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Background
It is a form of contract that is awarded to former workers which entitled them to a stream of income and other forms of subsidy when they retire from the labor force. The party who is obligated to provide such scheme can be the employer, an insurance firm or the government. The amount of pension to be awarded during retirement years varies depending on the type of the scheme. Generally, the contribution of the worker will be applied with a fixed formula that depends on the amount of the contribution and the number of employment years. There is also a type of a scheme wherein the amount to be received by the worker depends on the investment performance of his contribution during retirement.
In the UK, there are major pension schemes available. These include basic state pension, second state pension, occupational pensions, individual pensions, group pensions and stakeholder pensions. In state pensions, the role of the government is explicit and automatic to avoid old aged people from being poor. To be entitled with this, the workers must have an age of at least 65. Because of its nature, pensions that are awarded by the state are commonly of utmost importance. There are three categories of state pension. The first is the basic state pension which is a function of the amount the worker has contributed to National Insurance.
The second type is called the additional pension. The requirement is that the workers must have contribution in the National Insurance and run much like the basic pension. Their difference is that there are additional perks and membership is not mandatory. For example, there are Graduated Retirement Benefits, State Earnings-Related Pension Scheme and the State Second Pension. The third type is referred as pension credit. This is the latest category of the state pension scheme in the UK primarily responsible to reduce the quantity of the old-aged population that is in poverty. There is several advantages pension credit such that taps tax, savings and other investment vehicle of the claimants.
Pricing of Pension Schemes
Being financial instruments, options provide the right without obligation to parties that enter contracts for a specified security. There are two general kinds of options; namely, call option and put option. The former gives the right a party to purchase a security at a specified price, also called strike price, prior to expiration date. Reversely, the latter gives the right the selling of security at a specified price prior to expiration date. Traditionally, participants in an option primarily aim to hedge their risks but option trading is also a source of speculative investment. For example, the holder of a call option may exercise his or her right if the strike price at expiration is greater than the strike price at the date of purchase. The holder would gain the positive difference between the acquisition and exercise dates. On the other hand, the party who has the obligation to facilitate the option of the holder can gain if the reverse about the strike price happens.
Different types of options are traded in the financial market such as exchange-traded, over-the-counter, real-estate, prepayment and employee stock options. Further, there are also specific categories on how to exercise option like European, American, Bermudan and Barrier options. They are classified based on limitations of having certain options under them. For example, there is an option who can only be exercised at expiration date (European option), any trading day on or before expiration, (American), specific day on or before expiration (Bermudan) a kind of option that demands a particular strike price before the transaction can occur (Barrier). Due to the enormous role of options, various techniques are developed to measure the risks associated with its trading, and consequently, to price them.
Developed in the late 1970s by Cox and others, this model uses iterative process that enables the classification of valuation analysis during the valuation date up to expiration. The first characteristic of binomial option pricing is that it can reduce price volatility of the underlying asset which theoretically reduces its risk. Secondly, this model minimizes speculative behavior through reduction of arbitrage opportunities. Third, there is simplicity in analysis that coincides on how developed trading locations operate which assumes an efficient market. Lastly, the model condenses the maturity of the option.
Developed in the early 1070s by Scholes and others, black-scholes model price options over a specified period of time. It also assumes that the price of options is similar to Brownian schedule that has continuous drift and volatility. In pricing stocks, it analyzes the behavior of the stocks for continuous price changes, the concept of time value of money, the strike price of the option and the extirpation date of the option. The differences of the two approaches option pricing have their advantages and disadvantages but binomial option pricing model can have more comparative implications. Discussed below are four characteristics of option pricing model which can provide implications on the advantages and disadvantages of black-scholes model.
The Global Financial Market
Due to mobility of foreign exchanges as well as technological advancement, globalization of financial markets was made possible. Diversification of investment such as buying of foreign securities suited to the taste of investors who developed progressive strategies of investing. As a result, the role of foreign investors is dramatic in benefiting the increased trade and higher liquidity of domestic financial markets. Globalization served as an opportunity for host economies (e.g. usually the developing countries) to absorb the excessive funds from home economies (e.g. usually the developed countries). This phenomenon is evidenced way back through the gold standard system from 1870 to 1914 when many nations expanded their economic well-being due to financing provided by the savings and surplus of other countries.
