Investment appraisal practices: A comparative study of conventional and Islamic financial institutions

This paper compares the use of capital budgeting techniques of conventional and Islamic financial institutions, using data obtained from a survey of 105 conventional and Islamic financial institutions. Our main aim is to analyze the use of capital budgeting and risk techniques by the two types of financial institutions from a comparative perspective to see whether prohibition of riba makes a difference. Standard difference-of-means tests of the mean scores methods were used to test the hypotheses of the study. The results reveal a number of important conclusions. First, discounted cash flow techniques are found to be more widely used by financial institutions, and among those techniques internal rate of return is the most common. Second, Islamic financial institutions are found to adopt traditional methods that do not comply with the principles of Islamic Sharia'a. Third, a huge gap is found between the theory base of Islamic institutions and some of the practices of those institutions. Fourth, firms' characteristics, such as size, listing status, sources of revenue and government ownership, have some impact on their decisions to adopt capital budgeting criteria, methods of estimating costs of capital and risk. Finally, the decisions to select particular capital budgeting techniques, cost of capital estimation methods, and risk assessments are partly related to the characteristics of the chief financial officers.     

Do organizations adopt sophisticated capital budgeting practices to deal with uncertainty in the investment decision?: A research note

This study examines the impact of uncertainty on the sophistication of capital budgeting practices. While the theoretical applications of sophisticated capital budgeting practices (defined as the use of real option reasoning and/or game theory decision rules) have been well documented, empirical evidence on the factors that affect the importance and use of these sophisticated capital budgeting practices is scarce. I investigate the relation between specific uncertainties and sophisticated capital budgeting practices in 189 Dutch organizations. The empirical results show that sophisticated capital budgeting involves the use of multiple tools and procedures (such as Monte Carlo simulations, certainty equivalents, Game Theory decision rules and Real Option Reasoning). An increase in financial uncertainty is associated with the use and importance of sophisticated capital budgeting practices. Finally, size and industry are also related to the use and importance of sophisticated capital budgeting practices.     

Capital Allocation in Financial Firms

This paper develops a theory of capital allocation in financial intermediaries where the cost of "risk capital" is a critical consideration. The implication for capital budgeting is that financial firms should use a modified NPV rule in which projects are valued by calculating the NPV of cash flows using marketdetermined discount rates and then subtracting a deadweight cost of capital that reflects the project's marginal contribution to firm-wide risk.
By taking account of deadweight costs—mainly monitoring and moral hazard costs associated with having too little equity capital as well as "free cash flow" agency costs and higher taxes associated with having too much—the capital allocation model predicts that financial firms will diversify across businesses with similar deadweight costs. Such diversification reduces the cost of risk capital for the individual businesses, thereby creating more profitable investment opportunities at the margin and enabling the businesses to operate on a larger scale. The authors note that their model has similarities to but also important differences from the standard applications of RAROC models.     

Mediating instruments and making markets: Capital budgeting, science and the economy

We examine in this paper how certain instruments link science and the economy through acting on capital budgeting decisions, and in doing so how they contribute to the process of making markets. We use the term “mediating instruments” to refer to those practices that frame the capital spending decisions of individual firms and agencies, and that help to align them with investments made by other firms and agencies in the same or related industries. Our substantive focus is on the microprocessor industry, and the roles of “Moore’s Law” and “technology roadmaps”. We examine the ways in which these instruments envision a future, and how they link a multitude of actors and domains in such a way that the making of future markets for microprocessors and related devices can continue. The paper begins with a discussion of existing literatures on capital budgeting, science studies, and recent economic sociology, together with the reasoning behind the notion of “mediating instruments”. We then address the substantive issues in three stages. Firstly, we consider the role of “Moore’s Law” in shaping the fundamental expectations of an entire set of industries about rates of increase in the power and complexity of semiconductor devices, and the timing of those increases. Secondly, we examine the roles of “technology roadmaps” in translating the simplified imperatives of Moore’s Law into a framework that can guide and encourage the myriad of highly uncertain and confidential investment decisions of firms and other agencies. Thirdly, we explore one particular and recent example of major capital investment, that of post-optical lithography. The paper seeks to help remedy the empirical deficit in studies of capital budgeting practices, and to demonstrate that investment is much more than a matter of valuation techniques. We argue, through the case of the microprocessor industry, for greater attention to investment as an inter-firm and inter-agency process, thus lessening the fixation in studies of capital budgeting on the traditional hierarchical and bounded organization. In addition, we seek to extend and illustrate empirically the richness of the notion of “mediating instruments” for researchers in accounting, science studies, and economic sociology.     

