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Compensation System And Organizational Commitment:The Case Of Langkawihotels

Rozila Ahmad rozila@uum.edu.my Abstract This paper examines the relationshipbetween compensation system and hotel managers organizational commitment. Clearly managerial compensation is a critical area influencing hotel performance but few studies of executive compensation in the hospitality industry have been published and none related to organisational commitment. In this study, executive compensation was evaluated on the basis of four dimensions: external competitiveness, compensation based on performance, incentive-base mix and openness and participation. Organisational commitment was measured on three dimensions: affective, continuous and normative. A total of 250 questionnaires were distributed to three, four and five-star hotel managers in Malaysia with a response rate of 42%. The finding revealed that all four dimensions of a compensation system were positively related to managers organisational commitment, especially affective commitment. Compensation system openness and participation were however not significantly related to normative commitment. The significance of these findings is discussed. Keywords: Compensation, human resource management, hotel, organizational commitment, Malaysia 1. Introduction Organizational commitment is a key factor in the service sector(Chiang &Birtch, 2010; Gjerald&Ogaard, 2010; He, Murmann& Perdue, 2012; Kazlauskaite, Buciuniene&Turauskas, 2006; Lee, Hung & Chen, 2012).In the hospitality industry the concept has received increasing attention from academics(Chiang &Birtch, 2010; Gjerald&Ogaard, 2010). Studies highlighting the importance of organizational commitment have found a negative relationship between organizational commitment and costly behaviour such as absenteeism, turnover intention and turnover(Hemdi&Nasurdin, 2006; Lee et al., 2012; Smith, Gregory & Cannon, 1996; Sun, Aryee& Law, 2007;Walsh& Taylor, 2007). In addition, increased commitment can enhance the quality of work, productivity, service quality and organizational cohesiveness (Lee et al., 2012; Smith et al., 1996). Compensation plays an important role in developing organizational commitment (Dhawan&Mulla, 2011). The importance of compensation is proven by a number of empirical researches. Pay satisfaction is a significant predictor of employee turnover (Carraher, 2011)and it has an almost equal impact on affective and normative commitment (Dhawan&Mulla, 2011).Compensation drives organization competitiveness by increasing employees motivation,

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performance, initiative, and engagement to the organisation (Danish &Usman, 2010; Resurreccion, 2012). However, these are studies on compensation in other industries. Compensation practices in the hotel industry are diverse and complex (Ahmad et al., 2010; Hooi, 2006). There are variations even in hotels of the same star rating especially the compensation system for the managers (Ahmad et al., 2010). Compensation practices for managers vary significantly more than non-managers (Ahmad et al., 2010; Namasivayam, Maio& Zhao, 2007). Ahmad et al. (2010) provide detailed information regarding compensation policies and practices in five-star international chain hotels in Malaysia. Results indicated that hotels that provide employees with generous compensation reported higher organizational commitment. However, due to the qualitative nature of the study, the effect of various components of the compensation system on organizational commitment remains vague. Existing studies merely provide descriptive information of compensation practices in the industry (Ahmad, et al., 2010; Hooi, 2006; Todd &Peetz, 2001). Therefore, a study relating compensation system and organisational commitment in the hotel industry would be beneficial. Chiang and Birtch (2010) have studied the relation between compensation and attitude which comprised of organizational commitment, job satisfaction and turnover intention in Hong Kong hotel and tourism industry. However, the study only focused on non-managerial employees compensation based on performance (CBP) and did not include other practices of compensation such as external competitiveness (EC), incentive base mix(IBM) and openness and participation (OP). Study on managers compensation in the hotel industry with results that confirmed as well as opposed to the results of previous studies further strengthens the need to conduct more studies in the industry (Ozdemir&Upneja, 2012). Effective managerial compensation requires an understanding of how key components of a compensation system affect important drivers of profitability such as organizational commitment. The objective of this study is to examine the relationship between managers evaluations of dimensions of their compensation system and their self-reported organizational commitment. The study was undertaken among Malaysian hotel managers. Due to time and financial constraints, the study in Malaysia focused on Langkawi Island.

