Download bounded and contextual rationality

RATIONALITY IN TRANSITION: Using holistic approach to rationality to explain some
developments in the Slovenian business system
Marko Jaklic
Hugo Zagorsek
University of Ljubljana
Faculty of Economics
INTRODUCTION
The assumption of rationality, as interpreted by the mainstream economics, is one of the cornerstones
of economic science. It is believed that notion of rationality provides us with powerful tool for
simplification of economic analysis. If agent behaves rationally, his decisions can be predicted by
using logical and mathematical tools (Lange, 1945). Otherwise, it is believed, we are left in chaos of
ad hoc hypothesis, which may cover many facts, but may lack overall cohesion and scientific
refutability. The idea of means/ends rationality combined with assumptions of perfect knowledge,
complete transitive preference ordering and deliberative choice has been implanted in minds of
economists so strongly, that every attempt to question the standard concept of rationality was at risk of
being described as non-economist. Only a few decades ago, have various models, inspired mainly by
Simon’s work in this area (1961, 1972), started to emerge.
The aim of this paper is to present different notions of rationality and to develop a holistic approach to
rationality taking into account boundedness and contextuality of rationality simultaneously. We
believe that holistic approach to rationality best describes some peculiarities in the Slovenian business
system and gives potentially better advice to decision-makers in the transition process. Slovenian
economy has experienced four major transitions in the last two centuries. First began in 1848 when
feudalism was abandoned and peasants have finally became owners of their land. Second occurred in
1918 when Slovenia ceased to be a part of Habsburg monarchy and became the westernmost state of
Yugoslavia. Third happened after the Second World War, with establishment of socialism. Fourth, and
final one began in the late 1980s when Slovenia, first within Yugoslavia and after 1991 as an
independent state, abandoned self-management socialist system and started to move towards the open
market economy. What is remarkable is the fact that despite such a strong changes in business
environment, some basic, beneath the surface customs, rules of conduct and conventions have
survived virtually unchanged. It is these ancient contextual factors that play important role in
behaviour and decisions of today’s managers. It is our hypothesis that these institutions “worked
relatively well” for centuries but many aspects of these institutions have become “backward” for
Slovenian economic development in the last transition period. This is not to say that these institutions
will disappear but a high level of evolution or change in them is needed if stronger economic
development is to be achieved.
BOUNDED AND CONTEXTUAL RATIONALITY
Simon has argued that “satisficing” rather than maximizing behaviour better characterizes human
behaviour and proposed that the concept of economic man be replaced by that of administrative man
(Simon, 1961).1 Rationality of economic agents is bounded, because information is not readily
available or free, and mind also does not have unlimited deliberating capabilities. Because deliberation
and data collecting is costly, individuals are usually prepared to settle for satisfactory outcome, by
using various rules of thumb and heuristics, rather than searching for an optimal one. However, both,
unbounded and bounded rationality implicitly assume that rationality is universal, that is common to
all individuals regardless of society and historical period that they belong, and independent of
conceptual frameworks within which they operate. Economic thought in general is leaning towards
universality. While business community has long ago acknowledged cultural, religious and social
differences between nations or traditions and adapted its practices and polices to local customs,
theoretical economists still believe that all people, e.g. Aborigines, Europeans, Chinese, Arabs,
software developers, machine workers and religious fanatics, are subject to the same universal
economic laws. They may differ in their preferences, but in mainstream economics preferences are
given and are not subject of scientific enquiry. It is believed that they will all behave and decide
equally rationally, regardless of whether by that notion we assume unbounded or some kind of
bounded rationality.
This conviction has its foundations in Enlightenment philosophy, which advocates the principle of
absolute or universal truth, justice and rationality. There has to be some source of truth and value
outside human needs and cognition, which guides us throughout our existence on earth. And Reason is
the ultimate instrument of man in search of this basic, universal truth. To rationally justify is to appeal
to principles undeniable by rational people and thus rationality becomes independent of social
particularity. This approach is problematic in that nobody could find such principles (Rempel, 1999).
Various ideologies and competing systems of values and believes, either religious or non-religious,
seek to monopolize truth and justice. Thus they believe that “there are things so sacred, that they must
be protected by the arm of the state from irreverence and challenge – that absolutes of truth and virtue
exist and that those who scoff are to be punished” (Schlesinger 1989).
In the last decades, texts on rationality increasingly use “person” instead of “man” when describing rationality of economic
agents. In our text, we will use “person” even when original authors use “man”.
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In the last two decades totally opposite, relativistic philosophical view is gaining in influence
(Westacott, 2000). Relativism asserts the relativity of truth, knowledge and rationality. Rationality is
relative to a particular conceptual scheme (world view), which can be shared among members of entire
society, culture or period, or unique for a more narrow social groups or individuals. Relativists do not
simply assert that the different cultures or communities have different views about which beliefs are
true and what behaviour is rational. Nor do they merely claim that different communities operate with
different epistemic norms – i.e. criteria of truth and standards of rationality. That seems to be obvious
at least to philosophers if not for economists. Their major claim is that no one set of epistemic norms
is metaphysically privileged over any other. Our beliefs and values do not arise from something
“higher” or “absolute”, they are product of our biology, culture, upbringing, education and “the
idiosyncratic twists and turns of our career through life” (Clark, 2000).
One of the main characteristics of human beings is their ability to justify their actions and beliefs to
others and to themselves. Most of us are trying to be self-consistent in a sense that we do not hold
obviously contradictory beliefs and that we act according to our avowed values. Our actions can be
justified if we can back them up with our believes. If we are rational, we can indicate how the
particular act or belief in question fits into a larger network of higher values and cognitive
commitments. This higher values and commitments are in accordance with our most basic beliefs and
values about what is fundamentally right and how the world fundamentally is, which serve as a
background criteria for all lower hierarchy commitments and actions. If we attempt to justify our basic
beliefs, we could maybe show that they are mutually coherent, but will not be able to provide any
logical justification for them, and prove that they are derived from something ultimate and absolute.
Strawson (1987) claims that “we have an original non-rational commitment which sets the bounds
within which, or the stage upon which, reason can effectively operate, and within which the question
of the rationality or irrationality, justification or lack of justification of this or that particular judgment
or belief can come up” (emphasis added). The rational is thus embedded and elaborated within a prerational context of preferences and cognitive assumptions (Clark, 2000). Similarly, MacIntyre (1988)
asserts that rationality and justice are both tradition constituted and tradition constitutive2. Rationality
can operate only within a certain tradition that is within an already given system of assumptions and
motives.
Tradition in its broader meaning is for MacIntire simply an “argument extended through time”. In this paper tradition is
understood as certain conceptual framework, which is common to all of its members and by which they distinguish
themselves from members of other traditions. It can be defined in terms of history, geography, nationality, culture, gender,
religion, major believes, et.
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2
Various examples demonstrate that rationality is strongly dependent of our pre-rational beliefs.3 As
MacIntyre (1988) point’s out “there is no set of independent standards of rational justification by
appeal to which the issues between contending traditions can be decided”. There is no neutral common
ground form which to evaluate the conflicting traditions of science and religion. Although there are
many common beliefs between traditions, reliance on rationality and the power of argument will not
lead to unification of different worldviews. In other words, even if reasonable persons from all over
the world decided to sit together and tried to unite their worldviews through rational debate, they
would fail, because they originate from different traditions and thus view the world through different
conceptual frameworks.
The notion of rationality as understood both by neoclassicist and their major critics is inadequate
because it doesn’t take into the account the fact that rationality can operate only within a certain
tradition. Rationality is contextual, that is, contingent upon tradition. With help of the concept of
contextual rationality, we can study economic relations between distinct social groups more
accurately. By considering institutional and other factors that affect a society, economics scientist can
identify the conceptual framework within which that society operates, and thus identify the kind of
rationality, which is common to it. In areas where it is fairly similar to her (western, scientific,
materialistic, etc.) rationality, she can imply standard measures and solutions, known from the bulk of
economic theory. But in areas where there exists discrepancy between these two rationalities,
economist has to be aware that standard solutions will not be good enough, and has to adapt them to
suit the distinct conceptual scheme of studied society or social group. Notion of contextual rationality
can be useful methodological aid to identify, explain and eventually improve certain types of
economic behaviour that could easily be labelled as irrational.
Let us examine what are the factors, which influence and define contextual rationality. They are
certainly numerous and various but main factors are: institutions, conventions, customs, habits, beliefs,
expectations and feelings. They will be dealt with in the following section, with emphasis on their
contribution to contextual rationality.
Institutions: rules, conventions, procedures and customs. According to Simon, various rules of
thumb, heuristics and other mental shortcuts are important tools, which help individuals to cope with
their limited deliberating abilities. He implicitly presumes, that when a problem is simple and easy to
solve and all the relevant information are provided (like in some laboratory tests), agents will
optimise, that is, they will find the best solution (Hargreaves Heap, 1993, pg. 79). In other words,
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E.g. the example of Muslim and scientist (Clark, 2000). First is capable to rationally argue about his attitude towards
women “because it is the word of Allah”. Scientist could label his belief as irrational. However, if scientist tries to justify his
own commitment to evidence, he will encounter great difficulties in trying to justify his conviction that something that has
regularly happened in the past will happen again.
