Concepts and Theories of Auditing

Concepts and Theories of Auditing Auditing has been present for years in different stage of development following the evolution of accounting. Starting since the epoch when the records were approved after a public reading, to the era when governments officials were measured by their honesty. Followed by the times of the industrial revolution were the ownership of companies started separating from management; when owners required more protection of their investments increasing the use of auditors, consequently; to the times were an auditor was always searching for frauds or errors (Whittington Pany, 2004, p. 7) and then to ascertain the actual financial condition and earnings of an enterprise (Montgomery, 1913, p. 9). However, the acceptance of auditing as an academic discipline is not old and just after the development of different concepts and techniques within the audit model such as the use of sampling, the study of the internal control environment, and the risk assessment, is when more focus to the theoretical and conceptual framework of auditing it is been devoted. Andrew Sayer (1992) discussed the concept of theories in social science from the perspective of theory as an ordering-framework (p. 50), indicating that theory allows the use of the observed data and their relationships to predict and explain empirical events. Additionally Cooper and Schindler (1998) define theory as a set of systematically interrelated concepts, definitions, and propositions that are advanced to explain and predict phenomena (facts) (p. 47). Another concept is expressed by Singleton and Straits (2005) explaining theory as a set of interconnected propositions (p. 19). The success in the explanations or predictions of any phenomena depends on the level that the theory holds and do not fails fitting in the situation, and the challenge is to perfect the process of matching theory and fact (Cooper and Schindler (1998). Different authors have started the development of the audit theory such as Mautz and Sharaf (1961) with their publication titled The Philosophy of Auditing; also Tom Lee (1986) with his approach in the book Company Auditing, and later David Flint (1988) with his book Philosophy and principles of auditing (as cited in Moizer, 1989). The auditing analysis in this demonstration will be framed on the postulates proposed by David Flint (1988) as a foundation for the theory of auditing. Flint (1988) stated that there is a matter of public accountability demanding an independent audit for its demonstration with clear definition and intention, based on evidence that only skilled auditors gather, measure it, and compare it against the standards, which generates economic or social benefit (as cited in Moizer, 1989). Following are the seven postulates or assumptions stated by Flint (1988): There is a relationship of accountability or a situation of public accountability. Accountability cannot be demonstrated without an audit. An audit requires independence and freedom. The subject matter of audit is susceptible to verification by evidence. Auditors are skilled judges who are able to measure and compare actual performance against standards of accountability. The meaning, significance, and intention of statements to be audited must be clear. An audit produces an economic or social benefit. (Flink, 1989) Whenever an economic relationship exists one of the parties owe a duty of an acceptable accountability, consequently audits are voluntary, imposed for the health of the relationship. There are also audit related to the interest of the public in matters of the society institutions. As expressed by Whittington and Pany (2004) dependable information is essential to the very existence of our society (p. 1). They explained the social need for audit and professionals who can attest that the reported information is fair respect to the reality for purpose of allocating resources for the production of services and goods based on reliable financial information (p. 1). Normally the financial and economic aspects of the related subject matter are complex, not physically accessible, or have the level of significance that necessary demand an audit to accept the accountability. No all investors or stakeholders of an entity understand the complexity of the business and financial environment, or are near to the place were their resources are to oversee for accountability. The credibility of the information is important and the preferable form of obtaining credible information to rely on is by using independent auditors to perform an audit. That reduce the business risk that relates to the permanence and profits of the company, and the information risk that the financial information used to make a decision is materially misstated (Whittington Pany, 2004, p. 6). Therefore, if the audit must add credibility it must be performed independently and without bias or prejudice. Audit is subject to verification and that is possible only if sufficient evidential matter of the audit is gathered. Additionally, some standards of accountability and performance need to be in place to easy the auditors measurement. Therefore, the parties involved must agree on their acceptable standards. The auditing community has set some professional guidance as a form of general accepted practiced standards. For an audit to add value to the financial information, the purpose of the information should be clear, and the findings effectively communicated. The audit should be performed only when its benefits weigh more than the costs. As a consequence auditors should be aware of the cost of collecting evidence especially in situation were the risk is high. The practice of auditing auditors agree on an attest engagement in which they issue or does issue an examination, a review, or an agreed-upon procedures report on subject matter or an assertion about subject matter that is the responsibility of another party (e.g., management) (Whittington Pany, 2004, p. 2). In an examination of financial statement, referred to as an audit the standards may be the Generally Accepted Accounting Principles (GAAP), and the auditors collect sufficient evidence to attest about how fair is the information in the financial statement respect to the GAAP. However, here are three types of audits: (a) audits of financial statements, (b) compliance audits, and (c) operational audits. Financial audits determine if the statements were prepared according with GAAP. Compliance audit verifies if the company had complies with law, regulations or polices and procedures. Finally, operational audits review the effectiveness and efficiency of particular unit of an organization (Whittington Pany, 2004, p. 11). Relative to the public accounting standards, the American Institute of Certified Public Accountants (AICPA) has developed the framework for the general accepted auditing standards (GAAS), which are the fundamentals principles of independent auditing in the U. S. The framework is divided in three major areas that are summarized as follow: General standards. A professional possessing adequate technical training and proficiency, independent in mental attitude and free from bias and with professional care planning and performing diligently, perform the audit. Standards of field work. The audit should be adequate planned and the staff properly supervised. Auditor should acquire sufficient understanding of the internal control environment to be able to determine the weak areas, and gather sufficient competent evidence to support their conclusions. Standards of reporting. The final report should state if the statements are consistent with GAAP and if necessary indicate those circumstances departing from GAAP, include adequate informative disclosure, and includes the opinion of the auditors about the financial statements. Likewise, the AICPA has issued a series of auditing standards on auditing procedure, auditing and accounting guides, and auditing statements of position, to help auditor in the fulfillment of their responsibility of detecting misstatement (Whittington Pany, 2004, pp. 34-35). Auditing involve a serious processes that expose auditors to a different situations in which they need to exercise professional ethics. Those moral principles and values leading decisions and actions of the profession of auditing are provided by the AICPA in the Code of Professional Conduct, and by the Institute of Internal Auditors (IIA) Code of Ethics. Normally auditors are involved in a decision process of ethical dimension. CPAs decisions during performing their duties can affect thousands of investors and their resources; therefore, they need to measure the implication of their decisions. Additionally, as Whittington and Pany (2004) indicated, what is considered unethical in a particular society is not specifically prohibited (p. 11), giving relevance and support to the need for the establishment of those principles and values in the accounting and auditing profession. The public accounting, as well as the rest of professions, has the following characteristics: (a) their responsibility to serve the public with independence and due care with fairness and free from bias. (b) Involves a complex body of knowledge that includes different authoritative pronouncements of standards and principles governing the profession and the financial reports due to the need of technical competency. (c) Has establishes some standard of admission to the profession that each CPA is required to meet. In addition (d), need public confidence to be successful (Whittington Pany, 2004, pp. 61-62). The AICPA leads public accountants to recognize their responsibility to the public in general, to their clients, and to the profession. The section one of the code of conduct describes the organization and CPAs principles of responsibilities, public interest, integrity, objectivity and independence, due care, and scope and nature of services. The section two depicts the institutes rules that are compounded by the following: independence, integrity and objectivity, general standards, compliance with standards, accounting principles, confidential client information, contingent fees, acts discreditable, advertising and other forms of solicitation, commissions and referral fees, and form of organization and name (Whittington Pany, 2004, pp. 63-83). Similarly, the IIA has their own code of ethics divided in three main sections, an introductory section, principles, and rules of conduct. Their principles apply to the profession and practice of the internal auditing, and include integrity, objectivity confidentiality, and competency. The IIA rules on conduct include integrity, objectivity, confidentiality, and competency (Whittington Pany, 2004, pp. 83-84). The IIA is the organization that provides the standards for the professional practice of internal auditing. As it can be deduced from the previous summaries, both institutes the IACPA and the IIA require high level of self-discipline and commitment to a honorable professional behavior, integrating similar principles of integrity, objectivity, and competence. Their rules differ in the fact that internal auditors perform internally; public accountants attest on the financial statements to the company as outsiders performing professionally to honor the public trust. However, the concept of independence is common to both ramification of auditing because it refers to the ability to maintain and objective and impartial mental attitude (Whittington Pany, 2004, p. 66), and without of conflict of interest. After the previous review of the auditing theory and how CPAs support it with a professional framework that includes principles, ethical codes, and general accepted standards for the auditing practice, the following section depicts a discussion of audit procedures as well as an introduction of important concepts that are fundamental part of the theory of auditing and the auditing practice. The Audit Procedures The ultimate product after the performance of an audit is the issuance of a report indicating if the financial statements audited comply with GAAP. Sufficient evidence must support the audit report and such evidence is gathered and documented by exercising rigorous procedures that, among other important goals, help the auditors in assessing the risk of misstatement. According to Whittington and Pany (2004), audit procedures involve: (a) the understanding of the client, the business, and industry to use it in assessing risks; (b) the understanding of the internal control environment; (c) the design and performance of controls testing to assess how effective the controls are in preventing or detecting material misstatements; and (d) the design and performance of substantive procedures that include analytical procedures, direct testing of transactions and ending balances (pp. 138-139). Because the internal control is the focus of interest for this demonstration, a separate section will discuss it. The substantive procedures include analytical procedures, the testing of transactions, and the testing of the ending balances on the statements. Analytical procedures consist of an analysis and evaluation of the information present in the financial statements, and a review of the relationship between financial and nonfinancial information. The assumption behind the analytical procedures is that the relationship and trend of the financial information is expected to follow the historical data and projections of the business and in contrary situation evidence must be obtained to support the reasonability of the changes (Whittington Pany, 2004, p. 141). Different techniques are use during the analytical procedures. From simple verification of a number to complicated mathematical models, such the comparison of cumulative expenses and revenues with prior years to find significant differences, the use of multiple regression model to estimate revenues by using economic and industry data, and ratio analysis and its comparison with other businesses in the same industry (Whittington Pany, 2004 (p. 141). The testing procedures seek to prove the occurrence and correct recognition of transactions, and prove of existence and misstatements on what the ending balances represent. The substantive testing procedures are performed as an interim mode before year-end, and then after the business year-end. The level of risk established by the auditors during the overall business assessment guides the extent of the substantive audit procedures. The greater the risk of material misstatement the greater the needed extent of substantive procedures (Whittington Pany, 2004, p. 139), but always keeping under evaluation the cost-benefit relation of increasing the procedures to perform. Among the most common test performed in an audit process, Whittington and Pany (2004) summarized the following: Accounting System: Comparison-Agreeing amounts from different internal records. Documentary evidence: Tracing-Establishing the completeness of transaction processing by following a transaction forward through the accounting records. Vouching-Establishing the existence or occurrence of recorded transactions by following a transaction back to supporting documents forms a subsequent processing step. Inspection-Reading or point-by-point review of a document or record (the terms examine, review, read, and scan are used to describe the inspection technique). Reconciliation-Establishing agreement between two sets of independently maintained but related records. Third-party representation: Confirmation and evaluating a response from a debtor, creditor, or other party in reply to a request for information about a particular item affecting the financial statements. Physical evidence: Physical examination-viewing physical evidence of an asset. Observation-viewing a client activity. Computations: Reperformance-repeating a client activity. This may include operations such as footing (providing the total of a vertical column of figures); cross footing (proving the total of a horizontal row of figures); and extending (re-computing by multiplication). Data interrelationships: Analytical procedures-Evaluation of financial information made by a study of expected relationships among financial and nonfinancial data. Client representations: Inquires-questions directed toward appropriate client personnel. According to Whittington and Pany (2004), auditors also collect evidence from some subjective areas such as the accounting estimates, the fair market value measurement and disclosures, and transactions with related parties (pp. 146-148). After the development of audit procedures auditors test for existence or occurrence to search for misstatements and completeness searching for understatement, from transactions start to finish, and they test the accounting system from source documents to journals to ledgers. (Whittington Pany, 2004, p. 195). The audit program includes two main parts, the assessment of the effectiveness of the client internal controls, and substantive testing. Normally the system portion of an audit program is divided by cycle such as revenue, purchasing and payments, production, payroll, investing, and financing (Whittington Pany, 2004, p. 196). Audit Risk The risk concept is use in different disciplines for different purposes. A simple definition of the concept is that: risk is the level of exposure to the chance that some event happens. The event might be beneficial or prejudicial, or might have subsequent implications to other situations or process. Therefore, in business there is a risk of losing money, a risk of fraud, and a risk of misstatement the financial information. As consequence, business and individuals manage risk and the level of exposure to specific risk according to their judgment. The audit process involves the management of risk in different areas with the goal to reduce it to the minimum level possible. Whittington and Pany (2004) introduced some of the risks concepts such as: business risk, the risk associated with a companys survival and profitability (p. 6). Information risk, the risk that the information used to assess business risk is not accurate (p. 6). Audit risk, the risk that the auditors may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated (p. 35). Inherent risk, the possibility of a material misstatement