Corporate Finance Decision Practice in China:

A Pilot Study

ByHong Xu

A Major PaperSubmitted to the Faculty of Graduate Studies through the Odette School of Business in

partial fulfillment of the requirements for the degree of Master of Business Administration at the University of Windsor

Windsor, Ontario, Canada

September, 2007

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Abstract

In this paper, I conduct a pilot survey on the corporate finance decision practices

of 35 Chinese companies. The major findings are as follows: First, Chinese companies

use more NPV and IRR than payback period technique in their capital budgeting

practices. Second, most Chinese financial managers use the cost of specific source as the

discount rate for project valuation. Third, there are evidences to support trade-off theory,

and market timing theory. In the meantime, there is weak support for the maturity

matching theory and little support for the notion that companies have a target debt ratio.

Importantly, Chinese managers indicate that equity is less risky than debt. Fourth,

Chinese companies’ dividend policy is not “sticky”. This implies that the managers tend

to adjust dividend policy at the prospect of a good investment opportunity.

Acknowledgements

I would like to extend my special thanks to Professor Rajeeva Sinha. He has been guiding me through out the designing of the survey and the writing of the paper during the past six months.

I would like to thank Professor Keith Cheung. He has given me valuable comments on the writing of the paper.

I would like to thank all the local surveyors in China. They are Shawn Shen, Linfeng Xu, Collin Dong, Jianjun Peng, Jingsong Chen, Xinting Liu, Qian Gao, Xiao Wang, Jun Che, Jie Liu and Haigang Liu.

Finally, I would like to thank all the survey participants. Without their participations, my survey would not be complete.

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CHAPTER I: INTRODUCTION

I conducted a pilot survey on the corporate finance practices of 35 Chinese

companies in order to shed light on how Chinese financial managers make financial

decisions, to identify the binding constraints faced by the decision makers and to

facilitate future studies. It is only a pilot survey due to time constraints.

Companies constantly face myriads of financial decisions. When internally

generated funds are not sufficient to support a company’s operation, it is necessary to

raise external funds. A company then has to decide how to raise funds. Both equity and

debt financing can serve their objectives, but sometimes one is more appropriate than the

other. On the other hand, when the company has cash surplus, the managers have to

decide whether to pay dividends or to take on new projects. A dividend payout may be at

the expense of the company’s long-term growth. Although there are many financial

theories to provide optimal financial choices, the company sometime does not follow all

the theories. Past empirical studies have shown discrepancies between some financial

theories and real world practices.

A corporate financial policy survey is a unique way to find out these

discrepancies. Survey results are valuable for researchers to improve existing financial

theories and to develop new theories. At the same time, as the survey covers a broad

range of companies from different industries in different development stages, it provides

managers with an opportunity to learn from each other.

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Many surveys had been conducted on corporate financial practices, but most of

them were focused on North American and European countries. For example, Graham

and Harvey1(G&H) conducted a U.S. corporate financial practice survey in 1999; Cohen

and Yagil2 conducted a corporate financial policy survey in 2006 and expanded the scope

to include UK, German, Canadian and Japanese companies; Brav, Graham and Harvey3

conducted a US corporate payout policy survey in 2003. However, I have not found a

corporate financial survey that is conducted on Chinese companies. China, as an

important representative of the emerging markets, has become more and more attractive

to foreign investors, who are eager to know how the Chinese companies make financial

decisions. Based on these thoughts and inspired mostly by G&H’s corporate financial

policy survey, I conducted this pilot survey on Chinese companies.

Because of time constraints and the nature of a major paper, I am not able to

conduct a full-scale survey, which would most likely involve a group work, cover a much

larger sample of companies and involve a high level of sponsorship. Instead, I decided to

conduct a pilot survey in order to lay down the framework and design for future study.

The surveyed companies cover all the major industries. The survey questions

cover capital budgeting, cost of capital, capital structure and dividend policy, and have

tested a broad range of financial theories and notions.

I found that the Chinese financial managers use Net Present Value (NPV) and

Internal Rate of Return (IRR) more frequently than they use payback period technique in

1 ? John Graham & Campbell Harvey; The Theory and Practice of Corporate Finance: Evidence from the Field; Journal of Financial Economics 60 (2001); p.187-2432 ? Gil Cohen & Joseph Yagil; Corporate Financial Policies: An International Survey; Working Paper; Retrieved on May 4, 2007; http://www.efmaefm.org/0EFMAMEETINGS/EFMA%20ANNUAL%20MEETINGS/2007-Vienna/Papers/0321.pdf.3 ? Alon Brav, John Graham & Campbell Harvey; Payout Policy in the 21st Century; Journal of Financial Economics 77 (2005); p.483-527.

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their capital budgeting practices. The cost of the specific source of funding is the most

frequently used discount rate among the Chinese companies. This is in contrast to the

survey results of North American and European countries, where Weighted Average Cost

of Capital (WACC) is the most frequently used discount rate. Although some financial

managers indicated that they used WACC as discount rate, none of them indicates that

they calculate the cost of equity capital.

I found strong support for trade-off theory and market-timing theory in financial

structure practices. I also found that the companies do not have a strict target debt ratio. I

found evidences to support management entrenchment theory, which holds that

entrenched CEOs tend to avoid a high debt ratio. Minimal evidence was found to support

the notion that free cash flow can lead to over-investment or inefficiency. I also found

that equity is considered the cheapest and the least risky source of fund.

I found that the availabilities of extra cash and new investment opportunity were

more important than historical dividend levels in deciding a company’s dividend policy.

This finding implies that the dividend policies of Chinese companies are not very

“sticky”.

The remainder of this paper is organized as follows: Chapter 2 reviews the

literatures regarding capital budgeting, cost of capital, capital structure and dividend

policy. Chapter 3 discusses survey design and methodology. Chapter 4 offers the major

findings of the survey. Chapter 5 concludes the paper.

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CHAPTER II: LITERATURE REVIEW

Capital Budgeting

NPV, IRR and profitability index are usually classified as the sophisticated

capital budgeting techniques because they consider the time value of money. In the

meantime, simple payback period, hurdle rate and accounting rate of return are usually

classified as unsophisticated techniques.

Many previous surveys have been conducted on corporate capital budgeting

practices. Bierman4 surveyed the 100 largest Fortune 500 Industrial companies. He found

that 99% of the companies used either NPV or IRR, 85% of them used payback period

technique, followed by return on investment (59%). G&H confirmed some of Bierman’s

findings. In Graham & Harvey’s survey on 392 CFOs, they found that 76% of CFOs used

IRR, 75% of them used NPV and 57% of them used payback period. In an international

survey conducted by Cohen and Yagil5, IRR and NPV rank higher than payback period in

most developed countries except Japan. In Japan, according to Cohen and Hagil’s survey,

NPV is the most frequently used technique, followed by payback period. IRR is less

frequently used than payback period in Japan.

In Asia-Pacific region, Kester et al6 conducted surveys in Australia, Hong Kong,

4 ? Harold Jr. Bierman; Capital Budgeting in 1992: A Survey; The Journal of the Financial Management Association; Autumn 1993; Vol. 22 Issue 3; p24-245 ? Gil Cohen & Joseph Yagil; Corporate Financial Policies: An International Survey; Working Paper; Retrieved on May 4, 2007; http://www.efmaefm.org/0EFMAMEETINGS/EFMA%20ANNUAL%20MEETINGS/2007-Vienna/Papers/0321.pdf.6 ? George W. Kester, Rosita P. Chang, Erlinda S. Echanis, Shaiahuddin Haikal, Mansor Md. Isa, Michael T. Skully, Tsui Kai-Chong & Chi-Jeng Wang; Capital Budgeting Practices in the Asia-Pacific Region: Australia, Hong Kong, Indonesia, Malaysia, Philippines, and Singapore; Financial Practice & Education, Spring/Summer 1999; Vol. 9 Issue 1; p25-33

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Indonesia, Singapore, Philippine and Malaysia. They found that the managers in all

countries and areas except Hong Kong used NPV or IRR more frequently than payback

period. In Hong Kong, payback period is the most frequently used technique.

