions, 6th ed. EngelwoodCliffs, NJ: Prentice Hall.

Meerschwam, David M. (1991). Breaking Financial Bound-aries: Global Capital, National Deregulation, and Finan-cial Services Firms. Boston: Harvard Business SchoolPress.

SURENDRA KAUSHIK

FINANCIAL MARKETS(SEE: Capital Markets)

FINANCIAL STATEMENTANALYSIS

Financial statement analysis is the process of ex-amining relationships among financial statementelements and making comparisons with relevantinformation. It is a valuable tool used by inves-tors and creditors, financial analysts, and othersin their decision-making processes related tostocks, bonds, and other financial instruments.The goal in analyzing financial statements is toassess past performance and current financial po-sition and to make predictions about the futureperformance of a company. Investors who buystock are primarily interested in a company’sprofitability and their prospects for earning a re-turn on their investment by receiving dividendsand/or increasing the market value of their stockholdings. Creditors and investors who buy debtsecurities, such as bonds, are more interested inliquidity and solvency: the company’s short- andlong-run ability to pay its debts. Financial ana-lysts, who frequently specialize in following cer-tain industries, routinely assess the profitability,liquidity, and solvency of companies in order to



make recommendations about the purchase orsale of securities, such as stocks and bonds.

Analysts can obtain useful information bycomparing a company’s most recent financialstatements with its results in previous years andwith the results of other companies in the sameindustry. Three primary types of financial state-ment analysis are commonly known as horizon-tal analysis, vertical analysis, and ratio analysis.

HORIZONTAL ANALYSIS

When an analyst compares financial informationfor two or more years for a single company, theprocess is referred to as horizontal analysis, sincethe analyst is reading across the page to compareany single line item, such as sales revenues. Inaddition to comparing dollar amounts, the ana-lyst computes percentage changes from year toyear for all financial statement balances, such ascash and inventory. Alternatively, in comparingfinancial statements for a number of years, theanalyst may prefer to use a variation of horizontalanalysis called trend analysis. Trend analysis in-volves calculating each year’s financial statementbalances as percentages of the first year, alsoknown as the base year. When expressed as per-centages, the base year figures are always 100percent, and percentage changes from the baseyear can be determined.

VERTICAL ANALYSIS

When using vertical analysis, the analyst calcu-lates each item on a single financial statement as apercentage of a total. The term vertical analysisapplies because each year’s figures are listed verti-cally on a financial statement. The total used bythe analyst on the income statement is net salesrevenue, while on the balance sheet it is totalassets. This approach to financial statement anal-ysis, also known as component percentages, pro-duces common-size financial statements. Com-mon-size balance sheets and income statementscan be more easily compared, whether across theyears for a single company or across differentcompanies.

RATIO ANALYSIS

Ratio analysis enables the analyst to compareitems on a single financial statement or to exam-ine the relationships between items on two finan-cial statements. After calculating ratios for eachyear’s financial data, the analyst can then exam-ine trends for the company across years. Sinceratios adjust for size, using this analytical toolfacilitates intercompany as well as intracompanycomparisons. Ratios are often classified using thefollowing terms: profitability ratios (also knownas operating ratios), liquidity ratios, and solvencyratios. Profitability ratios are gauges of the com-pany’s operating success for a given period oftime. Liquidity ratios are measures of the short-term ability of the company to pay its debts whenthey come due and to meet unexpected needs forcash. Solvency ratios indicate the ability of thecompany to meet its long-term obligations on acontinuing basis and thus to survive over a longperiod of time. In judging how well on a com-pany is doing, analysts typically compare a com-pany’s ratios to industry statistics as well as to itsown past performance.

CAVEATS

Financial statement analysis, when used carefully,can produce meaningful insights about a com-pany’s financial information and its prospects forthe future. However, the analyst must be aware ofcertain important considerations about financialstatements and the use of these analytical tools.For example, the dollar amounts for many typesof assets and other financial statement items areusually based on historical costs and thus do notreflect replacement costs or inflationary adjust-ments. Furthermore, financial statements con-tain estimates of numerous items, such as war-ranty expenses and uncollectible customerbalances. The meaningfulness of ratios and per-centages depends on how well the financial state-ment amounts depict the company’s situation.Comparisons to industry statistics or competi-tors’ results can be complicated because compa-nies may select different, although equally ac-ceptable, methods of accounting for inventories



and other items. Making meaningful compari-sons is also hampered when a company or itscompetitors have widely diversified operations.

The tools of financial statement analysis, ra-tio and percentage calculations, are relatively easyto apply. Understanding the content of the finan-cial statements, on the other hand, is not a simpletask. Evaluating a company’s financial status,performance, and prospects using analytical toolsrequires skillful application of the analyst’s judg-ment.

(SEE ALSO: Analytical Procedures)

MARY BRADY GREENAWALT


Financial statements provide information ofvalue to company officials as well as to variousoutsiders, such as investors and lenders of funds.Publicly owned companies are required to peri-odically publish general-purpose financial state-ments that include a balance sheet, an incomestatement, and a statement of cash flows. Somecompanies also issue a statement of stockholders’equity and a statement of comprehensive in-come, which provide additional detail on changesin the equity section of the balance sheet. Finan-cial statements issued for external distributionare prepared according to generally accepted ac-counting principles (GAAP), which are theguidelines for the content and format of thestatements. In the United States, the Securitiesand Exchange Commission (SEC) has the legalresponsibility for establishing the content of fi-nancial statements, but it generally defers to anindependent body, the Financial AccountingStandards Board (FASB), to determine and pro-mote accepted principles.

The balance sheet, also known as the state-ment of financial position or condition, presentsthe assets, liabilities, and owners’ equity of thecompany at a specific point in time. The assetsare the firm’s resources, financial or nonfinancial,such as cash, receivables, inventories, properties,and equipment. The total assets equal (balance)

the sources of funding for those resources: liabili-ties (external borrowings) and equity (owners’contributions and earnings from firm opera-tions). The balance sheet is used by investors,creditors, and other decision makers to assess theoverall composition of resources, the constric-tion of external obligations, and the firm’s flexi-bility and ability to change to meet new require-ments.

Firms frequently issue a separate statementof stockholders’ equity to present certain changesin equity, rather than showing them on the faceof the balance sheet. The statement of stockhold-ers’ equity itemizes the changes in equity over theperiod covered, including investments by ownersand other capital contributions, earnings for theperiod, and distributions to owners of earnings(dividends) or other capital. Sometimes compa-nies present a statement of changes in retainedearnings rather than a statement of stockholders’equity. The statement of changes in retainedearnings, also known as the statement of earnedsurplus, details only the changes in earned capi-tal: the net income and the dividends for theperiod. Then the changes in contributed capital(stock issued, stock options, etc.) must be de-tailed on the balance sheet or in the notes to thefinancial statements.

The income statement, also known as thestatement of profit and loss, the earnings state-ment, or the operations statement, presents thedetails of the earnings achieved for the period.The income statement separately itemizes reve-nues and expenses, which result from the com-pany’s ongoing major or central operations, andthe gains and losses arising from incidental orperipheral transactions. Certain irregular items(such as discontinued operations, extraordinaryitems, effects of accounting changes) are pre-sented separately, net of tax effect, at the end ofthe statement. When revenues and gains exceedexpenses and losses, net income is realized. Netincome for the period increases equity. The re-sults of the firm’s operating activities for theperiod as presented in the income statement pro-vide information that can be used to predict theamount, timing, and uncertainty of future cash



flows. This statement is useful to investors, credi-tors, and other users in determining the profit-ability of operations. The income statement mustalso show earnings per share (EPS), where the netincome is divided by the weighted average num-ber of shares of common stock outstanding.Since EPS scales income by the magnitude of theinvestment, it allows investors to compare di-verse companies of different sizes; hence, inves-tors commonly use it as a summary measure-ment of firm performance.

In 1998, the FASB required that companiespresent a separate statement that classifies allitems of other comprehensive income by theirnature. Other comprehensive income includes allequity changes not recorded in the income state-ment or in the statement of changes in retainedearnings and that do not result from contribu-tions by owners. In addition to providing a sepa-rate statement, companies must display the totalof other comprehensive income separately fromretained earnings and additional paid-in capitalin the equity section of the balance sheet.

The statement of cash flows replaced thestatement of changes in financial position in 1987as a required financial statement for all businessenterprises. The statement of cash flows presentscash receipts and payments classified by whetherthey stem from operating, investing, or financingactivities and provides definitions of each cate-gory. Information about key investing and fi-nancing activities not resulting in cash receipts orpayments in the period must be provided sepa-rately. The cash from operating activities re-ported on the statement of cash flows must bereconciled to net income for the period. BecauseGAAP requires accrual accounting methods inpreparing financial statements, there may be asignificant difference between net income andcash generated by operations. The cash-flowstatement is used by creditors and investors todetermine whether cash will be available to meetdebt and dividend payments.

Financial statements include notes, which areconsidered an integral part of the statements. Thenotes contain required disclosures of additional

data, assumptions and methodologies employed,and other information deemed useful to users.

The financial statements of publicly ownedcompanies also include an auditor’s report, indi-cating that the statements have been audited byindependent auditors. The auditor’s opinion isrelated to fair presentation in conformity withGAAP.

The external financial statements requiredfor not-for-profit organizations are similar tothose for business enterprises, except that there isno ownership component (equity) and no in-come. Not-for-profit organizations present astatement of financial position, a statement ofactivities, and a statement of cash flows. Thefinancial statements must classify the organiza-tion’s net assets and its revenues, expenses, gains,and losses based on the existence or absence ofdonor-imposed restrictions. Each of three classesof net assets—permanently restricted, temporar-ily restricted, and unrestricted—must be dis-played in the statement of financial position, andthe amounts of change in each of those classes ofnet assets must be displayed in the statement ofactivities. Governmental bodies, which areguided by the Governmental Accounting Stan-dards Board (GASB), present general-purposeexternal financial statements that are similar tothose of other not-for-profit organizations, butthey classify their financial statements accordingto fund entities.

(SEE ALSO: Accounting; Financial Statement Analysis)

BIBLIOGRAPHY

Engstrom, J., and Hay, L. (1996). Essentials of Accounting forGovernmental and Not-for-Profit Organizations. Chicago:Irwin.

Financial Accounting Standards Board. (1987). Statement ofFinancial Accounting Standards No. 95: Statement of CashFlows. Stamford, CT: Author.

Financial Accounting Standards Board. (1993). Statement ofFinancial Accounting Standards No. 117: Financial State-ments of Not-for-Profit Organizations. Stamford, CT: Au-thor.

Financial Accounting Standards Board. (1997). Statement ofFinancial Accounting Standards No. 130: Reporting Com-prehensive Income. Stamford, CT: Author.



Gross, M., et al. (1995). Financial and Accounting Guide forNot-for-Profit Organizations. New York: Wiley.

Revsine, L., Collins, D., and Johnson, B. (1999). FinancialReporting and Analysis. Upper Saddle River, NJ: Pren-tice-Hall.

VICTORIA SHOAF

FISCAL POLICY

Fiscal policy is manifested in a government’s pol-icies on taxation and expenditures. To obtainfunds for their operation, government units gen-erally collect some form of taxes. The expendi-ture of these funds not only provides goods andservices for constituents, but has a direct impacton the economy. For example, if expenditures arelarger than the funds received by the govern-ment, the resulting deficit tends to stimulate theeconomy, as goods and services are produced forgovernment purchase. In contrast, if a govern-ment runs a surplus by not spending all the fundsit collects, economic growth will generally becurtailed, as the surplus funds are removed fromcirculation in the economy.

THE FEDERAL BUDGET

In the United States, the fiscal process of thefederal government begins each February withthe president sending to Congress a proposedfederal budget for the coming fiscal year, whichbegins in October. Congress then develops a bud-get resolution, which is to be completed by April.The budget resolution contains overall revenueand spending budgets as well as the budgetedamount of discretionary and mandatory spend-ing for each functional area, such as nationaldefense. Mandatory spending is required by priorlegislation, while discretionary spending must beapproved during the current year’s legislativeprocess. The majority of all federal governmentspending is mandatory spending for establishedprograms.

Using the budget resolution as a guide, billsthat provide budget authority for annual discre-tionary spending must be completed by Juneeach year. Legislative changes can also be made to

mandatory spending or tax provisions at thistime. However, any legislation that would cuttaxes or increase mandatory spending must beaccompanied by legislation that would raise reve-nue or cut spending in other areas to pay forthese changes. Consequently, any new legislationin this area must be ‘‘budget-neutral.’’

In fiscal 1998, the federal government hadreceipts of $1,721 billion and expenditures of$1,651 billion, leaving a surplus of $70 billion.This was the first surplus recorded by the federalgovernment since 1969, ending almost thirtyconsecutive years of deficits. During this time,the nonstop annual deficits forced the U.S. gov-ernment to borrow additional money each yearto make up the difference between the federalgovernment’s receipts and outlays. As a result,the outstanding federal debt reached roughly$5.5 trillion in 1998, representing more than$20,000 per citizen of the country. Paying theannual interest charges on this debt consumes asignificant portion of the federal budget.

FEDERAL GOVERNMENT REVENUE

Individual income taxes have been the federalgovernment’s largest source of funds for manyyears. In 1998, $829 billion in individual incometaxes were collected, comprising 48 percent of thefederal government’s receipts. Robust economicgrowth in the 1990s steadily increased individualincome tax payments and was a large factor inturning the mushrooming deficits of the priorthirty years into a surplus in 1998, as tax collec-tions grew faster than government spending.

Social Security taxes, which are paid by mostworkers in the United States, are the other majorsource of funds for the federal government. In1998, payments of $540 billion were made intothe Social Security system. These taxes, which area percentage of a worker’s wages, have increasedsubstantially as a result of a growing work forcein the 1990s with many workers in their peakearning years.

FEDERAL GOVERNMENT EXPENDITURES

The enormous impact of the Social Security sys-tem on the federal government’s budget is dem-

FISCAL POLICY


onstrated by the fact it is the largest outlay of thefederal government each year. In 1998, almost 23percent of federal government expenditures werepayments of monthly benefits to families of re-tired and disabled workers. In 1940, in the earlyyears of the Social Security program, there wereonly 222,000 beneficiaries receiving a total of $35million a year in benefits. By 1998, the federalgovernment was sending $379 billion to almost45 million Social Security beneficiaries. Whenthese payments are coupled with the burgeoningcost of Medicare, which generally provides healthinsurance for the same individuals who receiveSocial Security benefits, it means that the UnitedStates spent over 35 percent of the federal budgeton this group of retired and disabled individualsin 1998. With the increased life expectancy ofsenior citizens and the large number of baby-boomers nearing retirement age, Social Securityand Medicare will continue to consume a largepart of the federal budget dollar in the foreseeablefuture.

Defense spending is the largest item of dis-cretionary spending in the federal budget. In1998, $270 billion, 16 percent of the federal bud-get, was spent on the armed forces of the UnitedStates. With an ever-larger portion of the federalbudget being consumed by mandatory spendingprograms, defense spending has been the targetof budget cuts since the resumption of nor-malized relations with the countries that consti-tuted the former Soviet Union.

Interest on the federal government’s debt isthe other major federal government outlay, in1998 requiring $243 billion in net interest pay-ments on the federal debt, which exceeded $5trillion. Declining interest rates and reduced fed-eral government borrowing, however, haveslowed the growth of this budget item.

IMPACT ON THE ECONOMY

As discussed previously, the federal government’spolicies on taxes and spending have a large im-pact on the economy. The economic theory ofthe famous English economist John MaynardKeynes advocates the use of the government’sfiscal policy to offset imbalances in the economy.

According to Keynes, a government should usefiscal policy to stimulate an economy slowed by arecession by running a deficit, that is, by spend-ing more than it takes from the economy in taxes.On the other hand, to slow down an economythat is threatened by inflationary pressures, Key-nes urged increasing taxes or cutting spending tocreate a budget surplus that would act as a dragon the economy.

Keynes thought fiscal policy could be an au-tomatic stabilizer for the economy because itautomatically responds to changes in economicactivity. Government spending on items such asunemployment benefits generally increases dur-ing a recession, whereas government receiptssuch as income taxes will fall during a recession,moderating the extremes of the business cycle.Consequently, fiscal policy, along with monetarypolicy, which is dictated by the Federal Reserve,has an important influence on the health of theeconomy in the United States.

IMPACT ON FOREIGN COUNTRIES

The impact of fiscal policy in the United Statesextends far beyond the country’s borders. For ex-ample, top marginal income tax rates in thiscountry have declined substantially since the late1970s, when they were as high as 70 percent. Thisreduction in top rates has made it difficult forCanadian companies to attract and retain keyexecutives because Canadian income taxes onhigh-income individuals are now substantiallygreater than in the United States. Even Canadianhockey teams have found that higher income taxrates north of the border encourage many of theirplayers to flee to teams based in the UnitedStates, where they can retain a larger portion oftheir earnings. Consequently, even the balance ofpower in the National Hockey League is influ-enced by the fiscal policy of the U.S. government.

BIBLIOGRAPHY

A Citizen’s Guide to the Federal Budget: Budget of the UnitedStates Government, Fiscal Year 1999. (1999). Washington,DC: Executive Office of the President.

FISCAL POLICY


Baker, Dean. (1995). Robbing the Cradle?: A Critical Assess-ment of Generational Accounting. Washington, DC: Eco-nomic Policy Institute.

Bruce, Neil. (1998). Public Finance and the American Econ-omy. Reading, MA: Addison-Wesley.

DAVID MCGRADY


The Food and Drug Act of 1906, which prohib-ited the interstate trade of misbranded or taintedfood, drinks, and drugs, was passed by Congresson the same day as the Meat Inspection Act. Atthis time there was no Federal Drug Administra-tion, but there was a Bureau of Chemistry. In1927, a separate enforcement agency known asthe Food, Drug and Insecticide Administrationwas created; in 1930, it was renamed the Foodand Drug Administration (FDA). In 1938, afterfive years of battle with Congress, the FederalFood, Drug, and Cosmetic Act was passed. Ac-cording to the FDA’s Web site, it contained thefollowing new provisions:

● Extending control to cosmetics and therapeu-tic devices.

● Requiring new drugs to be shown safe beforemarketing—starting a new system of drugregulation.

● Eliminating the Sherley Amendment require-ment to prove intent to defraud in drugmisbranding cases.

● Providing that safe tolerance is set for un-avoidable poisonous substances.

● Authorizing standards of identity, quality, andfill-of-container for foods.

● Authorizing factory inspections.

● Adding the court injunctions to the previouspenalties of seizures and prosecutions.

Later the FDA’s jurisdiction was expanded toinclude microwaves and any radiation-emittingconsumer products, as well as veterinary drugsand pet food. The agency monitors the manufac-ture, transportation, and sale of food and drugs.To ensure its efficiency, the FDA operates in 157

cities and employs approximately 9000 people.Among its employees are chemists, microbiolo-gists, and investigators who visit 15,000 locationseach year.

FDA inspectors visit businesses that are regu-lated by the FDA. If a problem exists, the FDAallows the company to voluntarily correct theproblem or recall the faulty product. If the com-pany refuses to cooperate, the FDA can go tocourt to force cooperation. Court action can in-clude criminal prosecution if necessary.

In the area of drug control, the FDA does notconduct its own experiments but closely exam-ines the results of the company’s research. FDAinspectors conduct three types of inspections:study-oriented, investigation-oriented, and bio-equivalence inspections. Study-oriented inspec-tions are needed in case of new drug or new-product applications for approval. An investiga-tor-oriented inspection may be ordered if otherinvestigators looking at the same study think thefindings are inconsistent. If one study is the solebasis for a marketer request, a bioequivalencestudy is conducted.

Once a drug or device is approved, theagency’s responsibility does not end. The FDAmonitors any complaints and looks for any ad-verse reactions associated with the product. As aresult, approximately 3000 products are recalledeach year.

In addition to ensuring the quality of theproduct itself, the FDA has had a major influenceon businesses and the way goods are packaged;for example, medicines and products dangerousto children are now packaged in childproof bot-tles, and labels on containers of food productsmust list the nutritional contents and theiramounts.

Any company that produces a product that isunder the jurisdiction of the FDA has felt thepressure of its regulations, and complaints havebeen made about the slowness of the FDA’s pro-cedures. However, no country’s citizens enjoymore protection regarding the products they usethan U.S. citizens.

FOOD AND DRUG ADMINISTRATION


Demonstrators protest against Food and Drug Administration (FDA) policies.

More information is available from the Foodand Drug Administration, Fishers Lane, Rock-ville, MD 20852 or http://www.fda.gov.

BIBLIOGRAPHY

Food and Drug Administration. Frequently Asked Questions.

Archived at: http://www.fda.gov/opacom/fgs.

Food and Drug Administration. FDA Inspections of Clinical

Investigators. Archived at: http://www.verity.fda.gov/

search97.

Food and Drug Administration. Milestones in United States

Food and Drug Law History. Archived at: http://www.fda

.gov/opacom/backgrounder.

Food and Drug Administration. Small Business Guide to

FDA. Archived at: http://www/fda.gov.opacom.

FOOD AND DRUG ADMINISTRATION


Food and Drug Administration. Warning Letters. Archivedat: http://www.fda.gov/ora/compliance.


FOOD, DRUG, AND COSMETICACT OF 1938

The Food, Drug, and Cosmetic Act of 1938 is themost important of the pure food and drug actspassed and administered by the Food and DrugAdministration (FDA) of the U.S. Department ofHealth and Human Services. Food and drug lawswere enacted to ensure the safety, proper la-beling, and purity of foods, drugs, vaccines, de-vices, and cosmetics. The 1938 act is a revision ofthe first food and drug law, enacted in 1906,which brought attention to many abuses in theform of poor health practices and excessive pric-ing. The 1938 revised law and subsequentamendments, give consumers greater protectionfrom dangerous and impure foods and drugs;they require labeling that discloses the nature ofthe contents of the package when the buyer can-not see the product or judge its composition andvalue. They also provide safeguards against theintroduction of untested new drugs (VersawareTechnologies, 1999).

The Food, Drug, and Cosmetic Act of 1938addressed the wholesomeness of the food supplyby giving the FDA powers to engage in economicregulation, to set legally enforceable food stan-dards, and to establish affirmative labeling re-quirements (Hardy, 1990). Consequently, theFDA examines food products’ adulteration fromthe perspectives of both wholesomeness andsafety. For example, the FDA has investigatedseveral cases involving the alteration of fruitjuices by dilution with sugarwater or less expen-sive juices that represent both reductions inwholesomeness and economic fraud.

Another condition of economic fraud cov-ered by the Food, Drug, and Cosmetic Act ismanufacturer misbranding of food: The food isnot adulterated, but the consumer is deceived. In1993, the FDA seized 2400 cases of Procter &

Gamble’s Citrus Hill orange juice because thelabel used the word ‘‘fresh’’ when the productwas, in fact, produced from concentrate.(Colford, 1991).

Since the passing of the first food and druglaw, food laws and regulations have evolved from(1) concerns centering around food fraud, (2) toconcerns about food safety, (3) to protection ofthe nutritional integrity of food, (4) to truth inlabeling, (5) to, most recently, concern about therelationship between health and food. Manyamendments to the Food, Drug, and CosmeticsAct of 1938 and other food-related laws and actshave been passed by Congress and will continueto be enacted in response to future technologicalchanges and developments.

Manufacturers of food, drugs, cosmetics, andtheir related products must comply with the law.Penalties for violations include seizure of illegalgoods, injunctions, restraint of shipments thatviolate the law, and criminal prosecution of thoseresponsible for the violation, with fines up to$500,000, imprisonment up to ten years, or both,for repeated offenses.

BIBLIOGRAPHY

Colford, S. W. (1991). ‘‘FDA Getting Tougher.’’ AdvertisingAge April. [Cited in Meier, K. J., Garman, E. T., andKeiser, L. R. (1998) Regulation and Consumer Protection:Politics, Bureaucracy and Economics. Houston, TX:DAME Publications.

