Tag: fall2010

Amid growing uncertainty about the stability of the European Union, an increasing number of North American companies are looking to capitalize on opportunities in emerging markets. One such market that is particularly attractive is China, but setting up shop there is not as straightforward as these companies might perceive. Recent legal developments surrounding information management in China have the potential to dampen the enthusiasm of global investors.

A key to establishing business presence anywhere is building a local infrastructure, which includes data centers for hosting information. In April the Chinese government made this practice more difficult when it announced an amendment to its Protection of State Secrets Law, forcing Internet service providers and telecommunications companies to share their information. The state-owned Xinhua News Agency reports that the amendment requires these companies to “halt and report leaks of what the government deems to be state secrets.”

So what is the definition of a state secret? According to Xinhua, it is “information that concerns state security and interests and, if leaked, would damage state security and interests in the areas of politics, economy and national defense, among others.” The official Chinese government website posted a broad definition of what constitutes a commercial secret, defining it as covering information related to “strategic plans, management, mergers, equity trades, stock market listings, reserves, production, procurement and sales strategy, financing and finances, negotiations, joint venture investments and technology transfers.”

Outside of China, media reaction to the legislation has been critical. For example, The New York Times called it an obvious attempt to impose control over cell phone and Internet communications. The Wall Street Journal has opined that this amendment is simply a reaction to the criticism of the Chinese government’s handling of the recent Rio Tinto scandal, which led to the arrests of several of the mining corporation’s employees for espionage and bribery.

This discussion brings to mind the early 2010 decision by Google to move its servers out of mainland China and into Hong Kong because of heavy interference by the authorities. Although technically still part of China, Hong Kong has retained considerable autonomy under its designation as a special administrative region. The principle of “one country, two systems” has enabled Hong Kong to follow economic and political policies different from those of mainland China.

The Hong Kong Basic Law, which serves as the constitutional document of the region, went into effect in 1997 and will stay in place until 2047. Under this law Hong Kong’s diplomatic relations and defense are the responsibility of the Chinese government. At the same time, articles 27–38 of the Basic Law stipulate that “Hong Kong residents shall have, among other things, freedom of speech, freedom of the press and of publication; freedom of association, freedom of assembly, freedom of procession, of demonstration, of communication, of movement, of conscience, of religious belief, and of marriage; and the right and freedom to form and join trade unions, and to strike.”

Whether other companies will follow Google’s lead is not clear. Hosting companies like Rackspace that have data centers in Hong Kong have not experienced a noticeable surge in business due to this amendment so far. It is likely that companies are not making their intentions public for fear of antagonizing the Chinese government.

The April amendment does little to change the fact that there is a lack of transparency in the rules that organizations are expected to follow while doing business in China. But one thing is certain: For all those North American companies looking to take advantage of sales in the Chinese market without compromising on sharing their information, Hong Kong is a good option.

Whether you are the CEO of a Fortune 500 company or just trying to manage yourself, Dick Daft, the Brownlee O. Currey Jr. Professor of Management, says you must learn to control your “inner elephant.”

In his recently published book, The Executive and the Elephant: A Leader’s Guide to Building Inner Excellence, Daft combines research in management, psychology, neuroscience and Eastern spirituality to argue that everyone has two sides to his or her personality. The “executive” is objective, rational and responsible, while the “elephant” is emotion-driven, impulsive and habitual. Daft believes that truly successful leaders must recognize both sides and follow practical exercises to learn to control their inner elephant and ultimately change a weakness in their behavior.

“I find that virtually every leader has a bottleneck within them. If they could remove it—if they could be just a little less critical-minded toward other people or if they could be more focused and attentive—they could be a much better leader overall,” Daft says. “What this book does is help them identify that weak link and remove it.”

Daft says that almost every leader makes six mental mistakes: (1) reacting too quickly, (2) inflexible thinking, (3) wanting control, (4) emotional avoidance and attraction, (5) exaggerating the future, and (6) chasing the wrong gratifications. All of these are tied to a person’s emotional and impulsive side, or their elephant.

“The whole idea of the executive is to be objective and not to interpret things just based on your own likes and dislikes, your own hang-ups, your own issues,” he says. “You have to be able to detach from that and be able to see the other point of view, the big picture, with some level of objectivity. When people can be in that place, they make wonderful decisions. It’s when they get anchored in their own neediness, their own greed, that they get into trouble.”

