Mid American Journal of Business Fall 2002

V O L U M E 17, N U M B E R 2
FALL 2002

ournal

usiness

mid-american

EDITORIAL

The Knowing-Doing Gap

Ashok Gupta

DEAN’S FORUM

Consumers and Expectations

James W. Schmotter, Dean, Western Michigan University

EXECUTIVE VIEWPOINT

After Enron: Government’s Role and Corporate Cultures

Carl Levin, United States Senator, Michigan

ARTICLES

The Social Impact of Business Failure: Enron

Uma V. Sridharan, Lori Dickes, and W. Royce Caines

Corporate Pension Plans: How Consistent are the Assumptions
in Determining Pension Funding Status?

Gale E. Newell, Jerry G. Kreuze, and David Hurtt

More Than Altruism: What Does the Cost of Fringe Benefits Say
about the Increasing Role of the Nonprofit Sector?

Rosemarie Emanuele and Walter O. Simmons

Subscription Supply Chains: The Ultimate Collaborative Paradigm

Robert L. Cook and Michael S. Garver

Selecting a Business College Major: An Analysis of Criteria and Choice Using

the Analytical Hierarchy Process
Sandra E. Strasser, Ceyhun Ozgur, and David L. Schroeder

BOOK REVIEWS

Business @ the Speed of Thought

Douglas M. Brown

Leading Quietly: An Unorthodox Guide to Doing the Right Thing

Alex Thompson

Mid-American Journal of Business

Subscriptions

All orders, inquiries, address changes, reprints etc. should be
addressed to:
Mid-American Journal of Business
Subscriber Service, Bureau of Business Research
Ball State University, Muncie, IN 47306

Telephone: 765-285-5926 FAX: 765-285-8024
www.bsu.edu/MAJB

Subscription prices in USA, Canada, and Mexico are:

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All others add $5 per year for additional postage.

Permissions

For permission to quote, reprint, or translate Mid-American
Journal of Business materials, write or call: Judy A. Lane,
Managing Editor, Bureau of Business Research,
Ball State University, Muncie, IN 47306
email: jlane@bsu.edu, Telephone: 765-285-5926

Manuscripts

Send four manuscripts, $12.00, and editorial correspondence to:

Dr. Ashok Gupta
College of Business
Ohio University
Athens, OH 45701

Editorial Board

Ashok Gupta, Ph.D., Editor-in-Chief
College of Business
Ohio University
Athens, OH 45701

email: gupta@ohiou.edu

Cecil Bohanon, Ph.D.
College of Business
Ball State University
Muncie, IN 47306
email: cbohanon@bsu.edu

Richard Divine, Ph.D.
College of Business
Central Michigan University
Mt. Pleasant, MI 48859
email: divin1rl@cmich.edu

Laurence Fink, Ph.D.
College of Business Administration
University of Toledo
Toledo, OH 43606
email: lfink@pop3.utoledo.edu

Norman Hawker, Ph.D.
Haworth College of Business
Western Michigan University
Kalamazoo, MI 49008
email: norman.hawker@wmich.edu

Michael Hicks, Ph.D.
Lewis College of Business
Marshall University
Huntington, WV 25755

email: hicksm@marshall.edu

Curtis Norton, Ph.D.
College of Business
Northern Illinois University
DeKalb, IL 60115
email: nortonc@niu.edu

T.M. Rajkumar, Ph.D.
Richard T. Farmer School of
Business Administration
Miami University
Oxford, OH 45056
email: rajkumtm@muohio.edu

Judy A. Lane, Managing Editor
Bureau of Business Research
Ball State University
Muncie, IN 47306
email: jlane@bsu.edu

Board of Reviewers

Shaheen Borna
Ball State University

Larry Compeau
Clarkson University

Max Douglas
Indiana State University

William Dodds
Fort Lewis College

Ed Duplaga
Winona State University

Ray Gorman
Miami University

Mark Hanna
Georgia Southern University

Gary Kern
Indiana University at South Bend

Douglas Naffziger
Ball State University

Gale Newell
Western Michigan University

W. Rocky Newman
Miami University

Pamela Rooney
Western Michigan University

B. Kay Snavely
Miami University

Daniel Vetter
Central Michigan University

Leslie Wilson
University of Northern Iowa

Dale Young
Georgia College

The Mid-American Journal of Business provides a medium for business researchers and other
business professionals—executives, consultants, and teachers—to discuss research developments
and their practical implications. The Journal is sponsored by the following institutions:

Lynne Richardson, Dean
College of Business
Ball State University

John Schleede, Dean
College of Business Administration
Central Michigan University

Calvin A. Kent, Dean
Lewis College of Business
Marshall University

Roger Jenkins, Dean
School of Business Administration
Miami University

David Graf, Dean
College of Business
Northern Illinois University

Glenn Corlett, Dean
College of Business
Ohio University

Sonny Ariss, Interim Dean
College of Business Administration
The University of Toledo

James Schmotter, Dean
Haworth College of Business
Western Michigan University

No part of this publication may be reproduced or transmitted in any form without written permission.
© 2002 by Ball State University ISSN: 0895-1772

Produced at the Bureau of Business Research, Ball State University, Sandra Burton, Publications Coordinator

www.bsu.edu/business/MAJB

Mid-American Journal of Business, Vol. 17, No. 2

The Social Impact of Business Failure: Enron
Sridharan et al. highlight the conflicts of interest
and discuss the social and financial impact of a
combined business and oversight failure at Enron.

Uma V. Sridharan, Lori Dickes, and
W. Royce Caines

BOOK REVIEWS

Business@ the Speed of Thought
by Bill Gates

Douglas M. Brown

EXECUTIVE VIEWPOINT

After Enron: Government’s Role and Corporate
Cultures
Levin maintains that what happened at Enron was
not just a failure of regulations and law, it was a
failure of corporate culture, a failure of values, a
failure of heart.

Carl Levin

Subscription Supply Chains: The Ultimate
Collaborative Paradigm
Cook and Garver argue that supply chain members
need to get closer to the end consumer by forming
collaborative relationships that center around
demand planning.

Robert L. Cook and Michael S. Garver

DEAN'S FORUM

Consumers and Expectations
Managing customer expectations starts with
realistic marketing.

James W. Schmotter

Fall 2002 Volume 17 Number 2

CONTENTS

EDITORIAL

The Knowing-Doing Gap
Discussing a problem, formulating decisions, and
crafting plans for action are not the same as actually
fixing the problem.

Ashok Gupta

Corporate Pension Plans: How Consistent are the
Assumptions in Determining Pension Funding
Status?
Pension plan assumptions regarding discount rates,
projected salary increases, and expected return on
plan assets are investigated in relation to the
funding status of a pension plan.

Gale E. Newell, Jerry G. Kreuze, and David Hurtt

Selecting a Business College Major: An Analysis
of Criteria and Choice Using the Analytical Hierarchy
Process
In this article, Strasser et al. use the Analytic
Hierarchy Process (AHP) technique to provide
insights into criteria used by students and the
decision process they follow in choosing a major.

Sandra E. Strasser, Ceyhun Ozgur, and
David L. Schroeder

More Than Altruism: What Does the Cost of Fringe
Benefits Say about the Increasing Role of the
Nonprofit Sector?
Emanuel and Simmons attribute the significantly
lower expenditure for fringe benefits by nonprofits
to more than altruism of the workers.

Rosemarie Emanuele and Walter O. Simmons

ARTICLES

Leading Quietly: An Unorthodox Guide to Doing the
Right Thing
by Joseph L. Badaracco, Jr.

Alex Thompson

Mid-American Journal of Business, Vol. 17, No. 2

CALL FOR PAPERS

Call for Papers

The program committee invites you to submit:

•

Regular research papers: You can submit a
complete paper in this category. If your paper is
in an abstract form or in a proposal form, see the
categories listed below.

•

Work-in-progress or proposals: The MWDSI
Board of Directors has decided to create an
environment where academicians can discuss
their ideas for future research in all track areas.
Papers submitted in this category are encour-
aged to be of regular paper length.

•

Papers or reports on teaching-related issues: In
addition to an Innovative Education track,
sessions will be dedicated to instructional
issues in all track areas. Submissions in this
area are strongly encouraged.

•

Symposia, tutorials, workshops: Proposals for
symposia, tutorials and workshops are invited
in, but limited to the track areas listed.

•

Student Research Papers: Student research papers
may be submitted according to the track areas
listed.

•

Case Studies: Case studies will report on the
application of theory to actual business practices.

Submissions will be blind refereed. Student
papers will be incorporated into the regular
presentation sessions during the conference. By
submitting a manuscript, the author(s) certify
that it is not copyrighted, previously published,
presented, accepted, or currently under review for
presentation at another professional meeting.
Submission of a paper implies that an author will
register for the conference, attend the conference and
present the paper, if accepted.

Program Participation

Paper reviewers, discussants, and session chairs will
be needed. Please contact Program Chair Gene
Fliedner to indicate your interest. Participants may
be asked to serve in these capacities.

Membership Requirement

Awards will be given for Best Paper and Best
Student Paper at the meeting. Student Papers must
be authored by students only and identified as
eligible to compete.

Instructions for Contributors

Contributors should mail their submissions directly

to the Program Chair. All submissions must be
postmarked by December 1, 2002 to be considered
for publication in the proceedings. Papers submitted
after December 1, 2002 but before December 15,
2002 can still be reviewed and accepted for the
meeting, but will not be included in the Proceedings.
Papers submitted after December 15, 2002 will not
be accepted for the meeting. Authors may choose to
indicate their preference of time of day (i,e, a.m. or
p.m.) and the day of the meeting (i.e. Thursday,
Friday or Saturday) for their paper presentations.
These time and day requests will be honored on a first
come, first serve basis. Early submissions are encour-
aged to permit early acceptance notifications (roughly
within 60 days of submission). An advanced
registration fee for at least one author will be required
to guarantee publication of the accepted paper in the
Proceedings. Authors will be notified of publication
preparation guidelines upon acceptance. Contribu-
tors are asked to follow the following guidelines for
submissions:

•

Submit four (4) typed, double-spaced copies
of your paper, abstract or special session
proposal.

•

Include in your submission a separate title
page (on each copy) including author(s)’ names
and affiliations. The main body of the paper
must have a title but should not include
author(s)’ names and affiliations.

•

Include with your submission two 3x5 cards
listing: author(s), affiliations,complete mailing
addresses, telephone numbers, e-mail addresses,
title of submission, selected track, name of
corresponding author.

Submission Deadline: December 1, 2002

2003 Annual Meeting—Sponsored by Miami University

Miami University, Marcum Conference Center—Oxford, Ohio

March 27-29, 2003

MIDWEST

DECISION

SCIENCES

INSTITUTE

Submit to:

W. Rocky Newman
Department of Management
Miami University
Oxford, OH 45056

Receive $500 cash award and
opportunity to be published in
Mid-American Journal of Business.

EST

APER

WARD

Tracks:

Accounting and Finance

Global Business Management
and Strategy

Information Technology and
e-business

Operations Management—
Manufacturing

Operations Management—
Service

Quantitative Methods and
Statistics

Supply Chain and Marketing
Management

Student Papers

Program Chair

W. Rocky Newman
Tel: (513) 529-4219
newmanw@muohio.edu
Miami University
Oxford, OH 45056

Proceedings Editor

Tom Gattiker
(513) 529-8013
gattiktf@muohio.edu
Miami University
Oxford, OH 45056

Local Arrangements
Coordinator

Tim Krehbiel
(513) 529-4837
Krehbitc@muohio.edu
Miami University
Oxford, OH 45056

EDITORIAL

The Knowing-Doing Gap

Ashok Gupta
Editor-in-Chief

These days there is a crisis of confi-

dence all around, in corporations,
churches, colleges – who can we trust?
Corporate leaders are maximizing their
personal wealth rather than shareholder
value. Priests are advising others to
control their greed and lust while trapped
in the affairs of the world themselves.
College administrators swear to provide
relevant and rigorous education while
engaging in showmanship of innovative
pedagogical approaches and wasteful
expenditures on one hand and increasing
tuition and reducing faculty positions on
the other. Do these people not know what
is the right thing to do? I doubt if the
problem is lack of knowledge. They are
all smart people. They all know what to
do. There is just not enough doing. Why
do we still believe that setting up a
committee to examine an issue will solve
the problem? Why do we believe that
having Executive Advisory Boards in the
Colleges of Business will make our
education relevant to business needs?
Why do we believe that having policies
on key issues is equivalent to their
effective implementation? Perception of
action has become more important than
real action. Let’s not kid ourselves —
discussing a problem, formulating
decisions, and crafting plans for action
are not the same as actually fixing the
problem.

In this issue……

What happens when those trusted to

protect the integrity of the system for the
long-term interest of shareholders
become its destroyers? This first article
by Sridharan et al. highlights the conflicts
of interest that pervade the financial
system and discusses the social and
financial impact of a combined business
and oversight failure at Enron. The article
could be used as a pedagogical tool in

business ethics, business strategy, and
corporate governance.

Pension expense can be a significant

element in determining net income and
the funding status of the plan is important
in evaluating the financial risk of a firm.
The pension plan’s funding status can also
impact the financial health of large numbers
of employees in retirement. Newell et al.
investigate the relationship between
pension plan assumptions regarding
discount rates, projected salary increases,
and expected return on plan assets and the
funding status of a pension plan.

Although it is well established that

wages are significantly lower in the
nonprofit than in the for-profit sector, not
much is known about the cost of fringe
benefits in the nonprofit sector. In the third
article, Emanuele and Simmons report that
nonprofit organizations spend over 80
percent less on fringe benefits than compa-
rable for-profit firms and government
agencies. They attribute this differential
to more than altruism of the workers.

While great strides have been taken

toward forming collaborative partnerships
between business-to-business firms, the
end consumer is typically not viewed as a
supply chain partner. Cook and Garver
argue that supply chain members need to
get closer to the end consumer, resulting
in better demand planning, dramatic cost
reductions, superior customer value and
satisfaction through lower costs, in-
creased convenience, and improved
availability of products.

While students’ strengths and interests

are important in deciding their major field
of study, what other criteria might they
use in their decision making process?
Using the Analytic Hierarchy Process
(AHP) technique, Strasser et al. provide
insights about the criteria students use
and the decision process they follow in
choosing a major for their studies.

Mid-American Journal of Business, Vol. 17, No. 2

This special issue will explore the implications of social responsibility on
the practices of for-profit organizations. Articles will examine the various
effects on business practices.

Articles representing original research will examine various social and
economic themes, such as those listed below:

• E-commerce

(e.g., access, privacy, equality, employee benefits)

• Human resource management

• Environmental impacts

• Public policy and business taxation

• Responsible marketing

(e.g., targeting children, marketing dangerous products)

• International trade

(e.g., sweat shops, outsourcing, gray markets)

• Competition law, regulation and GATT/WTO

• Financial transparency

• Copyright and intellectual property

• Cost transfer from private sector to public sector

Social Impacts of Business Practices

Reprints of any article are available from the Managing Editor

or on-line at www.bsu.edu/MAJB.

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Schmotter

Mid-American Journal of Business, Vol. 17, No. 2

James W. Schmotter, Dean
Western Michigan University

DEAN’S FORUM

Consumers and Expectations

All of us who labor in business col-

leges recognize the comments above.
Probably most of us have also participated
in the perennial debate about whether or
not students are customers, a debate not
likely to subside anytime soon. In fact,
various trends promise to increase the
consumerist viewpoint among our stake-
holders. The transparency of information
provided on the Internet and through
various other media has greatly increased
competition among our institutions. This
competition leads to more professional
marketing approaches, to more sophisti-
cated understandings of consumer needs,
and to more explicit promises in our
efforts to close the sale. Rising tuition and
costs of higher education everywhere also
increase the consumerist attitude; the
parent foregoing lifestyle amenities and
the student incurring debt both believe
that their investment entitles them to
special treatment as valued customers.
They are, after all, purchasing a very
expensive good. We ourselves in business
education have encouraged this attitude
through the stakeholder-oriented, continu-
ous improvement approach that AACSB
accreditation standards have mandated
since 1991. We in B-Schools know how to
do strategic planning, and our educational
models invariably include folks who look
a lot like customers.

However, we all know it is not that

simple. Unlike Wal-Mart or General
Electric, we provide our “customers” a
complex, intangible “product” that may
not satisfy all their preferences. Certainly
if those preferences include grades of at
least B with one hour of study per week
in “fun” courses always scheduled
between noon and 3 PM on Tuesdays and
Thursdays, they will be disappointed.
Likewise, we cannot guarantee a job
paying a stipulated starting salary in a
specific company or industry to all
graduates. We cannot even provide
assurance that they will be motivated in
all classes by equally dedicated profes-
sors resembling Richard Dreyfus in his
recent short-lived academic TV series.
Neither can we promise them they will
find love, happiness, and personal
gratification during their years with us.
Customers who come to us with such
expectations will be disappointed, and we
must manage these expectations.

Managing expectations starts with

realistic marketing. In the war for student
talent and ranking position, we often
overstate our achievements and capacity.
No business school can be all things to all
possible students, but many admissions
catalogues give that impression. Nearly
all of us can find a media ranking which
attaches some number, even if context-

Distinguished University President

“Students are our customers, and we must meet their needs. After all, we operate in a

competitive admissions marketplace.”

Outraged Senior Professor

“I’m appalled that we call our students “customers” (ugh!); that demeans everything that

the academy stands for!”

Aggrieved Undergraduate Parent

“Look, I’m paying (fill in the dollar amount) a year for my son to be here, and you had

better (fill in the blank)!”

Schmotter

Mid-American Journal of Business, Vol. 17, No. 2

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less, to our quality. Likewise, many of our institutions
suffer from serious mission-creep. Strong undergraduate
programs dilute their quality by expensive forays into the
MBA world. The drumbeat sounds on many campuses
for the establishment of new doctoral programs, but for
questionable reasons such as individual faculty ego or
inclusion in particular institutional taxonomies. Unhappy
customers are often the ultimate result of expectations
based on overly ambitious aspirations.

Setting sound expectations, on the other hand, is based

on equally sound information. Students and parents
should expect to know the qualifications of the faculty
who teach them. Course syllabi should be clear and
outline learning goals for individual courses. Information
on class size and ease of access to required courses
should be readily available. Student services personnel
should complement the academic mission, not replace or
hinder it with bureaucracy. Information about career
placement should be accurate and timely, even if it does
not confirm the claims of admissions recruiting materials.

Yet simply meeting these basic expectations does not

adequately address the dilemmas that increasing consum-
erism engenders. Our “customers” must have a better
understanding of what exactly it is that they are purchas-
ing. Here is one way to help them build that understanding.

Higher education, like many other professional

services, requires active participation by consumers to be
effective. The consumer must bring attention, engage-
ment, and effort in order for the product to add value. A
more passive approach, which I fear is common of
undergraduate education on most of our campuses, will
result in far less value added. It is not unlike buying a
gym membership and expecting to add muscle tone
without pumping iron or thinking that an expensive new
driver will lower your handicap without hours on the
practice tee. This is not smart consuming.

The importance of active engagement by students in

their education to ensure value added results returns us to
one of the traditional purposes of higher education, and
one upon which we call can agree, no matter if we use the
“C” word or not. This purpose is to fire the imagination
of young minds within the classroom, library, laboratory,
or late night residence hall bull session. It is up to us,
from the first day that students arrive on our campuses, to
demonstrate to them through instruction and personal
example, the special opportunity for intellectual growth
they possess during their time with us. They can watch
“Friends” or drink Budweiser the rest of their lives, but
they can only reap the rewards of smart consumption of
higher education during this unique time in their lives. If
the understanding of that reality is clear, our ability to
manage customer expectations in face of all of society’s
countertrends becomes far easier. And we become
recognized as the terrific bargain that we really are.

EXECUTIVE VIEWPOINT

While the events of 9-11 forced us to

rethink our sense of security in a troubled
and ever-shrinking world, on a somewhat
smaller scale but no less sudden and
dramatic, the collapse of the Enron
Corporation just a few months later has
raised troubling questions about our sense
of economic security and about the engine
of our economic stability and prosperity
— American corporations. While thou-
sands of Enron employees and sharehold-
ers saw their paychecks, their retirement
savings or the value of their investments
disappear overnight, countless millions of
Americans were wondering, could it
happen to me?

But that was not the only question

being asked in the wake of the largest
bankruptcy in American history. People
want to know how it happened. They want
to know how so many Enron executives
could walk away from the disaster they
created with tens of millions of dollars in
their pockets. They want to know, with all
the systems in place to protect employees
and consumers—the auditors, the Board
of Directors, the Securities and Exchange
Commission—how the sudden bankruptcy
of a company this large could happen.
And with more than 50 percent of Ameri-
can households now owning stock,
directly or indirectly, these questions are
being asked on Main Street, not just on
Wall Street.

Looking for answers to these and other

important questions, several Congres-
sional committees have begun to investi-
gate various aspects of the Enron disaster.
One of these investigations is being
conducted by the Permanent Subcommit-
tee on Investigations. This subcommittee
of the Governmental Affairs Committee

had its origins during World War II when
then Senator Harry Truman led an
investigation of price gouging and
contractor fraud in defense industries.
Later on it was the venue for labor
racketeering hearings, organized crime
hearings, and a wide variety of investiga-
tions into various criminal enterprises
from drug trafficking to the fraudulent
use of the student loan program to
insurance fraud. In recent years, we have
conducted an in-depth investigation into
money laundering and how drug traffick-
ers, terrorists, and other criminals try to
use our financial institutions against us.
As a result of this work, it was able to
adopt tough, new anti-money laundering
laws. Given the Subcommittee’s expertise
in issues related to financial institutions
and the international movement of
money, it could contribute to unraveling
the Enron mess.

To that end, in January, the Subcom-

mittee issued over fifty subpoenas to
Enron, Enron officers and board members,
and Arthur Andersen and, as a result, we
now have over one million pages of doc-
uments to review and digest. It is time
consuming and difficult work. A popular
phrase today is, “This isn’t rocket science.”
In some respects these elaborate financial
structures that Enron created are “rocket
science.” And what fueled that rocket is
not fiduciary duty but personal greed.

Enron was the largest energy trader in

the world, worth $80 billion, with 20,000
employees. It reached that point by the
tangled and deceptive use of a reported
3,000 affiliates, approximately 800 of
which were in offshore tax havens.

The Subcommittee found that when it

pared down the hundreds of incredibly

* Adapted from Remarks of Senator Carl Levin, to the Economic Club of Detroit,

Monday, April 22, 2002

After Enron:

Government’s Role and Corporate Cultures

US Senator Carl Levin
Michigan

“…what happened at
Enron was not just a
failure of regulations
and law, it was a
failure of corporate
culture, a failure of
values, a failure of
heart.”

Levin

Mid-American Journal of Business, Vol. 17, No. 2

complex financial transactions that were the hallmark of
Enron, many were nothing more than smoke and mirrors
bookkeeping tricks designed to artificially inflate earn-
ings rather than achieve economic objectives, to hide
losses rather than disclose business failures to the market,
to deceive more than inform. The decisions to engage in
these complex transactions were fueled by interlocking
conflicts of interest, a shocking disregard of investors,
and arrogance. Business managers are all familiar with
the concept of compound interest and how it allows
wealth to grow. Enron created a new concept—compound
conflicts of interest, which allowed deception to grow to
new heights or more appropriately... new lows.

Let us look at the ABCs of Enron—and this is meant

literally. That is, Enron was so creative at creating new
types of devious and deceptive business practices that
you can not keep track of them without using a scorecard
to sort it out.

Deception Type A…reporting the sale of an asset on
the company’s financial statement, despite a quiet
understanding that Enron will buy it back after the
financial statement is filed or despite a hidden guaran-
tee that the entity buying the asset will receive a
certain rate of return. Five of the seven assets sold that
way at the end of the last two quarters of 1999 had to
be bought back, within six months’ time. But those
guarantees did not show on the books as liabilities,
only the sale prices showed as income.

Deception Type B…making a loan look like a sale so
the company’s financial statement reflected the
transaction as income instead of debt. One $350
million example involves Mahonia, an Enron transac-
tion with an offshore company named appropriately
enough after a flower that grows in the dark. It was set
up as a complex, three-party transaction using multiple
energy derivatives. In the end, when the bare bones of
the transaction were exposed, it was nothing more than
a loan by a big investment bank to Enron. The invest-
ment banks not only knew what was going on in these
transactions, they actively marketed these schemes to
other investors.

Deception Type C…inflating the value of the assets
Enron held for sale. For example, Enron would buy a
power plant on day one for $30 million and within a
month or so they would begin carrying it on their
books as an asset worth $45 million.

Deception Type D…Enron using its own stock to
backstop a risk another entity was supposed to be
assuming for Enron. The infamous example occurred
in a set of transactions appropriately enough called the
Raptors. And, of course, the risk retained by Enron in
these transactions was not clearly disclosed on the
company’s financial statements. Even the most
sophisticated investors were misled.

Those are the types of deceptive transactions the

Subcomittee has identified so far in its investigation. We
may have to use the whole alphabet by the time we are
done. On top of the deceptions—and no doubt the reason
they went on without detection or objection—are the
conflicts of interest among the people and entities
involved.

Enron created a new concept—
compound conflicts of interest, which
allowed deception to grow to new
heights or more appropriately...
new lows.

The first conflict of interest involved Enron’s manage-

ment, the folks who spun this web of deception. Enron
hired aggressive, bright managers and paid them exorbi-
tantly. In fact, the company made some 2,000 millionaires.
Enron’s CEO earned $140 million in a single year. It also
handed out bonuses like candy at Halloween. Two execu-
tives who closed a deal on a power project in India, which
is now in trouble, got bonuses in the range of $50 million
just for closing the deal. The head of one Enron division
was moved out of the company and walked away with
more than $250 million in the year he was shown the door.

There is nothing inherently wrong with generous

compensation for a company’s managers, but when that
compensation is so completely divorced from the eco-
nomic realities of a company, it can constitute a conflict
of interest, and it certainly did in Enron. Those kinds of
compensation arrangements focus company managers on
today’s deal or today’s stock price and not on the long-
term value or growth of the company. That focus helped
run up the value of management’s own stock options in
the short run, but did nothing to protect the long-term
interest of employees and shareholders.

A particularly egregious variation on this type of

conflict of interest can be seen in the case of Andrew
Fastow. Fastow, Enron’s Chief Financial Officer, was
allowed to be the managing partner of an entity called
LJM that was used to buy assets from Enron no one else
would buy. LJM bought many of these assets and sold
pieces to outside investors because of Enron’s undis-
closed guarantees. Talk about a conflict. Enron was
basically negotiating the sales of these assets with its own
employees. And, to top it off, Fastow ended up making
well over $30 million from the partnership.