Hardy, S. B. (1990). ‘‘Assuring a Healthy Food Supply: ACase for Fundamental Reform of Regulatory Programs.’’American Review of Public Administration 20:220-243.

Versaware Technologies, Inc. ‘‘Pure Food and Drug Acts.’’http://www.funkandwagnalls.com/encyclopedia/low/articles/p/p020001431f.html. March 10, 1999.

PHYLLES BUNN


Business leaders and economists are continuallyinvolved in the process of trying to forecast, orpredict, the future of business in the economy.Business leaders engage in this process becausemuch of what happens in businesses today de-



Procter and Gamble was the subject of an FDA investigation in 1993.

pends on what is going to happen in the future.For example, if a business is trying to make adecision about developing a revolutionary newautomobile, it would be nice to know whetherthe economy is going to be in a recession orwhether it will be booming when the automobileis released to the general public. If there is arecession, consumers will not buy the automobileunless it can save them money, and the manufac-turer will have spent millions or billions of dol-lars on the development of a product that mightnot sell.

The process of attempting to forecast thefuture is not new. Most ancient civilizations usedsome method for predicting the future. Today,computers with elaborate programs are oftenused to develop models to forecast future eco-nomic and business activity. Contemporarymodels of economic and business forecastinghave been developed in the last century. Today’sforecasting models are considerably more statis-tical than they were hundreds of years ago when

the stars, and other mystical methods, were usedto predict the future. Almost every large businessor government agency performs some type offormalized forecasting.

Forecasting in business is closely related tounderstanding the business cycle. The founda-tions of modern forecasting were laid in 1865 byWilliam Stanley Jevons, who argued that manu-facturing had replaced agriculture as the domi-nant sector in English society. He studied theeffects of economic fluctuations of the limitingfactors of coal production on economic develop-ment.

Forecasting has become big business aroundthe world. Forecasters try to predict what thestock markets will do, what the economy will do,what numbers to pick in the lottery, who will winsporting events, and almost anything one mightname. Regardless of who does it, forecasting isdone to identify what is likely to happen in thefuture so as to be able to benefit most from theevents.



QUALITATIVE FORECASTING MODELS

Qualitative forecasting models have often provento be most effective for short-term projections. Inthis method of forecasting, which works bestwhen the scope is limited, experts in the appro-priate fields are asked to agree on a commonforecast. Two methods are used frequently.

Delphi Method. This method involves askingvarious experts what they anticipate will happenin the future relative to the subject under consid-eration. Experts in the automotive industry, forexample, might be asked to forecast likely inno-vative enhancements for cars five years fromnow. They are not expected to be precise, butrather to provide general opinions.

Market Research Method. This method in-volves surveys and questionnaires about people’ssubjective reactions to changes. For example, acompany might develop a new way to launderclothes; after people have had an opportunity totry the new method, they would be asked forfeedback about how to improve the processes orhow it might be made more appealing for thegeneral public. This method is difficult because itis hard to identify an appropriate sample that isrepresentative of the larger audience for whomthe product is intended.

QUANTITATIVE FORECASTING MODELS

Three quantitative methods are in common use.

Time-Series Methods. This forecasting modeluses historical data to try to predict future events.For example, assume that you are interested inknowing how long a recession will last. Youmight look at all past recessions and the eventsleading up to and surrounding them and then,from that data, try to predict how long the cur-rent recession will last.

A specific variable in the time series is identi-fied by the series name and date. If gross domes-tic product (GDP) is the variable, it might beidentified as GDP2000.1 for the first-quarter sta-tistics for the year 2000. This is just one example,and different groups might use different methodsto identify variables in a time period.

Many government agencies prepare and re-lease time-series data. The Federal Reserve, forexample, collects data on monetary policy andfinancial institutions and publishes that data inthe Federal Reserve Bulletin. These data becomethe foundation for making decisions about regu-lating the growth of the economy.

Time-series models provide accurate fore-casts when the changes that occur in the vari-able’s environment are slow and consistent.When large-degree changes occur, the forecastsare not reliable for the long term. Since time-series forecasts are relatively easy and inexpensiveto construct, they are used quite extensively.

The Indicator Approach. The U.S. govern-ment is a primary user of the indicator approachof forecasting. The government uses such indica-tors as the Composite Index of Leading, Lagging,and Coincident Indicators, often referred to asComposite Indexes. The indexes predict by as-suming that past trends and relationships willcontinue into the future. The government in-dexes are made by averaging the behavior of thedifferent indicator series that make up each com-posite series.

The timing and strength of each indicatorseries relationship with general business activity,reflected in the business cycle, change over time.This relationship makes forecasting changes inthe business cycle difficult.

Econometric Models. Econometric modelsare causal models that statistically identify therelationships between variables and how changesin one or more variables cause changes in an-other variable. Econometric models then use theidentified relationship to predict the future.Econometric models are also called regressionmodels.

There are two types of data used in regressionanalysis. Economic forecasting models predomi-nantly use time-series data, where the values ofthe variables change over time. Additionally,cross-section data, which capture the relationshipbetween variables at a single point in time, areused. A lending institution, for example, mightwant to determine what influences the sale of



homes. It might gather data on home prices, in-terest rates, and statistics on the homes beingsold, such as size and location. This is the cross-section data that might be used with time-seriesdata to try to determine such things as what sizehome will sell best in which location.

An econometric model is a way of determin-ing the strength and statistical significance of ahypothesized relationship. These models are usedextensively in economics to prove, disprove, orvalidate the existence of a casual relationshipbetween two or more variables. It is obvious thatthis model is highly mathematical, using differentstatistical equations.

For the sake of simplicity, mathematicalanalysis is not addressed here. Just as there arethese qualitative and quantitative forecastingmodels, there are others equally as sophisticated;however, the discussion here should provide ageneral sense of the nature of forecasting models.

THE FORECASTING PROCESS

When beginning the forecasting process, thereare typical steps that must be followed. Thesesteps follow an acceptable decision-making pro-cess that includes the following elements:

1. Identification of the problem. Forecastersmust identify what is going to be fore-casted, or what is of primary concern.There must be a timeline attached to theforecasting period. This will help theforecasters to determine the methods tobe used later.

2. Theoretical considerations. It is necessaryto determine what forecasting has beendone in the past using the same variablesand how relevant these data are to theproblem that is currently under consider-ation. It must also be determined whateconomic theory has to say about thevariables that might influence the fore-cast.

3. Data concerns. How easy will it be to col-lect the data needed to be able to makethe forecasts is a significant issue.

4. Determination of the assumption set. Theforecaster must identify the assumptionsthat will be made about the data and theprocess.

5. Modeling methodology. After careful ex-amination of the problem, the types ofmodels most appropriate for the problemmust be determined.

6. Preparation of the forecast. This is theanalysis part of the process. After themodel to be used is determined, the anal-ysis can begin and the forecast can beprepared.

7. Forecast verification. Once the forecastshave been made, the analyst must deter-mine whether they are reasonable andhow they can be compared against theactual behavior of the data.

Each of the seven steps has substages; how-ever, the steps that have been presented are themajor concerns to the forecaster. Those with adeep interest in forecasting might pursue morein-depth treatments.

FORECASTING CONCERNS

Forecasting does present some problems. Eventhough very detailed and sophisticated mathe-matical models might be used, they do not alwayspredict correctly. There are some who wouldargue that the future cannot be predicted at all—period!

Some of the concerns about forecasting thefuture are that (1) predictions are made usinghistorical data, (2) they fail to account for uniqueevents, and (3) they ignore coevolution (develop-ments created by our own actions). Additionally,there are psychological challenges implicit inforecasting. An example of a psychological chal-lenge is when plans based on forecasts that usehistorical data become so confining as to prohibitmanagement freedom. It is also a concern thatmany decision makers feel that because they havethe forecasting data in hand they have controlover the future.

Regardless of the opponents to forecasting,the U.S. government, investment analysts, busi-



ness managers, economists, and numerous otherswill continue to use forecasting techniques topredict the future. It is imperative for the users ofthe forecasts to understand the information anduse the results as they are intended.

BIBLIOGRAPHY

Fulmer, William, E. (2000). Shaping the Adaptive Organiza-tion: Landscapes, Learning, and Leading in Volatile Times.New York: AMACOM.

Moore, Geoffrey H. (1983). Business Cycles, Inflation, andForecasting. Cambridge, MA: Ballinger.

Sherman, Howard, J., and Kolk, David X. (1996). BusinessCycles and Forecasting. New York: HarperCollins.

Stock, James H., andWatson, MarkW., eds. (1993). BusinessCycles, Indicators, and Forecasting. Chicago: University ofChicago Press.

ROGER L. LUFT

FOREIGN CORRUPT PRACTICESACT OF 1977

The Foreign Corrupt Practices Act of 1977(FCPA) evolved from investigations by the Officeof the Special Prosecutor that provided evidenceof illegal acts perpetrated by U.S. firms in foreignlands. More than 400 U.S. companies admittedto making questionable payments to various for-eign governments and political parties as part ofan amnesty program (U.S. Department of Justicehttp://www.usdoj.gov). Given the environmentof the 1970s and the proliferation of white-collarcrimes (e.g., insider trading, bribery, false finan-cial statements, etc.), particularly the paymentsmade to foreign officials by corporations, Con-gress felt obligated to introduce legislation thatled to the act. Congress’s objective was to restoreconfidence in the manner U.S. companies trans-acted business.

THE ACT

The FCPA is unique. Throughout history, gov-ernments have had laws making it illegal forgovernmental officials to take a bribe. One basicprovision of the FCPA is that it prohibits U.S.partnerships, companies, and organizations from

not only giving payments but also offering or au-thorizing payments to foreign officials or politicalparties with the objective of encouraging or as-suring business relationships.

There are two types of bribery provisions.The first prohibits any bribes made directly bythe U.S. company. The second prohibits any or-ganization from knowingly arranging for a bribethrough an intermediary. Many thought that theFCPA would place U.S. companies at a disadvan-tage in the international marketplace since theycould no longer influence foreign governments,officials, political parties, or candidates throughgifts or payments. There has been no conclusiveevidence that this has actually happened.

The FCPA includes record-keeping provi-sions for companies not involved in criminalconduct. These provisions were an amendmentto the Securities and Exchange Act of 1934. TheFCPA amendment requires all firms under SECjurisdiction to maintain an adequate system ofinternal control whether or not they have foreignoperations. This provision of the act applies toissuers of registered securities and issuers re-quired to file periodic reports with the SEC.

ACCOUNTING PROVISIONS

The accounting provisions require companies to‘‘keep books and records, and accounts, which, inreasonable detail, accurately and fairly reflect thetransactions and dispositions of assets’’. The pur-pose of this accounting provision is to make itdifficult for organizations to ‘‘cook the books’’ oruse slush funds to hide any corrupt payments.Representative means for transfer of corrupt pay-ments included:

● Overpayments

● Missing records (‘‘No receipt’’)

● Unrecorded transactions

● Misclassification of costs (bribes recorded asconsulting fees or commissions)

● Retranscription of records

The accounting provisions include a require-ment that companies design and maintain ade-

FOREIGN CORRUPT PRACTICES ACT OF 1977


quate systems of internal accounting controlsthat provide reasonable assurance that:

● Transactions are executed in accordance withmanagement’s authorization

● Transactions are recorded as necessary

● Access to assets is permitted only in accord-ance with management’s authorization

Any internal document that misrepresentsthe actual nature of a financial transaction couldbe used as the basis for a charge that the ‘‘booksand records’’ section of the FCPA has been vio-lated.

ENFORCEMENT

Enforcement of the act is shared. Civil and crimi-nal enforcement of the bribery provisions forthose not required to file with the SEC rests withthe Department of Justice. Responsibility for civilenforcement of the bribery provisions for thosewho have SEC filing requirements rests with theSEC.

In 1988 the FCPA was amended to allow for‘‘facilitating payments’’ for expediting routinegovernmental action. These payments are distin-guishable from corrupt payments in that these‘‘grease payments’’ are for facilitating the per-formance of officials who are obligated to per-form said duties. Questions regarding thisamendment, affirmative defenses, or other provi-sions of the FCPA should be directed to counsel,or companies may wish to use the Department ofJustice’s Foreign Corrupt Practices Act OpinionProcedure. Under this procedure, upon receivinga question from a company or individual, theattorney general has thirty days to issue an opin-ion regarding the inquiry. The objective is toalleviate uncertainty regarding acts covered bythe FCPA.

PENALTIES

The FCPA provides penalties for violations.Criminal penalties for bribery violations includefines of up to $2 million for firms; fines of up to$100,000 and imprisonment of up to five yearsfor officers, directors, and stockholders; and finesof up to $100,000 for employees and agents (fines

imposed on individuals cannot to be paid bycompanies). The SEC or attorney general mayalso bring actions that lead to civil penalties. Also,the act’s penalties do not supersede penalties orfines levied under the provisions of other stat-utes. A violation of the bribery provisions of theFCPA may give rise to a private cause of actionfor treble damages under RICO (Racketeer Influ-enced and Corrupt Organizations Act).

The penalties can have long-term ramifica-tions for companies. For example, a companyfound guilty of violating the FCPAmay be barredfrom doing any business with the federal govern-ment. A company indicted for an FCPA violationmay not be eligible to obtain various exportlicenses.

COMPLIANCE

Clearly, large multinational corporations cannotmonitor every transaction of every dollar amountby every employee. However, companies do havea due-diligence obligation to implement ade-quate systems with sufficient internal controls.Key ways to avoid violation and liability includeestablishing policies and procedures that providereasonable assurance that the business is adher-ing to the act’s provisions. Suggested due-dili-gence steps for compliance with the FCPA in-clude the following:

● Utilizing the compliance program under theCorporate Sentencing Guidelines Act (see nextsection)

● Performing a risk evaluation of locationsknown for unethical business practices

● Performing risk evaluation of employees/agents who operate out of the home country

● Assuring that personnel who work out of thehome country are knowledgeable regardingthe provisions of the FCPA

● Assessing internal controls to be assured theyare sufficient

● Monitoring internal controls, including re-views by auditors

● Reviewing critical transactions, such as thoserelated to consulting services

FOREIGN CORRUPT PRACTICES ACT OF 1977


● Establishing a procedure requiring that criticalemployees, vendors, and contractors providewritten statements that they are in compliancewith the requirements of the FCPA

SUBSEQUENT DEVELOPMENTS

On November 1, 1991, the Corporate SentencingGuidelines Act was enacted. The guidelines ap-pear to be a direct descendent of the FCPA. Theguidelines for organizations ‘‘are designed so thatthe sanctions imposed upon organizations andtheir agents will, taken together, provide justpunishment, adequate deterrence, and incentivesfor organizations to maintain internal mecha-nisms for preventing, detecting, and reportingcriminal conduct’’ (U.S. Sentencing Guidelines,chapter 8, intro. comm., appendix p. Al).

In most corporations, accountants and audi-tors have responsibility to prevent, detect, andreport errors and irregularities. The CorporateSentencing Guidelines are legislation to deterwhite-collar crime. The guidelines’ major objec-tive is requiring organizations to monitor busi-ness activities to detect criminal conduct withintheir own ranks.

The guidelines allow organizations to usemitigating factors to reduce their exposure tofines. One mitigating factor is maintaining a cor-porate compliance program. The corporate com-pliance program is to be the responsibility of anofficer or high-level employee. Elements of thecompliance program include:

● Established standards and procedures

● Communication of the standards to employees

● Systems designed to detect criminal conduct

● A reporting system in place whereby individu-als may report criminal conduct

● Disciplinary mechanisms that are consistentlyenforced

FURTHER GUIDANCE

Information regarding the FCPA or the ForeignCorrupt Practices Act Opinion Procedure may beobtained from the Fraud Section of the CriminalDivision, U.S. Department of Justice, Room

2424, Bond Building, 1400 New York Avenue,NW, Washington, DC 20530; (202)-514-0651.

(SEE ALSO: Securities and Exchange Commission)

CHARLES H. CALHOUN

FOREIGN EXCHANGE

(SEE: Currency Exchange)

FORMALIZATION

(SEE: Organizational Structure)

FRANCHISING

Franchising is an arrangement whereby a sup-plier, or franchiser, grants a dealer, or franchisee,the right to sell products in exchange for sometype of consideration. It is a business arrange-ment involving a contract between a manufac-turer or another supplier and a dealer that speci-fies the methods to be used in marketing a goodor service. The franchiser may receive some per-centage of total sales in exchange for furnishingequipment, buildings, management know-how,and market research. The franchisee supplies lab-or and capital, operates the franchised businessand agrees to abide by the provisions of thefranchise agreement.

Historically, franchising was a grant by a kingto allow a citizen an exclusive right to sell aproduct or render a service. For this right, thesovereign protected the exclusivity and the sub-ject paid the government an appropriate tributein service, food, goods, or money. Franchising inthe United States started shortly after the CivilWar, when the Singer Company began to set upsewing-machine franchises. The concept becameincreasingly popular after 1900 in the automobileindustry. Because of this, other automotive fran-chises developed for gasoline, oil, and tires. In the1950s, food operations made a dramatic entranceinto franchising with the development of Mc-

FRANCHISING


Donald’s, currently one of the world’s largestfranchise organizations.

In 1999, franchising accounted for $916 bil-lion in annual sales, with 533 outlets employingmore than 7 million people. A new franchiseopens somewhere in the United States every sixminutes. Franchising accounts for approximately40 percent of all United States retail sales. Be-cause of changes in the international market-place, shifting employment options in the UnitedStates, the expanding U.S. economy, and corpo-rate interest in more joint-venture activity, fran-chising will continue to increase rapidly.

Franchising represents the small entrepre-neur’s best chance to compete with the giantcompanies that dominate the marketplace. With-out franchising, thousands of businesspeoplewould never have had the opportunity to owntheir own businesses.

The largest percentages of franchise opera-tions are in the recreation, entertainment, andtravel fields, followed closely by business services,nonfood retailing, and automotive products andservices. In 1999, the top ten franchises in de-scending order were Yogen FruzWorldwide (firstplace), McDonald’s, Subway, Wendy’s Interna-tional Inc., Jackson Hewitt Tax Service, KFC,Mail Boxes Etc., TCBY Treats, Taco Bell, andJani-King.

Retail franchise agreements fall into threegeneral categories. In one type of arrangement, amanufacturer authorizes a number of retailstores to sell a certain-brand name item. Thisfranchise arrangement, one of the oldest, is com-mon in the sales of cars and trucks, farm equip-ment, shoes, paint, earth-moving equipment,and gasoline. About 90 percent of all gasoline issold through franchised independent service sta-tions, and franchised dealers handle virtually allsales of new cars and trucks.

In the second type of retail franchise, a pro-ducer licenses distributors to sell a given productto retailers. This arrangement is common in thesoft drink industry. Most national manufacturersof soft drinks—Coca-Cola, Dr. Pepper, Pep-siCo—grant franchises to bottlers, which thenservice retailers.

In the third type of retail franchise, a fran-chiser supplies brand names, techniques, or otherservices, instead of complete products. The fran-chiser may provide certain production and distri-bution services, but its primary role in the ar-rangement is careful development and control ofmarketing strategies. This approach to fran-chising, very common today, is used by such or-ganizations as Holiday Inn, AAMCO, McDon-ald’s, Dairy Queen, KFC, and H&R Block.

A good franchise system can offer theprospective franchisee a diversified array of busi-ness savvy. In most instances, the franchisee en-joys the benefit of a nationally recognized tradename, national recognition, and the instant col-lective goodwill of the franchise. Standard qualityand uniformity of a product or service coupledwith an existing—and successful—system ofmarketing and accounting are other benefits. Inaddition, expert advice on location, design, capi-talization, and operational issues is provided bythe franchiser. Specialization on a national levelis done in order to maintain the necessary re-search and market analysis that will enable thefranchisee to remain competitive in an ever-changing marketplace. In other words, a businessframework is supplied that reduces the numberof risks that may arise when starting a new busi-ness. Most often these risks are associated withthe financial investment involved. However, thefranchise agreement often offers a cost savings bysharing a centralized purchasing system, and insome instances, direct financial assistance.

ADVANTAGES AND DISADVANTAGESOF FRANCHISING

Franchising offers several advantages to both thefranchisee and the franchiser. It enables a fran-chisee to start a business with limited capital andto benefit from the business experience of others.Moreover, nationally advertised franchises, suchas ServiceMaster and Burger King, are often as-sured of customers as soon as they open. If busi-ness problems arise, the franchisee can obtainguidance and advice from the franchiser at littleor not cost. Franchised outlets are generally moresuccessful than independently owned businesses.

FRANCHISING


Less than 10 percent of franchised retail busi-nesses fail during the first two years of operation,whereas approximately half of independent retailbusinesses fail during that period. The franchiseealso receives material to use in local advertisingand can benefit from national promotional cam-paigns sponsored by the franchiser. At the turn ofthe twenty-first century, Taco Bell franchiseesprofited from a national advertising campaignfeaturing a Chihuahua demanding ‘‘Yo quieroTaco Bell’’ (‘‘I want some Taco Bell’’). The adshelped boost same-store sales at Taco Bell by 3percent in an otherwise flat industry. The talkingdog was especially popular among teenagers, whospend more than $12 billion per year at fast-foodrestaurants.

The franchiser gains fast and selective prod-uct distribution through franchise arrangementswithout incurring the high cost of constructingand operating its own outlets, thus giving it morecapital for expanding production and advertis-ing. It can also ensure, through the franchiseagreement, that outlets are maintained and oper-ated according to its own standards. The fran-chiser benefits from the fact that the franchisee,being a sole proprietor in most cases, is likely tobe very highly motivated to succeed. Success ofthe franchise means more sales, which translateinto higher income for the franchiser.

Despite these numerous advantages, fran-chise arrangements also have drawbacks for bothparties. The franchiser can dictate many aspectsof the business: decor, design of employees’ uni-forms, types of signs, and numerous other detailsof business operations. In addition, franchiseesmust pay to use the franchiser’s name, products,and assistance. Usually franchisees must pay aone-time franchise fee as well as continuingroyalty and advertising fees, often collected as apercentage of sales. For example, Subway re-quires franchisees to come up with $40,000 to$80,000 in start-up costs. Franchisees often mustwork very hard, putting in twelve-hour days, sixor seven days a week. In some cases, franchiseagreements are not uniform; one franchisee maypay more than another for the same services. Thefranchiser also gives up a certain amount of con-

trol when entering into a franchise agreement.Consequently, individual establishments may notbe operated exactly the way the franchiser wouldlike.

When entering into a franchise agreement,franchisees must be prepared to make majorcommitments of both money and time. Theymust be prepared to invest a substantial amountof money, both in the initial franchising fee andin start-up costs and carrying funds to provide acash flow sufficient to operate the business dur-ing the beginning months or, if necessary, years.Most franchisees average a net profit of less than$30,000 a year.

The second commitment is that of time; inthe beginning, the proprietor will be obliged todevote long hours to the details of the businessoperation. Experience has shown that this com-mitment is the common denominator to manysuccessful franchise operations. Franchisees mustrely to a large extent upon their own aptitude anddrive in order to learn the business. They mustalso rely upon the product, services, and businessskills of the franchiser.

In deciding whether or not to enter into afranchise agreement, there are several key pointsthat need to be considered. The first consider-ation is price and costs. What is the total cost?What are the initial fees? What are the ongoingcosts? Are there any hidden extras? Are you re-stricted in your right to purchase other goods?

The second consideration is the location.Where will the franchise be located? What is theterritory that it will serve? What are the protec-tions and limitations? Who can compete withyou?

The third issue involves control and support.What controls will be in place? What policies andregulations govern the franchise agreement?What training and ongoing support will be sup-plied?

Advertising is the fourth consideration. Thefranchisee needs to determine what national andregional advertising will be supplied, as well aswhat the franchisee pays for and what the fran-chiser finances.

FRANCHISING


The last area of concern involves profits andlosses, transfer and death, and duration and ter-mination. Potential franchisees need to deter-mine not only what protection they will receivefor their earnings if they are successful but alsowhat obligations they will be responsible for if thefranchise fails. In addition, they need to find outwhether, in the event of their death, the franchiseagreement can be transferred to their heirs orautomoatically reverts to the franchiser. Finally,they need to determine what stipulations, penal-ties, and other responsibilities are involved interminating the contract with the franchisershould they no longer wish to continue in thebusiness.