It is not only the story of developing nation benefiting from developed nation. The reverse is also true in the case of US when its equities market experienced increased rate of return from 12% to almost 14% and reduction of volatility of that return from 18.3% to 17.5% when it started to buy foreign shares. Another important outcome of globalization of financial markets has minimal relation to finances. The spill-over effect includes the best practices on corporate governance honed in developed processes and business environment which is largely lacking in developing countries. Legal framework and principles of conduct in host countries are significant elements of the investing propensity of foreign investors. These comprise of disclosure requirements, taxation, ownership barriers and protection of the right of minority shareholders.
These initial aspects give rise to several other criteria which investors are looking to their next funds destination within the developing world which include access of information to domestic issuers and application of international accounting/ auditing/ financial reporting. In the end, corporate governance of host economies is being molded if not pressured by international investors for the sake of the latter investments. Indirectly, domestic institutions undergo gradual change to provide the investing and business environment that foreign investors demand. After this response, only then will globalization can impact increased efficiency and economic growth of local economies. To note, there is a stimulus-and-response phenomenon between foreign investors and domestic economy.
In the case of Poland, flow of foreign investments did not necessarily result to increase in stock market liquidity because most of these funds are supplied to big companies (e.g. blue chip firms). This priority disabled the large volume of funds to positively impact the whole market and would had been distribute in sub-optimal manner. The rational behavior of investors for liquid shares enables them to sell these securities without restriction and fear of loss. There were two elements that the stock market of Poland required to be able to progress on its privatization efforts; namely, increase of issuance by large domestic companies and listing of foreign investors in domestic exchange.
Banks participated not only because of globalization but also for the fact that competition from the corporate bond market predated their clients. As a result, banks joined foreign exchange trading and its hedging as well as inclusion to the derivative market. In London, large banks provide high liquidity to shoulder the risk involved in one example of derivative market which is the interest rate swaps market. This is an illustration that domestic banks can enter derivatives market as long as the global finance industry is helping on increasing the liquidity and volume of transactions.
Among other financial sectors, pension funds are clear manifestation of how globalization changed the way financial entities deal with one another. It also plays a key role in improving liquidity of the global market. It is natural for pension funds to materialize in transactions between different markets with different liquidities because of the significant arbitrage opportunities involved. If a market is not liquid, there is no potential for short-run transaction without confronting excessive risks in the process. On the contrary, pension funds in more developed and efficient market such as US would operate in less liquid markets to look for the above average return. In effect, price anomalies are more substantial in less liquid markets than more liquid ones wherein the use of information competence towards the former can exploit an arbitrage opportunity (e.g. search for Alpha) in favor of the latter. Generally, less liquid markets not only tend to incur spot price abnormality but also behave for greater price volatility.
Speculation of pension funds gives financial markets additional liquidity and expanded number of financial instruments available. This in turn can be used by banks, companies and other institutions for their financing, hedging and investing needs. However, the growth of pension funds is negatively related with the improvement of the market’s informational efficiency because price anomalies are decreased. As long as there are emerging markets in the global arena, pension funds will continually used the inefficiencies of how domestic financial markets are regulated, operated and played by participants. Pension funds are attracted to inefficiencies and are willing to pour-in funds to local economy for the sake of speculating on price changes and winning the quest for Alpha.
UK Chartered Accountants
The Labor Force
A newspaper reported that accountants in the United Kingdom earns 55% more than French, however, offset by working longer hours than any other country in Europe (Ledger 2001). This statement can bring about many questions such as UK labor force response to family-work conflict and demand on luxury items. The country is industrialized and belongs to upper bracket of world economies with United States and Japan. Also, it is recently reported that it slowly getting back in its economy. So why then there is a need for its accountants to work for extending hours whereas public utilities are priced minimal, mostly, free? Or it is the very high compensation due to supply shortage or demand surplus that shakes the preference of the population and institutions to place greater significance to the industry?