of an assertion before considering the clients internal control (p.128). Control risk, the risk that a material misstatement will not be prevented or detected on a timely basis by the clients internal control (p. 129) Detection risk, the risk that the auditors will fail to detect the misstatement with their audit procedures (p. 129). Within the audit risk, auditors assess the risk level of occurrence of the different form of misstatement of financial statement, such as errors, fraud, and illegal acts. In measuring audit risk auditors use the following model: AR = IR x CR x DR Where: AR = Audit risk, IR = Inherent risk, CR = Control risk, and DR = Detection risk. (Whittington Pany, 2004, p. 130) Additionally, because the auditors are expose to some legal responsibility and are subject to be sued by any clients stakeholder, they have to take in consideration the reputation of the management, financial strength, and other financial rating to assess the overall risk or engagement risk of the association with that particular business (Whittington Pany, 2004, p. 174). The process of planning the audit involves the understanding of the client and its environment, an overall audit strategy, and the risk assessment of financial statements material misstatement. Therefore, auditors seek to understand the nature of the client and accounting polices, the industry, regulations and external factors affecting the client, the clients objectives, strategies, and related business risk, how the client measure and review performance, and the internal control environment. (Whittington Pany, 2004, pp. 179-180). Consequently, auditors use different sources to obtain the client overall understanding. That includes electronic research tools, visit to different plant or location of the client, and some analytical procedures. (Whittington Pany, 2004, pp. 181-183). A Companys internal control consists of the policies and procedures established to provide reasonable assurance that the objectives of the company will be achieved; including the clients internal control, they could identify areas of strength as well as of weakness. The stronger the internal control, the less testing of financial statement account balances required by the auditors. For any significant account or any phase of financial operation in which controls were weak, the auditors expanded the nature and extent of their tests of the account balance. With the increased reliance on sampling and internal control, professional standards began to emphasize limitations on auditors ability to detect fraud. The profession recognized that audits designed to discover fraud would be too costly. Good internal control and surety bonds were recognized as better fraud protection techniques than audits. (Whittington Pany, 2004, p. 8) The assessment of inherent risk involves considering the likelihood that material misstatement in financial statement will result, and each risk related to the management assertions. At this stage, auditors identify what it is not correct or the significant risk by area and based on that assessment they adjust their approach, modifying the nature, timing, and extent of the audit procedures (Whittington Pany, 2004, pp. 188-189). Audit Evidence Evidence is all data and information gathered by the auditors to support auditors conclusions. The importance of the evidence is that audit risk is reduced by gathering audit evidence (Whittington Pany, 2004, p. 127) and when the risk is high more evidence is necessary as well as the increasing the coverage of audit procedures. According to Whittington and Pany (2004), evidence need to be collected for each financial statement assertion sufficiently to support their opinion. As issued in the Statement of Auditing Standard (SAS) 31 about evidential matter, the financial statement assertions are the following: Existence or occurrence-assets, liabilities, and owners equity reflected in the financial statements exist; the recorded transactions have occurred. Completeness-all transactions, assets, liabilities, and owners equity that should be presented in the financial statements are included. Rights and obligations-the client has rights to assets and obligation to pay liabilities that are included in the financial statements. Valuation or allocation-assets, liabilities, owners equity, revenues, and expenses are presented at amounts that are determined in accordance with generally accepted accounting principles. Presentation and disclosure-accounts are described and classified in the financial statements in accordance with generally accepted accounting principles, and all material disclosures are provides. (Whittington Pany, 2004, p. 174) The above assertions are the base for the risk assessment performed by auditors, and to determine misstatements possible to occur and consequently decide the audit procedure to exercise. Guidelines are included in the SAS 31 regarding what sufficient competent evidence is, which relates to the quantity of evidence auditors should collect. The competence of the evidence is determined by the combined condition of relevant and valid. That means that it most related to the assertion, and that it is dependent on the circumstance in which it is obtained. The reliability or validity of the evidence increase when is received from independent sources, when is produced by an effective internal control, gathered directly by the auditor, is documented, obtained from original documents, and when is received from more than one source (Whittington Pany, 2004, p. 132). Different types of audit evidence is obtained by the auditors such as accounting information system, internal and external documentary evidence, third-party representations such as confirmations, reports, and lawyers letters; physical evidence such as fixed assets and inventory, computations re-performance, data interrelationships of financial and nonfinancial information, and client representations oral and in writing (Whittington Pany, 2004, pp. 131-137). An important supporting evidence of the audit report and conclusions is the audit documentation, which is required by the SAS 96 for the auditors understanding and review of the audit work, the nature of audit work performed, and to show the agreement between the records and the financial statements. The working papers have some important functions: (a) are the best way to assign and coordinate the auditing work, (b) help audit managers and partners in the supervision and reviewing or the work of assistants, (c) support the audit reports, (d) documents the auditors compliance with GAAS, and (d) assist in the conduction of future audit to the client (Whittington Pany, 2004, pp. 148-150). The working papers are confidential and unrestricted documentation owned by the auditors, principally because they represent the major factor to use in case of negligence charges. Part of the working paper are the administrative working papers, the working trial balance, separate schedules, adjusting journal entries and supporting schedules, and analysis of ledgers accounts such as a reconciliation, computational working paper, corroborating documents. They are filed in two major groups, permanent file, and current files (Whittington Pany, 2004, pp. 151-158). Audit Sampling As a large-scale corporate grow rapidly auditors began to sample selected transactions, rather than study all transactions. Auditors and business managers gradually came to accept the proposition that careful examination of relatively few selected transactions would give a cost-effective, reliable indication of the accuracy of other similar transactions (Whittington Pany, 2004, p. 8). As explained before, auditors need sufficient and competent evidence to support their conclusions, but because business grows involving high volume of economic events and transactions, they need to rely in sampling testing. Audit sampling can be statistical or no statistical, involves the selection of a sample from a group of items and the use of the sample characteristics presuming that the auditors can draw inferences about the whole population. (Whittington Pany, 2004, p. 309). From the previous sampling introduction, we have the sample risk that is the risk that the auditors conclusion based on a sample might be different if they examine the whole population. According to Whittington and Pany (2004) sampling risk is reduced by increasing the size of the sample (p. 309) or by auditing the whole population. Auditors use statistical and no statistical sampling to perform a random selection, which involve that every item in the population has an equal chance of being selected for inclusion in the sample. Different techniques are used such as random number tables, random number generators, systematic selection, haphazard selection, block selection, and stratification (Whittington Pany, 2004, pp. 310-313). There is a sample risk for test of controls in which auditors face the risk of assessing control risk too high, which is related to efficiency, or too low based on the operating effectiveness of the control. The AICAP guide suggest the statistical sample sizes for tests of controls at 5 percent risk of assessing control risk too low, providing the following tolerable deviation rate per assessed level of control risk: for low 2 7%, for moderate 6 12 %, for slightly below the maximum 11 20%, and for maximum level of control risk they recommend to omit test (Whittington Pany, 2004, pp. 316-320). Besides sampling, auditors became aware of the importance of effective internal auditing. Following section presents a discussion about internal auditing. Internal Auditing The internal auditing developed rapidly during the decade of 1930s generating the foundation of the Institute of Internal Auditors (IIA), which is an organization with local chapter in the main cities worldwide. The IIA defines internal adducting as follows: An independent, objective assurance and consulting activity designed to add value and improve an organizations operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance process. (The Institute of Internal Auditors [IIA], 2008) Internal auditors are an important part of the internal control environment of entities, representing the highest level of control that measure and evaluate the effectiveness of other controls. Additionally to the financial controls, the internal auditors scope includes the evaluation and testing of control effectiveness, and other assurance and consulting services to the management. Some companies have focus on outsourcing the internal audit functions, which is also provided by CPA firms as an extended audit service and according to the AICPA guiding. However, opposition to the participation of accounting firms exist under the argument of possible conflicts of interest having then as part of the internal control when they also audit the company. The IIA have issued the standards for the practice of internal auditing with the following purpose: To delineate basic principles that represent the practice of internal auditing. Provide a framework for performing and promoting a broad range of value-added internal auditing. Establish the basis for the evaluation of internal audit performance. To foster improved organizational processes and operations. The auditing standards of the IIA includes two parts, the first is the attribute standards that state basic requirements for the practice of internal auditing. According with this attribute, organizations should define in a formal document or internal audit charter, the purpose, authority, and responsibility of the internal audit, and the nature of assurance and consulting services that the internal auditors will provide. Additionally, the chapter should include recognition of the definition of internal auditing, the code of ethics, and the auditing standards (IIA, 2008). The standards also state the independence and objectivity condition for internal auditors during the performance of their work. The need of freedom from conditions, bias, and subordination of judgment, or conflict of interest that impairs their ability to perform objectively, is rigorously presented in the standards. Additionally, the competencies, knowledge, and skills that an auditor must possess are described as well as the due professional care requirement for the performance of the engagement as important elements of the IIA standards. Finally, the attribute standards set requirements for continuing professional development and quality assurance for the internal audit activity (IIA, 2008). The second part of the IIA standards covers the Concepts and Theories of Auditing Concepts and Theories of Auditing Auditing has been present for years in different stage of development following the evolution of accounting. Starting since the epoch when the records were approved after a public reading, to the era when governments officials were measured by their honesty. Followed by the times of the industrial revolution were the ownership of companies started separating from management; when owners required more protection of their investments increasing the use of auditors, consequently; to the times were an auditor was always searching for frauds or errors (Whittington Pany, 2004, p. 7) and then to ascertain the actual financial condition and earnings of an enterprise (Montgomery, 1913, p. 9). However, the acceptance of auditing as an academic discipline is not old and just after the development of different concepts and techniques within the audit model such as the use of sampling, the study of the internal control environment, and the risk assessment, is when more focus to the theoretical and conceptual framework of auditing it is been devoted. Andrew Sayer (1992) discussed the concept of theories in social science from the perspective of theory as an ordering-framework (p. 50), indicating that theory allows the use of the observed data and their relationships to predict and explain empirical events. Additionally Cooper and Schindler (1998) define theory as a set of systematically interrelated concepts, definitions, and propositions that are advanced to explain and predict phenomena (facts) (p. 47). Another concept is expressed by Singleton and Straits (2005) explaining theory as a set of interconnected propositions (p. 19). The success in the explanations or predictions of any phenomena depends on the level that the theory holds and do not fails fitting in the situation, and the challenge is to perfect the process of matching theory and fact (Cooper and Schindler (1998). Different authors have started the development of the audit theory such as Mautz and Sharaf (1961) with their publication titled The Philosophy of Auditing; also Tom Lee (1986) with his approach in the book Company Auditing, and later David Flint (1988) with his book Philosophy and principles of auditing (as cited in Moizer, 1989). The auditing analysis in this demonstration will be framed on the postulates proposed by David Flint (1988) as a foundation for the theory of auditing. Flint (1988) stated that there is a matter of public accountability demanding an independent audit for its demonstration with clear definition and intention, based on evidence that only skilled auditors gather, measure it, and compare it against the standards, which generates economic or social benefit (as cited in Moizer, 1989). Following are the seven postulates or assumptions stated by Flint (1988): There is a relationship of accountability or a situation of public accountability. Accountability cannot be demonstrated without an audit. An audit requires independence and freedom. The subject matter of audit is susceptible to verification by evidence. Auditors are skilled judges who are able to measure and compare actual performance against standards of accountability. The meaning, significance, and intention of statements to be audited must be clear. An audit produces an economic or social benefit. (Flink, 1989) Whenever an economic relationship exists one of the parties owe a duty of an acceptable accountability, consequently audits are voluntary, imposed for the health of the relationship. There are also audit related to the interest of the public in matters of the society institutions. As expressed by Whittington and Pany (2004) dependable information is essential to the very existence of our society (p. 1). They explained the social need for audit and professionals who can attest that the reported information is fair respect to the reality for purpose of allocating resources for the production of services and goods based on reliable financial information (p. 1). Normally the financial and economic aspects of the related subject matter are complex, not physically accessible, or have the level of significance that necessary demand an audit to accept the accountability. No all investors or stakeholders of an entity understand the complexity of the business and financial environment, or are near to the place were their resources are to oversee for accountability. The credibility of the information is important and the preferable form of obtaining credible information to rely on is by using independent auditors to perform an audit. That reduce the business risk that relates to the permanence and profits of the company, and the information risk that the financial information used to make a decision is materially misstated (Whittington Pany, 2004, p. 6). Therefore, if the audit must add credibility it must be performed independently and without bias or prejudice. Audit is subject to verification and that is possible only if sufficient evidential matter of the audit is gathered. Additionally, some standards of accountability and performance need to be in place to easy the auditors measurement. Therefore, the parties involved must agree on their acceptable standards. The auditing community has set some professional guidance as a form of general accepted practiced standards. For an audit to add value to the financial information, the purpose of the information should be clear, and the findings effectively communicated. The audit should be performed only when its benefits weigh more than the costs. As a consequence auditors should be aware of the cost of collecting evidence especially in situation were the risk is high. The practice of auditing auditors agree on an attest