THE FRANCHISING SECTOR

A franchise is like any other business property inthat it is the buyer’s responsibility to know whathe or she is buying. Poorly financed or poorlymanaged franchise systems are no better thanpoorly financed or poorly managed nonfranchisebusinesses. It is important to remember thatthere are trends in franchises, just as in othertypes of businesses. Growth areas for franchisingin the 1990s included providing home care (find-ing nannies for children and nurses forhomebound patients), catering to children (op-erating educational and child-care centers), tend-ing people’s homes (maid service), servicing cars,and, as always, operating fast food establish-ments.

The growth of the franchised fast-food in-dustry has been truly spectacular. These franchiseoperations are second only to automobile dealer-ships and gasoline stations in gross volume ofsales. Most often located at key intersections oron busy highways, fast-food enterprises enjoy ahigh visibility.

In this segment of the franchise industry, themajority of franchise operators have alreadyowned other businesses before entering into afast-food franchise. Many successful operatorsare college graduates, but the significant numberof successful franchisees with only a high schooleducation suggests that education alone is not adetermining factor. A fast-food franchise is the

type of venture in which both husband and wifecan contribute to the success of the business.

Most fast-food franchisers consider geo-graphic location to be an important factor in thesuccess of the operation. And, like franchisers inother fields, they cite the importance of adequatecapitalization, the efficient operation of the fran-chise system, good customer relations, qualityemployees, and the contributions of the fran-chisees, such as their management skills and es-pecially their hard work.

According to Cassano’s Pizza and Subs, afranchiser with twelve outlets in four states, thesuccessful franchise operator must have severaltraits: (1) an excellent attitude toward customerservice and customer relations; (2) an entrepre-neurial ability and spirit combined with goodbusiness techniques; (3) a willingness to take ahands-on attitude toward the business. Newcom-ers to the Cassano’s franchised fast-food businessmust have prior retail management experienceand previous food service experience. All newfranchisees are trained at the home office in Day-ton, Ohio, for one month. After that, the fran-chise provides ongoing training and managerialassistance.

GLOBAL FRANCHISING

Franchising is growing rapidly abroad, with morethan 370 franchise companies operating in about40,000 outlets overseas. Canada is the largest ofthese markets, followed by Japan, Europe, Aus-tralia, and the United Kingdom. In 1995, Subwaysigned a deal with Japanese financiers to open1000 franchise outlets in Japan. Subway tailoredits products to fit the local tastes—for example,offering the Japanese market fried pork sand-wiches.

Franchising can be a workable way for smallfirms to enter foreign markets, especially marketswhere there are few competitors. For example,Automation Paper Company, a small New Jer-sey-based supplier of high-technology paperproducts, used franchising to gain exclusive rep-resentation in target markets. The franchisees re-ceive rights to the company’s trademark, as wellas training for local staffs and the benefit of the

FRANCHISING


firm’s experience, credit lines, and advertisingbudget.

The problems facing franchise companies ininternational transactions are relatively less for-midable than those facing other service sectors.Franchisers must comply with the same localrequirements as other businesses, and the fran-chise agreements must comply with local con-tract law, antitrust law, and trademark and li-censing laws. Aside from language and culturaldifferences, many of the problems of conductingbusiness in foreign countries are the same asthose involved in the United States. The successor failure of foreign franchising will depend inlarge measure on the soundness of the fran-chiser’s domestic market position and on thefranchiser’s ability to provide the necessary ex-pertise to others in another part of the world.

Some franchises popular in the United Statesactually started in another country. For example,Molly Maid started in Canada in 1980 and cameto the United States four years later.

All trends indicate that franchising will con-tinue to expand both domestically and interna-tionally, creating great opportunities for existingand new businesses; developing new entrepre-neurs, new jobs, new products, new services; andproviding export opportunities. Rising personalincome, stable prices, high levels of consumeroptimism, and increased competition for marketshare are turning many companies, both smalland large, to franchising. Education will play animportant role in the future of franchising, asboth high schools and colleges increase the num-ber of courses that are taught in marketing, busi-ness management, and entrepreneurship. In ad-dition, changing patterns in Americandemographics, coupled with the increased num-ber of women in the work force, are influencingthe number of new franchises each year. In 1998,approximately 14 percent of franchisee-ownedoutlets are run by women, whereas 21 percent arerun by female-male partners.

Furthermore, shifting demographic patternsand the use of new technology have intensifiedcompetition among franchise companies. Thesefactors have increased the number of mergers

and acquisitions in the franchising system, and itis expected that this merger/acquisition trend willpersist for several years. Creativity and imagina-tion in the treatment of goods and services arethe focus of most business ventures today. Edu-cation, computers, and the ability to work withand manage people will be profitably utilized bynew emerging businesses. All these developmentssuggest that franchising will be one of the leadingmethods of doing business in the first decade ofthe tweny-first century, even in an environmentof mixed signals in the economy.

BIBLIOGRAPHY

Conlin, Elizabeth. (1991). ‘‘Second Thoughts on Growth.’’Inc. March: 66.

Moore, Lisa. (1991). ‘‘The Flight to Franchising,’’ US News& World Report. June 10: 78-81.

Pride, William, and Ferrell, O.C. (2000). Marketing Conceptsand Strategies. Boston: Houghton Mifflin.

U.S. Bureau of the Census. (1997). Statistical Abstract of theUnited States. Washington, DC.

PATRICIA A. SPIROU


The equity and credit markets (capital markets)in the United States are considered to be amongthe most efficient in the economically developedworld. One reason for the efficient operation ofthese markets is the public availability of credit-able financial statements to individuals and insti-tutions and the confidence in these statements bythose using them as a basis for their investmentand credit decisions. A potential serious threat tothe efficient functioning of these markets is theincidence of fraudulent financial reporting.

Fraudulent financial reporting is intentionalor reckless conduct, acts, or omissions, that resultin materially misleading financial statements.Confidence in the operation of capital markets isdiminished when the system of public disclosureis eroded by reported instances of fraudulentreporting.

FRAUDULENT FINANCIAL REPORTING


John Dingell, chairman of the Subcommittee onOversight.

In the mid-1980s, the failure of a number offinancial institutions led various groups to deter-mine possible causes, including the extent offraudulent reporting involved in the failures. TheSubcommittee on Oversight and Investigationsof the U.S. House of Representative’s Committeeon Energy and Commerce held hearings con-cerning the accounting profession. The subcom-mittee’s intent was to determine whether thesystem of public disclosure and reporting neededcorrective action. In opening the hearings, thechairman, Representative John Dingell, ques-tioned whether the public disclosure and auditsystem then in effect was meeting public expecta-tions. In August 1986, Congressman Dingell andother members of the committee proposed legis-lation to amend the Securities and Exchange Actof 1934 to require independent public account-ants (auditors) to include procedures for materialfinancial fraud detection, to require reporting oninternal control systems, and to require the re-porting of fraudulent activities to appropriate en-

forcement and regulatory authorities. The legisla-tive proposals were not accepted. There persistedthe belief that the profession could respond suc-cessfully to the challenges without further legalrequirements.

A private-sector response to these hearings,the National Commission on Fraudulent Finan-cial Reporting (Treadway Commission)—jointlysponsored and funded by the American Instituteof Certified Public Accountants (AICPA), theAmerican Accounting Association (AAA), the Fi-nancial Executives Institute (FEI), the Institute ofInternal Auditors (IIA), and the National Associ-ation of Accountants (NAA) (now the Instituteof Management Accountants)—was formed in1985 to identify factors contributing to fraudu-lent financial reporting and to develop recom-mendations to reduce its future occurrence. TheTreadway Commission issued its report in Octo-ber 1987.

TREADWAY COMMISSION REPORT

The Treadway Commission concluded that theresponsibility for fraudulent financial reportingwas not vested in one group. While the commis-sion conceded that financial statements are theresponsibility of a company’s management, itissued a series of recommendations for the publiccompany, the independent public accountant,the Securities and Exchange Commission (SEC),and the educational community.

The report identified a number of factorsthat might contribute to fraudulent financial re-porting, including a number of environmental,institutional, and individual personal incentivesto engage in fraudulent financial reporting. Insti-tutional incentives include falsely improving fi-nancial appearances in financial statements forthe purpose of maintaining market stock pricesor to meet investor expectations as well as de-laying the reporting of financial difficulties inorder to avoid failure to comply with covenantsin debt agreements. Individual incentives includefalsely reporting results in order to achieve tar-geted results for bonus or incentive compensa-tion purposes, as well as to avoid penalties for



poor performance in achieving targeted profitobjectives.

The commission indicated that the oversightbodies that establish auditing standards andthose that monitor compliance have a continuingresponsibility to uphold the integrity of the pub-lic disclosure and reporting system. The Com-mission also concluded that many of the Securi-ties and Exchange Commission’s fraudulentfinancial reporting cases against auditors’ allegedfailure to conduct the audits in accordance withgenerally accepted auditing standards.

RECOMMENDATIONS FOR THEPUBLIC COMPANY

The commission made a number of recommen-dations affecting public companies. These in-cluded proposals that companies develop andvigilantly enforce written codes of corporate con-duct because such codes foster a positive ethicalclimate and discourage incidences of fraudulentfinancial reporting by positively affecting behav-ior throughout the public company.

The commission noted that company auditcommittees (those members of a company’sboard of directors who have responsibility foroversight of the financial reporting process) havehistorically been generally successful in exercisingtheir oversight responsibility regarding financialreporting. However, it offered a number of rec-ommendations that would improve this system.The commission proposed that boards of direc-tors of all public companies be required by SECrule to be composed of independent (outside,nonemployee) directors. Other specific recom-mendations included proposals to expand the au-thority of the audit committee and to enhancecommunications with the company’s internal au-ditors and independent public accountants.

RECOMMENDATIONS FOR THEINDEPENDENT PUBLIC ACCOUNTANT

The commission issued a number of specific rec-ommendations designed to improve the auditor’sability to detect fraudulent financial reporting.One significant proposal was a recommendationthat the Auditing Standards Board (ASB) of the

AICPA revise standards to restate the indepen-dent public accountant’s responsibility for thedetection of fraudulent financial reporting. Thecommission recommended that the independentpublic accountant be required to take proactivesteps to assess the potential for fraudulent finan-cial reporting and design audit tests to providereasonable assurance of detection. Other recom-mendations included suggestions for improveddetection capabilities through required analyticalreview procedures in all audit engagements andimprovements to peer review processes and otherintra-accounting firm review procedures. Thecommission also suggested that the SECstrengthen the civil and criminal sanctions affect-ing registrants and the independent public ac-countant.

RECOMMENDATIONS FOR THE SECURITIESAND EXCHANGE COMMISSION

The commission acknowledged that strong andeffective deterrence is essential in reducing theincidence of fraudulent financial reporting. Thecommission’s recommendations to the SEC in-cluded increasing deterrence by issuance of newSEC sanctions, greater criminal prosecution, im-proved regulation of the public accounting pro-fession, adequate SEC resources, improved fed-eral regulation of financial institutions, andimproved oversight by the state boards of ac-countancy.

RECOMMENDATIONS FOR EDUCATION

The commission concluded that education couldinfluence present and future participants in thefinancial reporting system. Therefore, recom-mendations were made related to curricula, pro-fessional certification examinations, and contin-uing professional education.

The commission recommended that thebusiness and accounting curricula should conveya deeper understanding of internal controls andthe overall control environment within whichfinancial reporting takes place. Students need tobe taught the complex regulatory and law en-forcement framework that government and pri-vate-sector bodies have developed to provide



safeguards to protect the public interest. Studentsalso need to develop skills that will help prevent,detect, and deter fraud in financial reporting. Theethical dimension of financial reporting shouldbe given more emphasis in college and universityprograms.

The commission recommended that certifi-cation examinations and continuing educationprograms give greater attention to the knowl-edge, skills, and ethical values that would pro-duce a better understanding of fraudulent finan-cial reporting and possibly promote a reductionin the incidence of such fraud.

RESPONSE OF THE AUDITINGSTANDARDS BOARD

In response to the Treadway Commission reportand to other influences, the Auditing StandardsBoard issued ten new auditing standards in April1988. These Statements on Auditing Standards(SASs) include requirements affecting the audi-tor’s responsibility to detect and report errorsand irregularities, consideration of internal con-trol structure in a financial statement audit, andcommunication with a company’s audit commit-tee.

SAS No. 53, ‘‘The Auditor’s Responsibility toDetect and Report Errors and Irregularities,’’stated auditor responsibility more clearly thanhad the earlier statement with the same title. SASNo. 53, however, was superseded in 1997 with anew SAS, No. 82, ‘‘Consideration of Fraud in aFinancial Statement Audit.’’ This revised State-ment clearly identified the responsibility of theauditor to provide reasonable assurance that thetwo types of misstatements are detected: thosearising from fraudulent financial reporting andthose arising from misappropriation of assets.

Another SAS, No. 61, ‘‘Communication withAudit Committees,’’ was issued to enhance therole of the audit committee of the board of direc-tors in understanding the scope and results of theaudit so that the committee members would bemore effective in overseeing the financial report-ing and disclosure process for which the com-pany’s management is responsible. In complyingwith this Statement, the auditor is required to

communicate to the audit committee such mat-ters as the company’s management’s significantaccounting policies, judgments, and accountingestimates, and disagreements with the auditors.The audit committee is to be informed of anyconsultation that management had with otheraccountants and of difficulties the auditors en-countered while performing the audit.

SAS No. 55, ‘‘Consideration of Internal Con-trol in a Financial Statement Audit,’’ changed theresponsibility of the auditor for internal control.The new Statement required the auditor to de-velop an understanding of internal control suffi-cient to plan the audit and to document theunderstanding. Prior to the issuance of the newStatement, the auditor was not required to de-velop such an understanding. SAS No. 55 wasamended with the issuance of SAS No. 78 in1997, which redefined internal control. Controlenvironment and risk assessment, among theconcerns of the Treadway Commission, weremore clearly described in SAS No. 78 and theauditor’s responsibility for both factors clearlyspecified.

CONTINUING ATTENTION TO THEPROBLEMS OF FRAUDULENT

FINANCIAL REPORTING

Attempts have continued to enhance under-standing of fraudulent financial reporting in theUnited States. In early 1999, for example, theCommittee of Sponsoring Organizations of theTreadway Commission (COSO) issued the re-sults of a study of Accounting and Auditing En-forcement Releases issued by the SEC between1987 and 1997. This study attempted to improveways of determining who participated in a fraudas well as the size and duration of the fraudulentbehavior.

The Blue Ribbon Committee, formed at therequest of the SEC chairman, the New York StockExchange, and the National Association of Secu-rities Dealers, was charged with recommendingways to enhance the effectiveness of audit com-mittees. The committee reported its recommen-dations in early 1999. The focus of the recom-mendations was related to audit committee



oversight responsibilities relating to financial re-porting.

The SEC, with its oversight responsibility forfinancial reporting, continues to provide leader-ship in cooperation with other groups for thereduction of fraudulent financial reporting.

(SEE ALSO: Audit Committees; Auditing)

BIBLIOGRAPHY

Mancino, June. (1997). ‘‘The Auditor and Fraud.’’ Journal ofAccountancy April: 32-36.

McConnell, Donald K., Jr., and Banks, George Y. (1997).‘‘The New Fraud Auditing Standard.’’ CPA JournalJune:22-30.

Report of The National Commission on Fraudulent FinancialReporting. (1987).

GERARD A. LANGE

FREE ENTERPRISE(SEE: Economic Systems)

FUND ACCOUNTING(SEE: Government Accounting; Not-For-Profit Ac-counting)

FUTURE BUSINESS LEADERSOF AMERICA

Future Business Leaders of American (FBLA) isone of ten nationally recognized vocational stu-dent organizations in the United States (Gordon,1999). The organization is a nonprofit educa-tional association for students who are preparingfor careers in business and business-related fields.The organization is composed of four divisions:

● FBLA for middle school students

● FBLA for high school students

● Phi Beta Lambda (PBL) for post-secondarystudents

● A professional division composed of business-people, educators, and other individuals who

uphold the goals of the organization (‘‘Fre-quently Asked Questions,’’ 1999).

FBLA has been in existence since 1937. Dr.Hamden I. Forkner of Teachers College of Co-lumbia University developed the first chapter inNew York City (Vaughn et al., 1990). In 1940 theNational Council for Business Education recog-nized and sponsored FBLA. The first high schoolchapter was chartered in Johnson City, Tennes-see, on February 3, 1942. Currently, more than25,000 active members participate in the organi-zation.

Students participating in FBLA have the op-portunity to develop leadership skills; enter avariety of competitions at local, state, and na-tional levels; establish occupational goals; andlearn from business and professional individualsin their communities. The goals of FBLA (andPBL) are the following:

● To promote competent, aggressive businessleadership

● To understand American business enterprise

● To establish career goals

● To encourage scholarship

● To promote sound financial management

● To develop character and self-confidence

● To facilitate transition from school to work(‘‘Frequently Asked Questions,’’ 1999)

Conferences, seminars, awards, publications,and scholarships are services provided for mem-bers of the organization. By providing practicalhands-on activities for students in the businessarena, FBLA continues to prepare young menand women to become successful leaders in ourever-changing society. More information is avail-able from FBLA or PBL at FBLA/PBL Inc., 1912Association Drive, Reston, Virginia 22091;(800)FBLA-WIN; or http://www.fbla-pbl.org/.

BIBLIOGRAPHY

‘‘Frequently Asked Questions about FBLA-PBL.’’http://www.fbla-pbl.org/. 1999.

Gordon, Howard R. D. (1999). The History and Growth ofVocational Education in America. NeedhamHeights, MA:Allyn and Bacon.

FUTURE BUSINESS LEADERS OF AMERICA


Vaughn, P. R., Vaughn, R. C., and Vaughn, D. L. (1990).Handbook for Advisors of Vocational Student Organiza-tions. Athens, GA: American Association for VocationalInstructional Materials.

JILL T. WHITE

FUTURE BUSINESS LEADERS OF AMERICA


GENERAL ACCOUNTINGOFFICE

(SEE: U.S. Government Accounting Office)


Most individuals who understand the basics offinancial reporting are familiar with the phrasegenerally accepted accounting principles (GAAP)and will readily identify the Financial AccountingStandards Board (FASB) as the standard-settingbody in the United States currently responsiblefor establishing accounting principles for non-governmental entities. However, some may notbe aware that there is no single reference sourcefor GAAP because these principles are derivedfrom a variety of sources. For example, althoughthe FASB is responsible for issuing FASB State-ments of Financial Accounting Standards, Inter-pretations, and Technical Bulletins, the AmericanInstitute of Certified Public Accountants(AICPA) issues Statements of Position, Auditand Accounting Guides, and Practice Bulletins,and the FASB Emerging Issues Task Force (EITF)issues EITF Abstracts.

It may seem that accounting principles couldbe generally accepted because of popular vote orconsensus of opinion. However, generally ac-cepted accounting principles is a technical ac-counting phrase defined in Accounting Princi-

ples Board (APB) Statement No. 4, Basic Conceptsand Accounting Principles Underlying FinancialStatement of Business Enterprises, as ‘‘the conven-tions, rules, and procedures that define acceptedaccounting practice at a particular time.’’ GAAPincludes not only broad guidelines of generalapplication but also detailed practices and proce-dures that provide a standard by which to mea-sure financial presentations. For the most part, infinancial reporting, ‘‘generally accepted’’ implies‘‘substantial authoritative support.’’

THE GAAP HIERARCHY

Although there is no single reference source forGAAP, there is a hierarchy established by theAICPA in Statement on Auditing Standards No.69, The Meaning of ‘‘Present Fairly in ConformityWith Generally Accepted Accounting Principles’’ inthe Independent Auditor’s Report (SAS 69). At thefoundation of that hierarchy are the principlesestablished by the FASB and its predecessors, theAPB and the AICPA Committee on AccountingProcedure. From that foundation, the hierarchyformulates a ‘‘pecking order’’ for all the rules andprocedures that are incorporated in the prepara-tion of financial statements and that have cometo be known as GAAP.

The GAAP hierarchy includes four successivecategories (A-D), each of which establishes a dif-ferent level of authority. Generally speaking, ifthere is a conflict between accounting principlesrelevant to the circumstances from one or more

G

409

sources in Categories A, B, C, or D, the treatmentspecified by the source in the higher category isthen followed. In other words, Categories Athrough D of the hierarchy descend in authority.Therefore, Category A takes precedence over allothers, Category B takes precedence over Catego-ries C and D, and Category C takes precedenceover Category D. If a situation is not covered byguidelines in Categories A through D, other ac-counting literature should be considered. How-ever, that literature should be consulted onlywhen guidelines in higher categories are not ap-plicable.

Category A Category A consists of the follow-ing officially established accounting principles:(1) FASB Statements of Financial AccountingStandards, (2) FASB Interpretations, (3) APBOpinions, and (4) AICPA Accounting ResearchBulletins. All of those accounting principles areincluded in Volumes I and II of Original Pro-nouncements, which is updated annually andpublished by the FASB. In addition, FASB State-ments and Interpretations are available individu-ally from the FASB as published.

The accounting principles included in Cate-gory A are often referred to as ‘‘Rule 203pronouncements’’ because the bodies responsiblefor establishing those principles have been so des-ignated by the AICPA Council, pursuant to Rule203 of the AICPA Code of Professional Conduct.Specifically, from September 1939 to August1959 the AICPA committees on terminology andon accounting procedure were responsible forissuing fifty-one Accounting Research Bulletins(ARBs). In 1953, the first forty-two of those wererevised, restated, or withdrawn and now appearas ARB No. 43, Restatement and Revision of Ac-counting Research Bulletins. On September 1,1959, the AICPA committees were superseded bythe APB, which issued thirty-one Opinions untilit ceased operations in June 1973. At that time,the FASB took over the responsibilities of stan-dard setting from the APB and as of March 31,2000, had issued 137 Statements of Financial Ac-counting Standards and 44 Interpretations.

Category B Category B consists of (1) FASBTechnical Bulletins and, if cleared by the FASB,(2) AICPA Statements of Position and (3) AICPAIndustry Audit and Accounting Guides. Techni-cal Bulletins are available individually from theFASB as published and are also included collec-tively in Volume II of Original Pronouncements.Statements of Position and Audit and Account-ing Guides are available individually from theAICPA as published. In addition, Statements ofPosition are included collectively in AICPA Tech-nical Practice Aids.

FASB Technical Bulletins provide timelyguidance for applying Category A accountingprinciples and resolving accounting issues not di-rectly addressed in those principles. The follow-ing kinds of guidance may be provided in aTechnical Bulletin:5

● Guidance that clarifies, explains, or elaborateson an underlying standard.

● Guidance for a particular situation (usually aspecific industry) that differs from the generalapplication required by the standard in anARB, APB Opinion, or FASB Statement or In-terpretation. For example, the guidance in aBulletin may specify that the standard doesnot apply to enterprises in a particular indus-try or may provide for deferral of the effectivedate of a standard for that industry.

● Guidance that addresses areas not directlycovered by existing standards.

The AICPA’s Accounting Standards ExecutiveCommittee (AcSEC), which works closely withthe FASB and its staff, is the senior technicalcommittee of the AICPA authorized to set ac-counting standards and to speak for the AICPAon accounting matters. AcSEC’s standard-settingactivities are often industry-specific or narrow inscope, whereas the FASB’s activities result instandards that are more general and broader inscope. AcSEC issues AICPA Statements of Posi-tion, which present conclusions with respect toan emerging problem or diversity in practice. Inaddition, AcSEC issues AICPA Audit and Ac-counting Guides, which either interpret GAAP asapplicable to a specific industry or, in some cases,establish industry-specific GAAP. For example,

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES


Guides have been published for agricultural pro-ducers and cooperatives, airlines, casinos, con-struction contractors, and health care organiza-tions.