Georgopoulos indicated that if an individual is aware of the potential benefits and costs of doing the job, he can adjust his effort (productivity) accordingly. In addition, the decision criteria of choosing between high or low performance are embedded on ability of that particular job to contribute to his personal goals (cited in Miner 2002 p. 191). However, in the real world, incomplete information is tantamount to ignorance to potentialities and therefore being subject to external stimulus. This study is simply a generalization of such circumstance with the goal of configuring the importance of basing recruitment and selection practices (RSPs) to the characteristics of the job seeker. Alternatively, this can serve as a guide for employment seeking individuals whether to use certain signals in determining the best employer that can maximize their individual needs.
To evaluate the performance of the labor market, efficiency of the pricing and equity of the market system should be considered (Briggs Jr. & Marshall 1989). This is useful to be able to appreciate the quantity and quality of the labor being supplied or demanded in a certain industry including the determination how equitably the supply of labor is spread in the economy. This is important especially for the developed economies wherein population rates are decreasing. Pricing of labor can be based according to the long-run trend, cyclical movement and cross-sectional data. As the third refers to the present and more dynamic situation in the economy, the first two refers to more predictable movement of the labor market.
Further, traditional conceptual framework used to determine the price of labor is attributed to supply and demand analysis (Briggs Jr. & Marshall 1989). Supply of labor is affected by variables such as wage rate, household incomes, size of the households, and age structure of the population. On the other hand, the demand side includes the wage rate, industrial pattern of demand for goods and services, the capital stock of the economy, and the general level of prices. However, these variables are acknowledged to be insufficient for analyzing the labor market of an economy.
For our purposes, in explaining the wages differential, these variables and our own theories including the characteristics of the perfect labor market will aid us in explaining a certain phenomenon. The ideal labor market includes characteristics such as workers and employers have full information of the market, they wanted to maximize their welfare and profits, workers are mobile, employers are not in deciding collusively, and labor is organized while each have their own decision (Briggs Jr. & Marshall 1989). These features fit perfectly to push the wage towards equilibrium whenever there is a short-term demand and supply fluctuations.
Principles of Worker Compensation
Since no organization is alike, same is the situation in human resources management landscape. Even there were written, proven and based-from-experience theories and beliefs on how to handle employees for the benefit of the company, each are under varying conditions and corporate values. Because of this, human resources personnel tend to have general approach to these available strategies while final decisions are subjective and contingent. Also, the emergence of sudden organizational change, internal problems and other external junctures that caught an organization unprepared result to puzzled human resources decisions. This includes wage increase behind annual net loss, employee benefits under inefficiency brought by machine breakdown or expansion in face of corporate tax increase. Such incidents leave the HR personnel torn between corporate constraints and employee welfare.
HR role in compensation schemes and career development are crucial factors in employee motivation for optimum performance because these affect their present and future status and undertakings. An employee who feels that the company is providing just wages or issue appropriate performance-based benefits will manifest work satisfaction. On the other hand, when he is not afraid to loose job and a persistent hard-worker because of ample knowledge gained from relevant trainings and provision of clear career paths, he will exemplify work excellence.
Every organization wants to have a pool of human resources that can create sustainable competitive advantage. According to Barney (1991), an organization aiming to achieve this should have a certain resource, in this case human capital, which can create value for the firm. It must also be rare, inimitable and non-substitutable (cited in Wright 2001). Since human resources are not only proven to be the most important company resource but also the most complex in terms of making it act for the achievement of corporate objectives, HRM is responsible to keep motivation among employees within the context of corporate culture, employee characteristics and other outside factors
Conclusion and Recommendation
Privatization provides the future retirees to shoulder investment risks and channel their contributions based on their return expectation. They are benefited because customized needs will be addressed and retiree satisfaction is optimized. In macroeconomic terms, it can trigger increase in wealth of retirees that can trickle down to rise in consumer spending which can lead to economic expansion. In contrary to the current Pension Scheme, however, privatization houses moral hazards because excessive risks that will be confronted by individuals can proceed to investment crash. The current system is characterized by lower risks and management costs compared to the possibility of zero returns and reduction of principal in privatization. As the current system is bound for bankruptcy, it is aggravated by high payroll taxes, poor return and discrimination against women, low-waged and minority workers. However, it minimizes the issues of insolvency that privatization failed to resolve.