There were other conflicts of interests. Enron directors

were supposed to exercise their best business judgment
on behalf of shareholders. But Enron directors were
picked by management and were so extraordinarily well
paid, receiving cash and stock worth about $300,000 a
year, that their independence was jeopardized. They too
had so much to gain from the deceptions that passed for

Levin

Mid-American Journal of Business, Vol. 17, No. 2

accepted business practice at Enron that they were
content to accept whatever explanations and information
management gave them. They failed to look hard, ask
tough questions, and consider personal motivations of
management that prompted the deceptive transactions
that ultimately contributed to Enron’s downfall.

If Enron’s board was too compromised to bring

independent oversight to the company, what about its
auditors? Enron’s now infamous auditors, Arthur
Andersen, earned $52 million in fees from the company
in the year 2000, the last full year they worked for the
company. Enron was Andersen’s largest client. For two
years Andersen served as both Enron’s external and
internal auditor and for many years it also served as
Enron’s management consultant. Therefore, they were
auditing their own work. Employees of Andersen
routinely crossed over to work for Enron, and an
Andersen employee who actually questioned an Enron
practice while serving on an audit team was promptly
reassigned to another client at Enron’s urging. With so
much to gain from its relationship with Enron’s
management, there was too much temptation for Arthur
Andersen to avoid blowing the whistle.

Well then, how about the financial analysts? These

folks are supposed to give objective advice on stocks,
but the analysts are often employed by the investment
banks that earned huge fees for designing, promoting,
and actually becoming partners in Enron deals. New
York’s attorney general has shown how conflicted these
investment banks can be by revealing the recent e-mails
of financial analysts at Merrill Lynch, describing to each
other as “junk” the investments they were recommend-
ing to the public to “buy.” Four types of deception and a
variety of conflicts of interest allowed those deceptions
to take root and grow to a bankruptcy that at latest count
leaves Enron owing over $100 billion.

So now the question everyone might ask is what to

do about it? The answer to that question is in two
parts, with the first part focusing on what government
should do.

It is possible to draw a parallel between the new

threats to the nation’s security posed by 9-11 and the
new threats to economic security raised by the collapse
of Enron. The attacks on New York and Washington
changed the perception of Americans, the world around
them, and their own country. Americans began to see,
what they perhaps should have seen all along, that
government is not some distant alien force in our lives.
Government is the fireman running into a building from
which others are fleeing for their lives. It is the rescue
worker sifting through rubble long after others have
abandoned hope. And it is the civil servant quietly going
back to work in the Pentagon, just yards away from
where a colleague’s life was cut short by a senseless act
of terror. Government is the people, acting together for
the common good.

Over the last twenty-five years, with both Democratic

and Republican administrations in the White House, the
country moved steadily towards a less regulated economy
and few would argue that we should suddenly reverse
direction. But the challenge for America today, made
clear by the Enron fiasco, is to find the legitimate role for
government to play in this new, largely deregulated
economy.

When Franklin Roosevelt became president seventy

years ago he had more than his share of critics who were
convinced that his policies would spell the end of our free
enterprise system. But in the wake of the Great Depres-
sion, his reforms saved our economic system from its own
excesses and provided a foundation of economic security
that made this country the prosperous and free nation it is
today.

Today the challenge Americans face is different than

FDR’s. Increasingly Americans are both workers and
shareholders and as such, they are vulnerable to the kind
of manipulations and deceptions that left hundreds of
thousands of Enron employees and shareholders with
nothing but broken dreams for all their years of hard
work. This country needs to think boldly about what
economic security means in this new economy.

And in that spirit I have introduced legislation that

would establish a Shareholders’ Bill of Rights.

– This bill of rights would reform the way account-

ing standards get issued so that the board that
issues them is truly independent and accountable
to the public. To ensure its independence, the
board must have funding that is not connected to
the major accounting firms or their corporate
clients. The end result should be standards that
prevent any company from claiming that Enron-
like accounting contortions are within the rules.

– It would strengthen auditor independence by

preventing auditing firms from providing non-
auditing services, such as consulting, during the
course of an audit and for two years afterward.

– It would require shareholder approval of any stock

option compensation plan that will not be shown
on company financial statements as an expense.

– It would require prompt disclosure of company

loans to board members and officers.

In addition, Congress needs to strengthen the Securi-

ties and Exchange Commission so that this critical
watchdog agency is not hopelessly outgunned by those
companies it oversees.

As previously noted, the answer to the question what

to do to prevent further “Enron-type fiascos” required a
two part answer. The second part is not about government
at all, it is about the private sector. While there must be a
new role for government in the new economy, govern-

Levin

Mid-American Journal of Business, Vol. 17, No. 2

ment action cannot provide most of the answer. That is
because what happened at Enron was not just a failure of
regulations and law, it was a failure of corporate culture,
a failure of values, a failure of heart. And even the best
government policy cannot change that. That change will
come from the actions of leaders in the business commu-
nity who by their example promote a culture of openness,
of competency, and of candor.

Corporate boards and corporate officers have a

fiduciary duty to their stockholders. That duty, that
fiduciary duty, needs to be reinforced in this new century.
When business leaders ignore that duty, the results are
corrosive to our society as a whole. They undermine the
basic sense of fairness and honesty that binds us together
as a people. The pursuit of personal profit at any cost
cheapens the core values that make America the great
country it is. How can Americans tell their children to
play by the rules when con men disguised as corporate
managers walk away from an Enron with millions in their
pockets while leaving behind nothing but a trail of false
profits and broken dreams? Americans know what a
difference the right kind of business leadership can mean
for a community because this country has been blessed
with a number of business leaders who have exemplified
corporate citizenship at its best.

It is a much different world since September 11, but this

country should remember something that has not changed,
something that is as true today as it was fifty or a hundred
years ago. To realize its great potential as a nation
America must always strive to find the right balance
between the bottom line and the common good.

About the Author

Carl Levin is the chairman of the Senate Armed Services

Committee. He was an early and consistent advocate of efforts
to prepare the American military to combat terrorism and other
emerging threats of the post-Cold War world. Senator Levin
also serves as the chairman of the Permanent Subcommittee on
Investigations of the Governmental Affairs Committee. He is a
member of the Small Business Committee and the Senate Select
Committee on Intelligence.

Levin is perhaps best known for his efforts to make our

government both more effective and more ethical. He authored
the Competition in Contracting Act, which has led to significant
reductions in federal procurement costs. His Whistleblower
Protection Act protects federal employees who expose wasteful
practices.

In 1956 he graduated with honors from Swarthmore college

and from Harvard University Law School in 1959. He practiced
and taught law in Michigan until 1964 when he was appointed
an assistant attorney general of Michigan and the first general
counsel for the Michigan Civil Rights Commission. He has
represented Michigan in the U.S. Senate since 1978.

The Social Impact of Business Failure: Enron

Uma V. Sridharan,

Lander University

Lori Dickes,

Lander University

W. Royce Caines,

Lander University

Abstract

Between October and November 2001 the world

witnessed the collapse of Enron, a major US publicly
traded corporation with global operations. The Enron case
highlights the impact corporate failure has on American
society and capital markets and underscores the need for
better enforcement of regulations and ethical business
behavior. This paper discusses the role played by Enron’s
senior management, its board of directors, Enron’s audi-
tors, consultants, bankers, Wall Street and the government,
in the spectacular rise and fall of this corporate giant. It
also examines the impact of Enron’s failure on its
employees, the employees of Andersen, and on thousands
of ordinary Americans who invested in the stock via their
pensions and mutual funds. This paper highlights the
conflicts of interest that pervade the financial system
and discusses the social and financial impact of a com-
bined business and oversight failure. Students and
teachers of finance, corporate governance, and business
strategy may be interested in this paper as a pedagogical
tool to teach undergraduate finance, business ethics,
business strategy, and corporate governance.

Keywords: corporate governance, strategy, business
ethics, board of directors, mutual funds, social
impact, financial transparency, securities acts,
pension funds

Introduction

Enron, once the world’s largest energy company, was

ranked number seven by Fortune magazine in April 2001
in Fortune’s ranking by market capitalization of the five
hundred largest corporations in the United States. On
December 2, 2001, Enron filed for Chapter 11 bank-
ruptcy. The sudden and swift collapse in the market value
of this corporate giant has had major ramifications for
nearly all of its stakeholders including, but not limited to,
its shareholders, employees, creditors, and auditors. The
causes and consequences of the Enron bankruptcy filing
highlights the social impact of business failure, which is
the focus of this paper.

Before the collapse of Enron, many individuals and

institutions in the United States, including representatives
in the US Congress, were largely in favor of deregulation
of business. However, in the wake of huge losses at the
Enron Corporation, the debate on regulation vs. deregula-
tion has been revived and gained momentum. It has
become increasingly evident that corporate failure of the
magnitude of Enron causes serious economic, political,
and social dislocation.

Before the securities market crash of 1929 and the

Great Depression, there was very little support for
governmental regulation of securities markets. Many
individuals and institutions lost significant sums of
money in the 1929 crash, which also brought about a
steep decline in public confidence in securities markets.
To restore the investing public’s faith in capital markets,
Congress passed the Securities Act of 1933 and Securities
Exchange Act of 1934. These laws were designed to
restore investor confidence in U.S. capital markets by
providing for more structure and oversight.

The Securities Exchange Act of 1934 created the US

Securities and Exchange Commission (SEC). The primary
mission of the US Securities and Exchange Commission
is to protect investors and maintain the integrity of
securities markets. The SEC oversees corporate disclo-
sure of information to the investing public. Public
companies in the United States with more than $10
million in assets and whose securities are held by more
than 500 owners are required to file annual and quarterly
statements (Forms 10K and 10Q) with the SEC. These
forms are supposed to disclose information about such
public companies’ financial condition and business
practices. This disclosure is expected to help investors
make informed investment decisions. This SEC review
process is intended to check if firms are meeting their
disclosure requirements. The SEC seeks to improve the

…corporate failure of the magnitude of
Enron causes serious economic, political,
and social dislocation.

Sridharan, Dickes, and Caines

Mid-American Journal of Business, Vol. 17, No. 2

quality of the information disclosed and to help make a
company’s financial statements ‘transparent’, i.e., more
easily understood by the investing public. The rest of this
paper is organized in five sections. The first section
discusses the roles and responsibilities involved in the
financial reporting process. The second section covers a
brief history of Enron, including a summary of events
leading up to its bankruptcy filing. The third section
discusses the social impact of this corporate failure. The
fourth section discusses how and why the US corporate
governance system failed to prevent this corporate
collapse. It examines the role played by various agencies
including Enron’s consultants, its top management, its
board of directors, external auditors, Wall Street analysts,
and the government (SEC). The final section concludes
the paper with a discussion of reforms following the
Enron failure.

Roles and Responsibilities

The United States’ securities laws and corporate

governance system requires that a board of directors
supervise the management of each public corporation.
Every director is expected to act in good faith and in the
best interests of the company. The director, in exercising
his or her duties, is expected to exercise skill and dili-
gence. A director may be sued for the failure to take
reasonable care, or for a breach of duty of care to the
firm, in circumstances where it can be shown that he or
she failed to exercise due care. If it can be shown that a
director was knowingly a party to conducting the firm’s
business in a reckless manner, the Courts may make the
director personally liable for any harm caused to the firm.

The role of the audit committee of the board of

directors is delineated in the charter of the audit commit-
tee. Generally, the audit committee of the board of
directors is responsible for recommending the selection of
the company’s external auditors and for recommending
the fees payable to external auditors. The audit committee
is also generally expected to review the audit plan
developed by management and the external auditors, and
to periodically review the performance of the external
auditors. The audit committee is required to review the
firm’s annual financial statements, including whether the
firm’s accounting and management systems and reports
comply with generally accepted accounting principles
(GAAP). The audit committee is expected to periodically
review the firm’s system of internal controls includ-ing
its risk management policy. The SEC views the firm’s
audit committee as playing a critical role in the financial
reporting system and requires extensive disclosures about
a public company’s audit committee and its interaction
with the company’s external auditors. The SEC requires
audit committees to state whether they have reviewed and
discussed the audited financial statements with the firm’s
management and the independent external auditors.

When a public company files its annual and quarterly

reports with the SEC, the firm’s management is required
to take responsibility for the integrity and objectivity of
the firm’s financial statements. Management is expected
to prepare the company’s financial statements in confor-
mity with GAAP. Management is also expected to have in
place a system of internal controls designed to provide
reasonable assurance of the reliability of financial
statements as well as the protection of the firm’s assets
from unauthorized acquisition, use, or disposition. The
internal control system is to be strengthened by having
written policies and guidelines that are to be implemented
by qualified personnel who are carefully selected and
trained for the task.

The public firm’s financial statements are to be

reviewed by independent external auditors. The firm’s
external auditors have a duty to be objective in their
review of the firm’s financial statements. While it is the
responsibility of the firm’s management to prepare the
financial reports, it is the responsibility of the firm’s
external auditors to express an opinion on these financial
statements based on their independent audit. The auditors
are expected to perform the audit to obtain reasonable
assurance that the financial statements are free from
material misstatement. The auditors are required to opine
if the financial statements prepared by management fairly
present, in all material respects, the financial position of
the firm and its subsidiaries on a given date. It is the
responsibility of Wall Street analysts to provide an honest
and unbiased evaluation of a firm’s performance and
prospects when they issue buy, sell, or hold recommenda-
tions on the stock of a firm.

Despite all the checks and balances provided for in the

U.S. corporate governance system as discussed above,
Enron collapsed under the burden of its accounting
scandals, just as its accountant Sherron Watkins warned
in internal memos to the CEO Kenneth Lay and its
external auditors, in August 2002 (Hamburger and Brown
2002). The Enron case exemplifies the great harm an
accounting scandal and a large corporate bankruptcy can
wreak upon society and its members.

Enron History

In July of 1985, Houston Natural Gas Inc. merged with

Inter North Inc., a natural gas company based in Omaha,
Nebraska, to form Enron an interstate and intrastate
natural gas pipeline company. In 1989, Enron began
trading natural gas commodities. In just a few years,
Enron became the largest natural gas merchant in North
America and the United Kingdom. Guided by the strate-
gic advice provided by world-renowned business consult-
ants McKinsey and Company (McKinsey), and the
leadership of its former CEO, Jeffrey Skilling (a former
employee of McKinsey), Enron transformed itself from
an energy company to a risk management firm that traded

Sridharan, Dickes, and Caines

Mid-American Journal of Business, Vol. 17, No. 2

everything from commodities to derivatives. Enron’s
consultants may have advised Enron to pursue a strategy
of building a large firm with very few real assets on its
balance sheet. The use of special purpose entities (SPEs)
allowed Enron to operate extensive undercover and risky
trading operations in a manner that did not properly
reflect their debt on its balance sheets. The ‘asset-light’
strategy, the SPEs, and the off-balance-sheet financing
they provided to Enron appear to be the root cause of
Enron’s eventual failure.

firm reported a $638 million third-quarter loss and
disclosed a $1.2 billion reduction in shareholder equity,
partly related to SPEs run by CFO Andrew Fastow. This
disclosure brought closer attention to the manner in which
Enron was financing its operations. Thereafter, a quick
downward spiral in the stock price of the firm ensued as
additional disclosures followed. On October 22, 2001,
Enron acknowledged that the SEC was inquiring into a
possible conflict of interest related to the company’s
dealings with its SPEs. On November 8, 2001, Enron
filed documents with the SEC revising its financial
statements for the past five years to account for $586
million in losses. Faced with the possibility of a down-
grade in its credit rating and a consequent cash shortage,
Enron’s management attempted to sell Enron to energy
rival, Dynegy, who initially agreed to buy Enron for over
$8 billion in stock. However, Dynegy backed out of the
merger agreement on November 28, 2001 shortly after
independent credit agencies downgraded Enron’s debt to
junk status to reflect Enron’s rapidly deteriorating
financial condition. This led to the final collapse in the
price of Enron stock that thereafter traded below one
dollar per share after trading as high as $90 per share.
Enron was forced to seek protection under Chapter 11 of
the US Bankruptcy code on December 2, 2001. The firm
was eventually de-listed from the prestigious New York
Stock Exchange.

Social Impact of the Enron Bankruptcy

As the value of Enron stock plunged in value, many

Enron employees lost their jobs and nearly all of their
retirement savings. In their testimony before Congress,
former Enron employees testified that while they had
retired with $700,000 to $2 million in Enron stock, they
now had virtually nothing except their social security
funds. To make matters worse, many of these employees
were restricted from selling their stock even as the stock
price declined in value, while senior officers of the firm
were able to sell their Enron stock without similar
restrictions (Schultz 2002). The issues of restricting stock
sales and the percentage of stock held in individual
401(K) plans are some of the many troubling issues to
emerge from the Enron crisis.

The steep financial losses and loss of jobs is not

limited to the employees of Enron. Over 28,000 employ-
ees at Andersen’s U.S. operations, many of whom were
completely uninvolved with the Enron audit, are at risk of
losing their jobs and thousands of Andersen employees
have already been laid off. Around 1,750 Andersen
partners may lose most of their entire life savings as the
ongoing financial viability of the auditing firm is in
jeopardy (Dugan and Spurgeon 2002; Bryan-Low 2002).
Following the release of the Powers Report, it appears the
Justice department focused immediate and greater
attention on the role of Andersen in this corporate

GAAP requires a firm to consolidate the financial

statements of an SPE with the firm’s own financial
statements unless the following two conditions are met:

a. The SPE has to have an independent owner with a

minimum of 3 percent equity capital at risk through-
out the transaction.

b. The independent owner has to exercise control of the

SPE (Hancock and Britt 2002).

Enron’s external auditors Andersen LLP (Andersen)

approved Enron’s use of SPEs. However, some of
Enron’s SPEs did not meet GAAP non-consolidation
rules. Enron’s use of SPEs and the manner in which
Enron accounted for them made Enron’s financial
statements very complex and difficult to understand. The
SPEs also provided rich rewards to some of its officers,
including the firm’s former Chief Financial Officer
(CFO), Andrew Fastow. Andersen performed both the
external and the internal audits for Enron and also served
Enron as a consultant in non-audit and tax matters.
Andersen’s three-way relationship with Enron created the
possibility for several conflicts of interest.

On the political front, Enron, its chairman Kenneth

Lay, and its auditors contributed generously to the
campaigns of many politicians in both major political
parties in the United States (Watts 2001; Adamson 2002;
Spain 2002a, b). Its political donations may have given
Enron some political power and some influence over the
formulation of a U.S. energy policy favorable to the
company. Despite its strong political connections and
high visibility, the hazardous nature of its capital struc-
ture strategy and its risk management business essen-
tially made Enron a firm built on very weak financial
foundations.

The first sign of weakness in the firm’s financial

structure became obvious on October 16, 2001 when the

The ‘asset-light’ strategy, the SPEs,
and the off-balance-sheet financing …
appear to be the root cause of Enron’s
eventual failure.

Sridharan, Dickes, and Caines

Mid-American Journal of Business, Vol. 17, No. 2

accounting scandal. In March 2002, the Justice depart-
ment indicted Andersen, the entire auditing firm, not just
individual auditors at Andersen, for obstruction of justice
when they shred documents relating to the Enron audit. It
is noteworthy that similar indictments have not yet been
issued for the top managers at Enron. Following this
indictment of Andersen, the trickle of corporate clients
dropping Andersen as their external auditor of choice
became a flood. By April 8, 2002, Andersen had lost
around 150 U.S. public clients, which will have an
immediate and severe negative impact on its revenues.

Andersen’s chances of winning a favorable settlement

with the Justice Department was greatly reduced when
David Duncan, the lead Andersen partner involved in the
Enron audit, pled guilty on April 9, 2002 to criminal
obstruction of justice charges due to his involvement in
Enron-related document shredding. On April 19, 2002,
Andersen broke off settlement talks with the Justice
Department. The case is expected to go to trial in Hous-
ton, Texas, on May 6, 2002. If Andersen is convicted of
obstruction of justice, it would be extremely difficult for
the firm to survive because the firm would be unable to
continue to audit publicly owned firms without obtaining
a waiver from the SEC. Even without a criminal convic-
tion, following the example set by the Arizona state
board, several other state accounting boards may revoke
Andersen’s licenses, without which Andersen will be
unable to practice in such states. Following the Justice
Department’s indictment of Andersen, several additional
lawsuits have been filed against Andersen by sharehold-
ers of Enron who seek to hold Andersen accountable for
Enron’s audits. The financial losses due to loss of
business with the departure of clients, the potential
liability from an SEC investigation and the Justice
Department’s indictment and numerous lawsuits raise the
odds that the Enron bankruptcy will bring about the
bankruptcy of its external auditor. This will clearly hurt
many Enron and Andersen stakeholders, including those
not directly involved with the accounting scandal.

The sharp and sudden decline in the value of Enron

stock adversely affected the retirement savings of thou-
sands of ordinary Americans who had no direct connec-
tion with the firm. Many Americans invest their retire-
ment savings in mutual funds and especially in index
funds because of their relative safety and reliable perfor-
mance. Enron was a member of the Standard and Poors
(S&P) 500 Index until November 29, 2001. All Index
funds seek to replicate the performance of their Index.
Therefore, over twenty-five mutual funds listed in the
S&P 500 Index had to include Enron stock in their
investment portfolios until Enron was removed from the
S&P 500 Index. Because Enron was dropped so late from
the S&P 500 Index, many individual investors who
invested in index-funds lost money because by the time
Enron was dropped from the S&P 500 Index, the stock
had lost over 99 percent of its market value. To the extent

index funds reduced their holdings of Enron as the market
value of the firm fell, they would have been able to cut
their losses. However, they could not completely elimi-
nate their exposure to Enron as long as Enron was in the
Index. There were also many other actively managed
portfolios, including those of many university foundations
(such as the investment portfolio of the University of
California), which had substantial exposure to Enron.
Portfolio managers of some of these investment funds did
not in fact reduce their exposure to Enron as its stock
price fell. Some asset management companies even used
the price decline as an opportunity to add to their posi-
tions. For example, Alliance Capital Management
(Alliance), the investment manager for the Florida
Retirement System (FRS), bought 4.9 million shares of
Enron for FRS between August and November 2001.
Two days before Enron filed for bankruptcy, Alliance
sold 7.5 million shares of Enron. Alliance was the asset
management firm with the largest exposure to Enron
(see Table 2). Estimates of losses in FRS’ portfolio
holdings of Enron range from $281 million to $321
million. FRS fired Alliance in December 2001. The
American Federation of State, County and Municipal
Employees, one of the largest public employee unions in
the US, is currently investigating why the Florida State
Board permitted Alliance to continue buying Enron
shares even after the SEC investigation into Enron was
announced in October 2001.

Mutual funds are only required to release complete

lists of their holdings twice a year. Therefore, it is
difficult to precisely identify how many other actively
managed funds also held Enron stock in their portfolios.
It is known that many reputable mutual fund companies
including Janus, Alliance, Putnam, Aim, Fidelity, and
Vanguard families of mutual funds held substantial
amounts of Enron stock (See Tables 1 and 2, and Wiser
2001). Enron stock formed part of the investment portfo-

Table 1

Mutual Fund Holdings of Enron as of August 31, 2001

Galaxy II Utility Index

Utility

6.97

iShares Dow Jones U.S. Utilities

Utility

6.51

Fidelity Select Natural Gas

Natural Resources

5.69

AIM Global Infrastructure

Global

4.02

Goldman Sachs Research Select

Large-Cap Growth

3.43

MFS Utilities

Utility

2.17

SM&R Growth

Large-Cap Core

2.15

Federated Utility

Utility

1.50

Morgan Stanley Global Utilities

Utility

1.40

Deutsche Top 50 U.S.

Large-Cap Growth

1.40

Source: Lipper, based on annual and semi-annual reports

as of Aug. 31, 2001

Lipper Fund

Enron as % of

Funds

Classification

Fund’s Assets, 8/31

Sridharan, Dickes, and Caines

Mid-American Journal of Business, Vol. 17, No. 2

lios of several state pension plans, university and other
non-profit foundations. As of June 20, 2001, the Teachers
Retirement System of Texas owned 2.2 million shares and
CALPERS held 3 million shares (Wiser 2001.)

Portfolio managers of the funds that held Enron had a

fiduciary responsibility to make safe and knowledgeable
investments. In order to accomplish this, portfolio
managers had an additional responsibility to adequately
scrutinize all documents a firm files with the SEC before
they invest in the firm. Although financial statements

provided by Enron were allegedly lacking in financial
transparency, a prudent financial manager should have
refrained from investing in any firm whose financial
statements he/she did not fully comprehend. Portfolio
managers failed in their fiduciary responsibility to keep
individual investors’ funds safe when they invested in
Enron if they did not properly understand how the firm
made the profits it reported. The social impact of this
failure in fiduciary responsibility is reflected in the
millions of dollars lost in Enron stock investments by
individual and institutional investors. Many of Enron’s
trading partners such as Citigroup and J.P. Morgan also
suffered steep losses because of the Enron collapse and
within days of the Enron bankruptcy filing provided the
public and their stakeholders with preliminary estimates
of their Enron exposure (See Table 3).

Causes and Consequences of Multiple
Failures

The failure of Enron was a result of a combined failure

on several fronts. It was a failure of the high-risk, asset-
light business and financial strategy pursued by Enron
presumably under the advisement of its business consult-
ants, McKinsey and Company. The Wall Street Journal
reports that McKinsey and Company, in an internal
document, praised Enron’s use of “off balance sheet
funds using institutional investment money [which]
fostered its securitization skills and granted it access to
capital at below the hurdle rates of major oil companies”
(Hwang 2002, B1). The consultants deny being involved
in the review of decisions made about Enron’s invest-
ments, yet McKinsey and Company served as advisors to
Enron’s board of directors in the year preceding Enron’s
bankruptcy filing and at least one senior partner from the
consulting firm attended six board meetings at Enron
from October 2000 to October 2001. At these board
meetings, the former Enron CEO Jeffrey Skilling report-
edly emphasized the need for SPEs to help bolster the
firm’s growth (Hwang 2002). If Enron’s balance sheet
had contained a greater proportion of tangible and
especially fixed assets with stable market values, the
market value of the firm may not have collapsed as it did,
and the fixed assets could have been sold to meet its
financial obligations.

There are many levels of blame in this corporate crisis.