engagement in which they issue or does issue an examination, a review, or an agreed-upon procedures report on subject matter or an assertion about subject matter that is the responsibility of another party (e.g., management) (Whittington Pany, 2004, p. 2). In an examination of financial statement, referred to as an audit the standards may be the Generally Accepted Accounting Principles (GAAP), and the auditors collect sufficient evidence to attest about how fair is the information in the financial statement respect to the GAAP. However, here are three types of audits: (a) audits of financial statements, (b) compliance audits, and (c) operational audits. Financial audits determine if the statements were prepared according with GAAP. Compliance audit verifies if the company had complies with law, regulations or polices and procedures. Finally, operational audits review the effectiveness and efficiency of particular unit of an organization (Whittington Pany, 2004, p. 11). Relative to the public accounting standards, the American Institute of Certified Public Accountants (AICPA) has developed the framework for the general accepted auditing standards (GAAS), which are the fundamentals principles of independent auditing in the U. S. The framework is divided in three major areas that are summarized as follow: General standards. A professional possessing adequate technical training and proficiency, independent in mental attitude and free from bias and with professional care planning and performing diligently, perform the audit. Standards of field work. The audit should be adequate planned and the staff properly supervised. Auditor should acquire sufficient understanding of the internal control environment to be able to determine the weak areas, and gather sufficient competent evidence to support their conclusions. Standards of reporting. The final report should state if the statements are consistent with GAAP and if necessary indicate those circumstances departing from GAAP, include adequate informative disclosure, and includes the opinion of the auditors about the financial statements. Likewise, the AICPA has issued a series of auditing standards on auditing procedure, auditing and accounting guides, and auditing statements of position, to help auditor in the fulfillment of their responsibility of detecting misstatement (Whittington Pany, 2004, pp. 34-35). Auditing involve a serious processes that expose auditors to a different situations in which they need to exercise professional ethics. Those moral principles and values leading decisions and actions of the profession of auditing are provided by the AICPA in the Code of Professional Conduct, and by the Institute of Internal Auditors (IIA) Code of Ethics. Normally auditors are involved in a decision process of ethical dimension. CPAs decisions during performing their duties can affect thousands of investors and their resources; therefore, they need to measure the implication of their decisions. Additionally, as Whittington and Pany (2004) indicated, what is considered unethical in a particular society is not specifically prohibited (p. 11), giving relevance and support to the need for the establishment of those principles and values in the accounting and auditing profession. The public accounting, as well as the rest of professions, has the following characteristics: (a) their responsibility to serve the public with independence and due care with fairness and free from bias. (b) Involves a complex body of knowledge that includes different authoritative pronouncements of standards and principles governing the profession and the financial reports due to the need of technical competency. (c) Has establishes some standard of admission to the profession that each CPA is required to meet. In addition (d), need public confidence to be successful (Whittington Pany, 2004, pp. 61-62). The AICPA leads public accountants to recognize their responsibility to the public in general, to their clients, and to the profession. The section one of the code of conduct describes the organization and CPAs principles of responsibilities, public interest, integrity, objectivity and independence, due care, and scope and nature of services. The section two depicts the institutes rules that are compounded by the following: independence, integrity and objectivity, general standards, compliance with standards, accounting principles, confidential client information, contingent fees, acts discreditable, advertising and other forms of solicitation, commissions and referral fees, and form of organization and name (Whittington Pany, 2004, pp. 63-83). Similarly, the IIA has their own code of ethics divided in three main sections, an introductory section, principles, and rules of conduct. Their principles apply to the profession and practice of the internal auditing, and include integrity, objectivity confidentiality, and competency. The IIA rules on conduct include integrity, objectivity, confidentiality, and competency (Whittington Pany, 2004, pp. 83-84). The IIA is the organization that provides the standards for the professional practice of internal auditing. As it can be deduced from the previous summaries, both institutes the IACPA and the IIA require high level of self-discipline and commitment to a honorable professional behavior, integrating similar principles of integrity, objectivity, and competence. Their rules differ in the fact that internal auditors perform internally; public accountants attest on the financial statements to the company as outsiders performing professionally to honor the public trust. However, the concept of independence is common to both ramification of auditing because it refers to the ability to maintain and objective and impartial mental attitude (Whittington Pany, 2004, p. 66), and without of conflict of interest. After the previous review of the auditing theory and how CPAs support it with a professional framework that includes principles, ethical codes, and general accepted standards for the auditing practice, the following section depicts a discussion of audit procedures as well as an introduction of important concepts that are fundamental part of the theory of auditing and the auditing practice. The Audit Procedures The ultimate product after the performance of an audit is the issuance of a report indicating if the financial statements audited comply with GAAP. Sufficient evidence must support the audit report and such evidence is gathered and documented by exercising rigorous procedures that, among other important goals, help the auditors in assessing the risk of misstatement. According to Whittington and Pany (2004), audit procedures involve: (a) the understanding of the client, the business, and industry to use it in assessing risks; (b) the understanding of the internal control environment; (c) the design and performance of controls testing to assess how effective the controls are in preventing or detecting material misstatements; and (d) the design and performance of substantive procedures that include analytical procedures, direct testing of transactions and ending balances (pp. 138-139). Because the internal control is the focus of interest for this demonstration, a separate section will discuss it. The substantive procedures include analytical procedures, the testing of transactions, and the testing of the ending balances on the statements. Analytical procedures consist of an analysis and evaluation of the information present in the financial statements, and a review of the relationship between financial and nonfinancial information. The assumption behind the analytical procedures is that the relationship and trend of the financial information is expected to follow the historical data and projections of the business and in contrary situation evidence must be obtained to support the reasonability of the changes (Whittington Pany, 2004, p. 141). Different techniques are use during the analytical procedures. From simple verification of a number to complicated mathematical models, such the comparison of cumulative expenses and revenues with prior years to find significant differences, the use of multiple regression model to estimate revenues by using economic and industry data, and ratio analysis and its comparison with other businesses in the same industry (Whittington Pany, 2004 (p. 141). The testing procedures seek to prove the occurrence and correct recognition of transactions, and prove of existence and misstatements on what the ending balances represent. The substantive testing procedures are performed as an interim mode before year-end, and then after the business year-end. The level of risk established by the auditors during the overall business assessment guides the extent of the substantive audit procedures. The greater the risk of material misstatement the greater the needed extent of substantive procedures (Whittington Pany, 2004, p. 139), but always keeping under evaluation the cost-benefit relation of increasing the procedures to perform. Among the most common test performed in an audit process, Whittington and Pany (2004) summarized the following: Accounting System: Comparison-Agreeing amounts from different internal records. Documentary evidence: Tracing-Establishing the completeness of transaction processing by following a transaction forward through the accounting records. Vouching-Establishing the existence or occurrence of recorded transactions by following a transaction back to supporting documents forms a subsequent processing step. Inspection-Reading or point-by-point review of a document or record (the terms examine, review, read, and scan are used to describe the inspection technique). Reconciliation-Establishing agreement between two sets of independently maintained but related records. Third-party representation: Confirmation and evaluating a response from a debtor, creditor, or other party in reply to a request for information about a particular item affecting the financial statements. Physical evidence: Physical examination-viewing physical evidence of an asset. Observation-viewing a client activity. Computations: Reperformance-repeating a client activity. This may include operations such as footing (providing the total of a vertical column of figures); cross footing (proving the total of a horizontal row of figures); and extending (re-computing by multiplication). Data interrelationships: Analytical procedures-Evaluation of financial information made by a study of expected relationships among financial and nonfinancial data. Client representations: Inquires-questions directed toward appropriate client personnel. According to Whittington and Pany (2004), auditors also collect evidence from some subjective areas such as the accounting estimates, the fair market value measurement and disclosures, and transactions with related parties (pp. 146-148). After the development of audit procedures auditors test for existence or occurrence to search for misstatements and completeness searching for understatement, from transactions start to finish, and they test the accounting system from source documents to journals to ledgers. (Whittington Pany, 2004, p. 195). The audit program includes two main parts, the assessment of the effectiveness of the client internal controls, and substantive testing. Normally the system portion of an audit program is divided by cycle such as revenue, purchasing and payments, production, payroll, investing, and financing (Whittington Pany, 2004, p. 196). Audit Risk The risk concept is use in different disciplines for different purposes. A simple definition of the concept is that: risk is the level of exposure to the chance that some event happens. The event might be beneficial or prejudicial, or might have subsequent implications to other situations or process. Therefore, in business there is a risk of losing money, a risk of fraud, and a risk of misstatement the financial information. As consequence, business and individuals manage risk and the level of exposure to specific risk according to their judgment. The audit process involves the management of risk in different areas with the goal to reduce it to the minimum level possible. Whittington and Pany (2004) introduced some of the risks concepts such as: business risk, the risk associated with a companys survival and profitability (p. 6). Information risk, the risk that the information used to assess business risk is not accurate (p. 6). Audit risk, the risk that the auditors may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated (p. 35). Inherent risk, the possibility of a material misstatement of an assertion before considering the clients internal control (p.128). Control risk, the risk that a material misstatement will not be prevented or detected on a timely basis by the clients internal control (p. 129) Detection risk, the risk that the auditors will fail to detect the misstatement with their audit procedures (p. 129). Within the audit risk, auditors assess the risk level of occurrence of the different form of misstatement of financial statement, such as errors, fraud, and illegal acts. In measuring audit risk auditors use the following model: AR = IR x CR x DR Where: AR = Audit risk, IR = Inherent risk, CR = Control risk, and DR = Detection risk. (Whittington Pany, 2004, p. 130) Additionally, because the auditors are expose to some legal responsibility and are subject to be sued by any clients stakeholder, they have to take in consideration the reputation of the management, financial strength, and other financial rating to assess the overall risk or engagement risk of the association with that particular business (Whittington Pany, 2004, p. 174). The process of planning the audit involves the understanding of the client and its environment, an overall audit strategy, and the risk assessment of financial statements material misstatement. Therefore, auditors seek to understand the nature of the client and accounting polices, the industry, regulations and external factors affecting the client, the clients objectives, strategies, and related business risk, how the client measure and review performance, and the internal control environment. (Whittington Pany, 2004, pp. 179-180). Consequently, auditors use different sources to obtain the client overall understanding. That includes electronic research tools, visit to different plant or location of the client, and some analytical procedures. (Whittington Pany, 2004, pp. 181-183). A Companys internal control consists of the policies and procedures established to provide reasonable assurance that the objectives of the company will be achieved; including the clients internal control, they could identify areas of strength as well as of weakness. The stronger the internal control, the less testing of financial statement account balances required by the auditors. For any significant account or any phase of financial operation in which controls were weak, the auditors expanded the nature and extent of their tests of the account balance. With the increased reliance on sampling and internal control, professional standards began to emphasize limitations on auditors ability to detect fraud. The profession recognized that audits designed to discover fraud would be too costly. Good internal control and surety bonds were recognized as better fraud protection techniques than audits. (Whittington Pany, 2004, p. 8) The assessment of inherent risk involves considering the likelihood that material misstatement in financial statement will result, and each risk related to the management assertions. At this stage, auditors identify what it is not correct or the significant risk by area and based on that assessment they adjust their approach, modifying the nature, timing, and extent of the audit procedures (Whittington Pany, 2004, pp. 188-189). Audit Evidence Evidence is all data and information gathered by the auditors to support auditors conclusions. The importance of the evidence is that audit risk is reduced by gathering audit evidence (Whittington Pany, 2004, p. 127) and when the risk is high more evidence is necessary as well as the increasing the coverage of audit procedures. According to Whittington and Pany (2004), evidence need to be collected for each financial statement assertion sufficiently to support their opinion. As issued in the Statement of Auditing Standard (SAS) 31 about evidential matter, the financial statement assertions are the following: Existence or occurrence-assets, liabilities, and owners equity reflected in the financial statements exist; the recorded transactions have occurred. Completeness-all transactions, assets, liabilities, and owners equity that should be presented in the financial statements are included. Rights and obligations-the client has rights to assets and obligation to pay liabilities that are included in the financial statements. Valuation or allocation-assets, liabilities, owners equity, revenues, and expenses are presented at amounts that are determined in accordance with generally accepted accounting principles. Presentation and disclosure-accounts are described and classified in the financial statements in accordance with generally accepted accounting principles, and all material disclosures are provides. (Whittington Pany, 2004, p. 174) The above assertions are the base for the risk assessment performed by auditors, and to determine misstatements possible to occur and consequently decide the audit procedure to exercise. Guidelines are included in the SAS 31 regarding what sufficient competent evidence is, which relates to the quantity of evidence auditors should collect. The competence of the evidence is determined by the combined condition of relevant and valid. That means that it most related to the assertion, and that it is dependent on the circumstance in which it is obtained. The reliability or validity of the evidence increase when is received from independent sources, when is produced by an effective internal control, gathered directly by the auditor, is documented, obtained from original documents, and when is received from more than one source (Whittington Pany, 2004, p. 132). Different types of audit evidence is obtained by the auditors such as accounting information system, internal and external documentary evidence, third-party representations such as confirmations, reports, and