Daft says that people can remove a lot of inner struggle by being in the moment and accepting their “elephant” but not letting the elephant control them or their behavior. Real change, he believes, can only come from practice. He describes more than a dozen exercises that are grounded in practical application to help leaders control their elephant and change bad behaviors. He then gives examples of leaders who tried each individual approach and how it impacted them. A few exercises include engaging and writing down your intentions, slowing down your reaction time to think, and repeating a mantra.

“I’ve worked with a lot of executives who know what they should be doing,” he says. “They’ve gotten feedback that they should do something differently or act differently with their employees, but they’re unable to execute the new behavior. I wrote this book not so much to tell them what to do, but rather how to change the behavior.”

Daft has published 12 books and dozens of articles and has presented at more than 45 universities around the world. He also developed and managed the Center for Change Leadership, is a former associate dean at Owen, and is a fellow of the Academy of Management.

Daft is currently studying high-performance mental models, which include cognitive models of high-performing managers, and is examining high-performance management systems. He is also studying transactional versus transformational communication to engage people in organizational change.

“I know it sounds touchy-feely, this idea of introspection and looking within, but it is so powerful,” Daft says. “Know thyself—that has real power because once you know yourself, you can manage yourself. As long as you’re blind to your own bad habits, you’ve got no chance to be a strong leader.”

A recent study co-authored by Nick Bollen, the E. Bronson Ingram Professor in Finance, and Indiana University’s Veronika Pool demonstrates that risk-based performance flags can accurately prescreen hedge funds for fraud. The study supports strategies currently in use at the Securities and Exchange Commission (SEC), thereby contesting arguments often posed by opponents of additional regulation that government agencies do not have adequate resources to avert financial market scandals.

The SEC added risk-based “examinations” to its regulatory procedures shortly after Bernard Madoff was charged with perpetrating a massive Ponzi scheme. These examinations—similar to the performance flags analyzed in the study—are part of a series of reforms aimed at detecting hedge fund fraud early, thereby reducing the chances that such frauds will occur or go undetected and lead to the type of financial damage seen recently.

According to the study’s findings, the performance flags—low-cost, statistical tools—allow regulators to successfully identify high-risk hedge funds that can then be subjected to more intensive investigation. The alternative to the prescreening approach is to examine all hedge funds using the same in-depth regimen. Given the large number of hedge funds and the very rapid pace of change in financial markets, this is at best a challenging task for regulatory agencies with limited professional and financial resources.

“The approach we’re validating for hedge fund monitoring is in some ways similar to the one used by the IRS to determine which tax returns to audit,” Bollen says. “By statistically parsing through funds and identifying ‘red flags,’ we demonstrate financial regulation can work without being prohibitively expensive.”

Bollen also notes that the performance flag approach has application beyond hedge funds. “Prescreening for fraud can be applied efficiently to deter fraud in a wide range of investments. The flags might be different but the basic strategy is the same,” he says. “And the information we are providing can also benefit investment advisers by making them aware that prescreening can be a very effective way to protect client portfolios. They will have additional means to identify potential investments that should require especially careful due diligence.”

To unearth the findings, the researchers reviewed 8,770 existing and defunct hedge funds in the Lipper TASS and Center for International Securities and Derivatives Markets databases between 1994 and 2008. A sample of 195 problem funds that had been the subject of SEC enforcement actions or investor lawsuits was identified. The researchers then compared the problem and nonproblem funds using performance flags that had been developed previously by Bollen. These flags focused on suspicious patterns in hedge fund returns, including random returns, too few negative returns and too many repeat returns. The team found that funds charged with reporting violations triggered the performance flags at a substantially higher rate than other funds. For example, 51 percent of these funds had random returns compared to just 23 percent for nonproblem funds.

Bollen notes that the critical role of databases in identifying potential fraud underscores the importance of requiring hedge funds to disclose key information to designated databases, such as those highlighted above. This is currently a voluntary procedure.

“Mandatory reporting can only serve to aid regulatory agencies working to root out fraud,” Bollen says. “The increased data would also promote additional research that could protect investors from future schemes.”