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In a situation where total labour command (source of capital formation) is distributed in a way where W (referring to wage fund)--a highly productive asset--is greater than (R + P), referring to renteers and profiteers: non-productive asset, economies of scale are reaped via increases in productive investment; and, on the other hand, when (R + P) exceeds W, disinvestment occurs due to wasteful expenditure. Thus, in a situation where productive expenditure exceeds non-productive expenditure, budget deficit is conducive for economic development as expenditure generates income via multiplier effect; while budget deficit is a highly contagious disease in cases where unproductive expenditure exceeds productive asset and must be cut drastically as, otherwise, It would lead to serious structural maladjustment problems. At this point the views of the celebrated business cycle economist, Alvin Hansen are worth recalling:

In secular stagnation we have a prolonged maladjustment between (S + T) and (I + G); the source of stagnation lies in a change in the character of demand ... It is the transfer of liquid funds into real capital that will turn recession to recovery; it is the exhaustion of investment opportunities that will lead to recession.

Alvin Hansen, Lectures on Business Fluctuations and Fiscal Policy (offered at Michigan State University, U.S.A. : Mimeo, 1962-63 session)

Though, crucially important in the present day world of business, the subjects of bank fraud and staff-colluded and orchestrated day-light bank robberies, insolvency, bankruptcy, unethical-cum-manipulative business transactions, liquidation, etc., have received scanty analytical treatment. Problems as a result of companies and financial institutions engaging in fraudulent deals like currency trafficking, money laundering, forged letters of credit and bankers' receipts, manipulation and falsification of accounts, writing-off bad and doubtful debts to show deliberately reduced levels of non-performing assets by engaging in terminological inexactitudes, etc., have become established norms in today's business life. At this point, the words of the celebrated monetary economist, Irving Fisher are pertinent to recall:

As long as people feared for the safety of their funds, they would keep money out of banks. And as long as people kept their money out of banks, banks would be unable to lend.

U.S. House of Representatives : 1932

It must be remembered that money goes where it is treated best, goes the popular saying, Commenting on the accuracy or inaccuracy and reliability or unreliability of financial data provided by accountants, the Swedish 'Match-King' has this to say:

You know, it's a curious thing how every period in history has its own gods, its own high priests and holy days. It's been true of politics and religion and war, and now it's true of economics. We've created something new. Instead of being fighting men as in days of old, we're all in business, and we've chosen some new high priests and called them accountants. They too have a holy day, the 31st of December, on which we're supposed to confess. In olden times, the princes and everyone would go to confession because it was the thing to do, whether they believed or not.

Today the world demands balance sheets, profit and loss statements once a year. But if you're really working on great ideas, you can't supply these on schedule and expose yourself to view. Yet you've got to tell the public something, and so long as it's satisfied and continues to have faith in you, it's really not important what you confess. The December ceremony isn't really a law of the gods--it's just something we've invented. Alright, let's conform, but don't let us do it in a way that will spoil our plans. And some day people will realize that every balance sheet is wrong because it doesn't contain anything but figures. The real strengths and weaknesses of an enterprise lie in the plans.

Quoted by Bourn, A. M., Valuation and Profit, in Bourn, A. M., (ed), Studies in Accounting for Management Decision : London, 1969.

It is true but a sad commentary that though heavy reliance is placed on conventional accounting statements which are highly irrelevant under periodical monopolistic competitive conditions and which have got to be prepared and presented year after year as a duty to the shareholders/nations, it is a pure theoretical exercise in futility : Equally, the financial ratios derived from such accounting statements and which are used as barometers of a company's/country's performance, like for example, pay out ratio, net asset value, etc., are grossly misleading. Finance-oriented persons lacking real-world operating experience may be more concerned with romancing numbers based on mere guess work and unrealities than romancing operations--They may produce results on paper but somehow never actually realize them like policy makers (ministers) presenting year-after-year annual budgets for their country's growth and development which are mere rituals but never actually realize the budgeted figures. Added to it is the fact that accounting for the assets and liabilities relies on historical cost valuation; however, market values of financial assets and liabilities move inversely with interest rates, making it possible for traditional balance sheets and income statements to present information that might mislead financial statements users.