2. Literature Review 2.1. Four Components of a Compensation System Compensation should tie skills, performance and expectations of the individual and the organization together (Chiang &Birtch, 2010; Kline & Yu-Chin, 2007;Resurreccion, 2012). This can be done by practicing a compensation system that includes consideration of four major components: EC, CBP, IBM and OP policies (Lee, Scarpello&Rockmore, 1995; Montemayor, 1996; Nash, 1980). These four components of compensation systems are frequently used by large firms in developing their HR policies (Ahmad et al., 2010; Gomez-Mejia, 1992) and are
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often mentioned in the strategic compensation literature (Ahmad et al., 2010; Lee et al., 1995; Montemayor, 1996; Nash, 1980). Empirical studies have shown that hotels usually practice more than one compensation policy (Ahmad et al., 2010; Hooi, 2006) incorporating these factors but do not integrate them into a compensation system as is discussed in previous research on strategic compensation (Lee et al., 1995). Each of these four major components is discussed below. 2.1.1. External Competitiveness EC refers to compensating employees with pay and fringe benefits better than the competitors (Montemayor, 1996; Gomez- Mejia, 1992; Kline & Yu-Chin, 2007). Organizations that practice EC react to labour-market competition and external economic condition (Montemayor, 1996). Organization size and competitive segment affects compensation practices. Organization size is measured by sales, assets and number of rooms and employees (Nash, 1980; Kline &Yu-Chin, 2007). According to Kline and Yu-Chin (2007), large, full service-luxury hotels usually compensate employees better compared to the full service-moderate and limited service hotels. Large and full service hotels are forced to offer competitive salary to attract and retain employees with the skill and competency required in serving its target market (Kline &Yu-Chin, 2007; Nankervis, 2000). The work in larger, full service-luxury hotels is more complex and therefore, requires more experienced and competent individuals (Kline & Yu-Chin, 2007). These organizations offer higher salary compared to their competitors to attract people especially those from other hotels (Collins & Smith, 2006). This is an effective strategy to acquire experienced, skilled and competent staff especially in tight labour market (Cheng & Brown, 1998). Although it is important to compensate competitively, organisations should not pay or rewards employees excessively to ensure labour cost control (Kline & Yu-Chin, 2007). 2.1.2. Compensation based on performance CBP refers to compensating employees based on their contribution to the organizations profitability (Nash, 1980). It is also known as merit pay and is defined as pay and benefits awarded to employees based on their performance (Perry, Engbers&So, 2009). Consistent with equity and expectancy theory (Resurreccion, 2012), CBP is closely tied to productive characteristics of workers and its benefit has led more firms to employ the method of compensation (Carey, 2008; Hon, 2012; Lemieux, MacLeod & Parent, 2009). Strategic human resource management involves compensating employees based on their performance (Hoque, 2000; Sun et al., 2007). This is because people in a social exchange relationship expect pay and rewards to be distributed according to the level of their individual contributions (Kline &YuChin, 2007; Resurreccion, 2012). The effectiveness of CBP is evident from increased workers productivity, effort and earnings (Green & Heywood, 2007), creativity (Hon, 2012) and positive work attitudes (Chiang
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&Birtch, 2010). Despite the importance of CBP for an organisations success, a number of hotels in Malaysia have shifted from CBP to compensation based on seniority due to concerns about favouritism (Ahmad et al., 2010; Todd &Peetz, 2001) resulting in increased employee job satisfaction (Ahmad et al., 2010). However, it should be noted that other hotels in Malaysia continue to compensate managerial employees based on their performance (Ahmad et al., 2010; Hooi, 2006). CBP has a number of weaknesses such as favouritism, especially prevalent when good performance appraisal and management is absent (Perry et al., 2009; Ahmad et al., 2010). Thus those who favour compensation based on seniority argue that CBP results in inappropriate wage or salary differences among employees (Green & Heywood, 2007; Lemieux et al., 2009). Furthermore, its influence on employees motivation is not clear and its relation with work satisfaction is not convincing (Green & Heywood, 2007; Perry et al., 2009). CBP requires secrecy on pay information and the perception that the system is valid, fair and non-political (Perry et al., 2009). According to Mahoney (1989), CBP is suitable only for certain jobs and it is effective at higher levels of organisations which require low supervision. In the hotel industry such jobs are the managerial in nature. 2.1.3. Incentive base mix The third component of a compensation system is the IBM which refers to the mixture of variable and fixed pay and where the portion of variable pay depends on firm's performance (Gerhart& Trevor, 1996; Montemayor, 1996). Although hotel employees are paid a lower salary compared to other industries the mix of variable pay with basic pay helps to supplement the low basic wage (Nankervis, 2000). It also protects against employees termination in difficult times and results in more pay when organisation is in a better financial position (Gerhart& Trevor, 1996). The mixture of fixed and variable pay helps reduce an organisations fixed costs (Gerhart& Trevor, 1996). This is important because labour is the highest proportion of the hotel industry cost of operation (Ahmad et al., 2010). Furthermore, the volume and price of a hotel room is characterised by seasonal variation (Kandampully, 2007). If there is no mixture of fixed and variable pay, hotels may have problems retaining employees during the off peak season when the revenue is low. Hotels in Malaysia use a mixed variable and fixed pay system (Ahmad et al., 2010; Hooi, 2006). According to Ahmad et al. (2010) service points are used to calculate the monthly variable pay component. The amount of money for each point depends on the revenue of the business. Service point is taken from the 10% service charges that are collected and distributed among employees. In Malaysia, the allocation of points (one, two or three) varies between hotels. Some hotels allocate the points based on seniority while others allocate it based on an employees performance. Service points are usually awarded to all non-managerial employees, including back of the house employees (Ahmad et al., 2010; Hooi, 2006; Johnson, 1983). Some hotel organisations in Malaysia give service points to the managerial employees as well. A study
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on tipping system in Honolulu, Hawaii casual dining full-service restaurantsis an example of a similar used of variable pay (Lin & Namasivayam, 2011). Different from Lin and Namasivayam (2011), this study does not include tips as variable pay because tips are given by hotel guests and the amount varies greatly. In Malaysia some guests do not give tips at all because they have paid 10% service charge and because of the perception that the employees are paid to do the job. Commission is another form of variable pay that is usually given to salespeople. Kusterand Canales (2011) analysed the relationship among compensation system (fixed or commission), individual performance and sales organization effectiveness. Theydiscovered that salespeople who receive a greater proportion of compensation as a fixed salary give better individual performance and are more effective than those who are paid largely by commission. According to them, IBM has significant influence and control on employees performance and organization effectiveness. While compensation by fixed pay is used for behaviour control, compensation by a system of commission is used for motivation. In summary, the combination of fixed and variable pay makes employees fully develop their abilities in the job and this result in better individual performance and organisation effectiveness.However, it is not clear if the mixture of fixed with variable pay enhances positive behaviour such as organisational commitment. 2.1.4. Compensation openness and participation Compensation OP refers to openness in providing employees with information about their compensation and giving them the authority to participate and question pay decision (GomezMejia, 1992; Montemayor, 1996). Montemayor (1996) found that high performing organisations are more transparent and they encourage employees participation in compensation decision. Gomez-Mejia (1992) suggests that employee participation lowers operational costs, reduces bureaucracy and increases flexibility leading to a more functional compensation system although it is important for the administration to be systematic. The author further stated that compensation administration that is open and flexible is suitable for organisations that are less complex in terms of their technology, organisational structures, management styles and markets. According to Montemayor (1996), providing compensation information to employees and allowing them to question or challenge pay decision are important because of their effect on employees job satisfaction and acceptance of pay decisions. In line with this, Ahmad et al., (2010) discovered that high employee turnover and job dissatisfaction were reported by managerial employees in a five-star resort hotel that avoided answering employees questions regarding compensation. 2.1.5. Organisational commitment and its significance Organizational commitment is defined as a force that binds an individual to a course of action that is of relevance to the organizations target (Mathieu &Zajac, 1990; Meyer &Herscovitch, 2001). It is the internalized normative pressure on employees to act in a way
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which meets organizational goals and interests and this behaviour is exhibited solely because they believe it is the right and moral thing to do (Meyer, Allen & Smith, 1993). Finding means to increase employee organizational commitment is essential because organizationally committed employees have a strong sense of belongings and are willing to work harder to promote the well-being of the organization (Wright, Gardner & Moynihan, 2003). Meyer and Allen (1991) argue that from a psychological perspective, organizational commitment can be separated into affective, continuance and normative components. Affective commitment is the emotional desire to be attached to the organization due to the feeling of comfort and personal competence, continuance commitment is the need to be with the organization because of the costs associated with leaving the organization and normative commitment is the obligation to stay with the organization due to loyalty norm. Meyer et al. (1993) confirmed this in an empirical study. The advantage of distinguishing organizational commitment into these components is it allows more effective management of antecedents that lead to the various components of organizational commitment (Dunham, Grube & Castaneda, 1994). The three components of organizational commitment influence the employees behavioural outcome in the organization differently. Previous empirical research found that affective commitment is positively related to job performance and organizational citizenship (Meyer, Paunonen, Gellatly, Goffin& Jackson, 1989; Shore & Wayne, 1993). Continuance and normative commitment reduced employee turnover (Meyer et al., 1989). Among the three organizational commitment components, affective commitment has the strongest effect on positive work behavioural outcome (Allen & Meyer, 1990; Meyer et al., 1989). Employees with high affective commitment are also loyal (Wright et al., 2003).

2.1.6. A model of compensation system and organisational commitment A model of the relationship between compensation policies and organisational commitment has been developed based on the literature to better conceptualise a compensation system and how it relates with organisational commitment (Figure A.1). All the four compensation policies are antecedents of organisational commitment. EC creates incentives for better job performance, satisfies employees and reduces employee turnover (Davis &Gabris, 2008; Kline & Yu-Chin, 2007). CBP is associated with overall satisfaction which includes satisfaction with pay, job security and work hours (Green & Heywood, 2007). IBM ensures employment security even during difficult times (Gerhart & Trevor, 1996). It also enhances employees perception of fairness and distributive justice, and both are important because they influence employeesbehaviour and job satisfaction (Lin &Namasivayam, 2011). Compensation OP enhances employees acceptance of pays decision, employee retention and job satisfaction (Ahmad et al., 2010; Montemayor, 1996). Both concepts, satisfaction and turnover are associated
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with organisational commitment (Porter et al., 1974). In addition, it was found that pay satisfaction positively relates with affective and normative commitment (Dhawan&Mulla, 2011). Therefore, the hypothesis of this study is: compensation system will be positively related to hotel managers organisational commitment. The conceptual framework for this study is visualised in Figure A.1.

Figure A.1: Conceptual Framework of the Relationship between Compensation System and Organizational Commitment

