working paper the practice of corporate finance in an emerging

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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 15 th 2007.

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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.

2

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 well-

known 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 decision-

making 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

3

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,

4

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.

5

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

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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

3 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.

7

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.

8

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

6 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.

9

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.

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

10

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

11

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

12

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

13

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,

14

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

15

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

10 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.

16

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.

17

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,

18

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.

19

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23

TABLE 1: Summary of Finance Survey Studies in the Literature

Authors Firms Return Country(ies) Topics Covered

Lintner (1956) 28 4.7% United States Dividend Policy

Gitman and Forrester (1977) 103 38.4% United States Capital Budgeting

Gitman and Mercurio (1982) 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 Capital Budgeting

Cost of Capital

Sangster (1993) 94 19.15% United Kingdom Capital Budgeting

Epps and Mitchem (1994) 111 27.8% United States Capital Budgeting

Cost of Capital

Poterba and Summers (1995) 160 16% United States Capital Budgeting

Capital Structure

Billingsley and Smith (1996) 88 36.2% United States Cost of Capital

Eid (1996) 161 14.3% Brazil Capital Budgeting

Capital Structure

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 Capital Budgeting

Cost of Capital

Saul (1999) 150 N/A Brazil

Capital Budgeting

Cost of Capital

Capital Structure

Arnold and Hatzopoulos (2000) 149 49% United Kingdom Capital Budgeting

Graham and Harvey (2001) 392 9% United States

Canada

Capital Budgeting

Cost of Capital

Capital Structure

Bancel and Mittoo (2004) 87 12%

European Union

Norway

Switzerland

Capital Structure

Brounen, de Jong, and Koedijk (2004) 313 5%

France

Germany

Netherlands

United Kingdom

Capital Budgeting

Cost of Capital

Capital Structure

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

24

TABLE 2: Questionnaire Return Breakdown.

Media Firms

Contacted

First Wave

July 15th

2005

Second Wave

August 15th

2005 Total

Return

Rate

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%

Total 1,699 91 56.9% 69 43.1% 160 100.0% 9.42%

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

N Mean % N Mean % 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

BRAZILNORTH AMERICA

P-ValueFirm and CEO Characteristics

DIFFERENCE

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.

25

TABLE 4: Capital Budgeting and Cost of Capital.

N Mean % N Mean % Z

1. How frequently does your firm use the following techniques when

deciding which projects or acquisitions to pursue?

b. Internal Rate of Return (IRR) 369 3.09 75.6% 93 2.60 60.2% 3.146 0.002 ***

a. Net Present Value (NPV) 367 3.08 74.9% 94 2.71 62.8% 2.466 0.014 **

c. Hurdle Rate 360 2.48 56.9% 91 2.16 48.4% 1.542 0.124

f. Payback Period 356 2.53 56.7% 86 2.45 53.5% 0.555 0.579

j. Sensitivity analysis (e.g.: “good” vs. “fair” vs. “bad”) 357 2.31 51.5% 88 2.33 48.9% 0.457 0.648

d. Earnings multiple approach 352 1.89 38.9% 87 1.78 36.8% 0.373 0.709

g. Discounted payback period 343 1.56 29.4% 85 2.06 42.4% -2.038 0.042 **

l. We incorporate the “real options” of a project when evaluating it 331 1.47 26.6% 81 1.26 18.5% 1.670 0.096 *

i. Accounting Rate of Return (or Book rate of return on assets) 345 1.34 20.3% 83 2.06 41.0% -3.160 0.002 ***

k. Value at risk (VaR) or other simulation analysis 344 0.95 13.7% 82 1.67 31.7% -3.003 0.003 ***

h. Profitability index 337 0.83 11.9% 82 1.89 41.5% -4.334 0.000 ***

e. Adjusted Present Value (APV) 334 0.85 10.8% 83 1.77 33.7% -3.704 0.000 ***

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 313 2.50 58.8% 86 2.63 61.6% -0.469 0.639

d. A risk-matched discount rate for this particular project (considering both

country and industry) 316 2.09 50.9% 81 2.52 54.3% -0.531 0.595

b. The discount rate for the overseas market (country discount rate) 310 1.65 34.5% 78 1.83 39.7% -0.826 0.409

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

division) 301 0.95 15.6% 79 1.72 35.4% -3.089 0.002 ***

e. A different discount rate for each component cashflow that has a different risk

characteristic (e.g.: depreciation vs. operating cash flows) 304 0.66 9.9% 80 1.50 28.8% -3.205 0.001 ***

BRAZILNORTH AMERICA

P-ValueAnswers to the Questions...