No wonder, the budget(s) which are fictional and which have got to be presented by policy makers year after year, more as a duty to the country, have to undergo several step by step pathological tests which may take anywhere upto three years for completing several laboratory tests before the actual diagnosis of the problem, and which assume the form of presentation of the budget estimate for the current year; re-revised estimate; revised estimate (final estimate); and revised estimate (first estimate)--all revealing very wide divergences/differences from the actual figure. During the process of undergoing several laboratory tests, the country has got to cope up with problems emerging from statistical manipulations, wrong budget estimates and wrong guess work, etc.--all leading to structural imbalances in the economy. The conventionally-prepared and presented budget based on the distinct accounting model and relying on two financial statements--an income statement and balance sheet--is a naive approach. In this context, the words of the renowned corporate financial economist Shapiro are highly pertinent to recall :

The gap between the cash deficit and the deficit on an accrual basis is enormous. For example, Arthur Andersen & Co. prepared prototype consolidated federal financial statements using accrual accounting for the years 1974 through 1984. According to these figures, from 1974 to 1984 the accumulated deficit measured on an accrual basis rose to $3.8 trillion, nearly three times the reported national debt of $1.3 trillion.

But the key issue is not accounting : It is accountability. The use of cash accounting, which vastly understates the true cost of government, is not accidental. It has enabled politicians to increase benefits to special interest groups continually without reporting the true cost of those obligations. Thus the most important benefit of accrual accounting would be to reduce politicians' incentive to curry favor with today's voters at the expense of tomorrow's taxpayers.

Alan C. Shapiro, Why the Budget Deficit Doesn't Matter Continental Bank: Journal of Applied Corporate Finance (Fall 1989).

The finance manager has to ensure rational decision making at the successive stages of pre-investment and actual investment--as, in the absence of proper appraisal and evaluation and managerial abilities, there will be misallocation of resources, long gestation periods, investment cost-overruns, high rates of industrial mortality or lopsided growth.

In this context, the eloquent words of one-time Vice-President (Natural and Medical Sciences), Dr. Warren Weaver of the Rockefeller Foundation are pertinent to recall : one could list three stages of development in the history of scientific thought :

* ability to deal with problems of simplicity;

* ability to deal with problems of disorganised complexity;

* ability to deal with problems of organised complexity.

Financial Management Analysis is no exception to this law.

Warren Weaver, Annual Report of the Rockfeller Foundation (1958)

Though there have been frequent mergers, takeovers and corporate restructuring and that there has been considerable research by financial economists demonstrating large gains to share-holders, there has been scanty analytical treatment of post-takeover implications. The Massachusetts Institute of Technology (MIT) Research Project Report entitled, Management in the 1990s provides a shocking revelation about the extent of cheating that goes on :
   Everybody does cost/benefit analysis on projects. Most of them are
   fictional. The saddest part is that it is not just the benefits
   that are fictional, but the costs as well. They don't begin to
   assess what the real costs of the system are. You do cost/benefit
   analysis to get money ... [In essence] we cost-justify new systems
   on the basis of lies.

The general tenor of the MIT Report is supported by the results of a UK field study by Carr and Tmkins who found that managers often base their financial calculations on very questionable assumptions, and cheating sometimes occurs and they reveal the nature of the cheating through the comments of one of the managers they interviewed :
   When we phrase the capital appropriation we sometimes have to
   phrase it is such a way that it looks as though it is a payback
   within two-and-a-half years, although realistically we know it will
   be nearer four.

   Strategic Investment Decisions Appraisal Techniques : The Old and
   the New, Business Horizons, November-December 2000.

In this perspective, the statement by Nobel Laureate in Economics, Professor Myron S. Scholes is highly relevant:

When you have anger, it can lead to wrong assumptions and wrong governance solutions--wrong governance solutions might actually be very costly to society ... to illustrate: one way to achieve a higher return on equity is picking great investment projects--another way is to use leverage. And conditional on things working out, leverage is terrific. But unfortunately, if things don't work out, you have to reduce leverage--and it is very costly to adjust leverage or sell assets. In a crisis, leverage is like a cancer.

