Working Paper The Practice of Corporate Finance in an Emerging ...

Working Paper The Practice of Corporate Finance in an Emerging Market: Preliminary Evidence from the Brazilian Survey Abstract: We report preliminary results of the Brazilian administration of the well-known Graham and Harvey (2001) survey. We rigorously translated and validated the questionnaire before administering it over the Internet. We delivered the questionnaire to 1,699 Brazilian private and public firms and received 160 responses for a return rate of 9.4%. We compare the responses of Brazilian CFOs to those of North American CFOs made available by John R. Graham and Campbell R. Harvey. We identify several contrasts in the answers between the two groups of CFOs, and hypothesize that differences in the economic environment such as the role of the legal, institutional, and macroeconomic frameworks might explain the contrasts in financial managers’ decisions. We also suggest directions for further analyses of the data. Cristiane Benetti Faculdade de Tecnologia SENAC/RS [email protected] Roberto Frota Decourt Universidade Federal do Rio Grande do Sul [email protected] Paulo Renato Soares Terra* Universidade Federal do Rio Grande do Sul [email protected] [email protected] * Corresponding author. Universidade Federal do Rio Grande do Sul Rua Washington Luís, 855 – Office 321 Porto Alegre – RS – 90010-460 – BRAZIL Tel: +55 (51) 3316-3536; Fax +55 (51) 3316-3991 Keywords: Survey, Corporate Finance, Emerging Markets, Brazil. JEL Classification Codes: G31, G32, G34, C42. Acknowledgements: The authors would like to express their gratitude for the generous contributions provided by Marcos A. A. Balbinotti, Leonildo Bernardon, Dirk Brounen, Newton C. A. da Costa Jr., Abe de Jong, Carlos Alberto Diehl, William Eid Jr., John R. Graham, Campbell R. Harvey, Ricardo Hingel, Gilberto de O. Kloeckner, Kees Koedijk, Werner Kuchenbacker, Ricardo P. C. Leal, Wilson T. Nakamura, Walter L. Ness, Wladimir Omiechuk, Ernani Ott, Sandro Rigo, Antônio Z. Sanvicente, Eduardo Schiehll, Osvaldo B. Schirmer, Rodrigo O. Soares, Fernando C. Zanella, and João Zani. The authors would also like to thank Ms. Melícia S. Ferri, Flávia W. Nestrovski, and Mr. Eduardo L. Matzenbacher for the general research assistance. Any remaining errors are our responsibility. First Version: January 15th 2007.

The Practice of Corporate Finance in an Emerging Market: Preliminary Evidence from the Brazilian Survey This paper reports preliminary results from the Brazilian administration of the wellknown Duke Special Survey on Corporate Policy (Graham and Harvey, 2001), which has been previously used in North America and Europe. Our goal is to explore the practice of finance in an emerging market as a means to shed light on aspects that have been previously neglected by financial theory. This is of utmost importance given the need for cross-country comparative studies to better understand the financial decisionmaking process in different economic environments. This study follows a recent wave of field studies in finance (e.g., Graham and Harvey, 2001; Brounen, de Jong, and Koedijk, 2004; Bancel and Mittoo, 2004; Brav et al., 2005) that aim at narrowing the gap between academics and practitioners. In particular, here we focus on a cross-country comparative study. This is of particular importance given that, in contrast to the literature based on ex-post data, the practice of finance in emerging markets has been largely ignored in the finance literature. Emerging markets like Brazil may serve as convenient laboratories for understanding problems in finance relevant to developed markets as well. Volatile economic conditions, less liquid capital markets, highly concentrated firm ownership, a non-negligible share of state-owned firms, inefficient and weak institutions, poor monitoring practices, financing restrictions, and large amounts of information asymmetry are among the many distinct features of such markets. Such imperfections exacerbate issues that are thought to be important for financial decision-making and, as such, highlight the difficulties that may lie in the financial executive’s path. Rather than producing yet another survey, we make use of the same questionnaire previously administered to North American and European financial executives, in order to allow for direct comparisons across countries. Such comparisons

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will allow us to infer how the distinct economic environment of emerging markets helps shape the practice of finance in these countries. In order to achieve such comparability, it is necessary to ensure that the survey questions have the same meaning for respondents despite differences in language, culture, and institutional setting. Graham and Harvey (2001) draw attention to the potential problems inherent in a survey approach: “Surveys measure beliefs and not necessarily actions. Survey analysis faces the risk that the respondents are not representative of the population of firms, or that the survey questions are misunderstood.” (p.189). It is therefore imperative that the survey researcher takes all possible steps to minimize individual subjectivity interference in the translation, administration, and interpretation of the survey. Therefore, in this paper we borrow and benefit from the vast experience of the field of psychology with the aim of ensuring that the translated instrument indeed measures the same variables as the original. In particular, we followed the methods proposed by Vallerand (1989) and Hernández-Nieto (2002). In this manner, we seek to ensure that the survey instrument has the same meaning as the one that has been employed in research in North America and Europe. Survey studies in finance have a long tradition in the literature. Although most studies focused on the United States (e.g., Lintner, 1956; Gitman and Forrester, 1977; Gitman and Mercurio, 1982; Stanley and Block, 1984; Epps and Mitchem, 1994; Poterba and Summers, 1995; Billingsley and Smith, 1996; Bruner, Eades, Harris, and Higgins, 1998; Block, 1999; Graham and Harvey, 2001; Brav, Graham, Harvey, and Michaely, 2005), international surveys have been documented as well. Most studies focused on the United Kingdom (Sangster, 1993; Pike, 1996; Arnold and Hatzopoulos, 2000; Dhanani, 2005; Beatty, Goodacre, and Thomson, 2006). Interestingly, cross-country comparative studies have been relatively rare. Notable exceptions are Bancel and Mittoo (2004) and Brounen, de Jong, and Koedijk (2004). To the best of our knowledge,

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no financial survey focusing on emerging markets’ firms in general and in Latin America in particular has been published in English so far. The topics usually investigated in the finance survey literature are concentrated in capital budgeting decisions, cost of capital calculation, dividend policy, and capital structure decisions. A couple of studies implemented comprehensive financial policy surveys, the best-known being Graham and Harvey (2001) and Brounen, de Jong, and Koedijk (2004). In Brazil, the literature records a few survey studies in finance. Fensterseifer, Galesne, and Ziegelmann (1987) investigate the capital budgeting techniques of 153 Brazilian firms. Saul and Fensterseifer (1992) update the previous paper by also studying the cost of capital and the sensitivity of investment to the short term business cycle in 132 firms. Eid (1996) surveys 161 firms regarding their capital structure decisions. Finally, Saul (1999) implements the most comprehensive finance survey in Brazil by updating all the previous surveys, studying issues of capital budgeting, cost of capital, and capital structure decisions of more than 150 Brazilian CFOs. Table 1 summarizes some of the main surveys in finance. INSERT TABLE 1 ABOUT HERE This paper contributes to the literature in several ways. First, it explores the field study method in finance, which to date remains a relatively rare approach in this discipline. Second, it focuses on an emerging market context, which is even rarer in this field. Third, it borrows from the vast experience of psychology research in the rigorous translation and validation of survey instruments; something that, to the best of our knowledge, has never been attempted before in finance. Finally, by employing exactly the same questionnaire used in previous research in North America and Europe, this study highlights the similarities and differences between emerging and developed markets. 4

The remainder of the paper is presented in three parts. The first section details the research method and procedures used. The second section presents and discusses the results. The last section concludes the paper and indicates further analyses to be conducted in future research.

1. RESEARCH DESIGN: TRANSLATION, VALIDATION, AND ADMINISTRATION OF A FOREIGN LANGUAGE SURVEY IN BRAZIL This section presents the questionnaire’s translation and validation procedures, the sampling and data collection procedures, the descriptive statistics of the sample firms, and compares them to those in the sample of Graham and Harvey (2001).

