A general class of distortion operators for pricing contingent claims with applications to CAT bonds

ABSTRACT

The current paper provides a general approach to construct distortion operators that can price financial and insurance risks. Our approach generalizes the (Wang 2000) transform and recovers multiple distortions proposed in the literature as particular cases. This approach enables designing distortions that are consistent with various pricing principles used in finance and insurance such as no-arbitrage models, equilibrium models and actuarial premium calculation principles. Such distortions allow for the incorporation of risk-aversion, distribution features (e.g. skewness and kurtosis) and other considerations that are relevant to price contingent claims. The pricing performance of multiple distortions obtained through our approach is assessed on CAT bonds data. The current paper is the first to provide evidence that jump-diffusion models are appropriate for CAT bonds pricing, and that natural disaster aversion impacts empirical prices. A simpler distortion based on a distribution mixture is finally proposed for CAT bonds pricing to facilitate the implementation.     

Rethinking IT governance: Designing a framework for mitigating risk and fostering internal control in a DevOps environment

An increasing amount of companies is transforming their IT departments towards cross-functional teams which are responsible for both development and operation of software and use automation to speed up their delivery process. This novel approach, which is commonly known as “DevOps”, promises many benefits such as increased speed and frequency of deployment. However, companies using DevOps are often struggling with demonstrating control of their software delivery processes to IT auditing parties, due to the decentralized decision-making structures and high degree of automation in DevOps teams. The research at hand presents a framework which aims to provide guidance to organizations in mitigating and governing risks in IT teams and departments that make use of the DevOps paradigm. We have adopted a design science research approach, building on a literature review and semi-structured interviews with seventeen employees from nine Dutch companies that are in different stages of their DevOps transition. The results suggest that two main factors which influence how departments design their DevOps environment are risk appetite and the DevOps maturity. We furthermore find that companies in practice often use a mixture of traditional, manual IT controls and the automated controls suggested in literature. Based on these insights, a situational control framework is designed which suggests suitable risk mitigation practices.     

The Economics of Organizational Architecture

Drawing on the work of Michael Jensen and William Meckling, the co‐formulators of “agency cost theory,” the authors argue that there are two main challenges in designing the structure of organizations: (1) the “rights assignment” problem—that is, ensuring that decision‐making authority is vested in managers and employees with the “specific knowledge” necessary to make the best decisions; and (2) the “control” or “agency” problem—designing performance‐evaluation and reward systems that give decision‐makers strong incentives to exercise their decision rights in ways that increase the long‐run value of the organization. The authors provide a number of instructive applications and extensions of the Jensen‐Meckling organizational framework. Using a series of short case studies that range from the Barings Brothers' debacle in the early 1990s and the decade‐long restructuring of ITT to the cases of McDonald's and Century 21, the authors demonstrate the importance of designing performance‐measurement and reward systems that are consistent with the assignment of decision rights. In so doing, the authors also work to dispel the widespread notion, popular among advocates of Total Quality Management, that the widespread use of performance measures and incentives undermines efforts to promote teamwork within large organizations. A number of brief case histories of companies like Xerox and Mary Kay Cosmetics are used to show the critical role of performance measurement and individual rewards in reinforcing a quality‐centered corporate culture. As the authors conclude, “It is a mistake to think of the ‘soft’ and ‘hard’ aspects of organizations as mutually exclusive or even as competing.”     

Information system integration,enabling control and performance

The literature has demonstrated the complex relationship between information system integration approaches, such as Enterprise Resource Planning systems, and management control. In this paper, we begin our analysis by focussing on just one aspect of information system integration, namely in terms of data architecture, commonly referred to as the single database concept. We argue that whilst this particular aspect of integration should be related to perceived system success, the variety of ways in which information might be drawn on in practice means it provides no strong basis for predicting a link to business unit performance. Instead, building on Adler and Borys [Adler, P., & Borys, B. (1996). Two types of bureaucracy: Enabling and coercive. Administrative Science Quarterly, 41(1), 61–90] we argue that the level of information system integration fosters the four design characteristics that make up an enabling approach to management control. Each of these in turn is related to both perceived system success and business unit performance. We present PLS analysis of survey data collected from 169 managers that broadly supports these expectations.     