lawyers letters; physical evidence such as fixed assets and inventory, computations re-performance, data interrelationships of financial and nonfinancial information, and client representations oral and in writing (Whittington Pany, 2004, pp. 131-137). An important supporting evidence of the audit report and conclusions is the audit documentation, which is required by the SAS 96 for the auditors understanding and review of the audit work, the nature of audit work performed, and to show the agreement between the records and the financial statements. The working papers have some important functions: (a) are the best way to assign and coordinate the auditing work, (b) help audit managers and partners in the supervision and reviewing or the work of assistants, (c) support the audit reports, (d) documents the auditors compliance with GAAS, and (d) assist in the conduction of future audit to the client (Whittington Pany, 2004, pp. 148-150). The working papers are confidential and unrestricted documentation owned by the auditors, principally because they represent the major factor to use in case of negligence charges. Part of the working paper are the administrative working papers, the working trial balance, separate schedules, adjusting journal entries and supporting schedules, and analysis of ledgers accounts such as a reconciliation, computational working paper, corroborating documents. They are filed in two major groups, permanent file, and current files (Whittington Pany, 2004, pp. 151-158). Audit Sampling As a large-scale corporate grow rapidly auditors began to sample selected transactions, rather than study all transactions. Auditors and business managers gradually came to accept the proposition that careful examination of relatively few selected transactions would give a cost-effective, reliable indication of the accuracy of other similar transactions (Whittington Pany, 2004, p. 8). As explained before, auditors need sufficient and competent evidence to support their conclusions, but because business grows involving high volume of economic events and transactions, they need to rely in sampling testing. Audit sampling can be statistical or no statistical, involves the selection of a sample from a group of items and the use of the sample characteristics presuming that the auditors can draw inferences about the whole population. (Whittington Pany, 2004, p. 309). From the previous sampling introduction, we have the sample risk that is the risk that the auditors conclusion based on a sample might be different if they examine the whole population. According to Whittington and Pany (2004) sampling risk is reduced by increasing the size of the sample (p. 309) or by auditing the whole population. Auditors use statistical and no statistical sampling to perform a random selection, which involve that every item in the population has an equal chance of being selected for inclusion in the sample. Different techniques are used such as random number tables, random number generators, systematic selection, haphazard selection, block selection, and stratification (Whittington Pany, 2004, pp. 310-313). There is a sample risk for test of controls in which auditors face the risk of assessing control risk too high, which is related to efficiency, or too low based on the operating effectiveness of the control. The AICAP guide suggest the statistical sample sizes for tests of controls at 5 percent risk of assessing control risk too low, providing the following tolerable deviation rate per assessed level of control risk: for low 2 7%, for moderate 6 12 %, for slightly below the maximum 11 20%, and for maximum level of control risk they recommend to omit test (Whittington Pany, 2004, pp. 316-320). Besides sampling, auditors became aware of the importance of effective internal auditing. Following section presents a discussion about internal auditing. Internal Auditing The internal auditing developed rapidly during the decade of 1930s generating the foundation of the Institute of Internal Auditors (IIA), which is an organization with local chapter in the main cities worldwide. The IIA defines internal adducting as follows: An independent, objective assurance and consulting activity designed to add value and improve an organizations operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance process. (The Institute of Internal Auditors [IIA], 2008) Internal auditors are an important part of the internal control environment of entities, representing the highest level of control that measure and evaluate the effectiveness of other controls. Additionally to the financial controls, the internal auditors scope includes the evaluation and testing of control effectiveness, and other assurance and consulting services to the management. Some companies have focus on outsourcing the internal audit functions, which is also provided by CPA firms as an extended audit service and according to the AICPA guiding. However, opposition to the participation of accounting firms exist under the argument of possible conflicts of interest having then as part of the internal control when they also audit the company. The IIA have issued the standards for the practice of internal auditing with the following purpose: To delineate basic principles that represent the practice of internal auditing. Provide a framework for performing and promoting a broad range of value-added internal auditing. Establish the basis for the evaluation of internal audit performance. To foster improved organizational processes and operations. The auditing standards of the IIA includes two parts, the first is the attribute standards that state basic requirements for the practice of internal auditing. According with this attribute, organizations should define in a formal document or internal audit charter, the purpose, authority, and responsibility of the internal audit, and the nature of assurance and consulting services that the internal auditors will provide. Additionally, the chapter should include recognition of the definition of internal auditing, the code of ethics, and the auditing standards (IIA, 2008). The standards also state the independence and objectivity condition for internal auditors during the performance of their work. The need of freedom from conditions, bias, and subordination of judgment, or conflict of interest that impairs their ability to perform objectively, is rigorously presented in the standards. Additionally, the competencies, knowledge, and skills that an auditor must possess are described as well as the due professional care requirement for the performance of the engagement as important elements of the IIA standards. Finally, the attribute standards set requirements for continuing professional development and quality assurance for the internal audit activity (IIA, 2008). The second part of the IIA standards covers the

High Technology Semiconductor Company Acquisitions

High Technology Semiconductor Company Acquisitions The fast rate of technological change was one of the most important trends in the 1990s and this brought an increasing complexity and cost to the development of new technologies. Companies used their innovative assets as a major source of competitive advantage to quickly introduce new products and adopt new processes (Sen and Egelhoff, 2000). Acquisitions are completed in many industries for reasons that are aligned with the dominant competitive driving forces for that industry. In the area of high technology and seminconductors, the competitive drivers are short product life cycles and process advancement. Process advances are required to both support the incremental changes to existing products and to allow the creation of radically new one. The number of acquisitions rapidly increased through the decade for several reasons: the product life cycle was getting shorter; participating in the creation of industry and product standards was crucial; early entry helped capture market shar e; and R D risk could be reduced. Hagedoorn (1993) found the reduction in innovation time and acquisition of needed technologies as the most important reasons for one company to pursue another. Several researchers have written about the radical and incremental innovation capabilities, their distinguishing factors and the important consequences to the corporation. It has also been argued that large firms are effective with incremental innovations and small firms are better at radical innovations. (Ettlie, Bridges, and OKeefe, 1984; Dewar and Dutton, 1986; Christensen, 1992). Corporate decision to acquire or not acquire another company embodies a high level, serious management strategy decision toward repositioning a company in the competitive landscape. The decade from 1990 to 2000 was chosen as an important time for acquisition activity. There was frequent activity in acquisitions during a time of stable economic conditions creating good conditions for analysis. In 1990, the dollar value of all acquisitions and mergers in the United States was two percent of the Gross Domestic Product (GDP). In 2000, the value reached over 15% of the GDP (Mergerstat, 2003). In the first 10 months of 2000, in the technology sector alone, there were 2,019 acquisition and merger deals worth $573 billion (Reason, 2000). This occurred despite studies done in the 1980s and 1990s that found little positive effect financially for the acquiring company. The magnitude of the activity strongly suggests that some positive relationship could be found if examined in a different way o r using new metrics. This research uses a different methodology by exploring a single industry, selecting profitability growth as the metric from theoretical industry driving forces and analyzing profitability over time as a statistical repeated measures model using SPSS software. The results from this work may have strategic implications for remaining competitive in high technology, high-velocity industries. It should be noted here that the term acquisition, mergers and acquisitions and M A will be used interchangeably in this research and are defined in Appendix A along with other important terms. In high technology industries, such as semiconductors, a firm interested in new product innovation must aggressively invest to stay at the leading edge. Creating or acquiring new offerings can be dependent on a combination of efforts directed either internal or external to the company. Internal efforts include primarily Research and Development (R D) or newly formed affiliates, termed greenfields (Vermeulen Barkema, 2001; Sonenclar, 1984; Bradley Korn, 1981). External efforts can take the form of acquisition or mergers to best capture the intellectual property (IP) that is maintained in the categories of trade secret and proprietary know-how. Acquisitions, when done well, appear to have the advantage of capturing this kind of IP as compared to the other forms of external efforts. Acquisitions also potentially offer faster repositioning with less risk and lower cost than pursuing internal company endeavors (Singh Montgomery, 1987). A high technology companys success hinges on crea tion of innovative ideas, availability of creative personnel, speed of new product execution and cost effectiveness. Mergers and acquisitions are a highly favored management avenue for growth and competitive positioning. The importance of this management consideration and the impact of mergers and acquisitions continue to expand with billions of dollars involved. The importance in the technology sector becomes apparent when looking at the 724 firms that made their initial public offering (IPO) in 1992, but were not acquired or merged. Of these companies, 58% were selling at less than their IPO price six years later (Small Business Statistics, 2000). Product and service offering must constantly evolve and change (Thompson Strickland, 2001). High velocity innovation is fundamental to the growth and survival of high technology businesses. Organizations that are successful have a regular stream of unique products and services. Hewlett-Packard had over 50% of revenue in 1999 coming from products introduced in the previous two to four years. In high technology companies, the highest profit levels come from the newest products. Consequently, it is imperative to accelerate the innovation cycle, often through mergers and acquisitions, and this is critically important to remaining competitive. Entrepreneurial firms consistently outperform larger firms in both market and earnings growth on the Inc. 500 and Forbes 200 lists (Imparato Harari, 1994). There are several potential reasons for making an acquisition that have been identified and studied in the literature. In addition to the reasons for actually acquiring, there are a number of factors following the event that will influence the degree of success or failure that these efforts may experience. These elements that play a part in determining the outcome have been the focus of studies that are summarized in the Literature Review. WHAT MAKES HIGH-TECH COMPANIES AND THEIR ACQUISITIONS UNIQUE Both the popular business press as well as recent academic research seems to uniformly accept the unique nature of high-tech stocks. Kohers and Kohers (2000) state: The high-growth nature of technology-based industries distinguishes them from other types of industries. In addition to their high-growth potential, however, another distinctive feature of high-tech industries is the inherent uncertainty associated with companies whose values rely on future outcomes or developments is unproven, uncharted fields (p. 40). In fact, many pure technology stocks are young companies, underfunded and without prospects for generating any cash flows in the near future. Nevertheless, despite the inherent uncertainty of high-tech industries, investors seemed to disregard most equity fundamentals when valuing technology stocks, especially during the market upturn in the late 1990s. As a result, even though high-tech stocks were in general extremely volatile, many of them were trading at remarkable pre miums. The exploding rate of growth in M A activity that involved high-tech industries can be partly attributed to those overly optimistic valuations. Puranam (2001) argues: On the acquirers side, booming stock market valuations have made acquisitions for stock feasible for several relatively small (revenue wise) firms, as well as the more established larger ones. On the targets side, an increasing preference for the ready liquidity offered, by an acquisition, as opposed to the paper profits from an IPO have created an environment conducive to acquisitions of small start-ups. At the same time many of these acquisitions were also motivated by the acquirers need to obtain critical technologies and expertise in order to quickly enhance their own technological competence. Despite the burst of the high-tech market bubble and the failure of most of these acquisitions, investors continue to show an extreme faith on these stocks. Americans still believe that technology can create a better world. Each time the U.S. tech sector falls into a trough, new technologies and companies emerge to lead it forward again (Business Week, August 27, 2001). PROBLEM MOTIVATING THIS STUDY This research effort seeks to understand the relationship between acquisitions and profitability by looking at the industrial sector for high technology semiconductor companies. Many prior studies have shown little financial benefit to the acquiring company in research conducted beginning in the 1980s and extending to today using a variety of variables, measures and company sample selection. These studies will be discussed in more detail in the Literature Review. The researchers Rumelt (1984), Ravenscraft and Scherer (1987), Porter (1987) and Kaplan and Weisbach (1990) separately found that acquisitions that could be categorized as unrelated, or diversifications, did not lead to profitability improvements, but most of these studies obviously included a cross-section of divergent industries. The importance of innovation and new products in high velocity, competitive environments is discussed in literature and high velocity innovation is fundamental to the growth, profitability and sur vival of these businesses (Thompson and Strickland, 1999; Betz, 2001; Burgelman, Christensen and Wheelwright, 2004). The competitive advantage of capturing intellectual property through acquisition has also been discussed more recently. More clear evidence is beginning to emerge concerning the drive to acquire technology and the unique features of doing so (Prentice Fox, 2002). This research examines the correlation between the event of acquisition and subsequent company performance and growth of profitability in the decade of 1990-2000. Practicing managers in the area of management of technology are faced with the challenge of high velocity innovation being a requirement to maintain competitive positioning (Thompson Strickland, 2001). Two methods for constant innovation include internal efforts, such as Research Development (R D), and external efforts, such as acquisitions, on which this paper focuses. Prior studies have been cross-sectional across different industries and analyzed the benefits gained in terms of patents and R D (Bettis 1981), stock price (Matsusaka, 1990; Schleifer and Vishny, 1990; and Lubatkin, 1982) or increase in company size versus the cost of acquisitions. These studies have not captured one of the most unique features of the high technology industry where innovation and new products are dependent on intellectual property (IP) that is maintained in the categories of trade secret and proprietary know-how. Because of this characteristic, the high technology industry would be expected to yield different results. The importance of IP and know-how has been an area of academic focus working to clarify the concept of absorptive capacity in the 1990s, but empirical work to tie these concepts to firm performance was not pursued (Cohen and Levinthal, 1990; Barney, 1991; Prahalad and Hamel, 1990). The use of patents as a measure, as used in prior research (Acs and Aud retsch, 1988; Pakes and Griliches, 1980; Hitt, Hoskisson, Ireland and Harrison, 1991), does not capture the IP benefits in these categories or measure the success resulting from these external efforts. Acquisitions, when