3. Method 3.1. Procedures and respondents The relationship between compensation system practices and managerial employees organisational commitment was tested in a sample of hotel managers from three, four and fivestar hotels in Langkawi, Malaysia. Langkawi Island is selected due to its importance as a tourist destination. To fit the purpose of the research, co-relational design with quantitative approach was utilised. The variables in this study are divided into two categories: independent variable and dependent variable. The independent variable is compensation system with four dimension; EC, CBP, IBM and OP. The dependent variable is organisational commitment with three dimensions; affective commitment, normative commitment and continuance commitment. Self-administered questionnaire was used to collect data from the research sample. Before the actual data collection, a pilot study was carried out to test research instruments reliability and validity and to improve the quality of questionnaire by identifying and excluding potential problems. The pilot study was conducted by distributing questionnaires to 40 hotel managers from randomly selected three, four and five-star hotels. Cronbachs coefficient alpha was used to examine the internal consistency and the reliability of the instrument. To ensure content validity,
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experts in the field were consulted. Those experts were three hotel managers. Improvement was made to the instrument as advised by the experts. The unit of analysis for this research is individuals. The population is the total number of hotel managerial employees in Langkawi Island. This research used stratified random sampling technique to ensure that the findings represent three, four and five-star hotels. Population and sample was identified based on organization instead of individual because the hotel managerial employees name list could not be identified easily. Stratified random sampling, a type of probability sampling is used for this study to allow for generalisation of the findings to Langkawi Island. The stratified random sampling of this study had two stages and it was done based on Sekaran (1992). The first stage was selecting the stratum to be surveyed based on the hotels star rating and these are three, four and five-star hotels. Managers working in hotels with lower level of service were not selected for this study because these lodging establishments are usually owner operated. Hotels with less than 100 rooms were also excluded from this study because they usually employ very few managerial employees. At the next stage, hotels from each stratum were randomly selected from the accommodation list published in the Langkawi Development Authority website. Based on the list, the identified ratio of three, four and five-star hotels in Langkawi was 12:6:9. The ratio of 6:3:4 hotels were randomly selected. The ratio of questionnaires distributed in each type of hotel was 15:20:25 and the ratio of the total questionnaires distributed was 90:60:100. The number of questionnaires distributed was based on the approximate number of managerial employees in each type of hotel. Questionnaires were distributed with the help of the hotels human resource manager. 3.2. Instrument design A self-administered questionnaire was developed based on previous studies and theories related to compensation and organisational commitment. All of the questions were close-ended. The questionnaire was divided into three sections, A, B and C. The questionnaire was developed using English language due to the importance and the wide usage of the language among the managers in Malaysian hotel industry. Section A consists of socio-demographic questions to gain general information about the respondents characteristics such as their gender, age, educational level, marital status, occupation, education and income level and the star rating of their organisation. Section B measures the extent of compensation system practices towards managerial employees. It has 18 items that are rated using a 7-point numerical scale ranging from never to apply completely. Some of the items are self-developed based on Ahmad et al., (2010) findings while others are adapted from Gomez-Mejia (1992). Section C has 18 items regarding employees organizational
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commitment. Managerial employees were asked to rate their agreement on their attitude towards the organisation ranging from totally disagree to totally agree using a 7-point numerical scale. This study adapted the concept of organization commitment by Meyer and Allen (1997) which is divided into three categories; affective commitment, continuance commitment and normative commitment. 3.3. Data collection Out of 250 questionnaires distributed, 104 were returned showing a response rate of 42%. The ratio of the questionnaires returned by the three, four and five-star hotels is 28:51:21. Several efforts were taken to improve the response rate. Phone calls were made to the human resource managers to remind them to distribute the questionnaires and to inquire regarding the returned questionnaires. Effort to collect data was taken with care to avoid from annoying the human resource managers. Most of the human resource managers gave full cooperation. Despite the support received from the human resource managers, response rate was low except in the fourstar hotels. Difficulty in getting respondents lengthens the data collection period to more than three months. 3.4. Data analysis The data collected in this study was analysed using Statistical Package for Social Science version 19.0for Windows software programme. The analyses of data involved two stages. Firstly, Cronbachs coefficient alpha was used to examine the internal consistency and the reliability of the instrument. Reliabilities less than 0.6 are considered to be poor, those in 0.7 range are acceptable and those over 0.8 are good (Sekaran, 1992). Finally, Spearmans rho correlation coefficient was used to determine the magnitude of the relationships between each of the variables. Spearmans correlation was used instead of Pearsons correlation because the requirement for using parametric tests was not met. Descriptive analysis was also employed in order to provide a summary of the basic characteristics of the data. 3.5. Respondents profile Majority of the respondents were middle managers (39.4%) and this is followed by junior managers (34.6%), senior managers (25%) and a director (1%). Most respondents earned between RM2,001 to RM4,000 per month (51%). Only 1.9% were paid the range between RM8,001 to RM10,000 and RM10,001 and above. 32.7% were paid RM2,000 and less, 9.6% between RM4001 to RM6000 and 2.9% between RM6,001 to RM8,000. The ratio of respondents percentage from the three, four and five-star hotels was 31:49:20. The profile of respondents is displayed in Table A.1. Table A.1: Descriptive Statistics for Demographic Variables (n = 104) Variable Occupation Junior Management
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Frequency

Percentage

36

34.6

Middle Management Senior Management Director Income RM2000 and less RM2001 to RM4000 RM4001 to RM6000 RM6001 to RM8000 RM8001 to RM10000 RM10001 and above Hotel Three-star Four-star Five-star

41 26 1 34 53 10 3 2 2 32 51 21

39.4 25.0 1.0 32.7 51.0 9.6 2.9 1.9 1.9 30.8 49.0 20.2

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4. Data Analysis and Results The overall Cronbachs Alpha value for all compensation system attributes was 0.903 which indicates a strong internal consistency among the attributes. The mean score indicates that compensation system was moderately applied to the managers except for a few items. Compensation system items with the highest mean were My salary increments are based on my performance (5.1635) and My bonuses are based on my performance (4.8173). Items with low mean were I am given commission for selling the hotels product and services (2.6058), I have a say in my pay policies (2.9327) and There are no formal policy that discourage me from revealing my pay to co-workers (2.9519). The descriptive statistics of all attributes of compensation system are shown in Table A.2. Table A.2: Descriptive Statistics of Compensation System Attributes

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Compensation System Attributes M External Competitiveness My employer adopts among the best compensation system in the industry. My salary is among the best in the market. My benefit is among the best in the market. Compensation Based on Performance My salary increments are based on my performance. My bonuses are based on my performance. Rewards are distributed based on employees contribution to organisation. There is a large pay spread between low performers and high performers in a given job. An employee's seniority does not enter into pay decisions. Incentive-Base Mix A substantial portion of my compensation is variable. I am given service points which are based on the amount of the business. I am given bonus when the business is profitable. I am given commission for selling the hotels product and services. Openness and Participation My pay information is not a secret to me. There are no formal policies that discourage me from revealing my pay to coworkers. My organization openly discloses the administrative procedures on how pay levels and pay raises are established. My feelings and preferences for various compensation forms are taken seriously by top management. I have a say in my pay policies. 4.509 6 4.413 5 4.471 2 5.163 5 4.817 3 4.413 5 4.326 9 4.307 7 3.769 2 3.250 0 4.663 5 2.605 8 3.961 5 2.951 9 3.173 1 3.336 5 2.932 7 SD 1.474 7 1.485 3 1.545 2 1.448 9 1.537 7 1.883 0 1.503 7 1.589 3 1.495 8 2.162 1 1.749 4 2.183 0 2.194 1 2.115 0 2.124 5 2.125 3 2.072 8

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4.1. Compensation system and organisational commitment The measure of the correlation between compensation system and organisational commitment is based on Dancey and Reidy (2004) who stated that the score of 0.1 to 0.3 shows weak correlation, 0.4 to 0.6 are moderate and 0.7 and above are strong. Spearmans Correlation test on compensation system with organisational commitment found a significant positive relationship between compensation system and organisational commitment. CBPcorrelation with affective commitment (=0.772, p=0.000) was strong and its relation with normative (=0.638, p=0.000) and continuous (=0.527, p=0.000) commitment was moderate.EC correlation with affective commitment was strong (=0.734, p=0.000) and similar with CBP, its relation with normative (=0.650, p=0.000) and continuous (=0.543, p=0.000) commitment was moderate.IBM correlation with affective (=0.407, p=0.000), normative (=0.426, p=0.000) and total (=0.426, p=0.000) organisational commitment was moderate. OP relation with affective (=0.364, p=0.000) and normative (=0.407, p=0.000) organisational commitment was quite weak. Only the relation between OPwith continuous commitment was not significant. Spearmans correlation test on compensation system and organisational commitment by dimension is displayed in Table A.3. Table A.3: Correlation Test on Compensation System and Organisational Commitment (Dimension) Compensation System Compensation System (overall) EC CBP IBM OP Affective Commitment P 0.715 0.000 0.734 0.772 0.407 0.364 0.000 0.000 0.000 0.000 Continuous Commitment P 0.451 0.000 0.543 0.527 0.308 0.184 0.000 0.000 0.001 0.062 Normative Organizational Commitment Commitment P P 0.649 0.000 0.670 0.000 0.650 0.638 0.426 0.407 0.000 0.000 0.000 0.000 0.693 0.714 0.426 0.358 0.000 0.000 0.000 0.000

Spearmans correlation test by items revealed that the items with strong correlation with affective commitment were My salary is among the best in the market (=0.705, p=0.000), My benefit is among the best in the market (=0.705, p=0.000) and There is a large pay spread between low performers and high performers in a given job (=0.703, p=0.000). Most of the items in the compensation system were significantly and positively related to organisational commitment except for I am given service points which are based on the amount of the business, My pay information is not a secret to me and There are no formal policies that discourage me from revealing my pay to co-workers. My pay information is not a secret to me had a significant but weak negative correlation with affective (=-0.219, p=0.025) and normative (=-0.194, p=0.049) commitment. As for the item There are no formal policies that discourage me from revealing my pay to co-workers, only normative commitment was significantly related to the item and the positive relation was weak (=0.204, p=0.038). The
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result of Spearmans correlation test on compensation system and organisational commitment by item is displayed in Table A.4.