1.1. Translation and Validation Procedures1 The first step taken to translate the Duke Special Survey on Corporate Policy from the original English into Portuguese was to obtain the permission of the authors of the North American (Graham and Harvey, 2001) and European (Brounen, de Jong, and Koedijk, 2004) studies. We then chose to administer the extended European version in Brazil because it includes two additional questions on corporate governance.2 The translation procedures employed are similar to those used by Vallerand (1989) in his research. According to this author, the cross-cultural use of questionnaires incorporates important methodological aspects of research and the translation of instruments must be carried out in a systematic manner. It must be taken into account that the instrument will be administered in a different setting, which includes differences 1

A detailed description of the translation and validation procedures is laid out in a research note available from the authors. We are thankful to the research guidance provided by Dr. Marcos A. A. Balbinotti. 2 In this paper, however, we report only those questions that can be compared to the results obtained in North America by John Graham and Campbell Harvey, available at http://faculty.fuqua.duke.edu/~charvey/Research/GHSurvey/GH_JFE2001.XLS 5

in language, values, culture, customs, and social context. We validate the original instrument in the alternative language (in this case, Portuguese) in the population of interest (in this case, Brazilian), according to its metric properties. In this study we use the technique called backtranslation. This technique relies on multiple translators working individually and an independent committee that evaluates their work. The original English version was independently translated into Portuguese by two bilingual finance academics residing in Brazil. These two translated versions were then combined into a single translated version that was sent to three other bilingual finance faculty who backtranslated the instrument into English. One of the backtranslators is a native English speaker and resident of Brazil while the other two are native Brazilians residing in English-speaking countries. All of them hold doctoral degrees from English-speaking universities.3 It is imperative that the backtranslators do not have access to the original instrument or even knowledge of it. If the backtranslated version is similar to the original version in wording and meaning, then the translation process has been successful. If differences exist between the backtranslated version and the original, the committee must provide changes in the translated version or even require new translations of the same instrument for comparison and consolidation into a new version. Given the systematic procedure and controls involved, this technique assures that individual biases are removed from the translated version. In this study, an independent committee of three people evaluated the three backtranslated versions against the original version of the instrument, and made adjustments to the Portuguese translation where they thought necessary. The

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We have relied mostly on academics throughout this research. We aggressively tried to obtain the cooperation of financial executives in the implementation of this research, but we were not as successful as we would have liked. One reason is that academics are more likely to comprehend the importance of academic research. We realize that this may induce a bias in the analyses that follow. In order to minimize this bias, we engaged several academics whose previous professional experience included executive and consulting positions. 6

committee consisted of two finance faculty members (one of whom has extensive executive experience) and a finance graduate student. One of the original translators stood by in order to clarify any questions of the committee. All perceived differences in wording and meaning were discussed by the committee, which then suggested modifications in the Portuguese version of the questionnaire. A sample page of the final version of the questionnaire is provided in Appendix I. Content validity is subjective and non-quantitative in the strictest sense of the term and verifies whether the instrument indeed measures the content it sets out to measure (Vallerand, 1989). With the objective of making the instrument as clear as possible, we choose to evaluate content validity of the instrument by employing a panel of 5 judges.4 Instructions to the judges included a five point Likert scale5 for rating clarity of language and practical pertinence and a coded letter system (A, B, C, and D) for classifying the four theoretical dimensions of each question. The questionnaire also allowed the judges to provide additional comments on any specific question. The judges consisted of three academics and two Chief Financial Officers (CFOs), none of whom had participated in the previous parts of the process. The selection criteria for these judges were experience in academic or executive positions, and diversity in terms of educational background and industry experience. In order to evaluate the content validity of clarity of language and practical pertinence, we employed the Content Validity Coefficient (CVC) proposed by Hernández-Nieto (2002). This coefficient measures the degree of concordance among the judges regarding each question, as well as for the survey instrument as a whole. 4

Despite our preference for a panel of judges, we also pre-tested the questionnaire on a small sample of finance MBA students along the lines of Graham and Harvey (2001) and Brounen, de Jong, and Koedijk (2004). The results are qualitatively similar to those obtained from the panel of judges. 5 A scale commonly used in psychometric questionnaires, the Likert (1932) scale measures the respondent’s degree of agreement with a given statement. The relationship between the elements of the scale is ordinal and not necessarily cardinal. Traditionally, a five point scale is the most widely used in survey research, although seven and nine point scales are also found in the literature. 7

This coefficient also evaluates the validity of content that is lacking in other methods such as Cohen’s Kappa.6 Hernández-Nieto (2002) recommends a minimum of three and a maximum of five judges, and use of a five point Likert scale.7 If a given question is deemed unsatisfactory in terms of clarity of language, it must be adjusted before the questionnaire is administered to the population. If a given question is deemed unsatisfactory in terms of practical pertinence, it must be disregarded in the analysis of the results of the survey. Considering such technique, the content validity of the translated version of the Duke Special Survey on Corporate Policy for use in Brazil is generally satisfactory.

1.2. Sampling and Data Collection Procedures The target population was comprised of 1,699 firms. Of these firms, 256 are public corporations from the São Paulo Stock Exchange (Bovespa) directory and the remaining 1,443 are private firms from the SEBRAE8 directory in the states of São Paulo (704 firms) and Rio Grande do Sul (739 firms). Only private firms classified as “medium” and “large” in the SEBRAE directory were selected. First, each firm received an email directed to its Chief Financial Officer (CFO) or equivalent explaining the purposes of the survey and the link to the website. Next, the CFO was contacted by telephone as a follow-up. Following Klassen and Jacobs (2001), several ways to answer the questionnaire were offered to the CFOs: by post, by fax, by

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Cohen's Kappa is a statistical measure of reliability between two judges that takes into account the agreement occurring by chance (Cohen, 1960). A multiple judge agreement measure is Fleiss's Kappa (Fleiss, 1971). 7 While the CVC indicates the equivalence of content, it does not provide the metric properties of the translated version (Vallerand, 1989, Hernández-Nieto, 2002). The metric properties of a survey concerns characteristics such as its validity, reliability, and consistency. 8 SEBRAE is a para-governamental organization funded by firm contributions that has the objective to promote the development of small businesses in Brazil. It operates a number of educational, research, and consulting programs directed towards such businesses and their entrepreneurs and managers. 8

email, and by a website constructed specifically to that end.9 The usual confidentiality assurances were given in writing to all participants. CFOs were invited to participate in two successive waves. The first one started in July 15th 2005 and the second one started in August 15th 2005. The data collection was concluded in September 30th 2005. In total, 160 questionnaires returned (9.4% return rate). This return rate is similar to those of previous surveys: 392 firms for a 9% return rate (Graham and Harvey, 2001), 313 firms for a 5% return rate (Brounen, de Jong, and Koedijk, 2004), and 87 firms for a 12% return rate (Bancel and Mittoo, 2004). More than 80% of the questionnaires received were filled out through the website, while only one questionnaire (0.6%) was returned by e-mail, in line with the conclusions of the experiment of Dommeyer and Moriarty (2000). The detailed breakdown of the returned questionnaires is presented in Table 2. INSERT TABLE 2 ABOUT HERE The website alternated the order of the questions for each new respondent as a way to avoid that the questions in the beginning of the questionnaire were more likely to be answered. We find no evidence that some questions have been answered more frequently than others for reason of the ordering. We also test for non-response bias alongside the lines of Graham and Harvey (2001). We test whether the mean responses of the firms in the first wave (i.e. those that answered our first invitation) differ from those in the second wave (i.e. those firms that had to be contacted twice before answering the survey). There are statistically significant differences in only 6 (9) out of 88 questions at the 5% (10%) level. We conclude that non-response bias is likely small and therefore should not affect the results reported here.

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http://www.unisinos.br/pesquisa/survey2005 9

1.3. Firm and CEO Characteristics As expected, the sample of firms from Brazil presents sharp differences to those surveyed by Graham and Harvey. Brazilian firms are smaller and less internationalized. For instance, only 1.4% of the Brazilian firms in the sample declare sales revenues above US$ 1 billion, whereas 42.5% of the companies in Graham and Harvey (2001) sample cross that threshold. A bigger share of the Brazilian firms is closely held, regulates utilities, and presents larger share of managerial ownership, perhaps an indication of a less developed capital market in Brazil. Also, Brazilian CEOs are on average younger than North American ones. Summary statistics for both samples are presented in Table 3. INSERT TABLE 3 ABOUT HERE On the other hand, the distribution of firms across industries is very much similar between the Brazilian and the North American samples, both presenting a majority of manufacturing firms. Also, Brazilian companies pay dividends just as often as their North American counterparts. Brazilian CEOs are as educated on average as North American ones, although some of them do not have an undergraduate degree (14.3%) and none hold a non-MBA masters degree. Finally, although Brazilian CEOs have slightly more years in the current job on average, the difference is not statistically significant from the North American chief executives. Figure 1 presents these results in more visual detail. INSERT FIGURE 1 ABOUT HERE

3. SURVEY RESULTS: A COMPARATIVE STUDY ON THE PRACTICE OF FINANCE IN NORTH AMERICA AND IN BRAZIL This section presents and discusses the main findings from the Brazilian survey, and compares its results to those reported by Graham and Harvey (2001). The 10

discussion is structured in two topics: capital budgeting and cost of capital decisions, and capital structure and debt policy decisions.