Sensitivity analysis is considered a popular technique for dealing with

uncertainty. However, it is crucial to obtain the accurate probability of each cash flow

when this technique is used7. Jog et al8 found that, in Canada, sensitivity analysis is the

most frequently used method in forecasting cash flow.

Real options evaluation method was developed in the 1970s, but gained

popularity only in recent years. It is also recommended as a capital budgeting technique

because it accounts for the value of future flexibility9. Despite its theoretical

attractiveness, the use of real option is limited to some commodity-based operations, such

as oil refining and mining10.

Cost of Capital

Determination of the Cost of Equity Capital

Gitman and Mercurio11 surveyed 177 Fortune 1000 companies and found that

only 21.5% of these companies used CAPM to determine the cost of equity capital, and

28% of companies used CAPM in some fashion. Bruner et al12 found that CAPM is the

7 ? David R. Fordham & S. Brooks Marshall; Tools for Dealing with Uncertainty; Management Accounting; Sep 1997; Vol. 79 Issue 3; p38.8 ? Vijay M. Jog & Ashwani K. Srivastava; Capital Budgeting Practices in Corporate Canada; Financial Practice & Education; Fall/Winter 1995; Vol. 5 Issue 2; p37-439 ? Lenos Trigeorgis; Real Options and Interactions With Financial Flexibility; The Journal of the Financial Management Association; Autumn 1993; Vol. 22 Issue 3; p202-22410 ? Edward H. Bowman & Gary T. Moskowitz; Real Options Analysis and Strategic Decision Making; Organization Science; Nov/Dec 2001; Vol. 12 Issue 6; p77211 ? Lawrence J. Gitman & Vincent A. Mercurio; Cost of Capital Techniques Used by Major U.S. Firms: Survey and Analysis of Fortune's 1000; Financial Management (1972); Winter82; Vol. 11 Issue 4; p21-29,12 ? Robert F. Bruner, Kenneth M. Eades, Robert S. Harris & Robert C. Higgins; Best Practices in Estimating the Cost of Capital: Survey and Synthesis; Financial Practice & Education; Spring/Summer 1998; Vol. 8 Issue 1; p13-28

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dominant model used to estimate the cost of equity capital. G&H found that CAPM is the

most frequently used method by U.S. managers. G&H also found that the second and

third most frequently used methods are the average stock returns method and the

multibeta CAPM method respectively.

In the Asia Pacific survey13, Kester et al found that CAPM is seldom used to

estimate the cost of equity capital. Indonesian, Singaporean and Malaysian companies

never use CAPM. Very few companies in Hong Kong use CAPM.

Use of Discount rate

The frequently used discount rates include Weighted Average Cost of Capital

(WACC), the cost of specific source of fund, division’s discount rate, a risk matched

discount rate and different discount rate for different cash flow. Most textbooks

recommend the use of WACC:

WACC=Cost of Debt × (D/V) × (1-t) + Cost of equity × (E/V), where

t: Company’s marginal interest rate

D: Company’s present value of long-term debt

E: Company’s market value of equity, including common shares, preferred shares

V: Company’s total value (=D+E)

The reason is that both debt holders and shareholders have claims on any project’s cash

flow14. Therefore, the appropriate discount rate is the one that considers the claims of

each group in proportion to its relative contribution.

13 ? Kester et al; Capital Budgeting Practices in the Asia-Pacific Region: Australia, Hong Kong, Indonesia, Malaysia, Philippines, and Singapore; Financial Practice & Education, Spring/Summer 1999, Vol. 9 Issue 1, p25-3314 ? Alfred Rappaport; Creating Shareholder Value; The Free Press; 1986; p55-56

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Bruner et al15 found that WACC was the dominant discount rate used by the

leading North America companies. G&H found that 58.8% of U.S. companies used

WACC, 51% used risk-matched discount rate and 15.6% used the divisional discount

rate. Brounen et al16 found that 43% of European companies used WACC, and 26% used

risk-adjusted rate. Cohen and Yagil17 found that the cost of specific source of fund was

also frequently used in the developed countries including U.S., UK, Germany, Canada

and Japan, but ranked after WACC and risk-adjusted rate.

Noticeably, Kester et al’s study18 revealed significant differences among Asia

Pacific countries in use of discount rate. They found that Australian companies’ practices

are similar to those of North American and European companies, where WACC is the

most frequently used method, followed by risk adjusted rates. In all other Asia Pacific

countries, however, “the cost of specific capital used for financing the project” was the

most frequently used method. WACC was not frequently used in the Asian countries.

Factors Considered When Adjusting Discount Rate and Cash flow

In deciding discount rate, G&H found that the interest rate risk is the most

important factor, followed by the company size factor, the risk of inflation and the foreign

exchange risk. In adjusting a project’s future cash flow, G&H found that the commodity

risk and GDP were the most important factors.

15 ? Robert F. Bruner, Kenneth M. Eades, Robert S. Harris & Robert C. Higgins; Best Practices in Estimating the Cost of Capital: Survey and Synthesis; Financial Practice & Education; Spring/Summer 1998; Vol. 8 Issue 1; p13-2816 ? Brounen et al; Corporate Finance in Europe: Confronting Theory with Practice; Financial Management (2000); Winter 2004; Vol. 33 Issue 4; p71-10117 ? Gil Cohen & Joseph Yagil; Corporate Financial Policies: An International Survey; Working Paper; Retrieved on May 4, 2007; http://www.efmaefm.org/0EFMAMEETINGS/EFMA%20ANNUAL%20MEETINGS/2007-Vienna/Papers/0321.pdf.18 ? Kester et al; Capital Budgeting Practices in the Asia-Pacific Region: Australia, Hong Kong, Indonesia, Malaysia, Philippines, and Singapore; Financial Practice & Education; Spring/Summer 1999, Vol. 9 Issue 1, p25-33

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Capital Structure

Trade-off Theory

Capital structure reflects a company’s financing choices from short-term debt,

long-term debt, convertible debt, preferred stock and common stock. Modigliani and

Miller19 first established that, under the assumption of no taxes, no transaction cost and

no bankruptcy cost, a company’s value is independent of the company’s capital structure

choices. After relaxing the assumption by introducing taxes, Modigliani and Miller20

corrected their original theory by stating that a company’s value is positively related with

its debt ratio due to the tax deductibility of interest expense. Many researchers conducted

further studies by introducing the bankruptcy cost (or the financial distress cost) and

mostly agreed that, increase in debt ratio will eventually increase the possibility of

bankruptcy, which will eventually offset the tax benefit of debt and therefore reduce a

company’s value.

Trade-off theory21 states that an optimal capital structure reflects a trade-off

between the tax benefit of debt and the bankruptcy cost. In another word, the optimal

capital structure exists where the marginal tax benefit of debt is equal to the marginal

bankruptcy cost.

G&H found moderate support for the trade-off theory in their U.S. survey. The

tax advantage of interest deductibility is moderately important in the capital structure

decisions. They also found that the managers considered financial flexibility the most

19 ? Franco Modigliani & Merton H Miller; The Cost of Capital, Corporation, Finance and the Theory of Investment; American Economic Review; Jun58; Vol. 48 Issue 3; p26120 ? Franco Modigliani & Merton H Miller; Corporate Income Taxes and the Cost of Capital: A Correction. American Economic Review; Jun 1963; Vol. 53 Issue 3; p43321 ? Merton H. Miller; Debt and Taxes; Journal of Finance; May77; Vol. 32 Issue 2; p261

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important factor, followed by credit rating and earning volatility. Chen and Strange22

found that the tax advantage is not attractive to Chinese companies.