Category C Category C consists of (1) AcSECPractice Bulletins that have been cleared by theFASB and (2) consensus positions of the FASBEmerging Issues Task Force (EITF). AcSEC Prac-tice Bulletins are available individually from theAICPA as published and are also included collec-tively in AICPA Technical Practice Aids. Consen-sus positions of the EITF are available individu-ally from the FASB as published and are includedcollectively in EITF Abstracts, which is publishedby the FASB.

The EITF was established by the FASB in1984 to assist in the early identification of emerg-ing issues affecting financial reporting and ofproblems in implementing authoritative pro-nouncements. Each EITF Abstract summarizesthe accounting issue involved and the results ofthe EITF discussion, including any consensusreached on the issue. Each Abstract also reports,in its ‘‘status’’ section, subsequent developmentson that issue, such as issuance of a relevant Secu-rities and Exchange Commission Staff Account-ing Bulletin or an FASB Technical Bulletin. If theEITF can reach consensus on an issue, usuallythat is taken as an indication that no action isneeded by the FASB or AcSEC. Alternatively, ifno consensus is possible, it may be an indicationthat action by one of those bodies is necessary.

AcSEC Practice Bulletins are used to dissemi-nate AcSEC’s views for the purpose of providingpractitioners and preparers with guidance onnarrow financial accounting and reporting is-sues.6 The issues covered by Practice Bulletinsare limited to those that have not been and arenot being considered by the FASB. Therefore,AcSEC Practice Bulletins, which are reviewed bythe FASB, are only issued after the FASB has in-formed AcSEC that it has no current plans toconsider the issue.

Category D Category D includes (1) AICPAAccounting Interpretations, (2) FASB staff im-plementation guides, and (3) practices that are

widely recognized and prevalent either generallyor in an industry.

AICPA Accounting Interpretations (not tobe confused with FASB Interpretations, whichare included in Category A) were issued fromMarch 1971 through November 1973. The pur-pose of the interpretations was to provide timelyguidance for applying APB Opinions without theformal procedures required for an APB Opinion.In addition, they were used to clarify points onwhich past practice may have varied and beenconsidered generally accepted. The interpreta-tions, prepared by AICPA staff and reviewed bymembers of the accounting profession, are notconsidered to be official pronouncements of theAPB. Although most of the interpretations havebeen superseded by other accounting standards,Volume II of Original Pronouncements includesthose that continue in effect as well as referencepages for those that have been superseded.

Implementation guides, which appear in aquestion-and-answer format, are issued as aids tounderstanding and implementing various FASBStatements. Typically, those guides are issuedwhen an unusually high number of inquiries arereceived and the accounting required by a givenFASB Statement is particularly complex. Thepositions and opinions expressed in those guidesare those of the FASB staff and do not representofficial positions of the FASB. Staff implementa-tion guides are available individually from theFASB as published and also are included collec-tively in FASB Staff Implementation Guides.

OTHER ACCOUNTING LITERATURE

Occasionally new transactions or events forwhich there are no established accounting princi-ples must be reported. In those instances, it issometimes possible to identify an analogoustransaction or event for which there is an estab-lished principle and report the new transaction orevent similarly. In the absence of a pronounce-ment in one of the four categories above or ananalogous transaction or event, other accountingliterature should be considered. Examples ofother literature include: FASB Concepts State-ments; APB Statements; AICPA (AcSEC) Issues

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES


Papers; pronouncements of other accountingstandard-setting bodies, professional associa-tions, or regulatory agencies; technical informa-tion service inquiries; and accounting textbooks,handbooks, and articles.

SUMMARY

Generally accepted accounting principles are nota set of specific circumscribed standards that canbe easily found in one convenient set of rules.Rather, they are an amalgam arising from varioussources and with an established hierarchy. Gen-erally accepted accounting principles range fromofficial standards established by the FASB,through literature from the AICPA, to, in somesituations, articles. Yet the system seems to workreasonably well. Financial statements preparedpursuant to GAAP are highly regarded in theUnited States for the quality and comparability ofthe information they provide. Thus, investorsand other users have been well served by oursystem of financial reporting, which results in thefair presentation of financial information pre-pared in conformity with generally accepted ac-counting principles.

(SEE ALSO: Accounting; Financial Accounting Stan-dards Board; Government Financial Reporting)

BIBLIOGRAPHY

Financial Accounting Standards Board. (1999). AccountingStandards: Vol. I. General Standards; Topical Index; Vol.II: Industry Standards; Topical Index/Appendixes. NewYork: Wiley.

EDMUND L. JENKINSCHERI REITHER

GENERIC PRODUCTS(SEE: Product Labeling)

GLOBAL ECONOMY

The global economy refers to the increasing inte-gration of fragmented national markets for goodsand services into a single global market. In such a

market, companies may source from one coun-try, conduct research and development (R&D) inanother country, take orders in a third country,and sell wherever there exists demand regardlessof the customer’s nationality. Kenichi Ohmae(1989), a Japanese consultant, calls this theborderless world. While nobody would argue thatnational borders are completely irrelevant, cer-tain influences have caused the globe to becomesmaller and smaller. These include technologicaladvances in global communication and transpor-tation, the dilution of culture, a decrease in tariffand nontariff barriers, and a self-feeding changein the degree of global competition.

INTERNATIONAL TRADE

To comprehend the recent increase in globalmarkets, it is important to have some under-standing of the historical development of inter-national trade. While some form of internationaltrade existed prior to the colonial expansion ofEurope in the fifteenth and sixteenth centuries,mercantilism, or the trading of gold and silver forgoods, served as the precursor for the large flowsof goods, services, and information that currentlyexists. This philosophy of national power postu-lated that those countries with large amounts ofspecie could maintain the types of armies neces-sary to conquer other nations. The conquerednations then provided additional sources of reve-nues either through goods, slave labor, or goldand silver that could be used to support addi-tional armies, thereby creating a ‘‘virtuous’’ cycle.

From the demands of war, trade theory hasmoved through a number of stages. Adam Smith,the Scottish economist and philosopher, statedthat countries traded because they had anabsolute advantage. One nation’s workers couldproduce a given product more efficiently thanworkers in other countries. Rather than producethose products that it could produce but poorly,a country could specialize and exchange thoseproducts it produced efficiently for those pro-duced efficiently by another country and, there-fore, increase its overall wealth.

David Ricardo altered this theory to suggestthat a country need only have a comparative ad-

GENERIC PRODUCTS


vantage in order to specialize and trade to in-crease wealth. A country having an absolute ad-vantage in two goods might find that it wouldstill rather specialize in that good for which it hadrelatively greater production expertise. It couldthen trade its excess for a greater quantity of thesecond good than it could have obtained had itsplit its production between the two goods.

These theories of trade were followed byHecksher and Ohlin’s theory of factor proportions(1933), which suggested that countries will spe-cialize in the production and trade of either capi-tal-intensive products or labor-intensive prod-ucts, depending on whether their comparativeadvantage lies in capital or labor. Other theoriesof trade include Vernon’s product cycle theory,which suggests that a country’s comparative ad-vantage in products changes over time as thetechnology to produce that product changes, andPorter’s writings on the competitive advantage ofnations, according to which a nation’s competi-tive industries depend on domestic rivalry, de-mand conditions, factor conditions, and thestrength of related and supporting industries.

CAUSES OF INCREASING GLOBALIZATION

During the time that different trade theories haverisen and fallen, the world has become a smallerplace. One of the primary facilitators of the globalmarketplace is the technological advance of thetelecommunications industry.

In the days of Adam Smith, if a merchantwanted to trade a lot of wool for a case of portwine, the communication of that intent wouldrequire weeks. Sending a message to a subordi-nate in India took months. Such circumstanceslent themselves to fragmented individualizedmarkets with subsidiaries run by family membersor close friends. These in-country managers weretrusted to make decisions in the best interest ofthe company because no rapid means of commu-nicating new opportunities and information ex-isted. The opportunity to closely coordinate theactivities of several foreign operations simply didnot exist.

Today, communication between most partsof the world is instantaneous. A manager in Bonn

can telephone a manager in Rio de Janeiro todiscuss the latest news regarding the orange crop.If the Brazilian manager wants to send somecontracts to the German manager, it can be doneby fax; if the data demands are larger, the infor-mation can be transferred via the Internet.Should the Brazilian manager then need to travelto the middle of the Amazon rainforest to checkup on the supply of a certain healing plant, thatinformation can also be passed on to Germanythrough a sophisticated cellular phone.

These new capabilities allow vast amounts ofbusiness data to be transferred almost instanta-neously all over the world and at ever-decreasingcosts. The cost of a three-minute phone call be-tween London and New York fell from $13.73 in1973 to $1.78 in 1993.

These gains in communication technologyclosely parallel those in the transportation indus-try. P. Dicken (1992) indicates that between 1500and 1840 the best average speed of horse-drawncoaches and sailing ships was about ten miles perhour. Between 1850 and 1930, steam became adominant technology, with trains averagingsixty-five miles per hour and ships increasingtheir speed to thirty-six miles per hour. In the1950s, propeller aircraft achieved speeds of threehundred to four hundred miles per hour. Thesespeeds later increased to over six hundred milesper hour with the advent of the jet-engine tech-nology. Again, what this means is that an execu-tive who used to spend several weeks travelingfrom Lisbon to Rio de Janeiro to visit a factorycould visit factories all over the world in thatsame amount of time.

These advances have greatly increased thepotential for flows of goods and individualsacross national borders. Further advances in-clude such things as standardized shipping con-tainers, which can be easily transferred from seacarriers to land carriers and can be packed withgreater efficiency. In addition, the vast size ofmodern supertankers has greatly increased theamount of goods that can be shipped at one time.

In addition to advances in transportationand communication, some scholars, such as The-odore Levitt (1983), have argued that the world

GLOBAL ECONOMY


has become a smaller place in terms of tastes andpreferences. The tastes of teenagers around theworld may be as much informed by Hollywoodmovies and MTV as they are by cultural heritage.Levitt argues that such convergence of prefer-ences is not limited to any one age group, sinceadults worldwide enjoy Chinese food, countrymusic, pizza, and pita bread. While some conver-gence has certainly taken place, scholars such asSusan P. Douglas and Yoram Wind (1987) arguethat this cross-border similarity of tastes andpreferences is limited to certain countries andproduct lines.

While the extent of convergence is certainlyarguable, it is clear that at least in some countriesand with some product lines, the tastes and pref-erences of consumers seem quite similar. Thisreality encourages a global-market approach tobusiness as companies attempt to reach the larg-est number of consumers at the lowest price pos-sible.

Another factor leading to a more globalizedmarketplace is the historical decrease in tariff andnontariff barriers. In 1930 the United Statesraised tariffs under the Smoot-Hawley Tariff Actto an average of 53 percent. Other countries fol-lowed suit, and international trade slowed signifi-cantly. In 1947 several leading trading nationscreated the General Agreement on Tariffs andTrade (GATT) to serve as a forum for bringingdown trade barriers. Between 1947 and 1994,trading countries around the world have partici-pated in eight rounds of negotiating in an effortto reduce tariffs. The latest round, entitled theUruguay round, boasted 117 participants and re-sulted in an average tariff reduction of 35 per-cent. As tariff barriers fell, the inducement totrade was increased as foreign-produced goodsbecame more and more competitive with domes-tic goods.

In addition to the GATT agreements, severalcountries have participated in regional agree-ments encouraging even lower tariff rates amongparticipants. An example of such an agreement isthe North American Free Trade Agreement(NAFTA) implemented by Canada, Mexico, andthe United States in 1994. This agreement re-

duced tariffs over a fifteen-year period, liftedmany investment restrictions, allowed for easiermovement of white-collar workers, opened upgovernment procurement over a ten-year period,and created a mechanism for dispute resolution.As a result, retailers such as Wal-Mart and7-Eleven have expanded operations into Mexico,and many Mexican and Canadian firms havebeen enjoying the benefits of participating in theworld’s largest consumer market, the UnitedStates. In the first two years of NAFTA’s imple-mentation, trade among Canada, the UnitedStates, and Mexico increased by 43 percent.

In addition to NAFTA, numerous other suchagreements exist, including the European Union,the Carribean Community and Common Market(CARICOM), the Economic Community ofWestAfrican States (ECOWAS), the Association ofSoutheast Asian Nations (ASEAN), and the An-dean Common Market (ANCOM). Each of theseagreements seeks to promote trade through min-imizing the barriers to trade that exist in theregion.

Closely related to the liberalization of trade,technological advantages, and the convergence ofconsumer preferences are a set of competitivefactors centered around the ideas of economies ofscale (larger production volumes generatinglower per-unit production costs) and locationaladvantages. Marquise R. Cvar (1986) cites the ex-ample of Becton Dickinson, which in the 1980swas faced with new technologies in disposablesyringe production that could dramatically de-crease the cost of these medical devices. Unfortu-nately, the investment needed in technology wasso high that, to be efficient, the company wouldhave to capture 60 percent of the U.S. and Japa-nese markets. Further, it was believed that bydoubling volume, cost would decrease by 20 per-cent. Becton Dickinson responded by creatingstandardized syringes for markets in the UnitedStates, Europe, Mexico, Brazil, Australia, thePhilippines, Singapore, and Hong Kong. In sodoing, they were able to reduce the cost of theirproduct to 5 to 10 percent below those of localcompetitors while simultaneously providing gen-erally higher quality. These savings led to an

GLOBAL ECONOMY


average market share of 45 percent in thosecountries.

Further, this standardization approach alsoallowed Becton Dickinson to shift productionamong various plants located in the UnitedStates, Ireland, Spain, Mexico, and Brazil. Asexchanges rates fluctuated, the company was ableto increase production at more cost-effectiveplants while decreasing it elsewhere, resulting ineven greater savings. Further, companies in suchsituations may use profits in one country to sub-sidize their competitive activities in another.While anti-dumping laws prohibit selling ex-ported goods at a price below their cost of pro-duction or at a price lower than the price in thehome market, companies will sometimes seek toattack a competitor in a foreign market by engag-ing in dumping-like pricing in an attempt towrest market share. If the firm under attack hasoperations in the foreign firm’s home market, itcan respond in kind. A purely domestic firm doesnot have such options.

In response to the competitive advantage en-joyed by global companies such as Becton Dick-inson, local firms often respond by becomingmore global themselves. This cycle has created amore worldwide competitive market for a largenumber of products and services.

CONCLUSION

Changes in communications and transportationtechnology, convergence of consumer tastes andpreferences, trade liberalization, and the emer-gence of global competitors have all combined tocreate a much more integrated world economy.Companies like Becton Dickinson, Unilever, andSamsung profit from larger numbers of con-sumers and cheaper factors of production, whileconsumers may experience lower prices andhigher quality. Of course, some might argue thatthe benefits of the global marketplace come at aprice. Membership in trade organizations such asthe World Trade Organization (WTO) may limita country’s ability to create laws regarding theconduct of business within its borders since eachlaw must pass the scrutiny of the WTO. In addi-tion, the interrelatedness of markets may cause a

negative domino effect within a region, as hap-pened with the Asian crisis of the 1990s. Despitethese and other concerns, however, the globalmarketplace seems likely to continue its expan-sion as new technological advances continue toshrink the importance of geographic distance.

BIBLIOGRAPHY

Adonis, A. (1994). ‘‘Lines Open for the Global Village.’’Financial Times September 17: 8.

Cvar, Marquise R. (1986). ‘‘Case Studies in Global Competi-tion: Patterns of Success and Failure.’’ In Competition inGlobal Industries, edited by Michael E. Porter. Boston:Harvard Business School Press, pp. 483-516.

Czinkota, Michael R., Ronkainen, Ilkka A., and Moffett,Michael H. (1999). International Business, 5th ed. FortWorth, TX: Dryden Press.

Daniels, John D., and Radebaugh, Lee H. (1998).International Business: Environments and Operations, 8thed. Reading, MA: Addison Wesley.

Dicken, P. (1992). Global Shift. New York: Guilford.

Douglas, Susan P., and Wind, Yoram. (1987). ‘‘The Myth ofGlobalization.’’ Columbia Journal of World Business Win-ter: 19-29.

Grubel, H. (1981). International Economics. Homewood, IL:Irwin, 1981.

Hill, Charles W. L. (1998). Global Business Today. Boston:Irwin.

Levitt, Theodore. (1983). ‘‘The Globalization of Markets.’’Harvard Business Review May-June: 91-102.

Ohlin, B. (1933). International Trade. Cambridge, MA: Har-vard University Press.

Ohmae, Kenichi. (1989). ‘‘Managing in a BorderlessWorld.’’ Harvard Business Review, May/June: 152-161.

NORMAN S. WRIGHT

GROSS NATIONALPRODUCT (GNP)

(SEE: Gross Domestic Product)

GOALS AND OBJECTIVES

(SEE: Strategic Management)

GOALS AND OBJECTIVES


GOODS AND SERVICES

Goods and services are the outputs offered bybusinesses to satisfy the demands of consumerand industrial markets. They are differentiatedon the basis of four characteristics:

1. Tangibility: Goods are tangible productssuch as cars, clothing, and machinery.They have shape and can be seen andtouched. Services are intangible. Hairstyling, pest control, and equipment re-pair, for example, do not have a physicalpresence.

2. Perishability: All goods have some degreeof durability beyond the time of pur-chase. Services do not; they perish as theyare delivered.

3. Separability: Goods can be stored for lateruse. Thus, production and consumptionare typically separate. Because the pro-duction and consumption of services aresimultaneous, services and the serviceprovider cannot be separated.

4. Standardization: The quality of goods canbe controlled through standardization andgrading in the production process. Thequality of services, however, is differenteach time they are delivered.

For the purpose of developing marketingstrategies, particularly product planning and pro-motion, goods and services are categorized in twoways. One is to designate their position on agoods and services continuum. The second is toplace them into a classification system.

The goods and services continuum enablesmarketers to see the relative goods/services com-position of total products. A product’s positionon the continuum, in turn, enables marketers tospot opportunities. At the pure goods end of thecontinuum, goods that have no related servicesare positioned. At the pure services end are ser-vices that are not associated with physical prod-ucts. Products that are a combination of goodsand services fall between the two ends. For exam-ple, goods such as furnaces, which require ac-companying services such as delivery and instal-

lation, are situated toward the pure goods end.Products that involve the sale of both goods andservices, such as auto repair, are near the center.And products that are primarily services but relyon physical equipment, such as taxis, are locatedtoward the pure services end.

The second approach to categorizing prod-ucts is to classify them on the basis of their uses.This organization facilitates the identification ofprospective users and the design of strategies toreach them. The major distinction in this systemis between consumer and industrial products.Consumer goods and services are those that arepurchased for personal, family, or household use.Industrial goods and services are products thatcompanies buy to make the products they sell.

Two major changes have affected the market-ing and production of goods and services sinceabout 1950. The first was a shift in marketingphilosophy from the belief that consumers couldbe convinced to buy whatever was produced tothe marketing concept, in which consumerexpectations became the driving force in deter-mining what was to be produced and marketed.This change in orientation has resulted in in-creases in both lines of products and choiceswithin the lines.

The second change was an increased demandfor services. The growth in demand for ser-vices—and resulting production—continues toincrease at a faster rate than the demand formanufactured goods.

BIBLIOGRAPHY

Bearden, William O., Ingram, Thomas N., and LaForge,Raymond W. (1995). Marketing, Principles and Perspec-tives. Chicago: Irwin.

Evans, Joel R., and Berman, Barry. (1997). Marketing, 7thed. Upper Saddle River, NJ: Prentice-Hall.

Jackson, Ralph W., Neidell, Lester A., and Lunsford, Dale.(1995). ‘‘An Empirical Investigation of the Differences inGoods and Services as Perceived by Organizational Buy-ers.’’ Industrial Marketing Management March: 99-108.

EARL C. MEYER

MATTHEW F. HAZZARD

GOODS AND SERVICES



Government accounting has been viewed histori-cally as a key element in the movement fromabsolute power, (i.e., the government or a king oremperor) to relative power (i.e., a shared model ofgovernment). Under the shared model of govern-ment, government accounting was used by a par-liament to limit the king’s power to (1) spendpublic money, (2) raise taxes to cover the expen-ditures, and (3) determine the purpose of theexpenditure. The use of governmental account-ing remained unchanged during the evolutioninto modern democratic systems.

Thus government accounting requires theexecutive to (1) state the amount, nature, andpurpose of the planned expenditure and the taxesneeded to fund it, (2) ask for and obtain approvalfrom the legislature, and (3) comply with theexpenditure authority—that is, appropriation—granted by the legislature and demonstrate suchcompliance. Under government accounting, thelegislature is allowed to steer and control thebehavior of the government.

The basic foundation of governmental finan-cial accounting and reporting in the UnitedStates was established by the Governmental Ac-counting Standards Boards (GASB) in its ‘‘Ob-jectives of Financial Reporting,’’ which statedthat the purpose of financial reporting is to pro-vide information to facilitate decision making byvarious groups (GASB, 1987). The groups weredefined as (1) citizens of the governmental entity,(2) direct representatives of the citizens, such aslegislatures and oversight bodies, and (3) inves-tors, creditors, and others who are involved in thelending process. Although not specifically identi-fied, intergovernmental agencies and other usershave informational needs similar to the three pri-mary user groups. While the three user groupshave overlapping membership with corporate fi-nancial information users, citizens and legislativeusers are unique to governments. The use ofgovernmental accounting information centers onpolitical, social, and economic decisions in addi-tion to determining the government’s account-ability.

Accountability (GASB, 1987, 56-58) wasidentified as the paramount objective of govern-mental financial reporting because it is based onthe transfer of responsibility for resources or ac-tions from the citizens to some other party, suchas the management of the governmental entity.The assessment of accountability is fulfilled whenfinancial reporting enables financial data users todetermine to what extent current-period costsare financed by current-period revenues. Twobasic types of budgets are used by governmentsand are the same as those used by corporateentities—an annual operating budget and a capi-tal budget. Governmental annual operating bud-gets include estimated revenues and appro-priations for expenditure for a specific fiscal year.Capital budgets control the expenditures for con-struction projects and fixed asset acquisitions.Operating or capital budgets are recorded in theaccounting system as a means of control or com-pliance.

Many governmental entities are required bylaw to maintain a balanced budget in that reve-nues must equal or exceed appropriations; thelatter situation results in a budgetary surplus. If abudgetary deficit occurs in a governmental entitywith a balanced-budget requirement, additionalappropriations must be enacted by the legislativeprocess.

Governmental accounting uses a fund ac-counting structure as a means of controlling re-sources. That is, each type of financial activity issegregated into a separate set of self-balancingasset, liability, and net asset accounts. GASB cod-ification identifies three fund groups—governmental, proprietary, and fiduciary (GASB,1997, Sections 1100.103 and 1100.105). Govern-mental funds are used to account for financialresources used in the day-to-day operations ofthe government. Proprietary funds are those usedto account for the government’s business-typeactivities where fees are charged for the servicesrendered, for example, utility services. Fiduciaryfunds are those used to account for funds held bythe government in trust for others that cannot beused to support the government’s programs, forexample, an employee pension fund.



State and local governments report dual-per-spective financial information with both fullaccrual information and fund-based modifiedaccrual information in accordance with GASBStandard No. 34, Basic Financial Statements—and Management Discussion and Analysis—forStatement and Local Governments (GASB, 1999).

The management’s discussion and analysis(MD&A) is required supplementary informationpresented before the financial statements that issubjected to limited auditor review and presentsan overview of the government’s financial activi-ties for the part year. This narrative description ofthe financial performance is much like the man-agement discussion required of corporations bythe Securities and Exchange Commission (SEC).The MD&A provides an objective and easilyreadable analysis of the government’s financialactivities based on currently known facts, deci-sions, or conditions. The discussion comparesthe government’s current-year results with theprevious year and may include charts, graphs, ortables to illustrate the discussion. The discussionis general rather than specific so that the mostrelevant information is provided. At a minimum,fourteen prescribed elements are a part of theMD&A discussion; these elements explain therelationship among the financial statements andany significant differences in the informationprovided in the financial statement.