done well, should be expected to have an advantage on capturing this kind of IP. Acquisitions potentially offer faster positioning with less risk and lower cost than internal company endeavors which include primarily Research and Development (R D) (Gulati, 1995; Singh Montgomery, 1987). STUDY OVERVIEW This research effort focuses on one high technology industrial sector of semiconductors and studies the correlation between acquisitions, profitability, survivability and RD intensity over time. Many prior studies (Rumelt, 1984; Ravenscraft and Scherer, 1987; Porter, 1987; and Kaplan and Weisbach, 1990) have shown little financial benefit to the acquiring company, but most of these studies included a cross-section of divergent industries. The importance of innovation and new products in high velocity, competitive environments is widely discussed in literature. High velocity innovation is fundamental for the theory of growth, profitability and survival of these businesses. The competitive advantage of capturing intellectual property through acquisition has also been discussed more recently. More clear evidence is beginning to emerge concerning the drive to acquire technology and the unique features of doing so (Prentice Fox, 2002). This paper researches the correlation between the ev ent of acquisition and subsequent company performance, survivability, the growth of profitability and R D spending. CHAPTER 2 LITERATURE REVIEW ON HIGH-TECH COMPANIES Most research on high-tech companies is relatively recent and has its origin in various business fields. Chaudhuri and Tabrizi (1999) study the practices of 24 high-tech companies involved in acquisitions, and try to identify the key factors in capturing the real value in high-tech acquisitions. They conclude that in order to make a successful acquisition managers need to move beyond the traditional model of acquisitions where the people acquired are secondary to physical assets and brands. High-tech acquisitions need to focus on the people since technological capabilities tied to skilled people are the key to long-term success in these industries. Arora, Fosfuri and Gambardella (2000) examine how the growth of markets for technology affected the corporate strategies of the leading companies, which can now sell technologies that they do not use in-house and increase their potential returns to R D. They argue that globalization, along with the low transportation costs of technologies, has made large R D intensive companies realize that they have the potential to exploit their technology on a very large scale by licensing. However, in deciding how to exploit their technology small firms and technology-based startups face a different set of challenges. According to the authors they need to trade off the costs of acquiring capital and building in-house production, distribution and marketing capability against the rents that would be lost or shared with their partners in a licensing deal. Also, the authors argue that integration may reduce the innovative potential of the firm, because the acquisition of the complementary assets in evitably increases the size of firms and induces important changes in the culture of the firm and in the speed and fluidity of information flows. Finally, they claim that evaluating technologies and being able to use them requires substantial in-house scientific and technological expertise and therefore internal and external R D can be reviewed as complements and not substitutes. Liu (2000) focuses on a different issue by examining the markets reaction to innovation news announcement made by the U.S. biotech firms during the 1983-1992 period. He finds that the average AR to the announcements is as high as 3.98 percent for a three-day event window and biotech stocks trading volumes almost double on the day of the news announcement. The announcement period ARs are negatively related to firm-size and underwriter reputation, while positively related to the firms technology depth as measured by R D intensity. However, during the months following the announcement the average three-month post announcement AR is 2.73 percent. The negative drift in stock prices appears to be mainly driven by the firms weak science and technology (less R D intensive), firms with high Book to Market (B/M) ratios and large firms. In explaining his findings the author proposes an expectation error hypothesis. According to this hypothesis it is hard for investors or even managers to prec isely evaluate the economic value of innovations which in turn leads to the possibility of forming erroneous expectations. In high-tech industries the erroneous expectation is reflected in the investors over-optimism towards high-tech firms innovation news. Eventually, the stock prices adjust itself to reflect the firms fundamentals, especially its technology depth. The author attributes the observed evidence to the costly information required to value a high-tech firms innovation. Prentice and Fox (2002) provide a comprehensive review of the merger and acquisition process while focusing on the distinctive characteristics of high-tech companies. They argue that technology mergers are different from traditional mergers because of the importance that must be placed on people and their ability to innovate. Targets must be evaluated on intangible assets such as intellectual property and human capital. At the same time managers need to consider the issues of retention, culture and integration strategy from the beginning of the merger process to ensure success. There are two studies that are most relevant to this research. The first one is by Kohers and Kohers (2000) who examine the value creation potential of 1,634 mergers in the various high-tech areas between 1987 and 1996. They find that acquirers of high-tech targets experience significantly positive Ars at the time of the merger announcement, regardless of whether the merger is financed with cash or stock. Othe r factors influencing bidder returns are the time period in which the merger occurs, the ownership structure of the acquirer, the ownership status of the target and the high-tech affiliation of acquirers. They conclude that the market appears to be optimistic about such mergers and expects that acquiring companies will enjoy future growth benefits. The second related study is also by Kohers and Kohers (2001) who examine the post-merger performance of acquirers that purchase high-tech targets in order to determine whether the high expectations regarding the future merits of these investments are actually justified. Their results indicate that compared to non acquirers, acquirers perform poorly over the three-year period following the high-tech takeover announcement. Furthermore, glamour bidders show significantly lower long-run ARs, while value bidders do not experience significant post-merger ARs. Also, glamour bidders with a higher risk of agency problems show even worse post-merger performance while institutional ownership in the acquiring firm has a positive influence on acquirer long run ARs. Overall, the authors conclude that the market tends to exhibit excessive enthusiasm toward the expected benefits of high-tech mergers but many of these benefits do not materialize. CHAPTER 3 HYPOTHESES, METHODOLOGY AND DATA SOURCES STATEMENT OF HYPOTHESES Previous research in the literature has generally found little financial benefit for the acquiring companies that were associated with occurrence of the acquisition activity (Rumelt, 1974; Ravenscraft and Scherer, 1987; Porter, 1987; and Kaplan and Weisbach, 1990). Consequently, the first and second questions for this study are focused using the single industry of semiconductors, are stated in the null hypothesis format. First, firm profitability growth rates are compared in two groups, one that does acquire and one that does not. Secondly, individual firm profitability growth is examined before and after an acquisition event looking for a change in growth rate that is significant. Hypothesis 1 (H1): There will be no significant difference in profitability growth when firms making acquisitions are compared to firms not making acquisitions in the high-tech sector. Hypothesis 2 (H2): Acquiring firms making acquisitions are expected to have no significant change in profitability growth before and after the acquisition event. The literature yields less empirical work in analyzing the relationship between merger and acquisition actions and the longevity of a corporation. Theory certainly recognizes the close link between competitive capability and company survival. For the high technology industry of semiconductors, high velocity innovation is a requirement for remaining competitive. Research questions three and four are also stated in the null hypothesis format. Company longevity, or survival rate in number of year, is compared in two groups also, where one group does acquire and one does not. Lastly, an individual firms spending rate on R D is examined before and after an acquisition event looking for a significant change in the rate compared to the trend for the company. Hypothesis 3 (H3): Firms making acquisitions are expected to have no difference in survivability in this industry than firms who do not make acquisitions. Hypothesis 4 (H4): A companys R D intensity will show no significant change following the event of acquisition within this industry. SELECTION OF VARIABLES This research was conducted in a concentric approach by starting with one independent and one dependent variable initially to define the relationship and guide the next treatment in the study. As work continued, variables were selected and the methodology expanded to assess both within-subject and between-subject effects. The variables used in this study for Hypothesis 1 (H1) include profitability growth rate and a dummy variable to represent the presence or absence of the event of acquisition. The event of acquisition is represented by a dummy variable with a zero (0) representing no acquisition and with a one (1) representing an acquisition event. An acquisition event is identified by using a firms reported cash flows attributed to acquisition as stated in the Compustat database. The profitability growth rate is calculated from the total gross profit margin reported by year and cumulated over three years, then averaged to reduce fluctuations and facilitate identification of trends. The variables used for H2 analysis of profitability growth rate before and after an acquisition were the dummy variable for the presence of acquisition, the gross profit margin percentage (GPM %) calculated as a three (3) year cumulative average growth rate (CAGR) to smooth fluctuations and better identify a trend. This relationship was studied for three (3) years prior to the actual acquisition and five (5) years following the action. As the study progressed, a second dummy variable was used for company size to separate the effect of this independent variable as well. A repeated measures matrix was designed with two dummy independent variable as well. A repeated measures matrix was designed with two dummy independent variables, each with two levels and one dependent variable with repeated measures over nine years for a 2 x 2 x 9 repeated measures analysis using the SPPS software. The variables used for H3 analysis of acquisition relation to firm longevity were the acquisition dummy variable and the data from Compustat for the number of years that the company did financial reporting during the period of this study. H4 looks for the effects between acquisition and RD spending or intensity by using the acquisition dummy independent variable and R D intensity as the dependent variable. R D intensity is calculated using the R D expense reported as such by the companies and in the Compustat database. This Compustat item represents all costs incurred during the year that relate to the development of new products or services. This amount is only the company`s contribution and includes software and amortization of software costs and complies with Financial Accounting Standard Board (FASB) standards. This item excludes customer or government-sponsored research and development (including reimbursable indirect costs) and ordinary engineering expenses for routine, ongoing efforts to define, enrich, or improve the qualities of existing products. Methodology This study encompasses the time period of ten years from 1990-2000, inclusive. Semiconductor companies were selected as an entire group according to their NAICS/SIC codes. Using the Standard Poors Compustat database, there are 153 semiconductor companies included that were identified as active companies at the end of the calendar year 2000 by Compustat. These companies are listed in Appendix B. Active reporting for one year. Companies are designated as inactive and reclassified in the Compustat database when it is no longer actively traded on a stock market exchange due to bankruptcy, becoming a private company, leveraged buyout or merging. The research effort started with analysis one independent variable and one dependent variable in order to initially establish what the relationship was that existed, if it was significant and how to proceed with analysis. Exploratory work on Hypothesis 1 showed that there was a statistically significant and positive correlation between acquisitions and gross profit margin (GMP) growth broadly over the decade which differs from prior research. Hypothesis 2 moves toward a more detailed analysis of this finding. Consequently, in this chronology of discovery, the next step presented in Section 4.2 look at one dependent variable of profit margin growth and two independent variables of company size and acquisition activity. 3-way ANNOVA and regression treatments of the data are conducted using the data analysis tool available under Microsoft Excel Software looking at individual years in the ten year study period. The results show significance again and suggest that other interactions betwe en variables would yield additional understanding. The next step in the research was set up to look at one dependent variable, again gross margin (GPM) growth, repeatedly measured over time for each subject or company was entered for the nine (9) years 1995-2000 inclusive to capture acquisition effects giving 2 x 2 x 9 repeated measures design. The two independent variables were used in the dummy format with non-acquires given a code zero 0 and acquires assigned at one (1). Company size was the second dummy variable with firms less than $100M in sales per year coded zero (0) and if greater than $100M in sales, assigned a one (1). The statistical analysis using a repeated measures design analyzed the variable interactions and their relationship to GPM growth using the SPSS software. These results are presented in Section 4.5 Repeated Measures Analysis that was done using SPSS software. Descriptive statistics were an important first treatment of the data sets created. This includes the values for the following parameters: mean, median, range variance, standard deviation, kurtosis, and skewness. This treatment looks at characteristics of the data and the degree of normal distribution. The 3-way ANOVA investigations and regression treatment of the data were initially done using the data analysis tool software available in Microsoft Excel. Generally, the data sets for this study vary somewhat from the classical normal distribution, but ANOVA and MANOVA (multivariate ANOVA) within a repeated measures analysis are considered robust to violations of the normal distribution assumption (Maxwell Dealney, 1990; Stevens, 1996) SPSS Advanced Models 11.0 software was used to create general linear models of the data and conduct analysis of variance (ANOVA), regression, and analysis of covariance (ANCOVA) for the multiple variables in this model with repeated measures. The factors or independent variables were used to divide the population of 153 active semiconductor companies into groups. There were two independent variables used that were designated as dummy variables. The first variable of acquisition separated companies that did complete acquisitions from those that did not complete acquisitions during the decade of study. The second variable grouped the companies by size of sales at the end of the decade by either greater than $100 million or less than $100 million. Then the general linear model procedure was used to test the four null hypotheses, as stated above, regarding the effects of the independent variables on the dependent variable of gross profit margin growth as a repeated measure over the perio d 1992-2000. The investigation included looking at interactions between factors as well as the individual factors and the effects and interactions of covariates. This model specifies the independent variables as covariates for regression analysis. The SPSS repeated measures model creates a matrix for the sums of squares due to the model effects, gives the approximate F statistics and estimates parameters in addition to testing hypotheses. When an F test shows significance, SPSS performs post hoc tests to evaluate the differences between the means. This yields a predicted mean value for the cells of the model. Analysis of variance (ANOVA) was applied to named variables to study the portion of variance in the each variable that could be identified as explained and unexpected with regard to the event of acquisition. A covariance tool was also used when looking at the variables described above such as acquisition occurrence, company size and profitability growth changes. This compares whether the two ranges of data move together à ¢Ã¢â€š ¬Ã¢â‚¬Å" that is, whether large values of one set were associated with large values of the other (positive covariance), whether small values of one set were associated with large values of the other (negative covariance), or whether values in both sets were unrelated (covariance near zero). DATA SOURCES Standard Poors Compustat database was used for data collection in this research. The database contains fundamental financial, statistical and market data derived from publicity traded companies trading on the NYSE, NASDAQ, AMEX, OTC and Canadian stock exchanges. The calendar year for a company is the year in which the fiscal year ends and is the time period used as standard