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International Trends and Events in Corporate Finance and Management: A Survey Glenn H. Petry and James Sprow

Glenn H. Petry is Professor of Finance at Washington State University, Pullman, WA, and James Sprow is an Assistant Professor of Finance at Grand Valley State University, Allendale, MI. This paper was written while Professor Sprow was a doctoral student at Washington State University, Pullman, WA.

• Large firms, most of which have international sales, have heen the suhjects of many capital hudgeting studies. (See references [2] through [7] and [9] through [28].) Typically, those studies have focused on capital hudgeting techniques, hurdle rates, project ac- ceptance criteria, availahility of funds, etc. None have analyzed the prohlems affecting U.S. firms in their activities overseas, or their responses to certain important financial trends both here and abroad.

This article addresses important financial developments like the coming consolidation of the European Economic Community, the restructuring of the East Bloc countries, the potential reduction in U.S. military expenditures, and the rising use of junk honds and leveraged huyouts (LBOs). Our ohjective was to gain insights into the way these events are shaping U.S. firms, as well as the firms' attitudes and likely responses to them. This study included firms that range from highly multinational to those with little or no foreign sales, since our ohjective was to study not only full-fiedged multi- nationals, hut also emerging international firms and utilities with multinational suhsidiaries.

I. Survey Methodology and Responses

The level of response to mail surveys hy corporate financial executives in the United States dropped suhstantially after 1976. Except for two very short surveys ofthe very largest U.S. corpora- tions, most recent surveys have had response rates of 26 percent or less, compared to a median rate of 50 percent in surveys hefore 1976. To reduce the effects of low response rates, the authors enlisted the aid of two survey design experts.' While the findings and results are the sole responsihility of the authors, one or hoth of the survey consultants read all mailings and the questionnaire. The questions were all hased on ideas supplied hy 71 U.S. corporate

Dr. Donald Stem, Washington State University, is on the editorial board as a specialist in survey research for the .Journal of Marketing Research Dr. Donald Dillman is the Director of the Social and Economics Science Research Center at Washington State University and author of Mail and Telephone Surveys: The Total Design Method (Wiley Interscience, 1978).

financial executives (all members of the Financial Management Association); the survey was then pretested hy fourteen executives and four professors. Although the questionnaire was designed as carefully as possihle, one must nonetheless acknowledge the type of prohlem raised hy Aggarwal [1]. When discussing surveys on capital hudgeting, he pointed out problems in getting accurate corporation-wide assessment of technique usage. The problem should he alleviated in this survey since it focuses on policy and, hy summarizing groups, may even out imhalances. The fact that over half of the respondents requested the results, thus identifying them- selves and their companies, indicates serious attention to the survey. The high level of executive response also refiects strong interest in the data.

Since the emphasis was on existing or potential multinational firms, a random sample of 449 of the 1990 Business Week 1000 firms was chosen. (This was a reduction from a slightly larger sample due to mergers and the elimination of firms involved in the preparation of the questionnaire.) Questionnaires were sent to the chief financial officers during the summer and fall of 1990, and after five mailings, 151 executives of firms, or 33.6 percent, returned fully or mosdy completed surveys. This response rate is consider- ahly higher than for most post-1978 surveys that included firms smaller than the Fortune 500.

The list of respondents hy industry is shown in Exhihit 1. The industries represented are quite varied, the largest sectors heing utilities, financial companies and hanking, and consumer goods and retailing. There is a hroad representation of high-technology firms, capital and lahor intensive industries, service firms, and those with rapid product ohsolescence. (Some of these areas overlap.) To reduce the size of exhihits, the corporations are grouped into four hroad categories: 61 industrial, 40 consumer/retail, 16 finan- cial/hanking, and 34 utilities.