Pecking Order Theory

Pecking order theory23 holds that a company prefers internal to external

financing. When the internal fund is not sufficient to finance a new project, the company

chooses the external fund in the pecking order of the safe debt, then the riskier debt, then

convertible securities or preferred stock, finally equity. When the internal fund exceeds

financial requirements, the surplus is used to pay down debt first, then to repurchase

equity. Therefore, the company does not target a specific debt ratio. Its debt ratio reflects

the accumulative requirement of external fund.

G&H found evidence to support pecking order theory in their U.S. survey.

Specifically, they found that more small companies than large companies indicated that

they used debt when internal funds were not sufficient to fund operating activities. After

studying of Chinese listed companies, Tong and Green24 found evidences to support

pecking order theory, but not to support the trade-off theory. This finding is at odds with

Huang and Song’s study25. Huang and Song studied 799 Chinese listed companies and

concluded that trade-off theory explains Chinese companies’ capital structure.

22 ? Jian Chen & Roger Strange; The Determinants of Capital Structure: Evidence from Chinese Listed Companies. Economic Change & Restructuring; Mar 2005; Vol. 38 Issue 1; p11-3523 ? Stewart C. Myers; Capital Structure; Journal of Economic Perspectives; Spring 2001; Vol. 15 Issue 2; p81-10224 ? Guanqun Tong & Christopher J. Green; Pecking order or trade-off hypothesis: Evidence on the capital structure of Chinese companies; Applied Economics (10/20/2005); Vol. 37 Issue 19; p2179-218925 ? Guihai Huang & Frank M. Song; The determinants of capital structure: Evidence from China; China Economic Review, Mar 2006; Vol. 17 Issue 1; p14-36

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Free Cash Flow/Agency Cost Theory

Agency cost26 is inevitable because corporate managers, the agents hired by

shareholders, have the tendency of acting on their own interests. Free cash flow theory27

states that high debt ratio can be used to motivate managers to work hard. It argues that

leaving the managers with cash surplus (free cash) may result in organizational

inefficiency.

G&H found very few evidences to support the notion that companies use debt

commitment to make the managements work efficiently.

Market timing theory

Market timing theory28 holds that capital structure is the result of accumulative

outcome of managers’ past attempts to time equity market. Managers choose to issue

equity when the equity is over-priced; they choose to repurchase equity when they

believe that equity is under-priced. Market timing is the result of information asymmetry

between managers and investors. Managers use this information asymmetry to make their

decision before the information is available to the public. According to this theory, a

company does not pursue a target debt ratio. That is, the managers do not issue equity or

repurchase equity for the purpose of keeping a target debt ratio. The company’s existing

capital structure is the result of historical accumulative market timing activities.

Managers may also time changes in their credit ratings. If they predict that their

26 ? Michael C. Jensen & William H. Meckling. Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Sturcture; Journal of Financial Economics; Oct 1976; Vol. 3 Issue 4; p305-36027 ? Michael C. Jensen; Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers; American Economic Review; May 1986; Vol. 76 Issue 2; p32328 ? Malcolm Baker & Jeffrey Wurgler; Market Timing and Capital Structure; Journal of Finance; Feb 2002; Vol. 57 Issue 1; p1

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credit rating is going to improve, they may delay their debt issue or issue short-term debt

instead of long-term debt, and vice versa. Sophisticated managers may time interest rate

changes. When they expect that the interest rate is very high or it is declining, they may

delay their debt issue or issue short-term debt instead.

G&H found the managers tend to issue equity when stock price has risen, credit

rating is very important to the debt decision, and they tend to issue debt when interest

rates are low. This findings support the market timing theory.

Other Notions and Theories:

Managerial Entrenchment Theory: Berger et al29 studied relationship between

managerial entrenchment and company’s capital structure and found that entrenched

CEOs seek to avoid high debt ratio.

Product market and industry influences: One explanation for the existence of

different debt ratios is that customers are concerned about the availability of post-sales

service of some durable goods30. They may avoid purchasing a company’s product if they

think the company may go out of business.

29 ? Philip G. Berger & Eli Ofek; Managerial Entrenchment and Capital Structure Decisions; Journal of Finance, September 1997; Vol. 52 Issue 4; p1411-143830 ? S. Titman; The Effect of Capital Structure on a Firm’s Liquidation Decision; Journal of Financial Economics 13; p137-151

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Maturity matching: It is frequently found in textbooks that, as one of the most

important principles of capital structuring, the companies should match the maturity with

asset, and also match cash inflows with cash outflows. It is also a common sense that the

company may face financial distress if they fail to do so.

Bargaining with employees: It is argued by Chang31 that high debt ratio can be

used to bargain with employees on a company’s restructuring decision. Under a low debt

ratio, a company has no bankruptcy pressure and the employees have no incentives to

implement the restructuring pan even if the restructuring is necessary. High debt ratio,

however, can force the employees to cooperate with the restructuring decision. No

empirical evidence is found to support this notion in G&H’s survey.

Equity riskier than debt: It is normally found in textbooks that equity is riskier

than debt. Therefore, it requires a higher rate of return. Equity is riskier because

shareholders only have a claim on a company’s residual earnings (after payment of

interest expenses). In a liquidation scenario, shareholders are the last ones to be repaid.

Dividend Policy

Linter establishes that dividend policy is sticky and dividends are usually paid by

mature companies32. Mature companies usually target a long-term payout ratio when

deciding their dividend policy. That is, rather than paying dividend based on current

year’s earnings, they pay dividend only when they are expecting a long-term stable cash

31 ? C. Chang; Capital Structure as an Optimal Contract between Employees and Investors; Journal of Finance 47; 1992; p1141-115832 ? J. Linter; Distribution of Incomes of Corporations among Dividends, Retained Earnings, and Taxes; American Economic Review 46; 1956; p97-113

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inflow. They are reluctant to change dividend policy frequently. Especially, they want to

avoid a reduction in dividend payment. Therefore, dividend policy is usually conservative

and smooth from year to year. The most important reason for the sticky dividend policy is

that dividend information carries signal with regards to a company’s prospect.

Although Miller and Modigliani33 insist that corporate value is not affected by

dividend policy under an ideal, non-tax world, lots of empirical evidences show that taxes

affect payout decisions (e.g. G&H’s survey). In many countries, capital gains and

dividends are subject to different tax rates. Investors may prefer stock redemption to

dividend payment if their effective capital gain tax rate is lower than their effective

dividend tax rate. If this is the case, investors may chase stocks being repurchased and

drive stock price upward. In addition, as different investors have different effective

marginal tax rates, companies may target clienteles. That is, the companies can make

dividend policy attractive to their preferred investor groups.

33 ? M.H. Miller & F. Modigliani; Dividend Policy, Growth, and the Valuation of Shares; Journal of Business 34; 1961; p411-433

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Chapter III: METHODOGY

Survey Design

This pilot survey is a part of an initiative of pursuing a global-wide survey on

corporate finance decision practices. The purpose of this survey is to shed light on how

decision practices of Chinese companies differ from others, identify binding constraints

facing Chinese financial managers and obtain experience for commissioning the global

survey.

The major reason for conducting a pilot survey instead of a full-scale one is

because of time constraints. I had to finish the survey together with the major paper in a

time frame of 5-6 months in order to graduate in the fall of 2007. At the same time, I was

taking regular business courses. To conduct a full-scale survey, hundreds to thousands of

companies should be identified and emailed to. Frequent follow-ups would also be

needed to facilitate response. However, the time constraints make it inappropriate for me

to do these.

In the meantime, I have the following advantages for conducting a pilot survey.

First, I had previously worked in two financial institutions in China for over 10 years.

This makes it easier for me to interpret the findings and identify binding constraints faced

by Chinese financial managers. Second, I have many contacts in China. Most of them

work in Tax Bureaus34. Some others work as financial managers or investment analysts.

All of them have close contacts with various financial managers. Thinking of hiring my

34 ? Government agency. Equivalent to Revenue Agency of Canada.

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contacts as the local surveyors and asking them to spread the questionnaires to the

financial managers, I reached them when the survey was in early design stage and

obtained support from almost all of them. With these advantages, I am more comfortable

to conduct a pilot survey.