Along with the current system, there are three non-privatization alternatives with regards to Pension Scheme; namely, tax increases, reduction of benefits and obtainment of greater return by real capital asset investing. Increasing tax rates is supported by the research that UK citizens are willing to pay indefinite amount of tax as long as it targets appropriate programs in which apparently Social Security is inclusive. Further, it is projected that in the near future gross domestic product or GDP will outgrow Social Security taxes by at least 10% caused by pressures of aging population. To save the solvency of Pension Scheme from 2016 forecasted deficit, tax rise should meet 3 per worker and by 2030 such increase is required to hit ,543 per worker. In this course, adverse effects of tax increase option will result such as reduction in jobs as well as slower economic growth. There will be also less incentive for workers to work because their Social Security contributions are viewed as pure tax rather as investment that they will receive when they retire.
The second option is benefit cut. One advantage of this is that retirees would be able to receive greater face value even after the reduction of benefits because the payment is done periodically. The privatization alternative also offers benefit cuts but on extreme terms such as ad adjustment of benefit indexing formula with inclusion of adjusted wage productivity and setting a non-greater-than inflation rate ceiling for rising benefits. The benefit cut option will most likely follow the economic growth to prevent adverse economic impacts. Specifically, the current Pension Scheme plan of increasing the benefits should be lowered to 3%. Considering excessive benefit cuts of privatization approach, some analysts believed that reduction or even eradicating spouse benefits can be employed. This strategy is said to solve the issue of small-wage earners.
The third alternative is government-led investing by which the state will have the discretion of putting the money from the Pension Scheme to private assets. Privatization also allows this feature with the difference of decision-maker who will make the call which is the workers themselves through creation of private accounts. Government-led investing reduces the probability of individual workers to manager their finances on sub-optimal and risky manner. It addresses the lacking of the current system for higher returns with limitation of risks from private accounts. Potential retirees can enjoy greater returns on one hand and minimal risks on the other. However, there is bottleneck on this approach. One of the major hurdles is that the substantial finance eminent in Pension Scheme can buy a major stake on UK companies. In effect, the negative image of Government agencies and even politicians can mix in corporate world.
Bibliography
Internet
AC Nielsen Website 2006, viewed April 14, 2008, <www.acnielsen.com>
Euro Monitor 2003, viewed on April 14, 2008, <www.euromonitor.com>
Internet (2006). Reeds Accountancy. Retrieved on April 14, 2008 from
http://www.reed.co.uk/client/xml/brochureInfo.asp?type=clientdetails/116.xml&contentType=company&ID=116&redirect=1
World Bank, viewed April 14, 2008, <www.worldbank.org>
Books and Journals
Brubeck, M (ed), Theune, C (ed), Wessels, W & Zapf 1980, Minimum Wages, Fringe Benefits and Working Conditions, American Enterprise, Washington, DC.
Condrey, Stephen E. Handbook of Human Resource Management in Government. San Francisco: Jossey-Bass Publishers, 2001, pp. 47-48.
Ledger, W 2001, ‘UK tops Euro pay league; British bosses are the best-paid in Europe’, The Evening Standard. 14 August.
‘Shortage Ups Accountants’ Pay Sharply’ 2005, Manila Bulletin, 20 July.
Wagar, T 1998, ‘Determinants of Human Resource Management Practices in Small Firms: Some Evidence from Atlantic Canada’, Journal of Small Business Management, vol. 36, no. 2.
Schipper, K & Vincent, L 2003, “Earnings Quality”, Accounting Horizons, vol.17, pp. 97+.
Williamson, O 1985, The Economic Institutions of Capitalism, New York: Free Press.
Credit:ivythesis.typepad.com
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