3.1. Capital Budgeting and Cost of Capital The questionnaire devotes 5 questions to the issues of capital budgeting and cost of capital. The results for this group of questions are presented in Tables 4 and 5. Also, Figures 2 and 3 display the information visually. Regarding the techniques employed in investment decisions, North American CFOs use relatively more often the traditional Internal Rate of Return (IRR) and the Net Present Value (NPV) criteria, while Brazilian CFOs favor accounting-based criteria such as the accounting rate of return and the profitability index, as well as the discounted payback period. This finding might be an indication that in less developed capital markets, where there is less liquidity and less active secondary markets, accounting becomes a more important source of information for valuation decisions. Curiously, Brazilian CFOs also claim to make relatively more frequent use of less common techniques as the Value at Risk (VaR) and the Adjusted Present Value (APV) than their North American colleagues, which may be interpreted as a consequence of a more instable economic environment. INSERT TABLE 4 ABOUT HERE Regarding the use of different discount rates for overseas valuation, Brazilian CFOs claim that they use divisional and multiple discount rates relatively more often than North American CFOs. Considering that Brazilian firms are less internationalized in terms of sources of revenues than American ones, these results should be taken with care. INSERT FIGURE 2 ABOUT HERE

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The traditional one factor Capital Assets Pricing Model (CAPM) is relatively less employed in Brazil than in North America. In Brazil, multi-factor CAPM are chosen relatively more often by CFOs than in North America. Also, Brazilian CFOs claim to listen more often to their investors and observe regulatory decisions in order to set their cost of equity capital. This finding is consistent given that a substantial proportion of the firms in the Brazilian sample is made up of private firms and regulated utilities. Along the same lines, Brazilian firms have significantly smaller Price/Earnings ratios than North American companies, also an indication of more mature industrial sectors such as utilities. INSERT TABLE 5 ABOUT HERE Table 5 presents the results for the adjustment of discount rates and/or cash flows to a set of risk factors. In Brazil, firms claim that they adjust both the discount rate and the cash flows to a number of risk factors related to monetary policy (unexpected inflation, interest rate, term structure, and foreign exchange). This is perhaps an indication of the memory left by hyperinflationary and volatile periods in Brazil’s recent economic history. Also interesting, there is statistically significant evidence that North American CFOs adjust relatively less often the components of investment projects than Brazilian ones for all risk factors. INSERT FIGURE 3 ABOUT HERE

3.2. Capital Structure and Debt Policy The questionnaire dedicates substantial attention to capital structure and debt policy decisions. Indeed, it contains 9 out of 15 questions devoted to these subjects. In order to present and discuss the results of these questions, we grouped them quite

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arbitrarily in capital structure decisions (questions 8, 9, and 10) and debt policy decisions (questions 5, 7, 11, 12, 13, and 14). The three capital structure questions are “yes/no” questions regarding the CFO plans to issue foreign debt, convertible debt, and common stock, followed up by the factors that affect such decisions. It is remarkable how we obtained few answers from Brazilian firms regarding those three decisions (around 28, 11 and 14 answers for each question, respectively). This is possibly the result of our sample containing smaller, closely held firms in contrast to the bigger, public corporations of Graham and Harvey (2001). It may also be a consequence of a less developed capital market, where the firms rely more heavily in banking credit for financing. Foreign debt, convertible debt, and common stock are financing instruments used only by a minority among the biggest firms in the country. Table 6 presents these results. INSERT TABLE 6 ABOUT HERE Among the factors that CFOs take into account when deciding on foreign debt issues, North American firms are relatively more concerned with foreign exchange risk (natural hedge and assets-liabilities matching) and tax treatment, while Brazilian CFOs express their concerns with the cost of domestic debt relative to foreign debt. This finding again is readily traceable to the high level of real interest rates practiced in Brazil since the adoption of inflation targeting by the central bank in 1999 and the commitment of the government to generate primary fiscal surpluses. The less competitive financial system is also often suggested as a reason for the high cost of the domestic debt. The three panels of Figure 4 display such results visually. INSERT FIGURE 4 ABOUT HERE Convertible debt is also a minor concern of the typical Brazilian CFO. Of those that do think about issuing it, cost considerations are the main concern. Interestingly,

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transaction costs also figure as the most important factor for the North American CFO, who use convertibles especially as a means of issuing common stock cheaply. The industry effect is significant for Brazilian firms, which claim that successful experiences of other firms in the sector are an important factor in their own decision. Finally, risk considerations and the attraction of outside investors is relatively more important for North American than for Brazilian firms. In terms of common stock offerings, North American firms are significantly more concerned with corporate governance issues (earnings and holdings dilution, stock price under/overvaluation and momentum, executive incentive plans, and debt-to-equity targets) than Brazilian ones. In our interpretation, this is due to two reasons: (1) the relative underdevelopment of the Brazilian stock market (high transaction costs, low liquidity, concentrated trading) and (2) the shortcomings of the investor protection laws and regulations, which make corporate governance concerns less stringent in Brazil than in the U.S., for instance. It is worth noting that the most often cited factor in the decision to issue common stock in the point of view of the Brazilian CFO is that they consider it to be the cheapest source of funds available. Such belief is so plainly against the prescriptions of financial theory and indicates that the CFOs are unaware of the real costs involved in using equity financing. Of course, such findings raise concerns about the way Brazilian firms calculate their cost of capital and how they choose among investment opportunities. On the other hand, since the absolute number of answers to this question is small, we cannot draw definite conclusions regarding these issues. Debt policy is explored in a number of questions addressing debt maturity, the rating of the firm’s debt, the strictness of target debt ratios, and the factors that affect the amount of debt bore by the firm. The results are presented in Table 7. INSERT TABLE 7 ABOUT HERE

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North American CFOs list assets-liabilities maturity matching, refinancing risk, relative cost of short versus long term debt, and market timing as relatively more important factors for their debt maturity decisions. Brazilian CFOs are more concerned with credit rating and risk taking mitigation instead. It is also important to notice that the availability of long term debt financing in Brazil is restricted. As mentioned above, capital markets instruments are extensively used only by a handful of large corporations and the majority of private firms rely mostly on bank credit to finance their operations. Bank credit is usually of shorter maturity than capital market instruments,10 so perhaps the answers reflect this environment. Figure 5 presents the results for debt policy. INSERT FIGURE 5 ABOUT HERE Credit rating is a privilege of only 31.7% of the Brazilian respondents, in contrast to 52.6% of the North American sample. This reflects the fact that the Brazilian sample comprises smaller, private firms, to whom credit rating does not seem a top priority. In terms of target debt ratios, North American firms set targets slightly more strictly than their counterparts in Brazil, where more than 68% of the firms claim to have no or loose target ratios. A visual representation of this result is presented in Figure 6. INSERT FIGURE 6 ABOUT HERE CFOs differ in the factors that determine the amount of debt of the firm. In the perspective of the North American CFOs, personal tax rates and credit rating are relatively more important, while for Brazilian CFOs concerns such as financial flexibility, executive incentives, credibility in the goods, labor, and financial markets, and the distribution of firm income among debtholders and stockholders are seen as more

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There is an exception though. BNDES, a state-owned bank, finances industrial projects from Brazilian and foreign firms willing to invest in the country. This bank offers long term financing at subsidized cost, sometimes lower than short term credit instruments, which biases the term structure of interest rates as they are perceived by CFOs. Of course, the bank’s resources are limited and it cannot provide credit in the volume demanded by the private sector. 15

important. Interestingly, Brazilian CFOs are relatively more concerned with being an unattractive takeover target than North American ones. This is puzzling given that Brazilian firms are more closely held than North American ones,11 and that the percentage of managerial ownership is larger in Brazil than in North America. Among other factors that affect the debt policy of the firm, North American CFOs declare their concerns with market timing (level of interest rates and stock prices), while Brazilian ones are once more concerned with transaction costs, again an indication of a less developed capital market. A larger share of Brazilian CFOs affirm that they issue debt when they accumulated enough earnings, which contrasts with the usual view that financial restrictions are binding in emerging markets. Finally, the long term debt-to-assets ratio is not significantly different between the two samples, although North American firms are on average more levered than Brazilian ones, a finding also related to the availability of long term financing in a more sophisticated capital market.