As we are aware, the major drawback of a pilot survey is that the sample may

not be representative of the population companies. The local surveyors are volunteers and

are sure to conduct the survey with integrity. However, they are inevitably constrained by

their scope of reaches. Therefore, this pilot survey well serves the purpose of obtaining

experience for the global survey, and shedding light on how companies make financial

decisions, but readers of this paper should be aware of the possibility of sample bias.

The survey instrument is adapted from G&H’s U.S. Corporate Financial Policy

Survey. Some modifications have been made. See Appendix A for detailed modifications

of the survey instrument. A major concern for using the G&H survey is that many

questions asked of U.S. financial managers may not be relevant to the practices of

Chinese companies. For example, G&H survey asked questions about overseas

investment and foreign debt issuance. These questions are appropriate for U.S. managers

who are facing mature and saturated domestic market, but are not relevant to most

Chinese companies. In addition, financial managers in emerging markets like China may

not be as sophisticated as managers of developed countries in using financial techniques

and theories because of binding constraints. Therefore, I have tried to modify the survey

to make it fit in the unique situations faced by Chinese financial managers. At the same

time, I have also tried to avoid over-adapting, so I keep most of questions of G&H’s

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survey instrument.

The survey covers the financial areas of capital budgeting, the cost of capital,

capital structure and dividend policy. In the survey, I ask the financial managers to rank

the importance of some factors or score the frequency of using some techniques. The

ranks and scores range from 0 to 4. A score of 0 means Not Important or Never Used. A

score of 4 means Very Important or Always Using. Compared to a bipolar scale (e.g. –2 to

+2), the unipolar scale (e.g. 0 to 4) is more effective in capturing the different degrees of

the same attribute (e.g. importance, frequency, etc)35.

As this is a survey conducted by University of Windsor student, it is required

that the survey should obtain the approval of Research Ethics Board (REB) of the

University. It is also required that the student surveyor should take a rigorous On-line

Ethical Conduct for Research course and pass the tests prior to the application. The

application package also includes an Information Letter addressed to survey participants.

In the information letter, it is required that all the potential risks for the survey

participants be explicitly specified. For this international survey, cross-border

confidentiality and human rights issues had been the major concerns of the REB. Because

of these concerns, the application had been returned to us twice for clarification before it

became acceptable to the REB. Confidentiality issue is related to the email delivery

method used in the survey. There were concerns that contents of the emails may be

viewable to some third parties. This is true for any cross-border emails in any countries.

However, only government agency has the authority to “check” emails and our contents

are not secrets to the government. Even if some illegal third parties intercepted the

35 ? Ron Kenett; On the Planning and Design of Sample Surveys; Journal of Applied Statistics; May 2006; Vol. 33; No. 4; p405-415

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emails, the information contained in the survey is so general that it should not be useful

to them. Human rights issue is related to potential political risks. However, this survey

has no political contents. The major concern is that the stringent approval criteria used by

the REB may discourage student researchers from conducting survey studies. Survey

studies are considered an important link between real world practice and academic study,

which will be missing as a result.

Delivery and Response

There are four methods generally used to deliver the survey instrument: mail,

telephone, web-based questionnaire and email. Mailing survey takes much longer time,

so this method does not fit my time frame. I do not have telephone contacts of the

potential respondents, so telephone also is not appropriate. A web-based questionnaire

can be very useful, but not efficient for a pilot survey. In the end, I choose email to

deliver the survey instruments. According to Chinese Internet Network Information

Centre (CNNIC)’s report36, Internet users in China had reached 137 million by the end of

2006. Computer system is used almost by all different size of companies. Intranet is also

widely used in large companies. These factors are in strong support of the use of the

email delivering method.

Leveraging my contacts in China, the questionnaires were delivered to the

potential respondents in a unique way. I sent the survey instrument to my contacts (local

surveyors) in China; they then forwarded it to the financial managers they have contacts

with. After the financial managers finish the questionnaires, they either send the

36 ? Retrieved from Internet on May 10, 2007; http://www.cnnic.net.cn/html/Dir/2007/02/05/4432.htm

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questionnaires directly to me or ask the local surveyors to forward the questionnaires to

me. We gave the financial managers three weeks to finish the questionnaires. At the end

of each week, I followed up by calling or sending emails to the local surveyors to boost

the response.

Our local surveyors are located in four major cities, including Beijing, Shanghai,

Shenzhen and Wuhan. Therefore, the respondents are mostly from these four cities. These

cities represent the most developed regions in China. There are concerns that the sample

companies may represent companies in those cities, but may not well represent the

companies in other areas of China.

Our local surveyors emailed out at least 80 questionnaires. Thirty-five were

completed and sent back. The response rate is 44%, which is very high as the result of the

special delivering method used and the frequent follow-up.

Summary of Sample Data

Sales

If we define large company as the one with sales greater than 1 billion yuan37

and small company as the one with sales less than 1 billion yuan, we have 45.7% of small

companies and 54.3% of small companies in the samples. Most of small companies’ sales

range from 10 million yuan to 100 million yuan. Most large companies’ sales range from

1 billion yuan to 5 billion yuan. See Figure 1-1.

Industry

37 ? Unit of Chinese currency, 1 yuan approximately equals to 0.014 Canadian dollars

18

Most of companies in the sample are in manufacturing industry (28.6%),

followed by retail/wholesales (20.0%) and financial/insurance (17.1%). See Figure 1-2.

This is similar to G&H’s survey, in which most sample companies are in manufacturing

industry, but followed by Financial, and then Retail/Wholesales.

Figure 1-1: Sample companies’ revenue/sales range.

Figure 1-2: Sample companies’ industry type.

Figure 1-3: Companies’ type

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Company Type

I did not use the universal classification criteria for company type, such as

public/private, or listed/unlisted. Instead I used listed/stated-owned/other classification.

The purpose is to highlight the special feature of Chinese companies: the significant

existence of state-owned companies. Some of state-owned companies are listed; some are

not. This classification method may cause confusion. For example, some listed state-

owned companies may label themselves as listed companies; others may label themselves

as state-owned companies.

In the sample, 57.1% of companies are unlisted and non-stated owned

companies. 28.6% of companies are state-owned companies. Only 14.3% are listed

companies. See Figure 1-3. Chinese government has been working on privatizing

medium to small-size enterprises and exiting from highly competitive industries in the

past 10 years. This has resulted in booming private enterprises. In addition, there are

currently more than 1,400 companies listed on Shenzhen and Shanghai exchanges. Total

market capitalization is approximately 2.6 trillion U.S. dollars. Market capitalization to

20

GDP ratio is 1:1. Therefore, there are concerns that listed companies are under-

represented in the survey sample. The ratio of listed companies in my survey is also low

compared to G&H’s U.S. survey, in which 64% are listed companies.

CEO Characteristics

53.9% of CEOs age between 40-49 years old. 54.3%’s tenure is 5-9 years. Their

education level is almost evenly distributed among undergraduate (28.6%), MBA (31.4%)

and non-MBA master (34.3%). See Figure 1-4 to 1-6.

These CEOs represent the new generation of Chinese managers who have better

opportunity to get higher educations. Compared with their U.S. peers (G&H), the Chinese

CEOs are younger, have more non-MBAs and have longer tenure.

Figure 1-4:

Figure 1-5:

21

Figure 1-6:

Figure 1-7: Other characteristics of sample companies

22

Other Characteristics

Only 22.3% of sample companies have issued or considered issuing common

stocks. This implies that debt is still the major source of financing for Chinese

companies. See Figure 1-7. Only three companies in the sample have issued or

considered issuance of convertible debts. In addition, in the sample, 34% of companies

pay dividends.

23

Chapter IV: SURVEY FINDINGS

Capital Budgeting

Through literature review, we have known that, in major developed countries,

IRR ranks higher than NPV. In most developed countries, both IRR and NPV consistently

rank higher than payback period. In most Asian countries, IRR or NPV generally ranks

higher than payback period. In the meantime, payback period is more frequently used in

Asian countries than it is in developed countries.