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agents use rules of thumb and heuristics only when problems that they are facing are very complicated
for them or when they do not have necessary information to make a decision – which is typical for
many everyday economic situations – otherwise, they optimise. But vast empirical research clearly
demonstrates (Conlisk, 1996; Stanovich & West, 1999) that agents use rules of thumb and heuristics
even when problems that they are facing are simple and easily solved.4 Evidence suggests, that rules of
thumb and heuristics are more important to human cognition than it is proposed by concept of
bounded rationality.
Institutional economists point out that rules of thumb are shared among people, and are usually not
personal affairs as one could understand from Simon’s work (Hargreaves Heap, 1993, 79). People use
various rules of thumb, conventions and procedures on a daily basis. These institutions are same for
all members of a certain tradition and help them in their everyday interactions. Why would a rational
agent follow institutions? Answer might be, that it is a rational thing to do, because other agents ensue
them too, which allows him to predict their behaviour. But question arises, why do others follow
same institutions. Certain convention is in use only because it exists, not because it is more rational to
follow one convention then others. From the neoclassical point of view it is not possible to explain
why some and not the other conventions or customs are in use. Even if we assume bounded rationality
in the sense of limited deliberating capabilities and limited and costly information, the origin of
institutions is an elusive concept. One could seek the answer in ethics and its account of what is
acceptable and what is not. Or one could turn to evolutional economics, according to which
institutions are formed as more or less unintended consequences of economic action of agents. They
can be portrayed as emerging through a process of the repeated play of certain kinds of games, such
as the coordination game or the prisoner’s dilemma (Sugden 1986). Over time, agents will hit the
strategies that are “evolutionary stable”; and these strategies, which are relatively simple bundles of
rules, become institutionalised. Certain wide spread conventions can become internalised that is it can
become a habit in a sense that agents do not deliberate about its usage but follow it automatically.
They automatically expect that other agents will follow it also.5
Habits. Unboundedly rational agent or economic person, is capable of justifying her every action and
belief, because they are an outcome of her conscious deliberation and thoughts. Boundedly rational
agent or administrative person acts on a basis of conscious deliberation as well, even if he reaches his
4
Consider for example the experiment, known among psychologists as the Linda problem (Tversky in Kahneman, 1983),
where the vast majority of subjects in study made a crucial mistake in a very simple probability test on conjunction of
alternatives.
5
For example, it is rational to drive on a right side of a road in USA or continental Europe. Drivers do not consciously
deliberate on which side of a road will they drive and at the same time they anticipate that other drivers will do the same.
4
decision in some other, different way than former. But people often act unconsciously, out of habit,
and do not even contemplate about it. 6
Hodgson (1993) drawing on the work of Koestler (1967) and Camic (1986) asserts that human mind
could be considered as a hierarchical system. The highest level is constituted of conscious and
deliberate decisions. On that level agents use optimisation, rules of thumb, heuristics, and institutions
to form a belief or reach a decision and act upon it. Lower in the hierarchy of mind are habits, which
are almost completely automated. Camic (1986, pg 1044) has defined them as “more or less …
independent desires to act in a previously learned manner …”. They can occasionally be influenced
by decisions from higher levels of mind. The lowest level in hierarchy of mind is represented by
impulses, instincts and other more or less autonomous acts, like breathing or hunger. Although we are
capable of partially controlling these impulses (i.e. we can hold our breath and not breathe for a
while) it is unlikely that we do so.
We can distinguish between two types of habits: shared and personal. Shared habits are institutions
(conventions, procedures, etc.) that have become internalised by an individual. Greeting a friend or
acquaintance, driving on a right side of a road, … , are some examples, of habits, which are common
to all the people of western tradition, and maybe even broader. Each tradition usually has some
institutions that are used so frequently that they become habits for their members. For example, all
Muslims remove their shoes before entering to a mosque. That is something that they do
automatically, without deliberation, out of habit. Some believe that shared habits are same as customs.
But there is a slight difference between these two expressions – custom is a broader notion, which
encompasses both shared habits and other institutions, unique for a particular tradition. Personal
habits, on the other hand, are characteristic for specific person. Although many persons can share the
same habit, like getting up early, fast and dangerous driving or smoking, they are not common to all
the members of society. 7 In short, habits are indispensable instrument of human mind, which enable
us to perform routine acts almost unconsciously, thus freeing our limited deliberating resources to
perform certain more demanding or creative activities.
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THE RATIONALITY MATRIX
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Car driving is a fine example. At first we are aware of every aspect of driving, but soon, these actions become automatic,
and our attention is turned towards other issues, like keeping an eye on the traffic or conversation with fellow passengers.
People do not consciously think on which side of the road they will drive, every time they start their vehicle. But habits are
not unchangeable. In Australia, for example, foreigners have to and can drive on the left roadside, but they have to
consciously concentrate on that. If they are not careful, they can quickly indulge to their habits and drive to the other side of
road.
7
You can expect that all the Muslims would remove their shoes before entering a mosque, and all Germans would drive on
the right side of the road, but you cannot suppose that all Muslims are smokers or that all Germans are early risers.
5
If we link together all ideas of rationality that were previously discussed, we could realize, that there
are two dimensions of rationality. First dimension is concerned with a question of boundedness of
rationality in a sense of limited deliberating capabilities as well as limited and costly information. It
can be unbounded, if we presume that human deliberating capabilities are unlimited and that all
necessary information is available and free. Otherwise rationality is bounded. Second dimension is
involved with a question of universality of rationality. We can either assume that it is sufficiently
universal (in general or in particular case) for our purposes or that it is contextual. If we take into a
consideration impact that institutions, habits, and believes of a society or some smaller group of
people have on agents’ rationality, we assume contextual rationality. Otherwise we assume that it is
universal. For methodological purposes we can connect these two dimensions into the rationality
matrix and consider differences between various approaches to rationality (Figure 1).
Figure 1: Two dimensions of rationality – the rationality matrix.
Rationality:
Unbounded
Bounded
UNIVERSAL
CONTEXTUAL
1. Neoclassical (mainstream)
3. “Philosophical” approach to
approach to rationality
rationality
2. Limited capabilities approach
4. Holistic approach
to rationality
to rationality
The rationality matrix introduces for major concepts or approaches to the notion of rationality, which
are classified by the presumptions of its boundedness and contextuality.
(1) If we presume that rationality is identical enough among all individuals, that is universal, all
necessary information is freely available and human mind has unlimited (or virtually unlimited)
deliberating capabilities, than we operate within neoclassical, mainstream approach to rationality.
Majority of economical theories and models explicitly or implicitly assumes this kind of rationality
from its agents. It is simple and abstract concept. It allows intensive usage of mathematics and logic in
the economics and is usually associated with optimisation. Of all concepts of rationality, it is the least
realistic, that is farthest from actual human behaviour. Because of this, the real life validly and
usefulness of conclusions and solutions based upon mainstream concept of unbounded rationality is
questionable.
(2) Theories and models that take into a consideration boundedness of rationality, but still consider it
universal (either implicitly or explicitly) belong to limited capabilities approach to rationality. This
approach has significantly gained in influence in the last decades. Bounded rationality is much more
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realistic notion in comparison to unbounded, albeit more complicated and unclear. Its major weakness
is in neglecting the influence of some aspects of human rationality (like institutions, habits, etc.).
Because of this, it is for example very weak in explaining some cases of economic behaviour that
deviate from standard Western/American conceptual framework.
(3) Some consider rationality to be unbounded, but at a same time take into account differences
between different traditions, which are consequence of institutions, habits and values of a society and
their influence on its members. This line of thinking is distinctive of some institutionalists, which have
emphasized the importance of institutions on human economic behaviour. Otherwise, this concept is
mainly in a domain of philosophers who argue mostly about universality of rationality, but do not
engage into its deliberation or information limitations.
(4) Holistic approach to rationality acknowledges both, boundedness and contextuality of rationality. It
recognizes the influence of contextual factors like institutions, habits, values, on rationality, while also
acknowledging that information is scarce and costly and that human deliberating capabilities are
limited. It is the most realistic concept and its power to accurately explain economic behaviour is
probably the greatest, but it is also the most complex one, so it is probably hard to get exact and
sometimes even useful solutions. Holistic approach to rationality allows us to become aware of
complexity.8 At the same time it cautions against mindless copying of economic solutions or strategies
that have been successful in one environment to another.
8
With holistic approach to rationality we can, for example, better explain the origins and formation of preferences. For
mainstream economics preferences are given that is exogenous, and their formation is not considered to be the domain of
economics. But having a comprehensive and consistent set of preferences certainly requires some cognitive endeavour
(Pagano, 1991). Understanding of our preferences is tiresome and pretentious activity, and sometimes requires mastering
certain knowledge and skills. Because having complete and consistent set of preferences is costly and tiring activity, it is
rational for an agent to be economical (bounded) and form only partial preferences. Our initial choices are also very much
influenced by institutions, customs and values of the society that surrounds us (contextual) and they very much determine
directions and areas where our preferences would be completely developed and areas where they would be incomplete.