3.3. Summary In sum, there are several issues in which North American and Brazilian CFOs share opposite points of view and some in which they agree. In order to make sense of the results and provide a useful synthesis, we arranged the main findings in Table 8. INSERT TABLE 8 ABOUT HERE In our point of view, differences in the responses of North American and Brazilian CFOs can be traced back to the institutional characteristics of the economic environment in which their firms operate. Capital restrictions, illiquid and concentrated capital markets, poor corporate governance regulation, less competitive financial 11

Even most public corporations in Brazil have a well-defined controlling shareholder. 16

markets, and more restrictive fiscal and monetary policies may explain the differences in opinions between the two samples. This is an interesting hypothesis that we raise, which remains to be tested in a future study.

4. CONCLUDING REMARKS This study presents preliminary evidence on the practice of finance in an emerging market. After rigorously translating and validating the survey instrument, we administered it to 1,699 Brazilian firms in two waves. We received 160 responses (9.4% return rate) which we compare to the sample gathered by Graham and Harvey (2001). Brazilian firms are smaller, less internationalized, more closely held, and operate more in the utilities sector than North American firms, and Brazilian CFOs are younger than North American ones. Regarding financial policies, several contrasts are documented between the two groups of CFOs. A preliminary analysis of the results raises the hypothesis that differences in the practice of finance emerge from the institutional environment specific to Brazil. Field research in corporate finance enables a better understanding of the decision-making process of financial managers. Cross-cultural field research such as this one may help highlight the role of the legal, institutional, and macroeconomic frameworks in the financial manager’s decisions. Therefore, cross-country comparative field studies are a promising path for the furthering of financial theory. Of course, the analyses presented in this study are only preliminary. More in depth analyses are forthcoming. For instance, in this study we concentrated on unconditional answers. It is important to verify whether the conclusions presented here hold for answers conditional on firm and CEO characteristics such as size,

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Price/Earnings ratio, leverage, industry, rating, CEO age, tenure and education, and others. These shall be our next steps. Disclaimer This paper is a work in progress and it is being updated on a regular basis. Before citing any of its findings, please contact the authors for the more current version available.

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9. COHEN, J. (1960). “A Coefficient of Agreement for Nominal Scales”. Educational and Psychological Measurement 20: pp.37-46. 10. DHANANI, A. (2005). “Corporate Dividend Policy: The Views of British Financial Managers”, Journal of Business Finance & Accounting 32, pp.1625-1671. 11. DOMMEYER, C. J. and MORIARTY, E. (2000). “Comparing Two Forms of an EMail Survey: Embedded vs. Attached”. International Journal of Market Research 42, pp.39-50. 12. EID Jr, W. (1996). “Custo e Estrutura de Capital: O Comportamento das Empresas Brasileiras”. RAE Revista de Administração de Empresas 36, n. 4, pp.51-59. 13. EPPS, R. W. and MITCHEM, C. E. (1994) “A Comparison of Capital Budgeting Techniques Used in the United States with Those Used in Japan and Korea”. Advances in International Accounting 7, pp.205-214. 14. FENSTERSEIFER, J. E., GALESNE, A., and ZIEGELMANN, J. (1987). “A Utilização de Técnicas Analíticas nas Decisões de Investimento de Capital das Grandes Empresas no Brasil”. Revista de Administração 22, n. 4, pp.70-78. 15. FLEISS, J. L. (1971). “Measuring Nominal Scale Agreement among Many Raters”. Psychological Bulletin 76: pp.378-382. 16. GITMAN, L. J. and FORRESTER Jr., J. R. (1977). “A Survey of Capital Budgeting Techniques Used by Major U.S. Firms”. Financial Management 6, pp.66-71. 17. GITMAN, L. J. and MERCURIO, V. (1982). “Cost of Capital Techniques Used by Major U.S. Firms: Survey and Analysis of Fortune’s 1000”. Financial Management 14, pp.21-29.

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18. GRAHAM, J. R. and HARVEY, C. R. (2001). “The Theory and Practice of Corporate Finance: Evidence from the Field”. Journal of Financial Economics 60: pp.187-243. 19. HERNÁNDEZ-NIETO, R. A. (2002). Contributions to Statistical Analysis. Universidad de Los Andes, Mérida, Venezuela. 20. KLASSEN, R. D. and JACOBS, J. (2001). “Experimental Comparison of Web, Electronic and Mail Survey Technologies in Operations Management”. Journal of Operations Management 19: pp.713-728. 21. LIKERT, R. (1932). “A Technique for the Measurement of Attitudes”. Archives of Psychology 140, New York: Johnson Associates, pp.1-55. 22. LINTNER, J. (1956). “Distribution of Incomes of Corporations among Dividends, Retained Earnings, and Taxes”. American Economic Review 46, n. 2, pp.97113. 23. PIKE, R. (1996). “A Longitudinal Survey on Capital Budgeting Practices”, Journal of Business Finance & Accounting 23, pp.79-92. 24. POTERBA, J. M. and SUMMERS, L. H. (1995). “A CEO Survey of U.S. Companies’ Time Horizons and Hurdle Rates”. Sloan Management Review 37, n.1, pp.43-53. 25. SANGSTER, A. (1993). “Capital Investment Appraisal Techniques: a Survey of Current Usage”. Journal of Business Finance & Accounting 20, n. 3, pp.307332. 26. SAUL, N. and FENSTERSEIFER, J. E. (1992). “Critérios de Avaliação e Seleção de Investimentos de Capital nas Grandes Empresas Brasileiras: o ‘Timing’ dos 21

Projetos e o Desempenho dos Investimentos”. XVI ENANPAD, vol. 2, Canela, September, Annals... pp.25-38. 27. SAUL, N. (1999). “Critérios de Decisão e Avaliação de Investimento nas Grandes Empresas do Brasil”. XIII Congreso Latinoamericano de Estrategia SLADE, Buenos Aires, May. Annals... 16p. 28. STANLEY, M. T. and BLOCK, S. B. (1984). “A Survey of Multinational Capital Budgeting”. The Financial Review 19. pp.36-54. 29. VALLERAND, R. J. (1989). “Vers une Méthodologie de Validation Trans-Culturelle de Questionnaires Psychologiques: Implications pour la Recherche en Langue Française”. Psychologie Canadienne 30: pp.662-680.

22

TABLE 1: Summary of Finance Survey Studies in the Literature Authors Lintner (1956) Gitman and Forrester (1977) Gitman and Mercurio (1982)

Firms

Return

Country(ies)

Topics Covered

28

4.7%

United States

Dividend Policy

103

38.4%

United States

Capital Budgeting

87

25.7%

United States

Cost of Capital

Stanley and Block (1984)

121

35.7%

United States

Capital Budgeting

Fensterseifer, Galesne, Ziegelmann (1987)

153

32.2%

Brazil

Capital Budgeting

Saul and Fensterseifer (1992)

132

23.3%

Brazil

94

19.15%

United Kingdom

Epps and Mitchem (1994)

111

27.8%

United States

Poterba and Summers (1995)

160

16%

United States

Billingsley and Smith (1996)

88

36.2%

United States

Eid (1996)

161

14.3%

Brazil

Pike (1996)

99

78.1%

United Kingdom

Capital Budgeting

Bruner, Eades, Harris, and Higgins (1998)

135

32%

United States

Cost of Capital

Block (1999)

297

33.75%

United States

Sangster (1993)

Capital Budgeting Cost of Capital Capital Budgeting Capital Budgeting Cost of Capital Capital Budgeting Capital Structure Cost of Capital Capital Budgeting Capital Structure

Capital Budgeting Cost of Capital Capital Budgeting

Saul (1999)

150

N/A

Brazil

Cost of Capital Capital Structure

Arnold and Hatzopoulos (2000)

149

49%

Graham and Harvey (2001)

392

9%

United Kingdom United States Canada

Capital Budgeting Capital Budgeting Cost of Capital Capital Structure

European Union Bancel and Mittoo (2004)

87

12%

Norway

Capital Structure

Switzerland France

Capital Budgeting

Germany

Cost of Capital

Netherlands

Capital Structure

Brounen, de Jong, and Koedijk (2004)

313

5%

United Kingdom

Corporate Governance

Brav, Graham, Harvey, and Michaely (2005)

384

16%

United States

Dividend Policy

Dhanani (2005)

164

16.4%

United Kingdom

Dividend Policy

Beatty, Goodacre, and Thomson (2006)

192

23%

United Kingdom

Capital Structure

23

TABLE 2: Questionnaire Return Breakdown. Firms Contacted

Media

First Wave th

July 15 2005

Second Wave th

August 15 2005

Return Rate

Total

E-mail

0

0.0%

1

0.6%

1

0.6%

Website

80

50.0%

53

33.1%

133

83.1%

Fax

3

1.9%

2

1.3%

5

3.1%

Post

8

5.0%

13

8.1%

21

13.1%

91

56.9%

69

43.1%

160

100.0%

Total

1,699

9.42%

TABLE 3: Firm and CEO Characteristics in North America and in Brazil. Firm and CEO Characteristics

NORTH AMERICA N Mean %

BRAZIL Mean %

N

DIFFERENCE P-Value Z

a. Sales revenue

378

3.79

74.3%

71

2.56

56.3%

3.346 0.001 ***

b. Foreign sales

374

2.08

71.1%

69

1.87

55.1%

2.856 0.004 ***

c. Industry

351

3.81

84.9%

68

3.65

80.9%

0.845 0.398

d. Public or Private

373

1.36

63.8%

70

1.51

48.6%

2.616 0.009 ***

e. Pay Dividends?