Figure 2-1: Response to Question #1: How often does your firm use the following techniques when deciding which project to pursue? The managers were asked to score the frequency of different techniques on a scale of 0 to 4. A score of 0 means Not Using. A score of 4 means Always Using. The scores shown below refer to average score of all answers.

I asked the Chinese financial managers to score how frequently they use

different valuation techniques based on a scale of 0 to 4. A score of 0 means never using

and 4 means always using. In this paper, I define the score of 0 to 1.5 as Rarely Used/Not

24

important, 1.5 to 2.5 as Moderately Used/Moderately Important, and 2.5 to 4.0 as

Frequently Used/Important. In the survey, I found NPV is the most frequently used

techniques (scoring 3.18) in China, followed by Hurdle rate (3.15), Internal Rate of

Return (3.06), Payback Period (2.91). See Figure 2-1 for the findings.

The frequent use of NPV and IRR may indicate that some Chinese managers

have started embracing the sophisticated capital budgeting techniques.

This survey shows that hurdle rate is almost as frequently used as NPV in China,

and is more important than payback period. G&H’s survey shows that hurdle rate is as

frequently as payback period in America. These findings imply that hurdle rate is an

important technique in capital budgeting practices. However, textbooks cover very little

about this technique.

Table 2-1: Comparison of developed countries with China in capital budgeting techniques:

US* UK* Germany* Canada* Japan* Australia* China**IRR 4.00 4.16 4.08 4.15 3.29 3.93 3.06NPV 3.88 4.00 3.50 4.09 3.57 3.80 3.18Payback Period 3.46 3.89 3.33 3.57 3.52 3.55 2.91Sensitivity Analysis 3.73 4.04 3.46 3.70 2.62 3.51 1.70CAPM 2.16 2.68 2.35 1.67 2.35 2.24 N/ADecision Tree 2.40 1.87 2.04 1.87 1.90 2.02 N/AProfitability Index 1.58 2.08 2.38 1.63 2.16 1.96 1.65VaR 1.76 2.20 2.15 1.69 2.00 1.96 1.65*Source of data: Cohen and Yagil’s survey38. In their survey, respondents are asked to score the frequency of using the capital budgeting techniques on a scale of 1 to 5 (1=Never, 5=Always). **Results from my survey, in which managers were asked to score the frequency of using the techniques on a scale of 0 to 4 (0=Never, 4=Always).

38 ? Gil Cohen & Joseph Yagil; Corporate Financial Policies: An International Survey; Working Paper; Retrieved on May 4, 2007; http://www.efmaefm.org/0EFMAMEETINGS/EFMA%20ANNUAL%20MEETINGS/2007-Vienna/Papers/0321.pdf.

25

Table 2-2:Comparison of Asia-Pacific countries and China in capital budgeting techniques:

Australia* Hong Kong* Indonesia* Malaysia* Philippines* Singapore* China**IRR 3.96 3.12 3.88 3.54 4.28 3.61 3.06NPV 3.96 2.76 4.12 3.63 3.44 3.16 3.18Payback Period 2.86 4.00 2.75 3.60 3.63 3.61 2.91Accounting Rate of Return 1.89 2.40 1.50 2.20 2.38 2.59 2.48Sensitivity Analysis 4.35 3.92 3.88 3.26 4.39 3.27 1.70Decision Tree 1.11 1.31 1.56 1.00 1.12 1.33 N/AScenario Analysis 3.82 4.31 4.62 2.89 4.45 3.98 1.70*Source of data: Kester et al’s survey39. In their survey, respondents are asked to score the frequency of using the capital budgeting techniques on a scale of 0 to 5 (0=not used, 1=not important, 5=very important).**Results from my survey, in which managers were asked to score the frequency of using the techniques on a scale of 0 to 4 (0=Never, 4=Always).

Table 2-3: Comparison of U.S. companies with Chinese company in capital budgeting:

U.S.* China**IRR 3.09 3.06

NPV 3.08 3.18

Payback Period 2.53 2.91

Hurdle Rate 2.48 3.15

Sensitivity/Scenario Analysis 2.31 1.70

Earnings multiple approach 1.89 1.19

Discounted payback period 1.56 2.25

Real Option 1.47 0.74

Accounting Rate of Return 1.34 2.48

VaR 0.95 1.65

Adjusted present value 0.85 2.24

Profitability Index 0.83 1.65*Source: G&H’s Survey. In their survey, managers were asked to score the frequency of using the techniques on a scale of 0 to 4 (0=Never, 4=Always).**Results from my survey, in which the same scoring scale as G&H’s survey is used.

39 ? Kester et al; Capital Budgeting Practices in the Asia-Pacific Region: Australia, Hong Kong, Indonesia, Malaysia, Philippines, and Singapore; Financial Practice & Education; Spring/Summer 1999; Vol. 9 Issue 1; p25-33

26

Comparison of survey results from different areas show that sensitivity analysis

and scenario analysis are not frequently used in China, but are frequently used in most of

other countries, including Asian countries.

Refer to Table 2-1, Table 2-2 and Table 2-3 for the comparison of the survey

results with developed countries survey, Asia-Pacific survey and G&H survey. Keep in

mind that, in Cohen et al’s survey, a 0-5 scale is used; in Kester et al’s survey, a 1-5 scale

is used; and in G&H and in my survey, a 0-4 scale is used.

Consistent with most of other countries, Chinese managers rarely use Value at

Risk and Real Option techniques.

Cost of Capital

Use of Discount Rate

Through literature review, we have known that WACC is the most frequently

used discount rate in developed countries, followed by risk-adjusted discount rate.

However, in Asia, the cost of specific source of fund is the most frequently used the

discount rate

In this survey, the managers were asked how frequently they use different

discount rates. Cost of specific source of fund is found to be the most frequently used

discount rate, followed by risk-matched discount rate and WACC. See Figure 2-2. This

result repeats that of most Asian countries or areas, such as Hong Kong, Malaysia,

Indonesia and Singapore (See Table 3-1), but departs from that of developed countries,

such as US, UK and Netherlands (See Table 3-2). In developed countries, WACC is the

27

most frequently used as discount rate.

Figure 2-2: Response to Question #2: If your firm uses discount rates when evaluating a new project, please indicate how frequently your company uses the following discount rates? The managers were asked to score the frequency of different discount rates on a scale of 0 to 4. A score of 0 means Not Using. A score of 4 means Always Using. The scores shown below refer to average score of all answers.

Table 3-1: Use of Discount Rate in Asia-Pacific countries:

Australia Hong Kong Indonesia Malaysia Philippines SingaporeWACC 48.20% 23.80% 28.60% 29.45% 16.10% 10.80%Risk-Adjusted Discount Rate

37.50% 19.10% 28.60% 23.50% 51.60% 37.80%

Cost of Specific Source of Fund

14.30% 57.10% 42.80% 47.10% 32.30% 51.40%

This table is excerpted from Kester et al’s Asia-Pacific Survey. This table shows the popularity of different discount rates used by the financial managers.

28

Table 3-2: Comparison in use of discount rate with developed countries:

UK* Netherlands* U.S.** China***WACC 1.97 2.48 2.5 2.63Risk-matched Discount Rate 1.17 1.27 2.09 2.66A Divisional Discount Rate 0.91 0.96 0.95 1.47A Different Discount for different CF 0.58 0.26 0.66 1.88Cost of Specific Source of Fund N/A N/A N/A 2.97*Source: Brounen et al40. In their survey, managers were asked to score the frequency of using the techniques on a scale of 0 to 4 (0=Never, 4=Always).**Soruce: Graham and Harvey’s survey. They used the same scoring scale as Brounen et al.***This column shows the results from my survey. I used the same scoring scale as above two surveys.