Enron’s top managers are clearly responsible for poor
business decisions and mismanagement of the corpora-
tion. Not surprisingly, when required to testify before the
U.S. Congress on the reasons for Enron’s collapse, most
of Enron’s managers sought refuge under the Fifth
Amendment. Decisions that individuals and corporations
make often have multiple, systemic effects. Often,
individual decision makers underestimate the conse-
quences that follow from their decisions. When the
governing bodies of corporations do not understand, or

Table 2

Selected Institutional Holdings of Enron

as of September 30, 2001

Alliance Capital

42.94 million

Janus Capital

41.4 million

Putnam

23.1 million

Barclays Global

23.1 million

Fidelity

20.8 million

Smith Barney

19.4 million

State Street

16.1 million

Aim

14.0 million

Vanguard

11.4 million

Morgan Stanley

10.1 million

Source: CBS Marketwatch.com, November 28, 2001

Number of Enron Shares

Institutions

Held 9/30/2001

Bear Stearns

$69 million

ABN Amro

110 million Euro

ING Barings

$195 million

PPL

$10 million

Chubb

$220 million

Aegon

$300 million

Candian Imperial Bank

$215 million

of Commerce CIBC

Credit Lyonnais

$259 million

Duke Power

$100 million

Centrica

$30 million

Deutsche Bank

less than $ 100 million

RWE Trading

10-11 million Euro

Sempra

less than $15 million

J P Morgan

$2.6 billion

Citigroup

$260 million or more

American Electric Power

$50 million

ONEOK

$40 million

Source: Wall Street Journal Reports, October to December 2001

Table 3

Number of Enron Shares Held

Preliminary Estimates of Exposure to Enron

Exposure to Enron

Amount

Sridharan, Dickes, and Caines

Mid-American Journal of Business, Vol. 17, No. 2

take account of all future consequences, serious moral
hazards result. Messick and Bazerman (1996) argue that
potential consequences are often ignored because of five
possible biases: ignoring low probability events, limiting
the search for stakeholders, ignoring the possibility that
the public will find out, discounting the future, and
undervaluing collective outcomes. It now appears that
Enron management and the Board maintained all of the
five biases to some extent. The many decision makers
involved with Enron would have better served all stake-
holders if they had considered the full spectrum of
consequences associated with their decisions (Messick
and Bazerman 1996, p.3).

2002). According to the Powers Report, some of the
involvement of the Enron officers in some SPEs may not
have been fully disclosed to either Enron’s Chairman and
CEO, Kenneth Lay, or to the Board of Directors. The
Board approved the CFO’s participation in the SPEs with
full knowledge of the potential conflict of interest.
However, the Enron Board believed that the conflict of
interest and the risks associated with it could be moni-
tored effectively by oversight provided by senior manage-
ment and the Board. The Board believed that the benefits
of the SPE transactions outweighed the potential risks and
costs. In hindsight, it appears that the controls designed
were not sufficiently rigorous and that management and
board oversight was insufficient. According to the Powers
Report, the Enron Board believed that the SPE transac-
tions were genuine economic hedges when in reality they
were merely accounting hedges that permitted Enron to
manage its earnings. The Board’s decision to permit the
CFO to control some SPEs was unwise. The Board can
justifiably be criticized for failing to request additional
information where the information presented by manage-
ment was insufficient to make effective decisions. The
Powers Report concluded that some board members did
not fully understand the risks and consequences of the
SPE transactions. Enron paid Andersen $5.7 million for
advice on some SPE transactions (e.g. SPEs named LJM
and Chewco). The Board and its audit committee appar-
ently relied heavily on the advice provided to the Board
and management by Andersen on SPE transactions. The
Powers Report simply states that the Board of Directors
of Enron failed in its oversight duties, mostly via inaction.
Several insurance firms who underwrote liability cover-
age for Enron’s directors and officers are reported to be
considering the suspension of insurance policies on the
grounds that Enron directors and officers may have
misled insurers by renewing the insurance policies based
on earnings reports that were subsequently restated
(Lublin and Emshwiller 2002).

Academic literature acknowledges the importance of

actively managing a firm’s reputation. Customers,
employees, and shareholders of businesses are increas-
ingly intolerant of ethical lapses in business management.
As a result, firms are required to be more closely focused
on reputation management (Fry 1997). Giampetro-Meyer
(1998) recognizes that even the most socially responsible
businesses have serious ethical failures at times. More-
over, she rightly acknowledges that, as organizations
increase in size and complexity, it is often difficult to
carry out their missions in a consistent and responsible
manner. She argues, “For-profit, publicly-held companies
are messy, filled with contradictions and inconsistent
behavior” (Giampetro-Meyer 1998, p.3). From all
appearances, Enron’s Board of Directors and officers did
not adequately consider their company’s reputations, or
their own, in the decision-making process. As Enron grew
from a mere natural gas pipeline company to become the

The Board of Directors for any corporation is an

important body in the provision of effective corporate
governance and oversight of management. Carroll (1979)
lists the four responsibilities of the managers of a busi-
ness organization in the order of priority as: economic,
legal, ethical, and discretionary. Enron’s directors and
officers may have failed to adequately perform their task
of protecting the investments of Enron shareholders in at
least three (economic, ethical, and legal) of the four
responsibilities outlined by Carroll (1979). Ethical
behavior for corporations is outlined in a company’s code
of ethics, which specifies how an organization expects its
employees to behave when on the job (Hunger and
Wheelan 2000.) Enron’s Board of Directors suspended
the company’s code of ethics twice in 1999 to permit the
creation of two SPEs controlled by Enron’s former CFO,
Andrew Fastow, who stood to personally benefit from
these arrangements. Enron’s audit committee may have
failed in its responsibilities as outlined in the introduction
of this paper. The audit committee included educated,
respected professionals such as a retired professor of
accounting from Stanford University, the former head of
the Commodity and Futures Trading Commission, and
the director of regulatory studies at George Mason
University. Hence Enron shareholders may have believed
it extremely unlikely that the audit committee of Enron
would fail in its core responsibility of providing oversight
of the company’s external auditors, reviewing the firm’s
system of internal controls and risk management policy,
and ensuring the compliance of the firm’s accounting and
management systems and reports with GAAP.

A possible explanation for this puzzle is contained in

the Report of the Special Investigative Committee of the
Enron Board of Directors (Powers, Troubh, and Winokur

Enron’s Board of Directors suspended
the company’s code of ethics twice in
1999 to permit the creation of two SPEs
controlled by Enron’s former CFO,
Andrew Fastow, who stood to personally
benefit from these arrangements.

Sridharan, Dickes, and Caines

Mid-American Journal of Business, Vol. 17, No. 2

largest natural gas merchant in the U.S., and later a global
energy and risk management business, it seems that its
management and Board found it difficult to carry out the
mission of the firm in a consistent and responsible
manner.

including the lead partner handling the Enron audit,
David Duncan. Andersen then began a public relations
campaign to restore its tarnished image. On January 18,
2002 Enron’s Board of Directors fired Andersen as its
auditor. One of the more troubling aspects of the Enron
failure is the shredding of audit related documents by
Enron and Andersen shortly after they realized that Enron
had several accounting irregularities. As Skupsky (1993)
writes, “it is a well-established fact that the legal respon-
sibility for records management generally lies personally
with those who are responsible for the entire organization
…officers and directors are unprotected by the ‘corporate
shield’ when willfully failing to meet their responsibili-
ties” (Skupsky 1993, 33). One consequence of the Enron
case is the increased awareness of the board’s responsibil-
ity and auditors’ responsibility to preserve all material,
especially financial and audit-related documents. The
document shredding by some Andersen employees may
well bring about the demise of Andersen as the Justice
Department proceeds with its criminal indictment for
obstruction of justice against Andersen.

Enron could not have succeeded without the coopera-

tion and support of its bankers and trading partners who
helped finance its operations. Some Enron bankers (e.g.,
JP Morgan) helped finance Enron’s elaborate strategy of
tax avoidance. Consequently, Enron did not report a tax
liability or pay any income taxes for several years
(Sapsford and Raghavan 2002.) The trading and financing
scheme Enron had with its banker and trading partner,
J.P. Morgan, was initially financially rewarding to the
banker, providing it with about $100 million a year in
revenues while the bank believed it had insured any
possible default by Enron (Sapsford and Raghavan 2002).
However, subsequent to Enron’s bankruptcy filing,
several insurers filed lawsuits claiming the trading
transactions were a sham thereby voiding the insurance
contracts. Immediately following the Enron bankruptcy
filing, J.P. Morgan estimated its Enron liability at about
$900 million ($500 million of unsecured exposure and
$400 million backed by pipeline assets). However, after
insurers refused to honor their commitments J.P. Morgan
increased its estimate of Enron exposure to $2.6 billion.
It now seems clear that J.P. Morgan’s assistance in
helping Enron practice tax avoidance, while not illegal,
did not benefit the long run interests of Enron or J.P.
Morgan.

The stock research that Wall Street analysts publish

and provide to their clients and/or to the public must be
independent, fair, and unbiased. Analysts are not sup-
posed to mislead investors with excessively optimistic
corporate research especially when they publish stock
research on their firm’s investment banking clients. The
periodic representations Enron made to the SEC, via its
10-Q filings, were severely lacking in financial transpar-
ency (clarity). In March 2001, several months before the
stock of Enron collapsed, a Fortune Magazine journalist

Securities laws in the U.S. require inde-
pendent auditors to obtain reasonable
assurance that the financial statements
are free from material misstatement.

Enron’s collapse also might have been averted had

there been a truly independent and objective review of its
financial statements by its auditors. Securities laws in the
U.S. require independent auditors to obtain reasonable
assurance that the financial statements are free from
material misstatement. Auditors are required to opine if
the financial statements present in a fair manner, in all
material respects, the financial position of the client firm.
In his testimony before Congress, the CEO of Andersen,
Joseph Bernadino, admitted that his firm had made an
error in judgment (Babington 2002,1).

Andersen was far more than just an independent

external auditor to Enron. Andersen functioned as the
external auditor, the internal auditor, and as tax consult-
ant to Enron. Andersen claimed to have pioneered a
unique integrated audit system in its audit of Enron. In
this integrated audit system, Andersen operated like a
branch of Enron, maintaining offices within Enron
headquarters. It now appears that the distance necessary
between auditor and client did not exist. In addition, it
appears the integrated audit system may have led to
several conflicts of interest and possible legal and ethical
violations. Andersen was involved in structuring some of
the SPE transactions, which were not true economic
hedges, but merely vehicles that permitted Enron to
manage its earnings. As mentioned earlier, Andersen was
paid $5.7 million for its advice on SPE transactions. In
the year before Enron’s bankruptcy filing, Andersen
earned $25 million for its audit of Enron and $27 million
for non-auditing work, including tax-related and consult-
ing services. According to the Powers Report, Andersen
“…apparently failed to note or take action with respect to
the deficiencies in Enron’s public disclosure
statements,[and]… failed to bring to the attention of
Enron’s Audit and Compliance Committee serious
reservations Andersen partners voiced internally about
the related party transactions” (Powers, Troubh, and
Winokur 2002, 25).

On January 16, 2002, Andersen disclosed that some

partners and employees in its Houston office had de-
stroyed and deleted thousands of documents relating to
the Enron audit. Immediately following that disclosure,
Andersen fired four of its partners in its Houston office,

Sridharan, Dickes, and Caines

Mid-American Journal of Business, Vol. 17, No. 2

raised a red flag about the notable lack of transparency in
Enron’s financial statements (McLean 2001). Credit
analysts at Standard and Poors and Fitch have conceded
that the numbers presented by Enron were extremely
complicated and difficult to understand. Nevertheless,
most of Wall Street was bullish on Enron stock. The
positive rating given to Enron stock by Wall Street firms
undoubtedly induced many investors (individual and
institutional) to invest in the stock. Some Wall Street
analysts remained bullish on Enron even as the value of
the stock plunged precipitously and this may have
influenced the decisions of investors.

The impact of a positive recommendation given by

Wall Street should not be underestimated. Prior academic
research in finance has shown that upgrades and down-
grades by Wall Street clearly influences investor enthusi-
asm for individual stocks. It also has a significant impact
on the market value of a firm (Glascock, Davidson, and
Henderson 1987; Zaima and McCarthy 1988; Hand,
Holthausen, and Leftwich 1992; Goh and Ederington
1993; Elayan, Maris, and Young 1996; Liu, Seyyed, and
Smith 1999; Kliger and Sarig 2000). The positive recom-
mendation given by Wall Street to Enron stock, although
perhaps based on the imperfect information it received
from the firm via its conference calls and SEC filings,
contributed to inflating Enron’s stock price. Furthermore,
the delayed response by Wall Street in downgrading
Enron stock accentuated the financial losses of some
investors by persuading them to hold onto Enron stock
for too long. Critics of Wall Street behavior are quick to
point out that the potential for conflicts of interest exists
with many large Wall Street firms. Wall Street firms
typically earn large fees for the investment banking
services they provide to companies, which may make
them somewhat reluctant to provide any negative com-
mentary on a firm that is also a client. To what extent this
might have played a role in Wall Street’s positive cover-
age of Enron is not fully known. However, Wall Street
had a variety of relationships with Enron and its top
management that created conflicts of interest. Wall Street
firms served as lenders and underwriters to Enron in
several Enron stock and bond deals; managed assets for
the firm as well as for investors owning Enron equity and
debt; provided Enron with merger and acquisition advice
and did private banking business with Enron top manage-
ment. The conflicts of interest resulting from this multi-
plicity of Wall Street relationships with Enron, may have
contributed to Enron’s failure. Given the serious ramifica-
tions of these types of conflicts of interest, this matter is
currently under investigation by the House Committee on
Government Reforms (Sapsford and Wilke 2002).

In the context of the Enron investigation, Congress

questioned the SEC Chairman Harvey Pitt, its former
chief accountant, Lynn Turner, and former SEC Chairman
Arthur Levitt. The SEC may have been overloaded with
the job of reviewing the information provided by firms

during the flood of initial public offerings that took place
from 1998 to 2000. Due to this work overload, it is
possible that accountants at the SEC failed to adequately
review the filings made by Enron in a timely and detailed
fashion. Had a rigorous detailed review been done earlier
by the SEC, Enron’s problems might have been detected
sooner. The SEC commenced its investigation of Enron
only after October 16, 2001, when the firm disclosed its
earnings shortfall. The delayed oversight activity by the
SEC was obviously much too late to stem the tide of
Enron’s collapse.

Reforms Following the Enron Collapse

The collapse of Enron and the economic and emotional

impact it continues to have on thousands of ordinary
Americans, Enron and Andersen employees, and investors
demonstrates the widespread impact a major business
failure can have on society. The fact that the issue was
found worthy of indirect mention by President Bush in his
State of the Union address on January 29, 2002, is
testimony to the magnitude and importance of this
business failure on American society and the U.S. capital
markets. Americans have learned many sad lessons from
this debacle and it is expected that some legal and social
reforms will follow. The reforms will most likely include
legislation surrounding employees’ pension and benefit
plans and enforcement of the oversight role played by a
firm’s auditors and Board of Directors.

Following the collapse of Enron, Senators Corzine and

Boxer proposed a twenty percent limit for any one stock
that can be invested in any single 401(K) plan. In addi-
tion, President Bush called for the creation of a task force
to identify methods to strengthen American’s retirement
security. This task force, composed of Commerce, Labor,
and Treasury Department members, will closely examine
the potential problems related to employer’s restrictions
on portfolio diversification and employees’ sale of stock.
They will also research whether employees get proper
investment advice regarding their retirement plans and
whether the government has adequate tools to protect
workers’ pensions (Chen 2002).

In addition to the federal government’s proposals,

many institutional investors, including the many mutual
funds that lost money by holding Enron in their stock
portfolios, are pressing firms to adopt conflict-of-interest
policies that would prevent a firm’s auditors from doing
non-audit work for their client. The Enron auditors
maintain they do not believe their non-auditing fees
compromised their auditor independence (Solomon 2002).
A recent unpublished study by DeFond, Raghunandan,
and Subramanyam (2002) also finds no significant
association between the ratio of audit to non-audit fees
paid and the likelihood of an auditor issuing a going
concern opinion. However, the authors admit the study
does not consider “the broader range of issues raised by

Sridharan, Dickes, and Caines

Mid-American Journal of Business, Vol. 17, No. 2

the role of auditors and the reliability of their financial
disclosures (Andreczak 2001). The SEC chairman argues
that the current system of corporate disclosure is “out-
moded and incomprehensible… and driven by a system of
disclosure to avoid liability rather than to inform inves-
tors” (Schroeder 2002a). The SEC upholds there should
be “ a series of accounting industry reforms, including
new forms of oversight and new rules for expanded
corporate disclosures” (Schroeder 2002a). The SEC is
also considering increased regulation of U.S. credit
agencies because the rating agencies were very late in
downgrading the stock of Enron (Schroeder 2002c). On
April 24, 2002, the US House adopted HR 3763, a bill
designed to boost investor confidence. The bill makes it a
crime to lie to an auditor, creates a new independent
board to oversee accountants, and grants wider oversight
powers to the SEC. The bill also prohibits accounting
firms from providing certain consulting services to
companies whose books they audit; requires audit papers
to be kept for seven years, and bars executives from
trading in company stock during blackout periods in
which employees were prohibited from selling the stock
from their retirement savings accounts. The bill has yet to
be approved by the Senate.

The Enron case has focused public attention on the

distance that must be necessarily maintained between
business and government. Even the perception of govern-
ment culpability in the Enron case has shaken the Ameri-
can public’s faith in the impartiality of government.
While it is clear that Enron’s financial contributions to
both parties did not win the firm its requested bailout
from the White House in October 2001, it is possible that
the firm’s management was able to influence government
policy to its advantage in prior years. While no impropri-
eties have been proved to date, the media has raised many
questions about the relationship between Enron and the
government (Wilke 2002). The Enron case has heightened
public awareness of the need for distance between
business and government while at the same time sparking
debate about when regulation is necessary.

The complete story of Enron is yet to be fully told and

the case will likely be discussed and debated in court-
rooms and classrooms of business schools for many years
to come. The story of Enron is replete with numerous
instances of conflict of interest in the present system of
corporate governance. The failure of Enron demonstrates
the vital role business plays in American society and
therefore underscores the importance of good governance
in business. It also reinforces the multiplicity of stake-

the Enron case and does not examine whether highly paid
auditors might be influenced to allow companies to
inflate or even misstate earnings” (Gentile 2002, p.1).

The fallout of the Enron crisis may be a period of

greater regulation over a broad range of issues ranging
from regulation of utilities to regulation of accounting
standards. There is no doubt that this corporate collapse
will increase the debate concerning the deregulation of
public utilities and other related industries. Yetmar,
Cooper, and Frank (1998) acknowledge that the auditing
profession has inherent conflicts between the public
interest and the interests of the client, which create the
possibility for a variety of problems. Both Arthur Levitt
(former chairperson of the SEC) and Lynn Turner (former
SEC chief accountant) have called for reform of the SEC
and the accounting profession (Schroeder 2002b). Levitt
has suggested that the SEC needs to adopt new standards
that better track the effect of executive stock options on a
firm’s financial statements and to require full disclosure
of off-balance-sheet transactions and SPEs like those that
Enron used to hide its losses. The current SEC chairman,
Harvey Pitt plans a series of reforms of the accounting
industry including new forms of oversight and new rules
for greater disclosure. (Schroeder 2002a).

The SEC has been concerned about improving the

standards for SPEs for over fifteen years. The Commis-
sion first asked the Financial Accounting Standards Board
(FASB) to improve these standards in 1985. The FASB
responded with a set of rules that allowed firms consider-
able flexibility in reporting these transactions. Because
the rules in place are not stringent, Enron was able to
manipulate its financial situation. In 2000, the SEC went
back to the FASB asking for a set of stronger rules
regarding the reporting on special purpose entities. The
stronger rules did not come soon enough to prevent the
Enron accounting scandal. On April 23, 2002, Enron
reported it may write down the value of its assets by $14
billion due to “possible accounting errors or irregulari-
ties” in earlier financial statements prepared by Enron
management and reviewed by Andersen (Pacelle 2002).
The Enron debacle may have motivated the FASB to
quickly create a stronger set of rules governing the
disclosure of SPEs that may help prevent future account-
ing scandals. In August 2002, the FASB is expected to
release the final draft of an Interpretation of Statement
No. 94

. The FASB is considering a new approach to

accounting for SPEs. The new approach, if approved, will
require consolidation of non-substantive entities by the
primary beneficiaries of the SPE’s activities. The FASB
is also considering changing the threshold for equity
capital at risk from three percent to ten percent (Hancock
and Britt 2002).

The collapse of Enron stock, its financial restate-

ments, and the subsequent disclosures made by its
auditors have shaken the faith of the investing public in
the entire accounting industry with particular concern for

The Enron debacle may have motivated
the FASB to quickly create a stronger set
of rules governing the disclosure of SPEs
that may help prevent future accounting
scandals.

Sridharan, Dickes, and Caines

Mid-American Journal of Business, Vol. 17, No. 2

holders that any large corporation must consider in its
decision making processes.

Apart from the obvious social impact of financial

losses created by the Enron collapse, the social impact of
the crisis of confidence that this incident has created in
capital markets is greatly troubling. As a result of the
Enron collapse the public currently has less confidence in
the management of large corporations, in the indepen-
dence of auditors, in corporate accounting and reporting
practices, in Wall Street analysts, in mutual fund and
pension fund managers, in the SEC and in the govern-
ment. This lack of confidence is reflected in our currently
weak financial markets. Investor perception of reality and
facts is as important as the facts themselves when inves-
tors make their assessments of firms. Investor perception
of wrongdoing in the Enron case has had a depressing
effect on the stock market and the U.S. economy even
though no wrongdoing has yet been proven. The multi-
plier effect of this crisis in confidence cannot be taken
lightly. Its result, among other things, is a more difficult
environment for business and government. While the task
of effectively managing a company the size and scope of
Enron is daunting, there is an ethical obligation to make
every effort to manage these firms by reviewing all the
consequences of the decisions they make. There is the
potential that some social good will eventually emerge
from this business failure as government, business, and
employees come together to reform the systemic flaws
that the Enron crisis illuminated.

Note

1. SFAS No. 94, Consolidation of All Majority Owned

Subsidiaries, October, 1987.

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Sridharan, Dickes, and Caines

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About the Authors

Uma V. Sridharan is Associate Professor of Finance at

Lander University, South Carolina. She received her Ph.D. in
Business Administration from The University of Iowa, Iowa
City. Her recent research interests are in corporate governance,
business ethics, business strategy, financial planning, health-
care finance, and regional economic development. She has
published articles in Financial Management, The Financial
Review, Journal of Managerial Issues, and Journal of Financial
and Strategic Management.

Lori A. Dickes is Director of Economic Education at Lander

University, South Carolina. She teaches Economics courses and
provides economic education outreach to teachers and students
in grades K-12. She received her M.A. in Applied Economics
and M.A. in Political Science from The University of Central
Florida. Her recent research interests include economic and
business education, history of economic thought, business
ethics, and regional economic development issues.

W. Royce Caines is Professor of Economics at Lander

University, South Carolina. He received a Ph.D. in Applied
Economics from Clemson University. His research interests
include regional economic development, real estate issues, and
investment analysis and business strategy. He has published in
the Journal of Real Estate Research, Journal of Real Estate
Portfolio Management, and in other regional publications.

Midwest

Finance Association

March 27-29, 2003

Adam’s Mark Hotel, St. Louis, MO

Topics:

All aspects of financial economics, financial
planning and financial education.

Research Paper Submission Deadline:

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Mid-American Journal of Business, Vol. 17, No. 2

ing, human resources, and operations;
experience product and process develop-
ment, multicultural and international experi-
ence design and management, and
strategy. The aim of this issue is to provide
a coherent, integrated perspective on state
of the art concepts regarding experience
design and management in services.

Persons interested in submitting a paper

for the special issue on experience design
and management in services are encour-
aged to email the Guest Editor directly:
mellie.pullman@mail.biz.colostate.edu.

Please submit four manuscripts copies to:

Madeleine (Mellie) Pullman
Management Department
Colorado State University
Fort Collins, CO 80523-1275

Manuscripts should conform to the

journal’s submission guidelines, which are
available on the World Wide Web at:

http://www.biz.colostate.edu/jbm

UBMISSION

EADLINE

: D

ECEMBER

31, 2002

The views expressed in published

articles are those of the authors and not
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rial Review Board. Responsibility for the
correctness of quotations and citations rests
with the author.

The Journal of Business and

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Institute.

“EXPERIENCE DESIGN AND MANAGEMENT IN SERVICES”

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HAS

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ECEMBER

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ournal of

usiness and

anagement

Special Issue —Fall 2003

ALL

APERS

The Journal of Business and Manage-

ment is pleased to announce a special
issue addressing experience design and
management in services. The Guest Editor
will be Madeleine (Mellie) Pullman, De-
partment of Management, Colorado State
University.

In today’s economic environment,

customers are faced with an enormous
amount of service offerings both in the
physical locations and through other chan-
nels such as the Internet. With this glut of
information, attention has become the
scarce resource and organizations must
“battle for the eyeballs.” Not only is it diffi-
cult for the service provider to get the
customer’s attention for its offering, but
keeping that attention can be even more
challenging. Providers must transform a
vanilla “me too” service into a memorable
event that the customer will want to
repeat again and will want to recount to his
or her friends. In other words, companies
must create or stage an experience. Gen-
erally defined, an experience occurs when
a customer has any sensation or knowl-
edge acquisition resulting from some level
of interaction with different elements of a
context created by a service provider.

The aim of this special issue is to bring

together new papers that explore experi-
ence design and management in many
service contexts. Possible contexts include
but are not limited to: Internet site design
and services; interdisciplinary issues for
design and management such as market-

Corporate Pension Plans:

How Consistent are the Assumptions in Determining Pension Funding Status?

Gale E. Newell,

Western Michigan University

Jerry G. Kreuze,

Western Michigan University

David Hurtt,

Western Michigan University

Abstract

With the bankruptcy of Enron and the accompanying

loss of pension benefits of its employees, pensions have
recently received significant press. Accounting for
pension plan obligations, for defined benefit plans in
particular, requires companies to make assumptions
regarding discount rates, projected salary increases, and
expected long-term return on plan assets. Such assump-
tions, in turn, determine the funding status of the pension
plan and the annual pension expense. Higher assumed
discount rates reduce the pension obligation, enhance the
funding status of the plan, and reduce any lump-sum
payments. Higher expected return on assets reduces the
current pension expense. This study investigates the
relationship between pension plan assumptions and the
funding status of a pension plan. The results reveal that
companies with pension plans that are more fully funded
assume higher discount rates and expected long-term
return on assets than do companies with less funded
plans. The effect of these assumptions is that higher
discount rate assumptions lead to better funding status,
and higher expected long-term rates of return on assets
partially offset the pension expense impacts of these
higher discount rate assumptions. We are doubtful that
more funded plans collectively should be assuming higher
discount rates and expected long-term return on plan
assets, especially since the actual return on plan assets
investigated did not correlate with these assumptions.

Introduction

Financial reporting on a company’s pension plan

provides valuable information to the users of the financial
statements, as well as employees and retirees of that
company. The pension expense can be a significant
element in determining net income, and the funding status
of the plan is important in evaluating the financial risk of
the firm. The pension plan’s funding status can impact the
financial health of a significant number of individuals
during their retirement years.