371

1.46

53.9%

70

1.37

62.9%

-1.308 0.191

f. Regulated Utility?

348

1.94

93.7%

70

1.40

38.6%

12.316 0.000 ***

g. If all options were exercised, what percent of common stock would be owned by the top three officers?

318

1.91

26.7%

54

2.54

51.9%

-2.912 0.004 ***

h. CEO education

354

1.95

21.8%

21

1.43

14.3%

0.976 0.330

i. Age of CEO

368

2.93

73.1%

68

2.65

57.4%

2.821 0.005 ***

j. CEO tenure (time in current job)

366

1.98

36.1%

68

2.15

44.1%

-1.175 0.241

The table presents summary statistics from the North American (Graham and Harvey, 2001) and Brazilian surveys. Source data for the North American survey is obtained from http://faculty.fuqua.duke.edu/~charvey/Research/GHSurvey/GH_JFE2001.XLS. N is the number of valid responses for each question; Mean is the average score for each question (0-4 for Likert scale questions, 0-1 for “yes/no” questions; % is the percentage of scores above 2 for Likert Scale questions (“Always” and “Almost Always”/”Important” and “Very Important”) and the percentage of “yes” in the “yes/no” questions; Z is the statistic for the difference of proportions between the North American and the Brazilian samples; * significant at the 10% level; ** significant at the 5% level; *** significant at the 1% level.

24

TABLE 4: Capital Budgeting and Cost of Capital.


Answers to the Questions... 1. How frequently does your firm use the following techniques when deciding which projects or acquisitions to pursue? b. Internal Rate of Return (IRR) a. Net Present Value (NPV) c. Hurdle Rate f. Payback Period j. Sensitivity analysis (e.g.: “good” vs. “fair” vs. “bad”) d. Earnings multiple approach g. Discounted payback period l. We incorporate the “real options” of a project when evaluating it i. Accounting Rate of Return (or Book rate of return on assets) k. Value at risk (VaR) or other simulation analysis h. Profitability index e. Adjusted Present Value (APV) 2. How frequently would your company use the following discount rates when evaluating a new project in an overseas market? To evaluate this project we would use... a. The discount rate for our entire company d. A risk-matched discount rate for this particular project (considering both country and industry) b. The discount rate for the overseas market (country discount rate) c. A divisional discount rate (if the project line of business matches a domestic division) e. A different discount rate for each component cashflow that has a different risk characteristic (e.g.: depreciation vs. operating cash flows)

BRAZIL Mean %

N


369 367 360 356 357 352 343 331 345 344 337 334

3.09 3.08 2.48 2.53 2.31 1.89 1.56 1.47 1.34 0.95 0.83 0.85

75.6% 74.9% 56.9% 56.7% 51.5% 38.9% 29.4% 26.6% 20.3% 13.7% 11.9% 10.8%

93 94 91 86 88 87 85 81 83 82 82 83

2.60 2.71 2.16 2.45 2.33 1.78 2.06 1.26 2.06 1.67 1.89 1.77

60.2% 62.8% 48.4% 53.5% 48.9% 36.8% 42.4% 18.5% 41.0% 31.7% 41.5% 33.7%

3.146 2.466 1.542 0.555 0.457 0.373 -2.038 1.670 -3.160 -3.003 -4.334 -3.704

0.002 *** 0.014 ** 0.124 0.579 0.648 0.709 0.042 ** 0.096 * 0.002 *** 0.003 *** 0.000 *** 0.000 ***

313

2.50

58.8%

86

2.63

61.6%

-0.469 0.639

316

2.09

50.9%

81

2.52

54.3%

-0.531 0.595

310

1.65

34.5%

78

1.83

39.7%

-0.826 0.409

301

0.95

15.6%

79

1.72

35.4%

-3.089 0.002 ***

304

0.66

9.9%

80

1.50

28.8%

-3.205 0.001 ***

Source data and columns defined as in Table 3; * significant at the 10% level; ** significant at the 5% level; *** significant at the 1% level.

25

TABLE 4: Capital Budgeting and Cost of Capital (Continued).


Answers to the Questions... 3. Does your firm estimate the cost of equity capital? If “yes”, how do you determine your firm’s cost of equity capital? b. Using the Capital Asset Pricing Model (CAPM, the beta approach) a. With average historical returns on common stock c. Using the CAPM but including some extra “risk factors” f. Back out from discounted dividend/earnings model, e.g.: price =dividend/(cost of capital growth) d. Whatever our investors tell us they require e. By regulatory decisions 6. What was your firm’s approximate (trailing) Price/Earnings ratio over the past 3 years?... (e.g.: 18)

26

BRAZIL Mean %

N


359

0.65

64.6%

86

0.57

57.0%

1.369 0.172

232 220 226

2.81 1.70 1.52

71.1% 39.5% 34.1%

46 42 45

1.78 1.45 1.91

37.0% 33.3% 48.9%

5.239 0.000 *** 0.802 0.423 -1.664 0.097 *

213

0.87

15.5%

42

1.19

26.2%

-1.404 0.162

217 215

0.86 0.42

14.3% 7.0%

45 43

1.80 1.58

33.3% 34.9%

-2.312 0.022 ** -3.168 0.002 ***

222 16.61

58.1%

39

5.25

9.6%

8.318 0.000 ***

TABLE 5: Risk Factors and Project Valuation.

4. When valuing a project, do you adjust either the discount rate or cash flows for the N. following risk factors? Am.

Discount Rate BRA

Z

P-Value

a. Risk of unexpected inflation 11.9% 13.8% -0.160 0.874

Cash Flow N. Am.

BRA

Z

Both P-Value

N. Am.

BRA

Z

Neither P-Value

N. Am.

BRA

Z

P-Value

14.4% 27.5% -1.156 0.252

11.9% 42.5% -2.722 0.008 **

61.8% 16.3% 5.381 0.000 ***

15.3% 16.0% -0.066 0.947

8.8% 21.0% -1.051 0.299

24.6% 46.9% -2.142 0.034 **

51.3% 16.0% 3.845 0.000 ***

8.6% 16.9% -0.696 0.490

3.7% 16.9% -1.080 0.291

12.6% 37.7% -2.189 0.032 **

75.1% 28.6% 6.416 0.000 ***

d. GDP or business cycle risk

6.8% 16.9% -0.835 0.409

18.8% 20.8% -0.175 0.862

18.8% 33.8% -1.342 0.183

55.6% 28.6% 3.054 0.003 **

e. Commodity price risk

2.9% 13.3% -0.843 0.410

18.9% 30.7% -1.044 0.299

10.9% 22.7% -0.995 0.324

67.4% 33.3% 4.314 0.000 ***

f. Foreign exchange risk

10.8% 10.4% 0.034 0.973

15.3% 20.8% -0.473 0.638

18.8% 45.5% -2.428 0.017 **

55.1% 23.4% 3.547 0.000 ***

b. Interest rate risk (change in general level of interest rates) c. Term structure risk (change in the long-term vs. short term interest rate)

g. Distress risk (probability of 7.4% 23.3% -1.304 bankruptcy) h. Size (small firms being 14.5% 17.8% -0.280 riskier) i. “Market-to-book” ratio (ratio of market value of firm to book 4.0% 18.2% -1.168 value assets) j. Momentum (recent stock 3.4% 21.3% -1.456 price performance)

0.199

6.3% 17.8% -0.938 0.355

4.8% 24.7% -1.609 0.117

81.3% 34.2% 7.057 0.000 ***

0.780

6.0% 20.5% -1.185 0.244

13.4% 27.4% -1.190 0.238

65.6% 34.2% 3.869 0.000 ***

0.253

2.0% 11.7% -0.786 0.445

7.1% 22.1% -1.253 0.217

86.9% 48.1% 6.902 0.000 ***

0.157

2.9% 10.7% -0.627 0.539

4.9% 16.0% -0.907 0.372

88.9% 52.0% 6.895 0.000 ***

The table presents the frequency of responses of each risk factor to each item (Discount Rate, Cash Flows, Both, Neither). Source data and columns defined as in Table 3; * significant at the 10% level; ** significant at the 5% level; *** significant at the 1% level.