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HOLISTIC APPROACH - Rationalizing irrationalities of Slovenian Business
System
In this section we will first identify four key contextual factors that have influenced Slovenian
economy in an unusual and sometimes even unpredictable way.9 Next we will discuss the origins and
evolution of these factors as Slovenian economy kept changing from feudalism to capitalism to
socialism and finally back to capitalism. To illustrate the persistence and power that these factors have
on all the actors of Slovenian economy, including politicians, managers, workers and consumers, we
will provide some examples of peculiarities of Slovenian economy today and try to explain them using
these factors.
Any inquiry into such a complex subject as a historical development of the country’s economy and
society is bound to be incomplete and partial. However we assert that majority of specific
developments and peculiarities of Slovenian Business System that exist today are the result of few
basic socio–economic flows, which have gradually developed in the 19th century and have survived all
the changes of the business environment practically unaffected. We have identified four major socioeconomic flows or as we will call them through the rest of this paper, four contextual factors:

Strong localism

Specificity and importance of informal networks (relationships)

High discretion and autonomy of managers

Inability of cooperation between companies
It is our intention to show that these “background institutions” have in many aspects become
“backward institutions” in the socio-economic development of Slovenia in the last transition period,
which started in the late 80s. During the last decade Slovenia has become a small open economy
(population of 2 million people), which tries to become a full member of EU. The economic success in
this new context has become the main criterion for all decision-makers (especially for managers and
politicians).
2.1
Strong localism
Slovenia is a very small but extremely diverse country. It covers the area of 20.273 km2, which is
roughly half the size of Switzerland, and yet it includes four distinct European natural habitats: the
mountainous Alps, the limestone Dinaric karst area, the fertile Panonian plain and the ardent
It must be mentioned, that our definition of contextual factors is similar to Whitley’s (1992) “background institutions”,
which are ”patterns of social behaviour” where rapid shifts in “proximate institutions” have no significant effects on the
economic development of the country.
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Mediterranean. The landscape is characterized by high mountain ranges, which are separated by lower
lying valleys. Only one sixth of its territory is level country (Plut, 1999) Four neighbour countries
Italy, Austria, Hungary and Croatia have throughout the history tried to control some of its parts.
Habsburg monarchy was first to include all of the Slovene regions. But even under Habsburg rule
southwestern parts were under Italian influence and northeastern regions under Hungarian influence.
Mountainous terrain made transportation and communication between valleys difficult, hence local
communities had developed in some sort of self-sufficient isolation. Neighbouring valleys have
evolved different dialects of speech and different economies, depending on the availability of natural
resources. They were loosely connected into larger regions of Dolenjska, Kranjska, Štajerska,
Gorenjska and Primorska. The loyalty of people belonged firstly to their local community and
secondly to their region. Not until 1848 did Slovene intellectuals issue the first political programme
for an United Slovenia and started propagating the idea of Slovenia as an autonomous republic within
Austro-Hungary or as an independent state.
Even at the end of 19th century, when the country gradually began to industrialize and the lack of
available land for cultivation caused a permanent state of crisis for peasants from all over Slovenia,
strong local cohesion and “valley mentality” have survived almost intact.10 Since there were no major
industrial towns to migrate to, peasants who were unable to support themselves and their families had
to move to other parts of Europe and primarily to the United States. Those who stayed, continued with
a basically subsistence based form of farming, where farmers traded their surplus agricultural and
traditional cottage products on small neighbouring markets. Although this system has prevented
farmers from engaging in a capitalist process of modernisation, it simultaneously prevented the
farming communities from destroying their traditional village mutualism and co-operation.
At the end of the 19th and the begging of the 20th century the country gradually began to industrialise.
But it was not an usual pattern of fast industrialisation in a few urban centres that happened in
Slovenia. It was rather a community-based industrialisation, where foreign owners had built factories
in different valleys, depending on the availability of natural resources and cheap labour (Jaklic, 1999).
Factories have served as an additional source of income for peasants, which had still primarily
engaged in an agricultural activity and considered themselves to be a farmers and not workers. This
arrangement had survived the First World War and the fall of the Habsburg monarchy. In a new
Kingdom of Serbs, Croats and Slovenes (shorter: Yugoslavia), Slovenia was the most industrialised
and most developed region. Foreign owners took advantage of the fact that it had ceased to be a
supplier of raw materials and intermediate products for Austro-Hungarian Empire and was instead in
position to supply an emerging Yugoslav market with high value finished products. As agricultural
10
For more on the “valley mentality” in Slovenia see Kristensen, Jaklic, 1998.
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prices dropped again, an increasing number of peasants sought to supplement their agricultural income
with industrial wages, which have caused the rapid growth of new factories. In this way had local
valley communities managed to keep their traditional agriculture-based way of life and
industrialisation had not only not broke strong communal bonds but had in fact enabled “valley
communities” to remain in blissful isolation with relatively unchanged costumes and conducts until
the Second World War.
The WWII has brought the new communist regime in power, and along came the new economic
system – socialism. But Yugoslav socialism was in a few distinct ways different from the Soviet kind
of socialism. Yugoslavia never succeeded in building up a strong institutionalised central planning
system. Continuous changes and reforms made it impossible for central planners to gain a strong
position like in other East European countries during that period (Prasnikar, Prasnikar, 1986). Politics
were conducted through highly shifting procedures viewed from the formal dimensions of the system
and hardly anyone could learn to master one system and plan strategies before institutions and formal
rules were changed again. Local politicians had much more political and economical power than their
East-European counterparts and they have used it to bolster economic development in their “favourite”
regions, that its in valleys that they have originated from or where they had currently lived.
Unlike in Russia and other East-European countries Yugoslav partisans that have fought in a war were
not drastically affected by political purges and bogus trials that would have eliminated potential
adversaries to the ruling clique and at the same time ruined all possibilities of creating some sort of
informal network for allocation of government funds. In Yugoslavia the politics of allocation was
much more a game of give and take within a network of former partisans which were acting in dual
roles: as politicians and entrepreneurs. Having a vast political and economical power they were able to
smooth transition into socialism to such an extent that there were no major changes in life of peasant
workers (Kristensen, Jaklic, 1998). The latter have expected from their new leaders to provide them
with a secure and steady jobs in a factory that would grant them social security but would not be to
demanding, challenging or time consuming, so that in the afternoon they could still work on their
farms or in their communities.
Throughout the socialist years localism and self-centeredness of valley communities have thrived.
People have lived and worked in their own communities and had almost not migrated to larger cities.
In 1981 less than 40% of the people lived in urban areas.11 They were happy with routine,
undemanding and modestly paying jobs which allowed them to use their craftsmanship and
11
In the year 1995 around 50% of the people lived in urban areas. In western Europe the share of the urban population was
more than 75% (Plut, 1999). Slovenia has never reached high level of urbanization, but already suburban settlements are
growing faster than urban cities.
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entrepreneurial abilities in the local “grey economy” that had generated them additional income as
well as respect and status in local community.
But the socialist system could not last forever and when it has collapsed it was expected that the above
explained communal life would disintegrate along with the old socialistic companies. Price and
(international) competition became more and more important factors in a new market economy. But as
we will try to show with the case of merger of two Slovenian banks, the traditional local life is still
very strong.
2.1.1
Localism in transition: The case of banking sector
The idea behind the merger of Slovenian second largest bank Kreditna Banka Maribor (Credit Bank of
Maribor - KBM) and one of small regional banks Komercialna banka Nova Gorica (Commercial Bank
of Nova Gorica - KBNG) was sound and economically viable. In the beginning of the 90’s the larger
Slovenian banks, which possessed around 70% of the bank capital in Slovenia, were unable to operate
and were in need of rehabilitation. The reason for their financial failure originates from some
peculiarities of Yugoslav system of self-management. The owners of Slovenian banks where
companies that were at the same time their main clients. But actual control of a bank was not in the
hand of its owners but in hand of various politicians and bureaucrats. As a rule, each region had a few
major companies and a communal bank whose main purpose was to service them and local
community. Bank performance was usually not measured in financial terms but in its ability to provide
its clients with favourable loans for investing in production or for improving the living standard of the
local community.
Because of the high inflation, real interest rates throughout the 80’s where in fact negative. This
benefited companies by enlarging their actual equity and improving their capital structure12. But it was
devastating for banks that had suffered heavy losses and were able to operate only with regular
monetary boosts from the central bank, which kept issuing new money emissions. Coupled with
bankruptcy, financial troubles of their clients and losses from the exchange rate differences, majority
of Slovenian banks was in need of serious rehabilitation in the beginning of 90’s. Their rehabilitation
Ribnikar (1994) asserts that inflation was “natural habitat” for Slovenian companies, meaning that they could not have
grown or developed without it. In the system of self management companies were usually created by political decisions.
Their equity, which at least in principle belonged to all residents of Yugoslavia, was insignificant. Most of the profits was
channelled to employees and their families through larger wages, supplements for accommodation, and transportation,
stipends, subsidized vacations, etc. Growth thus had to be financed by loans, which has led to very unusual capital structure,
where equity represented around 10% and debt represented around 90% of company’s capital. Since nobody was foolish
enough to invest their own money into a company where all additional private capital would immediately belong to some 20
million people, there was no regular way for improving companys’ capital structure and the burden of high interest payment
would in the long run be to heavy to endure, even though companies have tried to carry it over to consumers via higher
prices. But since nominal interest rates were not indexed, high inflation meant that real interest rates were small or even
negative, as has happened in the 80’s, thus actually enlarging companies equity and improving its capital structure.