The Financial Accounting Standards Board (FASB)

addresses these issues in Statement of Financial Account-

ing Standards No. 87 (SFAS No. 87), “Employers Ac-
counting for Pension Plans.” This statement specifies the
required accounting and disclosures for defined benefit
pension plans. A defined benefit pension plan is a pension
plan where the company has the obligation to provide a
specified level of pension benefits to retired employees.
The company funds these future obligations currently.
The extent of present funding levels, coupled with
expected returns on those funds and estimated benefits to
be paid, determines the funding status of the plan. This
needs to be differentiated from a defined contribution
plan or a 401(k) plan where the company deposits
specified amounts of dollars into an investment account.
These amounts and their cumulative returns determine the
pension benefits available to the retirees, with nothing
guaranteed, as was painfully discovered recently by
numerous Enron employees and retirees. Although
defined contribution plans have enjoyed popularity over
the last two decades and over forty million workers now
have 401(k) accounts, such accounts represent only 20
percent of total household pension reserves (Hubbard
2002). Defined benefit plans continue to be a significant
factor in the pension landscape.

Accounting for defined benefit pension plans requires

companies to make many estimates (or assumptions).
These include estimates of the return on assets accumu-
lated in the pension fund, estimates of future salary
increases of those employees covered by plans that are
pay related, and determination of the discount rate to be
used in calculating the present value of pension payments
to be made many years in the future. In addition, esti-
mates must be made concerning employee turnover and
life expectancy. The assumptions chosen can significantly
influence annual pension expense and the reported

…assumptions regarding discount
rates, projected salary increases, and
expected long-term return on plan
assets [can] in turn, determine the
funding status of the pension plan and
the annual pension expense.

Newell, Kreuze, and Hurtt

Mid-American Journal of Business, Vol. 17, No. 2

obligation (PBO), as a higher rate results in lower pension
plan contributions. Moreover, higher rates effectively
reduce the lump-sum payments to workers who get laid
off, change jobs, or retire. Lump-sum payments are
computed by discounting the expected future pension
benefits. Higher discount rates produce a lower present
value amount – the lump-sum payment. Companies,
therefore, have incentives to use higher discount rates,
especially if their pension plans are less funded. Under
the current conditions of diminished actual returns on
pension plan assets, the discount rate assumptions
become increasingly important.

There are many assumptions inherent in pension

accounting. One of the objectives of this study is to
determine if firms make different pension assumptions
depending on the funding status of their pension plans.

We are interested in the consistency of the assumptions
used between plans with different funding status. In other
words, are pension plan assumptions independent of the
pension plan funding status, or are companies modifying
their pension plan assumptions depending on the funding
status of their pension plan as a means of managing
reported funding status? We found in this study that the
more funded pension plans tend to be larger, assume a
greater return on plan assets, and use a higher discount
rate than did less funded pension plans.

Background

In years 2000 and 2001, the U.S. equity markets

experienced a significant reversal of the large positive
returns earned in prior years. The Standard & Poor’s
(S&P) 500 index fell 9.1 percent in 2000, which was its
first negative year since 1990. During 2001 the S&P
index fell another 21 percent. The Russell 3000 Index and
the Wilshire 5000 Index dropped as well in both 2000 and
2001. Although actual returns on most pension fund
portfolios decreased during 2000, sixty-three of the S&P
500 firms increased their 2001 expected returns over
2000 estimates, while only thirty-one adjusted their
estimates downward (Henry 2001).

Prior to 2000, the actual returns on pension plan assets

far exceeded the expected returns. Consequently, large
amounts of cumulative unrecognized gains have been
created for most companies. These cumulative unrecog-
nized gains were amortized in 2000 and 2001 and thereby
reduced pension expense. In fact, for 2000, Goldman
Sachs indicates that thirty-five companies in the S&P 500
received more than 10 percent of their earnings from
pension credits. General Electric, for example, recorded a
$1.74 billion pension credit, representing 9 percent of its
pretax earnings.

The lower actual return on pension plan assets during

2000 and 2001 created unrecognized losses for those
years. These losses combined with a lower 30-year
Treasury bond rate produce an increase in future pension

funding status of the pension plan. Specific components
in the determination of annual pension expense, including
service cost, interest on pension obligation, actual return
on plan assets, amortization of unrecognized prior service
costs, and amortization of a gain/loss component, are
discussed in Table 1.

The discount rate assumed in calculating the pension

fund liability is especially important. The higher the rate
assumed, the lower the liability calculated, and the
smaller the required contributions to the pension plan.
This assumption is especially important for plans having
fewer plan assets compared to its projected benefit

Service Cost

Service cost is the estimated increase in future pension benefits
due to the employees working this year. This is calculated by
using an estimated discount rate to find the present value of the
estimated increase. The higher the discount rate used the lower
the service cost. A lower discount rate will result in higher
service cost.

Interest on Pension Obligation

Interest on the pension obligation recognizes the increase in the
liability due to interest. The estimated interest rate assumed is the
rate, which would be necessary to settle the obligation, and is
referred to as the settlement rate. The higher the settlement rate
used the higher the expense and the lower the rate the lower the
pension expense.

Actual Return on Plan Assets

The actual return on plan assets is the return earned through
dividends, interest, and appreciation of the pension plan assets
and is a reduction in the pension expense. This does not require an
estimate.

Amortization of Unrecognized Prior Service Costs

When a pension plan is first adopted or when it is amended there
may be some pension benefits granted to employees for previous
employment at the company. The present value of these benefits is
referred to as prior service costs and that cost is spread over the
expected service life of the employees benefiting from the
adoption or amendment of the plan. The longer the expected
service life the lower the pension expense will be. Conversely, the
shorter the expected service life used the higher the annual
pension expense.

Gain or Loss

The gain or loss component is comprised of two amounts. First,
the difference between the actual return and the estimated return
on the plan assets for the current year, and second, the amortiza-
tion of any accumulated recognized gain or loss from previous
periods. The first has the effect of using the estimated return,
instead of the actual return, in calculating pension expense. The
higher the expected return the lower the pension expense. The
effect of the second is to amortize the difference between actual
and expected past actuarial results over future years. This
amortization occurs only if the unrecognized gain or loss from
past periods reaches a specified amount.

Table 1

Determination of Pension Expense

The pension expense on the income statement and the
fund’s funding status are calculated using the five following
components:

Newell, Kreuze, and Hurtt

Mid-American Journal of Business, Vol. 17, No. 2

expense and greater projected liabilities, which may
require firms to increase future plan funding as required
by the Employee Retirement Income Security Act
(ERISA). So significant are these earnings shortfalls that
these required contributions are causing many employers
to contemplate terminating their pension plans (Clair
2001). In addition, these lower actual returns may cause
plans to appear underfunded by the Pension Benefits
Guarantee Corporation (a government corporation that
guarantees pension payments to employees of defaulted
defined benefit pension plans), thereby requiring higher
premium payments. Larry Sher, a principal at
PricewaterhouseCoopers’ Unifi Network unit, reports that
poor recent investment performance of pension fund
assets have caused some pension funds to dip closer to
levels government pension watchdogs consider
underfunded (Shultz and Francis 2001).

This study is an extension of the Deloitte & Touche

and Godwin studies in that the consistencies of both
discount and projected salary rates in relation to the
funding status of the pension plan is investigated. That is,
the choice of pension assumptions will be investigated in
relation to the company’s pension plan funding status.
Companies with fewer pension plan assets in comparison
to their pension plan PBO have an incentive to assume
higher discount rates and lower salary increases. These
assumptions become important because actual returns on
pension assets have diminished significantly, causing
companies to report greater pension expenses and giving
the appearance that their pension plans are less funded. In
addition, the expected long-term return on assets assump-
tion, which impacts the amount computed as current
pension expense is analyzed. The higher the expected
long-term return on assets assumed, the lower the pension
expense. For example, General Electric decided in
November 2001 to reduce its expected rate to 8.50
percent from 9.50 percent, which increased its pension
expense by $550 million, or 2 percent of pretax income.
Similarly, Dow Chemical Co. reduced its expected return
from 9.50 percent to 9.25 percent, resulting in a $100
million increase in pension expense for 2002. According
to Milliman USA, a consulting firm, if the fifty biggest
companies with pension plans reduced their projections of
long-term return on assets by one percentage point, their
collective pretax profit would fall $5.2 billion (Henry,
Arndt,and Brady 2002). The actual returns realized on
plan assets is also determined and compared with the
expected long-term assets returns, to investigate the
reasonableness of management’s earnings expectations.

Methodology

SFAS No. 87 requires firms to disclose in their annual

reports any underfunded pension plans. A plan is deemed
underfunded if its accumulated benefit obligation (ABO)
is greater than the fair market value of the plan assets.
ABO is defined as the present value of the expected
pension plan obligation, using an assumed discount rate
and assuming employees receive no pay increases in the
future. This unlikely event understates the probable
obligation. As a result, not many firms have reported
underfunded plans.

Firms must also report the present value of the pension

obligation assuming there will be future salary increases.
This obligation, termed the projected benefit obligation
(PBO), is typically larger than the ABO. The difference
between the PBO and the market value of the plan assets
provides a more accurate picture of how adequately the
pension plan is funded and that difference is used in this study
to determine the funding status of a firm’s pension plan.

The disclosures concerning actual returns on plan

assets, estimated returns on plan assets, the discount rate,
and the projected rate of compensation increase are

Deloitte & Touche, in its 2001 Survey of Economic

Assumptions Used for SFAS No. 87 Purposes, gathered
defined benefit pension information from 235 Fortune
500 companies, as of December 31, 2000 (Deloitte &
Touche 2001). These companies reported a mean discount
rate of 7.50 percent, an average salary increase assump-
tion of roughly 4.50 percent, and an average expected
long-term rate of return on plan assets of 9.23 percent.
Significant variations among companies were found with
the average salary increase assumption (with only a
quarter within 25 basis points of the average and almost
20 percent were 100 basis points or more away from the
average) and with the expected return on assets (with
10% reporting expected returns of 8.00% or less and 17%
with expected returns of 10.00% or more). Greater
consistency in assumptions was evidenced with mean
discount rates disclosed, with 75 percent of the companies
reporting rates between 7.25 percent and 7.75 percent.
This consistency is reasonable considering that compa-
nies must base this discount rate on the 30-year Treasury
bond rate.

Examining the actuarial assumptions made from 1987

to 1996 by 214 companies, Godwin (1999) divided those
firms into two categories based upon the extent to which
their pension plan was funded. The more funded plans,
for all years, chose discount rates below the sample
average rate, while the less funded plans chose higher
than average discount rates. The rate differences were
statistically significant at the 0.01 level (using t-tests) for
nine of ten years. Since higher discount rates result in
lower liabilities, these findings indicate that firms may be
using discount rates to inflate their funding status.

…lower actual returns may cause plans
to appear underfunded by the Pension
Benefits Guarantee Corporation…

Newell, Kreuze, and Hurtt

Mid-American Journal of Business, Vol. 17, No. 2

investigated. The range of rates used in estimating return
on plan assets, the discount rate in calculating the PBO,
the projected compensation increase, and the actual return
on plan assets are analyzed to determine if the funding
status of the pension plan was correlated with these
assumptions.

We gathered data on all Compustat firms from the

active and research files with calendar year-ends in 1999
and 2000 and the required pension information. A total of
814 firms had the data needed to calculate the information
used in the study. It was important to have similar year-
ends to eliminate the variability in choice of rates of
return on assets and discount rate assumptions based upon
timing of year-end. Compustat data provided sufficient
information to compute the funding status of the pension
plan, the company’s expected return on plan assets, the
discount rate used to compute the PBO, and the projected
rate of compensation increase. The actual return on
pension plan assets, however, was not obtainable from
Compustat. Consequently, the annual reports from a
random subsample of seventy-five of the Compustat
companies were investigated. The actual rate of return on
assets earned by these companies was computed to see if
those rates were related to the funding status of the
pension plan. For all firms, the pension plan disclosures
for 1999 and 2000 were reviewed.

Results

One of the objectives of the study is to investigate the

differences in the assumptions among firms in the discount
rate, the estimated return on plan assets and the projected
salary increase. The maximum, minimum, and mean of
these assumptions for the 814 surveyed companies on
Compustat for both 1999 and 2000 are presented in Table 2.

Discount Rates Assumed

The weighted average assumed discount rate used to

measure the PBO varied among companies, from 3
percent to 13 percent in 1999 and from 6 percent to 11

percent in 2000. Considering that a one-percentage
change in the assumed discount rate can have a material
impact on the PBO determination, these wide ranges in
discount rate assumptions across firms adversely restrict
the effectiveness of comparisons among companies.
Fortunately, these companies remained steadfast across
years in their discount rate assumptions. The mean
assumed discount rate across years remained fairly
constant at 7.52 percent for 1999 and 7.49 percent for
2000, and was consistent with the 7.50 percent mean
discount rate in the Deloitte & Touche study. The mean
change in assumed discount rate from 1999 to 2000 was
only .06 percent, but the range of changes of -7.47
percent to 2.00 percent suggests considerable variability
in assumptions across firms. This variability in rates
across firms is quite surprising especially since the FASB
encourages firms to assume discount rates according to
the 30-year Treasury bond rate.

Expected Long-Term Rate of Return Assumptions

The average expected long-term rates of return on plan

assets remained steady from 1999 to 2000, averaging 8.84
percent in 1999 and 8.88 percent in 2000. Variations
among companies, however, were found in the assumed
future rates of return. The expected rates of return on plan
assets varied from 4 percent to 15 percent in 1999 and 4
percent to 13 percent in 2000. Such variations seem to
indicate rosier performance assumptions by some fund
managers than others. Alternatively, these rates may
indicate the fundamental risk aversion or risk taking
posture of various pension fund managers.

Average Expected Increases in Compensation

Compared to the assumed return on plan assets, the

average assumed rate of future compensation levels
showed more variability at 3.97 percent in 1999 and 4.55
percent in 2000. Salary increase assumptions ranged, for
both 1999 and 2000, from 0 percent to 11 percent, a
similar range to those observed for the expected return on
assets and the assumed discount rate. These means and

ranges were again consistent to
those observed in the Deloitte &
Touche study.

Actual Returns Realized

Another aspect of the study is

to investigate the actual returns
on pension plan assets. This
information was obtained from
the seventy-five companies
selected for further study. The
actual return was computed on a
percentage basis. Unfortunately,
companies only report total
actual returns and do not report
the timing of benefits paid to

Expected Return on Assets

15.00%

4.00%

8.84%

1.02

13.00% 4.00% 8.88%

0.98

Assumed Discount Rate

13.00

3.00

7.52

0.65

11.00

6.00

7.49

0.44

Projected Salary Increase

11.00

0.00

3.97

1.77

11.00

0.00

4.55

0.86

Change in Assumed

2.00

-7.47

-0.06

0.46

Discount Rate From 1999
to 2000

Actual Return on Assets *

28.22

-2.49

14.67

5.60

32.26

-7.21

4.93

7.40

* Actual return is from subsample of 75 firms.

Table 2

Pension Plan Assumptions, Estimates and Funding Status

814 Calendar Year-End Companies

1999

2000

Max

Min

Mean

Std Dev

Max

Min

Mean

Std Dev

Newell, Kreuze, and Hurtt

Mid-American Journal of Business, Vol. 17, No. 2

retirees and company contributions to the plan. As a
result, for purposes of this study, the actual percentage
return on plan assets was computed by dividing the actual
return on assets by the beginning of year fair market
value of plan assets. This computation yielded signifi-
cantly different actual return percentages among the
companies. For 1999, the actual return percentage on plan
assets ranged from a negative 2.49 percent to a positive
28.22 percent, while the 2000 ranges were from a nega-
tive 7.21 percent to a positive 32.26 percent. These
differences, according to SFAS No. 87, do not impact
income currently, but are included in a cumulative
unrecognized gain or loss balance and amortized into
pension expense over the remaining service period of
employees. However, the pension funding status is
adversely impacted by lower
actual returns, which may result
in greater future required pension
fund cash flow requirements.

Funding Status Determinations

A high assumed discount rate

and a low salary increase rate
assumption reduce the pension
plan’s PBO, making the pension
plan appear more funded.

For

companies with pension plans
having a PBO significantly
greater than the fair market value
of the plan assets, there may be
an incentive to assume a high
discount rate and/or a low salary
increase rate, to improve their
funding status. Higher assumed
discount rates create a lower
PBO, but the corresponding
pension expense is higher due to
the greater interest component in
the annual pension expense. So,
there is a trade-off to assuming a
higher discount rate.

To determine whether pension

plan assumptions are correlated
with the funding status of a
pension plan and the periodic
pension expense, the companies
were stratified into three catego-
ries based on the ratio of their
PBO to the fair market value of
their plan assets at the end of
1999. Firms with a high ratio
were deemed as less funded,
while firms with a low ratio were
more funded. The 814 companies
were divided into three equal
groups based upon this ratio: a

more funded group (PBO/FMV ranging from 0.28 to
0.80), a moderately funded group (PBO/FMV from 0.801
to 0.96), and a less funded group (PBO/FMV from 0.961
to 82.5). A series of t-tests were performed comparing
the less funded group to the more funded group, as these
two groups would be most unlike each other from a
funding status. The analysis for 2000 is based on the same
classification scheme used in 1999. That is, the changes
in assumptions and estimates made during 2000 are
categorized based on the funding classifications in 1999.

Despite using a ratio of PBO to FMV of plan assets

to categorize companies between more funded and less
funded pension funding status classifications, the plans
deemed more funded were also the largest plans. As
presented in Table 3, the mean plan assets of more funded

Table 3

Pension Plan Assets and Estimates by Funding Classification (814 companies)

Maximum

Minimum

Mean

Std Dev

t-test

Maximum

Minimum

Mean

Std Dev

t-test

1999

Pension Plan Assets:***
More Funded Plans

$50,243,000

$171,000

$2,326,771

$6,792,730

Less Funded Plans

12,196,000

4,000

459,387 1,303,777

.00 **

Expected Return on Assets:
More Funded Plans

11.50%

4.60%

9.04%

0.89

Less Funded Plans

12.00

4.00

8.67

1.00

.00 **

Assumed Discount Rate:
More Funded Plans

12.50

5.75

7.57

0.56

Less Funded Plans

12.00

3.00

7.45

0.75

.03 **

Projected Compensation Increase:
More Funded Plans

8.50

0.00

4.06

1.65

Less Funded Plans

11.00

0.00

3.96

1.72

.50

Actual Return on Assets:****
More Funded Plans

28.22

5.01

14.77

5.37

Less Funded Plans

22.68

-2.49

14.03

6.72

Funding Status Cutoffs
(PBO/FMV):
More Funded Plans

0.80

0.28

0.67

0.11

Less Funded Plans

82.50

0.96

1.61

5.09

2000

Pension Plan Assets:***
More Funded Plans

$55,225,000

$190,000

$2,347,462

$6,937,816

Less Funded Plans

13,119,000

472,848

1,377,715

.00 **

Expected Return on Assets:
More Funded Plans

11.50%

4.50%

9.07%

0.85

Less Funded Plans

12.00

4.00

8.73

0.99

.00 **

Assumed Discount Rate:
More Funded Plans

11.00

6.00

7.49

0.44

Less Funded Plans

13.00

3.00

7.47

0.88

.09 *

Projected Compensation Increase:
More Funded Plans

9.25

0.00

4.59

0.79

Less Funded Plans

11.00

1.20

4.52

0.88

.37

Actual Return on Assets:****
More Funded Plans

11.77

-7.21

2.67

4.22

Less Funded Plans

32.26

-3.48

6.78

9.26

* significant at the .10 level.

*** assets are presented in thousands.

** significant at the .05 level.

**** actual return is from subsample of 75 firms.

Newell, Kreuze, and Hurtt

Mid-American Journal of Business, Vol. 17, No. 2

plans were $2,326,771,000 and $2,347,462,000 for 1999
and 2000, respectively. These amounts are significantly
larger than the mean plan assets for less funded plans of
$459,387,000 and $472,848,000 for 1999 and 2000,
respectively. More funded pension plans for 1999 and
2000, respectively, had a mean PBO/FMV of plan assets
ratio of 0.67 and 0.74. This deterioration in the ratio is
expected with a downturn in the stock and bond markets,
as the fair market value of plan assets may be negatively
impacted. For less funded plans, however, the opposite
was true. The PBO/FMV of plan assets ratio showed
improvement from 1999 to 2000 by moving from 1.61 to
1.36. This movement is somewhat unexpected, given
stock and bond market performance. It may be the result
of attempts by less funded plans to improve their funding
status with additional pension fund payments. Alterna-
tively, pension fund managers of less funded plans may
invest plan assets more conservatively, causing the stock
and bond market downturn in 2000 to have a smaller
impact on these plans.

The results of the t-tests comparing the assumed

discount rates, the projected rate of compensation
increase, and the expected return on assets between the
more funded plans and the less funded plans are pre-
sented in Table 3. The expected return on asset assump-
tion for both 1999 and 2000 varied significantly between
groups. The mean expected return on assets was lower
for the less funded group of companies for both 1999
(9.04% for the more funded group compared to 8.67%
for the less funded group) and 2000 (9.07% for the more
funded plans and 8.73% for the less funded plans). This
significant difference is intriguing. Companies having less
funded pension plans are not as optimistic of high returns
on assets as are companies with more funded pension
plans. Perhaps a more conservative investing strategy is
causing these plans to be less funded. Another objective
of the study, discussed later, will investigate whether
these companies are in fact realizing a lower return on
assets than are companies with more funded pension
plans.

The more funded group of pension plans used a

significantly higher discount rate when determining the
pension plan’s PBO than did the less funded group of
companies. The mean discount rate used for 1999 for the
more funded and less funded plans was 7.57 percent and
7.45 percent, respectively. Similarly, in 2000, the
assumed discount rate for more funded plans was 7.49
percent and 7.47 percent for less funded plans. Since

lower discount rates increase the PBO amount and
increase the PBO/Fair Market Value of Plan Assets ratio,
these lower discount rates used by less funded plans are
at least partially contributing toward the plan’s funding
status. These findings are consistent with Godwin (1999),
who found that firms use “discount rates to help inflate
their funded status.”

The projected compensation increase, on the other

hand, did not vary significantly between the two groups.
The mean projected compensation increase was only
somewhat lower (but not statistically significant) for both
1999 and 2000 for the less funded group of companies.

Actual Returns and Funding Status Relationship

Another objective of the study is to investigate

whether actual return on plan assets was associated with a
plan’s funding status. As previously discussed, more
funded plans assumed a higher expected return on assets
than did the less funded plans. By analyzing actual
returns, we investigate whether these higher expected
rates of return are being realized by more funded plans.
To investigate this relationship, the annual reports of a
subsample of seventy-five randomly selected companies
were analyzed. The pension plans of these companies
were categorized as more funded and less funded using
the same funding status categories (more funded plans
with PBO/FMV of Plan Assets less than 0.80 and less
funded plans having a ratio greater than 0.96) previously
determined with the 814 companies from Compustat. Of
the seventy-five companies, twenty-five had pension
plans categorized as more funded, while twenty-two
companies had pension plans with a funding status of less
funded. The pension funding status of this subsample
therefore appears representative of the larger sample, as
the seventy-five companies were almost evenly split into
the three predetermined funding status categories. As
presented in Table III, the mean actual return on assets
for the more funded plans (14.77%) was slightly higher
than that of the less funded plans (14.03%) for 1999.

The opposite was true in 2000, however. The mean actual
return on assets for less funded plans of 6.78 percent
exceeded the 2.67 percent mean actual return on asset for
the more funded plans. For 1999, the more funded plans
in the 814-company sample assumed a higher expected
return on assets and the more funded categorized funds in
the 75-company sample also realized a higher actual
return on plan assets. Conversely during 2000, the more
funded plans classified in the 814-company sample
expected a higher return on assets but the more funded
classified firms in the 75-company sample realized a
lower actual return on assets. This may be due to the
more aggressive pension plan investments showing the
greatest returns prior to 2000 (perhaps for more funded
plans), with the more conservative investments being
more successful in 2000 (maybe for less funded plans),
with a disappointing stock and bond market performance.

Companies having less funded pension
plans are not as optimistic of high returns
on assets as are companies with more
funded pension plans.

Newell, Kreuze, and Hurtt

Mid-American Journal of Business, Vol. 17, No. 2

Summary

The intent of this study is to determine if firms make

different pension assumptions depending on the funding
status of their pension plans. More funded plans, as a
whole, assume higher expected return on assets and
higher discount rates when computing the plan’s PBO
than did companies with less funded plans. The higher
assumed discount rates reduce the plan’s PBO, making it
appear more funded. Moreover, higher discount rates
reduce lump-sum payments for employees. The higher
assumed discount rate and expected return on assets,
however, offset each other when computing pension
expense. Higher assumed discount rates increase the
expense, while higher assumed return on assets rates
reduce pension expense. Both types of plans assumed
comparable projected compensation increases.

Actual returns for the subsample of companies re-

vealed higher actual returns in 1999 but lower actual
returns in 2000 for more funded plans, as compared to
corresponding actual returns of less funded plans. The
higher returns by less funded plans in 2000, in a disap-
pointing stock and bond market, may reveal the invest-
ment strategy of pension fund managers for less funded
plans as opposed to more funded plans, which realized a
greater return in 1999, in a good stock and bond market.

Business executives, investors, pension fund managers,

and regulators should recognize that the discount rate and
the expected return on assets chosen can significantly
influence the perceived funding status of a pension plan
and the recorded amount of annual pension expense.
These assumptions can create difficulties when making
comparisons of pension plans among companies. Differ-
ences in perceived funding status could be solely attribut-
able to discount and salary increase rates selected.
Likewise, annual pension expense is dependent upon the
choice of expected return on assets. The mandated
disclosures associated with defined benefit pension plans
can provide the necessary information to properly
evaluate the funding status of a pension plan, and inves-
tors and creditors should make use of those disclosures in
investment and credit decisions.

Notes

1. For purposes of this study, the terms more funded plans

refers to the relationship between the fair market value of
the plan’s assets compared with the plan’s PBO. The
greater a plan’s assets exceeds its PBO the more funded
the plan is considered. Conversely, less funded plans have
fewer plan assets compared to its PBO. In summary, the
terms more and less funded plans do not refer to the size of
the plan, but rather to the relationship of the plan assets to
its PBO.

2. It is important to note that funding status, for purposes of

this study, is defined as a pension plan’s assets compared
to its PBO. The fair market value of a pension plan’s assets

frequently is readily available. However, the determination
of a plan’s PBO can be influenced by the discount and
salary rate assumptions chosen. High discount rate and low
salary increase rate assumptions cause the PBO to be
lower, and thus creates the appearance of a more funded
pension plan. In this study, we are investigating the
relationship between these rate assumptions and the
corresponding funding status of the pension plan. Firms
with fewer plan assets in relationship to their PBO may be
more inclined to assume a higher discount rate and a lower
salary level to make their pension plan appear more
funded.

3. A t-test for differences in means was performed on these

actual return differences across the two funding status
categories. The results indicate that the actual return
differences between the more funded to the less funded
groups was statistically significant for 2000, but not for
1999. The t-test results were not presented in the paper,
however, due to concerns as to its appropriateness for
small sample sizes, given the fact that there were 25 and 22
firms in the more funded and less funded categories,
respectively.