The full accrual information reports the fullcost of providing government services, with de-tails on how much of the cost is borne by tax-payers and by specific users of the government’sservice. The full accrual reports are similar tothose of profit-seeking corporations. The govern-ment’s equity is displayed as net assets ratherthan stockholders’ equity. The full accrual resultsof the government’s financial activity are dis-played in two government-wide reports—(1) thestatement of net assets and (2) the statement ofactivities.

The statement of net assets displays informa-tion about the government as a whole, reports allfinancial and capital resources, and assists thefinancial statement user in assessing the medium-and long-term operational accountability of the

government. Separate columns are used to dis-tinguish between the financial data for the gov-ernmental activities and the business-type activi-ties that comprise the total primary government.As the term statement of net assets implies, thestatement format presents the assets minus liabil-ities that equal the total net assets, that is, equity.Assets and liabilities are presented in their orderof liquidity. That is, assets are presented in theorder to their nearness to producing cash, andliabilities are presented in the order to theirnearness to consuming cash. Assets and liabilitiesmay be displayed in a classified, current, andnoncurrent format if desired. The government’snet assets are presented in three components: (1)capital assets net of related accumulated depreci-ation and debt, (2) restricted net assets with con-straints imposed on their use by parties outsidethe government, and (3) unrestricted net assets.

The statement of activities reports the netexpense over revenue of each individual functionor program operated by the government. The netexpense over revenue format reports the relativefinancial burden of each of the programs on thegovernment’s resource provides—taxpayers. Theformat highlights the extent to which each pro-gram directly consumes the government’s reve-nues or is financed by fees, contributions, orother revenues.

In addition to the governmentwide fullaccrual information, state and local governmentspresent financial statements on the fund-basedmodified accrual basis. In the modified accrualbasis of accounting, revenues are recognized onlywhen they become both measurable and availableto finance expenditures for the fiscal period. Ex-penditures are recognized when the related liabil-ities are incurred, if measurable, except forunmatured interest on long-term debt, which isrecognized when legally due.

Fund-based financial statements assist in as-sessing the government’s short-term fiscal ac-countability. Most funds are established by gov-ernments to show restrictions on the planned useof resources or to measure, in the short-term, therevenues and expenditures of a particular activ-ity. Fund activity displayed in the fund-based fi-



nancial statements is grouped by governmental,proprietary, and fiduciary categories as identifiedby the GASB codification. The equity componentof modified accrual fund-based financial state-ments is reported as fund balance rather than netassets, which is used in the full accrual statement.

A balance sheet and a statement of revenues,expenditures, and change in fund balance arerequired for each of the three fund groups. Be-cause the fund financial statements are preparedusing the modified accrual basis, a required rec-onciliation is prepared that explains the differ-ences between the net change in fund balancesand the change in net assets in the govern-mentwide statement of activities. The proprietaryfunds also present a statement of cash flows.Unlike corporate cash flow statements, the gov-ernmental cash flow statement is prepared usingthe direct method and has four categories—operating, noncapital financing, capital financ-ing, and investing activities.

Although some similarities exist between ac-counting for state and local governments andaccounting for the federal government, there areselected areas specific to each. For example, fed-eral agencies account for quarterly apportion-ments to procure goods and services, a processthat is generally ignored by state and local gov-ernments. The head of each agency in the execu-tive branch of the federal government has theresponsibility for establishing and maintainingaccounting and control systems in conformitywith principles, standards, and requirements es-tablished by the Federal Accounting StandardsAdvisory Board and the Federal Financial Man-agement Improvement Act of 1996.

Federal accounting provides the informationneeded for financial management as well as theinformation needed to demonstrate compliancewith budgetary and other legal requirements.Thus, federal accounting is based on a two-tracksystem. One track is a self-balancing set of pro-prietary accounts intended to provide informa-tion for management. The other track is a set ofself-balancing budgetary accounts that assurethat available budgetary resources and authori-

ties are not overexpended or overobligated andassist in budgetary reporting requirements.

Like its state and local government counter-part, the federal financial statements include anMD&A that provides a clear and concise descrip-tion of the reporting entity and its mission, activ-ities, program and financial results, and financialcondition (OMB, 1996). Federal financial state-ments are less prescriptive than state and localfinancial statements because federal agencies arepermitted significant latitude on the level of ag-gregation presented. The six statements in thefederal financial report include a (1) balancesheet, (2) statement of net cost, (3) statement ofchanges in net position, (4) statement of budget-ary resources, (5) statement of financing, and (6)statement of custodial activity.

(SEE ALSO: Government Accounting Standards Board;Government Financial Reporting)

BIBLIOGRAPHY

Federal Financial Management Improvement Act. (1996).Public Law 104-208.

Governmental Accounting Standards Board (GASB).(1987). Objectives of Financial Reporting. (Concept State-ment No. 1). Norwalk, CT:

Governmental Accounting Standards Board (GASB).(1997). Codification of Government Accounting and Fi-nancial Reporting Standards. Norwalk, CT.

Governmental Accounting Standards Board (GASB).(1999). Basic Financial Statements—and Management’sDiscussion and Analysis—for State and Local Govern-ments (Statement of Governmental Accounting StandardNo. 34). Norwalk, CT.

Office of Management and Budget (OMB). (1996). Bulletin97-1, Form and Content of Agency Financial Statements.U.S. Government, Washington. DC.

MARY L. FISCHER

GOVERNMENTALACCOUNTINGSTANDARDS BOARD

The Governmental Accounting Standards Board(GASB) was organized in 1984 under the aus-pices of the Financial Accounting Foundation to

GOVERNMENTAL ACCOUNTING STANDARDS BOARD


establish financial accounting and reporting stan-dards for state and local government entities.These standards are important because externalfinancial reporting can demonstrate financial ac-countability to the public. They are the basis formany legislative and regulatory decisions, as wellas investment and credit policies. The foundationis responsible for selecting the seven members ofGASB and its Advisory Council, funding theiractivities, and exercising general oversight. Ex-cept for the chairman of GASB, all members arepart time.

GASB’s mission is to establish and improvestandards of state and local governmental ac-counting and financial reporting that will (1)result in useful information for users of financialreports and (2) guide and educate the public,including issuers, auditors, and users of thosefinancial reports. To accomplish its mission,GASB acts to:

1. Issue standards that improve the useful-ness of financial reports based on (a) theneeds of financial report users, (b) theprimary characteristics of under-standability, relevance, and reliability, and(c) the qualities of comparability andconsistency.

2. Keep standards current to reflect changesin the governmental environment.

3. Provide guidance on implementation ofstandards.

4. Consider significant areas of accountingand financial reporting that can be im-proved through the standard-setting pro-cess.

5. Improve the common understanding ofthe nature and purposes of informationcontained in financial reports.

GASB formulates and uses concepts to guidethem in the development of their standards.These concepts provide a frame of reference forresolving accounting and financial reporting is-sues. This framework helps to establish reason-able bounds for judgment in preparing and usingfinancial reports; it also helps the public under-

stand the nature and limitations of financial re-porting. GASB actively solicits and considers theviews of its various constituencies on all account-ing and financial reporting issues. GASB’s activi-ties are open to public participation and observa-tion under ‘‘due process’’ procedures. Theseprocedures are designed to permit timely, thor-ough, and open study of accounting and financialreporting issues. Consequently, broad public par-ticipation is encouraged in the accounting stan-dard-setting process, which permits communica-tion of all points of view and expressions ofopinion at all stages of the process. Use of theseprocedures recognizes that general acceptance ofthe GASB conclusions is enhanced by demon-strating that the comments received during dueprocess are considered carefully.

GUIDING PRINCIPLES

In establishing concepts and standards, the GASBexercises its judgment after research, due process,and careful deliberation. Some of the principlesused by GASB are as follows:

1. One of GASB’s overriding principles isthat it be objective and neutral in its deci-sion making. This principle ensures, asmuch as possible, that the informationresulting from its standards is a faithfulrepresentation of the effects of state andlocal government activities. Objective andneutral means freedom from bias,precluding GASB from placing any par-ticular interest above the interests of themany who rely on the information con-tained in financial reports.

2. Another primary principle is to weighcarefully the views of its constituents in de-veloping concepts and standards. This per-mits GASB to (a) meet the accountabilityand decision-making needs of the usersof government financial reports and (b)gain general acceptance among state andlocal government preparers and auditorsof financial reports.

3. A third principle is to establish standardsonly when the expected benefits exceed the



perceived costs. GASB strives to determinethat proposed standards (including dis-closure requirements) fill a significantneed and that the costs they impose,compared with possible alternatives, arejustified when compared to the overallpublic benefit.

4. A fourth principle is to consider the appli-cability of its standards to the separatelyissued general-purpose financial state-ments of governmentally owned specialentities. GASB specifically evaluates simi-larities of special entities and of their ac-tivities and transactions in both the pub-lic and private sectors, and the need, incertain instances, for comparability withthe private sector.

5. A fifth principle is to bring about neededchanges in ways that minimize disruptionof the accounting and financial reportingprocesses. Reasonable effective dates andtransition provisions are established whennew standards are introduced. GASB con-siders it desirable that change should beevolutionary to the extent that can be ac-commodated by the need for under-standability, relevance, reliability, compa-rability, and consistency.

6. A final principle is to review the effects ofpast decisions for appropriateness. Thispermits continual interpretation, amend-ment, or replacement of standards, whendeemed necessary.

PUBLICATIONS

As of December 31, 1998, more than thirty finan-cial accounting and reporting standards had beenissued since GASB’s inception. A standard per-taining to a new financial reporting model forstate and local governments has been exposedand is expected to be issued in 1999 with aneffective date in 2001. Copies of these standards,along with other GASB publications, can be ob-tained from the GASB offices at 401 Merritt 7,P.O. Box 5116, Norwalk, Connecticut 06856-5116. Their phone number is (203) 847-0700 and

their Web site is http://www.asb.org. GASB’sWeb site is a subpart of the FASB (FinancialAccounting Standards Board) Web site.

OTHER FINANCIAL ACCOUNTING ANDREPORTING STANDARD-SETTING BODIES

Additional standard-setting bodies for the publicsector are as follows:

1. The Federal Accounting Standards AdvisoryBoard (FASAB) was established in 1990by the following three U.S. governmentprincipals: the Comptroller General, theDirector of the Office of Managementand Budget, and the Treasurer. FASAB’sprimary function is to make recommen-dations to the principals for financial ac-counting and reporting standards to beadopted for the U.S. federal government.More information is available fromFASAB at 441 G Street NW, Suite 3B18,Washington, D.C. 20548; (202) 512-7350;or http://www.financenet.gov/fasab.htm.

2. The Public Sector Committee of the In-ternational Federation of Accountants(IFAC-PSC) assumed responsibility in1998 for developing a set of financial re-porting standards to be adopted world-wide by public sector entities. More in-formation is available from IFAC-PSC at535 Fifth Ave., 26th floor, New York, NY;(212) 286-9344; or http://www.ifac.org/Committees/PublicSector/index.html.

Standard-setting bodies for the private sectorare as follows:

1. The Financial Accounting Standards Board(FASB) also falls under the auspices ofthe Financial Accounting Foundation. Itsresponsibilities are to set the financial ac-counting and reporting standards to beapplied by U.S. businesses. FASB is co-lo-cated with GASB in Connecticut andtheir Website is http://www.fasb.org.

2. Financial accounting and reporting stan-dards recommended for use by businessesthroughout the world are established by



the International Accounting StandardsCommittee (IASC). More information isavailable from IASC at 166 Fleet St., Lon-don EC4A 2DY, United Kingdom; �44(171) 353-0565; or http://www.iasc.org.uk.

BIBLIOGRAPHY

Codification of Governmental Accounting and Financial Re-porting Standards as of June 30, 1998. (1998). Norwalk,CT: Governmental Accounting Standards Board.

Freeman, Robert J., and Shoulders, Craig D. (1996).Governmental and Nonprofit Accounting: Theory andPractice. New Jersey: Prentice-Hall.

Wilson, Earl R., Hay, Leon E., and Kattelus, Susan C. (1999).Accounting for Governmental and Nonprofit Entities. NewYork: Irwin/McGraw-Hill.

JESSE W. HUGHES

GOVERNMENT AUDITINGSTANDARDS

Generally accepted government auditing stan-dards (GAGAS)—informally known as the Yel-low Book—are promulgated under the leader-ship of the comptroller general of the UnitedStates, who heads the U.S. General AccountingOffice. The responsibility includes both establish-ing and revising these standards. The staff of thecomptroller general’s office is aided by the Advi-sory Council on Government Auditing Stan-dards, whose members come from units of thefederal and state governments, representatives ofpublic accounting firms, and professors of ac-counting.

The first set of standards was issued in 1972;the second in 1988; the third in 1994. As of mid-2000, a review of the 1994 edition continues. Theguidance in the 1994 edition continues to be ineffect, except for changes contained in amend-ments. Two amendments have been issued as ofearly 2000. The amendments become effectiveonce they are completed. All changes to the Yel-low Book are initially presented in exposure draftso that interested parties can comment; thesecomments are considered in determining the ad-equacy of any change being proposed.

THE AUTHORITY OF GOVERNMENTAUDITING STANDARDS

The Yellow Book includes standards to guide allaudits of governmental units, irrespective of thelevel of the unit. The standards are consideredbroad statements of auditors’ responsibilities.The Introduction to the Yellow Book states itspurpose as providing ‘‘standards for audits ofgovernment organizations, programs, activities,and functions, and of government assistance re-ceived by contractors, nonprofit organizations,and other nongovernment organizations’’(Comptroller General of the United States,1994).

Federal legislation established the require-ment that all inspectors general comply with theGAGAS. Furthermore, inspectors general are re-sponsible for assuring that nonfederal auditorsalso comply with these standards when they auditfederal organizations, programs, activities, andfunctions. The Office of Management and Bud-get as well as the requirements of the Chief Fi-nancial Officers Act of 1990, the Single Audit Actof 1984, and other federal policies and regula-tions require the use of these standards in auditswhere federal funds are involved. The standardsare recommended for use by state and local gov-ernment auditors and public accountants in au-dits of state and local government organizations,programs, activities, and functions even thoughfederal funds are not involved in some instances.A number of states and local audit organizationshave officially adopted these standards.

THE NATURE OF AUDITS PERFORMED

GAGAS are provided for both financial and per-formance audits. The comprehensive guidanceapplies to the following:

● Financial statement audits. The statements in-cluded are the statement of financial position,results of operations, and cash flows, all ofwhich are in conformity with generally ac-cepted accounting principles. Financial state-ments audits also include audits of financialstatements prepared in conformity with severalother bases of accounting as established byauditing standards and related statements is-

GOVERNMENT AUDITING STANDARDS


sued by the Auditing Standards Board of theAmerican Institute of Certified Public Ac-countants.

● Financial related audits. Among such auditsare those (1) involving financial informationpresented in accordance with established orstated criteria, (2) related to specific financialcompliance requirements, (3) related to an en-tity’s internal control over financial reportingand/or safeguarding of assets, and (4) involv-ing compliance with laws and regulations andallegations of fraud. Also included are seg-ments of financial statements, statement ofrevenue and expenses, statement of fixed as-sets, budget requests, and variances betweenestimated and actual financial performance.

● Performance audits. Such audits include sys-tematic examination of relevant evidence toprovide an independent assessment of the per-formance of a government organization, pro-gram, activity, or function. Also, economy andefficiency and program audits are includedamong performance audits. Such economyand efficiency audits may, for example, deter-mine whether the entity is following soundprocurement practices; is acquiring appropri-ate types of resources; is properly protectingand maintaining resources; is avoiding dupli-cation of effort by employees; is avoiding idle-ness and overstaffing; is using efficient operat-ing procedures; is using optimum amounts ofresources; is complying with requirements oflaws and regulations that could effect acquisi-tion, protection, and use of resources; has anadequate management control system; and hasreported measures of economy and efficiencythat are reliable and valid. Program audits, forexample, may assess whether the objectives ofa program are proper, suitable, or relevant;and determine the extent to which a programis achieving its goals; identify factors inhibit-ing satisfactory performance; identify ways ofmaking programs work better; and determinewhether management has reported measuresof program effectiveness that are valid and re-liable.

Government audits may be a combination offinancial and performance audit, as, for example,when auditors conduct audits of governmentcontracts and grants with private-sector organi-

zations as well as government and not-for-profitorganizations where both financial and perform-ance objectives must be audited.

GOVERNMENT AUDITING STANDARDS FORFINANCIAL AUDITS

Standards are classified as general, field, and re-porting. The GAGAS incorporate the generallyaccepted auditing standards as promulgated bythe Auditing Standards Board of the AmericanInstitute of Certified Public Accountants. How-ever, there are some additional standards thatrelate to the accountability of government unitsfor compliance with laws and regulations. Thereare also more extensive reporting requirementsrelated to such accountability.

General standards relate to qualifications ofstaff assigned to conduct an audit, to the need forthe audit entity to be organizationally indepen-dent and the individual auditors to maintain in-dependent in attitude and in appearance and toexercise due professional care in the work relatedto an audit, and to the need for the audit organi-zation to have an appropriate internal qualitycontrol system that is externally reviewed at leastevery three years.

Field standards incorporate the three fieldstandards as established by the Auditing Stan-dards Board, which relate to planning, under-standing internal control, and obtaining suffi-cient evidential matter. Additional standardsrelate to following up on known material find-ings and recommendations from previous audits;to designing the audit to provide reasonable as-surance of detecting material misstatements re-lated to irregularities and/or direct and materialillegal acts; and to detecting noncompliance withprovisions of contracts or grant agreements thathave a direct and material effect on the financialstatements. There is also a field standard relatedto the need to prepare adequate working papers.

Reporting standards incorporate the four re-porting statements of the Auditing StandardsBoard. Additionally, there are standards that dealwith communication with audit committee; dis-closure of the fact that the audit was performedin accordance with generally accepted govern-



ment auditing standards; and disclosures relatedto compliance with laws and regulations regard-ing on internal control, privileged and confiden-tial information, and report distribution.

GOVERNMENT AUDITING STANDARDS FORPERFORMANCE AUDITS

The general standards are the same for financialand performance audits as discussed earlier. Fieldand reporting standards for performance auditsoverlap to some extent with those for financialaudits.

Field standards are related to (1) planning;(2) supervision; (3) design of the audit whenlaws, regulations, and other compliance require-ments are significant to the audit objective; (4)understanding of management controls whenrelevant to the audit; and (5) sufficient, compe-tent, relevant evidence.

Reporting standards are related to (1) prepa-ration of written reports that communicate re-sults; (2) appropriate issuance; (3) reportingaudit objectives as well as scope and methodol-ogy; (4) the need for a complete, accurate, objec-tive, convincing, and clear and concise report;and (5) report distribution.

AMENDMENTS TO GOVERNMENTAUDITING STANDARDS

As of mid-2000 there were two amendments tothe Yellow Book. Amendment No. 1, ‘‘Docu-mentation Requirements When Assessing Con-trol Risk at Maximum for Controls SignificantlyDependent upon Computerized InformationSystems,’’ and Amendment No. 2, ‘‘AuditorCommunications.’’

Amendment No. 1 relates to an additionalfieldwork standard requiring documentation inthe planning of financial statements of the basisfor assessing control risk at the maximum levelfor assertions related to material account bal-ances, transaction classes, and disclosure compo-nents of financial statements when such asser-t i ons are s ignificant ly dependent oncomputerized information systems. The Advi-sory Council on Government Auditing Standardsrecommended this new standard as a way of

tightening the rigor applied to an audit of thefinancial statements when computerized infor-mation systems are used for significant account-ing applications. Prior to the implementation ofthis standard, auditors were not required to doc-ument their assessment of control risk at maxi-mum; only if the assessment was below maxi-mum was support to be included in the workingpapers. This new standard, Amendment No. 1,became effective for financial statement audits ofperiods ending on or after September 30, 1999.

Amendment No. 2 adds a fieldwork standardand amends a report standard for financial state-ment audits. The purpose is the improvement ofauditor communication concerning the auditor’swork on compliance with laws and regulationsand internal control over financial reporting. Inthe report, the auditor is to emphasize the impor-tance of the reports on compliance with laws andregulations and internal control over financialreporting when these reports are issued sepa-rately from the report on financial statements.This amendment is effective for financial state-ments audits of periods ending on or after Janu-ary 1, 2000.

The review of government auditing stan-dards continued in progress as of mid-2000. TheGeneral Accounting Office staff monitors the ef-fectiveness of the guidance provided to auditors.Review of audits that are alleged to be defective insome respects leads to an assessment of the ade-quacy of guidance. Furthermore, changes in stan-dards and statements issued by the AuditingStandards Board, changes in the structure of or-ganizations, and the need to more sharply focusauditor responsibility lead to reconsideration ofaudit guidance.

Audits of financial status and of programsprovided by various government agencies arecritical to assuring accountability and adequatemanagement. Those audits are reported publicly.The quality of the audits as well as of the report-ing is related to the adequacy of the generallyaccepted government auditing standards.

(SEE ALSO: Auditing; United States General Account-ing Office)



BIBLIOGRAPHY

Comptroller General of the United States. (1999). AuditorCommunication. Government Auditing Standards.Amendment No. 2. Washington, D.C: United States Gen-eral Accounting Office.

Comptroller General of the United States. (1999).Documentation Requirements When Assessing ControlRisk at Maximum for Controls Significantly Dependentupon Computerized Information Systems. Amendment No.1. Washington, DC: United States General AccountingOffice. May.

Comptroller General of the United States. (1994).Government Auditing Standards (the Yellow Book). Wash-ington, DC: United States General Accounting Office.U.S. Government Accounting Office. http://www.gao.gov.

U.S. Government Accounting Office. www.gao.gov.

BERNARD H. NEWMAN

MARY ELLEN OLIVERIO


Government financial reporting is the processwhereby governments report their financial posi-tion and activities to the public at large. Thesereports are the standard that citizens, oversightbodies, and other stakeholders use to judge theirgovernment’s efficiency, effectiveness, and over-all financial condition. This article examines gov-ernment financial reporting from a historicalperspective, and today; it also looks at contempo-rary issues and possible future trends.

HISTORY

Government financial reporting evolved throughthe twentieth century. The National Committeeon Municipal Accounting (NCMA) was estab-lished in 1934 by the Government Finance Offi-cers Association (GFOA) and began to promul-gate formal standards. It issued the first ‘‘bluebook’’ in 1936, Bulletin No. Six, Municipal Ac-counting Statements (GFOA, 1988). From thatpoint, government financial reporting, alongwith government accounting and auditing, beganto develop into what it is today.

The National Council on Governmental Ac-counting (NCGA), which succeeded the NCMA,initiated the basic format of the current bluebook, which was later officially titled Governmen-tal Accounting, Auditing and Financial Reporting(GAAFR). In 1968, generally accepted account-ing principles (GAAP) for government were es-tablished in GAAFR (GFOA, 1988). Governmentaccountants and financial managers use the bluebook to this day as a reference for current stan-dards and practices in government financial re-porting.

In the past, some confusion existed concern-ing who set the standards that constituted GAAPfor governments. This issue became prominentwhen the American Institute of Certified PublicAccountants (AICPA) issued an industry auditguide in 1974 that, while endorsing most, modi-fied some principles set forth by the NCGA(GFOA, 1988). The AICPA later recognizedNCGA Statement No. One, Governmental Ac-counting and Financial Reporting Principles. Evenafter this statement was recognized, questionsstill arose. Conflicts with the standards set by theNCGA generally were associated with pro-nouncements issued by the Financial AccountingStandards Board (FASB). These conflicts werenot resolved until the Government AccountingStandards Board (GASB) was established in 1984(GFOA, 1988). From then on, the GASB wasclearly established as the primary authority forsetting government standards.

The GASB was created as a five-memberboard under the Financial Accounting Founda-tion (FAF). In addition to the GASB, the FAF alsoestablished the Governmental Accounting Stan-dards Advisory Council (GASAC) to advise theGASB of its members’ views and those of theorganizations they represent. The GASAC assiststhe FAF in approving appointments of GASBmembers.