12
11
was one of priority tasks of the new government and the central bank. The control of banks
undergoing rehabilitation was transferred to the state Agency for Bank Rehabilitation and the state
bonds were issued to replace the non-performing assets and to prepare the banks for future
privatisation (Ribnikar, 1994).
In the beginning of the 90’s, after the initial shock of separation and loss of Yugoslav market have
subsided, there were around 30 banks in operation. Most of them were small regional banks, and even
the largest two of them were small in comparison with other European banks. Slovenian banks were
not as efficient as foreign banks and being also so small, it was feared that once the foreign
competition arrives, it would destroy Slovenian banking system. Thus an idea to merge these regional
banks into a two or tree larger banking groups (pillars) was endorsed both by the Central Bank and by
the government. Creation of a few larger universal banks would rationalise operations, uniform
information systems, cut costs and generally make banks more competitive, flexible and stronger.
With their extensive local network of branch offices, reduced costs, and better knowledge of local
conditions, such banks would be able to resist and even fight foreign competition. It was expected that
that would also benefit the corporate sector and economy as a whole.
Since KBM was almost rehabilitated and KBNG was still in trouble, Agency for Bank Rehabilitation,
together with Bank of Slovenia (the central bank), has decided that the most efficient way to
rehabilitate the latter was to join both banks into a New Credit Bank of Maribor (NKBM). Beside
immediate economical benefits of merger they wanted to give a signal and to set a precedent, which
would encourage other small banks to form a strategic partnerships and eventually merge into a few
strong and efficient banking pillars.
However, there was this issue of strong localism. KBNG covers the area of Primorska, border region
that is heavily influenced by Italy and Italian culture. KBM has it headquarters in Štajerska, border
region that is traditionally connected with Austria and German culture. Bankers from Primorska,
together with local people and companies, could not tolerate that their bank would be acquired by
“foreign” bank; that is by bank from other region. They felt betrayed and even demonstrated on the
streets against the merger (or acquisition, as they rightfully perceived it). They reasoned that the new
bank would not care enough for their local community and would use them mainly as deposit
collectors. Because headquarters of the new bank would be in Maribor, they feared that companies
from Štajerska would be better served than companies from Primorska.
But it was not a happy marriage. Ex KBNG became factually a set of branch offices of NKBM. They
were allowed to perform routine task and to approve loans up to a certain limit. The new scheme has
caused massive disapproval among the employees as well as among client companies from Primorska.
12
The system just didn’t work and nothing the management of NKBM in Maribor could do would
improve it. After few years and a number of changes in the management boards of their branches in
Primorska, they have realised that the merger is just not working and decided to apply for permission
for separation of the two banks. The CEO of NKBM has explained that they were having troubles in
overcoming regional and sociological closeness of banks. Contextual factor, which had seemed so
unimportant in an initial proposal and evaluation of the merger, has proved out to be an obstacle too
big to overcome even for the experienced management of the second largest bank in Slovenia.
Even though the idea was probably right, its execution was evidently wrong. Slovenian banks are
certainly too small for international competition and should somehow merge together. But the mergers
should not be done by some decree of authorities, especially if those authorities are oblivious to the
contextual differences between different banks. If the authorities had been pursuing holistic approach
to rationality they would try to create such an environment where banks would realise that they have
to merge in order to survive and be successful. They should probably have to encourage gradual
cooperation of the banks, first through mutual collaboration on certain projects like computer support
or joint network of ATMs. Only after the managements of different banks have gained confidence in
each other and their owners realised that the only way to achieve satisfactory return on equity was
through the economy of scale would banks voluntarily decide to join one of the few banking groups
concentrated mainly around the two major Slovenian banks. Such a mergers would be on the
partnership basis, where regional banks could still serve local companies and communities (where they
are very good at accessing the risk) while enjoying the benefits of operating at the economy of scale in
some support functions.13 Hasty and thoughtless decision about merger, made by people who did not
take into a consideration soft institutional constrains and local patriotism of Slovenian organisations
has in fact backfired and actually stopped the process of gradual merging of the Slovenian banks
which was under way. Alarmed by the negative results of merger of KBM and KBNG other banks
have decided to wait and stay independent as long as it was possible.
2.2
Specificity and importance of informal networks and grey economy
The extent of hidden economy in the 90’s in terms of unreported incomes in Slovenia might represent
17 – 21% of the recorded GDP. In its strategy for the development of small businesses Ministry of
economic affairs had estimated, that “grey economy” represented 22% of official BDP in 1996. In
13
It is also a question if merged, centralized larger banks could be large and strong enough for international competition. It
might be that this solution would only make it easier and less costly for foreign banks to take over Slovenian banks. As
suggested, one solution could probably be to organize a network of small (Slovenian) communal banks, which should work
closely with local SMEs and leave the space for larger foreign banks to work with larger foreign and domestic firms.
However, the network co-operation between banks is to a large extent not possible because of another “background
institution”; inability of managers to cooperate, which is discussed in the following sections.
13
1995 around 26% of the active population or 239,000 persons actively participated in hidden or
unreported activities (Kukar, 1995, pg. 16-25). In terms of working hours that would be enough to
create some 80.000 new jobs. In the 1999 World Competitiveness Yearbook (IMD, 1999) Slovenia
was ranked last out of 45 countries earning 2,19 points out of 10 for the highest extent of grey
economy. It was also poorly ranked for the extent of tax evasion, transparency of financial institutions
and public confidence in managers (Table 1).
Table 1: Indicators of the extent of hidden economy in selected countries in 1999
Transparency of
Grey economy
Tax evasion
financial
Public confidence
in managers
institutions
A
B
C
A
B
C
A
B
C
A
B
C
Austria
4.87
3
1
5.47
15
3
7.08
18
7
6.85
14
5
Belgium
4.41
8
2
2.45
40
12
7.55
8
4
6.45
21
7
Spain
4.39
10
3
5.09
18
5
7.11
16
6
6.71
16
6
Finland
4.26
11
4
7.02
4
1
7.93
1
1
7.57
2
1
Hungary
4.20
13
5
3.06
30
8
6.35
25
9
5.53
37
9
Netherlands
4.17
14
6
5.67
14
2
7.76
4
2
7.02
9
3
Denmark
4.15
15
7
5.43
17
4
7.72
5
3
7.24
4
2
Portugal
3.76
23
8
2.92
32
10
7.12
15
5
6.37
24
8
Ireland
3.72
24
9
4.84
20
6
6.61
22
8
6.94
12
4
Czech Republic 2.75
41
10
2.54
35
11
4.11
42
12
3.36
47
12
Poland
2.64
42
11
3.23
28
7
4.70
40
10
5.19
41
10
Slovenia
2.19
45
12
2.94
31
9
4.31
41
11
4.50
44
11
Legend: A – Mark (1-10); B – Overall ranking; C – Ranking among the 12 selected countries
Source: The World Competitiveness Yearbook 1999, IMD
Grey economy in Slovenia was acting as a kind of a social buffer, soothing the transition and making
social peace possible in spite the fact that in the year 1993, for example, some 130,000 people or 14,4
percent of active population were unemployed (SURS, 1993). It is believed that when situation would
stabilize the share of informal economy in the GDP would fall, since growing number of “afternoon”
operations would either decline or become legitimate businesses.
Informal networks and grey economy are to a certain extent present in all world economies. They are
usually viewed as an obstacle to free competition that in the end reduces the potential GDP of the
14
country. But in some cases, allocation through the informal networks and moonlighting economy can
be beneficial for country’s development. We assert, that this contextual factor has significantly
contributed to the success of Slovenian economy under socialist regime and has been beneficial also
since the 19th century. We believe that it has survived and even thrived during the last transition and
that some of the mistakes of that period are the result of mostly not seriously taking into a
consideration the impact of informal networks and grey economy. However, we think that grey
economy has become one of the important obstacles for the future economic development in Slovenia.
One of the major challenges for managers and politicians of this time is to find a way to mobilise
hidden power, creative energy and entrepreneurship of informal economy and to incorporate it into a
formal one which should become more internationally competitive.