DIFFERENCE

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

26

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

N Mean % N Mean % Z

3. Does your firm estimate the cost of equity capital? If “yes”, how do you

determine your firm’s cost of equity capital?359 0.65 64.6% 86 0.57 57.0% 1.369 0.172

b. Using the Capital Asset Pricing Model (CAPM, the beta approach) 232 2.81 71.1% 46 1.78 37.0% 5.239 0.000 ***

a. With average historical returns on common stock 220 1.70 39.5% 42 1.45 33.3% 0.802 0.423

c. Using the CAPM but including some extra “risk factors” 226 1.52 34.1% 45 1.91 48.9% -1.664 0.097 *

f. Back out from discounted dividend/earnings model, e.g.: price

=dividend/(cost of capital growth) 213 0.87 15.5% 42 1.19 26.2% -1.404 0.162

d. Whatever our investors tell us they require 217 0.86 14.3% 45 1.80 33.3% -2.312 0.022 **

e. By regulatory decisions 215 0.42 7.0% 43 1.58 34.9% -3.168 0.002 ***

6. What was your firm’s approximate (trailing) Price/Earnings ratio over

the past 3 years?... (e.g.: 18) 222 16.61 58.1% 39 5.25 9.6% 8.318 0.000 ***

BRAZILNORTH AMERICA

P-ValueAnswers to the Questions...

DIFFERENCE

27

TABLE 5: Risk Factors and Project Valuation.

N.

Am.BRA Z

N.

Am.BRA Z

N.

Am.BRA Z

N.

Am.BRA Z

a. Risk of unexpected inflation 11.9% 13.8% -0.160 0.874 14.4% 27.5% -1.156 0.252 11.9% 42.5% -2.722 0.008 ** 61.8% 16.3% 5.381 0.000 ***

b. Interest rate risk (change in

general level of interest rates) 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 ***

c. Term structure risk (change

in the long-term vs. short term

interest rate)

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 ***

g. Distress risk (probability of

bankruptcy) 7.4% 23.3% -1.304 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 ***

h. Size (small firms being

riskier) 14.5% 17.8% -0.280 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 ***

i. “Market-to-book” ratio (ratio

of market value of firm to book

value assets)

4.0% 18.2% -1.168 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 ***

j. Momentum (recent stock

price performance) 3.4% 21.3% -1.456 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 ***

Cash Flow Both Neither

P-Value P-Value P-Value P-Value

4. When valuing a project, do

you adjust either the discount

rate or cash flows for the

following risk factors?

Discount Rate

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.

28

TABLE 6: Capital Structure.

N Mean % N Mean % Z

8. Has your firm seriously considered issuing debt in foreign countries? If

“yes”, what factors affect your firm’s decisions about issuing foreign debt?368 0.32 32.1% 76 0.37 36.8% -0.771 0.441

c. Providing a “natural hedge” (e.g.: if the foreign currency devalues, we are not

obligated to pay interest in domestic currency) 123 3.09 84.6% 28 1.46 25.0% 7.367 0.000 ***

b. Keeping the “source of funds” close to the “use of funds” 121 2.58 60.3% 26 1.35 30.8% 3.275 0.001 ***

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

tax rates) 120 2.18 50.0% 28 1.82 32.1% 1.929 0.056 *

e. Foreign interest rates may be lower than domestic interest rates 123 2.16 44.7% 26 2.73 69.2% -1.948 0.053 *

d. Foreign regulations require us to issue debt abroad 118 0.64 5.9% 28 0.71 14.3% -1.155 0.250

9. Has your firm seriously considered issuing convertible debt? If “yes”,

what factors affect your firm’s decisions about issuing convertible debt? 372 0.20 20.4% 73 0.16 16.4% 0.841 0.401

a. Convertibles are an inexpensive way to issue “delayed” common stock 79 2.52 59.5% 11 2.36 36.4% 1.715 0.090 *

f. Our stock is currently undervalued 77 2.29 49.4% 11 1.73 36.4% 0.900 0.371

g. Ability to “call” or force conversion of convertible debt if/when we need to 78 2.22 47.4% 12 2.83 66.7% -1.088 0.279

e. Avoiding short-term equity dilution 77 2.13 44.2% 11 2.18 45.5% -0.080 0.936

c. Convertibles are less expensive than straight debt 77 1.83 41.6% 11 3.09 81.8% -1.910 0.060 *

h. To attract investors unsure about the riskiness of our company 78 2.03 41.0% 11 1.27 18.2% 1.927 0.057 *

d. Other firms in our industry successfully use convertibles 77 1.03 11.7% 11 2.27 54.5% -2.032 0.045 **

b. Protecting bondholders against unfavorable actions by managers or

stockholders 76 0.63 1.3% 11 1.36 9.1% -0.853 0.396

BRAZILNORTH AMERICA

P-ValueAnswers to the Questions...

