By: Daniela Ruiz

The successful performance of a new company depends on many factors, among them the design of the product or service, the structural costs and expenses, definition of a financial plan, the structure and competitive climate of the industry, the characteristics of the entrepreneur, and the definition of a business model and strategies to be followed. This article will focus on the importance of defining a business model for value creation and the relationship that model has with the development of the company’s strategies.

Normally, entrepreneurs limit themselves to preparing a business plan. In recent years, however, the concept of business model has become increasingly popular. The emergence of innovative ways of doing business has forced entrepreneurs to reflect more deeply on the design of an innovative and sustainable model that will generate value for their customers, society and their investors.

So the questions we need to answer are: what is the difference between a business plan and a business model? What links are there between a business model and value creation? What companies have designed an innovative business model? And what is the link between the company’s business model and its strategy?

To answer these questions, we will begin by discussing the business plan. This well-known document usually runs between 50 and 100 pages and lists critical aspects in the industry, the market and the company, as well as the basic assumptions on funding needs and financial projections. The plan should contain at least the following sections: a) description and analysis of the industry, competition and proposed products or services that the new company will offer; b) market research and strategic positioning analysis; c) economics of the business; d) marketing plan; e) operating plan; f) human resources plan; and g) financial plan.

Briefly put, the business plan is a useful tool that has two primary purposes: first, to clearly document the business opportunity and guide the entrepreneur’s actions in seeking to take advantage of the identified opportunity; second, to communicate the business opportunity to prospective investors, the amount of resources needed to undertake the project, and the expected economic results of their investment.

Inevitably, the question arises: is it indispensable for all entrepreneurs to prepare a business plan? The answer is: not necessarily. There are successful companies that began operating without one. But the process of developing the plan is an invaluable exercise that can help the entrepreneur to analyze the business proposal in a systematic way.

So if the business plan is a complete and useful tool, why do we need to also design a business model? The answer is clear: designing a business model promotes innovation, and therefore value creation for the company, its customers and its stakeholders. The speed with which these innovative models have transformed some industries is unprecedented; today, definition of an innovative business model is crucial. Even though a product or service may not in itself be innovative, the model and the strategies applied to sell it may be. A single product, service or technology can have various business models, so it is crucial to develop the one that results in the greatest value creation. In fact, many of the world’s most innovative and creative companies have not sold innovative product services, but rather have sold them so successfully that they have generated tremendous value and even revolutionized their industries, based on innovative business models. Some examples of this are Apple in the sale of music, Skype in the sale of telephone calls, Netflix in the sale and rental of movies, Twitter and Facebook in social networks and Groupon in the sale of discount coupons, to name just a few.

It is important to be aware that the business model must be conceived of before the business plan is completely prepared; in fact, it should be the first step, once the business opportunity is identified. The business model will specify how the company works, how it will generate money and how it will create value; it is a program of action that identifies the process of value creation and serves as a template for applying strategies to organizational structures, processes and systems. One definition of the business model, following the author Alexander Osterwalder (2010) is that it describes the rationale of how a company creates, delivers and captures value. This model must be innovative, profitable and scalable, in order to seek out alternative strategies for carrying it out.

According to Osterwalder, a business model is composed of nine main building blocks, which cover the four central areas of the company: customers, product or service proposition, infrastructure and financial viability. The nine building blocks are as follows:

1. Customer segments: defines the different groups of persons or organizations the company seeks to reach and serve. A company can serve one or more customer segments. The key questions are: Who are we creating value for? Who are the most important customers?
2. Value proposition: describes the set of products or services that create value for a specific customer segment. The company must seek to solve a problem for its customers and satisfy their needs with value proposals. The question to ask is: What value are we giving the customer? What problem are we solving the customer? What need are we meeting? What type of product or service are we delivering to each segment?
3. Distribution channels: describes how the company will reach and communicate with the customer segment in order to deliver its value proposal. Value proposals may be delivered to customers through communication, distribution or sales channels. The questions are: What channels do our customer segments prefer? How are we reaching them? How are our channels made up? Which work better? Which are the most efficient in terms of cost-benefit? How are we becoming part of our customers’ routine?
4. Customer relationships: describes the type of relations the company seeks to establish and maintain with its specific customer segments. The questions to ask are: What type of relationship does each customer segment expect us to establish and maintain with them? How is this integrated with the rest of the business model? How much does it cost to retain each customer?
5. Revenue streams: represents the money that the company generates from each customer segment. Revenue flows are the result of the value proposal delivered successfully to the customers. The questions are: What is the most our customers would be willing to pay? Is the perceived benefit greater than the price? How much are they paying at present? How are they paying at present? How do they prefer to pay? How does the revenue flow contribute to total revenues?
6. Key resources: details the most important activities that are required to make the business model work and to be able to offer and deliver these elements. The question is: What key resources are required to attain our value proposal?
7. Key activities: describes the most important things the company must do to make its business model work. The question is: What key activities are required to achieve the value proposal?
8. Key partners: defines the network of suppliers and partners to make the business model work. The questions to ask are: what alliances must we form to achieve our value proposal? Who are our suppliers? What resources and key activities are needed from the alliances?
9. Cost structure: details the most important costs incurred in operating the business model. The questions are: what are the biggest costs inherent in the business model? What key resources and activities are the most expensive? Can we obtain economies of scale? Is it possible to obtain economies of scope?

Therefore, while the business plan is an extensive and detailed document, the business model describes a system of interlocking pillars for the company. The model can be visualized as a nine-block diagram, with an emphasis on the link between each of them toward a final goal: value creation. The following is one business model diagram:

Once the business model is conceived, the entrepreneur can create alternatives and strategies to put it into practice. Note that the business strategy and business model are not the same thing, even though both terms are often used interchangeably, since the latter does not include a critical dimension of performance: competition. However, decision makers will find it easier to design strategies to make their business model work and, at the same time, it will help them to identify various strategies to differentiate themselves, to achieve a sustained competitive advantage, and to create value.?

References:

Osterwalder, A. y Pigneur, Y. (2010). Business Model Generation. John Wiley & Sons.

Timmons, J. A. y Spinelly, S. (2008). New Venture Creation, Entrepreneurship for the 21st Century.

Magretta, J. (2002). “Why business models matter”. Harvard Business Review.

(2011). “The World’s Most Innovative Companies 2011″. FastCompany Magazine, No. 153.

By: Dr. Marco Alberto Huidobro

For decades, the governments of many countries have explored different ways to improve companies’ access to bank credit. In Mexico, one of the most popular strategies has been government participation in the credit market in order to channel financial resources from government-run development banks and promotion trusts to private companies.

But for years, there have also been questions about the role that government financial institutions play in promoting access to credit for private companies; some believe, for example, that their actions benefit primarily state-owned companies themselves, or that they do not share information that would encourage more lending by private banks. There even seems to be a lack of evidence that they encourage private banks to seek out new clients.

Following this debate, Cotler said that “if development banks were placing resources in sectors with little access to commercial bank credit, it should be possible to detect significant differences between development bank and commercial bank borrowers.” This is particularly significant since, if there is no difference between the type of borrowers served or credits offered by private and government banks, there would be little economic justification for government intervention in this market. In other words, if development banks simply replicate commercial bank practices, by definition they would not be promoting either increased access or improved efficiency in the credit market.

With this in mind, our study was developed based on the following research question:

Are there substantive differences between the characteristics of borrowers served and credits granted by the commercial banks and development banks to companies in the private sector?

The initial hypothesis of this paper is that there are no significant differences between the borrowers or the credits extended by development banks and commercial banks.

To verify this hypothesis, we analyzed the recent status of bank financing to companies in Mexico (what is called Bank Commercial Lending), based on an extensive database of more than 1.6 million records of loans extended by private and government banks as of December 2007. The information is nationwide in coverage and incorporates loans to companies, individuals with business activity and government entities, to fund productive activities in the farming, mining, manufacturing, industrial, retail, services and financial services industries. The main interest of this paper is in loans to private-sector companies and individuals with business activities.

