International Financial Management

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INTERNATIONAL FINANCIAL MANAGEMENT
HARVARD BUSINESS SCHOOL EC COURSE PAPER DECEMBER 2005

“INTERNATIONAL CAPITAL BUDGETING IN PRACTICE”

MARC LIEN 70605147

INTERNATIONAL CAPITAL BUDGETING IN PRACTICE

INTRODUCTION
I wrote this International Financial Management Paper with four objectives in mind: • To develop a survey instrument aimed at providing a rich description of the practices of international corporate finance, allowing us to infer whether corporate actions are consistent with academic theories. To construct a practical step-by-step approach to implementing such a survey with the objectives of maximizing response rate and minimizing biases. This approach would represent a plan of action to go from idea conception through to publication. To find evidence from prior surveys supporting the theory that multi-national corporations consistently over state their cost-of-capital. To improve my understanding of international corporate finance concepts and to provide an opportunity to research and explore the challenges and tradeoffs that financial executives face.



• •

I have attempted to provide a real practical aid to the future undertaking of a survey on international capital budgeting practices. To best achieve this aim, I structured this report in the form of a chronological project plan. The major steps in the eight point plan are: 1. Understand previous academic research 2. Define research objectives 3. Develop draft research instruments 4. Refine survey instrument 5. Select target companies 6. Construct delivery mechanism 7. Design marketing approach 8. Undertake research

Marc Lien 70605147

International Financial Management EC Course Paper

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INTERNATIONAL CAPITAL BUDGETING IN PRACTICE

1. UNDERSTAND PREVIOUS ACADEMIC RESEARCH
Prior to engaging in a new piece of academic research, I felt it important to review prior literature. Firstly, through a review of contemporary publications on a broad range of International Financial Management topics, I felt better capable of creating an informed survey instrument. Secondly, through a detailed critique of 20 previous surveys on Capital Budgeting since 1970 (see Appendix A), I was able to both identify best practice in survey construction and execution and, finally, this comprehensive review of prior survey literature enabled me to identify where any gaps exist in terms of academic understanding that could guide this piece of work. My survey review highlights three main routes that prior research has followed:

1. Determine whether a gap exists between capital budgeting practices in the field and those espoused by academics A broad range of surveys going back to Mao (1970) [1]1 have looked to understand and explain differences between the behavior of finance practitioners and the normative view held by the academic world. This body of research has captured three aspects of finance practice: how firms use capital budgeting techniques, how they incorporate and manage risk and how they determine their cost of capital. Klammer [2], Gitman [4], Schall [5] all identify that managers in firms have a preference to use simple payback techniques over more sophisticated DCF ones although this trend is changing over time (Block [7]). Later studies suggest the level of financial sophistication may be increasing in some areas but not in others. Blazouske [10], for example, notes that although firms use advanced capital budgeting techniques, few use any method of risk adjustment or management science techniques. Ryan (2002) [19] reviews past U.S surveys to see whether capital budgeting practices have changed in Fortune 1,000 firms over time. She concludes: “it appears the views of academics and senior managers of Fortune 1,000 companies on basic capital budgeting techniques are in stronger agreement than ever before.”2 Numbers in square brackets ‘[ ]’ reference surveys in Appendix A Ryan, P., “Capital Budgeting Practices of the Fortune 1000:...
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