THE EFFECTS OF BORROWING ON THE RATE OF GROWTH OF CAPITAL AND THE RISK OF RUIN OF A FIRM

The research reported in this paper used Monte Carlo simulation to study the long term effects of borrowing policy on the rate of growth of capital and the risk (probability) of ruin of hypothetical firms, operating in explicitly described, realistic capital budgeting environments. The capital rationing environment is described explicitly. The debt policies modeled were based on the results of interviews with senior financial executives in eight major firms. The results indicate that three intuitively appealing ranking procedures performed equally well and all out-performed a random selection decision procedure: yielding higher rates of capital growth with lower risks of ruin. In general, an aggressive borrowing policy resulted in a higher average capital growth rate for a firm but a conservative borrowing policy resulted in a lower risk of ruin. It is believed that the results provide some interesting insights which indicate that a computer simulation model could be used to aid management in the evaluation of their capital budgeting procedures and borrowing policies.     

An Empirical Study of the Adoption of Sophisticated Capital Budgeting Practices and Decision-Making Effectiveness

This paper examines the trend towards greater sophistication in investment selection techniques and control processes, and their impact on capital budgeting decision effectiveness. Based on a sample of 100 large UK firms, the study examines the capital budgeting practices employed over an 11-year period. Very significant increases in the uptake of sophisticated investment methods are reported, particularly in the analysis of project risk. These developments are partly explained by the rapid developments in computing within capital budgeting. Clear evidence is found to suggest that senior finance executives believe that the adoption of sophisticated investment practices gives rise to improved effectiveness in the evaluation and control of large capital projects.     

Unravelling the Capital Charging Riddle – Some Empirical Evidence from Victoria

Since 1995, the State of Victoria has been experimenting with capital charging regimes for budget sector agencies. The intent of these schemes is to allow the opportunity cost of capital to be reflected in the assessed total costs of outputs produced by agencies the subject of the charge. While literature produced by government central financial agencies has forcefully advocated this experiment, and asserted a range of resulting improvements to budget sector asset management and general financial management practices, academic examinations of the subject have been mixed in their conclusions. Empirical evidence relating to the effect and effectiveness of these schemes has been scarce. This paper seeks to contribute to the literature by providing some empirical evidence on the impact of capital charging in one jurisdiction, Victoria, Australia.     

Budget Rules and Flexibility in the Public Sector: Towards a Taxonomy

The practices and norms of public budgeting have often been seen as a brake on the flexibility needed of government organisations. This remains true despite historically significant financial management reforms designed around budgetary devolution. Seeing flexibility as operating along two dimensions – devolution and discretion – this paper revisits the underlying features of traditional public budgeting to develop a taxonomy of six generic ‘budget rules’. By isolating key properties of budget control, the paper uses two of the more prominent rules – annuality and purpose – to illustrate how the rules interact to generate control capacity, as well as the scope for rule variability in promoting increased flexibility.     

Internal capital market efficiency and the diversification discount: The role of financial statement comparability

This paper investigates how financial statement comparability affects the efficiency of internal capital markets and diversification discounts in multi‐segment firms through monitoring mechanisms. Previous studies suggest that financial statement comparability improves transparency and reduces the cost of information processing, mitigating information asymmetry between managers and shareholders. Using measures of comparability and internal capital efficiency, we find that financial statement comparability has a strong positive influence on internal capital market efficiency. Further, we find that by improving the efficiency of internal capital markets, financial statement comparability indeed mitigates diversification discounts. Especially, the effect of financial statement comparability is more pronounced for firms with high information asymmetry or operating environment volatility. The results support our arguments that financial statement comparability enhances the efficiency of internal capital markets and increases firm value in diversified firms by mitigating agency problems via monitoring and corporate control mechanisms.     

A Tale of Leadership in Value Creation

In this prologue to his new book, Curing Corporate Short‐Termism, the founder and CEO of Fortuna Advisors presents a fictional account of a corporate turnaround—a “composite” reflection of the author's many years of consulting experience that dramatizes the pressure to meet near‐term earnings targets and other kinds of “agency” problems facing a public company called Blue Dynamics Corp. The tale begins with the puzzlement of the incoming CEO, Betty Manning, at finding the company's highest‐return business unit starved for investment, even as the low‐return units continue to receive and spend capital with little success. At the core of the company's capital allocation and “underinvestment” problems, she finds a corporate‐wide performance measurement and reward system focused on setting and beating budgets and growth in EPS and ROE. Manning's solution is to divorce the performance and reward system entirely from the budgeting process and implement new annual incentives and target‐setting practices that result in both more reliable budgeting and forecasting and a longer‐term view of value creation. The new measure of economic profit, called BDVA (short for Blue Dynamics Value Added), is based on a customized measure of EBITDA less a capital charge. The adoption of the new measure has the effect of encouraging her team to take a number of decisive steps: make an objective, “fact‐based” case for a strategic acquisition whose price appears to be too high (at least using conventional measures like EPS accretion); pull the trigger on a divestment that appears to have been adding value, but is more valuable outside the firm; and, more generally and most important, guide operating managers toward an ideal balance of overall growth and return on capital.     