Our analysis contributes evidence that suggests the existence of significant differences between the types of borrowers and the loans granted by commercial and development banks in Mexico. On a more detailed level, the comparison clearly indicates the following:

• For any size of company, commercial banks lend more on average than development banks.
• In general, there is a direct relationship between the average size of the credit and the size of the borrower.
• In general, Mexican banks do not require collateral on their loans, and almost all cases of collateralized loan corresponded to commercial banks, which also demanded the highest degree of preference on that collateral.
• Government banks apply lower interest rates than their private counterparts, and apparently not because of lower funding costs.
• Generally speaking, government banks offer longer repayment terms than commercial banks, and there is a more marked difference in the micro and mid-sized borrower segments.
• Neither government nor private banks lend to borrowers in existence for less than two years, and both concentrate their loans on businesses that have been operating for more than 15 years. Therefore, it would seem that development banks do not necessarily improve access for younger borrowers to the bank credit market.
• More than 95% of bank borrowers are in urban areas, which could indicate a possible exclusion of rural areas from bank credit. But it may also reflect a heavy concentration of added value generation in urban areas, or the concentration of bank borrowers’ corporate domiciles in urban areas, meaning they tend to legally establish themselves in cities.
• Most of commercial bank financing goes to support borrowers’ short-term needs, whether for working capital with no specific use, or for other immediate needs, but not necessarily for investment, expansion or modernization of their productive facilities; this may inhibit their future possibilities for growth and increased competitiveness.

Subsequently, the study extends the initial hypothesis and argues that there are no relevant differences between the key factors that determine the interest margins that private and government banks charge on their loans to the private business sector.<br

Specifically, the document empirically studies whether development banks replicate the lending criteria followed by private banks by comparing how their interest rates, or better yet, their net interest margins, respond to differences in the same set of characteristics of loans and borrowers.

In examining loan characteristics, the study took into account the type of lending institution, the existence of collateral backing the loan, the balance, term and use of the proceeds. The characteristics of borrowers that were taken into account for the study were: whether it was an individual or corporation, its years of operation, size, economic activity and whether it was domiciled in a rural or urban area.

Once again, the study found signs of significant differences between the main factors that determine the interest margins that private and government banks assign to private-sector borrowers. Therefore, the results refute the original hypothesis and enable us to affirm that government banks do, in fact, perform a function that does not necessarily respond to the principles of private-sector profitability guiding commercial banks. In general, we found that the main factors that determines interest margins were, by order of importance, the following:

1. The type of bank lending institution-private banks apply much higher interest margins than development banks.
2. The type of borrower-corporate borrowers pay a lower interest margin than individuals.
3. Collateral-borrowers that put up collateral are assigned considerably lower interest margins than those who do not.
4. The size of the borrower-the larger the borrower, the lower the interest margin.
5. The use of the proceeds-loans that support liquidity requirements were assigned the highest interest margins.
6. The economic activity of the borrower-interest margins rise according to borrowers’ occupation in the primary, secondary and tertiary sectors, in that order, and the highest interest margins are charged to retail and services, in general.

Furthermore, to understand some of the differences in determining factors for both types of bank, the study proposes the following classification:

Institutionally determined differences. Commercial banks offer the lowest interest margins to borrowers in the farming sector; development banks offer the lowest interest margins to financial sector borrowers. These differences are determined exogenously, because the government has for years decided that development banks that serve the agricultural sector (special agricultural trusts called FIRA and Financiera Rural) act as second-floor lenders. The financial industry (which in the database used refers particularly to non-bank financial intermediaries) channels preferential funding, primarily and above all from Nacional Financiera, to companies and individuals engaged in activities outside of the primary sector.

Differences in the term of the loan and the use of the proceeds. Development banks set interest margins significantly lower than those set by private banks, on loans at terms longer than two years, as well as those for the purposes of investment, expansion or modernization of protective facilities, which is compatible with the traditional functions of development banks. However, the benefits of this practice may be very limited, because less than half of loans by public banks were placed at terms of more than two years. In fact, both private and government banks assigned more than 95% of their loans at terms of less than five years.

Differences of degree. Some of the differences are actually merely differences of degree or magnitude, because they follow the same direction. This is the case of the observed reductions in interest margin as the size of the borrower increases. On the other hand, neither commercial or development banks lend to borrowers with less than two years of business experience, and both concentrate their loans in corporations and individuals operating for more than 15 years.

Conclusions

There are three central conclusions to this paper. First, Mexican development banks do not always act in the same way as private banks in their lending practices. Specifically, there are some differences between the characteristics of the credits they extend and among the borrowers that each type of bank serves. Second, there is not enough evidence to affirm that government banks set the interest margins on their loans in the same way that commercial banks do. Third, this does not necessarily mean that development banks are mitigating imperfections in the market that create problems of credit accessibility.

Accordingly, Doctor Huidobro’s study contributes empiricl evidence for evaluating the contribution of government banking institutions to the lending market in Mexico.?

References

Werner, M. (1994). “La banca de desarrollo 1988-1994: balance y perspectivas”, Comercio Exterior, Vol. 44, No. 12, diciembre.

Armendáriz, B. (1999). “Development Banking”. Journal of Development Economics, Vol. 58, February.

Benavides, G. y Huidobro, A. (2009). “Are Loan Guarantees Effective?: The Case of Mexican Government Banks”. Well-Being and Social Policy, Vol. 5, No. I, México.

Cotler, P. (2000). “El comportamiento de la banca de desarrollo en México y su compatibilidad con la política económica”. En El futuro de la banca de desarrollo: el reto del fomento económico. Federalismo y desarrollo, Año 13, No. 69, julio-agosto-septiembre, Banco Nacional de Obras y Servicios Públicos, México.

Sapienza, P. (2004). “The Effects of Government Ownership on Bank Lending”. Journal of Financial Economics, No. 72.

In order to survive, human beings must be capable of carrying out three related activities: sensing events (also called stimulation), assessing the stimulus, and responding to that stimulus. An environmental stimulus is some feature of the environment that alerts the senses-for example, the colors of a stoplight, the smell of smoke or the sound of an ambulance siren-and provokes a response. The stimulus is in turn detected by receptors, which are specialized cells in the nervous system sensitive to these stimuli. When receptors are activated, the person experiences one or more sensations, which are basic aspects of perception.

Perception is one of the four elements of human conduct, along with motivation, thought and learning. Perception is the process of organizing and trying to understand the sensorial stimulation we receive, so it is an element that places individuals in contact with the world around them. If receptors do not receive stimulation from the environment or are unable to process it, no information will be transmitted to the brain, and perception will not occur. For example, the colorblind cannot express their perception about a color, because they are not sensitive to this type of information. A deaf person who fail to perceive certain sounds depending on the degree of deafness, so the stimulation will be incomplete.

Throughout modern history, most people have believed that vision is the most important sense, because when asked which of their senses it will be most painful to lose, almost all respond that it would be sight. Scientists have discovered that the brain has more neurons dedicated to sight than to hearing, taste or scent, and this is why individuals are believed to place so much importance on sight. This does not mean that the rest of the senses are less important-hearing, taste, touch and smell are crucial to the survival of human beings. Additionally, when we consider the behavior of individuals as consumers, some or all of the senses enter into action in making a decision to buy.

This article is about smell, one of the senses that human beings pay less attention to, because it is not crucial to human survival. However, certain odors are important, like the smell of the gas leak, food gone bad, or garbage left unattended for a few days. For the purposes of understanding consumer behavior, it has been proven that odors are associated with emotional memories. The connection between sense and memory is familiar to everyone; throughout their lives, individuals come to associate certain smells with pleasant or unpleasant memories: the smell of gasoline, a recently baked cake, perfume, a pine tree-all of which can evoke past sensations and emotions. Since there is no precise way to measure smell, as there is with color, language, or sound intensity, memory becomes the instrument for recognizing fragrance. It has recently been discovered that the nose does not contain olfactory receptors, but in fact serves to collect and filter the air we breathe. The olfactory receptors are located in a tissue area of each nostril, and since they are continually drying out, they are naturally replenished. The lifespan of an olfactory receptor is from 5 to 8 weeks.

An odor is perceived when the molecules of a certain substance combine with the air–the more there are, the more detectable they become; this blend reaches the olfactory receptors that are in an area of tissue in the nostril. There are are close to 10 million of these receptors, allowing human beings to recognize approximately 10,000 different essences. This capacity is at its keenest during the early years of adulthood, between 20 and 40 years of age, and although the olfactory systems of men and women are structurally identical, there may be differences in the sensitivity and memory of fragrance from one sex to the other. There are, however, very pronounced differences in terms of sensitivity in memory of odor: in general, women have a better scent memory than men.