DIFFERENCE

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

29

TABLE 6: Capital Structure (Continued).

N Mean % N Mean % Z

10. Has your firm seriously considered issuing common stock? If “yes”,

what factors affect your firm’s decisions about issuing common stock?369 0.36 35.5% 76 0.25 25.0% 1.969 0.050 **

l. Earnings per share dilution 131 2.81 67.2% 12 1.17 8.3% 7.043 0.000 ***

j. The amount by which our stock is undervalued or overvalued by the market 129 2.65 65.1% 14 1.64 28.6% 3.529 0.001 ***

a. If our stock price has recently risen, the price at which we can issue is “high” 132 2.52 62.9% 15 2.07 40.0% 2.026 0.045 **

c. Providing shares to employee bonus/stock option plans 131 2.34 52.7% 13 0.69 7.7% 5.574 0.000 ***

e. Maintaining target debt-to-equity ratio 134 2.28 52.2% 14 1.79 28.6% 2.114 0.036 **

i. Diluting the holdings of certain shareholders 131 2.11 48.1% 14 1.43 21.4% 2.562 0.011 **

b. Stock is our “least risky” source of funds 129 1.73 29.5% 15 2.00 20.0% 0.892 0.374

g. Whether our recent profits have been sufficient to fund our activities 133 1.72 29.3% 14 1.43 21.4% 0.705 0.482

f. Using a similar amount of equity as is used by other firms in our industry 130 1.45 23.1% 14 1.50 28.6% -0.422 0.674

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

using debt 129 1.32 21.7% 3 2.00 33.3% -0.392 0.696

k. Inability to obtain funds using debt, convertibles, or other sources 130 1.21 17.7% 13 1.15 23.1% -0.430 0.668

d. Common stock is our cheapest source of funds 129 1.16 17.1% 17 2.29 41.2% -1.670 0.097 *

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

dividends) 128 0.80 4.7% 13 1.38 30.8% -1.727 0.086 *

BRAZILNORTH AMERICA

P-ValueAnswers to the Questions...

DIFFERENCE

30

TABLE 7: Debt Policy.

N Mean % N Mean % Z

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 351 2.60 63.2% 72 2.00 40.3% 4.104 0.000 ***

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

times” 342 2.15 48.8% 71 1.80 35.2% 2.314 0.021 **

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

term rates 345 1.89 35.9% 73 1.66 26.0% 1.794 0.074 *

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

so decline 345 1.78 28.7% 71 1.18 19.7% 1.745 0.082 *

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

348 0.94 9.5% 70 0.97 17.1% -1.550 0.122

e. We expect our credit rating to improve, so we borrow short-term until it does 345 0.85 9.0% 71 0.94 18.3% -1.843 0.066 *

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

risky projects 348 0.53 4.0% 70 1.03 15.7% -2.464 0.014 **

7. What is the credit rating for your firm’s debt? Write NONE if debt not

rated... (e.g.: AA-, B+) 352 52.6% 56 31.7% 3.417 0.001 ***

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;

361 2.35 44.0% 19 2.21 31.6% 1.238 0.216

BRAZILNORTH AMERICA

P-ValueAnswers to the Questions...

DIFFERENCE

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

31

TABLE 7: Debt Policy (continued).

N Mean % N Mean % Z

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 357 2.59 59.4% 65 2.22 47.7% 1.884 0.060 *

d. Our credit rating (as assigned by rating agencies) 359 2.46 57.1% 66 1.61 31.8% 4.503 0.000 ***

h. The volatility of our earnings and cash flows 364 2.32 48.1% 65 2.20 49.2% -0.170 0.865

a. The tax advantage of interest deductibility 359 2.07 44.8% 68 1.94 39.7% 0.816 0.415

e. The transactions costs and fees for issuing debt 358 1.95 33.5% 68 2.07 47.1% -1.897 0.059 *

c. The debt levels of other firms in our industry 359 1.49 23.4% 65 1.35 23.1% 0.057 0.955