The dominant use of debt financing in Asia may be accountable for the

differences. Asian countries except Japan feature weak capital market. Equity prices are

more volatile than those of developed countries. As a result, the company using WACC

may have to adjust the company value constantly. Compared to WACC, cost of specific

source of fund provides a more straightforward reference rate. It is also much easier for

the managers to explain to shareholders when the managers propose to take on a new

project, as the difference between the expected return and cost of fund roughly represents

the added value to shareholders.

In this survey, the managers were asked what factors they incorporate into

adjusting project discount rate or cash flow. In adjusting discount rate, risk of unexpected

inflation ranks the most important factor, followed by interest rate risk and term structure

risk. In adjusting future cash flow, commodity price ranks the most important factor,

followed by company size and foreign exchange risk. See Table 4 for comparison of U.S.

40 ? Brounen et al; Corporate Finance in Europe: Confronting Theory with Practice; Financial Management (2000); Winter 2004; Vol. 33 Issue 4; p71-101

29

companies and Chinese companies.

Table 4: Comparison of U.S. companies with Chinese companies. In the question, we ask, “When valuing a project, do you adjust either the discount rate or cash flow for the following risk factors?” For example, in my survey (the shaded column), 33.3% of companies adjust discount rate because of unexpected inflation. Only 3% of them adjust future cash flow because of the unexpected inflation.

Discount Rate Cash Flow Both NeitherU.S.* China** U.S.* China** U.S.* China** U.S.* China**

a. Unexpected inflation 11.9% 33.3% 14.5% 3.0% 11.9% 36.4% 61.8% 27.3%b. Interest rate risk 15.3% 18.2% 8.8% 18.2% 24.7% 42.4% 51.3% 21.2%c. Term structure risk 8.6% 16.7% 3.7% 16.7% 12.6% 30.0% 75.1% 36.7%d. GDP or business risk 6.8% 6.3% 18.8% 18.8% 18.8% 28.1% 55.6% 46.9%e. Commodity price risk 2.9% 3.2% 18.9% 35.5% 10.9% 28.1% 67.4% 46.9%f. Foreign exchange risk 10.8% 12.9% 15.3% 19.4% 18.8% 38.7% 55.1% 29.0%g. Distress risk 7.4% 3.2% 6.3% 9.7% 4.8% 35.5% 81.5% 51.6%h. Size 14.6% 3.2% 6.0% 19.4% 13.4% 35.5% 66.0% 41.9%I. Market-to-book ratio 4.0% 6.3% 2.0% 6.3% 7.1% 21.9% 86.9% 65.6%j. Momentum 3.4% 3.3% 2.9% 13.3% 4.9% 50.0% 88.9% 33.3%*Source: G&H Survey.** The shaded column shows the results from my survey.

Cost of Equity CapitalThe managers were asked whether or not they calculate the cost of equity

capital. Surprisingly, none of respondents answer yes. How they calculate WACC

remains a mystery.

Capital Structure

Trade-off Theory

According to trade-off theory, the financial managers try to take advantage of the

tax advantage of debt, and use this to trade off the bankruptcy cost arising from potential

financial distress. In this survey, the financial managers were asked to score the

importance of certain financial factors in their debt decisions. I found strong supports for

30

trade-off theory. Based on the financial managers’ response, tax advantage of interest

deductibility ranks the second (with mean score of 2.82 of 4), narrowly followed by

potential distress cost (2.68) and volatility of cash flow (2.68). See Figure 2-3. These

findings show that the financial managers want to take advantage of the tax benefit of

debt. At the same time, they concern about the cost of financial distress.

Figure 2-3: Response to Question #7: What factors affect how you choose the appropriate amount of debt for your firm？The managers were asked to score the importance of different factors on a scale of 0 to 4. A score of 0 means Not Important. A score of 4 means Very Important. The scores shown below refer to average score of all answers.

Target Debt Ratio

The trade-off theory entails a target debt ratio. At this debt ratio, the marginal

benefit of debt equals the marginal cost of financial distress. I found limited support of

the target debt ratio notion in this survey. Only 29.0% of sample companies have strict or

somewhat strict target debt ratios (See figure 2-5). The financial managers indicated that

maintaining a target debt ratio is moderately important in common stock issuance

31

decision (1.71, figure 2-6). This implies that financial managers may not issue or

repurchase common stock to keep a target debt ratio. Increasing stock price is important

in common stock decision (3.14, figure 2-6). This implies that the financial managers

tend to give up target debt ratio at the presence of an increasing stock price. Changes in

common share prices are not important to debt decision (1.34, figure 2-4). This implies

that financial managers may not adjust their total debts when existing debt ratio has

changes as the result of rising equity value.

Figure 2-4: Response to Question #8: What other factors affect your firm’s debt policy？ The managers were asked to score the importance of different factors on a scale of 0 to 4. A score of 0 means Not Important. A score of 4 means Very Important. The scores shown below refer to average score of all answers.

Figure 2-5: Question #6: The firms are asked whether or not they have target debt ratio.

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Figure 2-6: Response to Question #11: Has your firm seriously considered issuing common stock? If no, please skip to the next question. If yes, what factors affect your firm’s decisions about issuing common stock? The managers were asked to score the importance of different factors on a scale of 0 to 4. A score of 0 means Not Important. A score of 4 means Very Important. The scores shown below refer to average score of all answers.

One financial manager wrote, “Chinese companies face so many regulation

constraints that they are not able to freely issue common stock or bond according to their

actual financial needs”. This partly explains why the sample companies are not strictly

sticking to a target debt ratio.

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In addition, the difference between the financial and the accounting definition of

debt ratio may also be attributable to the finding of “no target ratio”. As we are aware, the

financial definition of debt ratio is present value of long-term debt to total company value

(equity’s market value), while accounting definition of debt ratio is book value of liability

to book value of total asset. The capital market analysts are more concerned about the

financial definition, while accountants and bankers are more concerned about the

accounting definition. It is possible that Chinese companies target an accounting debt

ratio, but not financial debt ratio. This may explain why stock price is not important for

the managers’ debt decision.

Transaction Cost Effect on Debt Ratio

I found moderate support of the notion that transaction cost affects companies’

debt decision. The financial managers consider that transaction cost is moderately

important for issuing debt (1.55, see Figure 2-3), for delaying debt issue (2.17, figure 2-

4), and for retiring debt (2.19, see figure 2-4).

Since corporate bond issuance is usually not a consideration for most Chinese

companies, debt transaction cost should not be in form of bond floating cost and fees, but

be in some other forms related to the process of finding new debtors. This could be a

relatively long process for some companies. If this is the case, time value and opportunity

cost should be included in the calculation of transaction costs. If a bank’s loan is on

condition of taking over the companies’ overall banking relationship, which is often the

case, the potential consequence should also be included in the consideration.

34

Pecking-order Theory

Pecking-order theory, as mentioned in literature review section, states that

companies tend to first use debt financing, then equity financing, when they need external

fund. In the meantime, when they have financial surplus, the companies tend to first pay

down debts, then repurchase common shares.

The Chinese financial managers seem to follow Myers’s pecking order theory.

Retained earnings rank the most frequently used funds (3.21), followed by Debt (2.94),

Common Stock (1.17), and Convertibles (0.68). See Figure 2-7. This sequence is almost

the same as Myre’s pecking order: retained earnings first, then debt, then convertibles and

common stocks last.

I also asked financial managers to score the importance of the following

statement “when fund is not sufficient, we consider debt financing first, then convertibles

and common stock”. The mean score is 2.78 (See Figure 2-4). This supports Myers’s

Pecking-order Theory. In addition, the financial managers either issue debt (3.12, figure

2-4), or issue equity (2.57, figure 2-6), when internal fund is not sufficient. We can see

that debt ranks higher than equity in raising capital.

I asked the financial managers to score the importance of the statement “when

companies have cash surplus, we pay debt first, then repurchase equity”. The mean score

is 2.75 (See Figure 2-4). This supports the reverse version of the pecking order.