For many years, smell and taste were treated as if they were independent; but actually these two senses interact to determine flavor (just think about what your food tasted like the last time you had a cold). Individuals taste and smell correctly when their olfactory sense is functioning normally.

The sense of smell, then, is so important that it is one of the primary triggers in a decision to buy. In this article, we will present evidence of the development and use that marketing is made of scents and odors.

It has been proven that there are persuasive tactics that often make us react unconsciously to certain stimuli, like smells, colors, lighting, music, space and temperature, all of which can set off specific behavior and decisions. These incite the consumer to buy products or services without carefully processing the information, meaning they may be inclined to make a purchase without taking into account the pros and cons of the product itself.

One of the reasons for this behavior is that, frequently, this type of decision is malleable and depends on the context in which it is made; in other words, it is affected or influenced by subtle signals in the surrounding environment.

In a retail store, for example, the shopper can distinguish between the smell of the store itself and the fragrance of perfume. For some years now, department stores have followed a commercial strategy of injecting a pleasant odor into air-conditioning, which can have a heavy impact on consumers’ decisions, even before the shopper starts to buy.

One example of this strategy was used by the London department store Harrods for some weeks in 2008. In the women’s footwear department, there was a strong scent of chocolate; in the lawn furniture section, the smell was fresh cut grass; and at the cash registers, in essence of citrus fruit pervaded the air. Harrods’ objective was to get people to spend more time in the store, since they found that the more time shoppers remained in the store, the more they purchased. An increasing number of department stores have been adopting this strategy, not just to entice the public in, but to spend more time on the sales floor.

The hotel industry has also taken advantage of the benefits of using fragrances and odors. For example, the Hyatt Place Hotels chain creates a special environment with essences, and this strategy enables it to build up greater loyalty and brand recognition amongst its guests.

Another way in which marketing has taken advantage of fragrances is by directly injecting them into products. This is a very important element to be taken into account in the creation and development process, not just concerning the structure of the materials, the form and proportion of the products, but also how they smell, what they feel like, and how they are decorated. All of these characteristics can trigger a purchase decision, as some authors have proven when they show that the fragrance of a product can affect the purchase decision in any of the following ways:

1. Consumers can mentally confirm the performance of the product, which becomes a factor in their level of satisfaction at the time they use it or consume it.
2. They can have a considerable impact on consumers’ perception, differentiating a given product from others around it.
3. When products are very similar in their physical characteristics and shoppers have a hard time distinguishing between them, fragrance can determine the purchase decision.
4. The fragrance of the product can be the only sell proposal.
5. Fragrance can come to be thought of as a communicator of personality and emotions, enabling the consumer to identify with the product or brand.

One example of this last point is the use of lavender essence and body oils and aromatherapy. It has been proven that, when using lavender oil, women enter a state of relaxation and become less anxious, angry and aggressive. Men, on the other hand, feel more agitated and less relaxed.

The categories in which fragrances or odors are most frequently used as sell strategies are:

• Beverages
• Body care (bar and liquid soap and bath gel)
• Skincare
• Home care products (dishwashing liquid, surface cleaners, detergents and fabric softeners)
• Food
• Cigarettes

One of the body care products most defined by its scent is men’s shampoo, because in part of the population this has become the sole sell proposal. There is a shampoo brand called Ego, aimed at men, whose advertising stresses that a man’s shampoo should smell different from a woman’s shampoo.

There are other products that are well known for their smell: a new car, a recently laid carpet, a bouquet of flowers, cookies, or chocolates in a department store or soup market, a leather jacket or bag, fresh ground coffee or movie theater popcorn. Products like these produce very favorable reactions and consumers that stimulate them to buy impulsively and, subsequently, to repeat the purchase.

We are constantly bombarded by sensations like smells, images, sounds, flavors in touch, as advertisers compete to attract the market’s attention. Traditionally, consumers have been drawn toward products through scent. A mere whiff is enough to unleash a torrent of unexpected memory and any number of emotions: the summer at the beach, a forgotten romance, the smell of a pine tree at our childhood home. Every time an individual is attracted by an odor, he or she will react favorably or unfavorably. The job of marketing specialists is to stimulate consumers with pleasant sensations and use them to promote their product.?

References:

Davis, F. S. y Palladino, J. (2008). Psicología. 5ª ed. Pearson Educación: México.

Dijksterhuis, A. y Smith P.K. (2005). “The Unconscious Consumer: Effects of Environment on Consumer Behavior”. Journal of Consumer Psychology, Vol. 15, No. 3, pp. 193-202.

Jeffries, N. (2007). “Scent: New Frontiers in Branding”. Global Cosmetic Industry, Vol. 175, Issue 5, pp. 49-52.

Milotic, D. (2003). “The Impact of Fragrance on Consumer Choice”. Journal of Consumer Behaviour, Vol. 3, No. 2, pp. 179-191.

Rosenthal, J. (2008). “Led by the Nose”. Economist, Dec. 20, pp. 132-134.

By nature, companies must pay–or be prepared to pay–a price for the goods and services they use in their activities, what ever their area of business. So clearly companies require financial resources in order to make those payments. As we all know, there are three main sources of funding: internal resources generated by the company’s operations, funds contributed by the company’s owners or partners, and funds raised through some form of debt.

Generally, companies take on debt according to the characteristics of the products or services offered, the commercial phase of the business, the type of market in which they operate, legal and tax restrictions, and other factors. According to the rating assigned to the company by a rating agency or credit institution, lenders decide what interest rate must be paid on the loans that will be extended to the company, or what yield at maturity a bond issued by that firm must offer.

Generally speaking, the credit rating determines the opportunity cost of the debt; but many private small and midsize companies that are not listed on a stock exchange do not have the economic capacity to be rated by a specialized agency.

Accordingly, the purpose of this article is to introduce the reader to the types of risk that exist in the economy, focusing particularly on credit risk, which affects the funding cost (or interest rate) of a loan. We will also explain some of the methodologies proposed in the literature for estimating that cost. Finally, we will try to convince company treasurers that these models are viable for application in emerging economies like Mexico, taking into consideration the nature of its business community.

Theoretic Models

Amid an intense pace of globalization among countries in financial markets, and as transactions become increasingly complex, it is indispensable that organizations take risks to survive and prosper. According to Hull (2007), “A risk manager’s job is primarily to take responsibility for understanding the portfolio of risk the company is assuming at a given time, as well as the risk it will assume in the future, so that it can decide if those risks should be considered, and the actions that should be taken.”

Duffie and Singleton (1999) divide the risks facing financial institutions into five categories: (a) market risk, which the risk of unexpected change in prices or rates; (b) credit risk, which the risk of changes in value associated with unexpected changes in credit quality; (c) liquidity risk, which is the risk associated from the cost of adjusting financial positions, which can increase substantially and even jeopardize access to funding; (d) operating risk, which is the risk of fraud, system failures, trading errors, and any other factor internal to the organization; and (e) systemic risk, which is the risk of a drop in market liquidity or reactions in the chain of default.

Risk metrics depend on the time horizon, liquidity-evaluated through company financial statements-and, of course, the state of the economy. Accordingly, risk managers focus on the conditional distribution of profits and current losses, and predicting market values, volatilities and correlations. Basically, credit risk is included in market risk, because the former is a source of the latter. Therefore, this investigation will focus on evaluating credit risk.

The risk of default plays a key role in pricing and hedging credit. Moody’s defines default as follows: (a) a delay in payment; (c) a filing for bankruptcy; and (c) a restructuring of the balance or reduction in payments. The probability of default represents the possibility that the value of assets are below the point of default. Crosbie and Bohn (2003) define the point of default as a firm value somewhere between the amount of the company’s short and long-term liabilities.

For this reason, it is indispensable that firms offer a premium over the risk-free rate (spread), to compensate lenders for this risk of default. The premium should be high if the probability of default is high, and low when the probability of default is low. According to Crosbie and Bohn, these concepts can be combined into a single measurement of default risk called distance to default (DD), which compares net market value with the standard deviation of the annual percentage change in the asset value.

Based on distance to default, we can calculate the probability of default if we know the probability distribution of the company’s assets, or the default rate for a certain distance to default. The most important sources of information for a company to determine its probability of default are its financial statements, the market prices of its debt and its capital stock, and the risk ratings issued by rating agencies. This information is important, because it can be used to formulate projections on the future performance of the company. According to studies by Crosbie and Bohn, market information is a good predictor of estimated probability of default.