In the 19th century “moonlighting” was essential for the survival of Slovenian peasants and their
communities. After the abolishment of feudalism in 1848, Slovenian farmers were stuck with small
farms, which they had to buy from previous landowners. In order to do so, they had to take loans in
newly created saving and mortgage banks. They were heavily taxed by the Austro-Hungarian Empire
due to military needs for protection of borders. In addition, the hereditary rule stated that the heir had
to pay a fair share of the inheritance to his brothers and sisters in money, or the farm was divided in
equal parts. Because of that, and because of the rough farming conditions of the mountainous terrain,
small farmers were prevented from accumulation of wealth and discouraged to embark on any
entrepreneurial activity that would enable them to improve their farming conditions (Kristensen,
Jaklic, 1998). Even today, after one and half century, Slovenian farms are extremely small compared
to other European countries14. Since farmers were constantly living in a state of crisis, struggling to
produce enough to be able to pay rent, taxes and inheritance claims, they gradually began to cooperate
and help each other within their local communities. They started producing wooden crafts or textile
and offering various services on local “grey” market. United in face of a “foreign occupier” they
gradually institutionalised a system of reciprocity of services and help among neighbours. Rather than
to participate in an economy built on principles of market exchange, they developed a system which
could be kept secret and untaxed from the Empire authorities and which for these very same reasons
had a high degree of legitimacy among the population. The problem was that this unofficial, “hidden”
economical system could not by itself generate the money incomes necessary for it to be selfsufficient. Thus farmers were forced to generate supplementary wage-incomes from sources outside
the system. Depending on what was available in their valleys they started to work in the forests owned
by the catholic church or in a mines, sawmills and factories owned primarily by foreigners. Because
income from the factories and mines was only a supplement to their farming income, it was in a way a
subsidy to the mine and factory owners, who were paying very low wages to their workers. Thus the
hidden valley system of mutuality and formal foreign capitalist system cohabited in a mutually
14
60% of farms have less than 3 hectars and the average size is 3.3 as compared to 14 hectares in the EU (Kovacic, 1996).
15
reinforcing way. Since none of the systems permanently succeeded in dominating the other, they were
able to coexist up to the end of the Second World War.
After the WWII, partisans knew that the easiest way to gain local support, create legitimacy in a rural
society and simultaneously establish authority, was to simply allow people to live on their small lots
and to create enterprises that would offer “workers” additional, though not necessarily very high
wages (Kristensen, Jaklic, 1998). Thus factories that have been established at the end of WWII could
simply be seen as collective associations for the provision of money in terms of wages. The workers
could still conceive of themselves as farmers and orient their life and careers toward this form of life
with the necessary additional income being provided for as a collective good organised and managed
by the socialistic state. Those without land, eg. craftsmen and technicians, would also find their
challenges in the surrounding community, where their skills were welcomed among the house building
neighbours and friends and not in a formal economy where they kept working on undemanding and
unchallenging jobs. The decisive sign of community integration was the “house and garden”, because
this could only be achieved through active participation in the moonlighting, which meant learning
how to play the secret game of local mutualism.
On the higher level, former partisans, now successful politicians and/or managers, played a similar
game of allocation politics. Just like local communities, they have acted by the rules of mutualism and
reciprocity on the national level. Although different fractions of partisans competed mutually to
dominate the enterprise sector and to gain influence in different state agencies, they have also
collaborated with each other and negotiated about the allocation of state funds. Thus, the success of a
manager was dependant more on his “connections” and networks that he has belonged, that on
economic performance of his enterprise. As long as he was producing satisfactory business results it
was his ability of successful lobbying which was important for the development of local community
and companies.
2.2.1
Moonlighting and informal networks in action: Case of Ljubljana Stock Exchange
With the case of Ljubljana Stock Exchange we would like to show how strong “background
institutions” are even with respect to a new institution and how the same old behavioural of informal
relationships and patterns from the past decades or even centuries are repeating.
In the year 2000 the turnover of Ljubljana stock exchange reached 269,6 billion tolars and it’s nominal
annual growth has slowed to 1,5 percent (Repovz, 2001). At the same time the amount of direct
“bundle trading”, where stock exchange was just notified after the transaction, amounted for 156
billion tolars, which was more than 20% higher than previous year. Turnover on the unofficial “grey
16
market” came to 171 billion of tolars, with annual growth of around 30%. In fact, unofficial and
untransparent turnover added up to 327 billion tolars, or 22% percent more than stock exchange
turnover. For some observers the figures are startling und worrying. The transition is almost over, but
the “grey trading” is not declining, more, it keeps flourishing.
Various explanations and solutions were offered to make clear and to abolish this anomaly of
Slovenian capital markets. Relying on the historical evidence we assert that these developments are
just a continuation of an old tradition of moonlighting and relying on the contacts and informal
networks, which have altered itself and adapted to a new environment. Some new institutions, like
Stock Exchange, were simply copied from the anglo-saxon world, because it was a modern thing to
have them. It was believed that just by introducing these institutions transition economies could
transform their economies from planning to market economies. But contextual factors can not be
ignored and the case of Ljubljana Stock Exchange clearly shows that these institutions if not
introduced properly degenerates into some sort of “freak” institutions. Some Slovenian intellectuals
with deep understanding of the nature and peculiarities of previous and present economical and
political systems, have consciously or instinctively followed the holistic approach and had suggested
the alternative for the key priority of transition - the abolishment of the social ownership of business
enterprises.15 But political leaders have decided to listen primarily to foreign experts and consultants
(the prominent place among them has Harvard economist Jeffery Sachs) who offered universal
solutions, and to ignore experienced domestic economists, as they perceived to be “contaminated” by
the previous system.
When Ljubljana Stock Exchange was founded in 1989 it was first such institution in Yugoslavia and
was widely celebrated (or criticized) as a major step toward western, capitalistic economy. In
November 1992 The Law on Ownership Transformation of Companies was passed by the Parliament.
It has introduced a combination of free distribution and commercial privatisation of companies. The
basic transformation scheme was that 10% of a company’s shares were transferred to the
Compensation/Restitution Fund, 10% to the Pension Fund, 20% was designated for free distribution to
all Slovenian citizens via ownership certificates, 60% were available for internal free distribution to
employees via ownership certificates, or shares were sold on preferential terms (50%) discount to
insiders under a special internal buy-out scheme, or on commercial terms through public offering of
shares, public tender of public auction. It was expected that real privatisation in the economic sense
would be achieved gradually. After the initial allocation of shares, a process of concentration of shares
in hands of active owners would enable greater efficiency of economy. Stock exchange was expected
to play a major role in that process. Throughout the 90’s the major function of secondary capital
market was the “consolidation of social property” (Mramor 2000). If we disregard a few cases of
15
More on this in section 3.2.2.
17
financial institutions issuing securities, primary capital market was virtually non-existent. However, as
we already suggested, even the role of redistributing wealth was performed relatively poorly.
To avoid severe plummeting of share prices caused by excess supply of shares from small
shareholders that wanted to cash in their “gifts” from the state as soon as possible, and to limit the risk
of negative effects on interest rates and economic growth, two year moratorium was put on a transfer
of shares from internal distribution. Shares from internal buy-out were transferable only between
participants of the internal buy-out until the programme concluded. That was the start of the “grey
stock market”. Although it was legally unlawful to sell these shares, various “stock-brokers” had used
an arsenal of legal tricks including futures contracts combined with high pressure selling to persuade
small shareholders to sell them their shares with generous discount. After the initial redistribution of
shares, trading on the grey market has slightly declined, and trading on the stock exchange has grown,
mainly because of foreign institutional purchases. But in the beginning of 1997, Bank of Slovenia
introduced obligatory custody accounts for all foreign portfolio investments in order to protect the
macroeconomic stability of the economy. Stock players have succeeded in persuading the public, that
these restrictions have in fact resulted in cessation of foreign purchases and decline in scope of trading
on stock exchange. But some economists believed that that was not the main reason for stagnation of
the stock market. They have emphasised the role and power of managers, which did not have any
interest to participate in stock exchange.
Off market trading started to thrive once again, this time with the shares of Mutual Investments Funds.
Actually, most people didn’t invest their certificates directly in the companies, but have rather
exchanged them for the shares of so called Authorised Investment Funds (AIF), which were in turn
supposed to acquire stakes in various public companies, diversifying portfolio and thus reducing the
risks (same as mutual investments funds in developed economies). Through lavish and costly
marketing campaign in a country that has only two million inhabitants, AIFs succeeded in attracting
around 1,2 million of shareholders (Giacomelli, 1999). But when the time came to invest them into the
shares of real companies there was not enough companies left to invest in. The government has
overestimated the value of “social” property that was liable for privatisation.16 AIF’s were left with
unused certificates and were not able to operate properly nor to officially become listed on stock
exchange. Shareholders, which were on average quite uninterested in whole “stock business”, tempted
by the offers from various stock brokerages or independent “entrepreneurs” started to sell their shares
for the fraction of nominal price. Managers of AIF have also contributed to the growth of grey stock
market. In a highly informal manner they started to swap packets of shares of companies in order to
shape a more compact portfolio and take active role in corporate governance or just to present their
16
The infamous »privatisation gap« was estimated to amount around 120 billion tolars, which was approximately 4,8% of
BDP in 1998. The problem of »privatisation gap« was still not successfully solved in time of writing this article.
18
balance sheets in a more favourable way.17 These transactions did not go through official stock
exchange market but were just reported after their execution. Due to these transactions nominal value
of assets of AIFs was artificially raised, which allowed for the companies that manage AIFs (usually
owned by banks) to realise profits of 5,1 billion tolars, although the funds that they have managed
experienced loss of 40 billion tolars in 1996 (Giacomelli, 1999).