FINANCIAL REPORTING TODAY

Generally, government financial reporting is theprocess of communicating information concern-ing a government’s financial position and activi-ties. Financial information is often dispersedthrough financial reports. Government financial

GOVERNMENT FINANCIAL REPORTING


Standard-Setting Structure for Financial Reporting & Accounting

Financial Accounting Foundation (FAF)

Financial Accounting Standards Advisory Council (FASAC)

Financial Accounting Standards

Board (FASB)

Government Accounting Standards

Board (GASB)

Governmental Accounting Standards Advisory Council (GASAC)

Table 1

reports have several uses: They can be used tocompare actual financial results against the le-gally adopted budget; assess financial conditionand results of operations; assist in determiningcompliance with finance-related laws, rules, andregulations; and assist in evaluating efficiencyand effectiveness (GFOA, 1988). Although gov-ernment financial reports cannot meet the needsof every user, they can be used in a myriad ofways to assess accountability and make effectivedecisions.

The GASB has the responsibility of establish-ing and improving financial reporting standardsat the state and local government levels. Threeprimary user categories of government financialreports exist: citizens, legislative and oversightbodies, and investors and creditors (GFOA,1988). The executive branch and subordinate bu-reaus/agencies are not identified as primary usersbecause they have the ability to obtain this infor-mation from other sources (GFOA, 1988).

At the federal level, financial reporting wasn’trequired until 1996. The Chief Financial Officers(CFO) Act of 1990 was the initial legislative ele-ment requiring the federal government to pro-vide reliable, audited financial information totaxpayers, elected officials, appointed officials,and other stakeholders. Consequently, the Fed-eral Accounting Standards Advisory Board(FASAB) was established in October of 1990 toconsider and recommend accounting principles

for the federal government. The CFP Act of 1990was expanded in 1994 and required the federalgovernment’s twenty-four major agencies to pro-vide annual financial statements beginning withthose for fiscal year 1996.

Although various internal and supplementalfinancial reports exist, the most common is thecomprehensive annual financial report (CAFR).The GASB’s 1987 Codification of GovernmentalAccounting and Financial Reporting Standardsstates that ‘‘every government should prepareand publish as a matter of public record, a com-prehensive annual financial report’’ (section2200.101) The CAFR normally contains threedistinct sections: introductory, financial, and sta-tistical. These sections can be supplemented withother specialized sections as necessary.

Government financial reporting should assistin fulfilling government’s duty to be publiclyaccountable by providing users of these reportswith the means to evaluate the operating resultsof a government and assess the level of service(s)it provides. It is imperative that these reports bereliable, understandable, relevant, and timely inorder to enable informed citizens, legislators, andother stakeholders to hold government fiscallyaccountable.

CONTEMPORARY ISSUES/THE FUTURE

There seems to be a current trend toward fiscaldiscipline in government that has generated a



demand for better information on which to basedecisions. Consequently, state and local govern-ments must change their financial reporting frombasic stewardship reports on the various govern-ment funds to a more corporate-style report thatoffers analysis of the long-term impact of finan-cial management decisions (Klasney and Wil-liams, 2000). Currently, from annual financialreports, state and local governments focus on theindividual ‘‘funds’’ of government. These reportscan be difficult for readers of financial statementsto understand because the number of funds canrun into the dozens or hundreds. As a result ofGASB Statement No. Thirty-Four, financial re-ports must begin to include comprehensive in-formation about the cost of providing govern-ment services and show all of a government’sliabilities and assets, including infrastructure (Al-len, 1999). This new approach calls for govern-mentwide reporting, enhanced fund reporting,and management’s discussion and analysis(MD&A).

The concept of governmentwide reporting isthe most dramatic change in the new approach.This is a significant move because, until now,government followed only the modified-accrualbasis of accounting. The change is important topotential lenders and taxpayers because of theneed to capitalize and depreciate general capitalassets or infrastructure (Klasney and Williams,2000). Information concerning infrastructurewill include the cost and anticipated life of roads,bridges, sewer and water systems and other capi-tal assets. Since state and local governments in-vest $1 out of every $10 dollars ($140 billion to$150 billion annually) in the construction, im-provement, and rehabilitation of capital assets,that information should be very interesting tolocal taxpayers (Allen, 1999).

The elements of fund reporting have notchanged much. Fund categories will continue toapply their current measurement focus and basisof accounting; however, reporting fund types(such as special revenue and capital projects) isno longer required for governmental funds in thebasic financial statements. The new approach willalso establish two new fund types—permanent

funds (governmental) and private-purpose trustfunds (fiduciary). Governments must provide asummary reconciliation to the governmentwidefinancial statements at the bottom of fund finan-cial statements or in a separate schedule. This willbe an extensive undertaking for governmentfunds because of the difference in the measure-ment focus and basis of accounting (Klasney andWilliams, 2000). In addition to governmentwidereporting and enhanced fund reporting, eachgovernment entity’s financial management willnow present an MD&A as required supplemen-tary information before the basic financial state-ments. In response to users’ demand for a sum-mary of a government’s operations and financialsituation, the GASB expanded the number of is-sues that the MD&A must address. They includethe following:

● An objective discussion of the basic financialstatements and condensed financial informa-tion comparing current and prior years

● An analysis of the overall financial positionand results of operations

● An analysis of balances and transactions of in-dividual funds

● An analysis of significant variations betweenthe original and final budget and the finalbudget and actual results for the general fund

● A description of significant capital asset andlong-term debt activity during the year

● Known facts, decisions or conditions expectedto have a significant impact on financial posi-tion or results of operations (Klasney andWilliams, 2000).

The implementation of this new approach togovernment financial reporting will be challeng-ing at best. Some governments will find them-selves gathering information they haven’t trackedbefore and, in some cases, reconstructing infor-mation as far back as twenty-five years (GASB,1999). This is precisely why the GASB establisheda phased implementation plan based on eachgovernment’s total revenues (Klasney & Wil-liams, 2000). Implementation will begin on June30, 2002, for the largest governments (at least$100 million in revenues), with one additional



year for medium-sized governments ($10 millionto $100 million), and two additional years forsmaller governments (less than $10 million) (Al-len, 1999; GASB, 1999). Although implementa-tion may be rigorous, this new method is essen-tial for enabling decisionmakers to overcome thechallenges of a new, global society.

SUMMARY

The process of government financial reportingevolved during the twentieth century. The bluebook, or GAAFR, was established and continuesas the primary reference for government financialreporting standards at the state and local levels.The Government Accounting Standards Board(GASB) was established in 1984 and is the au-thority for setting those standards. The FederalAccounting Standards Advisory Board (FASAB)was established in 1990 and prescribes financialreporting standards at the federal level. Citizensand other stakeholders use government financialreports to assess a government’s performanceand overall financial position in order to holdthat government accountable for its actions. Themost common type of government financial re-port is the comprehensive annual financial report(CAFR). A current trend toward fiscal disciplineis the driving force behind many contemporaryissues. Chief among these issues is the GASBrequirement that all state and local governmentfinancial reports begin to include informationconcerning capital assets and debts. This changesthe essence of government financial reports frombasic fund stewardship to comprehensive, corpo-rate-style reporting.

(SEE ALSO: Government Accounting; Government Ac-counting Standards Board; Government AuditingStandards)

BIBLIOGRAPHY

Allen, Tom. (1999). ‘‘GASB Issues New Reporting Rules.’’American City and County, 114 (8): 8.

Government Accounting Standards Board (GASB). (1987).Codification of Governmental Accounting and FinancialReporting Standards. Stanmford, CT: Author.

Government Accounting Standards Board (GASB) (1999).‘‘GASB Overhauls Reporting Model’’. Journal of Ac-countancy 188 (2): 4.

Government Finance Officers Association (GFOA). (1988).Governmental Accounting, Auditing and Financial Report-ing. Chicago: Author.

Klasney, Edward M., and Williams, James M. (2000). ‘‘Gov-ernment Reporting Faces an Overhaul’’. Journal of Ac-countancy, 189 (1): 49.

ROBERT J. MURETTA, JR.

GOVERNMENT ROLEIN BUSINESS

Government regulation at the federal and statelevels has a major impact on how businessesoperate in the United States. In order to managebusiness activities in a complex society and tohelp respond to changing societal needs, govern-ments at all levels have created numerous regula-tory agencies. Although the duties and functionsof each agency vary, all influence the day-to-daybusiness activities that take place within theUnited States. Businesses that take a proactivestance toward understanding and complyingwith federal regulatory agencies will minimizetheir chance of fines, prosecution, or other regu-latory action. Therefore, it is in the best interestof businesses to maintain healthy relationshipswith regulatory agencies at all levels of govern-ment. Among the business activities regulated bygovernment are competitive practices, industry-specific activities, general issues of concern, andmonetary regulations.

COMPETITIVE PRACTICES

A number of laws have been passed to protectcompetitive practices. Among these laws are theSherman Antitrust Act of 1890, the Federal TradeCommission Act of 1914, and the Wheeler-LeaAct of 1938.

Sherman Antitrust Act of 1890. One of theearliest pieces of legislation that had a criticaleffect on the business sector was the ShermanAntitrust Act of 1890, passed by Congress inresponse to public outrage over a few large com-



panies that were forcing their smaller competi-tors out of business and becoming monopolies.Since there was no competition, consumers wereleft with higher prices and usually a lower-qualityproduct. The act had two main sections attempt-ing to prevent the formation of monopolies. Spe-cifically, section one maintained that forming atrust or a conspiracy resulting in the restraint oftrade was illegal. Section two provided that per-sons monopolizing or attempting to monopolizetrade were guilty of a misdemeanor. Basically, thefederal government was (and is) looking forcompanies engaging in price fixing, in dividingup the market share among different companiesto control the market, or in other business prac-tices that may create a monopoly.

The Justice Department is the federal agencyresponsible for enforcing the act. By prosecutingindividuals and companies violating provisionsof the law, imposing fines and jail time, or callingfor injunctions, the Justice Department preventsmonopolies from forming. The act also allowsinjured parties, usually other businesses, to filesuit and get relief from the federal courts forinfractions of the law. The Justice Departmentalso reviews almost every large merger or acquisi-tion that affects the U.S. marketplace. If the Jus-tice Department opposes a proposed merger,companies involved in the transaction can try towork out an agreement to allay the government’sconcerns or oppose the Justice Department infederal court, asking a judge to rule on the meritsof the case. Most companies planning a mergeror takeover normally have their legal depart-ments conduct exhaustive research in order toanswer potential questions from the Justice De-partment. The primary reason for this research isto avoid a long legal fight with the governmentthat is expensive and can cause significant delaysin the proposed merger or takeover.

Federal Trade Commission Act of 1914. TheFederal Trade Commission Act of 1914 createdthe Federal Trade Commission (FTC), whichconsists of five members with staggered terms ofseven years each. Board members are nominatedby the president and confirmed or rejected by theSenate. One person serves as the chairperson of

the commission and guides the agency’s dailyoperations. The FTC was originally created toenforce the provisions of the Sherman Antitrustand Clayton Acts. The FTC has the power toinvestigate unfair competitive practices on itsown. Firms may also petition the FTC to investi-gate alleged unfair competitive practices of whichit might otherwise be unaware. The agency canhold public hearings to investigate the allegedinfractions, and it may also issue cease-and-desistorders when it believes unfair competitive busi-ness practices are being used. Since the enforce-ment powers of the FTC and Justice Departmentoverlap, the two agencies often work together tosolve problems.

Wheeler-Lea Act of 1938.Congress respondedto public complaints about improper and decep-tive advertising by passing the Wheeler-Lea Actof 1938, which empowered the FTC to investigatebusinesses that engage in deceptive business ac-tivities or companies that use misleading or lessthan truthful advertising to entice consumersinto their stores. A common deceptive practicethat some companies have used in the past iscalled ‘‘bait and switch.’’ This practice refers toadvertising a product at an extremely low price todraw customers into a store but in reality havingvery little or none of the product available. Storeemployees then attempt to sell customers a moreexpensive product. This is but one example ofwhat the FTC may investigate.

INDUSTRY-SPECIFIC FEDERAL AGENCIES

Federal legislation has created agencies to moni-tor and regulate particular industries because ofconcern over industry-specific practices, amongthem the Interstate Commerce Commission, theFederal Communications Commission, and theFood and Drug Administration.

Interstate Commerce Commission (ICC). In1887, Congress passed legislation creating the In-terstate Commerce Commission. Originally, onlyrailroads were regulated, but as modern trans-portation methods developed, other transporta-tion modes were added to its list of responsibili-ties. The primary purpose of the ICC was to



monitor railroad companies (prices charged)that may have had a monopoly in some parts ofthe country. The commission could take correc-tive action, such as price modification, if it foundthat a railroad or other interstate business wasengaging in monopolistic business activities andcharging high prices for its services. Since this actapplied to a limited number of industries, Con-gress later passed the Sherman Antitrust Act of1890 (discussed earlier) to provide a muchbroader coverage of monopolies regardless of in-dustry.

Federal Communications Commission (FCC).The FCC monitors and regulates CB radio, radio,telegraph, telephone, and television operations. Ithas broad powers to set acceptable standards fortelevision regarding language, nudity, violence,or other material that may be perceived as inap-propriate by the general public. For example,television shows that are adult-oriented or con-tain violence are typically on late in the eveningso that children are less likely to see them. Inaddition, television shows often warn viewersabout their content through a rating system;since the rating is displayed on the screen,viewers can make an informed decision beforewatching a particular program.

The FCC also has the power to fine broadcastcompanies that use inappropriate language intheir programming. Since most television andradio stations know what are considered accept-able standards, fines are rarely issued. When finesare issued, however, a television or radio stationmay take the FTC to federal court to appeal thedecision. Broadcast companies that fight the FCCover a show’s content normally argue that theFirst Amendment gives them the right to broad-cast the contested material.

Food and Drug Administration (FDA). TheFDA is responsible for ensuring the safety ofcosmetics, drugs, and food. One of the mostimportant functions of the agency is new drugapproval. The FDA requires pharmaceuticalcompanies to provide detailed scientific data re-garding new drugs prior to approval. Specifically,the FDA will review the potential benefits and

negative side effects of all proposed drugs. Theagency reviews the information submitted by thepharmaceutical company and may also conductits own tests if additional study is deemedneeded. The FDA is extremely important to thebusiness community because if it rejects a newdrug, the pharmaceutical company developing itcannot sell it. FDA regulators must balance theinterests of the general public with those of thepharmaceutical company. The FDA does not en-dorse new drugs; rather, it approves them, statingthat they are thought to be safe.

GENERAL FEDERALREGULATORY AGENCIES

Federal legislation has also created agencies ad-dressing a broad range of issues, including theEqual Employment Opportunity Commission,the Occupational Safety and Health Administra-tion, the Environmental Protection Agency, andthe Consumer Product Safety Commission.

Equal Employment Opportunity Commission(EEOC). The Civil Rights Act of 1964 prohibitsdiscrimination on the basis of race, color, creed,sex, or national origin. This law applies to almostevery private company, nonprofit organization,and government employer, although some ex-ceptions were granted to religious corporations,Indian tribes, and private-membership clubs.The Civil Rights Act also created the Equal Em-ployment Opportunity Commission.

The original purpose of the EEOC was tomonitor and enforce the provisions of the CivilRights Act. Its powers were enhanced in 1972with passage of the Equal Employment Act,which gave the EEOC the power to file civillawsuits in federal court and to represent a per-son filing a grievance. Prior to filing the suit infederal court, the EEOCmust first try to settle thecase out of court with the alleged offending com-pany—an attempt to promote a more concilia-tory approach to solving discrimination prob-lems and to reduce the number of court cases.The company could agree, for example, to settlethe complaint by paying a fine, ordering remedialsteps to prevent further discrimination, and/or



working out the problem for the original com-plainant. In large cases, the EEOCmay work withthe Civil Rights Division of the Justice Depart-ment in order to settle the problem.

Occupational Safety and Health Administra-tion (OSHA). Enacted in 1970, the OccupationalSafety and Health Administration, was designedto ensure safe and healthy working conditions innearly every environment. OSHA’s basic premiseis that employers must provide a work environ-ment that is safe and free from hazards that maycause harm or death to their employees. In addi-tion, employers are obligated to follow occupa-tional safety and health standards that are or-dered by the secretary of labor (OSHA falls underthis department). Employers are given writtenguidelines so they know specific OSHA rules andregulations.

In order to verify that organizations arecomplying with these regulations, OSHA canconduct surprise inspections. Technically, em-ployers can ask OSHA to show a search warrantbefore the search is executed, but this is not nor-mally done because OSHA can get a warrantrelatively quickly. OSHA investigators may in-spect the building, but an employer has the rightto have a representative accompany the regula-tors during the tour. The investigators review ac-cident records and other documents to verify thatcompliance has been maintained. OSHA investi-gators also observe employees to verify thatguidelines set by the agency are followed (e.g.,wearing eye protection). If OSHA investigatorsbelieve that violations have occurred, they canissue citations against the employer. If the em-ployer agrees to pay a fine, OSHA will normallyinspect the building at a later date to ensurecompliance. If an employer believes that the fineor other sanction is inappropriate, a court ordercan be sought seeking relief from the fine orsanction. In rare instances, the secretary of labormay ask for an injunction against an employer.Injunctions are only sought in the most seriouscases, such as those in which there is imminentdanger to employees.

Environmental Protection Agency (EPA).Oneof the most pressing issues in the United States isprotecting the environment. A combination ofpressure from consumer groups, news media,and voters encouraged Congress to pass legisla-tion creating the Environmental ProtectionAgency in 1972. Prior to the creation of the EPA,no single federal agency had control over envi-ronmental issues, resulting in fragmented en-forcement and confusing or conflicting codes.The EPA was created to act as the focal pointregarding all pollution issues (air, noise, water,etc.).

In recent years, Congress has passed severallaws addressing a host of environmental issues(e.g., noise, pesticide, radiation, and water pollu-tion). When Congress passes a new law regardingthe environment, it is the EPA’s job to enforce itsprovisions with the powers contained in the leg-islation. One example of the EPA’s power is thatit can set acceptable air-quality standards for astate. If air-quality standards are not met within aspecified frame of time, fines or other punitivemeasures may be imposed on the offending state.

Consumer Product Safety Commission(CPSC). Another powerful federal agency wascreated in 1972 under the Consumer ProductSafety Act. The law created the Consumer Prod-uct Safety Commission, which was intended toprotect consumers from defective and dangerousproducts. In addition, Congress also wanted tounify the majority of laws regarding productsafety (except food, automobiles, and other prod-ucts already regulated by federal agencies) so thatthey would be effective and clear. The CPSC isvery powerful; it can ban products without acourt hearing if they are deemed dangerous andcan order recalls, product redesigns, and the in-spection of production plants. In more severecases, the CPSC may also charge officers, manag-ers, and/or supervisors with criminal offenses.

FEDERAL MONETARYREGULATORY AGENCIES

Several federal agencies have been established tomonitor monetary practices in the United States,



including the Securities and Exchange Commis-sion, the Federal Reserve Board, and the FederalDeposit Insurance Corporation.

Securities and Exchange Commission (SEC).The SEC was established to regulate the securitiesindustries in the United States. A quasi-regula-tory and judicial agency, the SEC regulates pub-licly traded stock-offering companies by re-quiring them to issue annual and other financialreports. In addition, the SEC regulates the stockmarket, brokers who sell securities, and large in-vestment firms. The SEC also looks for insidertrading, such as trading on secret knowledgeabout a company, other white-collar crime thatmay affect a company’s stock price, and securitiesfraud by stockbrokers. The agency can initiatecivil or criminal action against the individual orfirms charged with securities violations. Depend-ing on the circumstances, the penalties levied bythe SEC can be severe, with large fines and longjail terms being the norm. The SEC normallyworks closely with the Justice Department whencriminal prosecution is involved. As always, theSEC’s actions can be appealed to the federalcourts if the individual or firm believes thecharges are inaccurate or unjust.

Federal Reserve Board As the United Statesgrew, the nation’s banking system became morecomplex and subject to greater fluctuations with-out government regulation. The United Statesexperienced an acute money panic in 1907 thatput a severe strain on the banking system. As aresult of the financial panic, a National MonetaryCommission was established by Congress tostudy how the United States could protect thebanking system and, in turn, the money supply.National Monetary Commission recommenda-tions were implemented by Congress in 1913when the Federal Reserve Act was passed and theFederal Reserve Board was established. The pri-mary purpose of the Federal Reserve Board is tofunction as a semi-independent board designedto protect the banking system in the UnitedStates.

Federal Reserve Board activities are guidedby a board of governors. The board has seven

members, all of whom are nominated by thepresident and confirmed or rejected by the Sen-ate. Each member is appointed to a fourteen-yearterm, with vacancies occurring about every twoyears. To be nominated to the Federal ReserveBoard, an individual must possess excellent aca-demic credentials, be an established leader in thefinancial world, and have achieved an impeccablebusiness reputation. In order to separate theBoard from political influences and to ensurethat all decisions are based on economic ratherthan political issues, Board members areappointed and will likely serve through severalpresidential administrations. The Board isheaded by the chairperson, who is considered tobe the most powerful banker in the world. Assuch, the chairperson directs the overall missionof the Board and consults regularly with the pres-ident, secretary of the treasury, banking execu-tives, stock market representatives, and top bank-ing regulators from other countries to coordinatefinancial policy.

Federal Deposit Insurance Corporation(FDIC). Created after the Great Depression of the1930s, the FDIC insures each account up to$100,000 in the event of a bank failure. In returnfor this protection, participating banks, creditunions, and other financial institutions must paypremiums, which the FDIC uses to build upfunds for any future bailouts.

SUMMARY

Government regulations and agencies at all levelsof government have had a major impact on howbusinesses operate. In order to manage businessactivities in a complex, ever-changing society,governments at all levels have created numerousregulatory agencies through the legislative pro-cess. Although the duties and function of agen-cies vary, all influence day-to-day business prac-tices. Frequently regulated business activitiesinclude competitive practices, industry specificactivities, general issues of concern, and mone-tary regulations.



BIBLIOGRAPHY

Boone, L. E., and Kurtz, D. L. (1992). Contemporary Market-ing, 7th ed. New York: Dryden/Harcourt Brace.

Brue, S., and McConnell, C. (1999). Economics, 14th ed.New York: McGraw-Hill.

Churchill, G., and Peter, J. P. (1998). Marketing: CreatingValue for Customers, 2d ed. Boston: Irwin/McGraw Hill.

Dickson, P. R. (1994). Marketing Management. New York:Dryden/Harcourt Brace.

Kotler, P., and Armstrong, G. (1991). Principles of Market-ing, 8thd ed. Englewood Cliffs, NJ: Prentice-Hall.

ALLEN D. TRUELLMICHAEL MILBIER

GROSS DOMESTICPRODUCT (GDP)

Led by the auto industry, the United States econ-omy grew rapidly in the 1920s, generating morejobs, more income, and more free time that theAmerican consumer had in order to spend. Aslong as people were employed, paying for goodsand services, there was really no need to measurehow the economy was doing. However, in the1930s, the American economy went bust and afrustrated Congress asked if there was any way tomeasure the depth of the Great Depression.

On January 4, 1934, economist SimonKuznets, professor at the University of Pennsyl-vania, sent to the Senate a report entitled ‘‘Na-tional Income: 1929-1932,’’ the first accountingof U.S. productivity, essentially the gross nationalproduct (GNP). More than 4500 copies of thisreport were sold in just eight months. The basicconcept that Kuznet had was to limit this ac-counting measurement to the marketplace, andthus to the amount that consumers paid forgoods and services. Until 1992, the termGNPwasused to refer to the total dollar value of all fin-ished goods and services produced for consump-tion in society during a particular period of time(usually one year). In 1992 the Commerce De-partment began to compute gross domesticproduct (GDP) instead of GNP. The differencesbetween the two are slight and involve how tocount earning of assets owned by foreigners.

GNP counts the earnings in the homeland of theowner of the asset, while GDP counts the earn-ings of a manufacturer in the country in whichthe assets exists. For the United States, there isvirtually no difference between the two measures.