The bias in the sample is toward slightly larger firms, similar to that reported in other studies. The median market value of the Business Week 1000 respondents is 448, while the median ranking

22 FINANCIAL PRACTICE AND EDUCATION -- SPRING/SUMMER, 1993

of the population would be 500, The percentages of representation in the broad categories compare as follows:

Bus. Week 1000 Industrial 38,9

Consumer/Retail 29,0

Financial/Banking 17,0

Utilities 15.1

Total 100,0

Respondents 40.4

26,5

10,6

22,5

100.0

Exhibit 1. Industries of Questionnaire Respondents

Industry Growth

1. Utilities (electricity, gas, telephone)

2. Finance, Banking

3. CcHisumer Goods and Retailing

4. Electronics

5. Energy

6. Food and Beverage

7. Chemicals, Plastic

8. Forest Products

9. Machinery

10. HeaMi Care, Recreation & Entertainment

11. Aerospace, Defense 12. Drug

13. Trucks, Transport

14. Computers and Software

15. Publishing, Printing

16. Steei, Tools, Constraction

Percent 22.5%

10.6

9.9

4.6

6.6

5.3

5.9

2.7

4.0

4.6

4.0

3.3

2.7

Total

Industrial (4,5, 7,8, 9,11,13,14, and 16) Consumer/Retail (3,6,10,12, and 15) FinanciallBanking (2) Utilities (1)

151 100.0

The industrial and consumer/retail respondent groups closely match their percentages of representation in the Business Week 1000, but the rate of response by the financial sector was somewhat lower, probably because of consolidations and problems in that sector. There was a relatively high response by the utilities, possib- ly due to their greater public orientation and acceptance of public inquiries.

The respondents' answers were also compared for percentage of reported sales or revenues in foreign countries. Three categories were used: 0 to 8 percent foreign sales, 9 to 29 percent, and 30 percent and over, the latter group comprising almost exclusively industrial and consumer/retail firms.

n . International Events and Factors Affecting Profitability and Risk

Firms selling intemationally encounter both added risks and added rewards. The foreign competitive environment is shaped by different exchange rates, regulations, standards, local customs, labor relations and degree of integration in financial markets, U,S, multinational firms can reduce some risks by investing in foreign operations or using offshore suppliers, and increase profits by expanding their share of the world market. In theory, firms will invest where they obtain the best risk/reward combination,

A. Consolidation of the European Economic Community

In 1992, the consolidation of the European Economic Com- munity (EEC) will be complete, with possibly substantial effects on profits. With fewer regulations, costs should drop and market entry be easier. The survey responses, however, show that most firms do not think profits will be affected, or have no prediction about them. The most optimistic groups are the industrial and consumer/retail firms, where approximately 30 percent believe profits will rise; almost none of this group predict falling profits. Among all groups, the most intemationally oriented firms (30 percent or more of sales abroad) are considerably more likely to predict rising profits from the EEC, The most hopeful firms are concentrated in the following industries (in descending order): publishing and printing; steel, tools, and construction; drugs; machinery,

B. Restructuring of the East Bloc

Another major intemational event is the restructuring of the East Bloc countries, which is likely to increase trade provided the East Bloc governments are stable and capitalism is encouraged. Once much of the restructuring has taken place, investing should be much less risky, with more projects having a positive net present value. The industrial and the consumer/retail companies have the most favorable view of East Bloc business opportunities, with over 72 percent already doing business there or planning to do so. These optimistic views parallel closely the percentages of current foreign business the firms have. Almost none of the firms in the other two groups currently do business in the East Bloc, and only about 20 percent plan to.

The publishing/printing and drug industries expect to expand rapidly in Eastem Europe, These industries have relatively low marginal costs and low capital investments per dollar of sales, so they would risk less if the East Bloc govemments proved unstable. Few of the financial/banking group and none of the utility group have had any past involvement with East Bloc countries. However, a number of these firms now plan some activity. The utility com- panies apparently are working through subsidiaries or plan telecom- munications activity,

C. Stability and Restrictions on Currency

The selection of markets to pursue often depends on the stability of, and absence of restrictions on the currencies. Monetary policy can cause rampant inflation, restricted investment and currency conversion problems. Instability and current restrictions raise the