Many managers of companies have used “grey market” trading for the concentration of ownership but
also for hostile takeovers of other companies. Through various informal meetings, managers of
acquiring companies tried to persuade their more or less close friends who held leading positions as
managers of other companies or financial institutions to sell them their shares in company they wanted
to acquire. In the same manners managers of the “victim” company, which was as a rule always
against the acquisitions, tried to convince the same “friends” not to sell their shares.18 Whatever the
deal was, following transactions were rarely carried out through the stock exchange.19
Heritage of the past and customs acquired through the decades of operation are hard to change in a
single decade of transition. The fact is that informal economy and networks have a long history of
relatively successful activity. Although in the long run their efficiency could not be compared to that
of a market economy, they contributed to a higher standard of living in the past and probably to a less
painful transition in the 90’s. Old socialistic economy was formally abolished and new market
economy with all its appendages was introduced, but the old ways of doing things have survived. That
is one of the major reasons for the stagnation of Slovenian stock market. All major economic players
including managers, financial institutions and government officials prefer to do their business on
informal basis through direct negotiations and avoid stock market and its institutions. Since they all
participate in the grey market, except for the lonely voice of the Ljubljana Stock Exchange, there is no
real interest in abolishing it for the being.
17
Ribnikar (1999) asserts that unlike foreign mutual funds, AIFs are not real financial intermediates. They do not assist in
flow of funds from surplus financial cells to deficit financial cells, that is from citizens to companies. They have two distinct
functions that do not benefit companies. Their first function is to make it possible for their shareholders to easily sell their
free shares. Since most of the shareholders which sell their shares use newly acquired money for every day consumption the
only macroeconomic effect is just short term increase in consumption and decrease in saving. Second function of AIFs is to
transform their portfolio through transactions on the stock markets. Whereas mutual investment funds in developed
economies attempt to lessen the risk by diversifying their portfolio, AIFs are doing just opposite. They are concentrating their
assets and are gradually changing into a holding companies, which take an active role in the governance of the companies.
Since large part of their transactions does not take place on capital market but on unofficial grey market, they do not
contribute to the development and growth of Stock Exchange.
18
This is a very similar game to that among different fractions of managers after the WWII competing for power. For more
on this see Kristensen, Jaklic, 1998.
19 Even government has contributed to the growth of grey market. Arguing that the cost of placement on the stock exchange
were higher then the benefits of it, the Treasury department has decided not to place some government bonds on the stock
exchange.
19
2.2.2
Could it be done differently
At the end of the 80s and at the beginning of the 90s some economists have suggested different
approach, closer to holistic approach to rationality, to the subjects of privatisation and establishment of
capital markets in Slovenia. Ribnikar (1994) argued that privatisation that was proposed by foreign
experts and some domestic politicians is inappropriate and would only aggravate the transition,
because it did not consider properly the essence of the previous system. Ribnikar (1998) has suggested
different kind of privatisation that took into a consideration the real condition of the economy and
some contextual factors like high power of managers. According to him, “social capital” should
belong to all the people, but shares should not be distributed to them. It should be transferred to an
institutional investor in form of preferential shares.20 This public institutional investor would be
passive but firm owner of the company, meaning that it would not be in a hurry to sell its share and
would demand adequate return on equity. Only in case of the most important business decisions like
selling or acquisition of the company or in case of unsatisfactory performance of managers would it
exercise its right as an owner. The right to actively manage the company would belong to a private
investor or investors which would bring new capital to the company.21 The nominal amount of
“public” equity in company under management of public fund would stay the same, but its share in a
company would gradually reduce. This kind of privatisation would be socially acceptable and
probably economically more efficient than the selected one. All people would benefit from it in the
long run and on more equal footing. Managers (new investors) would be interested in increasing the
value of the company. Money of companies would be saved.22 General savings and investments would
not decrease and personal consumption would not increase as it was the case with the selected
privatisation scheme.
2.3
High discretion and autonomy of managers
In a survey about the behaviour of the companies in the transition period,23 top Slovenian managers,
when asked about the goal of the company, have as the most important rated principle of ensuring
long-term survival of the company. By itself this would maybe not be so important, given the
instability and uncertainty of transitional markets. But theoretically correct principle of maximization
of share value was rated as second to last (Figure 2). Thus the most important goal of the company in
20
This could very well be a pension fund.
It was expected that these investors would primarily be managers of the companies.
22 Companies have spent a lot of money just paying the consultants who were making valuations of the companies. Many
managers also tried to decrease the value of the company in order to ensure higher shares of ownership to them and other
internal owners, which had a negative impact on their real operations in the market.
23 A group of researchers at the Faculty of Economics in Ljubljana has conducted an extensive survey “Behaviour of
Slovenian companies and financial institutions in the period of transition” in 1997 and 1998. We gathered substantial data
about all aspects of business behaviour of 70 large Slovenian companies (with more than 500 empliyees) and 130 medium
sized companies (from 250 to 500 employees).
21
20
developed (especially anglo-saxon) economies, that is maximisation of the shareholder value, is
among the least important principles for Slovenian managers. Could we ascribe it only to their
ignorance (bounded rationality) or is there something more substantial (contextual) about it?
Figure 2: Importance of some financial principles for top finance managers
4,49
Ensuring long-term survival of the company
4,02
Keeping financial flexibility
3,96
Ensuring stability of financing funds
Keeping high credit rating
3,80
Ensuring financial independence
3,77
3,24
Maximisation of the share value
Having similar financial strategy as companies in
same industry
2,73
2,0
2,5
3,0
3,5
4,0
4,5
5,0
Mark
Source: Survey “Behaviour of Slovenian companies and financial institutions in the period of transition”, EF,
1999
In another survey24 managers of 250 Slovenian companies with more than 50 employees were asked
about their opinions on principal-agent relationships and more specifically about the suitability of
different kinds of owners from their point of view. 59% of the questioned managers feel that owners
that acquire the company through purchases on capital market without the consent of the management
is not suitable owner of the company. Because owners appoint managers and one of the main
functions of the stock markets is to allow anyone with enough money and interest to become an
owner, the most appropriate answer would definitely be “It is not my business”. Yet only 11% of the
questioned managers had opted for it (Figure 3). Most managers feel that they are foremost loyal to the
company and responsible for its well-being and do not feel that they work for the owners of the
company (Figure 4). Only 22% has stated that they work primarily for the benefits of the owners. It is
interesting to note, that almost as high number of managers, that is 21% of them, feels that they work
and are responsible for the well being of the society as a whole. Thus it seems that Slovenian
managers have a highly developed sense of social responsibility. They do not acknowledge AIFs, state
funds and small shareholders as real owners, because they believe that these groups are often confused
in their role of owners (they are not “wilful” owners, they have become owners by the government
24
Survey was conducted by the research group SPEM and by the leading Slovenian business newspaper “Finance”.
21
decree). Thus they are loyal to the company, which is a rather confusing idea, but suitable for the
confusing transition times.
Figure 3: Is an outside buyer that has bought the company through the capital market without the
consent of the management suitable owner?
No
59%
Yes
22%
It is not my
business
11%
Do not w ant to
asw er
8%
Source: GV, 2001
Figure 4: Loyalty of Slovenian managers
To the
ow ners
22%
Other
12%
Tho the
society
21%
To the
company
45%
Source: GV, 2001
The types of owners that are the most influential in the opinion of managers and the types that they
pay the most attention to, are larger Slovenian or foreign owners and AIFs. The least important groups
were small shareholders and various government funds. Obviously strong and knowledgeable owners
that could interfere with the work of the management are not welcomed by top Slovenian managers,
although such owners would certainly be more beneficial to the company than weak or uninterested
ones. Only 18% of questioned managers would approve of “strong owners” like AIFs or foreign or
domestic strategic partners having substantial power in their company (Figure 5). Most of them or
54%, would rather have state or employees as owners of the company. About one fifth would be most
22
happy with highly diversified ownership structure, where no single owner would have power to
question managerial decisions.
Figure 5: Optimal ownership structure as seen by top Slovenian managers
As much diversified as
possible
20%
Other
8%
Prevailing influence of
strategic partners
5%
Prevailing ownership of
management
14%
Prevailing influence of
Authorised Investment
Funds (AIFs)
2%
Prevailing influence of
inside owners
17%
Prevaliling influence of
state funds
23%
Prevailing influence of
foreign partners
11%
Source: GV, 2001
Judging from the above-mentioned research results, even ten years after the beginning of transition to
market economy, Slovenian managers still do not act as their counterparts in developed economies.
They openly disregard owners, which are primary stakeholders in the company and consider
companies as their own property, which only they could run successfully. Slovenian managers were
highly autonomous in the past, and they have managed to preserve their independence and sovereignty
in the leadership of the companies even in the new market system (Whitley, Jaklic, Hocevar, 1997).
The transition seems to have neither caused gains nor losses in power and influence compared to the
old system. Thus the selected model of privatisation, which was supposed to limit the power of
managers, has in fact failed. As suggested by Ribnikar, it would be much better if managers were
allowed to become the actual owners of the companies.
In a previous system of self-management authority and legitimacy of the managers was rarely
questioned. “Peasant workers” were usually content with simple jobs that provided modest but steady
income, and that did not require some elaborate organizational or managerial techniques. Since those
that did not operate according to the rules of a “fair days work” where usually punished by the local
communities within which the factories were located, managers rarely had to exercise power and
formal authority within the enterprise which could lead to workers discussion and initiation of political
action against them. (Kristensen, Jaklic, 1998). They could even be in favour of increasing rights of
23
participation, co-determination and self-management without jeopardizing their own position. Rather
these reforms contributed both to conceal their real power and to influence and to legitimise their
surprisingly strong position in the social life of a socialist country.