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5.

Discussions This study has found a significant and positive relationship between compensation system and organisational commitment. Out of four dimensions, two dimensions, CBP and EC showed a strong and positive correlation with affective commitment. Their relation with normative and continuous commitment was moderate. IBM and OPdimensions were also significantly and positively related to affective and normative commitment although the strength was quite weak. All dimensions of compensation system had a positive and significant relation with all dimensions of organizational commitment except for OP. Its relation with continuous commitment was not significant.

Table A.4: Correlation Test on Compensation System and Organisational Commitment (Item)

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Compensation System Attributes

Affective Commitment P

Continuous Commitment P

Normative Commitment P

Organizational Commitment P

External Competitiveness My employer adopts 0.669 0.000 0.520 among the best compensation system in the industry. My salary is among the 0.705 0.000 0.495 best in the market. My benefit is among the 0.705 0.000 0.514 best in the market. Compensation Based on Performance My salary increments are 0.670 0.000 0.433 based on my performance. My bonuses are based on 0.632 0.000 0.436 my performance. Rewards are distributed 0.652 0.000 0.457 based on employees contribution to organisation. There is a large pay 0.703 0.000 0.533 spread between low performers and high performers in a given job. An employee's seniority 0.622 0.000 0.437 does not enter into pay decisions. Incentive Base Mix A substantial portion of 0.199 0.043 0.229 my compensation is variable. I am given service points 0.072 0.468 0.038 which are based on the amount of the business. I am given bonus when 0.655 0.000 0.493 the business is profitable. I am given commission 0.384 0.000 0.267 for selling the hotels product and services. Openness and Participation My pay information is not -0.219 0.025 -0.081 a secret to me. There are no formal 0.171 0.083 -0.068 policies that discourage me from my pay 16 revealing e-Proceeding of GBSR2013 to co-workers. My organization openly 0.440 0.000 0.276 discloses the

0.000

0.625

0.000

0.650

0.000

0.000 0.000

0.602 0.612

0.000 0.000

0.646 0.663

0.000 0.00

0.000 0.000 0.000

0.535 0.519 0.499

0.000 0.000 0.000

0.598 0.579 0.591

0.000 0.000 0.000

0.000

0.594

0.000

0.678

0.000

0.000

0.588

0.000

0.612

0.000

0.019

0.278

0.004

0.275

0.005

0.704

0.119

0.231

0.089

0.369

0.000 0.006

0.602 0.386

0.000 0.000

0.640 0.391

0.000 0.000

0.413 -0.194 0.492 0.204

0.049 0.038

-0.160 0.124

0.105 0.208

0.004

0.467

0.000

0.429

0.000

There is consensus on the importance of EC(Carraher, 2011; Danish &Usman, 2010; Dhawan&Mulla, 2011; Gomez- Mejia, 1992; Kline & Yu-Chin, 2007; Montemayor, 1996; Resurreccion, 2012) and this study has provided evidence of its importance to enhance hotel managers organisational commitment. Providing managerial employees with the best salary and the best benefit contributed the most to the positive relationship.The finding of this study is consistent with past studies on pay satisfaction. While Carraher (2011) measured employees satisfaction with benefits by asking questions such as How good are the benefits you currently receive compared to those received by others in similar organizations, DhawanandMulla (2011) confirmed the relation between pay satisfaction with affective and normative commitment. They concluded that an employees satisfaction with pay is likely to affect the employees desire to remain with the organization for emotional and moral reasons. The findings of this study provide support to the importance of CBPthat has continuously been debated. Despite the concerns about favouritism and inappropriate salary differences (Ahmad et al., 2010; Green & Heywood, 2007; Lemieux et al., 2009), this study has provided empirical evidence on the significance of CBP in Langkawi hotels. The positive relation between CBP and organisational commitment is consistent with equity and expectancy theory (Chiang &Birtch, 2010, Resurreccion, 2012). The receipt of compensation is viewed as an exchange of effort and contribution to the organization. When the exchange is perceived to be fair and employees expectation is fulfilled, employees will become committed to the organization (Chiang &Birtch, 2010). This study also supports the notion that CBPis effective for jobs at a higher level of organisations which require low supervision (Mahoney, 1989). However, it is not contrary to Hon (2012) findings that found the influence of CBP on Hong Kongs hotel and service employees creativity. IBM also showed a significant and positive relation with organisational commitment although the strength was moderate for affective and normative commitment, and weak for continuous commitment. The main purpose of IBM is to reduce an organisations fixed costs and pay employees more when the organisation is in a better financial position (Gerhart& Trevor, 1996). As for the employees, the fixed pay provides security during weak financial position while the variable pay serves as a motivator (Kuster& Canales, 2011). Therefore, even though the positive relationship with organisational commitment was not strong, it is crucial for organisations survival. However, the importance of giving managerial employees service points requires a further research. Service point is usually given to only the non-managerial employees due to their low fixed pay (Ahmad et al., 2010; Hooi, 2006; Lin &Namasivayam, 2011). This partially explains the insignificant relation found between service points with organisational commitment. OP dimension had the weakest relation to organisational commitment. Out of five items, the relation of two items was not significant. In fact, the item My pay information is not a secret
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to me had a negative and significant relation with affective and normative commitment. However, the strength was weak. This indicates that pay secrecy is somewhat important for Langkawi hotel managers organisational commitment. This partially supports Perry et al. (2009) argument that CBP requires secrecy on pay information. Due to the significance of another three items from the dimension for hotel managers organisational commitment, the importance of the dimension should not be overlooked. Besides finding the relation between compensation system and organizational commitment, this studyalso discovered the extent of compensation system practices in Langkawi hotels. The statistic revealed that most of the items in the compensation system were moderately practiced.CBP was highly practised in Langkawi hotels and it was the opposite for OP. The salary increment and bonus of many hotel managers were given based on their performance. Very few of the managers have a say in pay policy. Of all the compensation practices, giving managerial employees commission for their sales of products and services was practised the least. In other words, very few managerial employees were given commission for their sales. Other items of compensation system were moderately practised. This research offers some implications to the owners and board of directors. Organizations that intend to enhance their managers organizational commitment are more likely to be successful if they practise a compensation system that is comprised of EC, CBP, IBM andOP. Although the relation between OP and continuous commitment was not significant,it is beneficial toinvolve themanagers, givethem the opportunity to participate and take their opinion seriously on matters related to pay policy. To generate and enhance employees affective commitment, organizations need to provide employees with the ability to participate in organization decision making (Dunham et al., 1994). Various authors have highlighted the importance of employees participation in the organizational decision making (Hales &Klidas, 1998; McGunnigle& Jameson, 2000). Employees participation may increase employee affective commitment due to the feeling of being a part of the family and having influence in the organizations management (Allen & Meyer, 1990).It is also beneficial to give managers commission for their sales of products and services.These practices were found to bepositively related to managersorganizational commitment. The fact that they are among the least practiced in Langkawi hotels might give organizations practising them a competitive advantage and perceived as among the best employer. This study has several limitations. Firstly, non-parametric test which is less powerful compared to parametric was used because the data was not normally distributed. Secondly, the response rate of less than half of the research sample is low even though it is acceptable. Finally, the findings of this research are limited to Langkawi. Similar research with a bigger sample conducted in Kuala Lumpur might have a different finding. Future research with a bigger context of study is beneficial for the hotel industry.
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6.