Types of Models for Determining Credit Spreads

The models for determining credit spreads are divided basically into statistical, structural and reduced-form. Statistical models, as their name would indicate, are based primarily on statistical and econometric tools, such as simple or multiple regression. Cossin and Pirotte (2001), however, point out that the problem of these models is their complete dependence on historic data, so they project expected default based on past information.

Like the financial options valuation model, credit risk theory is based on financial economics, developed early in the year 1974. Merton (1974) began with a relatively simple model, based on the structure of the firm. That is why these models are called structural models, because they are based on the division of firm value (V) between shareholders and lenders. In brief, the idea is to use the valuation of options to estimate the credit spread associated with the risk of default. With this method, we can analyze and evaluate the impact on credit spreads of changes in asset volatility, interest-rate volatility, different expiration terms, etc.

Cossin y Pirotte (2001) establish that reduced-form models, unlike structural models, work directly with the probability of default, but as an exogenous variable, calibrated on some data; in fact, the name (reduced-form) comes from the reduction of economic credit factors that are behind the probability of default. In these models, the default event is unpredictable, so we assume it behaves as a jump process.

As we can see, it is a little more complex to determine the parameters needed to develop any of the reduced-form models, because this requires an analysis of the default time series of various firms or instruments to determine the transition intensity matrix of default, as well as the average of the jumps. These difficulties are even greater in the case of emerging markets, and particularly for Mexico, because it is much more complicated to empirically determine the parameters required to apply the reduced form models, given the lack of databases, or because private firms or banks do not publish the necessary information.

In order to apply any of the models described in this article, it is indispensable that we know the characteristics of the economy and the efficiency of financial markets. Therefore, we will below briefly analyze the characteristics of the Mexican market in order to evaluate the viability of application of the above-mentioned models.

Characteristics of Mexico’s Business Community

According to Salas-Porras (1992), in Mexico, “there is still a high concentration of capital in a few families, which even today fear losing control of their equity. Even among publicly traded firms, families own at least 60%-70% of the capital stock in most cases. In the United States, on the other hand, a group of major corporations is considered totally controlled by shareholders’ interests if one individual or group of related individuals hold at least 10% of the voting stock, or 5% of the capital stock and have a strong position on the company’s Board of Directors.”

The same author notes that pressing financial needs oblige many companies to go public and to issue stock on domestic and international markets. In Mexico’s case the process of securitization is far behind what we see in industrialized countries, which is not surprising, given the peculiarities of capitalist development in Mexico. At the same time, the Mexican capital market has been stagnating, reflected in a limited number of initial public stock offerings and a decline in the number of stocks listed on the Bolsa. One way to solve the problem of the Mexican stock market is to introduce better corporate governance practices.

Corporate governance is defined as “a set of principles that govern the design, integration and functioning of a company’s governance bodies, like the Board of Directors and its support Committees.” According to a study by Castañeda (1998) into the characteristics of corporate governance among Mexican companies, protection of minority shareholder rights in this country is among the lowest in the world, even below what is found in other Latin American countries like Argentina and Chile.

In fact, comparing the Mexican capital market against its international peers, it seems obvious that it still needs to reach a higher degree of development, and other words, it is not a tremendously efficient market, largely because of the lack of protection for minority shareholders, as well as the heavy concentration of stock in a few hands.

Conclusions

Taking into account the information required to apply structural models, and considering the characteristics of the Mexican securities market, it would be relatively “easy” to use these models in the Mexican economy, because we could use the corporations listed on the Mexican Stock Exchange as a proxy to study small and mid-sized businesses. The companies listed on the stock market have all the elements to apply structural models with no difficulty, since the required factors can be calculated according to stock price time series, risk-free rates, and publicly available financial information. If an unlisted company decides to apply the structural models, it would be necessary to obtain information on comparable listed companies; but one of the difficulties that may arise when applying models in the Mexican market is the lack of efficiency in the financial markets, so it is important to use data that reflect as precisely as possible the characteristics of the firm being analyzed.?

References

Anderson, R. y Sundaresan, S. (2000). A comparative study of structural models of corporate bond yields: An exploratory investigation. Journal of Banking y Finance Vol. 24. pp. 255-269. E.U.

Black, F. y Scholes, M. (1973). The Pricing of Options and Corporate Liabilities. Journal of Political Economy 81. pp. 637-659.

Black, F. y Cox, J. (1976). Valuing corporate securities: Some effects of bond indenture provisions. The Journal of Finance Vol. 31. pp. 351-367.

Castañeda Ramos, G. (1998). La empresa mexicana y su gobierno corporativo. Antecedentes y desafíos para el siglo XXI. México. Alter Ego, S.A. de C.V.

Crosbie, P. y Bohn, J. (2003). Modeling Default Risk-Modeling Methodology. Moody’s KMV Company LLC. pp. 6-31.

Duffie, D. y Singleton, K. (1999). Modeling Term Structures of Defaultable Bonds. The Review of Financial Studies Special. Vol. 12. No. 4. pp. 687-720.

Hull, J.C. (2007). Risk Management and Financial Institutions. Prentice-Hall, Upper Saddle River, New Jersey, first edition, international edition.

Hull, J.C. (2008). Options, Futures and Other Derivates. Prentice-Hall, 7th. edition.

Merton, R. (1974). On Pricing of Corporate Debt: The Risk Structure of Interest Rates. Journal of Finance, 29. pp. 449-470.

Salas-Porras, A. (1992). Globalización y proceso corporativo de los grandes grupos económicos en México. Revista Mexicana de Sociología. Vol. 54. No. 2. pp. 133-162.

By: Sanjay T. Menon
Louisiana State University Shreveport

The word “empowerment” can mean different things to different people. It can mean the act of empowering, such as delegation or giving employees the authority to make decisions. It can mean the process of empowering, for example, reducing red tape and giving employees the needed resources to do their work as they think it needs to be done. It can also mean making employees feel empowered, for example, by providing opportunities for employees to contribute ideas and participate in decision making. It is therefore not surprising that different authors have different ideas and suggestions regarding empowerment.

From a practical standpoint, trying to empower employees does not automatically result in an empowered workforce. Regardless of the definition of empowerment or the methods used, the beneficial effects of empowerment can only be realized if the employee actually experiences empowerment or feels empowered. This is particularly true if the organization or individual managers merely pay lip service to empowerment. They may say that they are delegating but may not actually do so or they may nullify the empowering effect by saying “You are in charge; just keep me informed before you make any major decisions”. Or, there might be organizational conditions, such as a rigid bureaucracy, that prevent employees from feeling empowered despite the best intentions of the manager. So, to be truly empowered, the employee should be in a psychological state of empowerment. Therefore, managers should focus on actions that result in the psychological empowerment of employees.

Psychological Empowerment

There are three basic dimensions underlying the psychological experience of empowerment. The first one is that of perceived control. Employees who are truly empowered feel that they are in control of their work and work environment. When employees have the power to make significant decisions regarding their work, if they have the needed resources, and if they can make changes to make their work more efficient, they feel empowered. The second major cognition associated with psychological empowerment is that of perceived competence. Empowered employees feel confident that they are capable of successfully completing their tasks. They feel they have the necessary skills and training to accomplish their goals. The third aspect of psychological empowerment is goal internalization. Employees who have internalized the goals of the organization are energized by the prospect of achieving the goals. They are enthusiastic about accomplishing the mission of the organization. They have bought in to the vision and are motivated by it.

Thus, an empowered employee feels in control of his work and work environment, feels competent and enabled with regard to his work, and has internalized the goals of the organization. Empowerment efforts will bear fruit only if they result in empowered employees. Therefore, when managers design their empowerment initiatives, they should ensure a positive impact on all three underlying psychological dimensions. For example, it is not enough to delegate authority and responsibility. The manager should also make sure that the employee has the necessary skills and support to complete the task. Otherwise, the employee will not experience perceived competence and the increased responsibility will result in anxiety and stress, rather than empowerment. The manager should also make it a point to explain not only the purpose of the current assignment but also how it fits into the overall mission and vision of the organization. He should explain the short term and long term benefits of desirable behaviors for the employee, the unit, and the organization as a whole. This approach will help employees internalize the goals of the organization and work enthusiastically toward accomplishing them.