Figure 2-7: Response to Question #3: How frequently does your firm use the following sources of funds to finance a new project? The managers were asked to score the frequency of using different sources on a scale of 0 to 4. A score of 0 means Not Using. A score of 4 means Always Using. The

35

scores shown below refer to average score of all answers.

Although the above evidences indicate that the Chinese managers follow the

pecking order described by Myers, they may not necessarily be supportive of the pecking

order theory. In Myers’s theory, managers follow the pecking order of less risky source to

risky source of financing when internally generated fund is not sufficient. That is, less

risky debt, risky debt, convertibles, and then equity. As I will mention later, the Chinese

managers do not consider equity riskier than debt. The reason why Chinese managers use

debt before equity is that equity market is not well developed in China, and therefore,

debt is the dominant source of financing. Many of them use debt because they currently

have no other choices.

Market Timing

Stock Price Timing: The financial managers indicate that the increasing stock

price is very important for stock issuance (3.14, figure 2-6). This is in strong support of

stock price timing theory.

Credit Rating Timing: The survey shows that credit rating is important for debt

36

decisions (2.97, figure 2-3). Also, expectation of improving credit rating is moderately

important to short-term decision (2.28, figure 2-8). These findings imply that the

financial managers are timing their credit rating when they choose between long-term and

short-term debt.

Figure 2-8: Response to Question 5: What factors affect your firm’s choice between short- and long-term debts? The managers were asked to score the importance of different factors on a scale of 0 to 4. A score of 0 means Not Important. A score of 4 means Very Important. The scores shown below refer to average score of all answers.

37

Interest Rates Timing: I found evidence to support the interest rate timing notion.

First, low interest rates are important to debt issuance (2.70, figure 2-4). Second, low

short-term interest rates are important to short-term debt issue (2.76, figure 2-8). This

implies that the financial managers may choose short-term debts when short-term interest

rates are low. Last, when financial managers expect long-term debt to decline, they may

choose short-term debt issuance before long-term debt interest rates have actually

declined (2.00, figure 2-8). All these are in support of the interest rate-timing notion.

Management Entrenchment

In order to test whether or not the entrenched managements seek to avoid high

debt ratio, I conducted a correlation analysis between CEO tenure and debt ratios. First, I

gave each range of tenure and debt ratio a value. For example, for tenure range of 0-4

years, I gave it a value of 1; for tenure range of 5-9 years, I give it a value of 2; and so on.

I did the same to debt ratio. Second, as there are non-responses to either debt ratio or

tenure question, I deleted the non-pairing data. Finally, I ran the correlation analysis. The

correlation is –0.157, which shows that CEO tenure is negatively related to debt ratio.

This finding implies that entrenched CEO may avoid high debt ratio.

Product Market and Industry Influences

I found that the financial managers concern the companies’ financial image

perceived by customers (2.64, figure 2-3). This implies that the financial managers may

avoid using high debt ratio, which may send the customers a risky image. This finding

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supports the notion that product market has impact on a company’s debt ratio.

Figure 2-9: Response to Question #10: What factors affect your firm’s decisions about issuing convertible debt? The managers were asked to score the importance of different factors on a scale of 0 to 4. A score of 0 means Not Important. A score of 4 means Very Important. The scores shown below refer to average score of all answers.

0.00 1.00 2.00 3.00 4.00 5.00

h. Attract investors

g. Ability to call or force conversion

e. Avoiding short term equity dilution

c. Less expensive than debt

f. Stock is undervalued

b. Protecting bondholders

d. Same-industry factor

a. Convertibles are inexpensive

The same-industry’s debt level is moderately important to the financial

managers’ debt decision (1.97, figure 2-3). In the meantime, the same-industry’s equity

level is moderately important to financial managers’ equity decision (1.86, figure 2-6).

These are in moderate support of the notion that debt ratios are industry-specific.

Also, same-industry’s successful issuance of convertibles is very important to

the financial managers’ convertibles decision (4.00, figure 2-9). However, we have only

three sample companies having issued or considered issuance of convertibles. This small

sample may not be representative of the population companies.

Tax Clientele in Debt Ratio Decision

The Financial managers do not think that personal tax on interest income is

important in the company’s debt ratio decision (1.3, figure 2-3). This finding does not

39

support the clientele notion in debt ratio decision.

Certain characteristics of Chinese financial market may be attributable to this

result. Corporate bond market is almost not utilized in China. Most of debt financing

comes from banks or inter-companies. In addition, personal tax structure in China is

different from western countries. In North America, personal incomes (including interest

income) are taxed in a lump-sum manner and subject to a marginal tax rate. In China,

only personal salaries are subject to marginal tax rates. Most of other personal incomes,

including interest income, are subject to one single flat tax rate. This special tax structure

makes it impossible for the debt issuers to target personal clientele.

In additional, capital gains are not taxable to the personal investors in China. In

the survey, I ask the financial managers to rank the importance of “the non-taxable capital

gain policy” in their debt decisions. The answer is that the policy is not important (0.71,

figure 2-6). This finding also supports that the companies does not target different

clienteles in their capital structure decision.

Maturity matching

Surprisingly, the maturity matching notion only obtains weak support in this

survey (1.64, figure 2-8), even thought it is generally known as a common practice to

match maturity of debt with asset life. We also found that maturity matching is not as

important as other factors, such as interest rate, credit rating and refinancing risk.

Corporate Control

The survey only provides weak support for the notion that capital structure can

40

be used to affect takeover (1.56, figure 2-3) or dilute holding of certain shareholders

(1.57, figure 2-6).

In China, due to historical reason (e.g. most of companies were transformed

from state-owned companies), the companies are usually under the control of several

major shareholders. This is in contrast with the diversified shareholding in North

America. Therefore, corporate control may not be such a big issue as in North America.

Equity is a Riskier Source of Fund

The notion that equity is a riskier source of fund is not supported in this survey.

The financial managers indicated that equity is their least risky source of fund (3.00) and

that equity is their cheapest source of fund (3.00). See figure 2-6. Also, G&H found that

the notion of “equity is the least risky source of fund” is moderately supported (scoring

1.76 out of 4) in the U.S. survey. These findings reflect that the financial practitioners

may hold a different opinion from that of scholars with regard to the intrinsic risk of

equity.

Dividend Policy

I found only moderate support for the notion that dividend policy is sticky in the

survey. The financial managers score “consistent with historical policy” moderately

important (2.00). See figure 2-10. However, they score other factors such as “availability

of extra cashes” (3.56), “availability of good investment opportunity” (3.00) and cost of

raising new fund (2.89), much more important than “historical policy”. These findings

41

imply that the financial managers show a strong tendency to adjust dividend payments

when the company has extra cashes or has good investment opportunities. Therefore,

dividend policy is not sticky in China.

Institutional investors have moderate influence on the companies’ dividend

policy (2.33). At the same time, the financial managers tend to make dividend policy

attractive to institutional investors (2.33) rather than to retail investors (1.38). These

imply that the companies may use dividend policy to attract institutional investors.

Figure 2-10: Response to Question 14: Does your firm pay dividend? If not, skip. If do, please indicate the importance of the following factors in deciding dividend policy. The managers were asked to score the importance of different factors on a scale of 0 to 4. A score of 0 means Not Important. A score of 4 means Very Important. The scores shown below refer to average score of all answers.

42

Table 5: Survey Findings on Dividend Policy:

Theory or Concept Findings from U.S. companies* Chinese companies** Historical level Very important. Moderately important (2.00)Future earnings Very important Important (3.00)Stock price Not important Moderately important (2.11)Regulation requirement N/A Important (2.78)Institutional investor Moderately important Moderately important (2.25)Investment opportunities Moderately important Important (3.00)Retail investor Moderately important Not important (1.38)Industry factor Not important Important (2.78)Investor’s dividend tax Not important Moderately important (1.88)Cost of raising new funds Not important Important (2.89)M&A strategy Moderately important Moderately important (2.25)Signal Very important Moderately important (1.75)*Source: Brav, Graham & Harvey’s U.S. Payout Policy Survey41.**This column shows the results of my survey.