Conclusion This research provides the statistic of compensation system practices for the managerial employees in three, four and five-star hotels in Langkawi and examines the relationship between a compensation system with managerial employees organisational commitment. Except for a few items, the compensation system was moderately practised in Langkawi hotels. A more important finding was the significant and positive relation between a compensation system with organizational commitment. This study contributes to theory and practice. It makes two theoretical contributions. First, it extends the knowledge of compensation in the hotel industry, in particular, the Malaysian hotel industry. The need to provide further information of compensation practices and its effectiveness has been highlighted in the human resource management literatures (Ahmad et al., 2010; Hon, 2012; Ibrahim &Boerhaneoddin, 2010; Lin &Namasivayam, 2011; Resurreccion, 2012). Second, findings from this quantitative study have shown the relationship between compensation system and organisational commitment. This connection has been neglected in the hotel industry compensation literature. Knowledge of the relationship with organisational commitment is crucial because organizational commitment affects work behavioural outcomes such as turnover intention, turnover, job satisfaction, organizational citizenship and productivity (Mathieu &Zajac, 1990; Meyer et al., 1993; Meyer et al., 1989; Shore & Wayne, 1993; Wright et al., 2003). The findings of this study benefit the decision makers by providing information on the compensation practices of the industry in Langkawi. More importantly is the information on the compensation items that can enhance managerial employees organisational commitment. The information is valuable and may serve as a guide for planning competitive compensation system. References
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Gomez-Mejia, L.R. (1992).Structure and process of diversification, compensation strategy and firm performance. Strategic Management Journal, 13(5), 381-397. Graham, M.D., Roth, T.A.,& Dugan, D. (2008). Effective executive compensation: Creating a total rewards strategy for executives. New York: American Management Association. Green, C.,& Heywood, J.S. (2007). Does performance pay increase job satisfaction? Economica 75, 710 728. Hales, C.,&Klidas, A. (1998). Empowerment in five-star hotels: Choice, voice or rhetoric? International Journal of Contemporary Hospitality Management, 10 (3), 8895. He, P., Murmann, S.K.,& Perdue, R.R. (2012). Management commitment and employee perceived service quality: The mediating role of affective commitment. The Journal of Applied Management and Entrepreneurship, 17 (3), 79-97. Hemdi, M. A., &Nasurdin, A. M. (2006). Predicting turnover intentions of hotel employees: The influence of employee development, human resource management practices and trust in organisation. GadjahMada International Journal of Business, 8(1), 21-42. Hon, A.H.Y. (2012). When competency-based pay relates to creative performance: The moderating role of employee psychological need. International Journal of Hospitality Management,31, 130-138. Hooi, L.W. (2006). Japanese remuneration systems in Malaysia: A case study analysis. Compensation and Benefits Review, 38(31), 31-41. Hoque, K. (2000). Human resource management in the hotel industry: Strategy, innovation and performance. London: Routledge. Ibrahim, I.I., &Boerhaneoddin, A. (2010). Is job satisfaction mediating the relationship between compensation structure and organisational commitment? A study in the Malaysian power utility.Journal of Global Business and Economics, 1(1), 43-61. Johnson, K. (1983). Payment in the hotel industry: The role of fringe benefits. Service Industries Journal, 3(2), 191 213. Kandampully, J. (2007). Service management: The new paradigm in hospitality. New Jersey: Pearson Education. 21 e-Proceeding of GBSR2013

Kazlauskaite, R., Buciuniene, I.,& Turauskas, L. (2006). Building employee commitment in the hospitality industry. Baltic Journal of Management, 1(3), 300314. Kline, S., &Yu-Chin, H. (2007). Wage differentials in the lodging industry: A case study. Journal of Human Resources in Hospitality and Tourism, 6 (1), 69-84. Kuster, I.,&Canales, P. (2011). Compensation and control sales policies, and sales performance: The field sales managers points of view. Journal of Business and Industrial Marketing, 26(4), 273-285. Langkawi Development Authority.(2012). Tourists statistics, available at: http://www.lada.gov.my/v2/informasi/statistik-pelancong.html(accessed 12 December 2012). Lee, D.C., Hung, L.M.,& Chen, M.L. (2012).Empirical study on the influence among corporate sponsorship, organisational commitment, organisational cohesiveness and turnover intention.Journal of Management and Sustainability, 2(2), 43-53. Lee, M.B., Scarpello, V., &Rockmore, B.W. (1995). Strategic compensation in South Koreas publicly traded firms. The International Journal of Human Resource Management, 6(3), 686-701. Lemieux, T., MacLeod, W.B., &Parent, D. (2009).Performance pay and wage inequality. The Quarterly Journal of Economics, 124(1), 1-49. Lin, I.Y.,&Namasivayam, K. (2011).Understanding restaurant tipping systems: A human resources perspective. International Journal of Contemporary Hospitality Management 23(7), 923-940. Mahoney, T.A. (1989). Multiple pay contingencies: Strategic design of compensation. Human Resource Management,28, 337-347. Martocchio, J. J. (1998). Strategic compensation: A human resource management approach. New Jersey: Prentice Hall. Mathieu, J. E.,&Zajac, D. M. (1990).A review and meta-analysis of the antecedents, correlates, and consequences of organizational commitment. Psychological Bulletin, 108(2), 171-194. McGunnigle, P. J.,& Jameson, S. M. (2000). HRM in UK hotels: A focus on commitment. Employee Relations, 22(4), 403-422.

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Meyer, J. P., &Allen, N. J. (1991).A three-component conceptualization of organizational commitment.Human Resource Management Review, 1(1), 61-89. Meyer, J. P., Allen,N. J., & Smith, C. A. (1993). Commitment to organizations and occupations: Extension and test of a three-component conceptualization. Journal of Applied Psychology, 78(4), 538-551. Meyer, J. P., Paunonen, S. V., Gellatly, I. R., Goffin, R. D., &Jackson, D. N. (1989). Organizational commitment and job performance: It's the nature of the commitment that counts. Journal of Applied Psychology, 74(1), 152-156. Meyer, J. P.,&Herscovitch, L. (2001). Commitment in the workplace: Toward a general model. Human Resource Management Review, 11, 299-326. Montemayor, E. F. (1996). Congruence between pay policy and competitive strategy in high performing firms. Journal of management, 22(6), 889-908. Namasivayam, K., Maio, L.,& Zhao, X. (2007).An investigation of the relationships between compensation practices and firm performance in the U.S. hotel industry.International Journal of Hospitality Management,26(3), 574-587. Nankervis, A. (2000). Human resource management strategies as competitive advantage: A case example of the hospitality sector in Southeast Asia and the Pacific rim. Research and Practice in Human Resource Management, 8 (1), 111-133. Nash, A. (1980). Managerial compensation: Highlights of the literature. New York: Work in America Institute. Ozdemir, O.,&Upneja, A. (2012). Board structure and CEO compensation: Evidence from U.S. lodging industry. International Journal of Hospitality Management, 31, 856 863. Perry, J.L., Engbers, T.A.,& So, Y.J. (2009).Back to the future? Performance-related pay, empirical research, and the perils of persistence. Public Administration Review, 69(1), 39-51. Porter, L. W., Steers, R. M., Mowday, R. T.,&Boulian, P. V. (1974). Organizational commitment, job satisfaction, and turnover among psychiatric technicians. Journal of Applied Psychology, 59(5), 603-609. Resurreccion, P.F. (2012). Performance management and compensation as drivers of organization competitiveness: The Philippine perspective. International Journal of Business and Social Science, 3(21), 20-30. 23 e-Proceeding of GBSR2013

Shore, L. M.,& Wayne, S. J. (1993). Commitment and employee behaviour: Comparison of affective commitment and continuance commitment with perceived organizational support. Journal of Applied Psychology, 78(5), 774-780. Smith, K., Gregory, S.R.,&Cannon, D. (1996).Becoming an employer of choice: Assessing commitment in the hospitality workplace. International Journal of Contemporary Hospitality Management, 8(6), 3-9. Sun, L. Y., Aryee, S., &Law, K. S. (2007). High performance human resource practices, citizenship behaviour, and organisational performance: A relational perspective. Academy of Management Journal, 50(3), 558-577.