Comparing the performance of market-based and accounting-based bankruptcy prediction models

Recently developed corporate bankruptcy prediction models adopt a contingent claims valuation approach. However, despite their theoretical appeal, tests of their performance compared with traditional simple accounting-ratio-based approaches are limited in the literature. We find the two approaches capture different aspects of bankruptcy risk, and while there is little difference in their predictive ability in the UK, the z-score approach leads to significantly greater bank profitability in conditions of differential decision error costs and competitive pricing regime.     

The role of management control systems in planned organizational change: An analysis of two organizations

In the management control literature there is growing interest in the role of management control systems (MCS) in planned organizational change. The existing literature is concerned with either rational, technical change principles or more social and political interpretations of MCS facilitated change. This paper aims to extend this literature by combining technical approaches to MCS facilitated change with a behavioral approach in the study of two similar organizations. Moreover, the paper employs a holistic approach to change to develop a comprehensive understanding of the role of MCS in planned organizational change. A framework by Huy [Huy, Q. N. (2001). Time, temporal capacity, and planned change. Academy of Management Review 26(4), 601–623] is used to provide an integrative approach that focuses on both rational, systematic practices and the behavioral processes involved in their implementation. This is achieved by identifying four idealized intervention types: commanding, engineering, teaching and socializing. Understanding the application of these four intervention types requires analysis of the way they interact through time.     

Divestment and the Control of Divisionalised Firms

Increasing attention has recently been devoted in the accounting literature to the control of divisionalised firms. The general thrust of this literature is to take a uni-directional view of the development of organisations, so that adequate control requires finding an optimal divisionalisation of existing activities.

This paper shows that this approach misses an important managerial decision variable. Hence, rather than striving to develop increasingly complex systems, a solution to the control problem may be aided by the divestment of ill-fitting activities. The paper analyses the conditions where divestment may be an appropriate course of action for organisational management.     

Why is management a cliché?

This article introduces the term demotics of management by asking why so much management literature reads like a cliché. Typically this question has been approached by seeing the cliché as strategic. This article instead views the cliché as symptomatic. It marks a growing problem—how can management track labor out of the workplace and into the realm of social reproduction, a realm that is increasingly, with the tendency of immaterial labor, directly productive. This problem has produced not only the explosion of popular management literature, particularly in the United States, in the last 20 years, but also what might be called a demotics of management. This term may be understood as the proliferation of places where labor-power might be found. But the term also names management’s growing limits when faced with the dispersion and intensification of what Marx called the social individual. Management cannot adequately measure the labor it finds, and therefore must resort to miraculating what it encounters, to use a concept from the collaboration of Gilles Deleuze and Felix Guattari. The crisis of measurement brought on by the growing dominance of what Marx named the General Intellect is a profound challenge not only to management but specifically to its recording-machine, accounting. With the mounting crisis in recording, the very frenzy of popular management discourse reveals more than ever the threat that social reproductive labor already possesses the sociality to value itself differently and independently. The demotics of management thus marks both the proliferation of management in daily life, but also the prior, or what C.L.R. James might have called the completed, organization of immaterial labor that management encounters. Left to repeat what is already completed management can only utter the cliché, however, manically. At the same time, the cliché in management literature does mark the accomplishment of the circuit of exchange value, as it has since Taylor, even as it hints at the possibility of the separation from capital of a mass intellectuality where socialized labor may come to account for itself.     

Management control packages: a literature review and guidelines for public sector research

ABSTRACT

The effectiveness of a management control (MC) element, such as performance measurement, may depend on other MC elements, such as organizational values and training activities. This is why MC elements should be studied ‘as a package’, instead of as isolated elements. Although examining MC elements as a package has the potential to make significant contributions to ongoing debates, this approach is largely absent in the academic public sector management literature. This paper reviews the MC package literature, examines its implications for public sector research and practice, and aids future research by discussing research design choices and research directions.     