in this research. Companies with fiscal years ending in January through May are assigned by Compustant into the year in which the fiscal year begins. Companies with fiscal years that end in June through December are assigned to the year in which the fiscal year ends. The EDGAR (Electronic Data Gathering, Analysis and Retrieval) System database maintained by the United Stated Security and Exchange Commission (SEC) was also used. The EDGAR data is also collected from the same sources that are used to generate the Compustat database. Data from these controlled and verifiable sources were corroborated and augmented with information collected from semiconductor trade journals, company annual reports and the Mergers Acquisitions Journal that tracks statistics in this area. CHAPTER 4 RESULTS AND DISCUSSION HI à ¢Ã¢â€š ¬Ã¢â‚¬Å" ACQUISITON AND PROFITABILITY RELATIONSHIP A strong positive relationship was found to exist between the presence of acquisition activity and the growth in gross profit margin (GPM) by the end of the ten year study period. The statistical analysis is detailed below and is a departure from previous findings. This finding addresses the central question of this research endeavor to look for a relationship between acquisition events and profitability growth within the one industry of semiconductors. A positive financial effect is found and opens the path for additional analysis in this direction. Consequently, this information forms the foundation for the additional work presented in this research. >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> High Technology Semiconductor Company Acquisitions High Technology Semiconductor Company Acquisitions The fast rate of technological change was one of the most important trends in the 1990s and this brought an increasing complexity and cost to the development of new technologies. Companies used their innovative assets as a major source of competitive advantage to quickly introduce new products and adopt new processes (Sen and Egelhoff, 2000). Acquisitions are completed in many industries for reasons that are aligned with the dominant competitive driving forces for that industry. In the area of high technology and seminconductors, the competitive drivers are short product life cycles and process advancement. Process advances are required to both support the incremental changes to existing products and to allow the creation of radically new one. The number of acquisitions rapidly increased through the decade for several reasons: the product life cycle was getting shorter; participating in the creation of industry and product standards was crucial; early entry helped capture market shar e; and R D risk could be reduced. Hagedoorn (1993) found the reduction in innovation time and acquisition of needed technologies as the most important reasons for one company to pursue another. Several researchers have written about the radical and incremental innovation capabilities, their distinguishing factors and the important consequences to the corporation. It has also been argued that large firms are effective with incremental innovations and small firms are better at radical innovations. (Ettlie, Bridges, and OKeefe, 1984; Dewar and Dutton, 1986; Christensen, 1992). Corporate decision to acquire or not acquire another company embodies a high level, serious management strategy decision toward repositioning a company in the competitive landscape. The decade from 1990 to 2000 was chosen as an important time for acquisition activity. There was frequent activity in acquisitions during a time of stable economic conditions creating good conditions for analysis. In 1990, the dollar value of all acquisitions and mergers in the United States was two percent of the Gross Domestic Product (GDP). In 2000, the value reached over 15% of the GDP (Mergerstat, 2003). In the first 10 months of 2000, in the technology sector alone, there were 2,019 acquisition and merger deals worth $573 billion (Reason, 2000). This occurred despite studies done in the 1980s and 1990s that found little positive effect financially for the acquiring company. The magnitude of the activity strongly suggests that some positive relationship could be found if examined in a different way o r using new metrics. This research uses a different methodology by exploring a single industry, selecting profitability growth as the metric from theoretical industry driving forces and analyzing profitability over time as a statistical repeated measures model using SPSS software. The results from this work may have strategic implications for remaining competitive in high technology, high-velocity industries. It should be noted here that the term acquisition, mergers and acquisitions and M A will be used interchangeably in this research and are defined in Appendix A along with other important terms. In high technology industries, such as semiconductors, a firm interested in new product innovation must aggressively invest to stay at the leading edge. Creating or acquiring new offerings can be dependent on a combination of efforts directed either internal or external to the company. Internal efforts include primarily Research and Development (R D) or newly formed affiliates, termed greenfields (Vermeulen Barkema, 2001; Sonenclar, 1984; Bradley Korn, 1981). External efforts can take the form of acquisition or mergers to best capture the intellectual property (IP) that is maintained in the categories of trade secret and proprietary know-how. Acquisitions, when done well, appear to have the advantage of capturing this kind of IP as compared to the other forms of external efforts. Acquisitions also potentially offer faster repositioning with less risk and lower cost than pursuing internal company endeavors (Singh Montgomery, 1987). A high technology companys success hinges on crea tion of innovative ideas, availability of creative personnel, speed of new product execution and cost effectiveness. Mergers and acquisitions are a highly favored management avenue for growth and competitive positioning. The importance of this management consideration and the impact of mergers and acquisitions continue to expand with billions of dollars involved. The importance in the technology sector becomes apparent when looking at the 724 firms that made their initial public offering (IPO) in 1992, but were not acquired or merged. Of these companies, 58% were selling at less than their IPO price six years later (Small Business Statistics, 2000). Product and service offering must constantly evolve and change (Thompson Strickland, 2001). High velocity innovation is fundamental to the growth and survival of high technology businesses. Organizations that are successful have a regular stream of unique products and services. Hewlett-Packard had over 50% of revenue in 1999 coming from products introduced in the previous two to four years. In high technology companies, the highest profit levels come from the newest products. Consequently, it is imperative to accelerate the innovation cycle, often through mergers and acquisitions, and this is critically important to remaining competitive. Entrepreneurial firms consistently outperform larger firms in both market and earnings growth on the Inc. 500 and Forbes 200 lists (Imparato Harari, 1994). There are several potential reasons for making an acquisition that have been identified and studied in the literature. In addition to the reasons for actually acquiring, there are a number of factors following the event that will influence the degree of success or failure that these efforts may experience. These elements that play a part in determining the outcome have been the focus of studies that are summarized in the Literature Review. WHAT MAKES HIGH-TECH COMPANIES AND THEIR ACQUISITIONS UNIQUE Both the popular business press as well as recent academic research seems to uniformly accept the unique nature of high-tech stocks. Kohers and Kohers (2000) state: The high-growth nature of technology-based industries distinguishes them from other types of industries. In addition to their high-growth potential, however, another distinctive feature of high-tech industries is the inherent uncertainty associated with companies whose values rely on future outcomes or developments is unproven, uncharted fields (p. 40). In fact, many pure technology stocks are young companies, underfunded and without prospects for generating any cash flows in the near future. Nevertheless, despite the inherent uncertainty of high-tech industries, investors seemed to disregard most equity fundamentals when valuing technology stocks, especially during the market upturn in the late 1990s. As a result, even though high-tech stocks were in general extremely volatile, many of them were trading at remarkable pre miums. The exploding rate of growth in M A activity that involved high-tech industries can be partly attributed to those overly optimistic valuations. Puranam (2001) argues: On the acquirers side, booming stock market valuations have made acquisitions for stock feasible for several relatively small (revenue wise) firms, as well as the more established larger ones. On the targets side, an increasing preference for the ready liquidity offered, by an acquisition, as opposed to the paper profits from an IPO have created an environment conducive to acquisitions of small start-ups. At the same time many of these acquisitions were also motivated by the acquirers need to obtain critical technologies and expertise in order to quickly enhance their own technological competence. Despite the burst of the high-tech market bubble and the failure of most of these acquisitions, investors continue to show an extreme faith on these stocks. Americans still believe that technology can create a better world. Each time the U.S. tech sector falls into a trough, new technologies and companies emerge to lead it forward again (Business Week, August 27, 2001). PROBLEM MOTIVATING THIS STUDY This research effort seeks to understand the relationship between acquisitions and profitability by looking at the industrial sector for high technology semiconductor companies. Many prior studies have shown little financial benefit to the acquiring company in research conducted beginning in the 1980s and extending to today using a variety of variables, measures and company sample selection. These studies will be discussed in more detail in the Literature Review. The researchers Rumelt (1984), Ravenscraft and Scherer (1987), Porter (1987) and Kaplan and Weisbach (1990) separately found that acquisitions that could be categorized as unrelated, or diversifications, did not lead to profitability improvements, but most of these studies obviously included a cross-section of divergent industries. The importance of innovation and new products in high velocity, competitive environments is discussed in literature and high velocity innovation is fundamental to the growth, profitability and sur vival of these businesses (Thompson and Strickland, 1999; Betz, 2001; Burgelman, Christensen and Wheelwright, 2004). The competitive advantage of capturing intellectual property through acquisition has also been discussed more recently. More clear evidence is beginning to emerge concerning the drive to acquire technology and the unique features of doing so (Prentice Fox, 2002). This research examines the correlation between the event of acquisition and subsequent company performance and growth of profitability in the decade of 1990-2000. Practicing managers in the area of management of technology are faced with the challenge of high velocity innovation being a requirement to maintain competitive positioning (Thompson Strickland, 2001). Two methods for constant innovation include internal efforts, such as Research Development (R D), and external efforts, such as acquisitions, on which this paper focuses. Prior studies have been cross-sectional across different industries and analyzed the benefits gained in terms of patents and R D (Bettis 1981), stock price (Matsusaka, 1990; Schleifer and Vishny, 1990; and Lubatkin, 1982) or increase in company size versus the cost of acquisitions. These studies have not captured one of the most unique features of the high technology industry where innovation and new products are dependent on intellectual property (IP) that is maintained in the categories of trade secret and proprietary know-how. Because of this characteristic, the high technology industry would be expected to yield different results. The importance of IP and know-how has been an area of academic focus working to clarify the concept of absorptive capacity in the 1990s, but empirical work to tie these concepts to firm performance was not pursued (Cohen and Levinthal, 1990; Barney, 1991; Prahalad and Hamel, 1990). The use of patents as a measure, as used in prior research (Acs and Aud retsch, 1988; Pakes and Griliches, 1980; Hitt, Hoskisson, Ireland and Harrison, 1991), does not capture the IP benefits in these categories or measure the success resulting from these external efforts. Acquisitions, when done well, should be expected to have an advantage on capturing this kind of IP. Acquisitions potentially offer faster positioning with less risk and lower cost than internal company endeavors which include primarily Research and Development (R D) (Gulati, 1995; Singh Montgomery, 1987). STUDY OVERVIEW This research effort focuses on one high technology industrial sector of semiconductors and studies the correlation between acquisitions, profitability, survivability and RD intensity over time. Many prior studies (Rumelt, 1984; Ravenscraft and Scherer, 1987; Porter, 1987; and Kaplan and Weisbach, 1990) have shown little financial benefit to the acquiring company, but most of these studies included a cross-section of divergent industries. The importance of innovation and new products in high velocity, competitive environments is widely discussed in literature. High velocity innovation is fundamental for the theory of growth, profitability and survival of these businesses. The competitive advantage of capturing intellectual property through acquisition has also been discussed more recently. More clear evidence is beginning to emerge concerning the drive to acquire technology and the unique features of doing so (Prentice Fox, 2002). This paper researches the correlation between the ev ent of acquisition and subsequent company performance, survivability, the growth of profitability and R D spending. CHAPTER 2 LITERATURE REVIEW ON HIGH-TECH COMPANIES Most research on high-tech companies is relatively recent and has its origin in various business fields. Chaudhuri and Tabrizi (1999) study the practices of 24 high-tech companies involved in acquisitions, and try to identify the key factors in capturing the real value in high-tech acquisitions. They conclude that in order to make a successful acquisition managers need to move beyond the traditional model of acquisitions where the people acquired are secondary to physical assets and brands. High-tech acquisitions need to focus on the people since technological capabilities tied to skilled people are the key to long-term success in these industries. Arora, Fosfuri and Gambardella (2000) examine how the growth of markets for technology affected the corporate strategies of the leading companies, which can now sell technologies that they do not use in-house and increase their potential returns to R D. They argue that globalization, along with the low transportation costs of technologies, has made large R D intensive companies realize that they have the potential to exploit their technology on a very large scale by licensing. However, in deciding how to exploit their technology small firms and technology-based startups face a different set of challenges. According to the authors they need to trade off the costs of acquiring capital and building in-house production, distribution and marketing capability against the rents that would be lost or shared with their partners in a licensing deal. Also, the authors argue that integration may reduce the innovative potential of the firm, because the acquisition of the complementary assets in evitably increases the size of firms and induces important changes in the culture of the firm and in the speed and fluidity of information flows. Finally, they claim that evaluating technologies and being able to use them requires substantial in-house scientific and technological expertise and therefore internal and external R D can be reviewed as complements and not substitutes. Liu (2000) focuses on a different issue by examining the markets reaction to innovation news announcement made by the U.S. biotech firms during the 1983-1992 period. He finds that the average AR to the announcements is as high as 3.98 percent for a three-day event window and biotech stocks trading volumes almost double on the day of the news announcement. The announcement period ARs are negatively related to firm-size and underwriter reputation, while positively related to the firms technology depth as measured by R D intensity. However, during the months following the announcement the average three-month post announcement AR is 2.73 percent. The negative drift in stock prices appears to be mainly driven by the firms weak science and technology (less R D intensive), firms with high Book to Market (B/M) ratios and large firms. In explaining his findings the author proposes an expectation error hypothesis. According to this hypothesis it is hard for investors or even managers to prec isely evaluate the economic value of innovations which in turn leads to the possibility of forming erroneous expectations. In high-tech industries the erroneous expectation is reflected in the investors over-optimism towards high-tech firms innovation news. Eventually, the stock prices adjust itself to reflect the firms fundamentals, especially its technology depth. The author attributes the observed evidence to the costly information required to value a high-tech firms innovation. Prentice and Fox (2002) provide a comprehensive review of the merger and acquisition process while focusing on the distinctive characteristics of high-tech companies. They argue that technology mergers are different from traditional mergers because of the importance that must be placed on people and their ability to