27

TABLE 6: Capital Structure. NORTH AMERICA N Mean %

Answers to the Questions... 8. Has your firm seriously considered issuing debt in foreign countries? If “yes”, what factors affect your firm’s decisions about issuing foreign debt? c. Providing a “natural hedge” (e.g.: if the foreign currency devalues, we are not obligated to pay interest in domestic currency) b. Keeping the “source of funds” close to the “use of funds” a. Favorable tax treatment relative to the U.S./Brazil (e.g.: different corporate tax rates) e. Foreign interest rates may be lower than domestic interest rates d. Foreign regulations require us to issue debt abroad 9. Has your firm seriously considered issuing convertible debt? If “yes”, what factors affect your firm’s decisions about issuing convertible debt? a. Convertibles are an inexpensive way to issue “delayed” common stock f. Our stock is currently undervalued g. Ability to “call” or force conversion of convertible debt if/when we need to e. Avoiding short-term equity dilution c. Convertibles are less expensive than straight debt h. To attract investors unsure about the riskiness of our company d. Other firms in our industry successfully use convertibles b. Protecting bondholders against unfavorable actions by managers or stockholders

BRAZIL Mean %

N


368

0.32

32.1%

76

0.37

36.8%

-0.771 0.441

123

3.09

84.6%

28

1.46

25.0%

7.367 0.000 ***

121

2.58

60.3%

26

1.35

30.8%

3.275 0.001 ***

120

2.18

50.0%

28

1.82

32.1%

1.929 0.056 *

123 118

2.16 0.64

44.7% 5.9%

26 28

2.73 0.71

69.2% 14.3%

-1.948 0.053 * -1.155 0.250

372

0.20

20.4%

73

0.16

16.4%

0.841 0.401

79 77 78 77 77 78 77

2.52 2.29 2.22 2.13 1.83 2.03 1.03

59.5% 49.4% 47.4% 44.2% 41.6% 41.0% 11.7%

11 11 12 11 11 11 11

2.36 1.73 2.83 2.18 3.09 1.27 2.27

36.4% 36.4% 66.7% 45.5% 81.8% 18.2% 54.5%

76

0.63

1.3%

11

1.36

9.1%

1.715 0.900 -1.088 -0.080 -1.910 1.927 -2.032

0.090 * 0.371 0.279 0.936 0.060 * 0.057 * 0.045 **

-0.853 0.396


28

TABLE 6: Capital Structure (Continued).


Answers to the Questions... 10. Has your firm seriously considered issuing common stock? If “yes”, what factors affect your firm’s decisions about issuing common stock? l. Earnings per share dilution j. The amount by which our stock is undervalued or overvalued by the market a. If our stock price has recently risen, the price at which we can issue is “high” c. Providing shares to employee bonus/stock option plans e. Maintaining target debt-to-equity ratio i. Diluting the holdings of certain shareholders b. Stock is our “least risky” source of funds g. Whether our recent profits have been sufficient to fund our activities f. Using a similar amount of equity as is used by other firms in our industry h. Issuing stock gives investors a better impression of our firm’s prospects than using debt k. Inability to obtain funds using debt, convertibles, or other sources d. Common stock is our cheapest source of funds i. The capital gains tax rates faced by our investors (relative to tax rates on dividends)

29

BRAZIL Mean %

N


369

0.36

35.5%

76

0.25

25.0%

1.969 0.050 **

131 129 132 131 134 131 129 133 130

2.81 2.65 2.52 2.34 2.28 2.11 1.73 1.72 1.45

67.2% 65.1% 62.9% 52.7% 52.2% 48.1% 29.5% 29.3% 23.1%

12 14 15 13 14 14 15 14 14

1.17 1.64 2.07 0.69 1.79 1.43 2.00 1.43 1.50

8.3% 28.6% 40.0% 7.7% 28.6% 21.4% 20.0% 21.4% 28.6%

7.043 3.529 2.026 5.574 2.114 2.562 0.892 0.705 -0.422

129

1.32

21.7%

3

2.00

33.3%

-0.392 0.696

130 129

1.21 1.16

17.7% 17.1%

13 17

1.15 2.29

23.1% 41.2%

-0.430 0.668 -1.670 0.097 *

128

0.80

4.7%

13

1.38

30.8%

-1.727 0.086 *

0.000 *** 0.001 *** 0.045 ** 0.000 *** 0.036 ** 0.011 ** 0.374 0.482 0.674

TABLE 7: Debt Policy. NORTH AMERICA N Mean %

Answers to the Questions... 5. What factors affect your firm’s choice between short-and long-term debt? b. Matching the maturity of our debt with the life of our assets g. We issue long-term debt to minimize the risk of having to refinance in “bad times” a. We issue short term when short term interest rates are low compared to long term rates c. We issue short-term when we are waiting for long-term market interest rates so decline d. We borrow short-term so that returns from new projects can be captured more fully by shareholders, rather than committing to pay long-term profits as interest to debtholders e. We expect our credit rating to improve, so we borrow short-term until it does f. Borrowing short-term reduces the chance that our firm will want to take on risky projects 7. What is the credit rating for your firm’s debt? Write NONE if debt not rated... (e.g.: AA-, B+) 11. Does your firm have a target range for your debt ratio? 1=no target; 2=flexible target range; 3; somewhat tight target range; 4=strict target range;

BRAZIL Mean %

N


351

2.60

63.2%

72

2.00

40.3%

4.104 0.000 ***

342

2.15

48.8%

71

1.80

35.2%

2.314 0.021 **

345

1.89

35.9%

73

1.66

26.0%

1.794 0.074 *

345

1.78

28.7%

71

1.18

19.7%

1.745 0.082 *

348

0.94

9.5%

70

0.97

17.1%

-1.550 0.122

345

0.85

9.0%

71

0.94

18.3%

-1.843 0.066 *

348

0.53

4.0%

70

1.03

15.7%

-2.464 0.014 **

52.6%

56

44.0%

19

352 361

2.35

2.21

31.7%

3.417 0.001 ***

31.6%

1.238 0.216


30

TABLE 7: Debt Policy (continued). NORTH AMERICA N Mean %

Answers to the Questions... 12. What factors affect how you choose the appropriate amount of debt for your firm? g. The personal tax cost our investors face when they receive interest income d. Our credit rating (as assigned by rating agencies) h. The volatility of our earnings and cash flows a. The tax advantage of interest deductibility e. The transactions costs and fees for issuing debt c. The debt levels of other firms in our industry b. The potential costs of bankruptcy, near-bankruptcy, or financial distress i. We limit debt so our customers/suppliers are not worried about our firm going out of business n. We restrict our borrowing so that profits from new/future projects can be captured fully by shareholders and do not have to be paid out as interest to debtholders f. Financial flexibility (we restrict debt so we have enough internal funds available to pursue new projects when they come along) j. We try to have enough debt that we are not an attractive takeover target k. If we issue debt our competitors know that we are very unlikely to reduce our output/sales m. To ensure that upper management works hard and efficiently, we issue sufficient debt to make sure that a large portion of our cash flow is committed to interest payments l. A high debt ratio helps us bargain for concessions from our employees 13. What other factors affect your firm’s debt policy? a. We issue debt when our recent profits (internal funds) are not sufficient to fund our activities c. We issue debt when interest rates are particularly low d. We use debt when our equity is undervalued by the market g. Changes in the price of our common stock f. We delay retiring debt because of recapitalization costs and fees e. We delay issuing debt because of transactions costs and fees b. Using debt gives investors a better impression of our firm’s prospects than issuing stock h. We issue debt when we have accumulated substantial profits 14. What is your firm’s approximate long-term debt/total assets ratio?...% (e.g.: 40%)