Until the early seventies the power of managers depended on their relationship with and
embeddedness in the network of “old partisans”. Since allocation negotiations, deals, and decisionmaking were highly informal, the rules and strategies of the game could only be learned through
continuous participation. In effect, the longer managers from local enterprises had participated in the
game, the better they were able to play it with expertise. Thus, if workers in a local plant used the
formal rules of self-management to elect a new manager, they would risk losing a skilful lobbyist
capable of safeguarding their interests in exchange for a more popular person who might cause them
financial losses. Nevertheless the power of managers was not absolute. Jaklic (1999) indicates three
main criteria that were used by workers and the population of individual localities to measure and
assess their managers’ performance. First was their ability to generate financial and other resources.
Second was their ability to generate jobs and incomes through these resources that could answer the
local needs for monetary wages. In the beginning, this ability was primarily measured in terms of
quantity. Later, however, jobs and incomes became dependent upon their ability to produce products
that could be also sold on western markets by employing technologies imported form the West. Third
criteria was their ability to provide their workers with inexpensive loans to finance the building of new
houses, stipends for the children of workers, and similar services necessary for the growth and
prosperity of the local community. If the comparison with other manager within the same or a
neighbouring locality was in disfavour of local managers, workers had the right to and could in fact
turn their manager down by evoking the formalities of the Yugoslav self-management system. In
effect, as long as they have kept their workers and local community happy, socialistic managers had
unquestioned autonomy.
At the end of 70’ as Yugoslavia was becoming more and more dependent on foreign trade and was in
need of foreign currency, managers of those companies, that were able to sell their product to the
western markets, gained new and undisputed power. As long as they kept exported goods at some
“socially acceptable” price level and bringing in a hard currency, their decisions and actions where not
questioned. Losses from the sales on the foreign markets were compensated by raising prices on
domestic markets, where buying power of domestic consumer and enterprises would simply be raised
by printing more money. Gradually, managers and their sales forces learned to allocate surpluses
outside their official bookkeeping, thereby accumulating “private” funds of currency in foreign banks
or hoarding them at home. With their newly acquired wealth they were able to enhance their status in
local community and also significantly contribute to expansion and growth of grey economy as major
buyers of moonlighting goods and services and as a major suppliers of valuable foreign currency.
24
When Slovenia became independent in 1991, one of the major issues was which role managers should
play it the privatisation process. The initial proposition of the law followed the already explained
Ribnikar’s logic, which was to give managers the power and responsibility. This proposition was
based on the assumption that managers already had power, it only needed to be controlled properly. 25
Because new political parties wanted to get rid of the old managers which were perceived as “red
directors”, that is managers with strong political links to the communist party politicians, and wanted
their share of control over the economy, they supported privatisation concept that was supposed to
limit the power of managers. Finally the law was a compromise between concepts of a decentralised
multitrack and diversified approach with most of initiatives coming form enterprises and massive and
speedy privatisation, centrally administered by the Government and based on free distribution of
shares to the population. However, this kind of privatisation gave a lot of discretion to top managers,
allowing them to form different coalitions in order to retain control. At the end of privatisation process
the outcome for majority of the companies was that 60% of the shares was in the hands of internal
owners and 40% in the hands of external owners. Whereas in USA shares are predominately in hands
of individual owners and in Great Britain institutional investors have a prevailing influence, in
Slovenia shares are primarily in hands of internal owners and AIFs. Although it was expected that
uninterested individual shareholders, that is mainly workers, would gradually sell of their shares to the
“real” owners (so called “second round of privatisation”), managers have managed to rettain this
dispersed ownership structure, where small internal owners control around 60% of the shares
(Giacomelli, 1998).
Therefore it seems that the same old game between local communities, workers and managers was
being played under different set of rules. Managers have managed to retain their power and autonomy
by preventing strong external owners to take control in the firms. 26 Although workers participation in
The power of managers was very clearly exercised through “wild privatisation” which was very common at the beginning
of the 90s, when many managers of socially owned companies took advantage of a very liberal federal (Yugoslav) company
law that was still valid at that time. This law allowed them to create new companies by dropping down some of their assets
and later at least partially privatising these newly established companies without much supervision (Korze, Simoneti, 1993, p.
213). It was not an unusual procedure for managers to simply sign commercial contract favourable to private companies
(often owned by the very same managers) and in this was transfer business activity to bypass companies without proper
compensation.
26 Some believe that the power of manager came with significant costs, which could in long term seriously weaken the
companies. Since majority of employees in Slovenian companies were also their major owners, the problem of
“employeeism” occurred (Nuti 1997). “Employeeism” denotes the situation where workers that are also owners have such a
power in decision making process that they can bias the decisions towards raising the wages and keeping surplus work force.
Prasnikar and Svejnar (1998), using model composed from investment and income equations with data from Slovenian
companies, showed that employees of Slovenian companies indeed seize for themselves important part of added value (rentseeking behaviour), which would have to be used for investments. They show that during the first part of transition (19911995) amounts of funds allocated for investments were established in negotiations between employees and managers and
have found positive correlation between the negotiating power of managers towards employees and the extent of investments
of the company, and negative correlation between former and the rate of growth of wages and other personal incomes.
However, we claim that in the companies where managers and workers do not feel threatened from the external owners
employeeism does not arise. E.g. one of the highest value-added per employee company, with extremely high annual
investments, JUB, is controlled (majority ownership) by managers and workers.
25
25
decision-making process was formally reduced, they have effectively managed to retain important
negotiating power towards managers, since they acted in dual role of employees and owners. There is
always a chance that unsatisfied workers could sell their shares thus enabling hostile takeovers. Ten
years after the beginning of the transition, Slovenian managers still do not behave as scientists,
consultants or their counterparts from the developed economies would expect them to behave. They do
not pursue the “right” goal of the company, manipulate ownership structure of their companies, view
external owners with hostility, maintain strong links with the local community and are reluctant to
undergo any investments or changes that could jeopardise their position within the company or within
the society. But viewed from the contextual perspective they are by no means irrational. Because of
specific historical circumstances, institutions and customs, as well as limited information and
deliberating capabilities, they act as any other manager would act in this situation. They act rationally.
Whether their actions are good for the economy as a whole is not their concern, they leave it to
politicians to figure it out and steer the socio-economic development in the right direction. But in
order for the latter to do so, they must firstly truly understand why former behave the way they do.
In short, behaviour of Slovenian managers can be holistically explained, allowing for boundedness and
contextuality of rationality. Firstly, their power and autonomy originates from the previous system and
they have managed to keep it almost intact, as any selfishly rational person would do. Secondly,
undeveloped capital markets, low liquidity of shares and unpredictable investors who rely more on
information about the moves of foreign buyers or major capital players like central bank or
government than on financial data about the performance of the companies (Mramor, 2000, pg. 391),
make it almost impossible for shares to reflect the true value of the company. They are either
underrated or overrated, do not react on signals from the company and can not be reliable base for
allocation of capital and motivation of managers. Thirdly, AIFs, which are one of the most influential
and powerful institutional owners of companies, are not acting as responsible owners. Since their
shareholders have got their shares for free, and the values of their shares are very low because of the
“privatisation gap”, they do not strive for maximisation of value of their portfolio, but prefer
maximising cash flows that would enable them to cover their extraordinary high operating costs and
commissions of managing companies. Thus they exercise high pressure on managers for higher
dividends and are not overly concerned about the value of the shares in their portfolio. Fourthly,
internal owners, which are usually the largest group of shareholders, do not evaluate their managers on
the basis of increases of share value. Since they can benefit from the company in many different and
subtler ways, they do not demand that managers follow the principle of maximisation of share value.
2.4
Inability of cooperation between companies
26
Distinct feature of Slovenian business system is inability of corporations to form higher forms of
cooperation. When studying contractual relationships of companies, Jaklic and Hocevar (1999)
concluded that customer and supplier relations in Slovenia are as a rule short term and arm’s length27.
Better collaboration between companies and the development of long-term relations characterised by
risk and information sharing and by cooperation in marketing, finance or R&D is inhibited because of
the weak financial discipline, incomplete legislation and continuous changes in business conditions.
But more importantly low trust and uncooperativness are legacies of previous political and economical
systems that have survived and adapted to the new market conditions.
Although high degree of internal cohesion and cooperation was characteristic for Slovenian local
communities in the past, there was little collaboration outside the community or between different
“valley communitys”. Powerful natural obstacles, such as mountain ranges and rivers, along with the
lack of roads and other means of communication, has led to the development of small isolated and self
sufficient communities, which did not cooperate with other communities in order to survive. After the
Second World War “brotherhood and unity” of all Yugoslavian nations was strongly propagated, and
development of infrastructure that would connect all the cities and villages was one of the priority
tasks of the new regime. But that didn’t improve cooperation between the different regions of Slovenia
simply because there was no need for it and it was impossible to obliterate local-patriotism of valley
communities. One of stronger character traits of Slovenian people is envy and jealousy of somebody
else’s success. So if one region was successful, the neighbouring regions did not increase cooperation
with it in order to profit from its success, but have instead put greater pressure on their own managers
and companies to improve their business results and somehow outshine the success of the first region.