innovate. Targets must be evaluated on intangible assets such as intellectual property and human capital. At the same time managers need to consider the issues of retention, culture and integration strategy from the beginning of the merger process to ensure success. There are two studies that are most relevant to this research. The first one is by Kohers and Kohers (2000) who examine the value creation potential of 1,634 mergers in the various high-tech areas between 1987 and 1996. They find that acquirers of high-tech targets experience significantly positive Ars at the time of the merger announcement, regardless of whether the merger is financed with cash or stock. Othe r factors influencing bidder returns are the time period in which the merger occurs, the ownership structure of the acquirer, the ownership status of the target and the high-tech affiliation of acquirers. They conclude that the market appears to be optimistic about such mergers and expects that acquiring companies will enjoy future growth benefits. The second related study is also by Kohers and Kohers (2001) who examine the post-merger performance of acquirers that purchase high-tech targets in order to determine whether the high expectations regarding the future merits of these investments are actually justified. Their results indicate that compared to non acquirers, acquirers perform poorly over the three-year period following the high-tech takeover announcement. Furthermore, glamour bidders show significantly lower long-run ARs, while value bidders do not experience significant post-merger ARs. Also, glamour bidders with a higher risk of agency problems show even worse post-merger performance while institutional ownership in the acquiring firm has a positive influence on acquirer long run ARs. Overall, the authors conclude that the market tends to exhibit excessive enthusiasm toward the expected benefits of high-tech mergers but many of these benefits do not materialize. CHAPTER 3 HYPOTHESES, METHODOLOGY AND DATA SOURCES STATEMENT OF HYPOTHESES Previous research in the literature has generally found little financial benefit for the acquiring companies that were associated with occurrence of the acquisition activity (Rumelt, 1974; Ravenscraft and Scherer, 1987; Porter, 1987; and Kaplan and Weisbach, 1990). Consequently, the first and second questions for this study are focused using the single industry of semiconductors, are stated in the null hypothesis format. First, firm profitability growth rates are compared in two groups, one that does acquire and one that does not. Secondly, individual firm profitability growth is examined before and after an acquisition event looking for a change in growth rate that is significant. Hypothesis 1 (H1): There will be no significant difference in profitability growth when firms making acquisitions are compared to firms not making acquisitions in the high-tech sector. Hypothesis 2 (H2): Acquiring firms making acquisitions are expected to have no significant change in profitability growth before and after the acquisition event. The literature yields less empirical work in analyzing the relationship between merger and acquisition actions and the longevity of a corporation. Theory certainly recognizes the close link between competitive capability and company survival. For the high technology industry of semiconductors, high velocity innovation is a requirement for remaining competitive. Research questions three and four are also stated in the null hypothesis format. Company longevity, or survival rate in number of year, is compared in two groups also, where one group does acquire and one does not. Lastly, an individual firms spending rate on R D is examined before and after an acquisition event looking for a significant change in the rate compared to the trend for the company. Hypothesis 3 (H3): Firms making acquisitions are expected to have no difference in survivability in this industry than firms who do not make acquisitions. Hypothesis 4 (H4): A companys R D intensity will show no significant change following the event of acquisition within this industry. SELECTION OF VARIABLES This research was conducted in a concentric approach by starting with one independent and one dependent variable initially to define the relationship and guide the next treatment in the study. As work continued, variables were selected and the methodology expanded to assess both within-subject and between-subject effects. The variables used in this study for Hypothesis 1 (H1) include profitability growth rate and a dummy variable to represent the presence or absence of the event of acquisition. The event of acquisition is represented by a dummy variable with a zero (0) representing no acquisition and with a one (1) representing an acquisition event. An acquisition event is identified by using a firms reported cash flows attributed to acquisition as stated in the Compustat database. The profitability growth rate is calculated from the total gross profit margin reported by year and cumulated over three years, then averaged to reduce fluctuations and facilitate identification of trends. The variables used for H2 analysis of profitability growth rate before and after an acquisition were the dummy variable for the presence of acquisition, the gross profit margin percentage (GPM %) calculated as a three (3) year cumulative average growth rate (CAGR) to smooth fluctuations and better identify a trend. This relationship was studied for three (3) years prior to the actual acquisition and five (5) years following the action. As the study progressed, a second dummy variable was used for company size to separate the effect of this independent variable as well. A repeated measures matrix was designed with two dummy independent variable as well. A repeated measures matrix was designed with two dummy independent variables, each with two levels and one dependent variable with repeated measures over nine years for a 2 x 2 x 9 repeated measures analysis using the SPPS software. The variables used for H3 analysis of acquisition relation to firm longevity were the acquisition dummy variable and the data from Compustat for the number of years that the company did financial reporting during the period of this study. H4 looks for the effects between acquisition and RD spending or intensity by using the acquisition dummy independent variable and R D intensity as the dependent variable. R D intensity is calculated using the R D expense reported as such by the companies and in the Compustat database. This Compustat item represents all costs incurred during the year that relate to the development of new products or services. This amount is only the company`s contribution and includes software and amortization of software costs and complies with Financial Accounting Standard Board (FASB) standards. This item excludes customer or government-sponsored research and development (including reimbursable indirect costs) and ordinary engineering expenses for routine, ongoing efforts to define, enrich, or improve the qualities of existing products. Methodology This study encompasses the time period of ten years from 1990-2000, inclusive. Semiconductor companies were selected as an entire group according to their NAICS/SIC codes. Using the Standard Poors Compustat database, there are 153 semiconductor companies included that were identified as active companies at the end of the calendar year 2000 by Compustat. These companies are listed in Appendix B. Active reporting for one year. Companies are designated as inactive and reclassified in the Compustat database when it is no longer actively traded on a stock market exchange due to bankruptcy, becoming a private company, leveraged buyout or merging. The research effort started with analysis one independent variable and one dependent variable in order to initially establish what the relationship was that existed, if it was significant and how to proceed with analysis. Exploratory work on Hypothesis 1 showed that there was a statistically significant and positive correlation between acquisitions and gross profit margin (GMP) growth broadly over the decade which differs from prior research. Hypothesis 2 moves toward a more detailed analysis of this finding. Consequently, in this chronology of discovery, the next step presented in Section 4.2 look at one dependent variable of profit margin growth and two independent variables of company size and acquisition activity. 3-way ANNOVA and regression treatments of the data are conducted using the data analysis tool available under Microsoft Excel Software looking at individual years in the ten year study period. The results show significance again and suggest that other interactions betwe en variables would yield additional understanding. The next step in the research was set up to look at one dependent variable, again gross margin (GPM) growth, repeatedly measured over time for each subject or company was entered for the nine (9) years 1995-2000 inclusive to capture acquisition effects giving 2 x 2 x 9 repeated measures design. The two independent variables were used in the dummy format with non-acquires given a code zero 0 and acquires assigned at one (1). Company size was the second dummy variable with firms less than $100M in sales per year coded zero (0) and if greater than $100M in sales, assigned a one (1). The statistical analysis using a repeated measures design analyzed the variable interactions and their relationship to GPM growth using the SPSS software. These results are presented in Section 4.5 Repeated Measures Analysis that was done using SPSS software. Descriptive statistics were an important first treatment of the data sets created. This includes the values for the following parameters: mean, median, range variance, standard deviation, kurtosis, and skewness. This treatment looks at characteristics of the data and the degree of normal distribution. The 3-way ANOVA investigations and regression treatment of the data were initially done using the data analysis tool software available in Microsoft Excel. Generally, the data sets for this study vary somewhat from the classical normal distribution, but ANOVA and MANOVA (multivariate ANOVA) within a repeated measures analysis are considered robust to violations of the normal distribution assumption (Maxwell Dealney, 1990; Stevens, 1996) SPSS Advanced Models 11.0 software was used to create general linear models of the data and conduct analysis of variance (ANOVA), regression, and analysis of covariance (ANCOVA) for the multiple variables in this model with repeated measures. The factors or independent variables were used to divide the population of 153 active semiconductor companies into groups. There were two independent variables used that were designated as dummy variables. The first variable of acquisition separated companies that did complete acquisitions from those that did not complete acquisitions during the decade of study. The second variable grouped the companies by size of sales at the end of the decade by either greater than $100 million or less than $100 million. Then the general linear model procedure was used to test the four null hypotheses, as stated above, regarding the effects of the independent variables on the dependent variable of gross profit margin growth as a repeated measure over the perio d 1992-2000. The investigation included looking at interactions between factors as well as the individual factors and the effects and interactions of covariates. This model specifies the independent variables as covariates for regression analysis. The SPSS repeated measures model creates a matrix for the sums of squares due to the model effects, gives the approximate F statistics and estimates parameters in addition to testing hypotheses. When an F test shows significance, SPSS performs post hoc tests to evaluate the differences between the means. This yields a predicted mean value for the cells of the model. Analysis of variance (ANOVA) was applied to named variables to study the portion of variance in the each variable that could be identified as explained and unexpected with regard to the event of acquisition. A covariance tool was also used when looking at the variables described above such as acquisition occurrence, company size and profitability growth changes. This compares whether the two ranges of data move together à ¢Ã¢â€š ¬Ã¢â‚¬Å" that is, whether large values of one set were associated with large values of the other (positive covariance), whether small values of one set were associated with large values of the other (negative covariance), or whether values in both sets were unrelated (covariance near zero). DATA SOURCES Standard Poors Compustat database was used for data collection in this research. The database contains fundamental financial, statistical and market data derived from publicity traded companies trading on the NYSE, NASDAQ, AMEX, OTC and Canadian stock exchanges. The calendar year for a company is the year in which the fiscal year ends and is the time period used as standard in this research. Companies with fiscal years ending in January through May are assigned by Compustant into the year in which the fiscal year begins. Companies with fiscal years that end in June through December are assigned to the year in which the fiscal year ends. The EDGAR (Electronic Data Gathering, Analysis and Retrieval) System database maintained by the United Stated Security and Exchange Commission (SEC) was also used. The EDGAR data is also collected from the same sources that are used to generate the Compustat database. Data from these controlled and verifiable sources were corroborated and augmented with information collected from semiconductor trade journals, company annual reports and the Mergers Acquisitions Journal that tracks statistics in this area. CHAPTER 4 RESULTS AND DISCUSSION HI à ¢Ã¢â€š ¬Ã¢â‚¬Å" ACQUISITON AND PROFITABILITY RELATIONSHIP A strong positive relationship was found to exist between the presence of acquisition activity and the growth in gross profit margin (GPM) by the end of the ten year study period. The statistical analysis is detailed below and is a departure from previous findings. This finding addresses the central question of this research endeavor to look for a relationship between acquisition events and profitability growth within the one industry of semiconductors. A positive financial effect is found and opens the path for additional analysis in this direction. Consequently, this information forms the foundation for the additional work presented in this research. >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON ANALYSIS GOING ON >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

power of politics Essay -- essays research papers

Power Politics: The Framework Provided Understanding contemporary world politics is by no means an easy feat. To merely begin the process, one must first have an ample knowledge of historical as well as modern trends in international relations, the issues at hand both now and in the past and major events that affect the field. Several groups and styles of thinking have developed throughout the centuries to make attempts at comprehending world politics and most successfully carrying out international relations. One of these styles of thinking is often called power politics and can be referred to as realpolitik or realism. This school of thought focuses on ways in which power affects the international arena by assessing how states influence each other as the most important actors in world politics. Realpolitik pays attention to political power matters such as military preparedness and industrial capacities, ignoring issues of morality, ideology and other social aspects as reasons for actions of states. In this way, realism sets up a strong framework for understanding short-term, interstate relationships, yet leaves the comprehension of deeper, long-term issues weak in the background. Power politics maintains that human nature is generally selfish. This belief comes from their understanding of the trends in international relations. They feel that in the international field, states are the most important actors which act upon their own individual interests. Therefore, a state is deemed powerful if it has the ability to maintain its national interests by influencing other states. These trends date back thousands of years to the beginning of war. Once states came into existence, selfishness caused territorial expansion and war to soon follow. Countries began developing armies to carry out their interests with force, and their neighbors had to respond with their own armies. This began the trends that lead to power politics. The need to focus on defense superseded the need to address more liberal issues. Power politics are not only used in matters of war and defense. The general definition of power can be seen as a state’s ability to get its way, making other states do things that are in the interest of the first state. In realpolitik, states use militaristic, economic, and diplomatic strengths to influence other actors from whom they desire something. The ge... ...ely analyze a modern issue is the conflict between Iraq and Kuwait. When Iraq invaded Kuwait within the last decade, it was in the national interest of the United States to get involved due to the location of the conflict. With the annexed nation an important actor to keeping Iraq from having control of the Persian Gulf’s oil, the US used its superior military force to support its own national interest. This example shows us that a nation with a severely higher GDP and a preferable army can use force to influence other states. Despite the fact that power politics helps to analyze many of the world’s issues, it fails to analyze and represent others. As previously mentioned, realism ignores many of the important issues within the field of international relations. These issues include sub-state actors, alternate goals of states, the importance of change in the global arena to improve the quality of the world, and the collective good. It is because of the complexities of the international stage that we must not assume that one view of world politics is correct and the others are wrong. We must take into consideration each school of thought in order to understand how the world works.