31

BRAZIL Mean %

N


357 359 364 359 358 359 356

2.59 2.46 2.32 2.07 1.95 1.49 1.24

59.4% 57.1% 48.1% 44.8% 33.5% 23.4% 21.3%

65 66 65 68 68 65 62

2.22 1.61 2.20 1.94 2.07 1.35 1.45

47.7% 31.8% 49.2% 39.7% 47.1% 23.1% 32.3%

1.884 4.503 -0.170 0.816 -1.897 0.057 -1.627

0.060 * 0.000 *** 0.865 0.415 0.059 * 0.955 0.105

358

1.24

18.7%

65

1.80

35.4%

-2.415 0.016 **

358

1.01

12.6%

66

1.42

28.8%

-2.544 0.011 **

355

0.68

4.8%

63

0.95

12.7%

-1.753 0.080 *

358

0.73

4.7%

65

1.14

20.0%

-2.768 0.006 ***

356

0.40

2.2%

65

0.85

12.3%

-2.304 0.022 **

356

0.33

1.7%

64

0.64

7.8%

-1.737 0.083 *

357

0.16

0.0%

65

0.52

7.7%

-2.236 0.026 **

357

2.13

46.8%

68

2.06

45.6%

356 354 348 354 354

2.22 1.56 1.08 1.04 1.06

46.3% 30.8% 16.4% 12.4% 10.2%

66 63 64 66 66

1.80 0.57 0.66 1.11 1.39

27.3% 3.2% 7.8% 13.6% 22.7%

356

0.96

9.8%

63

0.67

6.3%

351

0.53

1.1%

64

0.66

9.4%

331

0.30

13.8%

54

0.20

9.3%

0.182 0.856 3.391 8.002 2.246 -0.263 -2.181

0.001 *** 0.000 *** 0.025 ** 0.793 0.030 **

1.019 0.309 -2.142 0.033 ** 1.048 0.295

TABLE 8: Summary of the Results.

Opinions Converge…

Capital Budgeting

• Use of intuitive, rule of thumb criteria (hurdle rate, payback)

Cost of Capital

• Widespread use of a single discount rate for the whole company • Historical returns • Dividend discount model

Capital Structure

• Use of convertible debt as a flexible instrument

Debt Policy

• The setting of flexible or rigid debt target ranges

32

Opinions Contrast… • North Americans use more IRR and NPV • Brazilians use more accounting-based and simulation criteria (accounting rate of return, value at risk) • Brazilians use more multiple discount rates • North Americans use more a single beta • Brazilians are more prone to use multiple betas and to listen to investors and regulators about discount rates • Brazilians claim to adjust both the discount rate and the cash flows of a project to several risk factors • Brazilians are more concerned with transaction costs of debt and equity issues • North Americans are more concerned with corporate governance issues • Brazilians believe relatively more that common stock is the cheapest source of funds • North Americans list market timing, personal taxes and credit rating as important factors • Brazilians are concerned with flexibility, credibility, incentives, and the distribution of firm income • Brazilians claim to use debt policy to avoid takeovers (in a market where takeovers are rare events)

a. Sales revenue 35% 26.8%

25% 20%

40% 35%

23.9% 23.5%

23.0%

19.0%

17.5% 16.9%

30% 25%

15%

5% 0% 25-99 million

100-499 million

500-999 million

NORTH AMERICA

17.1% 11.6%

0%

1-5 billion >5 billion

0%

1-24%

BRAZIL

c. Industry 63.8%

60%

36.2%

40% 30% 20% 10% 0% Public

BRAZIL

62.9% 53.9%

93.7%

80% 70%

46.1%

61.4%

60% 50%

37.1%

30%

37.1%

40% 30%

20% 10%

20% 10%

0%

0%

6.3%

No NORTH AMERICA

Yes

BRAZIL

g. If all options were exercised, what percent of common stock would be owned by the top three officers? 56.6%

50% 40%

44.4%

57.1% 40.1%

38.1%

30%

40%

20%

14.3%

10% 21.1%

10%

5.6%

0% Undergraduate

16.7%

20%

5.7%7.4%

0% 20%

BRAZIL

14.3% 0.0%

BRAZIL

50% 45%

50.3%

40% 35%

35.3% 27.9% 24.2%

30%

14.3% 13.3%

j. CEO tenure (time in current job)

60%

40%

8.5% 0.0%

NORTH AMERICA

i. Age of CEO

50%

MBA

30%

BRAZIL

h. CEO education 60%

42.6%

No NORTH AMERICA

Other

Yes

10%

BRAZIL

f. Regulated Utility?

40%

20%

Private

NORTH AMERICA

100% 90%

50%

50%

51.4%

48.6%

50%

Tech (software/biotech/et c)

Bank/Finance/Insur ance

Communications/M edia

ransport/Energy

Manufacturing

Mining, Construction

Retail and Wholesale

70%

e. Pay Dividends?

60%

>50%

BRAZIL

d. Public or Private

NORTH AMERICA

60%

25-49%

NORTH AMERICA

41.9% 45% 38.2% 40% 35% 30% 25% 16.2% 15.4% 20% 13.2% 13.2% 12.5% 15% 11.1% 9.4% 7.4% 5.9% 5.9% 5.7% 10% 4.0% 5% 0%

70%

9.9%10.1%

10% 5%

1.4% Masters degree

10%

44.9%

non-MBA masters

30%

b. Foreign sales 50% 45%

31.0%

44.1% 37.7% 32.4%

30% 25%

22.8% 22.1%

36.1% 26.2%

23.5%

20% 15%

14.7%

10% 5%

2.7%

0%

0% 60

9 years BRAZIL

Survey Answers to the Question "How frequently does your firm use the following techniques when deciding which projects or acquisitions to pursue?" b. Internal Rate of Return (IRR)

62.8%

c. Hurdle Rate

74.9%

56.9%

48.4%

56.7% 53.5%

f. Payback Period

51.5% 48.9%

j. Sensitivity analysis (e.g.: “good” vs. “fair” vs. “bad”) 38.9% 36.8%

d. Earnings multiple approach 29.4%

g. Discounted payback period l. We incorporate the “real options” of a project when evaluating it

18.5%

42.4%

26.6%

20.3%

i. Accounting Rate of Return (or Book rate of return on assets)

41.0%

13.7%

k. Value at risk (VaR) or other simulation analysis

31.7%

11.9%

h. Profitability index

41.5%

10.8%

e. Adjusted Present Value (APV) 0.0%

75.6%

60.2%

a. Net Present Value (NPV)

10.0%

33.7%

20.0%

30.0%

40.0%

50.0%

NORTH AMERICA

60.0%

70.0%

80.0%

BRAZIL

Survey Answers to the Question "How frequently would your company use the following discount rates when evaluating a new project in an overseas market? To evaluate this project we would use..."

58.8%

a. The discount rate for our entire company

61.6%

d. A risk-matched discount rate for this particular project (considering both country and industry)

50.9% 54.3%

b. The discount rate for the overseas market (country discount rate)

34.5% 39.7%

c. A divisional discount rate (if the project line of business matches a domestic division)

15.6% 35.4%

e. A different discount rate for each component cashflow that has a different risk characteristic (e.g.: depreciation vs. operating cash flows)

9.9% 28.8%

0.0%

10.0%

20.0%

30.0%

40.0%

NORTH AMERICA

50.0%

60.0%

70.0%

BRAZIL

Survey Answers to the Question "Does your firm estimate the cost of equity capital? If “yes”, how do you determine your firm’s cost of equity capital?"

71.1%

b. Using the Capital Asset Pricing Model (CAPM, the beta approach)

37.0%

39.5%

a. With average historical returns on common stock

33.3%

34.1%

c. Using the CAPM but including some extra “risk factors”

48.9%

f. Back out from discounted dividend/earnings model, e.g.: price =dividend/(cost of capital growth)

15.5% 26.2%

14.3%

d. Whatever our investors tell us they require

e. By regulatory decisions

0.0%

33.3%

7.0% 34.9% 10.0%

20.0%

30.0%

40.0%

NORTH AMERICA

50.0%

60.0%

70.0%

BRAZIL

FIGURE 2: Capital Budgeting and Cost of Capital

34

80.0%

Survey Answers to the Question "When valuing a project, do you adjust either the discount rate or cash flows for the following risk factors?" DISCOUNT RATE 15.3% 16.0%

b. Interest rate risk (change in general level of interest rates)

14.5%

h. Size (small firms being riskier)

c. Term structure risk (change in the long-term vs. short term interest rate)

j. Momentum (recent stock price performance) e. Commodity price risk 0.0%

23.3%

6.8%


16.9%

4.0% 3.4%

10.0% BRAZIL

15.0%

20.0%

25.0%

0.0%

18.8%

10.9%

i. “Market-to-book” ratio (ratio of market value of firm to book value assets) j. Momentum (recent stock price performance)

4.9%

g. Distress risk (probability of bankruptcy)

4.8%

0.0%

15.0%

20.0%

25.0%

30.0%

35.0%

NORTH AMERICA

a. Risk of unexpected inflation

48.1%

f. Foreign exchange risk b. Interest rate risk (change in general level of interest rates)