Economic development in Slovenia was therefore mostly result of intense competition between its
regions and regional companies, and not the product of benevolent socialistic cooperation and
collaboration between different people or companies. Even though most managers of socialistic
Slovenian companies belonged to informal networks, had extensive contacts with each other and even
negotiated about the allocation of funds and implementations of new western technologies, their
companies as a whole did not cooperate between themselves and have usually operated quite
independently from each other.
27
Sako (1992, 1994) distinguishes two basic types of inter-firm relations: a) Arm's length contractual relationships (ACR)
which combine low mutual dependence between companies, short-term relations, concentration on price and detailed
contracts, low trust in the competence of suppliers and goodwill of costumers, low degree of technology and risk sharing, and
b) Obligational contractual relations (OCR) which combine long-term mutual dependence and trust with considerable
information, technology and risk sharing. Iner-firm relations in the Anglo-Saxon countries are examples of the former and
Japanese and some other Asian countries are examples of latter. In general one would expect that in economies where the
government does not share risk with private companies, does not foster the development of intermediaries between
companies and regulates market bundaries and where developed capital markets exist, there are more incentives to develop
short-term ACR relations between the companies. On the contrary, in those countries where the government plays and active
role in the development of the economy and where the destiny of the bank and industrial sector depens on a credit-based
financial system, one can expect the development of long-term OCR links.
27
In the 70’s and 80’s three additional factors influenced inter-company relations and reduced the
possibility of emergence of more long-term relationships, where companies would mutually trust each
other and collaborate in some business functions like R&D or sales. First, political pressure had forced
companies to formally integrate into conglomerates called “Composite Organizations of Associated
Labour”. Around 46% of these companies consisted of smaller companies from different or unlinked
activities (Kiauta et al, 1975, pg. 4). Creation of these conglomerates was solely on political basis and
was not based on an examination of the economic synergies of such integrations. Because of
oppressive nature of these mergers there was no real cooperation between individual units of
conglomerates. There was no centralised control, which would create overall strategy for achieving the
greatest possible synergies. Flow of funds between companies was usually from the successful
companies to bad ones (Hocevar, Jaklic, Zaman, 1999). Since unprofitable companies were not shut
down their losses were covered by the well-performing companies. Data from that period confirm that
the profitable and successful companies were interested in high salaries and in the lowest possible
accumulation, because the accumulation would anyway be lost within the system (Kiauta et al, 1975).
This situation decreased the motivation of the well-performing companies and disabled the
development of the most promising companies. This resulted in a loss of trust between individual
units, which, under those conditions, was aggravated by the absence of a corporate strategy.
Second, the position of Slovenian companies on domestic market and the international trade regime
had a substantial impact on inter-firm relations. Before 1989 the Yugoslav market was very protected.
Even though Slovenia was the most export oriented Yugoslav republic, majority of sales were made
on the domestic market. In 1990, after serious decrease of sales on Serbian market, because of boycott
of Slovenian goods by the raising Serbian nationalists, Slovenian companies made around 82% of
their sales on the domestic market, and only 18% was exported to other countries (ZMAR, 1992, pg.
6). Main motivation for export was to receive foreign currency that was used to import products or
inputs for profitable sale on the Yugoslav market. Therefore companies were able to export their
products at lower prices than on domestic market and to compensate their losses and make profits with
sales of imported goods and their own products on domestic market. As the premier oligopolistic
companies of protected Yugoslav economy, Slovenian companies didn’t have to work hard to be
successful. Because of this, there were no incentives for stronger collaboration and joint development
with domestic or foreign partners in order to improve their position on international markets. Since
Slovenian companies had a dominant position on the “easy” Yugoslav market their managers thought
that they did not need to collaborate in order to be successful.
Third, Yugoslav banks were institutions for giving loans, and not intermediaries in a rational sense
(Ribnikar, 1989). In the past a group of dominant large banks dominated the Slovenian financial
system and these banks were established by companies that were at the same time owners and
28
borrowers. Commercial banks acted on their local (republican) territories as central banks. The
National Bank of Yugoslavia was the central bank of all republican ‘central’ banks. Liquidity was high
if the monetary policy was expansive enough. There was no need to examine credit capabilities of
bank customers or bills as in the end everything was paid by the National Bank, which was far from
being an autonomous agent (Ribnikar, 1989, p.69). The result of this system was higher and higher
inflation which finished in hyperinflation at the end of the 1980’s. In sum, the previous economic
system allowed companies to share their risks or transfer them to others in a very peculiar way. Risks
were quite ‘democratically’ distributed throughout the system - meaning that there was always
somebody outside the company to pay for the bad decisions of the managers - and there was no need
to establish deeper OCR relations with partners at home or abroad.
Loss of the Yugoslav market at the beginning of the 90’s forced Slovenian companies to orient
themselves toward west and to increase their export efforts. Only those companies that were in serious
trouble sought powerful foreign enterprises to invest in them. Lack of trust and inability of cooperation
can best be observed in a recent wave of mergers and acquisitions of prominent Slovenian companies.
Since radical restructuring has negative effect on the short-run revenues and profits, managers are
reluctant to authorise any major reforms or reorganizations within the company as this could shake
their influence both within the company and outside of it. Acquisitions, on the other hand, have
usually both short-run benefits in form of increased cash flow from the newly acquired company and
long turn benefits in strengthening the company, making it more capable to resist inevitable foreign
competition and making it harder for other enterprises to acquire it. Since there is still very little trust
or cooperation between managements of acquiring and acquired companies most Slovenian takeovers
are in fact hostile takeovers (hostile to the management). Slovenian managers take acquisition very
personally, as an attack on them directly, and are determined to fight till the end, even though it is
clear that merger would be beneficial for both companies. The defending managers usually try to
involve local community and even politicians to participate in their defence. Acquisitions are often
portrayed as a means for one region (usually central Ljubljana region) trying to conquer and subjugate
another, usually marginal region.28 By exercising their influence in the community and even on the
national level, defending managers have as a rule managed to make an acquisition more costly and in
some cases even managed to prevent it29.
For more on this “exercise of power” of different managers and its consequence on regional economic development in
Slovenia see Kristensen, Jaklic, 1998.
29 Example of “Slovenian” merger is attempt of a very dynamic and successful Slovenian company Comet to merge with
similar, but less successful company Swaty. Since both companies had complementary assortment of product in the machine
engineering field, had a strong presence abroad and were relatively small the merger would be beneficial for both companies,
especially for Swaty, which could gain access to some markets where Comet had a leading position. Management of Comet
wanted takeover to be a friendly one, but management of Swaty was against it, probably because of fear for their yobs. They
started strong campaign against the takeover as though “foreign” company is going to acquire their loved company. They
have obviously managed to persuade some government officials not to allow the merger. Although Comet had fulfilled all the
necessary legal requirements and it was established that merger would not be harmful to the competition in this area,
government, which had a power to ban the merger, decided not to allow the takeover to take place. Comet filed a suit against
28
29
the government because of lack of explanation for the government ban. After a few years of struggle Supreme Court has
ruled that the ban on merger was not in accordance with the law. But then in was to late for Comet, which was exhausted by
the legal battle. An Italian company has stepped in and become the owner of Swaty.
30
CONCLUSION
It was not the intention of this paper to present the “right” answers to the challenges of transition in
Slovenia. Forces behind boundedness and contextuality of rationality are such that changes can be
expected only through actions of decision-makers (managers, entrepreneurs, politicians, bankers,
owners, workers, customers,…) and the final outcome can rarely be predicted by a social scientist.
However, we wanted to show that if the holistic approach to rationality which assumes both,
boundedness and contextuality, would be taken more seriously in the transition process of the last
decade, better results could be achieved from the transition. And the same probably holds true for the
future. Probably the biggest challenge for Slovenian decision-makers is how to overcome narrowmindedness of “valley-communities” and open them to global challenges.
We have argued that during the transition period the context has changed considerably in Slovenia,
which will presumably have a considerable effect on the “background institutions” in the longer period
as well. Because of the nature of “background institutions” we do not expect them to disintegrate but
to evolve gradually into a new quality. We believe there are many possibilities for this to happen in a
way which would support faster socio-economic development in Slovenia. For example, there are
well-known cases of the Third Italy and West Jutland in Denmark where strong localism helps local
companies to be internationally competitive. International cases also show that informal networks and
grey economy could represent a solid basis for the proper entrepreneurial development. High
discretion and autonomy of managers could help in developing a special type of “family” SMEs with a
similar marketing and R&D logic to German “Mittelstand” companies. Inability of cooperation by
managers could help the acquisition process and the establishment of a few larger companies, which
would be open to global investors’ opportunities and pressures as well. On the other side, we have
seen that there is local mutualism present which could support the development of cooperation
between some SMEs, presumably newly established and coming from the grey sector, to become
competitive outside their “valleys”.
Based on the understanding of Slovenian specifics and knowing the successful cases Slovenian
decision-makers could form their own rational decisions for economic success. A social scientist could
help with this respect. In addition, much more has to be done with respect to theory and methodology
of contextual rational decision-making.
31
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