References

Clair, C. 2001. Pension fund liabilities are worsening. Pensions

and Investments 29(16):36.

Deloitte & Touche, Human Capital Advisory Services. 2001.

Survey of economic assumptions used for SFAS No. 87
purposes. New York: Deloitte & Touche LLP.

Financial Accounting Standards Board. 1985. SFAS No. 87.

Employers’ accounting for pensions. Norwalk, Connecticut:
Financial Accounting Standards Board.

Godwin, N. 1999. An examination of pension actuarial

assumptions over the decade following the issuance of FAS
87. Journal of Pension Planning and Compliance 25(1)
:62-75.

Henry, D. 2001. Wall Street risks. Business Week, 27 Aug.,

98-101.

. 2001. Why earnings are too rosy. Business Week,

13 Aug., 68-69.

Henry, D., M. Arndt, and D. Brady. 2002. The pension bomb.

Business Week, 18 Feb., 86-87.

Hubbard, G. 2002. Don’t reform 401(k) accounts out of

existence. The Wall Street Journal, 5 Feb., A18.

Schultz, E. and T.Francis. 2001. Employers seek to change way

pension payouts are calculated. The Wall Street Journal,
18 Dec., C1.

About the Authors

Gale E. Newell is a Professor in the Department of Accoun-

tancy in the Haworth College of Business at Western Michigan
University. He has a Ph.D. from Michigan State University and
is a CMA. His articles have been published in numerous
journals, including Journal of Accounting Education, Journal of
Business, Management Accounting, and Financial Analysts

Newell, Kreuze, and Hurtt

Mid-American Journal of Business, Vol. 17, No. 2

Journal. His current research interests include pensions and
accounting for stock options.

Jerry G. Kreuze is a Professor in the Department of Accoun-

tancy in the Haworth College of Business at Western Michigan
University. He has a Ph.D.. from the University of Missouri and
is a CPA. His articles have been published in numerous
journals, including Journal of Accounting Education, Issues
in Accounting Education, Management Accounting, and the
Journal of Corporate Accounting and Finance. His current
research interests include pensions and asset and liability
valuations.

David Hurtt is an Associate Professor in the Department

of Accountancy in the Haworth College of Business at Western
Michigan University. He has a Ph.D. from Texas A&M
University and is a CPA and a CMA. His articles have been
published in the Mid-American Journal of Business, the
Journal of Corporate Accounting and Finance, and the
Journal of Accounting and Economics. His current research
interests include pensions and market measures of information
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More Than Altruism:

What Does the Cost of Fringe Benefits Say about the Increasing Role
of the Nonprofit Sector?

Rosemarie Emanuele,

Ursuline College

Walter O. Simmons,

John Carroll University

Abstract

Previous research has found that nonprofit organiza-

tions pay lower wages than do other organizations. This
has been attributed to altruism on the part of workers who
are willing to donate some of the value of their time to
organizations that support causes in which they believe.
This paper extends that analysis to the cost of fringe
benefits. Do nonprofit organizations spend less on fringe
benefits than do other organizations? Utilizing a data set
containing information on wages and fringe benefits in
the nonprofit sector we estimate a standard wage equation
to test for such a relationship. We find that not only are
nonprofit organizations spending less on fringe benefits
than are other organizations, but that they are spending
significantly less than would be predicted by the previous
research on nonprofit wage differentials.

Introduction

The extent to which the federal government is asking

the private nonprofit sector to assume responsibility for
the provision of social services was highlighted in the
Presidents’ Summit on Volunteerism in Philadelphia in
1997. If nonprofits are to be successful in the provision of
social services they must be able to provide these services
at a cost that would encourage and sustain individual
participation in the nonprofit sector.

Although it is well established that wages in the

nonprofit sector are significantly lower than in the for-
profit sector, not much is known about the cost of fringe
benefits in the nonprofit sector. Is it also true that the
costs of fringe benefits in the nonprofit sector are lower
than in other sectors? If the cost of fringe benefits in the
nonprofit sector are lower than those in other sectors,
fringe benefits may offer another area of potential cost
savings for nonprofit organizations.

In this study we examine whether nonprofit organiza-

tions spend less on fringe benefits than do for-profit firms
and government agencies. Using data collected from
nonprofit organizations in the Grand Rapids, Michigan
area we estimate a simple wage equation model and
examine whether nonprofit organizations experience any

cost advantages in offering fringe benefits to their
employees. The results show that there is a surprisingly
large negative differential between the cost of fringe
benefits for nonprofit organizations and the cost in
government and for-profit organizations. We discuss
some possible explanations and implications for the
unexpectedly large differential.

Literature Review

Previous research comparing the nonprofit and for-

profit sectors has focused primarily on the wage differen-
tial between these sectors. Most of the empirical studies
find that wages are significantly lower in the nonprofit
sector (Weisbrod 1983; Preston 1988a, 1988b, 1989;
Leete 1994).

Preston (1989) proposed that one of the main explana-

tions for lower wages in the nonprofit sector is that workers
for nonprofit organizations are willing to accept lower
wages because they are “donating” some of their time.
Under such a model, workers at nonprofit organizations
function in ways similar to volunteers who are willing to
offer labor without a market return for their time.

In a study comparing the salaries of lawyers in the

nonprofit and the government “legal aid” sector to the
salaries earned by lawyers in other sectors, Weisbrod
(1983) found a wage differential of about 15 percent
between these two sectors.

Preston (1988) examines the wage differential between

day-care workers in the nonprofit sector and those in for-
profit organizations. She finds a wage differential of five
to ten percent. In a subsequent study Preston (1989)
compared wages in a variety of occupations, and found
that there is a five to twenty percent differential between

The results show that there is a surpris-
ingly large negative differential between
the cost of fringe benefits for nonprofit
organizations and the cost in government
and for-profit organizations.

Emanuele and Simmons

Mid-American Journal of Business, Vol. 17, No. 2

professional workers in the nonprofit sector and those in
the for-profit sector. Preston proposed that such differen-
tials are the result of workers’ “donative” motives for
working in nonprofit organizations.

Leete (1994) studied workers from many different oc-

cupations and found differentials that vary by occupation
and industry, some of which are actually positive for non-
profit workers. Leete’s work sheds doubt on the donative
explanation for nonprofit wage differentials. If the do-
nated labor hypothesis held, she explains that one would
expect differentials estimated at the aggregate level to be
larger than those estimated at the disaggregated level,
where functions of the nonprofit and for-profit firms are
likely to be most homogeneous. This is not the case. Esti-
mates derived from intermediate levels of industry aggre-
gation yield intermediate results with more disaggrega-
tion leading to more, not less, dispersion of estimates.

Data and Empirical Results

Our analysis is based on a 1994 survey administered

by the Direction Center, a nonprofit consulting group in
the Grand Rapids, Michigan area. The survey examines
personnel practices in nonprofit organization, for-profit
firms and government agencies, and includes information
on the cost of labor and fringe benefits offered to employ-
ees in 266 organizations from the Direction Center’s
mailing list. The 266 organizations represent a 40 percent
response rate. For the purpose of this study, for-profit
firms and government agencies are both treated as not

“nonprofit” organizations, as only nonprofits must adhere
to the nondistribution constraint. This constraint, which
prohibits nonprofits from distributing profits in the form
of dividends, makes altruistic donations possible
(Hansmann 1980).

Our major objective is to test the relationship between

nonprofit status and how expensive a fringe benefit
package is. The estimation of fringe benefits in this study
does not account for the entire worker benefit package.
Previous work (Emanuele 1997) has examined the total
cost of compensation in which the dependent variable was
the sum of wages and the cost of fringe benefits. That
study examined the determinants of total compensation in
the non-profit, for-profit, and governance sectors.

This present study focuses only on fringe benefits

because the cost of such benefits may reveal important
characteristics of the non-profit sector and the potential
cost savings available in this sector. Using information on
fringe benefits for each of sixteen different occupations
contained in the survey we estimate a human capital
earnings functions of the kind developed by Mincer
(1974). Following Mincer’s method we express the log of
fringe benefits (Ln E) as a function of a vector of inde-
pendent variables (X

Ln E = Sb

+ e

where e is a normally distributed error term. We estimate
fringe benefits functions for the full sample (all groups)
and a subgroup (primarily women).

Lbenefits

Log of Fringe Benefits

7.075

4.631

7.179

4.566

Management

1 if occupation is Management;

0.409

0.492

0.328

0.470

0 otherwise

Administration

1 if occupation is Administration;

0.311

0.463

0.371

0.483

0 otherwise

Social Worker/Teacher

1 if occupation is Social Worker/Teacher;

0.143

0.350

0.163

0.369

0 otherwise

Professional/Other

1 if occupation is Professional or any other type;

0.003

0.060

0.002

0.051

0 otherwise

Education

the average years of schooling for the job

15.34

2.240

14.89

2.084

Experience

years of experience for the job

6.240

7.195

5.94

6.720

Experience Squared

years of experience for the job squared

89.75 251.9

80.32

238.5

Size

A Measure of the Organization’s Revenues

Size 1

organizations with revenues of up to $100,000

0.165

0.371

0.119

0.357

Size 2

organizations with revenues between $101,000 and $500,000

0.365

0.482

0.395

0.489

Size 3

organizations with revenues between $501,000 and $5,000,000

0.419

0.493

0.401

0.490

Nonprofit

type of organization, 1 if organization is nonprofit;

0.955

0.205

0.954

0.208

0 otherwise

Table 1

Variable, Definitions, and Descriptive Statistics

All Groups

Primarily Women

(N=543)

(N=374)

Variable

Definition

Mean

S.D.

Mean

S.D.

Emanuele and Simmons

Mid-American Journal of Business, Vol. 17, No. 2

Our specification of the fringe benefits function

includes the following independent variables (their means
and standard deviation are displayed in Table 1). The
variable occupation is represented by four dummy
variables ranging from management category to profes-
sional /other category. The category professional/other is
the omitted reference group. The variable education refers
to the average years of schooling required for a position.
It is expected that individuals with post high school
education will likely demand more fringe benefits and
thus incur greater costs on the nonprofit organization.
Likewise, the experience of the individual should have a
positive correlation to the cost of fringe benefits. How-
ever, average experience squared may be negatively
related because as the average years of experience
exponentially increase individuals are more likely to be
more financially secured and less dependent on the fringe
benefits of the nonprofit organization. The variables
representing size are measures of the organization’s
revenues. In general, organizations with larger revenues
would be expected to provide more lucrative fringe
benefits, thus incurring higher cost. Organizations with
over $5,000,000 are used as the reference group. The type
of organization, whether the organization is nonprofit or
not is included to distinguish the costs of fringe benefits
between the two types of organizations.

Table 2 displays the estimated fringe benefits function

for the full sample. The regression results in Table 2
show that controlling for size of organization, type of job,
education and experience required for that job, nonprofit
organizations seem to be spending less on fringe benefits
than do comparable for-profit firms and government
agencies. Since the regression is one in which the depen-
dent variable is in the form of the log of a variable, and
the variable “nonprofit” is a dummy variable, taking on

values of only zero or one, the coefficient, “x”, must be
interpreted with the transformation:

= e -1 (Gujarati 1995).

As x is equal to -1.628954,

= -0.8038654.

That is, nonprofit organizations in this data set spend
over eighty percent less on fringe benefits than do
comparable for-profit firms and government agencies.
This is a large differential, and would not be expected to
arise from altruism alone (recall that the differential for
nonprofit vs. for-profit wages is typically found to be
about 15 to 20%).

Comparing the coefficient arising from a differential of

20 percent (the coefficient would be equal to -0.223) to
that found here (-1.628954), a t-statistic of -2.2285
indicates that one may reject the null hypothesis that
these coefficients are equal in favor of the alternative that
the differential for benefits is larger than that found
between wages in the nonprofit and for-profit sectors.
This implies that there is some additional effect at work
that is not found when examining only wages leading to
lower benefit costs in the nonprofit sector.

The remaining regression results are more or less

consistent with our prior expectations. The positive signs
on the occupation dummy variables indicate that indi-
viduals in the given occupations will incur more fringe
benefit costs. The effect is more pronounced and signifi-
cant for management occupations. The outcome on the
size variables indicates that an organization’s revenue is
inversely and significantly related to cost. Education and
experience also have positive correlation to the cost of
fringe benefits. The outcome in Table 3 (mainly women)
is similar but more pronounced.

Discussion and Implications

Three possible explanations may be found for this

unexpectedly large differential between the cost of fringe
benefits in the nonprofit sector and the cost of these
benefits in other sectors.

The first explanation is that of altruism, the explana-

tion used when studying the wage differential between
nonprofit and for-profit organizations. Previous research
has found that employees in the nonprofit sector are paid
less than are similar employees in other sectors (Preston
1988a, 1988b, 1989; Weisbrod 1983). This is commonly
attributed to the willingness of nonprofit workers to work
for lower wages in return for the opportunity to work for
an organization whose mission they support. Similar
reasoning may extend to fringe benefits; workers in the
nonprofit sector may be willing to accept smaller benefits
packages out of altruism and belief in the mission of the

Table 2

Log of Determinants of the Cost of Fringe Benefits:

All Groups

Variable

Coefficient

Standard Error

T-Statistics

Intercept

9.6465

1.7814

5.415

Management*

1.4910

0.5766

2.586

Administration

0.1772

0.5567

0.318

Social work/Teacher

0.4232

0.6618

0.640

Education

0.0977

0.0924

1.058

Experience

-0.0034

0.0454

-0.076

Experience Squared

0.0006

0.0012

0.481

Size l*

-7.7704

0.8728

-8.902

Size 2*

-3.9662

0.8100

-4.896

Size 3*

-1.1498

0.8068

-1.425

Nonprofit*

-1.6880

0.8289

-2.036

543

F value = 21.921, p value = 0.0001

R-Squared

0.29

= significant at the 0.05 critical level

Emanuele and Simmons

Mid-American Journal of Business, Vol. 17, No. 2

nonprofit. If workers are altruistic and therefore willing to
accept smaller compensation, then this allows nonprofit
organizations to produce social services at lower costs
than would be incurred by other organizations. Under this
model, the cost savings found here are unique to the
nonprofit structure.

An alternative explanation for this difference in the

cost of providing fringe benefits to nonprofit workers is
that such willingness may arise out of the fact that many
such workers are “second incomes” in families that rely
on fringe benefits earned in the other spouses’ employ-
ment. In the United States, 6.3 percent of employees work
in the nonprofit sector, a substantial percentage (68.7
percent) of which are women. This compares to approxi-
mately 37 percent of women employed in the labor force
as a whole. This pattern of employment makes it reason-
able to assume that many of these women in the nonprofit
sector are from families in which a spouse also works. It
also raises the question of how the presence of such
“second workers” affect compensation in the nonprofit
sector, and whether this effect results in even lower
wages and compensation in the nonprofit sector.

The standard models of household decision making

analyzes the determination of a worker’s “reservation
benefit” that will be demanded in conjunction with wages
in return for market labor (Killingsworth 1986). In
general, these models show that members of households
make decisions about whether to work for a given
compensation package based on the possible compensa-
tion packages offered by employers and the compensation
packages available to them through their spouse’s
employment. According to these models, each member of
a household seeks to maximize the total utility of the
household, given the compensation earned by other
members. In such models, family members who have
access to benefits earned by a spouse will be able to
accept jobs that offer smaller benefits packages than will
those who do not have access to benefits earned by a
spouse. In fact, each worker has a “reservation benefit”
which is the smallest benefits package they will accept in
return for work in the labor market. Such a reservation
benefit will be smaller if that worker is not dependent on
benefits from their job, but is able to rely on benefits
earned by a spouse. Consequently, one should observe
smaller benefits packages in sectors of the economy in
which there are many second workers who are making
such decisions; such as in positions in which there are a
large percentage of women.

Organizations that are involved in some subsectors of

the nonprofit sector are likely to have an even larger
majority of workers that are women. These subsectors
are: health services (78 percent women in this subsector),
social and legal services (75 percent women in this
subsector) as well as foundations (71 percent women in
this subsector) (Hodgkinson and Weitzman 1993). If there
is a large percentage of women in the nonprofit sector

(who, presumably, may rely on fringe benefits earned by
a spouse), then the difference between the cost of
benefits in the nonprofit sector and in the other sector
should be even larger when looking at those positions in
which employees are predominately women. This is
found in the regression presented in Table 3, which runs
a regression identical to that in Table 2 on only those
observations from positions that are at least fifty percent
female. Note that not only is the coefficient on nonprofit
status more largely negative, but that it is also significant
at a smaller significant level.

If nonprofit workers

tend to have spouses in the labor force, then fringe
benefits, such as health and life insurance, which may be
obtained through a spouse’s employment, will be less
important to those workers. This may allow organizations
in the nonprofit sector to spend less on fringe benefits
than might be spent by organizations for positions in
which a lower percentage of women work.

Both of these explanations predict that nonprofit

organizations will spend less on fringe benefits than will
comparable for-profits and government agencies. If both
the altruistic and second worker effects are at work, one
would expect to see even smaller fringe benefits pack-
ages in the compensation packages offered by nonprofit
organizations than would be predicted by the differential
found between nonprofit and for-profit wages. If the cost
of benefits in the nonprofit sector is lower than in other
sectors because of this “second income effect” then these
cost savings are not due to the nonprofit structure itself
but may also be realized by for-profit firms or govern-
ment agencies that hire a similar distribution of women.
Under such an explanation, the nonprofit structure is not
required to realize these cost benefits.

A third possible explanation for this large differential

between the cost of fringe benefits in the nonprofit sector
and the cost in other sectors is found in the accessibility

Intercept

10.640447

2.12534138

5.006

Management*

1.805541

0.69286711

2.606

Administration

0.227478

0.63028723

0.361

Social work/Teacher

1.110202

0.75182922

1.477

Education

0.104699

0.1159772

0.903

Experience

0.058807

0.05427893

1.083

Experience Squared

0.000533

0.00149728

0.356

Size l*

-8.778547

1.00662482

-8.721

Size 2*

-5.042997

0.90903846

-5.548

Size 3*

-1.946166

0.91396922

-2.129

Nonprofit*

-2.195450

0.95410967

-2.301

374

F value = 17.612, p value = 0.0001

R-Squared

0.32

= significant at the 0.05 critical level

Table 3

Log of Determinants of the Cost of Fringe Benefits:

Primarily Women Workers

Variable

Coefficient

Standard Error

T-Statistics

Emanuele and Simmons

Mid-American Journal of Business, Vol. 17, No. 2

that nonprofit organizations have to inexpensive fringe
benefits packages, which they may offer their workers.
For example, a hospital would probably not pay as much
to enroll its employees in a health care plan as would a
for-profit firm. In addition, a university would not have
to pay market rates for tuition for its employees. For
example, it is likely that universities offering free tuition
to the children of workers do not incur great costs by
adding one more student to a class. This tuition may be
valued quite highly by the recipient, who is therefore
receiving a generous benefit despite the small cost of
providing that benefit. The lower costs to providing
fringe benefits met by nonprofit organizations are in this
case a function of the services provided by the organiza-
tions and again not a function of the nonprofit structure
itself. For example, a state college could provide tuition
to its employees as easily as one that is incorporated as a
nonprofit organization could. A government agency or a
for-profit firm providing similar services would also be
able to realize similar cost savings on fringe benefits.

Conclusion

The unexpectedly large differential between the cost

of benefits offered in the nonprofit sector and those
offered to similar workers in other sectors begs for
explanation. One explanation for this differential is
linked to the nonprofit structure itself, implying that
there will be cost savings in moving the production of
services from the private or government sector to the
nonprofit sector. Other explanations, however, are not
linked to the nonprofit structure, and therefore do not
indicate unique savings in moving the production of
services to the nonprofit sector.

The differential between wages paid to workers in the

nonprofit sector and to those paid in other sectors has
been well documented. It may be that the differential
found here between the cost of fringe benefits in the
nonprofit sector and in other sectors is merely an
extension of the implications of worker altruism. In such
a case, the nonprofit structure, which does not allow for
the distribution of profits, is required if these savings are
to be realized. The transfer of the production of public
goods from the private or public sector is a wise move
under this explanation.

However, it is unlikely that such a large differential

arises from only the “donative” motive, which is widely
believed to lead to lower wages in the nonprofit sector,
such a motive has been found to result in a much smaller
differential between the wages in the two sectors. An
alternative explanation that might apply to fringe
benefits is that households are making household
decisions, in which one spouse is willing to accept
smaller benefits packages due to the generous packages
received through the other spouse’s employment. This
alternative explanation for the differential between the

cost of benefits between the nonprofit sector and other
sectors is supported by the even larger differential
between the cost of benefits in the nonprofit sector and
the cost in other sectors when those positions in which
employees are at least 50 percent women are isolated. If
this large differential between the cost of benefits in the
nonprofit sector and other sectors is due to a “second
income” effect, then the cost savings realized by the
nonprofit sector are not due to the nonprofit structure
itself but rather to the large percentage of women in that
subsector. Such savings may also be realized in the
government production of these services. Alternatively,
if the cost savings from lower benefits are the result of
the industry in which the nonprofit functions, such as
education or health care, then these lower costs are
again not a function of the nonprofit structure of
incorporation. Similar cost savings may be realized by
government production of these services.

Therefore, the only explanation for this large differ-

ential explored here that depends on the nonprofit form
of incorporation is that of altruism. This explanation,
however, is placed into some doubt by the extremely
large differentials between the cost of fringe benefits in
the nonprofit sector and those in other sectors.

References

Emanuele, R. 1997. Total cost differentials in the nonprofit

sector. Nonprofit and Voluntary Sector Quarterly
26(1):56-64.

Gujarati, D.N. 1995. Basic econometrics. New York: McGraw

Hill.

Hansmann, H.B. 1980. The role of nonprofit enterprise. The

Yale Law Journal 89:835-89.

Hodgkinson, V. and M. Weitzman. 1993. Dimensions of the

independent sector: A statistical profile. Independent
Sector: Washington, DC.

Killingswoth, M.R. 1983. Labor supply. Cambridge: Cam-

bridge University Press.

Leete, L. 1994. Nonprofit wage differentials in the United

States: New estimates from the 1990 Census. Working
Paper. Mandel Center for Nonprofit Organizations
Discussion Paper Series.

Mincer, J. 1974. Schooling, experience, and earnings. New

York: Columbia University Press and NBER.

Preston, A.E. 1988(a). The effects of property rights on labor

costs of nonprofit firms: An application to the day care
industry. Journal of Industrial Economics 36(3):337-350.

. 1988(b). The nonprofit firm: A potential

solution to inherent market failures. Economic Inquiry
26:493-506.

. 1989. The nonprofit worker in a for-profit

world. Journal of Labor Economics l7:438-463.

Weisbrod, B.A. 1983. Nonprofit and proprietary sector

behavior: Wage differentials among lawyers. Journal of
Labor Economics 1(3):246-263.

Emanuele and Simmons

Mid-American Journal of Business, Vol. 17, No. 2

About the Authors

Rosemarie Emanuele is an Assistant Professor of Mathemat-

ics and Chair of the Mathematics Department at Ursuline
College. She received her Ph.D. in economics from Boston
College in 1992. Her research has concentrated on the econom-
ics of the nonprofit sector, including the markets for paid and
volunteer labor in this sector.

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Subscription Supply Chains:

The Ultimate Collaborative Paradigm

Robert L. Cook,

Central Michigan University

Michael S. Garver,

Central Michigan University

Abstract

Supply chain practitioners have made great strides in

forming collaborative partnerships, yet the end consumer
is often left out of these plans. Being an important
member of the supply chain, we propose that supply
chains need to get closer to the end consumer – forming
collaborative relationships that center around demand
planning. Developing subscription relationships with end
consumers will lead to increased planning time, which
will result in dramatic cost reductions and superior
consumer value and satisfaction through lower costs,
increased convenience, and improved availability of
supply. Being a new and unique strategy, not all consum-
ers will adopt subscription supply chains. However, we
argue that some consumer segments will receive tremen-
dous value and satisfaction purchasing certain types of
products and services through subscriptions. Tremendous
opportunities await those supply chains who target the
right consumers, marketing the right products and
services through a subscription supply chain.

Introduction

Logistics and supply chain excellence are proving to

be a sustainable source of competitive advantage and a
prime determinant of business success (Bowersox and
Closs 1996). The past two decades have provided
numerous examples of significant improvements in
logistics and supply chain management, yet more can
still be accomplished. While researchers suggest that
significant improvement opportunities are still available,
they are becoming more difficult to obtain (Bowersox
1997). We argue that tremendous gains are still avail-
able, yet innovative supply chain strategies are necessary
to continue with the significant improvements of the
past.

The literature suggests that the end consumer is a key

member of the supply chain, and that all supply chain
activities should focus on providing superior consumer
value and satisfaction (Mentzer et al. 2000). Further-
more, supply chain management research suggests that
partnerships, collaboration, and information sharing are

keys to supply chain success (Quinn 2000). While
practitioners have made great strides in forming col-
laborative partnerships between business-to-business
firms, the end consumer is often left out of these plans.
In practice, the end consumer is typically not viewed as
a supply chain partner. Supply chain members simply
do not collaborate, form relationships, nor include end-
consumers in demand planning.

We argue that supply chain members need to get

closer to the end consumer – forming collaborative
relationships that center around demand planning.
Developing subscription relationships with end consum-
ers will lead to increased planning time which will
result in dramatic cost reductions and superior consumer
value and satisfaction through lower costs, increased
convenience, and improved availability of supply.

Being a new and unique strategy, not all consumers

will adopt subscription supply chains. However, we
argue that some consumer segments will receive
tremendous value and satisfaction purchasing certain
types of products and services through subscriptions.
This strategy will not be relevant for all products and
consumers, yet tremendous opportunities await those
supply chains who target the right consumers, marketing
the right products and services through a subscription
supply chain.

The purpose of this article is to put forth a new

business strategy – subscription supply chains. We will
first review the supply chain management literature,
highlighting current issues and gaps. Then, subscription
supply chains will be introduced, followed by benefits
and likely consumer reactions. Finally, limitations,
future research, and conclusions will be presented.

While practitioners have made great
strides in forming collaborative partner-
ships between business-to-business
firms, the end consumer is often left out
of these plans

Cook and Garver

Mid-American Journal of Business, Vol. 17, No. 2

Literature Review

Academic researchers and practitioners are embracing

supply chain management. As an academic discipline,
supply chain management is experiencing dramatic
growth (LaLonde 1997). As a result, a wide range of
supply chain management conceptualizations currently
exists. Mentzer and colleagues (2000) examine a number
of different supply chain management conceptualizations.
They conclude that supply chain management is:

1) A systems approach to viewing the channel as a

whole, from suppliers to end consumers.

2) A strategic orientation toward coordinating and

synchronizing the entire supply chain.

3) A consumer/customer focus to create customer value,

leading to customer satisfaction.