Empowering Practices

Over the years, organizational researchers and consultants have identified numerous empowering actions and techniques. Despite the wide variety of approaches, these techniques can be readily understood by looking at the empowerment dimension that they seek to affect. Traditionally, empowerment has been associated with techniques such as delegation where the manager transfers decision making authority to the employee. Another traditional approach has been the technique of participative decision making, where employees are involved in major decisions that affect their work, unit, and the organization as a whole. Employee participation can be informal within a particular unit or more formal as in the case of work councils, quality circles, quality management teams, and joint labor-management committees. With regard to working conditions, empowering techniques include flex time, work- at- home arrangements, and compressed work weeks. All these traditional approaches are based on increasing the worker’s experience of perceived control.

More modern approaches have focused on the dimensions of perceived competence and goal internalization. Programs such as cross-training, mandatory annual training, skill-based pay, job rotation, job shadowing, career management, talent management, and mentorship, all serve to increase employee feelings of competence. Managers can also enhance the self-efficacy of employees by providing task feedback, expressing confidence in their employees’ capabilities, and by recognizing and celebrating their successes. In recent years, greater attention has been paid to practices such as inspirational leadership, visionary leadership, charismatic leadership, and more generally, transformational leadership. A strong organizational culture shared by committed employees has also been proposed as a source of competitive advantage. All these latter techniques empower by enhancing the goal internalization of employees.

In general, in most work settings, it is preferable to assign responsibility for a particular work or business outcome rather than for specific decisions. Employees should be clear about what is expected, as well as what they can and cannot do on their own. Managers should provide employees with the information, equipment, and other resources needed to make informed decisions and successfully accomplish tasks. They should provide ongoing feedback accompanied by recognition and rewards as appropriate. It is important that all employees understand the mission and vision of the organization and how the work of the unit fits into the overall goals of the organization.

Empowering Conditions

Empowerment is often easier said than done. The main sources of difficulty in successfully implementing empowering decisions are the manager, the employee, organizational systems, and culture. Many managers and supervisors feel that power is a finite commodity and that sharing power and decision making automatically means that they become less powerful. They may also fear becoming irrelevant or redundant if decisions they previously made are now made by subordinates. This is particularly true of managers who are insecure to begin with. To minimize the possible resistance from immediate supervisors and managers, it is a good idea to first focus on the affected supervisors and managers before embarking on the empowerment initiative. They have to first buy into the logic and necessity of the program. They have to see the benefits to themselves and the organization. They have to understand that by reducing their day to day responsibilities, they will have more time for special projects, planning, and other strategic activity. If the supervisors and managers are not on board, there is a danger that they will resist or work against the empowerment initiative.

Just as supervisors and managers need to be ready to empower their subordinates, the employees must also be “ready” to be empowered. If attention is not paid to this issue, empowerment efforts can easily backfire. Empowerment often requires employees to use skills beyond technical expertise, such as decision making with incomplete information, making judgment calls, negotiating, and priority setting. Empowerment usually introduces some uncertainty and ambiguity as employees are now required to evaluate information which is often incomplete and make judgment calls, something previously done by the manager. If an employee does not possess these abilities or is not trained in these skills, then he or she can become frustrated rather than empowered. If the employee does not possess the skill set and capabilities to deal with the increased responsibility, then he or she will not experience perceived competence and control. The employee may instead experience anxiety and stress as the demands of the situation exceed his/her coping capacity. Many employees need to be coached and developed to assume more responsibility.

One must also keep in mind that not all employees are interested in being empowered. Some employees may not want the additional responsibility and some may not be willing to take on additional responsibility without additional compensation. The latter may think the empowerment initiative is nothing more than a cynical ploy by management to get employees to do more work. Some workers, especially those in unions, may worry that management may be co-opting them by blurring the line between management and workers. Many of these issues can be minimized when employees buy in to the vision of the organization and they internalize the goals. Providing the required training and support will help enhance feelings of competence and control.

Managers should also ensure that organizational systems, processes, and general work environment help rather than hinder empowerment efforts. First, there should not be outstanding issues in the work context that are a source of concern to the employees. For example, a climate of ignoring complaints of unsafe working conditions or unresolved disputes about pay and benefits will reduce employees’ interest in empowerment efforts. Excessive bureaucracy can also frustrate newly empowered employees when they take initiative or try creative solutions. Where possible, reward systems should encourage the desired behavior rather than discourage it. Further, if the consequences for failure are severe, employees will be reluctant to exercise their discretion and take risks or try unorthodox approaches.

The organizational culture and the larger societal culture should be compatible with empowerment. If the organizational culture is very authoritarian or is a very high pressure environment for competitive reasons, then empowerment may be difficult. If the societal culture considers large power differences between managers and employees to be normal, then empowerment could be resisted by both managers and employees. If the culture prefers stability and order to initiative and risk-taking, then the uncertainty and ambiguity that comes with empowerment may induce anxiety and dissatisfaction. If the culture is more collectivistic than individualistic, then it may be more effective to empower teams or work groups rather than individuals.

Lastly, both managers and employees must realize that there are realistic limits to empowerment. Decision making cannot be endlessly delegated downward beyond the optimum level where the decision should be made; so managers must still make the decisions that are beyond the employees’ scope and capability. Employees must also be clear on the limits of their discretion and should know when to approach their manager for guidance.?

Bibliography

Conger, J.A. & Kanungo, R.N. (1988). The empowerment process: Integrating theory and practice. Academy of Management Review, 13, 471-482.

Kotter, J. P. & Cohen, D. S. (2002). Creative ways to empower action to change the organization: Cases in point. Journal of Organizational Excellence, Winter 2002, p. 73 – 82.

Menon, S.T. (2001). Employee Empowerment: An Integrative Psychological Approach. Applied Psychology- An International Review, 50(1),153-180.

Randolf, W. A. & Sashkin, M. (2002). Can Organizational Empowerment Work in Multinational Settings? The Academy of Management Executive (1993), Vol. 16, No. 1, pp. 102-115.

Sagie, A. & Koslowsky, M. (2000). Participation and Empowerment in Organizations: Modeling, Effectiveness, and Applications. Thousand Oaks, CA. Sage Publications.

The Author

Sanjay T. Menon is Associate Professor of Management and India Studies Super Professor at Louisiana State University Shreveport. He holds a PhD. in Organizational Behavior from McGill University, Canada.

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By Alejandra Ortiz

Like many developed nations of the world, Mexico is beginning to experience a shortage of talent that runs from highly qualified and experienced professionals to specialists and technicians. According to the Talent Shortage Survey conducted in 35 countries by Manpower Inc., Mexico ranks among the nations most at risk of not being able to find the right people for available positions. This is not merely an alarmist scenario: studies about what today’s professionals want indicate that there is an area of opportunity in defying these trends by finding a harmonious balance between the life and the career of high potential professionals.

Historically, the debate over life and career in the business world was viewed exclusively as a woman’s problem. It was women that, in the 1960s, began joining the workforce in such significant numbers that the conflict between the demands of their jobs and their personal duties and aspirations reached critical proportions. At the heart of it was a battle between jobs and childrearing, which took on such importance that a number of companies began to adopt practices to make the workplace more flexible (for example, reduced hours, work from home or job-sharing).

Since the 1990s, however, we are seeing that demand for flexible work schemes is no longer limited to women. The men of generations X and Y are increasingly involved in family activities, cultural, social or recreational activities outside of their jobs, and a new type of male employee is taking shape. One that may be married to a woman who also works, and who wants to be more involved in his family without losing the prestige, support and compensation of his organization.

In other words, today both men and women want as much flexibility as possible to raise their families and carry out personal activities that they consider to be an essential part of their life’s goals. This generation of talent is increasingly less willing to sacrifice the quality of personal life for a prestigious spot in their organization. Therefore, taking the lead in understanding the new generations of talent means recognizing that for most people, work is not everything in life, as it may have been for the baby boomers in their time. Work may be viewed only as a means of attaining of the dreams, like running an Ironman or traveling around the world, building a family or writing a novel.

For some decades now, organizations have faced the challenge of offering a balance between life and career supported by the latest technological advances, allowing them to be more flexible in terms of time (reduced hours, scaled or compressed schedules), workplace (remote or from home), design (job sharing, reduced workload) and the not necessarily economic benefits (sabbatical months/years). Some organizations have achieved greater retention, productivity, organizational commitment, creativity levels, and work processes, as well as effective teamwork, thanks to more flexible work schemes.