PETRY AND SPROW - INTERNATIONAL TRENDS AND EVENTS 23

Exhibit 2. International Factors Negatively Affecting Current Profitability

Restrictive Practices

Tariffs or Regulations

Unstable Cuirencies

Foreign Government Subsidies

Shaky Governments in Less Developed Countries Third World Debt Problems

Varying Standards Between Countries

Lower Cost of Capital in Countries Without Plants

Lower Labor Costs in Countries Without Plants Patent Protection

Higher Productivity in Countries Without PlMits

Lower Tax Rates in Countries Without Plants Other

3.58

3.26

3.15

3.35

2.95

2.64

2.69

2.88

2.69

2.54

2.38

2.49

3.67

uimsumen Retail

2.79

3.03

3.12

2.59

2.52

2.28

2.14

2.00

2.24

1.69

1.79

3.33

financial/ Banking

3.64

2.82

2.70

2.73

3.27

2.55

2.45

1.91

2.55

2.09

1.00

Utilities

3.78

3.22

3.10

3.30

2.83

2.96

2.78

2.35

2.83

2.30

2.61

2.17

1.00

Weighted Average

3.44

2.16

3.07

2.84

2.67

2.58

2.53

2.51

2.34

' 2.26

2.18

2.88

Exhibit 3. Factors Expected to Negatively Affect Future

Intense Competition

High Medical Costs

Low Economic Growth in the U.S.

Government Regulations of the Environment, Safety, etc. High Litigation Costs

Large Budget Deficits

Regulation of Rates, Entry and Exit

Shaky U.S. Banking System

Shortening of Product Life

Shortening Lead Time

Increasing Investment by Foreigners

PAC Donations by Foreigners Other

Profitability

Industrial

3.55

3.40

3.17

3.29

3.30

3.33

2.60

2.37

2.13

1.88

1.98

4.00

Consumer/ Retail

3.83

3.13

3.17

2.69

2.60

2.70

2.77

2.20

2.60

2.23

1.63

1.31

Financial/ Banking

4.43

3.50

3.36

3.00

4.00

3.64

3.07

3.31

2.62

2.46

2.23

2.15

Utilitks

3.43

3.21

3.45

3.76

3.28

3.04

3.72

2.29

2.14

2.18

2.00

1.93

1.00

Weighted Average

3.71

3.30

3.26

3.22

3.20

3.14

2.97

2.42

2.32

2.19

1.90

1.79

2.60

cost of capital by increasing the variance of returns. Among the executives surveyed, 86 percent indicated that their companies do not invest or substantially limit their investments in those countries with hyperinflation or major currency restrictions.

D. Current Negative International Factors

shown in Exhibit 2, executives are especially concerned about restrictive practices that reduce access to foreign markets, tariffs and regulations, unstable currencies, and foreign government sub- sidies. It is interesting to note that the consumer/retail sector seems somewhat less anxious about these factors in international markets, perhaps because their products are less technical.

To construct a comprehensive mternational perspective, execu- The most intemational firms (30 percent and up of sales abroad) tives were asked to rate the current factors limiting profits. They give heav.er weight to the inlportance of unstable currendes rated the factors from 1 to 5, with 5 being the most negative. As restrictive practices, and patent protection. These m a y X on

24 FINANCIAL PRACTICE AND EDUCATION -- SPRING/SUMMER, 1993

greater importance the more a firm's sales and profits are at risk. Less intemational firms have less concem about shaky govern- ments.

It is worth noting that, overall, executives are less concerned about direct economic factors such as lower cost of capital, labor costs, tax rates, and higher productivity in a country if their firms have no plants there.

IIL U.S. Factors and Events Affecting Profitability and Risk

In Exhibit 3. the executives were asked to rate factors limiting future profitability, again using a scale of 1 to 5. Although the intemational aspect was present, the emphasis here was on domestic factors. For this question, the rankings tend to differ substantially. For example, intense competition that drives down marginal profits is the number one concem of the three non-utility sectors, but the utilities are understandably more worried about regulations that increase costs. While the group rankings do vary, they share common concerns about high medical and litigation costs, large budget deficits and low U.S. economic growth. The most concem about the latter factor, as one might expect, comes from the least intemational (0 to 8 percent of sales abroad) industrial and con- sumer/retail firms. In the financial/banking sector, the most inter- national firms seem more woiTied about intense competition, large budget deficits and litigation.