The Star Online.(2007)."Langkawi given geopark status", 8 June 2007, available at:http://thestar.com.my/news/story.asp?file=/2007/6/8/nation/17962886andsec=nation(accessed 30 December 2007).
Todd, P.,&Peetz, D. (2001). Malaysian industrial relations at century's turn: Vision 2020 or a spectre of the past. International Journal of Human Resource Management, 12(8), 1365-1382. Walsh, K., &Taylor, M.S. (2007). Developing in-house careers and retaining management talent: What hospitality professionals want from their jobs. Cornell Hospitality Quarterly, 48(2), 163-182. Wright, P. M., Gardner, T. M., &Moynihan, L. M. (2003). The impact of HR practices on the performance of business units. Human Resource Management Journal, 13(3), 21-36.

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Interdependence Between GCC Stock Market And Oil Prices And Portfolio Management Strategies Under Structural Breaks
Ahmed Almohaimeed
almohaimeed.ksu@gmail.com

Abstract
This study examines the interdependence between GCC stock market and Oil prices and portfolio management strategies by considering structural breaks in variance. The univariate and multivariate GARCH model are extended by including structural breaks which are determined endogenously by using ICSS algorithm proposed by Inclan and Tiao (1994). The estimated results based on VAR(1)-GARCH(1,1) model and weekly period from November 11, 2007 to September 18, 2012 indicate that the inclusion of structural breaks in the model substantially reduces volatility persistence and the estimated results of the half-life of shocks changes dramatically. Concerning the volatility dependency, we find that both oil prices and GCC stock market is affected by news and volatility in its own market. In addition, we find that the own news and volatility impact are smaller in size when we include structural breaks. Our finding indicates that structural breaks remover the interdependency between GCC stock market and crude oil and reduces the shock and volatility effect. For the portfolio management strategies, it is interesting to find that the model ignoring structural breaks gives an optimal weight smaller than the model that incorporates structural breaks. Also, we find that the estimated value of risk minimizing hedge ratio for the model without structural breaks is small compared to hedge ratio obtained from the model with structural breaks. JEL classification: C12, C32, G12, Q43
Key Words: Volatility dependency, GCC stock market, Oil prices, Multivariate GARCH, Structural breaks, ICSS algorithm, Portfolio management.

1. Introduction The Recent literatures on the volatility linkage and the conditional correlations between stock (.g. see markets include Lieven (2005) Kanas (1998), Francis et al.(2001) Worthington and Higgs (2004) John et al. (2010), revealed that there is evidence of interdependency between stock market and suggest that shocks and volatility can be transmitted across market. Furthermore, a lot of empirical studies have investigate the volatility transmission between oil prices and stock market such Sadorsky (1999), Jones and Kaul (1996), Park and Ratti (2008), Apergis and Miller (2009), Nandha and Brooks (2009) and Malik and Ewing (2009). Their
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findings show evidence of stock market reactions to oil price changes. Otherwise, recents studies include Malik and Hammoudeh (2007), Lescaroux and Mignon (2008), Arouri et al. (2011a) and Arouri et al. (2012) have focused on the links between oil prices changes and the Gulf Corporation Council (GCC) stock markets and revealed a strong interdependency between them. Malik and Hammoudeh (2007) found that oil prices receive volatility effetc only from Saudi, while all GCC stock market reacts to oil prices changes. Also, Arouri et al. (2011a) provide evidence of volatility dependencies between oil price and stock markets. Otherwise, many studies such Hamilton and Susmel (1994) and Lamoureux and Lastrapes (1990) show that there was a considerable reduction in the estimated persistence of volatility when structural breaks were incorporated in the standard ARCH model and conclude that structural breaks should be incorporated in the estimated conditional volatility model. Hamilton (1994) indicates that a good model should account for structural breaks. Lastrapes (1989) and Lamoureux and Lastrapes (1990) argue that the volatility persistence is overestimated when structural breaks in variance are neglected in estimated GARCH model. Mikosch and Starica (2004) and Hillebrand (2005) found that ignoring structural breaks in the GARCH model induce upward biases in estimates parameters of the volatility persistence. Ewing and Malik (2005) investigate the existence of asymmetry in the predictability of the volatilities of small and large companies in the USA. They find that spillover effects between small and large cap stock returns disappear when volatility shifts are taken into consideration. In the same context, Hammoudeh and Li (2008) examined the volatility of GCC stock markets using weekly data from 1994 to 2001. They found that most of the GCC markets were more sensitive to major global events such as the 1997 Asian crisis and the September 11 th attack than to local and regional factors. Moreover, Marcelo et al. (2008) investigate use Spanish stock market and weekly data from January 3, 1990 to January 5, 2005 and reveal that including structural breaks detected by using ICSS algorithm in estimated model reduce volatility persistence and shock and volatility spillover effects. Kasman (2009) investigates the structural breaks in variance in the stock markets of the BRIC countries. They found that persistence of volatility is dramatically declined when sudden changes in volatility are included. The major objective of this study is to examine the interdependence between oil prices and GCC stock market incorporating the structural breaks in conditional volatility. Additionally, the estimated conditional volatility base on VAR-GARCH model is used for portfolio management strategies, while the volatility shifts are identified by using iterated cumulative sums of squares (ICSS) algorithms proposed by Inclan and Tiao (1994). The underlining idea in this study is to examine the impact of structural breaks on the volatility link and volatility persistence, portfolio decision and risk managements. We deem out this research is distinguishable from the aforementioned studies of at least three points: Firstly, we use recent database covering GCC stock market and crude oil prices. Secondly, we include structural breaks in variance detected endogenously by ICSS algorithm to
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investigate volatility persistence and interdependence between GCC stock market and crude oil prices. Finally, we use the estimated results for portfolio management. More precisely, we estimated optimal portfolio weights as well as the hedge ratio by considering structural breaks in variance. The remainder of the paper is structured as follows. The following section provides Econometric Methodology. In section 3, summary statistics for the data are reported. The empirical results are presented and discussed in section 4. Section 5 contains the Portfolio management strategies and hedging while Section 6 relates the main concluding comments.

2. Econometric Methodology In this study we use univariate GARCH model to investigate the volatility persistence and halflife shocks with and without structural breaks. The structural breaks in variance (volatility shifts) are determined endogenously by using ICSS algorithm developed by Inclan and Tiao (1994). Also, the multivariate GARCH models are used to investigate the interdependence between GCC stock market and crude oil prices. The BEKK parameterization of multivariate GARCH model proposed by Engle and Kroner (1995) allows to capture to capture the shocks and volatility effect across return series.

2.1 Detecting structural breaks in variance Inclan and Tiao (1994) provide the iterated cumulative sums squares (ICSS) algorithm to detect structural breaks in the unconditional variance of return series due to a sudden shock. The ICSS algorithm is based on to IT (Inclan and Tiao) statistics for testing the null hypothesis of constant unconditional variance against the alternative of a structural break in unconditional variance. Let denote a independent times series with zero mean and unconditional variance , where and the

variance of each interval given by change in observations and

is total number of variance

are the set of change points. The intervals is given by:

unconditional variance over the

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(1)

The cumulative sum of squares from the first observation to the detect the number of structural breaks in unconditional variance. Let the test statistic is defined as follows: (2)

point in time is used to ,

Where

and

is he the sum of the squared residuals from the whole period. The

null hypothesis of constant unconditional variance is rejected if the maximum absolute value of is greater than the critical value. Inclan and Tiao (1994) suggests that the critical value of 1.358 is the percentile of the asymptotic distribution of in the plot. . Also, upper and

lower boundaries are established at

2.2 Univarite GARCH model without and with structural breaks The uivariate GARCH(1,1) model are use to investigate the volatility persistence. The GARCH model without volatility shifts is define as follows: (3)

Where term and and

represent the stock market returns or the oil prices return, the conditional variance. The parameters

represents the residual

represents the own past shocks effect and measures the

represents the own past volatility. The sum of the parameter

volatility persistence.