In some cases, however, the benefits do not last over the long term, and in some extreme cases, never materialize at all. Recent results into this field have shown us that poor outcomes are the result of the way in which schemes were structured to favor the life/career balance. Two basic counterproductive approaches can be identified:

First Mistake: The One-Size-Fits-All Model

Not all employees or businesses are the same. A great number of organizations have attractive policies for balancing life and career that are a good hook for bringing in and retaining employees. These policies have been standardized across the organization regardless of the business unit, position or nature of the job. Research shows that a large number of variables-work experience, personality, nationality, biological age and stage of life-influence the perception that employees have of the importance of or willingness to work in flexible work arrangements. that is, the same policies do not “fit” everyone. It is important to understand employees’ interests and perceptions to ensure that what we offer them will truly be attractive and useful for attaining their goals.

It is more difficult to introduce flexible work schemes in organizations with more industrial operations that depend largely on face-to-face interchange in the workplace itself (for example consumer products, manufacturing, etc.) than in knowledge-based organizations (for example personal services, sales, universities, etc.). In organizations that administer knowledge, the value chain depends on the interchange of voice and data communications. Therefore, flex time is more feasible, particularly with the support of technology. Aside from the type of industry, there are different types of jobs, and not all positions can be adapted to flexible work arrangements without previous re-design. Many workplace practices are residual from traditional work schemes that depended on the physical presence of the employees during “normal” working hours.

Second Mistake: Ambiguity and Distrust

Another factor that influences the success of a life-career balancing policy is the cultural environment. Commonly, these policies are introduced as exceptions or “under the table.” They may be published in the catalog of an organization’s talent management policies and analyzed, authorized and applied on a case-by-case basis. This creates a climate of secrecy in which, rather than a policy available to everyone, it becomes a measure of deference to an employee who requested it. For instance, a professional who is granted reduced work hours when she becomes a mother, negotiates directly with her boss on the introduction of a maternity policy and a new way of working. Immediately after the agreement, the boss is left with the feeling that the agreement could “upset the apple cart” and everyone on the team will want to do the same. The boss may ask herself, “what will I do to keep productivity up?” The professional, meanwhile, feels that her career has deteriorated and it would be difficult, if not impossible, for her to return to the fast track.

The figures are unmistakable. A study by Catalyst Inc. shows evidence that although both men and women in upper-level executive positions believe workplace flexibility is desirable, few of them take advantage of these policies, because they are convinced that if they do, they will jeopardize their career path.

This is what happens when job flexibility policies are applied with no regard for the integral process of performance management and professional development. They are policies that look good and sell well, but they are not properly applied. First, because they are not connected to the career path that the professional wants to follow- Second, the leaders that introduce them are not convinced or informed about the expected benefits, the impact on productivity and the makeup of their workforce.

So What’s the Answer? Toward A Comprehensive Life-Career Balance, beyond Flex Time Agreements

The solution can be found in three areas of opportunity for creating holistic systems for balancing life and career that overcome past limitations.

In the first place, institutional systems should be created to discuss different professional career paths. People’s need for a balance between life and career change over the course of their lives. According to Cathy Benko, in her book Mass Career Customization, it is well known that there are stages of life for any employee in which family life can become more important, and others in which this importance diminish. It is common for people to want to spend more time with their family in the early years of child raising, and in those years they will want to slow down their pace of work. But something that former systems have not taken into account is that in other phases of their lives, the priority will undoubtedly return to work. Therefore, if you give them a chance, employees will want to pick up the pace again and accelerate their career.

Based on this premise, we can conclude that a highly inclusive workplace should promote a wide range of forms of work, career options and flexibility agreements that can be adjusted to the different life stages of the employees. If people are given a chance to adapt the range of possibilities to their reality, while delivering value to the business, organizations can hold onto the best talent for a longer period of time. The idea is to do away with the rigid and standardize labor policy model, replacing it with a system that takes into account various job factors, like workload and workplace, the type of role, work processes and level of leadership. Doing this will allow employees to integrate their personal and professional lives without losing sight of their career goals. For example, a mother with a very young child decides to work less hours, work two days from home and ease back on her leadership role. She knows that her career will progress more slowly for some years, but she will continue contributing value to the company where she works.

A second element in success is the way this model is applied. Professionals should be encouraged to adjust their life-career balance scheme through ongoing conversations with their superiors. They should reach an agreement through open and transparent dialogue regarding the status of their career, their performance and expected results, and their impact on the business. These conversations may take place at the individual or group level. It is very important to involve the work team or unit by informing them about the work schemes of each of its members. Companies should consider new ways of getting the job done and sharing responsibility to avoid allowing productivity to sag. Leaders and managers are increasingly involved on an active basis in the development of their professionals. Defining a career plan in harmony with their personal lives should be the subject of frequent discussion.

Finally, we need to create a culture in which “results matter more than processes.” For this to happen, leaders must have the capacity to see professionals as whole people, with professional and family lives, as well as interests that go beyond the workplace. They must be convinced that productivity is a result of the energy, creativity and focus that employees bring to the job, and not the number of hours they invest in it. In a results-oriented culture, aligned with a flexible work scheme, such as the one outlined here, longer workdays should be seen as a lack of planning rather than a high level of commitment.

We are facing an imminent shortage of talent. Mexican organizations must prepare proactively to effectively face the need to retain their most talented people. Today’s professional value opportunities for professional development as much as they do their personal interests. The intervention proposed in this paper includes both, and seeks to create a harmonious balance between them. Solutions exist, but it will be up to leaders to work on applying them. After all, retaining talent also means not letting it go to the competition.
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References

Two Careers, One Marriage: Making it Work in the Work Place (1998), Catalyst Research Reports, January

Stewart, D. Friedman, Perry Christensen & Jessica Degroot (2000) Work and Life: The end of the Zero-Sum Game, Harvard Business Review on Work Life Balance, Pgs. 1-32

Benko, C. & Weisberg, A. (2007) Mass Career Customization: Aligning the Workplace with Today’s Nontraditional Workforce, Harvard Business School Press, ps. 229.

Gainy, T.W. & Clenney, B.F. (2006) Flextime and Telecommuniting: Examining Individual Perceptions, Shouthern Business Rewiew, Fall.

Pitt-Catsoupes, M., Sarkisian, N., Lynch, K., Carapinha, R. Jungui, L., McNamara, T., Bhate, R. & Sahani, S. (2011) The Generations of Talent Study: Assessing the Effect of Age, Career Stage, and Life Stage on Quality of Employment, Sloan Center on Aging & Work

Apgar IV, Mahlon (2000) The Alternative Workplace: Changing Where and How People Work, Harvard Business Review on Work Life Balance, Pgs. 155-196

Kossek, E.E., Lee, M.D. and Douglas T. Hall (2007) Making Flexible Schedules Work-for Everyone, Harvard Management Update, Volume 12, Number 5, P. 2

Women and Men in U.S. Corporate Leadership: Same Workplace, Different Realities? (2009) Catalyst Study, March

By: David J. Woehr
The University of North Carolina Charlotte

Sylvia G. Roch
State University of New York at Albany

A positive trend in recent selection and assessment research is an increased focus on multiple aspects of job performance. Specifically, job relevant performance has expanded beyond job specific task behavior to include other components such as organizational citizenship behavior, counterproductive work behavior, and adaptive behavior. Yet a key question in the literature focuses on the best way to assess and measure the different aspects of performance. On the surface this would seem a simple matter. How hard can it be to differentiate and assess levels of job performance across employees? In fact, most managers as well as researchers would agree that identifying and collecting relevant, psychometrically sound, and practical measures of job performance is a significant challenge.

At a very basic level, measures of individual job performance generally fall into two broad categories – objective and subjective. Objective measures include records of job-related outcomes (e.g., production counts, sales, accidents, salary, job-level, etc.). Alternately, subjective measures are those that rely on the evaluative judgment of another person (i.e., ratings and rankings). While objective measures might appear to be the preferred method for assessing performance, there is general agreement that objective measures are simply not feasible in most settings. Consequently, the use of subjective measures as criteria in selection and assessment research has been, and continues to be, far more common. Ironically, even for jobs for which objective measures should ostensibly be readily available (e.g., salespeople), subjective measures are often the criterion of choice. In a recent review of predictors of the job performance of salespeople, for example, 57% of the validation studies reviewed used subjective ratings of sales performance as opposed to actual sales data.