A central theme of all supply chain management

definitions is that end-consumers are a member of the
supply chain. Bowersox and Closs (1996) suggest end
consumers drive the supply chain and that all activities
should be directed at producing more value and satisfac-
tion to the end consumer. While many agree with this
concept, it is rarely achieved in practice. Often, supply
chain members focus on their immediate customers, with
little regard for the end consumer.

Partnerships

Strong relationships between supply chain members

are the foundation of supply chain excellence (Ellram and
Cooper 1990). The academic literature has examined
relationships in great depth, typically discussing trust and
commitment as key variables defining the nature of a
relationship (Morgan and Hunt 1994). Before firms can
share information and integrate processes, firms must
trust each other. Long-term commitment is necessary
before firms will be willing to invest time and resources
into creating long-term partnerships and value proposi-
tions (Cooper, Lambert, and Pagh 1997).

Currently, the supply chain management literature

focuses on partnerships between business-to-business
firms, yet they typically exclude the end consumer. While
the marketing literature is examining customer relation-
ship management strategies, supply chain research has
focused solely on business-to-business partnerships.
Because consumer demand is driving supply chain
decisions, relational development between supply chains
and end consumers is critical. Customer relationship
management initiatives need to be tied to supply chain
operations, plans, and strategies. Supply chain partner-
ships need to be established and maintained with the end
consumer, yet this phenomenon rarely occurs.

Collaboration and Information Sharing

Collaboration is a key concept of supply chain man-

agement. Mentzer, Foggin, and Golicic (2000) define

collaboration as companies in the supply chain actively
working together as one toward common objectives and
being characterized by the sharing of information,
knowledge, risk, and profits. Quinn (2000, 9) states, “It’s
widely acknowledged that the ability to collaborate with
your trading partners up and down the supply chain is a
prime determinant of business success.”

Collaborative

efforts have increased supply chain integration and, as a
result, reduced costs and increased customer service
(Cooper, Lambert, and Janus 1997). However, most
discussions of collaboration occur between business-to-
business partners. The supply chain literature simply
ignores collaboration between supply chain partners and
the end consumer.

Collaboration is typically discussed during relational

development and information sharing (Mentzer et al.
2000). Sharing demand information between supply chain
partners is often cited as a vital activity of supply chain
success (Cooper, Lambert, and Janus 1997). Sharing
accurate demand information allows supply chain
partners to better plan their operations, making more
effective decisions. While these collaborative efforts have
taken place between business-to-business partners, once
again, end consumers have been left out of the process.

Instead, supply chain partners forecast end consumer

demand and run their operations according to these
estimates. One thing is for certain, forecasts are always
wrong and error is always present. Forecasting error can
be very expensive and detrimental to the supply chain
(Mentzer and Kahn 1997). For example, if the forecast is
below actual demand, then consumer stock-outs occur,
resulting in customer dissatisfaction and defection. If the
forecast is above actual demand, then it is likely that
excessive inventory is positioned throughout the supply
chain. Forecasting error can have dramatic impacts on a
firm’s bottom line.

Forecasting experts suggest that firms need to move

away from forecasting demand and move towards
planning demand (Mentzer and Bienstock 1998). Instead
of forecasting, firms are planning and managing demand
by sharing production schedules, plans, and actual
demand figures. This strategy is producing dramatic
results for those pioneering firms (Moon, Mentzer, and
Thomas 2000). While planning demand is starting to be
done between business-to-business partners, it is not
being implemented with end consumers.

Information Technology

The Internet is driving radical change in supply chains

(Salcedo and Grackin 2000). Internet technology provides
supply chain participants with electronic connectivity that
enables all supply chain participants to share vital, real-
time information (Bauknight 2000). This leads to in-
creased supply chain visibility that enables supply chain
strategists to synchronize supply chain operations.
Information technology is quickly becoming the critical

Cook and Garver

Mid-American Journal of Business, Vol. 17, No. 2

link to reach maximum supply chain benefits (Cooke
1999).

The application of Internet technology to business-to-

business exchanges has been very successful as evidenced
by the growth of trading exchanges, e-procurement, and
portals. While there are fewer successful consumer
applications, companies such as Dell Computer, e-bay,
and Amazon.com have demonstrated that the Internet is a
valuable tool to communicate and interact with some
segments of consumers. Internet technologies make it
possible for supply chain member to work more closely
with end consumers.

End Consumers and the Supply Chain

End consumers are a vital member of the supply chain,

one that has been virtually forgotten by researchers and
practitioners. While business-to-business supply chain
partners are forming strong, collaborative relationships
and sharing critical demand information, these activities
are not being conducted with end consumers – key
members of the supply chain. Instead, supply chains are
guessing what consumers want, when they want, and how
many they want. Consumers have been left out of the
supply chain because it has been too difficult to form
relationships and share information with millions of end
consumers. Yet, advances in information technology now
make it both feasible and possible.

Subscription Supply Chains

This research makes a contribution to the literature by

placing end consumers at the core of supply chain
planning. We propose that supply chains develop strate-
gic and tactical plans that collect, utilize, and integrate
end consumer demands and preferences into the strategic
planning process through the use of long-term consumer
contracts (i.e., subscriptions). Magazine subscriptions
have long been used and are popular with many consum-
ers, yet little research attention has been devoted to
examining subscriptions, with no research involving
supply chains. Writing about subscriptions is typically
contained in industry specific trade publications, and has
not yet piqued the interest of academic researchers. In
practice, subscriptions are expanding into new products
and services, with many online companies embracing this
business model (Overby 2001; Quint 2002; Buckler 2001;
Greenemeier 2001). We suggest that this concept be
expanded to the supply chain with many new products
and consumers. As a result, supply chains will achieve
significant efficiencies, increased consumer value and
satisfaction (for certain target markets), and increased
financial performance.

A model of subscription supply chains suggests that

supply chains benefit by forming subscription relation-
ships with end consumers. The subscription is defined as
a formal agreement to receive and pay for a specific

product or service for a specified period of time. The
subscription contract would primarily collect consumer
demand and preferences, as well as other information that
may be important to marketers. In short, the subscription
is an agreement that consumers purchase specified
products, within a range of specified quantities over a
given time period, in exchange for important information
and price discounts.

With consumer demand and preferences “locked-in,”

this information is communicated throughout the supply
chain via internet technologies. With this information in
hand, the supply chain no longer has to react to consumer
demand, but instead can plan operations according to
actual consumer demand. Providing supply chains with
the appropriate planning time will allow them to achieve
maximum efficiencies while meeting customer require-
ments. The result is that supply chains can deliver
products and services to end consumers at a substantial
cost savings, which can then be shared with consumers
and other relevant supply chain partners. Key characteris-
tics of subscription supply chains are discussed below
(see Table 1).

Consumer Relationship

Long-term collaboration involving a
series of long-term contracts (contract
based relationship) that revolve around
sharing information and demand
planning. Program rewards consumers
for participation and length of
commitment.

Demand Planning

Supply chain and end consumer
collaboration to jointly determine
demand assortment, quantities, timing
and delivery location. Demand
parameters are specified and frozen,
but can be changed after leadtime
buffer.

Communication Vehicle

Internet supported by telephone and
fax.

Critical Information Flow

Consumer demand and preferences.

Manufacturing Plan

Make product according to supply
chain plan.

Manufacturing Operations

Taking advantage of leadtime buffers,
operate at a level that minimizes total
supply chain costs.

Inventory Posture

Use a strategy that enables the supply
chain participants to manufacture and
deliver the product by the due date
while using the minimum total supply
chain cost design.

Table 1

Subscription Supply Chain Characteristics

Characteristics

Description

Cook and Garver

Mid-American Journal of Business, Vol. 17, No. 2

Subscription Relationships with Consumers

Consumers must be active, long-term participants in

the strategic planning process. This implies that a long-
term contractual relationship must be established and
maintained. A key aspect of the subscription relationship
involves sharing information. From a supply chain
perspective, important information includes consumer
demand and preferences, along with other relevant and
desired customer information. From the consumers’
perspective, they will need information about their past
purchasing patterns and preferences, along with their
future commitments including orders and shipment dates.
By having access to past purchase patterns, they can
better estimate their future usage.

Demand Planning

When all supply chain participants are involved in

planning demand, significant cost reductions in manufac-
turing and logistics can be realized and more competitive
prices can be offered. For example, when a consumer
subscribes to a magazine over a three year period, joint
demand planning lowers the supply chain risk and cost
significantly. The result is that the subscription price is
substantially lower than the transaction price offered at
the newsstand.

Collaboration with end consumers must focus on

demand planning and preferences, and should involve a
joint determination of product assortment, product
quantities, delivery times, delivery locations and deliv-
ered price. For example, when a consumer agrees to a
three year magazine subscription from the National
Geographic Society, the following demand parameters are
determined:

product assortment = National Geographic Magazine

product quantity = thirty-six issues

delivery time = one issue each month

delivery location = consumer address

delivered price = a set fee for the thirty-six issues

All consumer demand variable parameters must be
specified and communicated in real time to all supply
chain participants.

When establishing initial subscription relationships,

consumers may have difficulty accurately planning out
their demand. Furthermore, consumers may also experience
demand and preference changes over time. If subscrip-
tions are too confining and do not allow for change, then
consumers may not make long-term commitments. Many
times, major life events (i.e., marriage, divorce, retire-
ment, illness) will cause major changes in both product
demand and preferences. To overcome this issue, sub-
scriptions must be flexible to handle changes in demand.
Yet, subscriptions supply chains derive their operational
benefits from known and stable demand. A balance must

be found between these competing objectives - accommo-
dating changes in consumer demand and maintaining
short term demand stability for the supply chain.

To illustrate this point, subscriptions with pet owners

will be demonstrated. Collaborating through a website,
the consumer would communicate personal information
(i.e., the number, type, and size of pets) as well as
projected product demand for specific products (i.e., ten
pounds of Purina puppy chow consumed monthly). A
database of typical consumption patterns could be
available for consumers to access when estimating their
consumption (i.e., a Labrador Retriever puppy typically
eats ten pounds of puppy chow per month).

Once consumer demand is planned and the subscrip-

tion is in place, consumers can monitor their demand over
time via the website, allowing consumers to gradually
monitor and change demand parameters accordingly.
Additionally, planned and unplanned demand changes
could also be implemented. For example, the puppy will
soon double in size and appetite, and food preferences
will need to be adjusted. Because these demand changes
can be predicted, they could be built directly into the
subscription (i.e., gradually increase puppy chow by
twenty percent for the first three months, then switch to
the adult dog food formula at 20 pounds a month). Of
course, some factors influencing demand cannot be
predicted (i.e., the pet dies, runs away, or the family finds
and adopts a new pet). While short-term demand param-
eters are locked in (i.e., one month’s delivery), future
demand may adjusted up, down, or even cancelled. If a
new pet is added to the family, then demand can be
increased accordingly over the appropriate time frame
and larger price discounts may be provided to the con-
sumer in return for their increased business. If the pet
runs away and no new pet is adopted, then it is likely that
the supply chain would terminate the contract with a
reasonable cancellation fee to compensate for incurred
supply chain costs. In addition to saving money, the
consumer no longer has to haul heavy bags of dog food
home from the grocery store. Instead, the product is
delivered to the consumer’s door.

Communication Vehicle

A key characteristic of a subscription supply chain is

fast and accurate communication. As discussed earlier,
advanced technology is essential to enable a collaborative
supply chain effort. This involves communication with

A balance must be found between these
competing objectives - accommodating
changes in consumer demand and
maintaining short term demand stability
for the supply chain.

Cook and Garver

Mid-American Journal of Business, Vol. 17, No. 2

both consumers and other supply chain participants.
Business-to-business supply chain partners are already
implementing information technologies to allow for real
time, accurate communication of valuable information.

Using the Internet as the primary communication

vehicle with consumers represents more of a challenge.
However, on-line activities are soaring and the Internet
household market penetration rate continues. By February
2001, 56 percent of the U.S. adult population (including
82 percent of college graduates) already have Internet
access according to a survey by Pew Internet & American
Life Project (Merrick 2001). However, until the Internet
is ubiquitous, other communication vehicles such as
telephone and fax may be used to support communication
with end consumers. Given the importance of internet
technologies, innovative and early adopting consumers
may be likely target markets.

Limited Transactions

A subscription not only facilitates demand planning,

but also enhances transaction efficiency by greatly
reducing the total number of transactions. For example,
buying the monthly issues of National Geographic
Magazine over a three year period would require thirty-
six transactions at a newsstand or one transaction when
using a three year subscription. While the transaction cost
savings per consumer may not be large, the total number
of consumer transactions and the resulting cost savings
are impressive. Using the previous example, 720 million
newsstand transactions could be replaced by 20 million
on-line subscriptions.

Manufacturing and Logistics Operations

Manufacturing would use a “make to plan” approach.

Using subscription demand information, manufacturing
would develop a production plan to operate at a level that
minimizes total supply chain costs. To operationalize this
plan, a lead-time buffer would be employed to protect
supply chain operations from the variability in total
demand caused by new subscriber additions, current
subscriber subscription renewals at a different level of
consumption and subscriber non-renewals. For example,
the initial delivery date of the first shipment for a new
subscriber would be set at a time in the future that
enabled supply chain participants to manufacture and
deliver the product(s) by the promised delivery date while
using the minimum total supply chain cost design. The
subscription renewal/non-renewal planning date would be
set well ahead of the actual subscription termination date.
Therefore, all order lead-times would be planned and all
planned order lead-times would be longer than actual
operational lead-times.

As a consequence, subscription supply chain opera-

tions could be configured to minimize total supply chain
costs. Of course, no single design would be applicable to
all supply chains. For a given supply chain, the optimum

supply chain design would depend on a number of critical
factors including: product value, product density, product
perishability, product handling characteristics, product
technical complexity, distance to market, market concen-
tration, topography, current fuel prices, and available
logistics infrastructure. For example, a high value product
such as a desktop personal computer might be manufac-
tured close to the delivery time and shipped via home
package delivery services directly to the consumer. A low
value product such as laundry detergent might be manu-
factured in large quantities well in advance of the deliv-
ery date and shipped via rail to major metropolitan
sorting sites, then packaged and transported with other

products by truck to multiple sorting sites around each
metropolitan area. Then, consumers would pickup their
assortment of purchases on the designated delivery day.
Many other design scenarios are possible.

Supply Chain Benefits: Improved Efficiency

Improved efficiency is the primary benefit for supply

chains and the impetus behind this strategy. A hallmark
of subscription supply chains is demand stability and
visibility. Demand assortment, volume, timing, and
location are known and visible to all supply chain
partners well before production and deployment occur.
Therefore, supply chains are able to take full advantage of
collaboration, the systems approach, and the total cost
concept. Highly integrated supply chains can operate at
high levels of efficiency, achieving the lowest total cost.
With certain products, cost savings through improved
efficiencies can be significant.

Several major marketing and market adjustment costs

can be significantly reduced or eliminated in a subscrip-
tion supply chain. The use of long-term contracts de-
creases the total number of supply chain transactions and
transaction costs. Price mark-downs on inventory and
write-offs of obsolete inventory would be greatly reduced
because products are manufactured to planned orders. In
addition, advertising to support a “sale” and some
consumer packaging costs would be unnecessary because
supply chain partners would not face an over-stocked
situation. Also, transshipment and expediting costs would
be eliminated. While not all consumers will adopt a
subscription supply chain, dramatic efficiency gains can
be realized even if a small percentage of consumers

choose this format.

Supply Chain Benefits: Improved Competitive Positioning

Subscription relationships also insulate the supply

chain from competition pressure and raise competitive
barriers to entry. Subscription supply chains would be
less vulnerable to short-run competitive tactics such as
price discounts, advertising campaigns, or other sales
promotions because the long-term contractual relationship
with the consumer insulates the supply chain from
competition. For example, if a certain cereal supply chain

Cook and Garver

Mid-American Journal of Business, Vol. 17, No. 2

discovered that sixty percent of the consumer cereal
market had signed three-year subscriptions for cereal
needs with a competing supply chain, what short-run
competitive response would be effective?

The subscription relationship strengthens over time,

because time and past purchasing volume will likely lead
to lower subscription prices. Developing a long-term
consumer relationship that strengthens over time essen-
tially raises the barriers to exit for consumers. For
instance, a consumer who is provided with lower prices
as the subscription relationship matures will find it
increasingly difficult to switch supply chains and forfeit
the considerable benefits.

Consumer Reactions and Acceptance of
Subscription Supply Chains

Operationally, the benefits of a subscription supply

chain are staggering. However, without consumer
acceptance, this strategy will never succeed. Consumer
reactions and acceptance must be determined by examin-
ing the answers to the following questions: 1) Will
consumers adopt a subscription model? 2) What con-
sumer segments are likely to adopt a subscription model?
3) What products are consumers willing to purchase
through a subscription?

Will consumers adopt a subscription model?

Many consumers already purchase from a subscription

supply chain. Although limited in their applications,
subscription supply chains have existed for a relatively
long time. Common examples include: subscriptions to
magazines for one or more years to a receive a price
discount, purchases of non-refundable airline tickets in
advance to ensure seat availability and to receive a price
discount, agreement to one or more years of standard pest
control treatments for the home, and the acquisition of
season tickets from a university or professional sports
franchise to ensure seat availability and receive a price
discount. Furthermore, the subscription model is now
being adopted by new companies with new product
categories. For example, Microsoft recently implemented
a subscription program to keep consumers using new
software releases.

Most consumers currently buy many of their products

and services on a transaction rather than contract basis.
Thus, appropriate marketing and education is critical to
train consumers to purchase through a subscription supply
chain. However, most consumers have historically
embraced new supply chain formats when consumer
value was significantly increased. If the new format will
provide consumers with significant cost savings, then the
format has a reasonable chance for success. Alderson
(1954) stated long ago that consumers will get more
involved in the channel to save money. At one time,
marketers asked the following questions: Will consumers

pump their own gas for a price discount? Will consumers
join clubs to save money? Will consumers buy everyday
items in bulk in a warehouse setting for a price discount?
Trends demonstrate that consumers are now joining clubs
and using bulk discounters (i.e. Costco) at quickly
growing levels. Consumers have shown that they will
adopt new purchasing channels or formats if they can
save money. Subscription supply chains will result in
significant cost savings for both consumers and compa-
nies.

What consumer segments are likely to adopt a
subscription model?

Not all consumers will adopt subscription supply

chains. For many consumers, they love to shop. Many
people find shopping relaxing and enjoyable. Observe any
fisherman at Cabelas and find that this segment truly
enjoys looking through racks of products, touching and
feeling the latest rods, reels, and lures. Other consumers
are simply resistant to change.

In contrast, there are also consumer segments who find

shopping to be stressful, time consuming, and a nuisance.
It is very possible that some consumers may love to shop
for certain products, yet dread this activity for other
products. For example, while fishermen may enjoy
looking for the latest lure, they may not enjoy shopping
for toilet paper, cleaning supplies, nor other household
items. Instead, we argue that subscription supply chains
will only be relevant for certain consumer segments and
certain types of products.

Because of the nature of subscription supply chains,

they would only provide value to consumer segments
with the following preferences: 1) assurance of availabil-
ity and delivery, 2) convenience, 3) time savings, and 4)
price discounts. Furthermore, we argue that consumer
segments with these preferences will find subscription
supply chains to offer a superior value proposition,
resulting in increased satisfaction and loyalty.

Subscription supply chains can provide very high

levels of product availability and delivery because
demand assortment and quantity are planned and lead-
time buffers are longer than operational lead-times.
Reliable fulfillment is highly valued by many consumers,
and in many situations, consumers value delivery reliabil-
ity more than delivery speed. For instance, when refilling
critical medical prescriptions such as diabetic supplies,
the consumer is more interested in delivery by a desig-
nated time than delivery at the earliest possible time.

A hallmark of subscription supply chains is transaction

convenience. Once a contractual relationship is in place,
product and services will be routinely delivered at the
scheduled time and place. As a result, shopping and
transaction time are both decreased substantially. In our
money-rich, time-poor society, time is a precious resource.
Subscription supply chains can reduce the stress and effort
that accompany product searches and tedious transactions.

Cook and Garver

Mid-American Journal of Business, Vol. 17, No. 2

For many consumers, value is synonymous with low

price (Zeithaml 1988). A key aspect of subscriptions is
substantial price discounts. Low prices are a powerful
competitive weapon, as illustrated by successful retailers
such as Wal-Mart and Costco. In addition to fulfillment,
convenience, and time saving, price discounts are a
substantial part of the value proposition.

The following segment profiles are likely adopters of

subscription supply chains:

Planners - These consumers value assurance that the
product or service will be available at the planned time
of consumption. These consumers are planning for a
special event(s) at a known time(s) throughout the
year. Examples include vacation services such as
airline seats, hotels, and rental cars; holiday celebra-
tions involving traditional foods, beverages, gifts, and
cards; important medications to be taken at a pre-
scribed time or fertilizer that must be applied to crops
or lawns at a prescribed time.

Time Worshipers - These consumers value leisure
time and as a result dislike nuisance shopping. While
low involvement products are defined differently by
each consumer, likely candidates for planned auto-
matic replenishment would be products or services
involved in household chores including: cleaning
supplies; paper products; clothes washing supplies and
pet food and supplies. In addition, these consumers
may want to shop for high involvement products but
do not have sufficient search time. Product examples
may include: best new red wine or mystery novel on
the market this month.

Price Worshipers - These consumers value low prices
and discounts. They pride themselves on saving
money and finding bargains on high quality items.
Most consumers are price sensitive regarding a
majority of their product purchases, especially high
volume products including: coffee, soup, detergent,
shampoo, deodorant, and razor blades among others.

Systematic Buyers - These consumers value consis-
tency and as a result have regular purchasing patterns.
Brand loyalty, fondness of routine, and fixed income
may motivate this behavior. Likely product candidates
are favorite food products, cigarettes, and newspapers.

What products are consumers willing to purchase
through a subscription?

Clearly, consumers will not purchase all products or

services from a subscription supply chain. The objective
here is to put forth characteristics of products that
consumers WILL and WILL NOT purchase from a
subscription supply chain. Key product characteristics
include: involvement, demand patterns, frequency of
usage, variety seeking, and annual expenditures.

High involvement products (i.e., clothes, automobiles,

stereos, and televisions) are not likely candidates for
subscriptions, because consumers often enjoy shopping
for these products, or feel they need to invest time and
effort to make a good decision. In contrast, low involve-
ment products are prime candidates for subscription
supply chains. These products often represent “nuisance
shopping” and may include a number of household items,
groceries, and pet supplies.

Products with regular and consistent demand are also

prime candidates for subscription supply chains. Products
like coffee, cigarettes, beverages, and toilet paper are
likely candidates because they are purchased and con-
sumed on a regular basis. Products with irregular demand
are unlikely subscription products. When product usage
rates are difficult to forecast or irregular, subscriptions
may not be a viable option, thus wedding products are
unlikely candidates.

Many consumers may also enjoy “variety seeking”

with certain products or services. For example, some
golfers enjoy playing a variety of different courses and
eating out at a number of different restaurants. For variety
seeking products and services, subscriptions may not be a
viable option. In addition, impulse shopping items are not
likely candidates. In contrast, brand loyal products are
likely candidates for subscription supply chains. Products
that enjoy brand loyalty – barbeque sauce, beer, tooth-
paste, shampoo, and soap – are likely because consumers
purchase these products on a regular basis.

Finally, products that represent a substantial annual

investment to consumers are likely to be subscription
products, because the hallmark of subscriptions are large
price discounts. Products with small dollar expenditures
may not be a viable solution. In short, low involvement,
brand loyal products that have regular demand with large
dollar expenditures over time are excellent candidates for
subscription supply chains. In contrast, high involvement,
variety seeking products with irregular demand are not
likely to be good subscription products.

Limitations and Challenges of Subscription Supply
Chains

Subscription supply chains have limitations and major

challenges that include: actual documented cost savings,
design and development, implementation, and effective

High involvement products (i.e., clothes,
automobiles, stereos, and televisions) are
not likely candidates for subscriptions. In
contrast, low involvement products are prime
candidates for subscription supply chains
…and may include a number of household
items, groceries, and pet supplies.

Cook and Garver

Mid-American Journal of Business, Vol. 17, No. 2

marketing. Large price discounts are a key component of
subscriptions. If the elimination of demand uncertainty
does not enable the supply chain participants’ significant
cost savings, then this strategy will simply not work. The
difficulty lies in that supply chain cost savings may not
be accurately realized, calculated, nor documented until
actual implementation. Determining products and
operations that will yield significant cost savings will be
difficult, yet essential. In short, increases in supply chain
planning time must lead to significant cost savings.

A major challenge lies in developing and designing a

subscription supply chain. What are the most effective
ways to identify likely consumers and products for a
subscription supply chain? Then, firms must target the
right consumers with the right value proposition. A front-
end system must be developed that interacts with
consumers in a user-friendly manner. It is imperative that
this information be tied to back end, supply chain
operations in a timely manner. Streamlining and radically
changing existing operations may be necessary to yield
significant cost reductions. For example, if the dominant
mode of transportation has been trucks, the increased
lead-times may now turn to rail as a means to decrease
costs. Breaking old ways of conducting business and
inventing new ones are essential to designing and
implementing subscription supply chains. Furthermore, a
proven model of best practices is not available, making
both the development and implementation of subscrip-
tions even more difficult.

Major marketing and education issues await those

pioneering supply chains. Changing consumer purchas-
ing patterns and habits is possible, yet extremely diffi-
cult. Training consumers to purchases products and
service through a subscription will take effective and
persistent communication over a long time frame.
Positive word-of-mouth advertising may be the most
important form of communication. Thus, subscription
supply chains should focus on customer satisfaction,
ensuring that consumers are delighted with the fulfill-
ment efforts of the supply chain. In short, it is essential
that subscription supply chains deliver reliable fulfill-
ment, convenience, time savings, and substantial price
discounts. Subscription supply chains will only succeed
if these value drivers are fully satisfied.

Future Research

To facilitate supply chain planners in the design,

development, and implementation of subscription supply
chains, future research efforts must be undertaken. First,
effective and efficient Internet sites must be developed.
The hallmarks of an outstanding front-end system need
to be determined. Second, with regard to demand
planning, methods must be developed to facilitate
consumers in product usage rate planning. What methods
will be most effective? Third, with regard to the commu-

nication vehicle, what design features will enable con-
sumers to plan demand, subscribe, pay, access informa-
tion, and communicate with supply chain partners
efficiently and effectively? Fourth, with regard to infor-
mation flow, what will be the ideal subscription length for
each product? What will price discount structures look
like? Fifth, with regard to supply chain operations, a
major shift in marketing activities will occur. Emphasis
will shift from developing mass advertising campaigns,
designing consumer packaging, managing “sale” mer-
chandise, managing shelf space, determining markdowns,
managing excess inventories, and processing consumer
transactions to communicating with individual consumers
and maintaining one-to-one relationships. How will this
major shift be accomplished? What will be the level of
cost savings achieved? How will these cost savings be
documented? Additionally, consumers may want to pick up
or have delivered their entire bundle of purchases for the
week/month. As a result, someone in the supply chain will
have to sort products into individual consumer orders. If
the consumer does not perform this task with their
shopping cart, then a retailer, crossdock firm, US Postal
Service, home delivery service, or some other new
intermediary will have to undertake this large sorting
task. How will this sorting effort be designed? What
technologies will be applied to the task? Finally, what will
be the optimally efficient supply chain configuration for a
given product? What opportunities will exist to consoli-
date shipments and share assets across supply chains?