Developing performance-measurement systems as enabling formalization: A longitudinal field study of a logistics department

This paper reports on a developmental approach to performance-measurement systems (PMS). In particular, we look at characteristics of a development process that result in the PMS being perceived by employees as enabling of their work, rather than as primarily a control device for use by senior management. We will refer to such a PMS as “enabling PMS”. The theoretical part of the study builds on ideas of enabling versus coercive formalization [Adler, P. S., & Borys, B. (1996). Two types of bureaucracy: Enabling and coercive. Administrative Science Quarterly 41 (March), 61–89]; on notions of organizational learning (e.g., [Zollo, M., & Winter, S. G. (2002). Deliberate learning and the evolution of dynamic capabilities. Organization Science 13(3), 339–351]); and on awareness of the incompleteness of performance measures (e.g., [Chapman, C. S. (1997). Reflections on a contingent view of accounting. Accounting, Organizations and Society 22, 189–205; Lillis, A. M. (2002). Managing multiple dimensions of manufacturing performance—An exploratory study. Accounting, Organizations and Society 27, 497–529]). The empirical context entails a mixed-method, 3-year longitudinal study of the logistics department of a medium-sized company in the beverage manufacturing industry. Qualitative data were gathered through interviews, participation in meetings, action research, and review of company documents. We also analyzed two waves of quantitative survey data, gathered from a panel of 42 employees. We find that a development process that is experience-based contributes to the enabling nature of the PMS, as it builds on existing skills, local practices, and know-how on performance measurement to enrich the PMS step-by-step over time. Also, experimentation with specific performance measures was found to enhance the enabling nature of the PMS: testing, reviewing, and refinement of conceptualizations, definitions, data, and presentations of new performance measures. Professionalism was significantly related to positive attitude toward performance measures in our survey data. The results also illustrate that transparency of the PMS itself is key to enabling PMS.     

Quadratic minimization with portfolio and intertemporal wealth constraints

We address a problem of stochastic optimal control motivated by portfolio optimization in mathematical finance, the goal of which is to minimize the expected value of a general quadratic loss function of the wealth at close of trade when there is a specified convex constraint on the portfolio, together with a specified almost-sure lower-bound on intertemporal wealth over the full trading interval. A precursor to the present work, by Heunis (Ann Financ 11:243–282, 2015), addressed the simpler problem of minimizing a general quadratic loss function with a convex portfolio constraint and a stipulated almost-sure lower-bound on the wealth only at close of trade. In the parlance of optimal control the problem that we shall address here exhibits the combination of a control constraint (i.e. the portfolio constraint) together with an almost-sure intertemporal state constraint (on the wealth over the full trading interval). Optimal control problems with this combination of constraints are well known to be quite challenging even in the deterministic case, and of course become still more so when one deals with these same constraints in a stochastic setting. We nevertheless find that an ingenious variational approach of Rockafellar (Conjugate duality and optimization, CBMS-NSF series no. 16, SIAM, 1974), which played a key role in the precursor work noted above, is fully equal to the challenges posed by this problem, and leads naturally to an appropriate vector space of dual variables, together with a dual functional on the space of dual variables, such that the dual problem of maximizing the dual functional is guaranteed to have a solution (or Lagrange multiplier) when the problem constraints satisfy a simple and natural Slater condition. We then establish necessary and sufficient conditions for the optimality of a candidate wealth process in terms of the Lagrange multiplier, and use these conditions to construct an optimal portfolio.     

Metaphors,semiotics and futures studies

Metaphor belongs to key concepts of semiotics. I have made my career in the field of semiotics and I appreciate the possibility to tell to the scientific community of futurists how a semiotician sees the various functions of metaphors and their connections to the future. The edited volume CLA 2.0 (Inayatullah & Milojevic, 2015) shows that in addition to metaphors, many futures researchers have found the general language-based approach of semiotics. The paper deals with three issues: first the theory of metaphors as such, much discussed in the semiotic literature; then what semiotics says about the future; and finally, what kind of semiotics we are considering here. I would propose to scrutinise the problem of metaphors and future in light of my own new theory which I call ‘existential semiotics’.     

The real estate takeover: Application of Grossman and Hart theory

In this article, I adopt a corporate takeover model to the problem of a developer who wants to renew an urban neighborhood. The problem outlined is a combination of the problems addressed by Grossman and Hart (1980)(. The Bell Journal of Economics 11, 42–64) and Shleifer and Vishny (1986)(. Journal of Political Economy 94, 461–488) in the corporate control literature. The relevant corporate story concerns value-improving monitoring performed by shareholders. Even though monitoring increases the value of the company for each investor, no shareholder would be willing to do it because there is an externality involved. Translating this into the language of urban redevelopment, no homeowner would do any improvement in the neighborhood unless he or she can internalize the benefit. The story in the urban renewal framework is more complicated. These property owners may differ in their valuation of even otherwise identical units since the owners may have different attachments to the neighborhood. I address some of these problems and also introduce the notion of dilution as the participating government agency's ability to force initial residents to sell to the developer or comply with costly new standards for development. Dilution increases the costs to potential holdouts.     