Two other points are worth mentioning. It's interesting, al- though perhaps not surprising, that the financial/banking group is more concemed about the banking system than are the other three groups. One might speculate that the banks are benefiting from asymmetric information, knowing more about conditions in the banking system than those outside it do.

Despite the considerable press devoted to increasing investment by foreigners, the executives surveyed seem to accept the notion of efficient capital markets. The effects of increasing PAC donations also cause them no concern, perhaps because they are net beneficiaries.

A. Junk Bonds and Leveraged Buy-outs

One of the issues addressed in the financial press has been whether the proliferation of junk bonds soaks up available credit, creates few economic benefits, and drives up interest rates. As shown in Exhibit 4, most ofthe executives feel there is little impact from junk bonds on lending to their firms or, in the case of banks, lending by them.

Many of the junk bonds are used to complete a leveraged buy-out (LBO). Asked about the LBOs' impacts on the U.S. economy (see Exhibit 5), over three-fifths of the respondents feel that they in- crease the risk of bankruptcy and make the economy less stable. Roughly one-fourth of the respondents have other criticisms: that LBOs raise interest rates and reduce the money available for equity capital. Apparently, on this issue some executives are not strong believers in the efficiency of financial markets. About the same percentage, however, have positive views: that LBOs improve competitiveness and provide needed reorganizations of firms. This view is more consistent with a belief in market efficiency. The least multinational firms are more likely to cite a need for reorganization of firms, while the most intemational are more likely to mention the negative effects of reducing equity capital or raising interest rates. Only about seven percent feel that LBOs have no significant nega- tive or positive impact.

B. Increasing Debt Levels

There has been a rising use of debt by Fortune 500 (and presumably Business Week 1000) industrial companies over the past 20 years or more (Fuller and Petry [8]). The Fuller/Petry study showed that increasing debt is associated with declining real profit margins, as firms apparently try to maintain their retum on equity by using leverage. In this survey, executives were asked the reasons (not the uses such as acquisition) for rising leverage. Almost two-thirds cited the cheaper cost of debt after taxes, compared to equity. (See Exhibit 6.) However, financial theory demonstrates that will always be true, so the explanation casts little light on causes ofthe trend.

Exhibit 4. Effects of Junk Bonds on Lending to Your Eirm

No Effect

More Difficult to Sell New Debt Issues

Banks Asked for More Information

Banks Increased our Lending Because of Soundness

Banks Asked for More Collateral

Banks Raised our Interest Rate

Banks Reduced Their Relative Lending

Other

idustrial

60.7%

6.6

4.9

1.6

3.3

1.6

3.3

Consumer/ Retail

47.5%

12.5

10.0

2.5

10.0

Financial/ Banking

62.5%

6.3

12.5

6.3

Utilities

47.1%

14.7

5.9

8.8

5.9

2.9

5.9

Unweighted Average

61.0%

11.8

8.1

4.4

3.7

2.9

1.5

6.6

Note: Percentages total more than 100 percent because of multiple responses.

PETRY AND SPROW -- INTERNATIONAL TRENDS AND EVENTS 25

Exhibit 5. Impacts of LBOs on U.S. Economy

Industrial Consumer/ Financial/ Utiliti^ Weighted Retail Banking Average

Increases Risk of Bankruptcy, Makes Economy Less Stable

Raises Interest Rates by Diverting Capital from Other Firms

Reduces the Money Available for Equity Capital

Provides Needed Reorganization of Firms

Improves Competitiveness

No Significant Positive or Negative Impacts

Other

Note: Percentages total more than 100 percent because of multiple responses.

59.0%

21.3

24.6

3.3

6.6

62.5% 30.0

25.0

27.5

22.5

10.0

7.5

56.3% 12.5

25.0

32.5

31.3

12.5

6.3

64.7% 32.3

20.6

14.7

20.6

5.9

2.9

61.6% 25.1

25.1

24.5

6.6

Exhibit 6. Reasons for Increasing Use of Debt Over Past 20 Years

Industrial Consumer/ Financial/ Utilities Weighted Retail Banking Average

Debt Costs after Taxes are Relatively Lower than Equity

Innovations in the Debt Market

Fear of Takeover

Belief that Investors & Lenders are Less Risk-Averse than Before

Belief that Growth is More Predictable

Economy Permanently Now More Stable

Investors/Lenders Don't Remember Depression

Other

Note: Percentages total more than 100 percent becau.se of multiple responses.