Conclusion

In the twenty-first century, supply chain strategists

should take the next logical step in supply chain integra-
tion by integrating consumer plans into the formal supply
chain strategic planning process. A new paradigm, the
subscription supply chain, will be characterized by long-
term contracts to facilitate demand planning with end
consumers. This strategy will not be relevant for all prod-
ucts and consumers, yet tremendous opportunities await
those supply chains who target the right consumers with
the right products through a subscription supply chain
model.

References

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end small business market. Information Today 4(Spring)
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About the Authors

Robert L. Cook is Professor of Marketing and Logistics at

Central Michigan University. His research interests include
applying computer technology to logistics and supply chain
design. He has published in numerous prestigious journals
including: International Journal of Purchasing and Materials
Management, International Journal of Physical Distribution
and Logistics Management, Journal of Business Logistics,
Journal of Advertising Research and Production and Inventory
Management Journal.

Michael S. Garver is Assistant Professor of Marketing and

Logistics at Central Michigan University. His research interests
include collecting and using customer value and satisfaction
data to drive process improvements and competitive advantage.
He has published articles in the Journal of Business Logistics,
Supply Chain Management Review, Industrial Marketing
Management, Marketing Research, Mid-American Journal of
Business, and Business Horizons.

Mid-American Journal of Business, Vol. 17, No. 2

Midwest Business Administration Association Meeting

2003 MBAA Professional Division Chairs

March 12, 13, and 14, 2003

Accounting

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and Business Law
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Business Administration
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Sandra E. Strasser

, Valparaiso University

Ceyhun Ozgur,

Valparaiso University

David L. Schroeder,

Valparaiso University

Abstract

According to the Chronicle of Higher Education

(2001), 15 percent of entering freshmen believe that there
is a good chance they will change their college major
and 8 percent are undecided. To gain insight into the
criteria that students use to select a major, a model of the
student decision making process was developed using the
Analytic Hierarchy Process (AHP). This model predicted
student’s first choice major with 88 percent accuracy for
sophomores and seniors. An analysis of the criteria revealed
judgement inconsistencies, particularly for accounting,
finance, and decision science majors. Not surprisingly,
sophomores were more inconsistent in their decision
making than were seniors. It was also determined that
students clustered the majors into two separate groups,
viewing accounting, finance and decision science majors
differently than marketing and management majors

Introduction

Many college students choose a major long before they

ever get to college and some select a major only to
change their minds as they progress through their re-
quired courses. According to the Chronicle of Higher
Education (2001), 15 percent of entering freshmen be-
lieve that there is a good chance they will change their
college major. One recent study found that 72 percent of
freshmen that initially chose a major changed their major
before graduating (Kroc et al. 1997). A handful of stu-
dents even change their minds more than once, frustrating
themselves, their advisors and their parents in the pro-
cess. The Chronicle of Higher Education (2001) also
states that over 8 percent of entering freshmen are unde-
cided. This group of students, the most problematic, have
a difficult time narrowing their choices, often ending up
in their third or fourth year of college and still listing
their major as undeclared. Aside from the fact that this
group finds graduating in four years more difficult, there

Selecting a Business College Major:

An Analysis of Criteria and Choice Using the Analytical Hierarchy Process

are other pitfalls that accompany their indecision. Because
classes cannot be planned, synergies cannot be taken
advantage of and opportunities for internships in the
major may be lost. Unfortunately students who cannot
choose a major also have trouble deciding upon a minor.
By the time a major is selected it is often too late to fit in
the required courses for a minor area of study and elec-
tives become filled with unrelated courses. If a student
should select a minor prior to a major, the two disciplines
may not complement each other.

To avoid some of these problems and to help students

make better decisions, college career centers are stocked
with instruments (both computerized and pencil/paper)
that test students’ interests and abilities. These instru-
ments are designed to help students determine to which
careers/majors they are most suited. While it is important
for students to understand where their strengths and
interests lie, are other criteria also involved in the deci-
sion making process that are not accounted for in the
existing instruments? If there are additional criteria,
maybe some are more important for particular majors
than others.

The purpose of this research is to develop a model to

analyze the criteria and decision process students use in
choosing a major. The model, using the analytic hierarchy
process (AHP), is based on the decision criteria used by
the students, as determined by student surveys and a
review of the literature. The AHP model requires students
to compare the majors not only with respect to different
criteria but also to the relative importance of the criteria
for each student.

The authors would like to thank the Associate Editor and anonymous reviewers for their insight and helpful suggestions on earlier drafts. This
research was supported by a grant from the Committee on Creative Work and Research, Valparaiso University.

While it is important for students to
understand where their strengths and
interests lie, are other criteria also in-
volved in the…decision process students
use in choosing a major?

Strasser, Ozgur, and Schroeder

Mid-American Journal of Business, Vol. 17, No. 2

How do students decide on a college major? Under-

standing how students choose a major may better ensure
that students are given the correct information and guid-
ance in making that decision, while offering insight into
the perceptions and assumptions that students may be
using to make their decision.

The remainder of this paper is organized as follows: a

review of the literature to determine what criteria have been
explored, an explanation of the methodology along with
details of the analysis of model development, application of
AHP, results of the analysis, and conclusions of this study.

Literature Review

Several studies support various criteria students use to

select a major in college and these are summarized in
Table 1.

Many authors supported the importance of “interest” in

the decision process. Hansen and Neuman (1999) found
that students’ interests, as determined by the Campbell
Interest and Skill Survey (CISS), were more important
than skill in determining a college major. Lapan (1996)
explored the factors affecting students who become math/
science majors, specifically looking at self-efficacy and
vocational interests. Interest was also an important crite-
rion in the model developed by Kaynama and Smith
(1996) and that of Coperthwaite and Knight (1995) as
measured by coursework.

Coperthwaite and Knight (1995) listed “ability” among

the fifty variables they analyzed in their model and found

it to have a large effect even though Hansen and Neuman
(1999) suggested a lesser effect.

The “influence of others” was included in the initial

analysis of Kaynama and Smith and found to have an
effect on the decision process, however, they omitted the
variable from their model.

The variable “compensation” appeared in many studies

(Coperthwaite and Knight 1995; Kaynama and Smith
1966; St John 1994) and was determined to be an impor-
tant factor. Related to compensation, Gabrielsen (1992)
suggested that the image, reputation, and prestige of a
major were important to students.

“Career opportunities” also emerged as a critical factor

in a study authored by Kirk (1990) and the study by
Kaynama and Smith (1996) who found “job availability”
to impact a student’s decision.

In addition to interest, ability, influence, compensation

and career, several studies included measures of personal-
ity, self-esteem and job satisfaction (Coperthwaite and
Knight 1995; Kaynama and Smith 1996; Lapan 1996).

Model Development

In an effort to achieve a parsimonious model, it was

necessary to select only those variables that were critical
to the decision making process. To gain a better under-
standing of the criteria, we used a convenience sample
and asked two senior capstone strategic management
classes (n = 60) and two sections of the sophomore busi-
ness statistics class (n = 57) to list the factors that they

Table 1

Summary of Decision Criteria Literature

Author(s) & Year

Coperthwaite & Knight (1995)

Gabrielsen (1992)

Hansen & Newman (1999)

Kaynama & Smith (1996)

Kirk (1990)

Lapan (1996)

St. John (1994)

43,614

128

204

101

3,893

discriminant analysis

survey

multiattribute & AHP

survey

structural path analysis

survey

college sophomores

college students

prebusiness students

graduate students

math/science students

high school students

Almost 50 variables including
course work, ability, self esteem,
importance of money

Image, reputation and prestige of
the major

Interest in subject more important
than skill in determining college
major

Influence of other, job satisfaction,
interest, job availability, and
money

Program quality and career
opportunities

Personality (introverted vs
extroverted) and vocational
interests

Debt burden not a factor (is
money?)

Too many variables,
cumbersome design

Limited to “self-
monitors”

Limited to Campbell
Interest and Skill
Survey

Influence was not
included in the model
– although it was
found to be an
important criteria

Limited to recruiting
nontraditional
students

Limited to math/
science

1980 high school
class

Decision Criteria

Determined in Study

Limitations

of Study

Subjects

Methodology

Sample

Size

Strasser, Ozgur, and Schroeder

Mid-American Journal of Business, Vol. 17, No. 2

considered important in selecting a major. Aside from
accessibility, we were interested to learn if there was a
difference between these two groups. No difference was
apparent. We tabulated and analyzed the responses and
prepared a list of the top fifteen factors in Table 2. Inter-
estingly, these factors could be subjectively divided into
three clusters that we titled interest in subject, influence
of others, and career where career included compensa-
tion, job availability and growth, and job requirements.
This provided a very close match to the criteria men-
tioned in the literature and provided some validity to the
clusters. While other studies included self-esteem, per-
sonality, and job satisfaction as decision criteria, our
students did not suggest these and we decided to exclude
them from the model. Another reason for excluding job
satisfaction from the model was because this criterion is
already captured in the other variables used to measure
career (compensation, job availability and growth, and
job requirements).

After clustering, we considered hierarchical relation-

ships within each cluster. While we decided to have a
single hierarchy for the interest in subject and influence of
others, the career cluster consists of three sub-criteria:
compensation, job availability and growth, and job require-
ments. The job requirements criterion includes two sub-
criteria: computer usage and interpersonal skills. The sche-
matic representation of the model is presented in Figure 1.

Application of AHP

The data in this study were analyzed using a multi-

criteria decision making approach called the analytic
hierarchy process (AHP). Saaty (1994), the founder of
AHP, claims that AHP is, “…natural to our intuition and
general thinking,” which combines logic and intuition,

and takes advantage of our ability to rank choices. Many
articles have been written on the successful implementa-
tion of AHP in various environments that involve a
selection or decision (Kalb and Hemaida 1999;
Liberatore and Miller 1995; Wang et al. 1998). Forman
and Gass (2001) provide an examination of the history,
development, methodology, and a summary of the wide
range of applications of AHP.

AHP breaks the problem into many smaller, simpler

decisions and then asks respondents to rank them by
using pair-wise comparisons, giving the decision maker
an organizational tool to attack the larger problem. The
College of Business Administration has five majors:
accounting, decision science (consisting of operations,
statistics, and information systems), finance, manage-
ment/international business, and marketing. The AHP
asks students to compare all ten pairs and to rank them on
their preferences based on all of the criteria in the model;
for instance, “Based on your interest in the subject, do
you prefer marketing or finance?” The scale used for this
study treats the value of 1 as a neutral point and the
values from 2 to 9 indicate preference in both directions
resulting in a 17-point scale. After ranking the choices in
terms of all of the criteria, AHP then requires the student
to rank the importance of all of the criteria (compare the
relative importance of computer skills and interpersonal
skills with respect to your career). Using the rankings of
the individual majors weighted by the rankings of the
criteria, AHP provides priority scores (0 to 1) for each
major and for each criteria (an explanation of the actual
calculations are provided in Saaty (1994)). The higher the
score, the more likely the student will select that major or
believes that criteria to be important in their decision.
AHP allows us to not only evaluate the student’s deci-
sion, but their criteria can be analyzed as well.

AHP also provides a measure of consistency for each

student’s judgement (0 to 1). If a student prefers decision
science to finance and finance to marketing, to be consis-
tent, they should also prefer decision science to market-
ing. When students are confused about the criteria or

Figure 1

AHP Model for Selection of a Major

Interest

in subject

Influence

of others

Career

Money

Job

requirements

Computer

usage

Interpersonal

skills

Selection

of a major

Job availability

and growth

Advisors

– Parents

Peers

Table 2

Student Generated Criteria

Quantitative analysis
Working with computers

Interest in the subject

Influence of others

Career

Compensation

Job availability and growth

Job requirements

Interpersonal skills

Computer usage

Personal preference

– Ability in subject matter
– Rigor/challenging

Enjoyable/fun

Earning potential
Earning growth

Employment opportunity
Advancement opportunity

Dealing with people
Team Work

‘ ‘ ‘ ‘ ‘ ‘ ‘ ‘ ‘ ‘

‘ ‘ ‘ ‘ ‘ ‘ ‘ ‘ ‘

‘ ‘ ‘ ‘ ‘ ‘ ‘

‘

‘ ‘ ‘ ‘ ‘ ‘

Strasser, Ozgur, and Schroeder

Mid-American Journal of Business, Vol. 17, No. 2

don’t fully understand the majors, their preferences may
not be consistent and they will receive a high inconsis-
tency score. The inconsistency score is computed as a
ratio of the actual number of inconsistencies divided by
the potential number of inconsistencies.

Methodology

The Questionnaire

A questionnaire was developed (Appendix A) to mea-

sure students’ preferences for the five majors currently
offered in the College of Business Administration. This
two-phase process began by asking students to compare
majors based on each of the model criteria and to rank
their preferences. A second phase required students to
compare each of the criteria and to rank the importance of
each within the model. In all, students made sixty-seven
pair-wise comparisons. To test the accuracy of the model,
the final question was to order the five majors according
to personal preference. This ordering would later be
checked against the predictions of the model.

The questionnaire was pretested using ten students

from the College of Business Administration and im-
provements were made based on their feedback.

The Sample

While the criteria suggested by both sophomores and

seniors were almost the same, the authors suspected that
students just starting out in the College might not have as
much information as seniors do and might give different
weights to the criteria. To determine if there was a differ-
ence in the decision making process between sophomores
and seniors, sixty-three sophomores and forty-nine
seniors from the College of Business Administration were
included in the study. None of these students were from
the first group that generated the criteria. The conve-
nience sample was considered large enough to have
sufficient power and was consistent with several similar
studies we reviewed.

The instrument was administered during class to en-

sure completion. As a reward to the students who partici-
pated in the study, every student received a printout
listing their individual priority scores for each of the five
majors. While many students viewed these as less than
miraculous, several students wanted to discuss the model
and to re-evaluate their choices. At the very least, most of
the students enjoyed the exercise and were pleased with
the results. Unfortunately, we could not ensure confiden-
tiality and still be able to offer the students feedback on
their preferences. We did not believe that this would be a
critical issue for data integrity as the results of the ques-
tionnaire are not sensitive.

The following results are based on those returns.

As this study is exploratory in nature, simple correlations
and independent t-tests were employed to investigate

the relationships among the factors and majors in the
model.

Results of Classification

To validate the model, we compared predicted majors,

based on the highest priority scores for each student, to
actual majors for all 112 in the sample. Table 3 represents
a breakdown of the percent of correctly classified students.

At Least the Top

84%

92%

88%*

Choice Predicted

Top Choice

16%

12%

Not Predicted

* This model predicted the exact order of all five majors for 38%

of the participating students.

Table 3

Percent of Students Correctly Classified

Sophomores

Seniors

Total

(n=63)

(n=49)

(n=112)

Overall, the AHP model predicted 88 percent of the

students’ first choice of major. This compares favorably
with a previous study by Kaynama and Smith (1996) that
used different factors and correctly classified 80 percent of
their students. It is interesting to note that our model cor-
rectly predicted the exact order of preference of all five
majors for 38 percent of the students. We were able to
discriminate at a very fine level for more than one third of the
students. The percent of correct classifications for sopho-
mores and seniors is not statistically different (p = .22).

Table 4 compares the percent of students predicted in

each major to the percent of students in the College of
Business Administration actually enrolled in each major.
While most of the numbers are similar, finance and deci-
sion science seem to be areas of disagreement. Too many
students were predicted to be decision science majors and
too few for finance. An analysis of the criteria, contained
in the next section, will be necessary to try to explain
these discrepancies.

Marketing

22%

24%

Management

29%

30%

Finance

18%

23%

Decision Science

15%

Accounting

17%

Table 4

Comparison of the Percentage of Actual vs. Predicted

Majors in the College of Business Administration

Predicted

Actual

n = 112

n = 400

Strasser, Ozgur, and Schroeder

Mid-American Journal of Business, Vol. 17, No. 2

Figure 2

Priority Scores

Results of Criteria Analysis Using Priority
Scores

This section of the paper is divided into three parts: an

analysis of the student criteria using the three levels of the
model; an analysis of the majors for both sophomores and
seniors; and a comparative analysis using the criteria, the
majors, and sophomore/senior standing.

Figure 2 illustrates the three levels of the model with a

bar graph of the priority scores for each level. The first
level includes the criteria interest, influence, and career.
Note that the priority score for interest (.503) is much
larger than career (.366) or influence (.131). The interpre-
tation is that, on average, students value the interest they
have in a major as far more important than the career
benefits of a major or someone else’s influence on them
to choose a particular major. While this seems intuitive, it
makes a good argument against those who suggest that
business students are in it for the money and don’t really
enjoy the discipline. We are a little surprised by the low
priority score given to influence. Anecdotally, students
seem to choose majors because their parents want them to
be accountants or because a high school teacher encour-
aged them to major in marketing. This is certainly not true
for the majority of students participating in this study.

Level two, a subset of career, includes the criteria

compensation, job availability and growth, and job re-
quirements. Both compensation and job requirements are
important elements with respect to a student’s career
choice. While job availability and growth were not con-
sidered as important, this is perhaps largely due to the
optimistic employment picture at the time of data collec-
tion. For the last several years prior to this survey, stu-
dents had been receiving multiple offers for high paying

jobs, often with signing bonuses. We have to wonder if
availability and growth would become more important to
students’ careers in a poor economic climate.

The third level of the model divides job requirements

into two subcategories of computer usage and interpersonal
skills. Based on priority scores, we can conclude that
students value interpersonal skills as being much more
important in their career than the computer usage. This
could be interpreted that students will choose a career
that fits their interpersonal skills rather than a career
based on the amount of computer usage they believe will
be required on the job. This level could be viewed as a
measure of the quantitative/qualitative dichotomy.

A more complete listing of the priority scores for

sophomores and seniors at all levels is provided in Table
5. The priority score for the interest criterion is very high
for all students who prefer management and marketing
and lower for those who prefer finance, decision science,
and accounting. The students believe that marketing and
management lead to greater usage of interpersonal skills
and finance, decision science, and accounting lead to
greater usage of computer skills. Priority scores for both
sophomores and seniors appear to form into the manage-
ment/marketing group and the finance/decision science/
accounting group. This clustering will be further ex-
plored later in the paper. As can be seen in Table 6, the
mean priority score for marketing received by sophmores
is about .21 and about .28 for management, the most
often predicted as first choice.

To graphically analyze the majors, boxplots of priority

scores are provided for both sophomores and seniors in
Figure 3. The boxplots are based on the individual prior-
ity scores for each student, for each of the five majors.

.503

.131

.366

.135

.091

.140

.044

.096

Interest

in subject

Influence

of others

Career

Money

Job

requirements

Computer

usage

Interpersonal

skills

Selection

of a major

Job availability

and growth

Level One

Level Two

Level Three

Strasser, Ozgur, and Schroeder

Mid-American Journal of Business, Vol. 17, No. 2

To gain a better understanding of the drop in account-

ing and the previous issue of underestimation of decision
science and overestimation of finance, a correlation
matrix was computed for all priority scores. The signifi-
cant correlations in priority scores were identified among
the five majors and the interest criterion of the model, and
are listed in Table 7. Interest was included based on its
high consistency score. Table 7 also includes significant
priority score correlations between preferences for majors
and interest in majors.

Marketing

0.210

0.220

Management

0.280

0.300

Finance

0.180

0.170

Decision Science

0.130

0.170

Accounting

0.210

0.130

(0 = low priority, 1 = high priority)

Table 6

Mean Priority Scores for Each Major

(n=49)

(n=63)

Sophomores

Seniors

Perhaps the most interesting aspect of these plots is the
decrease in predicted accounting majors. The accounting
faculty verified that many students change from account-
ing after their sophomore year. This decrease is particu-
larly intriguing in light of the stability of the other four
majors. What is causing the drop in accounting majors,
both predicted and actual? A second most interesting
result from these plots is the high number of outliers for
both sophomore and senior finance majors. The unusually
high number of outliers for the finance major indicates a
large variation in priority scores among the participants.
This variation is likely to occur as a result of inconsisten-
cies between the finance major and the selection criteria
in the decision making process.

Table 5

Summary of Mean Priority Scores

(n = 49)

(n = 63)

(0=low priority, 1=high priority)

Criteria

Sophomores

Seniors

Interest

0.478

0.523

Marketing

0.113

0.121

Management

0.174

0.156

Finance

0.066

0.086

Decision Science

0.080

0.059

Accounting

0.044

0.101

Influence

0.147

0.119

Marketing

0.037

0.019

Management

0.035

0.028

Finance

0.024

Decision Science

0.031

0.020

Accounting

0.020

0.027

Career

0.375

0.358

Compensation

0.118

0.148

Marketing

0.015

0.024

Management

0.021

0.034

Finance

0.036

0.035

Decision Science

0.019

0.015

Accounting

0.027

0.040

Job Availability & Growth

0.100

0.084

Marketing

0.018

0.016

Management

0.019

0.021

Finance

0.025

0.018

Decision Science

0.016

0.012

Accounting

0.021

0.018

Job Requirements

0.158

0.126

Computer Skills

0.042

0.045

Marketing

0.004

0.005

Management

0.004

0.003

Finance

0.008

0.009

Decision Science

0.018

0.016

Accounting

0.009

0.012

Interpersonal Skills

0.116

0.081

Marketing

0.038

0.024

Management

0.048

0.033

Finance

0.014

0.010

Decision Science

0.008

0.006

Accounting

0.009

Management is the only major correlated with interest.

The interpretation is that the model selects management for
students who place the greatest value on interest. A strange
twist to this is that none of the other majors are correlated
with interest. This does not mean that other majors are not
interested in the subject, but rather that other factors are
more important to their decision.

A second finding illustrated in this table is that majors

appear to cluster into two groups with management and
marketing forming one group and finance, decision sci-
ence, and accounting forming the other group. To explain
this phenomena, notice that if the model classifies the

Figure 3

Priority Scores by Major and Class

0.0

-.1

Mkt

Mgt

Fin

D.S.

Acct

Mkt = Marketing; Mgt = Management; Fin = Finance;

D.S. = Decisions Sciences; Acct= Accounting

Sophomore
N= 49

Senior
N= 63

= Extreme

Outliers

= Outliers

= Median

Priority Scores

* *

*
*

Strasser, Ozgur, and Schroeder

Mid-American Journal of Business, Vol. 17, No. 2

As a group, decision science,

finance, and accounting also seem to
act differently in terms of eliciting
consistent judgements. According to
logic, if a person prefers A to B and
B to C, then they should also prefer
A to C. The extent to which these
logical relationships are not main-
tained (if A is not preferred to C) is
reflected in an inconsistency score.
Table 8 lists five questions that
correlate significantly (p < .01) with
inconsistency for sophomores only.
There were no significant correla-
tions with inconsistency for seniors.

Sophomore students who preferred
decision science or accounting based
on the influence of others or who
thought that finance and accounting

lead to greater computer usage had higher inconsistency
scores. In general, students who have a stronger belief
that interest in the subject is important in choosing a
major have lower inconsistency scores.

In the case of influence involving accounting and

decision science, the student may be torn between what
she wants and what someone else wants for her, causing
confusion in preferences. Why then, doesn’t this confu-
sion occur in management, marketing, or finance? Are
students who prefer these majors less likely to be influ-
enced by others? Similar inconsistencies are observed
when students believe that finance and accounting lead to
greater usage of computer skills. Sophomores relating
computer usage to the other three majors show no incon-
sistency. This phenomena may be partially explained by
the confusion or lack of understanding about the role of
computers and technology in the context of accounting

Importance of Interest

.19*

Interest in Marketing

.81**

-.35**

-.24**

-.31**

Interest in Management

.86**

-.35**

-.31**

Interest in Finance

-.37**

-.25**

.77**

Interest in Decision Science

-.27**

-.23**

.78**

Interest in Accounting

-.35**

-.33**

.86**

* p value <.05

** p value < .01

Table 7

Correlations Between Measures of Interest

and the Priority Score for Each Major

Priority Scores for Majors

Decision

Marketing

Management

Finance

Science

Accounting

student as a management major, the student prefers man-
agement (based on interest and high positive correlation)
and does not select finance, decision science, or account-
ing (large negative correlations). Notice, however, that
interest in marketing is not correlated (positively or
negatively) to management. Perhaps the management
student is neutral toward marketing. If a student is classi-
fied as finance, they score high on finance interest and
negatively on marketing and management. Again, the
student would be neutral toward decision science and
accounting. This relationship holds for all of the majors.
A strong positive correlation in one major, negative
correlations in majors from the other group and no corre-
lations with majors from the same group. This would
indicate that students who are classified as management
majors are interested in management, dislike finance,
decision science, and accounting, and are neutral to mar-
keting. Students are being attracted to one major from a
group and remain neutral to the other major(s) in that
same group. At the same time they are detracted from all
of the majors in the second group.

It appears that marketing and management have some-

thing in common that is not a part of the decision science,
finance, or accounting majors. What is it about these two
groups that would form this interesting clustering? It
might be helpful to address this question in combination
with high turnover in accounting students. When students
change majors from accounting, what do they choose
instead? Do most accounting students stay within the
same cluster or do they move to management or market-
ing? Possible explanations could be the perception of
marketing and management as being non-quantitative and
more subjective than finance, decision science, and ac-
counting or a perceived difference in the level of difficulty
and challenge between the two groups of majors. Though
intriguing explanations, further investigation of these
hypotheses is necessary.

None of these correlations are significant for seniors.

** p values < .01

Table 8

Indicators of Inconsistency: Questions that

Significantly Correlate with Inconsistency

Scores of Sophomores

Correlations With

Questions

Inconsistency Scores

Which major do you prefer based on
the influence of others - decision science.

.44**

Which major do you prefer based on
the influence of others - accounting.

.36**

Which major do you think leads to greater
usage of computer skills in your career - finance.

.33**

Which major do you think leads to greater
usage of computer skills in your career - accounting.

.37**

The relative importance of interest in the
subject in choosing a major.

-.33**

Strasser, Ozgur, and Schroeder

Mid-American Journal of Business, Vol. 17, No. 2

and finance. It is interesting to note that the computer
usage in decision science had the highest priority score
and no inconsistency.

The importance of interest in choosing a major seems

to be the same for all majors. For sophomores, it appears
that the more important interest is in choosing a major, the
less inconsistent the decision. If interest is important to a
student, he may have a clearer picture of his preferences.
A possible explanation could be the disconnect between
choosing from the heart and choosing from the head. If a
student is using both, the results may be confusing.