Bank privatization in developing countries: A summary of lessons and findings

Although a large and growing literature shows that privatization can improve the performance of non-financial enterprises, there is less evidence on how it affects the performance of the banking sector. This paper summarizes the results from the papers in the special issue of the Journal of Banking and Finance on bank privatization. It concludes that although bank privatization usually improves bank efficiency, gains are greater when the government fully relinquishes control, when banks are privatized to strategic investors, when foreign banks are allowed to participate in the privatization process and when the government does not restrict competition.     

No-arbitrage Near-Cointegrated VAR(p) term structure models,term premia and GDP growth

The recent macro-finance literature does not agree either about the empirical properties of the expectation part and of the term premium on long-term bonds or about the importance or even the direction of the relationship between the term premium and future economic activity. This paper proposes a two-step approach to handle both problems. First, in a VAR setting, we extract a reliable measure of the term premium by means of averaging estimator techniques aiming at optimally solving prediction problems when highly persistent processes are present and, thus, providing a so called Near-Cointegrated VAR(p) approach. Second, we analyze the dynamic response of GDP to shocks to the term premium by using the New Information Response Function concept. As far as the first problem is concerned, we find that the NCVAR-based term premium measure is rather stable and counter-cyclical, as suggested by interest rates survey-based estimation of yield curve models and by its risk compensation role. Regarding the second problem, we find that an increase in the long-term spread caused by the term premium induces two effects on future economic activity: the impact is negative for short horizons (less than 1 year), whereas it is positive for longer ones.     

Trading volume and firm-specific announcements: Implications for the market model

The market model is commonly used in finance to study events and to evaluate security performance. With daily data, it is not uncommon to find low R-squares, in the range 0–10%. Prior studies have attempted to improve the fit of the model by excluding observations associated with high trading volume. In this study, we compare the results of the high-volume-exclusion approach with the more direct firm-specific announcement exclusion approach. The announcement approach excludes observations associated with Wall Street Journal Index news items regarding the firm. By excluding the [−1,0] fays relative to such news in a sample of 68 firms, we find that R-squares increase significantly by about 5%. By excluding the days relative to earnings announcements only, R-squares increase by about 4%. These results are then compared to the high-volume-exclusion approach. It is found that this approach is more efficient as an 8% increase in R-squares is produced.The results of this study provide valuable evidence to empiricists by comparing the two approaches to improving the fit of the market model. The high-volume -exclusion approach provides higher R-squares. However, the relative efficiency of the two approaches should be balanced against the arguments for the methodologically correct approach. The advantage of using the firm-specific announcement exclusion approach is that there is more confidence of excluding only firm-specific movements from the estimation of the market model. It also allows a researcher to quickly and unambiguously identify the announcements and delete the corresponding observations. Furthermore, we find that about 50% of the improved fit, relative to the volume approach, can be accomplished by excluding earnings announcements. The methodological disadvantage of using the high-volume-exclusion approach is that it is affected not only by firm-specific announcements but also by other factors, such as the heterogeneity of investor expectations. These factors may influence the choice of using firm-specific announcements rather than the high-volume approach despite the lower increment in R-squares.     

The role of environmental disclosures as tools of legitimacy: A research note

Legitimacy theory suggests companies with poorer environmental performance would be expected to provide more extensive off-setting or positive environmental disclosures in their financial reports. However, recent investigations of the performance/disclosure relation [Al-Tuwaijri, S. A., Christensen, T. E., &; Hughes II, K. E. (2004). The relations among environmental disclosure, environmental performance, and economic performance: a simultaneous equations approach. Accounting, Organizations and Society, 29, 447–471; Hughes, S. B., Anderson, A., &; Golden, S. (2001). Corporate environmental disclosures: are they useful in determining environmental performance? Journal of Accounting and Public Policy, 20, 217–240; Hughes, S. B., Sander, J. F., &; Reier, J. C. (2000). Do environmental disclosures in US annual reports differ by environmental performance? Advances in Environmental Accounting and Management, 141–161; Patten, D. M. (2002). The relation between environmental performance and environmental disclosure: a research note. Accounting, Organizations and Society, 27, 763–773] report mixed results. In this study, we use size-matched groups based on industry membership (environmentally sensitive versus non-environmentally sensitive) and environmental performance (worse performers versus better performers, based on data from KLD Research and Analytics, Inc.) to test for differences in the use of monetary and non-monetary non-litigation related environmental disclosure. Results indicate that the use of monetary and non-monetary components of the non-litigation related environmental disclosure varies across groups. In general, the findings provide additional support for the argument that companies use disclosure as a legitimizing tool.     