57.4%

41.0

3L1

14.8

8.2

9.8

4.9

6.6

67.5% 35.0

32.5

12.5

15.0

5.0

7.5

43.7% 37.5

25.0

12.5

6.3

73.5% 44.1

26.5

14.7

11.8

8.8

5.9

63.6% 40.4

30.5

13.9

11.3

7.9

4.0

6.0

Exhibit 7. Use of Funds Available From Reduced Military Expenditures

Reduce U.S. Government Deficit

Increase Spending on Education

Reduce L/T Capital Gains Rate

Eliminate or Reduce Taxes on Dividends

Increase Spending on Roads and Bridges

Increase Spending on Drug War

Reduce Personal Taxes

Reduce Corporate Taxes

Create Tax Credits for Business

Increase Other Social Spending

Other

Industrial

4.42

3.65

3.15

3.21

3.00

2.47

2.56

2.10

1.78

3.00

Consumer/ Retail

4.66

3.19

3.36

3.38

2.78

2.96

2.81

2.26

2.19

2.42

1.00

Financial/ Banking

4.57

3.62

3.79

3.71

3.23

3.33

2.31

2.08

1.92

5.00

Utilities

4.31

3.64

3.55

3.59

3.36

2.86

2.79

2.69

2.04

1.85

1.00

Weighted Average

4.48

3.52

3.38

3.37

3.16

3.02

2.61

2.49

2.10

1.99

2.71

26 FINANCIAL PRACTICE AND EDUCATION -- SPRING/SUMMER, 1993

Another 40 percent cited innovations in the debt market, and 30 percent specified fear of takeover. The latter reason for increased use of debt, which was most cited by intemational firms, suggests an agency problem among managers. It is interesting that the four reasons reflecting lowered risk over the past 20 years are the ones least cited. Even after the longest peacetime expansion in the U.S., which at the time of the survey had lasted about seven years, the respondents did not feel that rising debt levels were related to investors and lenders becoming less risk averse, or to economic growth being more stable.

C. The Peace Dividend Shifting U.S. Government Resources to Other Uses

It was widely believed before the Gulf War (and probably even after it) that federal funds from reduced military spending would be available for other uses. As shown in Exhibit 7 in this survey, the overwhelming favorite use for such funds was to reduce the federal deficit, with the second most important use being for education. The next three preferred allocations of funds were to reduce the long-term capital gains rate, eliminate or lessen the tax rate on dividends, and repair or construct infrastructure, e.g., roads and bridges. Respondents expressed less support for lower tax rates or more tax credits, or spending on social needs.

Those industrial and consumer/retail companies with the least intemational activity strongly supported reducing the long-term capital gains rate, possibly because of their greater domestic invest- ment; they were less supportive of educational spending. Interna- tionally oriented firms had by far the most interest in spending on social needs. The most international financial/banking companies strongly favored reducing taxes on dividends. This may result from a greater awareness that some other countries do not tax dividends, giving equity in those places an advantage.

D. Acquisitions and Capital Budgeting Decisions

When firms allocate funds to their divisions for capital invest- ment, the principal criteria should reflect risk and return. As shown in Exhibit 8, the executives do seem to act consistently with this theory of the firm's and shareholders' wealth maximization. The most frequent reason given for allocating funds is "potential for high

future returns." The next three reasons (average rating at least three): "already established product lines," "high past retums," and "good cost control," suggest either moderate or at least predictable risk, or high future retums. High past returns, however, are less important to the most intemationally-oriented firms, possibly be- cause they compete in a more rapidly changing environment where past retums are less relevant.