Interview with Nobel Laureate Myron S. Scholes, Journal of Applied Finance, 1 & 2 : 2009.

The global financial crisis of 2008-2009-2010-2012 was no ordinary crisis. Its origin (due to moral bankruptcy in the western : rich in particular : world) and the speed with which it was spreading throughout the world like an infectious disease has prompted decision-makers to recast their thinking on development policy issues. In the words of Divine Sathya Sai Saba:

Today money rules every aspect of human life. Man has been enslaved by money. Man should seek to possess only as much money as is most essential for his living. When we have more, it breeds pride, sloth and a contempt for others. In pursuant of money, man descends to the level of the beast ... Men are consumed by a limitless passion for wealth and power. Wealth is essential but within limits. With excessive wealth man turns arrogant and loses the sense of discrimination between right and wrong. Wealth without wisdom becomes an instrument of exploitation and tyranny. Wisdom without wealth becomes mere fantasy and a bundle of blueprint.

Sanathana Sarathi (Prasanthinilayam)

From a different perspective, it may be said that it is not enough to assess a government's performance on the basis of its ability to win votes through politicians' utopian promises at every election; financial economists must be willing and able to check its performance against more objective criteria, to keep the long-range targets of the Nation before every citizen. Unless he can do these things and show clearly how the society will benefit, he has little right to be taken seriously, by those who must bear long-run responsibility for major policy (public) decisions. The job of the modern economist, and his challenge was summed up by the celebrated scientist, Archimedes when the described the lever, in the year 250 B.C., as follows:

Give me a firm spot on which to stand, and I will move the earth.

Thus, financial economists and management accountants must concentrate their thinking on tackling these crucial issues of paramount importance. In this perspective, the following views of noted development expert M. Berry are highly pertinent. The future of management accounting is closely linked to the ability of this profession to develop and maintain business operating models, which enable management, and all employees, to think simultaneously in terms of costs and value. With respect to this essential need for change, a computational approach is rarely a good counselor: on a spreadsheet, a dollar or a Euro of cost is indistinguishable from a dollar or a Euro of value, yet their meaning is completely different. The priority requirement is, in fact, not for changes in computational software but in the social software used--in shifting the implicit conventions that we use to decode and understand the operations of a firm, to refocus their primary objective on value creation. Developing countries which are riding on pile-up debts may extinguish or reduce debt burden and through in-substance defeasance or debt capitalisation, in a number of ways like calling in equipment leased flotation of techno-economic development bonds if such bonds have a call future, purchasing the bonds on the open market and subsequently retiring the bonds, swapping or exchanging equity shares for bonds, selling the bonds (debt) to other parties, and through sophisticated equipment leasing by developing countries in developed countries. In this way international financial institutions like IMF, IFC, etc., may help debt-ridden countries by reevaluating such debt at historical (pre-1973 Tehran Oil Agreement) exchange rates and float 5 year-10 year Economic Development Bonds/Securities of say 75 per cent of debt value, guaranteed by the World Bank Group and the Bank for International Settlements in collaboration with the respective country's Central Bank. Such equipment-leased bonds will be marketed world-wide by World Bank Group to international financial institutions, commerical banks, governments and corporate sector. Through this technique, foreign investment by developing countries for grassroot organic economic development projects in less developed developing countries (aiming at reducing income disparities or welfare gap within a developing country) will assume a significant role and income generation, through multiplier effect, would take place and a part of development earnings may be set aside to purchase World Bank bonds.

i) Peterson, P. & Peterson, D., et. al., The Extinguishment of Debt through In-substance Defeasance. Financial Management (Spring 1985)

ii) Kumara Swamy, M. R., Naira Bonds--Alternative to IMF Financing Nigerian Journal of Financial Management (June-December 1985).

These crucial issues call for detailed theoretical and empirical research.

Om Sai Ram Centre for Financial Management Research

Mumbai-400 054, India

December 11, 2013

Professor Dr. M. R. K. Swamy

Managing Editor

Journal of Financial Management and Analysis
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Author:Swamy, M.R.K.
Publication:Journal of Financial Management & Analysis
Geographic Code:1USA
Date:Jul 1, 2013
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