There are three basic components that deter-mine the U.S. GDP:

1. Consumption, the amount that con-sumers pay for goods (durable and non-durable).

2. Investment, the amount of money spenton new production facilities, that is,plants and facilities.

3. Services, the amount that consumers payfor the services they use.

Several things were not included in GNP andsubsequently in GDP:

● Work that is provided in an economy bynonmarket transactions such as homemakersand military personnel. These factors were toodifficult for Kuznets and his team to measure.

● Illegal activities such as gambling and drugtrafficing. These factors are also difficult to es-timate; in addition Kuznets excluded themfrom GNP because he deemed them a ‘‘dis-service’’ to the economy.

● Goods and services that are bartered. Thesewere excluded because they cannot be mea-sured.

● Sale of intermediate goods (raw materials).

● Sale of used goods (used cars, furniture, etc.).

● Purely financial transactions such as sale ofstocks and bonds.

● Imports (goods made outside the UnitedStates).

The GDP is the ultimate benchmark thatmeasures the expansion and contraction of theU.S. multitrillion dollar national economy. Itcovers everything that is produced and sold in themarketplace. Bankers, investment brokers, andgovernment officials use the GDP to determinesuch things as interest rates, investment opportu-nities, and tax rates. The GDP is not the onlymeasure of output, however; economists useGDP because it is the most comprehensive of

GROSS DOMESTIC PRODUCT (GDP)


Product and Prices

Year 1 Year 2

Goods Output Prices Output Prices

Balls 10 balls $50 per ball 10 balls $55 per ball

Bats 10 bats $25 per bat 12 bats $25 per bat

Gloves 10 gloves $25 per glove 9 gloves $30 per glove

Table 1

output measures. This measure is important be-cause it helps societies understand both inflationand employment.

In the flow of payments in the economy,where does one measure? Consider, for example,an automobile. The mining operator receives anincome from the sale of iron ore, the mill ownerreceives income from the sale of finished steel,and the automobile manufacturer receives in-come from the sale of the finished car. In order toavoid the inaccuracy of counting the samemoneythree times, Kuznets decided to use only finalsales; thus the amount paid to the dealer for thecar is the only amount used in calculating GDP.The labor cost of the workers at all three loca-tions is added to GDP. In essence, the price of theautomobile includes the cost of the materialspurchased from suppliers. The value added tomanufacture the automobile can be found by de-ducting the cost of one product from the totalcost of the automobile.

The more goods and services a country pro-duces, the healthier that country’s economy be-comes. There is a major flaw in measuring eco-nomic success, however, in that when GDP(production) increases, negative externalities (airand water pollution) also increase. The environ-ment becomes degraded and negatively affectsthe quality of life. GDP measures goods andservices traded, but the negative externalities arenot included in this counting; however, thesenegative externalities increase GDP. For example,when the automobile industry wants to producemore cars, the smoke that is emitted from thesmokestacks includes carcinogens that may makepeople in the area sick. A person who gets sick

from the emitted smoke may go to the doctor.The doctor may prescribe medication. The costof the visit to the doctor and the cost of themedication are added to the total value of GDP.

Table 1 contains output and price statisticsfor a simple economy that produces only threegoods. In the first year, the value of output, orGDP, is $1000; in the second year, the GDP is$1120. These numbers are obtained by multiply-ing quantities by prices and then summing theresulting values. They give us current dollar ornominal GDP, that is, the value of output mea-sured in prices that existed when the output wasproduced.

GDP has risen by 12 percent from the firstyear to the second, but this increase is only par-tially due to additional output ($1120� $1000�$120). Part of the increase is due to changes inprices. To get a measure that contains only theincrease in output, we canmultiply the outputs ofthe second year by the prices of the first year.When we add up these values, they total $1025.This number implies that if only the quantities ofoutput had changed and not the prices, GDPwould have increased only from $1000 to $1025, arise of only 2.5 percent. This $1025 is real GDP.

BIBLIOGRAPHY

Eggert, James. (1997). What is Economics, 4th ed. MountainView, CA: Mayfield Publishing Company.

‘‘GDP: Gross Domestic Product.’’ http://www.dismal.com/toolbox/dict–gdp.stm. (1999).

‘‘Gross Domestic Product.’’ http://131.93.13.212/econ/Measuring/GNP1.html. (1999).

Mansfield, Edwin, and Behravesh, Nariman. (1992).Economics U$A, 3rd ed. New York: Norton.

Mings, Turley, and Marlin, Matthew. (2000). The Study ofEconomics: Principles, Concepts, and Applications, 6th ed.Dushkin/McGraw-Hill.

‘‘Narrative.’’ http://www.subjectmatters.com/indicators/HTMLSrc/Trainging/Indicators/GNP.html. (1999).

‘‘PP Presentation: Gross Domestic Product.’’ http://sorell.humboldt.edu/�economic/econ104/macto/ppt/tsld002.html. (1999).

Wilson, J. Holton, and Clark, J. R. (1997). Economics. Cin-cinnati, OH: International Thomson Publishing.

GREGORY P. VALENTINE

GROSS DOMESTIC PRODUCT (GDP)


HARDWARE

The concept of inventing hardware to assist incommercial productivity is not new. For exam-ple, thousands of years ago the Chinese soughtgreater efficiency in calculating numbers, leadingto the invention of the abacus, a hand-held me-chanical device. Another hardware milestone wasreached when Charles Babbage, in 1822, pro-posed a machine that would calculate mathemat-ical tables; much of his design was used in latercomputers (Long and Long, 1999). Herman Hol-lerith designed a method to store numbers ontopunched cards in order to calculate the 1890census, and the company he founded eventuallybecame IBM Corporation (Long and Long,1999).

THE COMPUTER ERA BEGINS

The first electronic computer, the ENIAC, wasdeveloped at the University of Pennsylvania in1946. It used vacuum tubes and weighed thirtytons. Remington Rand Corporation producedthe first commercial computer, the Univac, in1951, which also used transistors (Long andLong, 1999). Transistors replaced vacuum tubes,were far smaller, and used less power than tubes.Transistors were shortly thereafter replaced byintegrated circuits, which further minimized sizeand lessened power requirements. The availabil-ity of integrated circuits made the first personalcomputer possible in 1977 when Stephen Jobsand Steve Wozniak introduced the ‘‘Apple II’’

(Long and Long, 1999). IBM offered their firstmicrocomputer in 1981, and Apple’s Macintoshwas introduced in 1984. The Macintosh was thefirst popular computer with a graphical user in-terface (GUI), and it also had a laser printer thatcould combine text and pictures (Long and Long,1999). A GUI operating system receives inputfrom both the keyboard and a pointing device(mouse). This type of system was a boon to com-puter users who were not proficient or comfort-able with keyboarding, and today most personalcomputers require the use of a mouse.

CLASSIFICATIONS AND DEFINITIONSOF COMPUTERS

There are three main classifications of comput-ers: mainframe, minicomputer, and microcom-puter. The major categories can only be used asgeneral guidelines because of the huge variety inproduct lines. Computer ‘‘servers’’ have alsobeen included in this discussion because of theirimportant role in networking and Internet appli-cations.

A mainframe computer is any large com-puter system, such as that used by the InternalRevenue Service. Another typical use of a main-frame computer would be for an airline ticketingsystem, which can have thousands of users con-nected to one computer. The next smaller-sizedcomputer is termed a minicomputer. It is of me-dium scale and can serve up to several hundredusers. The microcomputer is the smallest in size

H

435

Steve Jobs (left) and Steve Wozniak (right).

and power, and the term is ‘‘generally synony-mous with personal computer, such as a Win-dows PC or Macintosh, but it can refer to anykind of small computer’’ (CMP Net OnlineEncylopedia). Microcomputers can also be por-table, and some have Pentium processors, four-teen-inch color screens, and multi-gigabyte harddrives. Very small computers include hand-heldunits and pen computers that store informationthe user enters with a stylus rather than a key-board (Hutchinson and Sawyer, 1998).

A ‘‘server’’ computer is one that is used toconnect a cluster of personal computers throughusing a local area network (LAN). World WideWeb pages are also stored on a ‘‘Webserver,’’which is typically a dedicated personal computer.

COMPUTER COMPONENTS

Central Processing Unit (CPU) The CPU is atthe heart of all computers. All data passesthrough it. According to the CMP Net OnlineEncyclopedia:

[The CPU is] the computing part of the computer.Also called the processor, it is made up of the controlunit and ALU. Today, the CPUs of almost all com-puters are contained on a single chip. The CPU, clockand main memory make up a computer. A completecomputer system requires the addition of controlunits, input, output and storage devices and an oper-ating system.

Micro, or personal, computers use microproces-sors that run at approximately 500 megahertz persecond. Mainframe computers measure theirspeed in millions of instructions per second.

Random Access Memory Random accessmemory (RAM) consists of microchips that allowfor the temporary storage of data. RAM functionsas the workspace for the CPU. The ‘‘workspace’’temporarily holds the program and the activecalculation before deriving an outcome. One ex-ample would be using a word processor’s spellingcheck tool on a document. The words beingchecked and the program would be temporarilystored in RAM.

Input Devices Computers receive informa-tion from a variety of sources. The most commoninput device is a keyboard, but the pointing de-vice (mouse or trackball) is equally importantwith today’s GUI interface. Other input devicesinclude video cameras, scanners, microphones,digital cameras, CD-ROMs, and voice commandsthat operate the computer.

Output Devices The computer monitor is anoutput device that is changing rapidly. For sev-eral decades computer screens only displayed let-ters or numbers onto a green or amber screen. Ascomputers began using GUIs, the display devicetook on greater significance. The success of Ap-ple’s Macintosh computer with the graphical userinterface caused Microsoft to come out with theirGUI, called the Windows Operating System.Thus, all current operating systems use GUI andcolor for both print and images.

The standard monitor for many years hasbeen a cathode-ray tube (CRT). CRT monitorsare still very common, and they are capable ofhigh-quality pictures. However, they are inher-ently bulky and relatively heavy. Portable compu-

HARDWARE


ters became possible only when smaller andlighter-weight and display units became avail-able. Current portable or laptop computers useLCD (liquid crystal display) panels, which areflat. LCD panels are now also being used fordesktop monitors. LCD units cost about threetimes what comparable CRT units do, but theyoccupy far less space and have a very brightpicture.

Computer projectors are commonly used todisplay data or information onto a large screen.This setup can be used to demonstrate programs,provide visuals for training, or show Web sites tolarge groups of people. Many businesspeopletravel with both a portable computer and a com-puter projector to visually display informationfor training or to aid in sales.

The GUI and the general popularity of com-puters have caused significant changes in thehardware available for printing. The earliestprinters were essentially automatic typewritersand had little flexibility. Today, there are a widevariety of printers currently available that arecapable of nearly professional-quality output.

Laser printers, which first became availablein the early 1980s, had an inherent advantageover earlier computer printers; that is, the laserbeam could place tiny ink dots anywhere on thepage. In practice, this means that laser printerscan print fonts of any size or typeface. Further,they can print text in any direction and also printpictures. Current laser printers print at a verycrisp 1200 dots per square inch and are consid-ered to be very reliable. Color laser printers arealso available, though they are much slower andalso more expensive than black-and-whiteprinters.

Ink-jet printers essentially spray ink onto thepaper. They are normally very quiet, are relativelyinexpensive, and have high-quality output. Fur-ther, all the newest ink-jet printers offer reason-ably high-quality color printing. Both the in-creased use of the Internet to download colorpictures and the prevalence of digital camerashave significantly increased the popularity ofcolor ink-jet printers.

Connection Devices Partially because of thepopularity of the Internet, more and more com-puters of all kinds have some means of connect-ing to other computers. For desktop computersin schools and businesses, a network interfacecard (NIC) is frequently used. Portable comput-ers and home desktop units typically use a mo-dem as a connection device. Modems connect apersonal or portable computer to dial-up net-works through a regular telephone line. This con-nectivity has served as a boon to telecommutingand changed the way work is performed in orga-nizations. Modems and NICs can serve as bothinput and output devices, depending on whetherthe computer is receiving or sending informa-tion.

Sound Cards and Speakers Today, any multi-media computer contains a device to reproducesound. Typically this means that computers havea sound card that contains a mini-amplifier andconnects to speakers. Sounds can also come fromprograms, from the Internet, and from partici-pants in desktop teleconferences. A sound cardcan also function as an input device when itutilizes a microphone.

Storage Devices The number and size of stor-age devices are increasing. Floppy disks are porta-ble, but they can store only a relatively smallamount of information compared to the neweststorage units, Zip� disks, which are also portableand small. A Zip� disk has about a hundredtimes the storage capacity of a floppy disk. Harddrives are internal storage devices that hold thecomputer’s operating system, the applicationsoftware, and other files.

A LOOK TO THE FUTURE

Computers have become a critical component ofthe workplace, home, and school. As we looktoward the future, some trends are emergingbased on the past few decades of hardware devel-opment. It is highly probable that computerhardware will become even smaller, lighter inweight, more portable, and less expensive. Key-boards may even become obsolete as voice-acti-vation equipment becomes more sophisticated. It

HARDWARE


is also likely that there will be a greater degree ofconnectivity within and between systems on aglobal basis, as well as between home to work.

There is an increasing emphasis in elemen-tary and secondary schools on the use of technol-ogy to access information and change the waystudents learn. We will see new generations ofstudents entering the work force with surpris-ingly sophisticated computer skills and, perhaps,less fear of new hardware and change in general.The foreseeable future holds the promise of moreand more integration of work and home bymeans of computers.

BIBLIOGRAPHY

CMP Net Online Encyclopedia. (1999). http://www.techweb.com/encyclopedia/.

Forcier, R. (1996). The Computer as a Productivity Tool inEducation. Boston: Merrill.

Hutchinson, S., and Sawyer, S. (1998). Computers, Commu-nications, and Information. Boston: Irwin/McGraw-Hill.

Long, L., and Long, N. (1999). Computers. Upper SaddleRiver, NJ: Prentice-Hall.

ARMAND SEGUINCYNTHIA SHELTON SEGUIN

HAWTHORNE STUDIES(SEE: Motivation)


Health issues in business are as critical today asthey were in the mid-twentieth century. Many ofthe injuries and illnesses have changed but theirimpact is no less dramatic. The increased use ofcomputers and job specialization have contrib-uted to a new generation of occupational haz-ards, especially repetitive motion injuries, alsoknown as cumulative trauma disorders. These areinjuries caused by repetitive hand, arm, or fingermotions that cause tendons to swell and becomeprogressively more painful. In advanced cases,workers lose the strength in their thumb andfingers and eventually become unable to com-

plete simple tasks, such as lifting a baby or tyingtheir shoes. Cumulative trauma disorders werethe most common type of illness reported in1997, accounting for 64 percent of the 430,000cases of illness reported (Herington and Morse,1995).

Every five seconds a worker is injured on thejob, and every ten seconds a worker is temporar-ily or permanently disabled. The estimated costfor injuries alone is $121 billion annually(Herington and Morse, 1995). This cost includeslost productivity and wages, administrative ex-penses, and health care. In reality, these costs maybe much higher. It is virtually impossible to pin-point exact costs due to the lack of accuratestatistics on workplace injury and illness. There isno comprehensive, integrated national system forcollecting data on occupational injury, illness,and fatalities. Another factor contributing to in-consistent data is the reluctance of many compa-nies to report incidents for fear of being targetedby the Occupational Safety and Health Adminis-tration for on-site inspections.

FEDERAL AGENCIES

There are two federal agencies designed to oper-ate in the occupational health and safety arena:the Occupational Safety and Health Administra-tion (OSHA) and the National Institute for Oc-cupational Safety and Health (NIOSH). Bothwere created by the same act in Congress in 1970;however, each has a very distinct purpose. OSHA,which is part of the Department of Labor, isresponsible for developing and enforcing rulesand regulations in regards to workplace healthand safety. NIOSH, which is part of the Depart-ment of Health and Human Services, is a researchagency, identifying the causes of work-relateddisability and injury as well as potential hazardsof new technology and practices.

During the 1990s, OSHA was criticized forbeing an agency of red tape that had lost sight ofits original mission ‘‘to assure as far as possibleevery working man and woman in the nation safeand healthful working conditions.’’ Historically,OSHA agents have been compensated for thenumber of violations they have found at job sites.

HAWTHORNE STUDIES


This has created an environment in which cita-tions are given for all violations regardless of howsmall, causing employers to fear OSHA ratherthan seek its help with health and safety issues.Until recently, OSHA has not promoted partner-ships with companies to solve health- and safety-related issues in the workplace. This did begin tochange under the Clinton administration. OSHAnow offers companies a choice between a part-nership or a traditional enforcement relation-ship. The companies who choose to go into part-nership with OSHA work with the agency todevelop health and safety programs. OSHA rec-ognizes the companies that truly commit to thenew partnership by reducing or eliminatingworkplace hazards through a more lenient in-spection policy, priority assistance, and reduc-tions in penalties up to 100 percent. By involvingboth the companies and the workers, a morecollaborative relationship has developed that hasinitiated better workplace practices and solutionsto health and safety issues. OSHA has also com-mitted to focus on the greatest hazards and mostdangerous workplaces and to update confusingrules and regulations.

The National Institute of OccupationalHealth and Safety, whose primary role is re-search, has developed the National OccupationalResearch Agenda (NORA), which identifies thetop twenty-one health and safety research areason which to focus its work through 2009 (seeTable 1). The agenda was developed in collabora-tion with numerous stakeholders, including em-ployers, employees, and labor organizations. Re-search areas were chosen based on the greatestneeds and the areas most likely to produce thegreatest overall gains to workers and industry as awhole. NIOSH is not able to tackle all of thesealone. It must be a collaborative effort with theentire health and safety community.

LEGISLATION

Two acts passed in recent years have had a signifi-cant impact on people who have experienced anoccupational illness or sickness. The first is theAmericans with Disability Act, passed in July1990. This act, which applies to employers with

more than fifteen employees, prohibits discrimi-nation against people with disabilities. Under thisact, an employee is entitled to certain rights re-garding employment upon returning from disa-bility leave and proving the ability to perform theessential functions of the job. The employer isrequired to provide ‘‘reasonable accommoda-tion’’ when necessary, that is, to change workschedules, adjust equipment, or modify tasks toenable the employee to continue to perform thejob held prior to taking the disability leave. Rea-sonable accommodation is required except whenthe employer can prove that it would cause un-due hardship on its part. Another option is totransfer the worker to another position withinthe company.

The second act is the Family Medical LeaveAct (FMLA), which was enacted in August 1993and applies to employers with fifty or more em-ployees. Employees who have worked for em-ployers in this category longer than one year areentitled to take up to twelve weeks of unpaidleave annually for certain medical or family situa-tions, including suffering from a serious healthcondition themselves. The FMLA requires em-ployers to guarantee employees who take a leavethe right to return to an equivalent job, that is,the pay, benefits, and other terms and conditionsof employment must be equivalent. This pro-vides employees who are temporarily disabledwith job security.

THE ROLE OF WORKERS’COMPENSATION LAWS

The original purpose of workers’ compensationlaws was to protect employers as well as employ-ees in cases of occupational injury or illness.Employers were protected from lawsuits initiatedby employees seeking restitution for workplaceillness or injury, and employees were compen-sated for the cost of medical care in addition tolost wages. Today, most private employers arerequired to have workers’ compensation insur-ance, with the exception of employers in NewJersey, South Carolina, and Texas.

Workers’ compensation insurance is no-fault.In other words, regardless of who is at fault (the



The National Occupational Research Agenda

Category

Disease and Injury

Work Environment and Workforce

Research Tools and Approaches

Priority Research Areas

Allergic and Irritant DermatitisAsthma and Chronic Obstructive Pulmonary DiseaseFertility and Pregnancy AbnormalitiesHearing LossInfectious DiseasesLow Back DisordersMusculoskeletal disorders of the Upper ExtremitiesTraumatic Injuries

Emerging TechnologiesIndoor EnvironmentMixed ExposuresOrganization of WorkSpecial Populations at Risk

Cancer Research MethodsControl Technology and Personal Protective EquipmentExposure Assessment MethodsHealth Services ResearchIntervention Effectiveness ResearchRisk Assessment MethodsSocial and Economic Consequences of Workplace Illness and InjurySurveillance Research Methods

Table 1

worker, employer, or neither), the employer isresponsible for compensating the worker forhealth care and lost wages. The employee’s re-sponsibility is to notify the employer as soon as aninjury or illness occurs. Today, workers’ compen-sation issues have become extremely complexbecause what is considered a compensable illnessor injury (warranting restitution by the employer)varies considerably from state to state. The mostliberal state isCalifornia,where anydisease allegedto be aggravated by work-related stress could becompensable. This liberal approach can distortstatistical data and also discourage employersfrom reducing workplace hazards. It also makes itextremely difficult to control the costs of workers’compensation insurance.

PREVENTION

Employers play a vital role in the prevention ofworkplace injuries and illnesses. They are respon-sible for evaluating workplace injuries to discoverpossible causes and for developing preventionstrategies for those injuries. Other employer re-sponsibilities include safety and hazard training,

drug testing, workstation evaluations, and en-forcement of the use of protective equipment.Employers have an array of resources from whichto draw when analyzing workplace hazards anddeveloping health and safety programs. Theseinclude industrial hygienists, certified safety pro-fessionals, federal and state OSHA programs, andNIOSH.

Ergonomics also plays a significant role in theprevention of workplace injuries and illness.Ergonomics is the science of designing and ar-ranging tools and equipment to fit workers. Theoverall goal is to prevent workplace illness andinjuries that result from poor workstation designor improperly designed equipment. Workstationevaluations are an example of an ergonomic pro-gram that many large companies employ. Duringthis evaluation, a health and safety professionalevaluates a worker performing daily tasks at his orher workstation. The health and safety profes-sional observes the worker in order to evaluate the‘‘fit’’ of the workspace, furniture, and equipmentto the worker. In the case of a worker who spendsthe majority of the day at a computer, the profes-



sional would look at several factors to determinethe degree to which the workstation fits. Thesefactors include the height and position of thecomputer screen and keyboard in reference to theworker’s body posture, the height and position ofthe worker’s chair, and the types of movementsthe worker makes while performing tasks. Fromthis evaluation, changes may be made to alleviatediscomfort and prevent harmful injuries. Earlyintervention is the key to preventing potentiallydisabling injuries. In addition to the evaluation,the health and safety professional gives the workeradvice on how to sit, how to position hands on thekeyboard, and how often to take breaks.

There are no comprehensive ergonomicstandards in force in the United States today. InFebruary 1999, OSHA proposed its first draft ofergonomics standards. Proponents believe it willhelp control the large numbers of musculoskele-tal disorders (disorders involving both muscleand skeleton, such as back pain and neck strain).These disorders account for 34 percent of all lostworkday injuries and illnesses and cost $15 bil-lion to $20 billion dollars annually in workers’compensation costs, according to the Bureau ofLabor Statistics. Business groups object to thefederally imposed standards, saying that the stan-dards will be a ‘‘blank check’’ for OSHA inspec-tors and will require all American businesses tobecome full-time experts in ergonomics. In addi-tion, the U.S. Chamber of Commerce points outthat there are presently (1) no scientifically estab-lished standards for what is ‘‘overuse’’ and (2) noexisting studies that demonstrate the connectionbetween ergonomic adjustments and injury pre-vention. While the connection does seem tomake sense, it must be admitted that more stud-ies need to be done before meaningful standardscan be established.

A final critical element in the prevention ofworkplace injuries and illnesses is the develop-ment of health and safety programs designed totrain and educate workers on workplace hazards.OSHA recommends the following elements for acomprehensive health and safety program:

● Management leadership and commitment

● Meaningful employee participation

● Systematic hazard identification and control

● Employee and supervisor training

● Medical management and program evaluation

In conclusion, the prevention of occupa-tional injuries and illnesses is a collaborative ef-fort involving employers, employees, federal andstate agencies and health and safety professionals.The field of occupational safety and health isextremely broad and complex.

BIBLIOGRAPHY

Bureau of Labor Statistics. http://stats.bls.gov/.

Herington, Thomas N., and Linda H. Morse, eds. (1995).Occupational Injuries. St. Louis, MO.