b. The potential costs of bankruptcy, near-bankruptcy, or financial distress 356 1.24 21.3% 62 1.45 32.3% -1.627 0.105

i. We limit debt so our customers/suppliers are not worried about our firm going

out of business 358 1.24 18.7% 65 1.80 35.4% -2.415 0.016 **

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

358 1.01 12.6% 66 1.42 28.8% -2.544 0.011 **

f. Financial flexibility (we restrict debt so we have enough internal funds

available to pursue new projects when they come along) 355 0.68 4.8% 63 0.95 12.7% -1.753 0.080 *

j. We try to have enough debt that we are not an attractive takeover target 358 0.73 4.7% 65 1.14 20.0% -2.768 0.006 ***

k. If we issue debt our competitors know that we are very unlikely to reduce our

output/sales 356 0.40 2.2% 65 0.85 12.3% -2.304 0.022 **

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

356 0.33 1.7% 64 0.64 7.8% -1.737 0.083 *

l. A high debt ratio helps us bargain for concessions from our employees 357 0.16 0.0% 65 0.52 7.7% -2.236 0.026 **

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 357 2.13 46.8% 68 2.06 45.6% 0.182 0.856

c. We issue debt when interest rates are particularly low 356 2.22 46.3% 66 1.80 27.3% 3.391 0.001 ***

d. We use debt when our equity is undervalued by the market 354 1.56 30.8% 63 0.57 3.2% 8.002 0.000 ***

g. Changes in the price of our common stock 348 1.08 16.4% 64 0.66 7.8% 2.246 0.025 **

f. We delay retiring debt because of recapitalization costs and fees 354 1.04 12.4% 66 1.11 13.6% -0.263 0.793

e. We delay issuing debt because of transactions costs and fees 354 1.06 10.2% 66 1.39 22.7% -2.181 0.030 **

b. Using debt gives investors a better impression of our firm’s prospects than

issuing stock 356 0.96 9.8% 63 0.67 6.3% 1.019 0.309

h. We issue debt when we have accumulated substantial profits 351 0.53 1.1% 64 0.66 9.4% -2.142 0.033 **

14. What is your firm’s approximate long-term debt/total assets ratio?...%

(e.g.: 40%) 331 0.30 13.8% 54 0.20 9.3% 1.048 0.295

BRAZILNORTH AMERICA

P-ValueAnswers to the Questions...

DIFFERENCE

32

TABLE 8: Summary of the Results.

Opinions Converge… Opinions Contrast…

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

• North Americans use more IRR and NPV • Brazilians use more accounting-based and simulation criteria (accounting rate of return, value at risk)

Cost of Capital

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

• 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

Capital Structure • Use of convertible debt as a flexible instrument

• 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

Debt Policy • The setting of flexible or rigid debt target ranges

• 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)

33

a. Sales revenue

8.2%

17.5%

23.0%

8.7%

23.5%

19.0%

26.8%

16.9%

31.0%

23.9%

1.4%

0%

5%

10%

15%

20%

25%

30%

35%

<25million

25-99million

100-499million

500-999million

1-5 billion >5 billion

NORTH AMERICA BRAZIL

b. Foreign sales

28.9%

44.1%

17.1%

9.9%

44.9%

33.3%

11.6% 10.1%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

0% 1-24% 25-49% >50%

NORTH AMERICA BRAZIL c. Industry

11.1%4.0%

41.9%

12.5%5.7%

15.4%9.4%

13.2%5.9%

38.2%

16.2%

5.9%13.2%

7.4%

0%5%

10%15%20%25%30%35%40%45%

Ret

ail a

ndW

hole

sale

Min

ing,

Con

stru

ctio

n

Man

ufac

turin

g

rans

port

/Ene

rgy

Com

mun

icat

ions

/Med

ia

Ban

k/F

inan

ce/In

sur

ance

Tec

h(s

oftw

are/

biot

ech/

etc)

NORTH AMERICA BRAZIL

d. Public or Private

63.8%

36.2%

48.6%51.4%

0%

10%

20%

30%

40%

50%

60%

70%

Public Private

NORTH AMERICA BRAZIL e. Pay Dividends?

53.9%

46.1%

62.9%

37.1%

0%

10%

20%

30%

40%

50%

60%

70%

Yes No

NORTH AMERICA BRAZIL

f. Regulated Utility?

6.3%

93.7%

61.4%

37.1%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Yes No

NORTH AMERICA BRAZIL g. If all options were exercised, what percent of common

stock would be owned by the top three officers?