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Otherwise, the univariate GARCH model is augmented by including a set of dummy variables. The GARCH model with structural breaks as given by: (4) Where a set of dummy variables taking a value of 1 from each breaks point structural

breaks detected by using ICSS algorithm and 0 elsewhere.

2.3 Bivarite GARCH model without and with structural breaks The interdependence between return series can be analyzed by us sing multivariate GARCH model. The BEKK specification of the conditional variance covariance matrix is more significant than univariate GARCH model to capture the linkage between return series. In this study, we represent the first and second moments by bivariate VAR(1)-GARCH(1,1) model: (5)

With

vector of oil prices returns and stock market returns, a and has a of independently where vector of autoregressive parameters. is a .

vector of

constant terms, terms sequence

vector of residual is a vectors and

conditional variance-covariance matrix and identically distributed

random

are respectively the conditional variance of oil prices is represented

returns and stock market returns. The market information available at time by . The conditional variance-covariance matrix is given by: (6)

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Where

is a

lower triangular matrix of constants, A and B are

square matrix. The

diagonal parameters of matrices A and B measures the effects of own past shocks and past volatility of return indexes on its conditional volatility. The off-diagonal elements in matrix and , and measures respectively the cross effects of shocks and volatility between

returns series. Following Ewing and Malik (2005), the BEKK parameterization given in equation (6) is augmented by including a set of dummy variables. The multivariate GARCH(1,1) with structural breaks take the following forms: (7) Where is a square diagonal matrix and is a row vector of dummy variables of represents the dummy variables of the

coorespending return series. The first elemnet of matrix

first return series and the second elements represents the dummy variables of the second return series and n represents the total number of structural breaks point found in variance of the first and the second return series.

3. Data In this paper we use weekly data for GCC stock market index and crude oil prices, the sample cover the weekly period from November 11, 2007 to September 18, 2012. The data are obtained from DataStream. The return index obtained as the first difference of the natural logarithm. Table 1 presents the descriptive statistics for the corresponding return series. This table provides that the highest weekly return is in crude oil and Saudi stock market while the highest volatility is in Qatar, Kuwait and Oman stock market. All return series, except Qatar, Kuwait and Oman are leptokurtic and skewed to the left, while the kurtosis statistics suggest the presence of asymmetry. As a consequence, the Jarque-Bera statistics reject the null hypothesis of normal distribution for all return under consideration. Furthermore, based on the Ljung-Box (LB) statistic of order 10, we can also reject the null hypothesis of white noise and assert that all series are autocorrelated. An application of the Lagrange multiplier test (ARCH-LM) show strong evidence of ARCH effect.
Table 1: Summary of descriptive statistics of return series Return Mean Saudia 0.13% Dubai -0.72% Bahrain -0.57% Qatar -0.18% Kuwait -0.48% Oman -1.34% Oil 0.02%

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Std.Dev Skewness Kurtosis Jarque-Bera LBQ(10) LBQS(10) ARCH-LM ADF

0.039 -1.108 4.177 161.122* 23.242 77.405 11.911* -7.161*

0.048 -1.398 6.069 321.834* 49.232 28.136 14.320* -5.466*

0.017 -1.166 4.425 180.404* 23.609 33.902 16.513* -5.983*

0.249 0.497 80.338 46531.572* 40.452 43.000 41.136* -12.628*

0.211 0.267 83.637 50425.219* 42.833 43.225 41.445* -11.989*

0.238 0.234 -0.338 322.402* 10.023 21.697 1.249* -8.884*

0.063 0.346 2.497 148.401* 20.688 53.162 9.385* -6.271*

Notes: (*) denote the significant level at 1%. std.dev. (standard deviation). JB (Jarque-Bera) is the statistics test for normality test. LB (Ljung-Box) is the statistics test for serial correlation of order 12. ARCH-LM is the statistics test for conditional Heteroskedasticity of order 2. ADF is the statistics test for unit root.

In the table 1, we present the results of the Augmented Dickey Fuller (ADF). The ADF statistics reject the null hypothesis of a unit root for all return series at the 1% significance level. As the result, we can conclude that all returns times series are stationary. Additionally, t ime series plots of weekly returns

for GCC stock market and crude oil prices are shown in Figure 1 and 2. It is easy to find that volatility clustering both in oil prices and GCC stock market returns suggesting the presence of ARCH effect.

.2 .1 .0 -.1 -.2 -.3

.8 .6 .4 .2 .0 -.2 -.4 -.6

.050 .025 .000 -.025 -.050 -.075 -.100

Dubai
.10 .05 .00 -.05 -.10 -.2 -.15 -.3 .4 .3 .2 .1 .0 -.1

Oman
.12 .08 .04 .00 -.04 -.08 -.12 -.16 -.20

Bahrain

Kuwait

Qatar

Saudia

Figure 1: Weekly GCC stock market return series

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.3

.2

.1

.0

-.1

-.2

Figure 2 : Weekly oil prices return series

4. Empirical results In this section, we will discuss the empirical results of univariate and multivariate GARCH model of conditional volatility with and without structural breaks.

4.1 Volatility shifts in unconditional variance The methodology used in detecting volatility shifts in unconditional variance is based on the ICSS algorithm. The results reported in table 2 shows that the ICSS algorithm identifies four structural break points for the Bahrain stock market, three structural break points for Kuwait and Oman stock market, two structural break points for Saudi stock market and one structural break points for Dubai and Qatar stock market and crude oil prices. The empirical structural breaks detected in unconditional variance can be caused by economic events or financial crisis. In the present study we do no attempt to investigate the real causes of the structural breaks but the structural breaks affect volatility behaviour over time. From the table 2, we can conclude that the most of structural break occurs during recent financial crisis (2008-2009). Indeed, there are common structural break points between returns series. Table 2: Structural break in unconditional variance: The ICSS algorithms results
Nb. Breaks 1 2 3 4 Bahrain 9-Jul-2008 kuwait 18-Aug2008 Oman Saudia Dubai 16-Sep2008 Qatar 16-Sep2008 Oil 22-Jul2009

26-Apr22-Apr-2008 2009 18-Aug2008 24-Jan-2011 27-Sep2009

16-Sep-2008 24-Jan-2011 17-May2010 10-Aug-2011 8-Apr-2012

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4.2 Volatility persistence without and with structural breaks The previous results about structural breaks are used in order to investigate volatility shifts effect on volatility dynamics. The estimated results of univaraite GARCH model without and with structural break are reported in table 3. We find the presence of past volatility effect for all returns series without and with structural breaks. The all GARCH parameter are highly significant. Also, we conclude the presence of past shock effect for all returns series, except Dubai and Oman stock market when structural breaks are ignored, while the past shock effect exist for all returns series, except Oman stock market after including structural breaks. Otherwise, we find the presence of high volatility persistence for all returns series, except crude oil if structural breaks are ignored.
Table 3: Univariate GARCH(1.1) estimation result without and with structural break Return Dubai Model without structural breaks 0.270 with structural breaks Half-Life shocks 0.671* 0.940 11.224 308.923 309.728 6.479 6.970 471.875 482.175 188.374 251.681 76.865 354.380 354.867 356.885 248.364 249.033

0.267*** 0.542* 0.809 3.276 0.809* 0.916 7.938 0.507** 0.561 1.199 0.440* 0.942 11.617 0.048* 0.126 1.177 0.242** 0.965 19.650 0.221* 0.596 1.339 0.729** 0.908 7.201 0.330* 0.496 0.989 0.419* 0.979 32.225 0.360* 0.775 2.720 0.522* 0.845 4.110 0.463* 0.720 2.112

Oman

without structural breaks 0.107 with structural breaks 0.054

Bahrain

without structural breaks 0.502** with structural breaks 0.079*

Qatar

without structural breaks 0.723** with structural breaks 0.375*

Kuwait

without structural breaks 0.179** with structural breaks 0.166*

Saudia Oil

without structural breaks 0.559* with structural breaks 0.415*

without structural breaks 0.323* with structural breaks 0.258*

Notes: The full set of results is available from the authors upon request. Reject of null hypothesis at 1%, 5% and 10% is denoted by *,**,***.