24.7%

5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 50.0%

81.3% 75.1%

28.6%

67.4%

33.3%

65.6%

34.2%

61.8%

16.3%


16.0%

86.9%

34.2%


42.5%

88.9%

52.0%


37.7%

22.1%

BRAZIL

10.0%


22.7%

7.1%

11.7%

5.0%


27.4%

11.9%


10.7%

j. Momentum (recent stock price performance)

45.5%

12.6%


2.9% 2.0%

i. “Market-to-book” ratio (ratio of market value of firm to book value assets)

33.8%

13.4%

h. Size (small firms being riskier) c. Term structure risk (change in the long-term vs. short term interest rate)

20.5% 16.9%

Survey Answers to the Question "When valuing a project, do you adjust either the discount rate or cash flows for the following risk factors?" NEITHER

46.9%

18.8%


17.8%

BRAZIL

24.6%


21.0%

3.7%

NORTH AMERICA

Survey Answers to the Question "When valuing a project, do you adjust either the discount rate or cash flows for the following risk factors?" BOTH


6.0%


13.3%

5.0%

6.3%


j. Momentum (recent stock price performance)

21.3%

2.9%

27.5%

8.8%



18.2%

20.8%

14.4%


16.9%

7.4%


15.3%

f. Foreign exchange risk a. Risk of unexpected inflation

8.6%

30.7%

18.8% 20.8%


17.8%

10.8% 10.4%


18.9%


11.9% 13.8%



Survey Answers to the Question "When valuing a project, do you adjust either the discount rate or cash flows for the following risk factors?" CASH FLOWS

28.6% 23.4% 16.0%

55.6% 55.1% 51.3%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0% 100.0 % BRAZIL NORTH AMERICA

NORTH AMERICA

FIGURE 3: Risk Adjustment Factors

35

Survey Answers to the Question "Has your firm seriously considered issuing debt in foreign countries? If “yes”, what factors affect your firm’s decisions about issuing foreign debt?"

c. Providing a “natural hedge” (e.g.: if the foreign currency devalues, we are not obligated to pay interest in domestic currency)

84.6% 25.0%

60.3%

b. Keeping the “source of funds” close to the “use of funds”

30.8%

a. Favorable tax treatment relative to the U.S./Brazil (e.g.: different corporate tax rates)

50.0% 32.1%

44.7%

e. Foreign interest rates may be lower than domestic interest rates

69.2%

5.9%

d. Foreign regulations require us to issue debt abroad

14.3%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

NORTH AMERICA

60.0%

70.0%

80.0%

90.0%

BRAZIL

Survey Answers to the Question "Has your firm seriously considered issuing convertible debt? If “yes”, what factors affect your firm’s decisions about issuing convertible debt?" a. Convertibles are an inexpensive way to issue “delayed” common stock

59.5% 36.4%

f. Our stock is currently undervalued

49.4% 36.4%

g. Ability to “call” or force conversion of convertible debt if/when we need to

47.4% 66.7%

e. Avoiding short-term equity dilution

44.2% 45.5%

c. Convertibles are less expensive than straight debt

41.6% 81.8%

h. To attract investors unsure about the riskiness of our company

41.0% 18.2%

d. Other firms in our industry successfully use convertibles b. Protecting bondholders against unfavorable actions by managers or stockholders

11.7% 54.5% 1.3% 9.1%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

NORTH AMERICA

60.0%

70.0%

80.0%

90.0%

BRAZIL

Survey Answers to the Question "Has your firm seriously considered issuing common stock? If “yes”, what factors affect your firm’s decisions about issuing common stock?" l. Earnings per share dilution

67.2%

8.3%

j. The amount by which our stock is undervalued or overvalued by the market a. If our stock price has recently risen, the price at which we can issue is “high” c. Providing shares to employee bonus/stock option plans

28.6%

52.7%

e. Maintaining target debt-to-equity ratio

52.2%

28.6%

48.1%

21.4%

b. Stock is our “least risky” source of funds

20.0%

g. Whether our recent profits have been sufficient to fund our activities

21.4%

f. Using a similar amount of equity as is used by other firms in our industry

29.5% 29.3%

23.1% 28.6%

h. Issuing stock gives investors a better impression of our firm’s prospects than using debt

21.7%

33.3%

17.7% 23.1%

k. Inability to obtain funds using debt, convertibles, or other sources

17.1%

d. Common stock is our cheapest source of funds

0.0%

4.7% 10.0%

41.2% 30.8%

20.0%

30.0%

40.0%

NORTH AMERICA

FIGURE 4: Capital Structure

36

62.9%

40.0% 7.7%

i. Diluting the holdings of certain shareholders

i. The capital gains tax rates faced by our investors (relative to tax rates on dividends)

65.1%

50.0%

60.0%

BRAZIL

70.0%

80.0%

Survey Answers to the Question "What factors affect your firm’s choice between short-and long-term debt?"

63.2%

b. Matching the maturity of our debt with the life of our assets

40.3% 48.8%

g. We issue long-term debt to minimize the risk of having to refinance in “bad times”

35.2% 35.9%

a. We issue short term when short term interest rates are low compared to long term rates

26.0% 28.7%

c. We issue short-term when we are waiting for long-term market interest rates so decline

19.7%

d. We borrow short-term so that returns from new projects can be captured more fully by shareholders, rather than committing to pay longterm profits as interest to debtholders

9.5% 17.1% 9.0%

e. We expect our credit rating to improve, so we borrow short-term until it does

18.3% 4.0%

f. Borrowing short-term reduces the chance that our firm will want to take on risky projects

15.7%

0.0%

10.0%

20.0%

30.0%

40.0%

NORTH AMERICA

50.0%

60.0%

70.0%

BRAZIL

Survey Answers to the Question "What factors affect how you choose the appropriate amount of debt for your firm?" g. The personal tax cost our investors face when they receive interest income

59.4%

47.7%

d. Our credit rating (as assigned by rating agencies)

57.1%

31.8% 48.1% 49.2%

h. The volatility of our earnings and cash flows

44.8% 39.7%

a. The tax advantage of interest deductibility

33.5%

e. The transactions costs and fees for issuing debt

47.1%

23.4% 23.1%

c. The debt levels of other firms in our industry b. The potential costs of bankruptcy, near-bankruptcy, or financial distress

21.3%

i. We limit debt so our customers/suppliers are not worried about our firm going out of business n. We restrict our borrowing so that profits from new/future projects can be captured fully by shareholders and do not have to be paid out as f. Financial flexibility (we restrict debt so we have enough internal funds available to pursue new projects when they come along) j. We try to have enough debt that we are not an attractive takeover target

32.3%

18.7%

35.4%

12.6% 4.8%

12.7%

4.7%

k. If we issue debt our competitors know that we are very unlikely to reduce our output/sales m. To ensure that upper management works hard and efficiently, we issue sufficient debt to make sure that a large portion of our cash flow is

2.2% 1.7% 0.0%

l. A high debt ratio helps us bargain for concessions from our employees

0.0%

28.8%

20.0% 12.3%

7.8% 7.7%

10.0%

20.0%

30.0%

40.0%

NORTH AMERICA

50.0%

60.0%

70.0%

BRAZIL

Survey Answers to the Question "What other factors affect your firm’s debt policy?" a. We issue debt when our recent profits (internal funds) are not sufficient to fund our activities

46.8% 45.6% 46.3%

c. We issue debt when interest rates are particularly low d. We use debt when our equity is undervalued by the market

27.3% 30.8% 3.2% 16.4%

g. Changes in the price of our common stock

7.8% 12.4% 13.6%

f. We delay retiring debt because of recapitalization costs and fees

10.2%

e. We delay issuing debt because of transactions costs and fees

22.7%

b. Using debt gives investors a better impression of our firm’s prospects than issuing stock h. We issue debt when we have accumulated substantial profits 0.0%

9.8% 6.3% 1.1% 9.4% 5.0%

10.0%

15.0%

20.0%

25.0%

NORTH AMERICA

30.0% BRAZIL

FIGURE 5: Debt Policy

37

35.0%

40.0%

45.0%

50.0%

NORTH AMERICA

Strict Target 9.7%

No Target 18.8%

Somewhat Tight Target 34.3% Flexible Target 37.1%

BRAZIL

Strict Target 15.8%

No Target 26.3%

Somewhat Tight Target 15.8%

Flexible Target 42.1%

FIGURE 6: Target Debt Ratios

38

APPENDIX I: Sample Page of the Final Portuguese Questionnaire.

39