Subjective evaluations of performance may be obtained from a variety of sources (e.g., supervisors, peers, subordinates, customers, etc.). However, supervisory ratings of individual job performance are the most frequently used and studied manner in which employee performance is assessed. Consequently a key concern for both research and practice is the extent to which supervisors can and will differentiate and accurately rate performance. Toward that end, a great deal of research has strived to improve the quality of performance ratings. Yet despite the volume of research devoted to this topic, many questions about the value and appropriateness of performance ratings as measures of job performance remain. Thus, an uncomfortable inconsistency seems to present itself. On the one hand, supervisory performance ratings serve as the predominant measure of job performance in the vast majority of selection and assessment research. On the other hand, questions about the quality and usefulness of performance ratings as a measure of job performance abound. In fact, ratings of job performance are one of the most predictable criterion measures available. Most studies investigating the criterion validity of predictors use performance ratings as the criterion, and many predictors, such as cognitive ability, structured interviews, and situational judgment tests, as expected, have strong correlations with performance ratings. In addition, the research on improving the quality of performance ratings highlights a number of interventions that can serve to maximize rating veridicality and thus inform good practice. These interventions fall into three categories: rating scale format, rater training, and rater motivation.

Rating Scale Format

Rating scale interventions aimed at improving performance ratings have a long history in the literature. Not surprisingly, a great deal of research in the 1960′s and 70′s concentrated on a direct comparison of ratings obtained via specific rating formats. Results of this research, however, tended to indicate that scale format had little impact on rating outcomes (evaluated primarily in terms of the psychometric properties of ratings and interrater agreement). Nonetheless, although much of the rating scale literature indicates that specific scale format may not lead to major differences in rating outcomes, it is predicated on the use of job-relevant professionally developed scales. So while it may not matter if one uses behaviorally anchored ratings scales, behavioral observation scales or graphic rating scales, it does matter that the scales used are based on a thorough job analysis and incorporate clear behaviorally-based definitions of the constructs to be evaluated.

Driven to a large extent by management practices in high visibility organizations, recent research has focused on relative performance ratings requiring the use of a forced distribution of ratees into pre-determined performance categories. Jack Welch, the former CEO of General Electric, advocated that an organization should assign its employees to three categories: top 20%, middle 70%, and the bottom 10%. Welch advocated that employees assigned to the bottom 10% should be terminated and that this process should occur yearly; thus continually raising the bar of performance and increasing the quality of employees. Other companies such as Cisco Systems, Hewlett-Packard. Microsoft, Lucent, Conoco, EDS, and Intel have adopted management systems based on this idea. In fact, it’s been estimated that as many as one-third of U.S. corporations evaluate employees based on systems that pit them against their colleagues. However, a 2005 survey conducted by the Society for Human Resource Management found that of the 330 human resource professionals surveyed, only 43 reported that their companies used forced rankings/distributions and only 2 reported that forced rankings always lead to terminations.

Research suggests that forced distribution scales may offer psychometric advantages over more traditional scales. Two recent reviews investigating the difference between forced distribution and traditional rating scales found that forced distribution scales demonstrate stronger correlations with a variety of criteria, such as production quantity, sales volume, general mental ability, verbal ability, quantitative ability, perceptual speed, and spatial/mechanical ability. However, while the use of forced- distribution based rating systems in which employees are evaluated relative to each other may result in short term benefits, it may also lead to negative rater and ratee perceptions of the process and ultimately poorer employee moral and performance. A number of respected companies such as Xerox, Pepsico, Goodyear, and Ford have tried forced rankings/distributions and either backed away from them or rejected them. Furthermore, a number of organizations, such as Ford, Goodyear, Microsoft, and Sprint, have recently been involved in adverse impact cases based on forced distributions/rankings. Thus, organizations must consider whether the possible psychometric benefits of relative scales outweigh the potential negative reactions associated with them.

Rater Training

While evidence for the impact of specific scale formats on performance ratings has been somewhat equivocal, evidence for the positive impact of rater training is more widely accepted. Moreover, the benefits of rater training may extend beyond the direct effect of improved rating accuracy. Rater training has the potential to improve “buy-in” from both the rater and ratee, which may in turn increase rater motivation to provide accurate ratings as well as ratee motivation to use the feedback provided to improve performance.

Although a number of rater training approaches have emerged from the performance appraisal literature, the most widely cited is frame-of-reference (FOR) training. The goal of FOR rater training is to train raters to use a common conceptualization (i.e., frame of reference) of performance when observing and evaluating ratees. Typical FOR rater training includes emphasizing the multidimensionality of job performance, concretely defining performance dimensions, providing sample behavioral incidents indicative of each dimension and corresponding evaluative standards, along with practice and feedback using these standards to evaluate performance. FOR training helps improve rating accuracy through two processes: (1) by helping raters understand which behaviors constitute specific levels of performance on specific dimensions, and (2) by establishing performance prototypes that allow raters to counteract normal information loss (i.e. forgetting) by categorizing ratee performance based on the performance prototypes presented during the training.

FOR training was developed within the context of performance appraisal. However, over the past 20 years it has been extended beyond this context. Researchers have shown that FOR training is directly applicable to a variety of evaluative contexts including assessment centers, selection test cut scores, employment applications, competency modeling, job analysis, interviews, and even therapy. Certainly one of the primary reasons for the popularity and expanded use of FOR training is the evidence demonstrating the positive impact of this training on the quality of performance ratings. To date, a relatively large number of empirical studies have examined the impact of FOR training and this body of evidence continues to grow. These studies present a consistent picture that providing raters a clear and consistent explanation of what and how they are supposed to rate, along with practice and feedback doing so, greatly facilitates the rating process.

Rater Motivation

Both rating scale format and rater training interventions target raters’ ability to provide accurate ratings (although it may be argued that both may indirectly affect rater motivation). However, it is widely recognized that performance rating problems may be as, or more, likely to be a function of rater willingness to provide accurate ratings. Thus, raters must be motivated, as well as able, to provide accurate ratings. Rater motivation is a function of the manner and context in which ratings are collected. The context may serve both to inhibit or facilitate rater willingness to provide accurate ratings. Quite simply if the negative consequences of providing accurate ratings outweigh the positive consequences, no rating scale or rater training intervention will be effective. Consequently, in an attempt to neutralize the negative consequences often associated with ratings used for administrative purposes (e.g., promotion, salary adjustments, feedback and development), most research studies, including predictor criterion validity studies, utilize ratings collected for research purposes only. However, research-based ratings may not always be feasible or preferable to organizational decision makers. Thus, organizations should pay careful attention to the motivational incentives inherent in any rating situation.

In sum, research aimed at improving the quality of supervisory performance ratings has a long history in the organizational literature. Moreover, this research provides important findings that can be used to inform good practice with respect to job performance evaluation. Specifically, a full understanding of the role of rating scale format, rater training, and contextual and process factors is crucial for maximizing the effectiveness of job performance ratings.?

Bibliography

Bennett, W., Lance, C. E. & D. J. Woehr (2006). Performance measurement: Current perspectives and future challenges. Mahwah, NJ: Erlbaum.

Cascio, W.F., & Agunis, H. (2008). Research in Industrial and Organizational Psychology From 1963 to 2007: Changes, Choices, Trends. Journal of Applied Psychology, 98, 1062-1081.

Murphy, K. R., & Cleveland, J. N. (1995). Understanding performance appraisal: Social, organizational, and goal-based perspectives. Thousand Oaks, CA: SAGE Publications, Inc.

Smither, J. W., & London, M. (2009). Performance Management; Putting Research into Action. Jossey-Bass; San Francisco, CA.

The Authors

David J. Woehr is Professor of Management at the University of North Carolina, Charlotte. He received his PhD in Industrial and Organizational Psychology from Georgia Institute of Technology. Dr. Woehr is coauthor of the book: Performance measurement: Current perspectives and future challenges.

Sylvia G. Roch is Associate Professor at the Psychology Department of the State University of New York at Albany. She holds a PhD in Industrial and Organizational Psychology from Texas A&M University.

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By: Lorenzo Rivarés
Director of the Center for Selection and Employment at Grupo Eulen, Madrid

Managing personal relationships in the business world has always been a key aspect of human resources management. Some companies forbid their employees from having personal ties to one another, while others refrain from regulating this aspect, saying it is a private matter that concerns the individual as a person more than as an employee; and still others encourage such relationships and take advantage of them to make their processes more efficient. For example, some companies compensate their employees with a referral bonus when they recruit other professionals to work in the company. Employee referral systems, whether compensated or not, have long been popular among companies, and sometimes have results contrary to what are expected.