How rating agencies achieve rating stability

Surveys on the use of agency credit ratings reveal that some investors believe that rating agencies are relatively slow in adjusting their ratings. A well-accepted explanation for this perception on the timeliness of ratings is the through-the-cycle methodology that agencies use. According to Moody’s, through-the-cycle ratings are stable because they are intended to measure default risk over long investment horizons, and because they are changed only when agencies are confident that observed changes in a company’s risk profile are likely to be permanent. To verify this explanation, we quantify the impact of the long-term default horizon and the prudent migration policy on rating stability from the perspective of an investor – with no desire for rating stability. This is done by benchmarking agency ratings with a financial ratio-based (credit-scoring) agency-rating prediction model and (credit-scoring) default-prediction models of various time horizons. We also examine rating-migration practices. The final result is a better quantitative understanding of the through-the-cycle methodology.By varying the time horizon in the estimation of default-prediction models, we search for a best match with the agency-rating prediction model. Consistent with the agencies’ stated objectives, we conclude that agency ratings are focused on the long term. In contrast to one-year default prediction models, agency ratings place less weight on short-term indicators of credit quality.We also demonstrate that the focus of agencies on long investment horizons explains only part of the relative stability of agency ratings. The other aspect of through-the-cycle methodology – agency-rating migration policy – is an even more important factor underlying the stability of agency ratings. We find that rating migrations are triggered when the difference between the actual agency rating and the model predicted rating exceeds a certain threshold level. When rating migrations are triggered, agencies adjust their ratings only partially, consistent with the known serial dependency of agency-rating migrations.     

The evolution of the application of capital budgeting techniques in enterprises

This study examines the evolution of the application of capital budgeting techniques. Previous studies mostly used cross-sectional inquiries to understand the capital budgeting practices of firms. Only a few researchers have undertaken longitudinal studies to generalise the findings of the individual cross-sectional studies to the wider population and to identify the emerging trends in the use of capital budgeting techniques (CBTs). This longitudinal study surveys 83 studies of capital budgeting practices across firms in India, South Africa, the United Kingdom (UK) and the United States of America (USA) for the period from 1966 to 2016. The findings show that six capital budgeting techniques, namely, the net present value (NPV), the internal rate of return (IRR), the payback period (PBP), the accounting rate of return (ARR), the return on investment (ROI) and the real option valuation (ROV), are the most popular methods for evaluating capital investments. Of these techniques, the ROV is the least used, and a general lack of familiarity with this technique and its complexity are the most commonly cited reasons for not using it. Another method that is used less than the first four techniques is the ROI. However, this technique is of growing significance and is mainly used in the UK, followed by the USA, South Africa, and India. Firms in the USA and UK have increased their use of the IRR as a primary method for evaluating capital projects and have retained the PBP as an ancillary technique to strengthen the available information when evaluating capital projects. Firms in India and South Africa are increasingly excluding both the PBP and ARR methods and are increasingly using the NPV when evaluating capital investments. Although this development is in line with the theory, it limits the scope of the available information when evaluating capital projects.     

Institutional Pressures, Monopolistic Conditions and the Implementation of Early Cost Management Practices: The Case of the Royal Tobacco Factory of Seville (1820–1887)

In spite of our increasing understanding of the underpinnings of early cost management systems, little is still known about the reasons for the implementation of such systems in firms operating under monopolistic conditions. This article studies the enforcement by law of cost and budgeting systems in the Royal Tobacco Factory of Seville (Spain), a manufactory of the state-owned monopoly. By doing this, we seek both to enhance understanding of the state's motivation to enact institutional pressures aiming at the implementation of early cost management practices as well as to study different organizational responses to simultaneous pressures arising from a single institutional source. It is suggested that the state's motivation to legally enforce the implementation of early cost and budgeting systems may be attributed to (a) the seeking of legitimacy by the state regulatory body, (b) the active agency of senior employees of the state regulatory body to keep their jobs and compensation packages on the eve of the privatization of the industry, and (c) the interest of the regulatory agency to instil the basis of mimetic isomorphism within the monopoly. Different responses by the RTF to pressures for reporting cost and budgeting information were explained by (a) the expected diffusion of firm's non-conformity within the institutional area, (b) the expected impact of institutional rules and norms on organizational goals, and (c) the extent to which the institutional source is consistent in its demands.     