Distance Learning Essay -- Essays Papers

Distance Learning Many institutions of higher education are experimenting with changes having to do with class offerings. According to Keegan, â€Å"It is not easy to define distance education.† An early descriptive definition states that distance education learners are usually taught as individuals and not in groups (Rossman 8). Distance education can be thought of as instructional delivery that does not constrain the student to be physically present in the same location as the instructor. Distance learning is a newly emerging trend that many institutions are taking advantage of. At the present, this type of learning is primarily used for those people who cannot attend courses on a campus. Distance learning is just another sign pointing towards the emergence of a worldwide electronic university. Through these programs, institutions are creating truly â€Å"global classrooms.† In today’s technologically advanced society, the term â€Å"classroom† has a new meaning. In distance learning, one’s classroom could consist of a television classroom, a â€Å"virtual classroom,† a teleconference, a â€Å"virtual reality† classroom, and others. The traditional classroom is being substituted for classrooms that accommodate each different distance-learning program. Virtual classrooms take place on the computer and can be accessed anywhere. Teleconferences take place on the telephone. On-line courses are held anytime on-line, which makes it easier for the student taking the course. Another form of distance education is visual learning, which includes using video systems and broadcast television. Television broadcasts are used for one-way video and audio presentations. Radios and tapes can also allow the student to listen to lectures one way and audio-... ... to the educating of today’s society. Distance learning is thought to be able to increase global unity, create an easier, less stressful way to receive a quality education, and overall create a greater passion for learning(Rossman 138). Works Cited Hodgson, Vivien E, Sarah J. Mann, and Robin Snell. Beyond Distance Teaching-Towards Open Learning. Philadelphia:Open University Press, 1987. 1-181. Kennedy, Kristen. â€Å"Intellectual Property in the Digital Age.† Technology and Learning 22(2001):8 Porter, Lynette R. Creating the Virtual Classroom:Distance Learning with the Internet. New York: John Wiley and Sons Inc.,1997.1-83 Rossman,Parker.The Emerging Worldwide Electronic University:Information Age Global Higher Education.Connecticut:Greenwood Press, 1992.1-89. â€Å"The Army Marches Into Online Learning.† Black Issues in Higher Education 24(2001):17

Community Service in High School Essay

Community service, work done without pay, is becoming increasingly familiar to high school students nation-wide. Schools are encouraging student to participate in communities that contribute so much to their public education. However, requiring 100 hours of community service is asking too much of students and should be reduced to 50 hours. Students already have their hands full among homework, clubs, sports, and their actual lives. Because the work may not be volunteering if it is required, then students can receive grades and credits that will show up on their transcripts for the community service they volunteer for. It is true of course, that requiring 50 hours of community service would take up students’ time for homework, clubs, and sports, but the service could be completed during the summer and student would have 4 years of their high school career to complete. Wouldn’t requiring the volunteer work make it not voluntary? Well, yes, of course! But it would give stu dents the chance to say, â€Å"I am never doing that again†, or â€Å"I am glad I did that.† Academic gain. Students will tend to do better in school because they would be able to apply what they are learning in school. Increase in self-efficiency for students because they learn that they can all make a difference in what they do, â€Å"Can-do-attitude.† Additionally students will increase their problem-solving skills, while volunteering students will run into problems that requires the use of their brain to solve. Again, applying what they lean in school to use in â€Å"real-life.† Right out of high school, students who volunteer are more likely to vote based on the attitude –â€Å"I can make a difference† – they get from the community service they partake in. Potential employers would see the community service hours attractive. That attraction could lead to a career, not just a job. The hours volunteered in the community could also help students receive future scholarships. The connections students create when meeting new faces or organizations would help with scholarships – the more people/organizations a students know = more possibilities of a recommendation. Community service would be beneficial for all that are involved. Students learning skill that prove beneficial for life. The community being able to receive back what they contribute to public education. So yes, requiring community service hours to graduate high school should be passed.

Advanced Flight Deck Technology for Safety

Over the years and through technology and the requirements of safety and comfort new deck flight plans have been devised and implemented. With this forward movement of a more integrated flight deck and commercial aircraft overall, this has led to a wider safety margin, a more economical cost of operations which in turn will help lower the consumers price of flights as well as their comfort and safety margin. The new flight deck of the Boeing 787 has taken into consideration many factors of the human element of not only pilots but passengers as well. Boeing has spent many years with engineers as well as the astronauts from Nasa to incorporate and implement a flight deck design that in its overall abilities will prove to be a much safer, a more reliable â€Å"tool† of flight ensuring the safety of all on board their commercial plane as well as ensuring specific ergonomic factors of the pilots, all of which in turn will help for a smoother flight and mitigate many more chances of potential accidents. At the same time there have also been the ongoing efforts to revolutionize the passenger decks for comfort, security and convenience. Before the new design process for the Boeing 787 flight deck was actually implemented there were several factors that were considered. The old style flight deck instrument control panel itself had many more individual panels to read and watch, their design somewhat sporadic in comparison with what a pilot needed to view and when. There was a limited streamline for functionality. Furthermore, certain controls were either in the way or out of the way making for increased eye, hand and body movement to make a simple adjustment. Pilot seats were more stationary, lacking the ability to swivel completely or to recline or even for basic lumbar support. The windshield has a lesser visibility radius than the new flight deck. The human factors of designing the new flight deck took into account certain specifics of ergonomics. This was to try and reduce strain on the lower back due to prolonged sitting, strain and wear on hands by operating simple hand controls and functions and less strain on eye movements or basic visibility. These were the more important factors to help alleviate potential health issues that pilots, overtime, would experience, furthermore the flight deck design has less capability of causing carpal tunnel, eye strain, dealing with glare functions and in general less tiredness of the pilots which the end result would mean a safer flight for all involved and a more rejuvenated pilot after the flight. The new design of this deck for the pilots has incorporated many changes. The controls, instead of all being joystick like are now more operational by the touch of a button which reduces carpal tunnel stress by having less rigidity that is common with all joystick controls. The windshield is now more anti glare and has the added function, in conjunction with the new panel, to allow for low visibility takeoffs and landings. The instrument panel has a much greater streamlined effect and fewer panels to view as well. The readouts are bigger and more detailed so that a pilot may not have to look as long or as hard to determine what they must do, this allows for quicker reaction time under all circumstances. The data entry devices have been moved more out of the way to an off side positioning instead of an underneath or above positioning of the readout panels. This helps eliminate accidental data entry as the main point of any flight panel is centered. This has helped in wing control specifically. The rudder and indicators of the rudders, landing gear, fuel and other various indicators necessary has been moved to the main control panel that now rests in front of the pilot versus the traditional placement of above the pilot. This way the pilot does not have to continually look up to check the indicators of a safe flight thus reducing body strain. One big change in the flight deck panel is the room for technological growth. Our technology is ever changing and the room left for this growth will help to ensure a placement of future technology without having to completely redesign the entire panel time and again. This has just become a more economy efficient plane. One thing that most people don’t realize, especially on longer flights is the need for paper to make notes on when flight plans need to be changed, when there needs to be an additional and yet unexpected change and this new implementation also helps with keeping a logbook more accurate and that is the built in, electronic scratch pad. Pilots can make notes about shifting winds, potential or unexpected weather pattern changes, a new noise that might be heard and for the mechanic or engineer to check out upon landing, whatever the case may be. Considering the scratch pad is built in and computer controlled, should there be a failing or an accident, this along with the traditional black box may help solve many questions as to why much quicker. Airport layouts are all different and each pilot must know the layout of the airport to help alleviate getting in the way or creating a ground accident before and after take off. The way this was dealt with is by programming an airport map function, for each airport, into a menu driven control panel. Pilots are able to look at these maps and determine their point of entry or take off in conjunction with the tower’s instructions. It gives them a much needed and yet basic heads up for comfortability in knowledge. This same programming also will record flight plans which in turn will tell you if you are off course and by how far. Additionally it will also give options to view other flight routes should an emergency or other type of landing need to be instituted. Lastly, in correlation is the gps like ability of marking waypoints. Many would not think there could be waypoints when in the air but the lay of the land, different mountain ranges and bodies of water can be considered waypoints. With these new implementations this allows both pilots, at the same time, to have and maintain the same operational ability instead of one pilot having control aspects over a part of the plane, and the co-pilot sequestered into a different set of controls altogether. This becomes more of the teamwork atmosphere that is need for the lives of those on board. There is a design for error tolerance where there wasn’t before, meaning that should a pilot make an error in the flight path, the programming will take over to correct the situation. This error tolerance is only 1% but if you keep off course by that 1% then you will be far from your intended destination. This allows for a human to machine interface and more safety factors. Instead of wondering what the plane is doing, a pilot will know what the plane is doing. There is obviously suggested training, especially with those who do not have flight management experience. Boeing has done what they can at this time to insure that their safety guidelines are not only met for human risk but that these guidelines are above what is required and to the scope of guideline by other facilities and engineering specs. Now with this new integrated, streamlined flight deck, the passenger cabins have also been upgraded to include better air quality, more natural lighting via larger windows, larger overhead bins which make it easier to get in and out of when retrieving personal items. The seats are wider as is the aisles and for those who are taller, there is a substantial more amount of headroom. There are current plans for future ATM’s to be located on this plane. So with all of this in mind, taking in normal human strengths and weaknesses which vary from person to person, this new flight deck allows for more safety, especially with fewer parts being used, less failing and quicker ability for response time, and potentially less fuel which in turn creates a savings that can be put off, in part, to the consumer when they purchase a ticket to fly on the commercial Boeing 787. The psychological effects not only on the pilots but on the customers, when they obtain this knowledge helps ease tension, behooves a less stressful environment for pilots and when all these functions are in place and all feel secure a flight goes much smoother. Small aircraft pilots would benefit greatly from this design as the majority of small plains are still archaic in their designs. Even though this is true, the safety factor needs are still the same. In some respects, with the technology into the Boeing flight deck, this actually makes the larger plane much safer than the smaller planes of personal pleasure. (CL Tapken 2008).