National Occupational Research Agenda (NORA)http://www.cdc.gov/niosh/images/table1.gif.

Rosenstock, Linda, and Cullen, Mark R. (1994). Textbook ofClinical Occupational and Environmental Medicine. Phil-adelphia, Pa.: Saunders.

U.S. Department of Health and Human Services, NationalInstitute for Occupational Safety and Health. http://www.cdc.gov/niosh/.

U.S. Department of Labor, Occupational Safety and HealthAdministration. http://www.osha.gov.

BRENDA J. REINSBOROUGH

HUMAN RELATIONS

Owners and managers of profit and nonprofitorganizations define human relations as fittingpeople into work situations so as to motivatethem to work together harmoniously. The pro-cess of fitting together should achieve higher lev-els of productivity for the organization, while alsobringing employees economic, psychological,and social satisfaction. Human relations coversall types of interactions among people—theirconflicts, cooperative efforts, and group relation-ships. It is the study of why our beliefs, attitudesand behaviors sometimes cause interpersonalconflict in our personal lives and in work-relatedsituations.

One of the most significant developments inrecent years has been the increased importance ofinterpersonal skills in almost every type of work

HUMAN RELATIONS


setting. For many employers, interpersonal skillsrepresent an important category of transferableskills a worker is expected to bring to the job.Technical ability only is usually not enough toachieve career success. Studies indicate that manypeople who have difficulty in obtaining or hold-ing a job possess the needed technical compe-tence but lack interpersonal competence.

HUMAN RELATIONS MOVEMENT

Problems in human relations are not new—cooperative efforts carry the potential for con-flicts among people. It is only within the past fewdecades that management has recognized thathuman relations can have considerable impacton organizational productivity. During this pe-riod, the human relations movement has ma-tured into a distinct and important field of study.

Although it is difficult to pinpoint exactlywhen the human relations movement began,most researchers agree that the earliest develop-ments emerged in the mid-1800s. In the begin-ning, the focus was mainly on improving effi-ciency, motivation, and productivity. But overtime, this research became more involved withredefining the nature of work and perceivingworkers as complex human beings.

Prior to the Industrial Revolution, mostwork was performed by individual craftworkers.Generally, each worker saw a project throughfrom start to finish. Skills such as tailoring, car-pentry, or shoemaking took a long time to perfectand were often a source of pride to an individual.Under this system, however, output was limited.

The Industrial Revolution had a profoundimpact on the nature of work and the role of theworker. Previously, an individual tailor couldmake only a few items of clothing in a certaintime period; factories could make hundreds. Em-ployers began to think of labor as another item inthe manufacturing equation, along with raw ma-terials and capital.

Employers at that time did not realize howworkers’ needs affected productivity. As a result,few owners or managers gave much thought toworking conditions, safety precautions, or

worker motivation. Hours were long and pay waslow.

Around the turn of the century, FrederickTaylor and other researchers interested in indus-trial problems introduced the concept of scien-tific management. They believed that productiv-ity could be improved by breaking down a jobinto isolated, specialized tasks and assigning eachof those tasks to specific workers. The develop-ment of scientific management coincided withthe revolutionary concept of mass production.Eventually it paved the way for the assembly line.

Taylor’s work was sharply criticized by thosewho believed it exploited workers. Employeeswere treated as a commodity, as interchangeableas the parts they produced. Taylor thought thatby increasing production, the company wouldend up with a larger financial pie for everyone toshare. Management would earn higher bonuses;workers would take home more pay. He did notforesee that his theories would be applied in waysthat dehumanized the workplace.

In the late 1920s, Elton Mayo and other re-searchers from Harvard University initiated whathave become known as the Hawthorne Studies atthe Hawthorne plant of Western Electric Com-pany near Chicago. The purpose of the investiga-tion was to explore the relationship betweenchanges in physical working conditions and em-ployee productivity. Specifically, Mayo was inter-ested in the effect of different intensities of lighton employee output. In one experiment, amplelight was provided to a group of six female work-ers. Later, the amount of light was significantlyreduced; but instead of productivity decreasing,as was expected, it actually increased.

The researchers attributed the phenomenonto what has since become known as the Haw-thorne effect—employees who participate in sci-entific studies may become more productive be-cause of the attention they receive from theresearchers. This discovery became important inthe human relations movement because it hasbeen interpreted to mean that when employeesfeel important and recognized, they exhibitgreater motivation to excel in their work activi-ties.

HUMAN RELATIONS


HUMAN RELATIONS AS A FIELD OF STUDY

Human relations is an interdisciplinary field be-cause the study of human behavior in organiza-tional settings draws on the fields ofcommunications, management, psychology, andsociology. It is an important field of study be-cause all workers engage in human relations ac-tivities. Several trends have given new impor-tance to human relations due to the changingworkplace.

The labor market has become a place of con-stant change due to the heavy volume of mergers,buyouts, a labor shortage, closings, and changingmarkets. These changes have been accompaniedby layoffs and the elimination of product lines.Even those industries noted for job security haverecently engaged in layoffs. As the United Statesattempts to cope with rapid technological changeand new competition from international compa-nies, there is every reason to believe that we willsee more volatility in the labor force. Interper-sonal skills will be even more critical in the fu-ture.

Organizations are developing an increasingorientation toward service to clients. Relation-ships are becoming more important than physi-cal products. Restaurants, hospitals, banks, pub-lic utilities, colleges, airlines, and retail stores allmust now gain and retain patronage. In anyservice firm, there are thousands of critical inci-dents in which customers come into contact withthe organization and form their impressions ofits quality and service. Employees must not onlybe able to get along with customers; they mustalso project a favorable image of the organizationthey represent.

Most organizations recognize improvedquality is the key to survival. The notion of qual-ity as a competitive tool has been around formany years, but today it is receiving much moreattention. In a period of fierce competition, aconsumer may not tolerate poor quality. Humanbeings are at the heart of the quality movementbecause workers are given the power and respon-sibility to improve quality.

Companies are organizing their workers intoteams in which each employee plays an impor-

tant role. If team members cannot work together,the goals of the organization will suffer. In somecases, workers are cross-trained so they can dothe work of others, if necessary.

The demographics of the workplace are alsochanging. Diversity is more and more typical. Inthe years ahead, a large majority of those enteringthe work force will be women and minorities.Passage of the American with Disabilities Act in1990 opened the employment door to more peo-ple with physical or mental impairments. And inthe future, we will see increased employment ofthe population over age sixty-five. Within thisheterogeneous work force, we will find a varietyof values and work habits. Supervisors will needto become skilled at managing diversity.

The leaders in today’s work force need differ-ent skills to be successful. The current generationof workers is better educated and better in-formed, and it also has higher expectations. Theyseek jobs that give not only a sense of accom-plishment but also a sense of purpose. They wantjobs that provide meaningful work. Today’smanagers must therefore shift from manager asorder-giver to manager as facilitator. They mustalso learn how to assume the roles of teacher,mentor, and resource person.

Few lines of work will be immune from thesetrends. Today’s employee must be flexible andadaptable in order to achieve success within aclimate of change. It is important for everyone todevelop those interpersonal skills that are valuedby all employers.

UNDERSTANDING HUMAN BEHAVIOR

Mental perceptions are influenced by everythingthat has passed through an individual’s mind.That includes all of a person’s experiences,knowledge, biases, emotions, values, and atti-tudes. No two people have identical perceptionsbecause no two people have precisely the sameexperiences.

Mental perceptions may sometimes lead toconflict. Each person has formed mental percep-tions relating to a number of controversial issues.For example, most workers have an opinion onabortion and capital punishment, among other

HUMAN RELATIONS


issues. When proponents and opponents clash invoicing mental perceptions of controversial is-sues, conflict occurs. If the issue is one pertinentto the workplace, such as affirmative action, hu-man values have the potential to lead to prob-lems.

Ethics also play a role in interpersonal con-flict. Ethics refer to moral rules or valuesgoverning the conduct of a person or group. Per-haps more than anything else, an individual’sadherence to values related to what is morallyright determines the respect that others hold forthat person. Lack of respect for one individual byanother is likely to lead to poor human relationsbetween the two.

The social dimension of behavior is deter-mined by a person’s personality, attitudes, needs,and wants. An individual’s personality is the to-tality of complex characteristics, including be-havior and emotional tendencies, personal andsocial traits, self-concept, and social skills. Theobjective of many training sessions for employeesand supervisors is to improve a person’s ability toget along with others. A person’s personality hasa major impact on human relations skills.

People reveal their attitudes through theirpersonality. An attitude is a mental position onepossesses with regard to a fact, issue, or belief.Attitudes that often present problems in theworkplace are those that concern biased and prej-udiced viewpoints. Generally, employees whopossess positive attitudes and who are open-minded are judged to have more desirable per-sonalities than those with negative attitudes whohold biased viewpoints.

COMMUNICATION

Perhaps the single most important aspect of de-signing any work environment is the plan thatlinks all workers and supervisors with multiplechannels of communication. Good communica-tion may be cited as the most important compo-nent of sound human relations. Despite the rec-ognition of the importance of communication, itpresents one of the most difficult and perplexingproblems faced in modern organizations.

Even in small organizations, where only a fewpeople are involved, sound communication isdifficult to establish. When an organization ex-pands in numbers, as well as in diversity amongits members, the establishment of communica-tion channels becomes even more difficult. Goodcommunication is essential for the smooth func-tioning of any organization. Managers need clearlines of communication to transmit orders andpolicies, build cooperation, and unify groups.Employees must be able to convey their concernsor suggestions and feel that management hasheard them. Clear communication among co-workers is vital to good teamwork, problemsolving, and conflict management. In short, ef-fective human relations is founded on good com-munication.

When people in organizations want to sendmessages, conduct meetings, or communicateperson to person, they have many options. Withincreased use of voice mail, e-mail, fax machines,and videoconferencing, it is a wonder peoplehave time to read all the incoming information,let alone interpret and respond to it.

Costly communication breakdowns are aprime factor in organizational problems rangingfrom high employee turnover to low productiv-ity. Poor communication also takes a toll in em-ployee injuries and deaths, particularly in indus-tries where workers operate heavy equipment orhandle hazardous materials.

Although some communication breakdownsare inevitable, many can be avoided. Employeeswho are treated with respect, are empowered tothink for themselves, and feel a sense of loyaltyare more apt to communicate openly with otherworkers and leaders throughout the organiza-tion.

TYPES OF RELATIONSHIPS

Human relations occurs on several levels. Indi-viduals interact in a variety of settings—as peers,subordinates, and supervisors. No matter whatthe setting, relationships are built. All types ofgroups exist in an organization. Formal groupsare officially designated, while informal groupsare formed unofficially by the members them-

HUMAN RELATIONS


selves. Some would argue the informal groupshave more power. In either situation, importanthuman relationships are taking place.

Employees relate to their work group, otherformal groups, and informal groups. The normsset by a group can greatly influence a person’sbehavior. Dress and language are two examples.Considering the number of groups in today’scomplex organizations, the influence is unlim-ited.

The organization provides an opportunityfor individual satisfaction. To achieve such satis-faction, and to continue as a successful memberin the organization, the individual must complywith organizational policies, procedures, andrules. The organization requires certain behav-iors from its employees. The rewards for suchbehaviors are demonstrated in the form of raises,promotions, and continued employment. Whenthe organization promotes an employee, it is re-lating to the individual.

Today’s complex organizations depend ondividing the work among many formalizedgroups. Informal groups will also emerge, eitherpositively or negatively affecting organizationaloutcomes. The relationship between organiza-tions and groups must also be considered whenquotas or standards are established. The accep-tance or rejection of such standards illustrates theinteraction between the organization and thegroup.

One also has a relationship to one’s self. Areyou happy with yourself? Are you happy withyour relationships with others? With the organi-zation? With your future? If not, perhaps youshould analyze your relationship with yourself.

Managers and supervisors achieve resultsthrough people. Therefore, today’s complex or-ganizations require managers and supervisors todisplay a concern for people. The successfulleader creates an effective balance between peopleand productivity, and recognizes human rela-tions as the key ingredient transforming organi-zational plans into organizational results. Al-though it is often misunderstood, effectivehuman relations will lead to success.

Human relations is not limited to supervi-sors—it applies to every employee in an organi-zation. Statistics indicate that successful peoplecompetently practice interpersonal skills, whilethe incompetent are left behind. Fortunately,these skills can be developed.

Good relationships must be built among in-dividuals and within groups of an organization.Although this is not an easy task, success withoutgood human relations in not possible. Every indi-vidual must be prepared to meet the challenge.

BIBLIOGRAPHY

Wray, Ralph, Luft, Roger, and Highland, Patrick. (1996).‘‘Fundamentals of Human Relations: Applications for Lifeand Work’’. Cincinnati, OH: Southwestern Publishing.

PATRICK J. HIGHLAND

HUMAN RESOURCEMANAGEMENT

Humans are an organization’s greatest assets;without them, everyday business functions suchas managing cash flow, making business transac-tions, communicating through all forms of me-dia, and dealing with customers could not becompleted. Humans and the potential they pos-sess drive an organization. Today’s organizationsare continuously changing. Organizationalchange impacts not only the business but also itsemployees. In order to maximize organizationaleffectiveness, human potential—individuals’ ca-pabilities, time, and talents—must be managed.Human resource management works to ensurethat employees are able to meet the organiza-tion’s goals.

‘‘Human resource management is responsi-ble for how people are treated in organizations. Itis responsible for bringing people into the orga-nization, helping them perform their work, com-pensating them for their labors, and solvingproblems that arise’’ (Cherrington, 1995, p. 5).There are seven management functions of a hu-man resources (HR) department that will be spe-cifically addressed: staffing, performance apprai-sals, compensation and benefits, training and



development, employee and labor relations,safety and health, and human resource research.

Generally, in small organizations—thosewith fewer than a hundred employees—theremay not be an HR department, and so a linemanager will be responsible for the functions ofHRM. In large organizations—those with a hun-dred employees or more—a human resourcemanager will coordinate the HRM duties andreport directly to the chief executive officer(CEO). HRM staff in larger organizations mayinclude human resource generalists and humanresource specialists. As the name implies, an HRgeneralist is routinely involved with all sevenHRM functions, while the HR specialist focusesattention on only one of the seven responsibili-ties.

Prior to discussing the seven functions, it isnecessary to understand the job analysis. An es-sential component of any HR unit, no matter thesize, is the job analysis, which is completed todetermine activities, skills, and knowledge re-quired of an employee for a specific job. Jobanalyses are ‘‘performed on three occasions: (1)when the organization is first started, (2) when anew job is created, and (3) when a job is changedas a result of new methods, new procedures, ornew technology’’ (Cherrington, 1995).

Jobs can be analyzed through the use of ques-tionnaires, observations, interviews, employeerecordings, or a combination of any of thesemethods. Two important tools used in definingthe job are (1) a job description, which identifiesthe job, provides a listing of responsibilities andduties unique to the job, gives performance stan-dards, and specifies necessary machines andequipment; and (2) the job specification, whichstates the minimum amount of education andexperience needed for performing the job(Mondy and Noe, 1996).

STAFFING

Both the job description and the job specificationare useful tools for the staffing process, the first ofthe seven HR functions to be discussed. Someone(e.g., a department manager) or some event (e.g.,an employee’s leaving) within the organization

usually determines a need to hire a new em-ployee. In large organizations, an employee requi-sition must be submitted to the HR departmentthat specifies the job title, the department, andthe date the employee is needed. From there, thejob description can be referenced for specific job-related qualifications to provide more detailwhen advertising the position—either internally,externally, or both (Mondy and Noe, 1996).

Not only must the HR department attractqualified applicants through job postings orother forms of advertising, but it also assists inscreening candidates’ resumes and bringing thosewith the proper qualifications in for an interview.The final say in selecting the candidate will prob-ably be the line manager’s, assuming all EqualEmployment Opportunity Commission (EEOC)requirements are met. Other ongoing staffing re-sponsibilities involve planning for new or chang-ing positions and reviewing current job analysesand job descriptions to make sure they accuratelyreflect the current position.

PERFORMANCE APPRAISALS

Once a talented individual is brought into anorganization, another function of HRM comesinto play—creating an environment that willmotivate and reward exemplary performance.One way to assess performance is through a for-mal review on a periodic basis, generally annu-ally, known as a performance appraisal orperformance evaluation. Because line managersare in daily contact with the employees and canbest measure performance, they are usually theones who conduct the appraisals. Other evalua-tors of the employee’s performance can includesubordinates, peers, group, and self, or a combi-nation of one or more (Mondy and Noe, 1996).

Just as there can be different performanceevaluators, depending on the job, several ap-praisal systems can be used. Some of the popularappraisal methods include (1) ranking of all em-ployees in a group; (2) using rating scales todefine above-average, average, and below-aver-age performance; (3) recording favorable and un-favorable performance, known as critical inci-



dents; and (4) managing by objectives, or MBO(Mondy and Noe, 1996).

Cherrington (1995) illustrates how perform-ance appraisals serve several purposes, including:(1) guiding human resource actions such as hir-ing, firing, and promoting; (2) rewarding em-ployees through bonuses, promotions, and so on;(3) providing feedback and noting areas of im-provement; (4) identifying training and develop-ment needs in order to improve the individual’sperformance on the job; and (5) providing job-related data useful in human resource planning.

COMPENSATION AND BENEFITS

Compensation (payment in the form of hourlywages or annual salaries) and benefits (insurance,pensions, vacation, modified workweek, sickdays, stock options, etc.) can be a catch-22 be-cause an employee’s performance can be influ-enced by compensation and benefits, and viceversa. In the ideal situation, employees feel theyare paid what they are worth, are rewarded withsufficient benefits, and receive some intrinsic sat-isfaction (good work environment, interestingwork, etc.). Compensation should be legal andethical, adequate, motivating, fair and equitable,cost-effective, and able to provide employmentsecurity (Cherrington, 1995).


Performance appraisals not only assist in deter-mining compensation and benefits, but they arealso instrumental in identifying ways to help in-dividuals improve their current positions andprepare for future opportunities. As the structureof organizations continues to change—throughdownsizing or expansion—the need for trainingand development programs continues to grow.Improving or obtaining new skills is part of an-other area of HRM, known as training and devel-opment.

‘‘Training focuses on learning the skills,knowledge, and attitudes required to initiallyperform a job or task or to improve upon theperformance of a current job or task, whiledevelopment activities are not job related, butconcentrate on broadening the employee’s hori-

zons’’ (Nadler and Wiggs, 1986, p. 5). Education,which focuses on learning new skills, knowledge,and attitudes to be used in future work, alsodeserves mention (Nadler and Wiggs, 1986).

Because the focus is on the current job, onlytraining and development will be discussed.Training can be used in a variety of ways, includ-ing (1) orienting and informing employees, (2)developing desired skills, (3) preventing acci-dents through safety training, (4) supplying pro-fessional and technical education, and (5) pro-viding supervisory training and executiveeducation (Cherrington, 1995).

Each of the training methods mentioned hasbenefits to the individual as well as to the organi-zation. Some of the benefits are reducing thelearning time for new hires, teaching employeeshow to use new or updated technology, decreas-ing the number and cost of accidents becauseemployees know how to operate a machine prop-erly, providing better customer service, improv-ing quality and quantity of productivity, and ob-taining management involvement in the trainingprocess (Cherrington, 1995). When managers gothrough the training, they are showing othersthat they are taking the goals of training seriouslyand are committed to the importance of humanresource development.

The type of training depends on the materialto be learned, the length of time learners have,and the financial resources available. One type isinstructor-led training, which generally allowsparticipants to see a demonstration and to workwith the product first-hand. On-the-job trainingand apprenticeships let participants acquire newskills as they continue to perform various aspectsof the job. Computer-based training (CBT) pro-vides learners at various geographic locations ac-cess to material to be learned at convenient timesand locations. Simulation exercises give partici-pants a chance to learn outcomes of choices in anonthreatening environment before applying theconcept to real situations.

Training focuses on the current job, whiledevelopment concentrates on providing activitiesto help employees expand their current knowl-edge and to allow for growth. Types of develop-



ment opportunities include mentoring, careercounseling, management and supervisory devel-opment, and job training (Cherrington, 1995).

EMPLOYEE AND LABOR RELATIONS

Just as human resource developers make sureemployees have proper training, there are groupsof employees organized as unions to address andresolve employment-related issues. Unions havebeen around since the time of the AmericanRevolution (Mondy and Noe, 1996). Those whojoin unions usually do so for one or both of tworeasons— to increase wages and/or to eliminateunfair conditions. Some of the outcomes ofunion involvement include better medical plans,extended vacation time, and increased wages(Cherrington, 1995).

Today, unions remain a controversial topic.Under the provisions of the Taft-Hartley Act, theclosed-shop arrangement states employees (out-side the construction industry) are not requiredto join a union when they are hired. Union-shoparrangements permit employers to hire non-union workers contingent upon their joining theunion once they are hired. The Taft-Hartley Actgives employers the right to file unfair labor prac-tice complaints against the union and to expresstheir views concerning unions (Cherrington,1995).

Not only do HR managers deal with unionorganizations, but they are also responsible forresolving collective bargaining issues—namely,the contract. The contract defines employment-related issues such as compensation and benefits,working conditions, job security, discipline pro-cedures, individuals’ rights, management’s rights,and contract length. Collective bargaining in-volves management and the union trying to re-solve any issues peacefully—before the unionfinds it necessary to strike or picket and/or man-agement decides to institute a lockout(Cherrington, 1995).

SAFETY AND HEALTH

Not only must an organization see to it thatemployees’ rights are not violated, but it mustalso provide a safe and healthy working environ-

ment. Mondy and Noe (1996) define safety as‘‘protecting employees from injuries caused bywork-related accidents’’ and health as keeping‘‘employees free from physical or emotional ill-ness’’ (p. 432). In order to prevent injury or ill-ness, the Occupational Safety and Health Admin-istration (OSHA) was created in 1970. Throughworkplace inspections, citations and penalties,and on-site consultations, OSHA seeks to en-hance safety and health and to decrease accidents,which lead to decreased productivity and in-creased operating costs (Cherrington, 1995).

Health problems recognized in theworkplace can include the effects of smoking,alcohol and drug/substance abuse, AIDS, stress,and burnout. Through employee assistance pro-grams (EAPs), employees with emotional diffi-culties are given ‘‘the same consideration andassistance’’ as those employees with physical ill-nesses (Mondy and Noe, 1996, p. 455).

HUMAN RESOURCE RESEARCH

In addition to recognizing workplace hazards,organizations are responsible for tracking safety-and health-related issues and reporting those sta-tistics to the appropriate sources. The humanresources department seems to be the storehousefor maintaining the history of the organization—everything from studying a department’s highturnover or knowing the number of people pres-ently employed, to generating statistics on thepercentages of women, minorities, and other de-mographic characteristics. Data for the researchcan be gathered from a number of sources, in-cluding surveys/questionnaires, observations, in-terviews, and case studies (Cherrington, 1995).This research better enables organizations to pre-dict cyclical trends and to properly recruit andselect employees.

CONCLUSION

Research is part of all the other six functions ofhuman resource management. With the numberof organizations participating in some form ofinternational business, the need for HRM re-search will only continue to grow. Therefore, it isimportant for human resource professionals to



be up to date on the latest trends in staffing,performance appraisals, compensation and bene-fits, training and development, employee andlabor relations, and safety and health issues—both in the United States and in the global mar-ket.

One professional organization that providesstatistics to human resource managers is the Soci-ety for Human Resource Management (SHRM),the largest professional organization for humanresource management professionals. Much of theresearch conducted within organizations is sent

to SHRM to be used for compiling internationalstatistics.

BIBLIOGRAPHY

Cherrington, David J. (1995). The Management of HumanResources. Englewood Cliffs, NJ: Prentice-Hall.

Mondy, R. Wayne, and Noe, Robert M. (1996). HumanResource Management. Upper Saddle River, NJ: Prentice-Hall.

Nadler, Leonard, and Wiggs, Garland D. (1986). ManagingHuman Resource Development. San Francisco: Jossey-Bass.

CHRISTINE JAHN



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