A Group Utility Maximizer Mechanism for Land Assembly

Buyers requiring large parcels of land for development purposes engage several owners in a bilateral trade seeking monetary payment in exchange for land – a business transaction most often referred to in the literature as the problem of land assembly. To avoid the holdout problem which is a typical consequence of such negotiations necessitates a good pricing strategy that meets the subjective valuation considerations of the owners and protecting property rights to warrant a fair and efficient outcome. Several approaches have been proposed in the literature that includes contributions from game theory in the form of Nash bargaining, Bayesian theory for incomplete information, auction theory and Mechanism Design which have individually enriched this field and proposed credible solutions. In this paper, we consider a setting that has a single buyer and N sellers. We take a Mechanism Design approach to study the assembly problem in a utilitarian framework, where we associate risk-averse utility functions with the sellers. Given a set of reserve prices reported by sellers, and their risk-aversion behaviour, we seek an incentive-compatible mechanism that simultaneously maximizes the sum of individual expected utilities while delivering a Pareto optimal per-seller penalty-reward structure. We show how this mechanism, inspired and adapted from the actuarial Risk Exchange concept in the Insurance industry, can be fruitfully applied to the land assembly problem, yielding an efficient and optimal solution to the holdout problem, while making very minimal demands on knowledge of sellers valuations. The working of the mechanism is illustrated with a simple example.     

Enhancement of value investing strategies based on financial statement variables: the German evidence

This paper examines the added-value of combining traditional valuation ratios with each other as well as with some financial statement variables in the German stock markets during the 2000–2015 period. The results show that combination pays off and, moreover, that the benefits of combination are greater in Germany than in most other developed stock markets. Particularly, we find strong evidence of the added-value of using Piotroski’s F-score as a supplementary selection criterion for value stocks as well as for low-accrual stocks. Our results show further that the F-score also boosts the efficacy of other valuation ratios besides the book-to-price ratio. In addition, the inclusion of F-score besides a relative value measure tends to increase the average market equity of portfolio firms. The decomposition of the full-sample-period performance into separate bull- and bear-period performance shows clearly that the better performance of F-score-boosted portfolios is mostly attributable to their outperformance during bearish periods, even though on average, they also generate higher bull-period returns than the comparable value portfolios formed without F-score. The use of F-score as a supplementary criterion also increases the proportion of stocks that earn above-market-average returns during the subsequent holding period. For the first time in the financial literature, we also document a strong relationship between high F-score stocks and momentum stocks.     

The determinants of companies’ levels of integration: Does one size fit all?

This article extends current knowledge in the field of integrated thinking and reporting (ITR) by providing new empirical evidence on the nature and determinants of companies' levels of integration (i.e. ITR levels). Based on legitimacy theory and stakeholder theory, we empirically investigate companies' levels of integration and examine the drivers of different ITR levels. Our results suggest that companies' levels of ITR, namely Holistic, Integrated, Conservative, and Minimalist, are related to company characteristics and tend to remain consistent over time exhibiting routine and imitation. Companies with greater size, leverage, bigger board size and meetings, as well as companies operating in sensitive industries and with higher environmental performance are more likely to exhibit a Holistic or Integrated level of integration, while Minimalist and Conservative levels are driven by the same variables in opposite direction. Furthermore, at country level, economic growth, market performance, citizens freedom and lower environmental performance significantly contribute to higher integration. These results could drive companies' choices alongside policymakers’ initiatives, by identifying which levers should be pulled to achieve the desired level of integration, and suggest the need for a tailored approach rather than a one size fits all within the debate on the future developments of ITR.