In an increasingly fast-paced and demanding labor market, the response times required to incorporate workers into a company are increasingly short. These shortened response times oblige firms to use personnel selection systems that are very unlike the scientific method, and frequently involve some variant of the “bring a friend” process. In essence, the “bring a friend” process involves asking a candidate that has already been hired, “do you have any friends we could call who might be good for this job?” Candidates recruit those of their friends they consider to be appropriate to fill the job vacancy and who are interested in the job offered.

Between 1995 and 2009, we worked with Luís González Fernández, full-time professor at the University of Salamanca, to study this recruitment process, conducting empirical research to determine its degree of effectiveness and the reasons for such effectiveness. We carried out our research among temporary employment agencies in Spain, because they allow us to control for workers’ attitudes in the selection process. This is because their work contracts are by nature temporary, and the employees belong to a company different from the one in which they work, so their ties to the company are more transactional (according to the typology defined by Rousseau, 1995, a transactional contract is one with specific terms and a temporary duration) than relational. We wanted to share experiences and propose this investigation among a large number of companies, and worked with the temp agency Flexiplan, one of the largest temporary employment agencies in Spain with more than 9,000 clients a year and more than 45,000 workers in the year 2005. During our work we met with more than 100 client companies interested in our research proposal.

Our hypothesis was that this recruitment process creates a sort of psychological contract, which in turn affects workers’ attitudes, and the attitudes affect their performance. The psychological contract is between the recruiting employee and the friends he or she recruits, and takes the form of a pact that is unofficial but recognized by all the parties: “I am recruiting you because I expect you to do a very good job,” and on the part of each of the recruited workers, “I know you have recruited me because you expect me to do a very good job.” This contract has an affective component, because the parties are friends; a component of expected performance because the whole group expects high performance; and a behavioral component, because the contract is fulfilled by doing a good job. We then hypothesized that the contract would influence the variables “commitment to the job to be performed,” “commitment to the work group,” “job satisfaction,” “satisfaction with co-workers,” and “involvement.” (To determine what attitudes to evaluate in peripheral workers, we took into account the reflection of Morrow, 1993, “clearly peripheral workers can be expected to stress other forms of commitment to their jobs than those who are based in the organization.”) Finally, the whole process would affect workers’ performance (figure 1).

Figure 1: “Bring a Friend” Recruitment Process and relationship to performance

Method

We worked with an experimental design based on equivalent groups, meaning that in each of the groups we compared two exactly equal groups, which differed only in the recruitment system (figure 2). While the experimental group was recruited using the “bring a friend” process, the control group was recruited using the usual temp firm recruitment processes. We compared 11 experimental groups in 6 different companies, for a total of 87 workers studied. We evaluated the level, homogeneity and stability of attitudes through a questionnaire prepared for this purpose, and applied it to each worker at three different points in time: at the start of their labor relationship; one month after hiring; and at the end of their labor relationship, taking into account that all workers had a temporary contract that lasted between three and five months. We prepared 315 records of workers’ attitudes based on their responses to the questionnaire. We analyzed workers’ performance using the dichotomic variable “turnover,” whether provoked by the company (failure to renew the contract or early termination of the contract) or by the worker (voluntary resignation).

Figure 2. Experimental Design of a Study of “Bring a Friend” Recruitment Process in the Temporary Employment Agency industry

Results

The psychological contract was present in all the experimental groups, and in none of the control groups. For the variables “commitment to the team” and “satisfaction with co-workers,” practically all of the comparisons made in the experimental group showed statistically higher scores that were more homogenous and stable over time than the control group. For the “commitment to tasks” and “job satisfaction” variables, most of the experiments with the experimental group showed statistically higher point scores that were more homogenous and stable over time than the control group. In the “involvement” variable, there was very little difference between each pair of groups studied. Among the experimental groups, 6.45% of the subjects belonging to experiments 1, 2, 3, 4, 5, 6, 7, 10 and 11 experienced turnover, compared to 33.33% of the subjects in the control groups, permitting us to conclude that the turnover of subjects in the experimental group is significantly lower than that of the control group.

We were greatly surprised to find that in experiments 8 and 9, 100% of the experimental subjects experienced turnover in the first month of the contract, compared to 33% among the control groups. Intrigued by this surprising result, we interviewed the heads of these two experimental groups, and found that in one case the company had decided to dismiss the recruiting worker before the end of the contract, which prompted a negative reaction among the other members of the work team, causing them to resign and/or lower their performance. In the other experiment, the contract for one of the members of the work team was not renewed for medical reasons, also prompting a negative reaction from the other members of the work team.

Conclusions

The “bring a friend” recruitment process generates a perception that a psychological contract has been created between the recruiting worker and the required workers that make up his or her work team, defined in terms of “I am recruiting you because I expect you to do a good job,” and on the part of each of the recruited workers, “you have recruited me because you believe I will do a good job.”

The “bring a friend” recruitment process affects the level, homogeneity and stability of attitudes among short-term workers, very significantly in the variables “commitment to the team” and “satisfaction with co-workers,” somewhat significantly in the variables “commitment to tasks” and “job satisfaction,” but with no impact on the “involvement” variable.

The performance of workers recruited using the “bring a friend” system is markedly group-oriented. A common effect this recruitment system is to significantly increase performance throughout the entire work group; but if the performance is negative, the reaction is also group-wide, making the entire group stand out for its noticeably inferior performance.

For certain temporary hirings, the “bring a friend” recruitment system is very efficient, because it requires few resources–recruit a worker–, the results are immediate, and because it has a very positive impact on worker attitudes and hence their performance. It generates a close-knit group of workers, bound together by the psychological contract among them, and very focused on the success of their performance. If for whatever reason, however–like the dismissal of one of the team members–the attitudes become negative, the reaction extends throughout the group, negatively affecting its performance.

Discussion

Should personal relationships with a company be “managed”? In meetings with more than 100 companies interested in participating in our research, many said that this was a recruitment system they habitually used, but that they did not know how actually efficient it was, and they therefore believed that it required further study. Some of these companies had had some unpleasant experiences in this area, mainly because it generated power networks that ran parallel to the company’s productive organization. Two examples illustrate these experiences: an automotive component factory in the province of Valladolid used this recruitment system to hire most of its workers, but found that it created social networks that were impossible to manage: “we have a bunch of brothers, uncles, nephews and cousins working here, and when the grandmother gets sick they negotiate the personal days they’re going to take, with the threat that if they all take off the same day they would paralyze production.” Another case in point is that of a major multinational Spanish services company that accidentally hired a specialist in theft, who brought his whole gang to work for the company, and they organized among themselves to steal from the company.

Personal relationships within a company are inevitable; workers build a network of relationships because this behavior is inherent to the person; humans are social animals. Certain persons weave these social networks for their own benefit, bringing friends into their work teams, doing changes in favor of an implicit moral debt, praising some workers while discrediting others, according to their own interests. The company’s obligation is to identify and be aware of these practices, to know the risks they entail, and the efficiency of their processes. If social networks arise that run parallel to the company’s productive organizations they will be hard to govern, with private interests that have nothing to do with production, and are even indifferent to the protection of all workers’ rights.

Intentionally or spontaneously, many companies use the “bring a friend” recruitment system in their hiring processes. Understanding and managing the incorporation of workers into companies can help make them more productive, contributing value to the analysis of quantitative results (productivity, turnover, absenteeism …) and making processes like “bring a friend” into efficiency systems. ?

References

Morrow, P. (1993). The Theory and Measurement of Work Commitment. Monographs in Organizational Behaviour and Industrial Relations, volume 15. Jai Press Inc. Greenwich, Connecticut.

Rousseau, D. M. (1995). Psychological contacts in organizations: Understanding written and in written agreements. London, UK: Sage. En Millward, L.J. & Hopkins. L.J. (1998). Psychological Contracts, Organizational and Job Commitment. Journal of Applied Social Psychology, 28, 16, 1530-1556

Acerca del Autor

Lorenzo Rivarés Sánchez, es Director del Centro de Selección y Empleo de Grupo Eulen en Madrid. Es Doctor por la Universidad de Salamanca, y posee la Certificación como Profesional en Remuneración Global por la World at Work Society.