Determinants of capital budgeting methods and hurdle rates in Nordic firms

We study the determinants for the choice of capital budgeting methods and the setting of hurdle rates (WACCs) in five Nordic countries. Combining survey data with a rich set of determinants, including ownership data, CFO characteristics, and financial data, we find that the use of the Net Present Value method and the sophistication of the capital budgeting are related to firm characteristics, variables proxying for real option features in investments and CFO characteristics (age and education). We also find support for significantly higher hurdle rates than motivated by economic theory. The premium is weakly positively related to managerial short‐term pressure and strongly negatively related to the sophistication level of the firm’s capital budgeting.     

Leaning Tower of Pizza: A Business Start‐up

The following take‐out pizzeria restaurant simulation highlights the information sources that an entrepreneur can use to prepare a cash budget and financial forecast for a new business venture. Based on the information contained in this simulation, students make a capital budgeting decision and prepare pro forma financial statements.     

Corporate capital budgeting and CEO turnover

When a firm has minimal agency and informational asymmetry problems it should make efficient capital budgeting decisions. Many firms over-invest prior to CEO turnover, halt investments in the period surrounding the turnover, and then greatly increase their level of expenditures. Empirical analysis of the cross-sectional and inter-temporal variation in the quality of firms' corporate capital budgeting decision reveals that the impact of CEO turnover is asymmetric between under- and over-investing firms, and this complements the larger literature using average firm-wide performance measures. Firms are more likely to have forced turnovers when there is more over-investment prior to the turnover, and these firms make more efficient investment decisions subsequently. Board influence is largely insignificant prior to a CEO turnover but is consistently associated with higher levels of investment subsequently.     

AN ANALYSIS OF THE FINANCIAL MANAGEMENT TECHNIQUES CURRENTLY EMPLOYED BY LARGE U.S. CORPORATIONS

Economic conditions have placed increased importance upon rigorous financial analysis. In order to determine which analytical techniques are currently emp loyed by management, a questionnaire was sent to each fm on the May 1980, FORTUNE 500 list. The researchsought to establish a profile of the respondents' organizational structure and to identify the primary procedures used in risk assessment, working capital management, capital budgeting, and operations research modeling. The results do suggest a basic profile of the more active employers of analytical techniques. Relatively sophisticated capital budgeting procedures appear to be accepted across most industries, and many firms support their decision making with a "package" of formal tools.     

Beyond Panglossian theory: strategic capital investing in a complex adaptive world

Traditional capital budgeting theory (as an extension of financial economics) is characterized as Panglossian because of its suggestion that rational market outcomes produce the best of all possible worlds. During the last two decades, practice-oriented theorists have increasingly been moving from algorithmic capital budgeting techniques to a focus on capital investment strategy. Also, during the last twelve years, economics researchers at the Santa Fe Institute (SFI) have scrapped the dubious assumptions of neoclassical economics and have turned to complex adaptive systems theory for a more realistic portrayal of the economy. This paper explores various SFI studies and their implications for capital investment theory and capital investment strategy. Brian Arthur's theory of increasing returns undermines the notion that capital budgeting techniques can be counted on to generate economic efficiency. His theory further suggests that the high tech, knowledge-based sectors of the economy inherently produce outcomes that are too unpredictable for the meaningful application of traditional capital budgeting techniques. Studies by David Lane and his colleagues suggest that the identity of agents, the attributes of artifacts and the possibilities for action tend to be emergent phenomena that are generated by the interactions of agents. These considerations suggest a form of strategic action that focuses on process. Finally, it is argued that the artificial life and other SFI types of computer simulation models are potentially useful tools for the study of strategic capital investment decisions.     

对发展我国汽车金融服务市场的思考

我国现有的非银行金融机构,不具备专业办理汽车消费信贷的要求。为此,我国金融机构序列中应增加一类新的机构———汽车金融公司,专门办理汽车消费信贷业务。这对我国汽车产业的发展必定是一个极大的促进。为此,需要我们在发展汽车金融服务市场方面作深入地研究。     

伊斯兰银行业公司治理:理论与实践

伊斯兰银行业公司治理由于其自身不同的经营特点而与传统银行业治理存在较大的差异,其治理结构、代理关系较为复杂,成为英美、德日模式之外较具代表性的一种模式。本文从伊斯兰银行的治理结构及其复杂的委托代理关系出发,论述了其面临的代理问题,并就其代理问题介绍了伊斯兰银行业的公司治理实践,以期为我国的银行业治理提供一定的借鉴。