56.6%

16.7%

5.7%

21.1%

42.6%

5.6% 7.4%

44.4%

0%

10%

20%

30%

40%

50%

60%

<5% 5-10% 10-20% >20%

NORTH AMERICA BRAZIL

h. CEO education

40.1% 38.1%

8.5%13.3%

0.0%

57.1%

14.3%

0.0%

14.3% 14.3%

0%

10%

20%

30%

40%

50%

60%

Und

ergr

adua

te

MB

A

non-

MB

Am

aste

rs

>M

aste

rsde

gree

Oth

er

NORTH AMERICA BRAZIL i. Age of CEO

2.7%

24.2%

50.3%

22.8%

14.7%

27.9%

35.3%

22.1%

0%

10%

20%

30%

40%

50%

60%

<40 40-49 50-59 >60

NORTH AMERICA BRAZIL

j. CEO tenure (time in current job)

37.7%

26.2%

36.1%32.4%

23.5%

44.1%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

<4 years 4-9 years >9 years

NORTH AMERICA BRAZIL FIGURE 1: Sample Characteristics

34

Survey Answers to the Question "How frequently does your firm use the following techniques

when deciding which projects or acquisitions to pursue?"

75.6%

74.9%

56.9%

56.7%

51.5%

38.9%

29.4%

26.6%

20.3%

13.7%

11.9%

10.8%

60.2%

62.8%

48.4%

53.5%

48.9%

36.8%

42.4%

18.5%

41.0%

31.7%

41.5%

33.7%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0%

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)

NORTH AMERICA 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%

50.9%

34.5%

15.6%

9.9%

61.6%

54.3%

39.7%

35.4%

28.8%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0%

a. The discount rate for our entirecompany

d. A risk-matched discount rate forthis particular project (considering

both country and industry)

b. The discount rate for theoverseas market (country discount

rate)

c. A divisional discount rate (if theproject line of business matches a

domestic division)

e. A different discount rate for eachcomponent cashflow that has adifferent risk characteristic (e.g.:depreciation vs. operating cash

flows)

NORTH AMERICA 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%

39.5%

34.1%

15.5%

14.3%

7.0%

37.0%

33.3%

48.9%

26.2%

33.3%

34.9%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0%

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

a. With average historical returns oncommon stock

c. Using the CAPM but includingsome extra “risk factors”

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

d. Whatever our investors tell usthey require

e. By regulatory decisions

NORTH AMERICA BRAZIL

FIGURE 2: Capital Budgeting and Cost of Capital

35

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

13.3%

21.3%

18.2%

16.9%

23.3%

16.9%

10.4%

13.8%

17.8%

16.0%

2.9%

3.4%

4.0%

6.8%

7.4%

8.6%

10.8%

11.9%

14.5%

15.3%

0.0% 5.0% 10.0% 15.0% 20.0% 25.0%

e. Commodity price risk

j. Momentum (recent stock price performance)

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

d. GDP or business cycle risk

g. Distress risk (probability of bankruptcy)

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

f. Foreign exchange risk

a. Risk of unexpected inflation

h. Size (small firms being riskier)

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

BRAZIL 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?"

CASH FLOWS

11.7%

10.7%

16.9%

20.5%

17.8%

21.0%

27.5%

20.8%

20.8%

30.7%

2.0%

2.9%

3.7%

6.0%

6.3%

8.8%

14.4%

15.3%

18.8%

18.9%

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0%

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

j. Momentum (recent stock price performance)

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

h. Size (small firms being riskier)

g. Distress risk (probability of bankruptcy)

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

a. Risk of unexpected inflation

f. Foreign exchange risk

d. GDP or business cycle risk

e. Commodity price risk

BRAZIL 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

24.7%

16.0%

22.1%

22.7%

42.5%

37.7%

27.4%

45.5%

33.8%

46.9%

4.8%

4.9%

7.1%

10.9%

11.9%

12.6%

13.4%

18.8%

18.8%

24.6%

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 50.0%

g. Distress risk (probability of bankruptcy)

j. Momentum (recent stock price performance)

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

e. Commodity price risk

a. Risk of unexpected inflation

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

h. Size (small firms being riskier)

f. Foreign exchange risk

d. GDP or business cycle risk

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

BRAZIL 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?"