It is interesting to note that the preferences of the CEO, Board of Directors, and major stockholders have little influence in allocating funds to the divisions. One would have to interpret this finding guardedly, since the CEO and Board of Directors certainly have some influence. In large firms, however, the capital budgeting decision is often made at lower management levels.

A related question, which is really about capital budgeting on a larger scale, concems the factors that affect acquisition decisions. The executives' rated responses, shown in Exhibit 9, again reflect a prudent lower-risk strategy. In all three sectors, the two most important aims in choosing acquisitions are to expand existing product lines (especially for the most intemational firms) and to enlarge geographic markets (especially the least intemational firms). The next most important factor, especially for the industrial and consumer/retail sectors, is movement into new but similar product lines. The financial/banking and utilities sectors rate this i'actor considerably lower than do the other sectors, possibly be- cause regulation limits their movement into new areas. The only other relatively important motivation is to acquire productive capacity. The "other" factor, which is the highest rated, includes increasing market share, as well as synergies which fit into one or several of the first four "expansion" responses.

The least important factors are in some ways the most notewor- thy findings. The executives' decisions are not driven by market undervaluation of a target's stock. This suggests either that they believe in market efficiency or that other factors are dominant. In other words, the strategic fit is more important than the market's valuation. The second interesting point is that tax factors are not important, a finding which highlights an old adage, "Never make an investment purely for tax reasons." The final point to note is the low interest in buying companies with dissimilar product lines. Apparently, the executive respondents leave the more extreme forms of portfolio diversification to investors and fund managers.

Exhibit 8. Reasons for Giving Divisions Capital Budgeting Eunds

Potential for High Future Returns

Already Established Product Lines

High Past Retums

Good Cost Control

Low Risk Investment

CEO's Preference

Less Competitive in Future

Currently Less Competitive Area

Board of Directors' Preference

Major Stockholders' Preference

lustrial

4.54

3.12

3.52

2.90

2.79

2.81

2.56

2.51

2.08

1.52

Consumer/ Retail 4.39

3.56

3.28

2.88

2.77

2.79

2.77

2.54

1.74

1.71

Financial/ Banking

4.43

3.43

3.62

3.00

2.64

2.33

3.00

2.08

1.38

Utilities

4.23

3.86

3.00

3.07

3.29

2.48

2.58

2.44

1.96

1.13

Weighted Average

4.42

3.46

3.38

2.95

2.90

2.69

2.61

2.53

1.96

1.47

PETRY AND SPROW -- INTERNATIONAL TRENDS AND EVENTS 27

IV. Conclusion

Academic studies usually compare predictions from financial theory with the actions of financial decision makers and their effects on firm value in the "real world." In this survey, although we looked at the correspondence between theory and the opinions of financial executives in 151 of the largest firms in the U.S., we also took a more prospective approach. We were interested in how these financial executives view current trends in the broader financial world and how these trends are affecting their firms, both today and

for the future. The degree of a firm's intemational exposure does seem to affect executives' opinions and decisions.

From the perspective of financial theory, many of the survey findings reveal managers acting in the interest of shareholders, and accepting the criterion of market efficiency. On the issue of increas- ing leverage to ward off a takeover, however, as well as on a few others, the executives surveyed either indicate an agency problem or do not seem to follow the guideline of market efficiency. •

Exhibit 9. Importance of Factors in Choosing Acquisitions

Expansion of Existing Product Line(s)

Expansion of Geographic Markets

Expansion into New tnit Similar Product Lines

Expansion of Productive Capacity

Undervaluation of Target's Stock hy Market

Tax Factors

Expansion into Very Dissimilar Product Line(s)

histrial

4.29

3.51

3.65

2.43

1.91

1.48

1.40

3.67

Consitmer/ RetaH

3.78

3.13 3.41

2.00

1.75

1.29

5.00

Financial/ Banking

3.50

3.93

2.77

2.62

2.18

2.58

2.23

5.00

Utilities

3.71

3.64

2.74

2.88

2.35

1.48

1.22

5.00

Weighted Averj^e

3.90

3.64

3.24

2.79

2.07

1.66

1.45

4.27

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28 FINANCIAL PRACTICE AND EDUCATION -- SPRING/SUMMER, 1993

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