In addition, as can be seen in table 3, the volatility persistence drops substantially for all returns series if structural breaks are included. We conclude that the degree of persistence decline in
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model with structural breaks. We note that Lamoureux and Lastrapes (1990) shows that the results of standard GARCH model indicate more volatility persistence if structural breaks are ignored and suggests indicate that structural breaks should be incorporated into a GARCH model. Otherwise, a high degree of persistence in volatility suggests that shocks on volatility die out slowly over time. In addition, the estimated results of half-life shocks determined by ( change dramatically for all returns series when we include structural breaks. The results implies that after accounting for structural breaks a shock is expected to lose its original impact in few week. We conclude that GCC stock markets and crude oil prices react relatively strongly to incoming news but absorb it fairly quickly. 4.3 Interdependence between GCC stock market and crude oil prices In this section, we will discuss the empirical results of multivariate GARCH model of conditional volatility without and with structural breaks in order to investigate the interdependence between GCC stock market and crude oil prices. The estimated results of VARGARCH(1,1) model that the autoregressive parameter of returns equations are statistically significant for all case1. Thus suggesting some evidence of short-term predictability in GCC stock market and crude oil prices.
Table 4 : Parameter Estimates of bivariate GARCH(1.1) without structural breaks Coef. a12 b12 a21 b21 Dubai -0.185 0.154* -0.532 -0.626* Oman 0.211 -0.844* 0.005 -0.076 Bahrain -0.005** 0.170 -0.271 0.342* Qatar 0.143 0.558* 0.104 -0.130* Kuwait 0.074 0.176 0.008* -0.006 Saudi 0.090 -0.233* -0.768 0.699*

with structural breaks a12 b12 a21 0.061 -0.275* -0.171 0.217 -0.913** -0.001 -0.026 0.088* -0.279 -0.142* 0.174* -0.008 0.117* 0.158* 0.005*** 0.037 -0.391* 0.649*

To save space, the estimated results of the mean equation are not reported but available from the authors upon request.

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b21

0.381

-0.070

0.275*

0.033*

0.010

0.563*

Notes: The oil prices return is denoted 1 and stock return is denoted 2. The full set of results is available from the authors upon request. Reject of null hypothesis at 1%. 5% and 10% is denoted by *,**,***.

From the estimated results, we can conclude that the diagonal parameters of conditional variance covariance matrix without and with structural breaks are all statistically significant at the 1% level implying the presence of past news and volatility effect for all return series 2. In addition, we find that the estimated parameter of past news and past volatility are smaller than before including structural breaks. Otherwise, the estimated results reported in table 4 shows that crude oil volatility affects all GCC stocks market, except Bahrain and Kuwait, while only crude oil shocks affect Bahrain stock market when structural breaks are ignored. Additionally, we find the presence of the volatility effect from crude oil to GCC stock market when we include structural breaks, while crude oil shocks affect only Bahrain and Kuwait stock market volatility. Also, the estimated results for the model with structural breaks show that all GCC stock market volatility affect crude oil volatility, except Dubai, Kuwait and Oman, while only Kuwait and Saudi stock market news affect crude oil volatility. We conclude that GCC stock market volatility receive volatility effect from crude oil. We note that the estimated results for interdependency change when the structural breaks are included, the crude oil receive volatility effect from GCC stock market, except Oman and Kuwait, while crude oil receive volatility effect only from Bahrain, Qatar and Saudi stock market when structural are included. Our finding provide that the estimated results about interdependency between crude oil and GCC stock market changes when structural breaks are included in the estimated conditional variance covariance matrix. 5. Portfolio management strategies and hedging 6. In this section, we discuss some financial implication for the portfolio decision and risk management. The estimated results of multivariate GARCH model can be used for the optimal portfolio designs and risk management by using estimated conditional volatility. Following Kroner and Ng (1989), the risk minimizing portfolio of the two assets is given by: (8)

The estimated diagonal parameters

and

are not reported in table 4 but available from the authors upon

request.

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Where

is the portfolio weight of the oil relative to the sector at time

and

and is the

are the conditional variance of oil prices and stock market indexes respectively.

conditional covariance between oil prices and stock market indexes. Assuming a mean-variance utility function, the optimal portfolio holdings of the oil portfolio is given as: and portfolio is . ) for each stock market. The estimated ,

. The optimal weight of the sector in the considered

Table 5 reports the optimal weights (average value,

results of the optimal weights suggest that Oman, Qatar and Kuwait stock market indexes have the highest hedge ratio. In addition, we find that the estimated results of optimal weights change dramatically when we include structural breaks. The optimal weights are increased for all portfolios after incorporating structural breaks. For example, the results suggests that the optimal holding of oil in $1000 of oil-Kuwait portfolio is $570, compared with $230 for the Kuwait stock market while the optimal holding of oil is $650, compared with $350 for the Kuwai stock market when we include structural breaks. Our results suggest that investors in Dubai should own more stock index than oil in the corresponding portfolio in order to minimize the risk without reducing the expected return. For the Qatar stock market, a portfolio weight of 72% implies that an investor willing to invest $1000 will get a minimum risk from a portfolio comprising of oil and Qatar stock market if the investor holds 72% in oil futures and 28% in stock market futures.
Table 5: Optimal Portfolio weight and hedge ratio without structural breaks Portfolio Oil / Dubai Oil / Oman Oil / Bahrain Oil / Qatar Oil / Kuwait Oil / Saudi 0.30 0.54 0.07 0.61 0.57 0.19 0.09 0.03 0.42 0.09 0.01 0.26 0.54 0.81 0.16 0.72 0.65 0.28 0.14 0.08 0.47 0.21 0.43 0.32 with structural breaks

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The estimated results of multivariate GARCH model can be used to determine optimal portfolio hedge ratio by using the multivariate GARCH model results. Kroner and Sultan (1993) show that to minimize the risk of a portfolio an investor should short in the stock market indexes. The hedge ratio is given by: (9) of the oil portfolio that is long

Where

the conditional covariance between the oil prices and stock market indexes and

is the conditional variance of the oil prices. From the estimated results reported in table 5, we find that highest hedge ratio have increased after accounting for structural breaks. The estimated results of the average values hedge ratio suggest that Bahrain, Kuwait and Saudi stock market indexes have the highest hedge ratio. For the Bahrain stock market, the results show that $1000 long in oil should be shorted by $420 of stock market when structural breaks are ignored compared with $470 after accounting for structural breaks. For Saudi, the results show that every dollar that is long in the oil the investor should short 26 cents when structural breaks are ignored and 32 cents after accounting of structural breaks. Our findings show how our estimated results could be used by financial market participants for making portfolio allocation decisions and risk management. In addition, we find that the results change when we include structural breaks in conditional volatility.

7. Conclusions The present study investigates the interdependence between GCC stock market and crude oil and portfolio management strategies under structural breaks. The results provide evidence of interdependency between GCC stock market and crude oil. The results indicate that GCC stock market receive volatility effect from crude oil, while only Bahrain, Qatar and Kuwait receive shocks effect from crude oil. Moreover, the estimated results show that crude oil receive volatility effect from GCC stock market, except Oman and Kuwait when we ignore structural breaks. In contrast, the results including structural breaks provide that only Bahrain, Qatar and Saudi stock market volatility affect crude oil volatility. Concerning the shocks effects, the estimated results change dramatically when we include structural breaks. In addition, we find that oil react negatively to Qatar stock market volatility if structural breaks are ignored and positively when we include structural breaks. Our finding indicates that structural breaks remover the interdependency between GCC stock market and crude oil and reduces the shock and volatility effect. In addition, we find that the own news and volatility impact are smaller in size when we include structural breaks.
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The estimated result can be used by investor and financial market participants for making optimal portfolio decisions and risk management. It is interesting to find that the model ignoring structural breaks gives an optimal weight smaller than the model that incorporates structural breaks. In addition, we find that the estimated value of risk minimizing hedge ratio for the model without structural breaks is small compared to hedge ratio obtained from the model with structural breaks. In this study, we show that ignoring structural breaks in conditional volatility may lead to wrong results about the interdependency between GCC sock market and crude oil and the degree of volatility persistence.

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