NEITHER

16.0%

23.4%

28.6%

16.3%

34.2%

33.3%

28.6%

34.2%

48.1%

52.0%

51.3%

55.1%

55.6%

61.8%

65.6%

67.4%

75.1%

81.3%

86.9%

88.9%

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

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

f. Foreign exchange risk

d. GDP or business cycle risk

a. Risk of unexpected inflation

h. Size (small firms being riskier)

e. Commodity price risk

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

g. Distress risk (probability of bankruptcy)

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

j. Momentum (recent stock price performance)

BRAZIL NORTH AMERICA

FIGURE 3: Risk Adjustment Factors

36

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?"

84.6%

60.3%

50.0%

44.7%

5.9%

25.0%

30.8%

32.1%

69.2%

14.3%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0%

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

domestic currency)

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

a. Favorable tax treatment relativeto the U.S./Brazil (e.g.: different

corporate tax rates)

e. Foreign interest rates may belower than domestic interest rates

d. Foreign regulations require us toissue debt abroad

NORTH AMERICA 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?"

59.5%

49.4%

47.4%

44.2%

41.6%

41.0%

11.7%

1.3%

36.4%

36.4%

66.7%

45.5%

81.8%

18.2%

54.5%

9.1%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0%

a. Convertibles are an inexpensiveway to issue “delayed” common

stock

f. Our stock is currently undervalued

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

to

e. Avoiding short-term equity dilution

c. Convertibles are less expensivethan straight debt

h. To attract investors unsure aboutthe riskiness of our company

d. Other firms in our industrysuccessfully use convertibles

b. Protecting bondholders againstunfavorable actions by managers or

stockholders

NORTH AMERICA 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?"

67.2%

65.1%

62.9%

52.7%

52.2%

48.1%

29.5%

29.3%

23.1%

21.7%

17.7%

17.1%

4.7%

8.3%

28.6%

40.0%

7.7%

28.6%

21.4%

20.0%

21.4%

28.6%

33.3%

23.1%

41.2%

30.8%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0%

l. Earnings per share dilution

j. The amount by which our stock is undervalued or overvalued by themarket

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 prospectsthan 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 rateson dividends)

NORTH AMERICA BRAZIL

FIGURE 4: Capital Structure

37

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

long-term debt?"

63.2%

48.8%

35.9%

28.7%

9.5%

9.0%

4.0%

40.3%

35.2%

26.0%

19.7%

17.1%

18.3%

15.7%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0%

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 comparedto long term rates

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

d. We borrow short-term so that returns from new projects can becaptured 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 itdoes

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

NORTH AMERICA BRAZIL Survey Answers to the Question "What factors affect how you choose the appropriate amount

of debt for your firm?"

59.4%

57.1%

48.1%

44.8%

33.5%

23.4%

21.3%

18.7%

12.6%

4.8%

4.7%

2.2%

1.7%

0.0%

47.7%

31.8%

49.2%

39.7%

47.1%

23.1%

32.3%

35.4%

28.8%

12.7%

20.0%

12.3%

7.8%

7.7%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0%

g. The personal tax cost our investors face when they receive interestincome

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 firmgoing out of business

n. We restrict our borrowing so that profits from new/future projects canbe captured fully by shareholders and do not have to be paid out as

f. Financial flexibility (we restrict debt so we have enough internal fundsavailable 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 toreduce our output/sales

m. To ensure that upper management works hard and efficiently, weissue sufficient debt to make sure that a large portion of our cash flow is

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

NORTH AMERICA BRAZIL Survey Answers to the Question "What other factors affect your firm’s debt policy?"

46.8%

46.3%

30.8%

16.4%

12.4%

10.2%

9.8%

1.1%

45.6%

27.3%

3.2%

7.8%

13.6%

22.7%

6.3%

9.4%

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 50.0%

a. We issue debt when our recentprofits (internal funds) are notsufficient to fund our activities

c. We issue debt when interest ratesare particularly low

d. We use debt when our equity isundervalued by the market

g. Changes in the price of ourcommon stock

f. We delay retiring debt because ofrecapitalization costs and fees

e. We delay issuing debt because oftransactions costs and fees

b. Using debt gives investors abetter impression of our firm’sprospects than issuing stock

h. We issue debt when we haveaccumulated substantial profits

NORTH AMERICA BRAZIL

FIGURE 5: Debt Policy

38

NORTH AMERICA

No Target18.8%

Flexible Target37.1%

Somewhat Tight Target34.3%

Strict Target9.7%

BRAZIL

No Target26.3%

Flexible Target42.1%

Somewhat Tight Target15.8%

Strict Target15.8%

FIGURE 6: Target Debt Ratios

39

APPENDIX I: Sample Page of the Final Portuguese Questionnaire.