As sophomores, limited class experience may cause

their beliefs to not fit with their overall concept of finance
or accounting. It is important to state that these inconsis-
tencies are not present for seniors, possibly because after
two years the students are able to understand themselves
better, have a clearer picture of the disciplines and can
make cleaner decisions. In fact, the inconsistency scores
for sophomores are significantly higher than the scores
for seniors (p = .033).

To further evaluate this difference, the priority scores

of sophomores were compared to those of seniors for
statistical significance. The results appear in Table 9.
Seniors were less likely to choose a major based on inter-
est than sophomores were and more likely to choose
based on career related factors such as personal abilities
and interpersonal skills. Seniors place more importance
on the growth potential of finance and decision science,
are less interested in accounting, and more interested in
marketing and management. This is exhibited in the
decrease of accounting majors in the senior class.

To summarize the effect of the criteria on the majors,

Table 10 lists the major priority scores (for sophomores
and seniors combined) and the one or two criteria priority
scores with which they are most highly correlated. All
correlations are statistically significant (p

≤ .05). Notice

that marketing is most correlated with interpersonal
skills. As sophomores advance and determine that their
interpersonal skills are more important to a career, they

may lean toward marketing. As discussed above, interest
and management are correlated, but the table also shows
a significant negative correlation with computer usage.
As students move away from computers, they may move
toward management. Finance has a high correlation with
the importance of compensation. This may be an indica-
tion that students majoring in finance may be looking for
higher salaries. The decision science major is signifi-
cantly correlated with computer usage and influence. As
most students are not aware of the major or what it means
as freshmen, the influence is probably from college
professors, advisors, or others they meet during their
college enrollment. Perhaps their influence is strong
enough to overcome an interest in another major or their
desire to find a career. This would explain the high rela-
tionship between inconsistency and influence in decision
science. Due to the high inconsistency regarding the
influence criterion, the model may be identifying too
many students as decision science majors. One potential
reason finance majors are not identified enough by our
model could be also due to inconsistencies in their under-
standing of the use of computers in finance.

Perhaps the most revealing bit of evidence as to why

the decrease in accounting majors can be seen is the fact
that no one criterion applies to accounting. It is possible
that accounting students change to other majors not because
they dislike accounting, but rather, they are driven to
other majors by interest, interpersonal skills, job require-
ments, etc. Accounting has no claim to fame in that any
of the criteria (as measured by the correlations between

accounting major priority scores and criteria
priority scores) point to an accounting major.
Sophomores appear to be inconsistent, particu-
larly when influenced to major in accounting
and when they believe that a major in account-
ing leads to greater use of computer skills. It is
probable that the influence to major in account-
ing is prior to college and that the inconsistency
occurs when sophomores compare accounting to
other majors. They may prefer a different
major, but feel compelled to major in account-
ing due to someone else’s influence (though this
would not be the strongest motivation as influ-
ence and accounting are not correlated signifi-
cantly). Again, by the time they become seniors,
they have sorted out the dilemma and many
leave accounting for other business majors.

Importance of interest in the subject

2.204

0.031

0.57

0.479

Importance of personal abilities

-2.009

0.049

0.109

0.157

Importance of interpersonal skills

-2.286

0.026

0.071

0.114

Growth potential of finance

-3.324

0.002

0.012

0.026

Growth potential of decision science

-2.301

0.025

0.008

0.02

Interest in accounting

2.849

0.013

0.109

0.048

Interest in marketing

-2.091

0.042

0.02

0.04

Interest in management

-2.396

0.019

0.028

0.046

Priority score of accounting

2.547

0.013

0.206

0.139

Table 9

A Comparison of Sophomore and Senior Priority Scores

Sophomore

Senior

p value

Score

As most [freshmen] students are not
aware of what [a particular major] means,
the influence [to select that major] is
probably from college professors, advi-
sors, or others they meet during their
college enrollment.

Strasser, Ozgur, and Schroeder

Mid-American Journal of Business, Vol. 17, No. 2

Conclusions

Often it is said that students select a major based on

interest, their dream of vast amounts of money, or their
distaste of computers. But is their decision based solely
on one factor? It may be desirable to weight their deci-
sions based on how important interest, compensation, and
computer usage is to each of them individually. The AHP
model does exactly that in incorporating the student’s
view of majors based on the criteria and the rankings of
the criteria themselves. In terms of correct classification,
an 88 percent success rate suggests that the model is not
only technologically exciting, but is a good fit as well.

Several interesting questions and possible relationships

came out of the small data set we have already collected.
Perhaps the most valuable idea to emerge is the sense that
the accounting major is very different from the other
majors. Nationwide, enrollment of accounting majors has
dropped by 23 percent in the last four years (Albrecht and
Sack 2000). The AHP model has the potential to answer
why, particularly for this college and these students. We
can hypothesize that our accounting students have been
influenced to become accounting majors, are not knowl-
edgeable about computer usage, and may not be making
decisions consistent with their logic and intuition. When
they change majors, it is probably not because they dis-
like accounting, but rather because they are positively
drawn to another major. A possible strategy to minimize
the inconsistencies and major shuffling, might be to spend
more time early on explaining what accountants do and
how the accounting discipline compares with other ma-
jors. This conversation is currently being held at this
college and is supported by the results of this study.

This study also raised some interesting questions, such

as why are management and marketing separate from
accounting, decision science, and finance in so many
criteria? What is it about these majors that makes them
different? Is this the quantitative vs. qualitative percep-
tion, the difference in perceived rigor, or is it something
else? Another question concerns the perceptions of
sophomores as opposed to seniors. How can we help
sophomores to make consistent decisions? For sopho-
mores, lack of both experience and knowledge of the

majors appear to be the key elements in making inconsis-
tent decisions. Seniors make more consistent decisions
because they learn more about the majors in their classes
and understand themselves better.

By helping students to choose a major as soon as

possible and making sure that the selection is appropriate,
we are giving our students the very best foundation for
their tenure in college, as well as for the rest of their
lives. The more we know of that decision process, the
more we can help.

Limitations and Future Research

It is important to note that there are numerous limita-

tions to this study. Our biggest concern is that the model
will act differently for entering freshmen and that its
predictive ability will be lessened. The next step for us is
to test the next entering freshman class and compare their
results with those of the sophomores and seniors. A
question will be added to the instrument asking if the
student is undeclared so that we can factor that informa-
tion in to the analysis as well. Finally, the purpose of a
model is to simulate the real world with as few of the
real-world complications as possible. As with any model,
the question always remains as to how well the model
replicates the actual decision process. Possible additional
criteria under consideration include the personality and
ability of the respondents and perceived rigor of the
discipline. Therefore, model adjustment and improvement
is the last phase of this research.

References

Albrecht, W.S. and R.J. Sack. 2000. Accounting education:

charting the course through a perilous future. American
Accounting Association Monograph.

Coperthwaite, C.A. and W.E. Knight. May 1995. Student input,

student involvement and college environment factors
impacting the choice of academic major. Annual Forum of
the Association for Institutional Research.

Chronicle of Higher Education, January 26, 2001. This year’s

freshmen at 4-Year colleges: A statistical profile, Fact File.

Forman, E.H. and S.I. Gass. 2001. The analytic hierarchy process

— An exposition. Operations Research 49(4):469-486.

Gabrielsen, E. 1992. The role of self monitoring, conformity,

and social intelligence in selection of a college major.
Annual Conference of the Eastern Psychological Associa-
tion.

Hansen, J.C. and J.L. Neuman. 1999. Evidence of concurrent

prediction of the campbell interest and skill survey (CISS)
for college major selection. Journal of Career Assessment
7(3):239-247.

Hemaida, R. and E. Kalb. 1999. The selection of first year

family practice residents using theanalytic hierarchy process.
Decision Sciences Institute Proceedings 1999 (2):867-869.

Kaynama, S.A. and L.W. Smith, 1996. Using consumer

behavior and decision models to aid students in choosing a
major. Journal of Marketing for Higher Education 7(2):57-73.

Kirk, J.J.,1990. Selection of graduate major: Implications for

student recruitment. College and University 66(1):35-40.

Marketing

Interpersonal skills

0.22

0.02

Management

Interest

0.19

0.05

Management

Computer

-0.19

0.04

Finance

Compensation

0.24

0.01

Decision Science

Computer

0.23

0.02

Decision Science

Influence

0.32

Note: Accounting is not correlated with any criteria

Table 10

Correlations Between Major Priority Scores

and Criteria Priority Scores

Major

Criteria

Correlation

p-value

Strasser, Ozgur, and Schroeder

Mid-American Journal of Business, Vol. 17, No. 2

Kroc, R., R. Howard, P. Hull, and D.Woodard. 1997. Gradua-

tion rates: Do students’ academic program choices make a
difference? Annual Forum of the Association for Institutional
Research.

Lapan, R.T. 1996. Efficacy expectations and vocational

interests as mediators between sex and choice of math/
science college majors: A longitudinal study. Journal of
Vocational Behavior 49(3):277-91.

Liberatore, M.J. and T. Miller. 1995. A decision support

approach for transport carrier and mode selection. Journal of
Business Logistics 16(2):85-115.

Saaty, T.L. 1994. How to make a decision: The analytic

hierarchy process. Interfaces 24:6, 19-43.

St. John, E.P. 1994. The influence of debt on choice of major.

Journal of Student Financial Aid v24 n1:5-12.

Wang, H., M. Xie, and T.N. Goh. 1998. A comparative study of

the prioritization matrix method and the analytic hierarchy
process technique in quality function deployment. Total
Quality Management 9(6):421-430.

About the Authors

Sandra Strasser is Associate Professor of Information and

Decision Sciences at Valparaiso University. Her current
interests include statistical process control and quality issues in
healthcare and the innovative teaching of quantitative courses.
She has published in Quality Progress, Interfaces and Teaching
Statistics as well as Journal of Business Logistics, Transporta-
tion Journal and Transportation Quarterly.

Ceyhun Ozgur is Associate Professor and Area Coordinator

of Decision Sciences in the College of Business Administration
at Valparaiso University. Among others, Ozgur has published in
Interfaces, OMEGA, Production Planning and Control,
International Journal of Operations and Quantitative Manage-
ment, International Journal of Quality and Reliability Manage-
ment, International Journal of Business Disciplines, Industrial
Mathematics and Teaching Statistics.

David L. Schroeder is Associate Professor of Information

and Decision Sciences at Valparaiso University. Among others,
he has published in Journal of International Business Studies,
Strategic Finance, Journal of Teaching in International
Business, Industrial Management & Data Systems, Journal of
Education for MIS, Internet Research, and Journal of Informa-
tion Systems Education.

This appendix includes a condensed version of the survey instrument. Due to its considerable length, we have decided not to include the entire

survey in this appendix. However, all of the survey questions (excluding the pairwise comparisons) are listed below.

1. Which major do you prefer based on your interest in the subject?
2. Which major do you prefer based on the influence of others?
3. Which major do you prefer based on compensation?
4. Which major do you prefer based on job availability and growth potential?
5. Which major do you think leads to greater usage of computer skills in your career?
6. Which major do you think leads to greater usage of interpersonal skills in your career?
7. Compare the relative importance of computer skills and interpersonal skills with respect to your career.
8. Compare the relative importance of money, job availability and personal abilities with respect to your career.
9. Compare the relative importance of interest in the subject, the influence of others and your career in choosing a major.

10. Rank your preference of majors (1 = highest, 5 = lowest)

Accounting

Decision Science

Finance

Management

Marketing

For survey questions 1 through 9 listed above, we have included a table under each question. These tables include the 17-point scale for all

possible pair-wise comparisons associated with each specific question and serve as a convenient response mechanism. We have included the table
below as an example. This table is repeated for questions 1 through 6, while other similar tables are used for questions 7 through 9.

Appendix

Survey: Selection of a College Major

1= equal

3 = moderate

5 = strong

7 = very strong

9 = extreme

1 MKTG

MGMT

2 MKTG

Finance

3 MKTG

4 MKTG

ACCTG

5 MGMT

Finance

6 MGMT

7 MGMT

ACCTG

8 Finance

9 Finance

ACCTG

10 DS

ACCTG

Brown

Mid-American Journal of Business, Vol. 17, No. 2

BOOKSHELF

Business @
the Speed of Thought

By Bill Gates

Warner Books
1st edition (May 15, 2000)

Reviewer: Douglas M. Brown
Central Michigan University

Bill Gates, as Chairman of Microsoft, has been a

leader of the information revolution for a quarter century
now. He, in partnership with Paul Allen, founded
Microsoft because they saw an opportunity to use a new
technology to change the way business is done. They had
a vision that computer technology could be used to
benefit and transform society and, of course, the business
world. I use the term “business” in a general sense. All
aspects of modern human interaction use information
technology to conduct the interaction. This is true of the
business world, the non-profit world, the higher education
world, and any other realm. As the increase in utility of
information technology continues to rise, questions arise
around cost/benefit issues. In practically any organiza-
tion, large dollar amounts and large teams of personnel
are utilized to facilitate the introduction and use of
information technology into an organization. The ques-
tions that follow revolve around outcomes. Are we using
the new resources appropriately? Are we getting our
money’s worth? Bill Gates says we are not and suggests a
new model he calls a “digital nervous system” as a way to
maximize value from technology and information.

In his book, Business @ the Speed of Thought, Gates

attempts to make the case that most organizations do not
get the maximum out of their technology. He asserts that
most organizations have the wrong mind-set about how
information should be handled and distributed within an
organization. “We need to break out of the mind-set that
getting information and moving information around is
difficult and expensive” (p.16). He feels that many
organizations do not maximize new technology because
they still have an old mind-set about which employees
should have access to which types of information.
“Companies should spend less time protecting financial

data from employees and more time teaching them to
analyze and act on it” (Gates, p.18). He realizes that there
will be a resistance to this open approach to information.
He knows that many in management will see the down-
side and the risks involved in allowing everyone access to
a majority of organizational information. He feels that the
only data that should be out of reach of employees are the
personnel records and the private compensation and
benefits information of employees. Many managers who
are more restrictive and protective of data will take issue
with his approach. Gates attempts to speak to these
doubters and reassure them based on his own experience.
Microsoft has this kind of ubiquitous information model,
which Gates calls a digital nervous system, in place
because he as the chairman believes in it. “The value of
having everybody get the complete picture and trusting
each person with it far outweighs the risk involved”
(p.18).

What is a digital nervous system? “When thinking and

collaboration are significantly assisted by computer
technology, you have a digital nervous system” (p.15).
He makes the case that in any organization too much time
is spent in acquiring and organizing data. This time
should be spent analyzing, dissecting, and acting upon the
data. The way this can be accomplished is by creating a
digital nervous system. In the digital nervous system
model, almost all organizational data, save personnel and
benefits data, should be easily and readily available to
any employee in the matter of a few mouseclicks. This
would make the information ubiquitous. A minimum
requirement for a majority of workers in the information
age is having the data available to be able to perform
their job. The information flow of the organization should
be as fundamental to the very fiber and functioning of the
organization as the flow of blood is fundamental to the
functioning of the body. Gates gives various examples of
organizations that are moving ahead and improving with
this concept. Organizations such as McDonalds and Dell
are examples in the business world. So what are the
rules?

Some of the principles espoused by Gates are used as

chapter headings to focus the reader on some overriding
values. Gates lays out the principles and provides anec-
dotal support on a chapter by chapter basis. An important
principle for Gates, from this reviewer’s perspective, is
found in his first chapter. Managers must have hard
verifiable data from which to make decisions. A manager
cannot guess, cannot theorize, cannot hypothesize his
way to a decision. A manager must work from the basis
of hard data. This is the key and essential piece that a
digital nervous system can provide for management

Brown

Mid-American Journal of Business, Vol. 17, No. 2

today. This chapter is called “Manage with the Force of
Facts”. The example used by Gates to illustrate the
principle is that of Alfred P. Sloan and how he trans-
formed the management structure at General Motors.

The question that this reviewer wanted to consider is

the type of organization in which this model can truly be
implemented. Since Bill Gates is the world’s richest man
and the head of one of the largest corporations in the
world he clearly sees this concept of a digital nervous
system as advantageous in the world he knows, the
business world.

Is this concept transferable to other types of organiza-

tions? Can this concept realistically be transferred to
governmental institutions or to higher education? Gates
provides a chapter addressing each of these areas. His
answer, not surprisingly, is yes. He makes a strong and
reasoned case as to why a digital nervous system would
obviously benefit any organization. He says it can work
in any organization. My question remains, is it transfer-
able?

For the argument Gates makes, the point he is coming

to is true. The digital nervous system is a concept that can
be used in any organization that is using information
systems to operate the business. The question I have is
would it really be universally implementable regardless of
the type of organization?

To implement any new system an organization must

provide support of upper management, a budget sufficient
to accomplish the implementation and training to the
employees. In the world in which Bill Gates operates,
these issues are already in place. He is the boss so
obviously they have the support of upper management.
Microsoft is one of the richest companies on Earth so it
would be assumed that the budget for an implementation
is not a problem. Gates is a product of the information
technology environment so he intuitively understands that
employees need training in new technology. This model
clearly works for his company and some other enor-
mously successful companies.

In higher education or government however, things

may be different. Management is not always so inclined
to embrace new technology or a new model of conducting
business. Clearly in public sector agencies, funding for
implementation projects is not as easy to secure or justify
as it would appear to be in a multi-billion dollar corpora-
tion such as Microsoft. Finally, training is not always
provided as it should be and in fact is usually the first
thing cut from the project when a budget crunch arises.

This book is a good look at how the “king of soft-

ware” views information. The question is whether or not
the model is truly applicable to other types of organiza-
tions where profit is not the motive. In higher education
will presidents, provosts, or deans truly allow an unfet-
tered flow of information? In government, will managers
really allow and trust the rest of the organization to
handle all of the data? Assuming that these areas do not

cause a problem, will the budget situation allow complete
implementation with corresponding necessary employee
training? Gates functions in an environment where
funding is not and probably never will be an issue. Public
sector administrators do not have that luxury. This is the
problem that Gates did not address and may not even
understand.

Thompson

Mid-American Journal of Business, Vol. 17, No. 1

BOOKSHELF

Leading Quietly:

An Unorthodox Guide
to Doing the Right Thing

Historically, we think of great leaders as people who

are change agents for a cause. That a great leader can
somehow bring about change by their charisma, passion,
and dedication to their cause. Martin Luther King,
Gandhi, Mother Teresa, John F. Kennedy, and Winston
Churchill were great leaders. In today’s modern business
world, we often associate Jack Welch or Rudolph
Giuliani as business leaders who possess many of the
same leadership strengths. But, in the reality of modern
day business, there are countless leaders who sit in the
shadows of the CEO and demonstrate great leadership.
These quiet leaders are content to live their lives true
to their moral compass without seeking recognition.
Quiet leaders are everyday people who make critical
and effective decisions that affect other people’s lives
and the future course of the business. While pointing
out this simple fact may seem rather obvious, their
style of management sets them apart from the conven-
tional thinking that encompasses more traditional
leadership theory.

The personality characteristics that comprise a “quiet

leader” form the crux of Joseph Badaracco, Jr.’s book,
Leading Quietly: An Unorthodox Guide to Doing the
Right Thing published by the Harvard Business School
Press. The book attacks the premise that great leaders are
determined only by situations that require quick and
decisive action, who champion a cause, are altruistic in
nature, are guided by clear vision and principle, and play
by all of the rules. The book argues that too often leader-
ship is viewed in terms of a pyramid where great leaders
are found at the top and everyone else falls below. “The
pyramid approach, by saying little about everyday life
and ordinary people, seems to consign much of humanity
to a murky, moral limbo. This is a serious mistake (p. 3).”

Badaracco, Jr. presents compelling arguments and
examples of everyday situations where people are forced
to act in ways that reveal the true nature of their character
and succeed. It is within the nature of these discussions
that the reader is able to discern Baddaracco’s argument
for a new type of leader, known simply as a quiet leader.
The methods that these quiet leaders incorporate into their
decision-making strategy may surprise some readers.

The structure of the book represents a four-year study

of understanding what constitutes quiet leaders. The book
draws on powerful real life experiences from managers
challenged with everyday business problems. Leading
Quietly highlights how these managers demonstrate
effective leadership skills in their subtle ways.

The basis of Leading Quietly is the understanding that

these leaders can be characterized as realists who do not
kid themselves into believing that they will always be
able to enact major social or organizational changes.
“Indeed, one of the frustrations of quiet leadership is that
dedicated men and women have to limit themselves to
what they can do, which often falls short of their hopes
and aspirations” (p. 44). This point does not minimize the
significance of quiet leaders; rather it reflects the reality
of working in constrained environments where difficult
decisions are often dictated by constraints in resources
and the extent of the political clout that a person carries.

Badaracco, Jr. argues that quiet leaders will try to buy

time when making important decisions in order to
understand the full implications of that decision. While he
acknowledges that it is not always possible to delay what
might be inevitable, this strategy stands in sharp contrast
to the “take the hill” strategy often associated with
traditional leadership. The ability to buy time is an
important skill that requires a manager to work the
organizational culture in their favor. This then ensures
that decisions are made with a clear understanding of the
facts. This ability to “drill down” is an important charac-
teristic of quiet leaders. “When quiet leaders face a
problem entwined with complexities, they work patiently
and persistently to get a grasp of what they know, what
they need to learn, and whose help they require” (p.92).

One example that the book uses to illustrate this point

is a situation where a newly appointed CEO of a large
hospital, Rebecca Olson, is faced with dealing with a
sexual harassment and discrimination case. The case
involves a high level employee, Richard Miller, who has
worked for the hospital for over twenty-five years. Olson
was an outside candidate who had previously worked for
a smaller chain of clinics, while Richard Miller was the
inside candidate that many people in the company felt
should have gotten the job. As Olson investigated the

By Joseph L. Badaracco, Jr.

Harvard Business Review Press,
2002

Reviewer: Alex Thompson
Central Michigan University

Thompson

Mid-American Journal of Business, Vol. 17, No. 2

allegations leveled at Miller, she found a pattern of
harassment and position abuse. The previous CEO of the
hospital was aware of the charges leveled at Miller but
decided to leave the decision to the new administration.
Rather than make a quick decision to terminate this high
level, long-standing employee, Olson used four guiding
principles that are integral to quiet leadership (pp. 18-28):

1. You don’t know everything.

2. You will be surprised.

3. Keep an eye on the insiders.

4. Trust, but cut the cards.

First, Olson came to the realization that she needed

more facts. The potential that the discrimination case
would lead to a “he said, she said,” was very real and
would make it difficult to discern the truth. Olson then
realized that as a newly hired CEO from the outside, she
did not have the same political clout that Miller had
developed over his twenty-five years of service at the
hospital. Thus, she tempered her decision by acting
slowly and without judgment. Olson knew that Miller had
many supporters throughout the board and throughout the
organization. The prospect of Miller fighting the charges
was a distinct possibility that would lead to unwanted
publicity. Olson commissioned an independent investiga-
tion and upon finding that Miller had a history of abuse,
she took decisive action. She had no reason to trust
anything Miller had told her and forced him to accept a
severance package that required his resignation.

The Olson case is just one of many business situations

that Badaracco uses to illustrate what constitutes an
effective, quiet leader. His use of examples is one of the
book’s strengths. Rather than deal with leadership
through abstract management theory, Badaracco uses
concrete examples of situations that highlight quiet
leadership skills.

The book helps to answer questions about: “What do

you do, when you do not have the time or resources to do
what you really believe you should do? What if doing the
right thing involves bending or breaking the rules? What
if a situation is so murky and uncertain you don’t even
know what the right thing is? What if someone with a lot
of power is pressuring you to do something wrong?” (p.
6). Leading Quietly helps the reader answer these ques-
tions and could be readily incorporated into any collegiate
level strategic management course.

• Behind-the-Scenes Tour of Harrah’s

• Emerging Technologies Hands-on Workshop

• Dynamic Speakers

• Referred Paper Presentations

Donna R. Everett, Executive Director,

at d.everett@moreheadstate.edu

or 606-783-2781 or visit the OSRA web site

at www.osra.org.

22ND ANNUAL

RESEARCH

CONFERENCE

22ND ANNUAL

RESEARCH

CONFERENCE

Las Vegas, Nevada

February 20-22, 2003

Dr. Reza Torkzadeh, Professor and Chair

of the MIS Department at the University
of Nevada-Las Vegas will be the Keynote
Speaker. Dr. Torkzadeh received his Ph.D. in
Operations Research from the University
of Lancaster, UK. His primary research in-
terests are in the areas of information sys-
tems success measures, computer self-ef-
ficacy, and Internet commerce. He is an
educator with broad experience working
with graduate and undergraduate students
on information technology research
projects.

EGISTRATION

DEADLINE

ANUARY

24, 2003

Advancing Technologies:

Winning in a Wireless World

To register for the OSRA 2003 Conference,
contact:

ONFERENCE

IGHLIGHTS

ACKNOWLEDGMENTS

The Mid-American Journal of Business acknowledges the following people who contributed to the editorial

process during the last year by reviewing one or more manuscripts. In addition to giving advice on whether to publish
each manuscript, they have provided from one to three pages of detailed suggestions for improvement. The quality of
the Journal benefits greatly from such service, which offers valuable feedback to authors. In alphabetical order our
referees for Volume 17, Number 2 are:

John Benamati

Miami University

Rebecca Bennett

The University of Toledo

James Cashell

Miami University

Natalie Churyk

Northern Illinois University

Raymond Cox

Central Michigan University

Sime Curkovic

Western Michigan University

Deborah J. Dwyer

The University of Toledo

Michael Garver

Central Michigan University

Bonnie Glassberg

Miami University

John Goodale

Ball State University

Howard Hammer

Ball State University

Douglas Havelka

Miami University

Jeffrey Hornsby

Ball State University

Leon Hoshower

Ohio University

David Karmon

Central Michigan University

David Keys

Northern Illinois University

Bruce Kuhlman

The University of Toledo

JoAnn Linrud

Central Michigan University

Clinton Longenecker

The University of Toledo

Krishna Mantripragada

Ball State University

Clarence H. Martin

Ohio University

F. William McCarty

Western Michigan University

Kathleen McFadden

Northern Illinois University

John Mitchell

Central Michigan University

Raymond Montagno

Ball State University

Gary Moore

The University of Toledo

W. Rocky Newman

Miami University

Fred Post

The University of Toledo

T.M. Rajkumar

Miami University

Pamela Rooney

Western Michigan University

Daniel Schneid

Central Michigan University

David Sinason

Northern Illinois University

Ray Stephens

Ohio University

Leo Stevenson

Western Michigan University

Donald Tidrick

Northern Illinois University

Craig Van Slyke

University of Central Florida

Abera Zegeye

Ball State University

Northern Illinois University

The Richard T. Farmer
School of Business
Administration

New in 2002

College of Business

College of Business
Administration

College of Business

College of Business
Administration

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These universities are the sponsoring institutions of the Mid-American Journal of Business

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