In China, dividends are taxable for personal investors (taxable income is

currently calculated by subtracting a hypothetical interest expense from 50% of dividend

income, and subject to single flat rate), but not for corporate investors (dividend income

is tax-deductible in order to avoid double taxation). In addition, capital gains are not

taxable for personal investors, but taxable to institutional investors (capital gains are

lumped into a company’s total income and subject to the corporate income tax). This tax

structure strongly encourages institutional shareholders to influence a company’s payout

policy. Paying dividend is in favor of institutional investors, but at the cost of personal

investors. In the mean time, stock redemption is in favor of personal investors, but at the

cost of institutional investors.

41 Alon Brav, John Graham & Campbell Harvey; Payout Policy in the 21st Century; Journal of Financial Economics 77 (2005); p.483-527

43

In China, the listed companies rarely redeem stocks. This might be explainable

with the institutional investors’ tax incentives. However, from 2003 to 2004 when many

stock prices were lower than the net asset (or equity) per share, I observed very little

redemption. During this period, the institutional investors, most of whom were

experiencing capital loss, should have no tax incentives to prefer dividend payment.

Therefore, institutional investors’ tax incentives cannot explain the rare redemption.

Capital thirstiness experienced by most Chinese companies, however, may be one of the

reasonable explanations. Facing lots of investment opportunities, the Chinese companies

are reluctant to pay dividends or redeem outstanding shares. Some listed companies do

pay dividends, but that may be under the pressure of regulations, which require that

paying dividend be a precondition for listed companies to get “passport” for seasoned

issuance. I also found that the regulator’s impact on the companies’ dividend policy is

high (2.78, figure 2-10). This is in support of the above opinion.

The findings on Chinese companies’ dividend policy are comparable with those

of Brav, Graham & Harvey’s U.S. payout survey42. See Table 5 for comparison of

Chinese companies with U.S. companies. The major differences exist in the following

areas: First, U.S. managers consider “cost of raising new funds” not important in

dividend policy, while Chinese managers consider it important. U.S. managers consider

“investment opportunity” moderately important, while Chinese managers consider it

important. U.S. managers consider “historical level” very important, while Chinese

managers consider it moderately important. These findings imply that Chinese dividend

policy is not as sticky as that of U.S. companies. Second, U.S. managers consider

42 Alon Brav, John Graham & Campbell Harvey; Payout Policy in the 21st Century; Journal of Financial Economics 77 (2005); p.483-527

44

“industry factor” not important, while Chinese managers consider it important. This

implies that industry factor is more important for Chinese managers’ dividend decisions.

Third, U.S. managers indicate that “signal” is important, while Chinese managers

consider it only moderately important. This may explain why U.S. dividend policy is

“stickier” than the Chinese one.

45

Chapter V: Conclusion

I conducted a pilot survey on 35 Chinese companies. Most of the survey results

confirm the existing financial theories. Some results raised questions and prompted us to

conduct future studies. The following are the major findings:

First, I found that Chinese companies more frequently use NPV and IRR than

payback period. This is similar with the findings of other studies in most developed

countries. I also found that the Chinese managers use hurdle rate more frequently than

IRR. However, very few textbooks cover hurdle rate. Sensitivity analysis is not

frequently used in China. This is in contrast with the frequent use of this technique in

most of other countries.

Second, most Chinese financial managers use the cost of specific source of fund

as the discount rate for valuation of specific investment, in the same way as their peers in

most Asian countries. This is in contrast with most developed countries, where WACC is

mostly used as discount rate. Importantly, none of the surveyed companies indicate they

calculate the cost of equity capital. This calls for further studies because how they

calculate WACC remains mystery.

Third, I found evidences in support of trade-off theory and market-timing theory,

in the similar manner as in G&H’s survey. In the meantime, I found weak support for

maturity matching and little support of the notion that companies have target debt ratio.

The Chinese managers also indicate that equity is less risky than debt. This finding is in

46

conflict with the mainstream financial theory. I found weak support of the notion that

debt policy can be used as anti-takeover measure. I found little support for tax clientele

notion.

Fourth, I found that dividend policy is not sticky, as the managers tend to adjust

dividend payment at the presence of good investment opportunity. In addition, the

regulator’s requirement is an important factor in the financial managers’ dividend

decisions.

Finally, as this is a pilot survey conducted under time constraints, the sample

data may not well represent the total population. Users of the data should be aware of the

possibility of sample bias.

47

Appendix A: Adaptation of Survey Instrument

G&H’s Survey Modified Survey RationaleQ1. How frequently does your firm use the following techniques when deciding which projects or acquisitions to pursue?

Q1. No modification. N/A

Q2. How frequently would your company use the following discount rates when evaluating a new project in an overseas market?b) Discount rate of overseas market

Q2. If your firm uses discount rates when evaluating a new project, please indicate how frequently your company uses the following discount rates?b) Cost of specific source of fund

Overseas investment is only the consideration of some very large Chinese companies. If I ask the question as it is, I may not get enough response. Therefore, I modified the overseas projects into any projects. In addition, through literature review, I notice that cost of specific source of fund is frequently used as discount in Asian countries.

N/A Q3. How frequently does your firm use the following sources of funds to finance a new project?

Q3 is added to the survey. I want to further test pecking order theory.

Q4. When valuing a project, do you adjust either the discount rate or cash flow for the following risk factors ？

Q4. No modificationN/A

Q5. What factors affect your firm’s choice between short- and long-term debts?

Q5. No modification N/A

Q11. Does your firm have a target range for your debt ratio?

Q6. Does your firm have a target range for your debt ratio?

N/A

Q12. What factors affect how you choose the appropriate amount of debt for your firm ？

Q7. What factors affect how you choose the appropriate amount of debt for your firm ？

N/A

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Q13. Q8. What other factors affect your firm’s debt policy ？h. We issue debt when we accumulate substantial profits.i. Others

Q8. What other factors affect your firm’s debt policy ？h. when we have accumulated substantial profits, we pay debt first, then repurchase equityi. we prefer debt to equity financing

I modified Factor h and added Factor i. Modify Factor h is to test the reverse case of pecking order theory. Factor i is to test the managers preference between debt and equity financing.

Q3. Does your firm estimate the cost of equity capital?If yes, how do you determine your firm’s cost of equity capital?

Q9. No modification. N/A

Q7. What is the credit rating for your firm’s debt?

N/A The application of credit rating system in China is still at pilot stage. There is no existence of a cross-country credit rating system in China.

Q8. Has your firm seriously considered issuing debt in foreign countries? If yes, what factors affect your firm’s decision about issuing foreign debts?

N/A Issuing foreign debts is the financial choice of some very few Chinese companies.

Q9. Has your firm seriously considered issuing convertible debt? If no, please skip to the next question.If yes, what factors affect your firm’s decisions about issuing convertible debt?

Q10. No modification. N/A

Q10. Has your firm seriously considered issuing common stock? If yes, what factors affect your firm’s decisions about issuing common stock?c. providing shares to employ as bonus or stock option plani. capital gain taxes faced by investors

Q11. Has your firm seriously considered issuing common stock? If yes, what factors affect your firm’s decisions about issuing common stock?c. Deletedi. investors don’t pay capital gain taxes (but pay dividend taxes)

Stock option plan is not a consideration for most Chinese managers, as two Exchanges (Shanghai Securities Exchange and Shenzhen Securities Exchange) only resumed option trade about a year ago. In addition, Chinese

49

investors are not required to pay capital taxes, but pay dividend taxes.

Q6. What is your company’s trailing P/E ratio over past 3 years?

Q12. What is your firm’s approximate Price/Earning Ratio?

In Q12, trailing P/E ratio is not commonly used among Chinese managers.

Q14. What is your firm’s long-term debt to long-term asset ratio?

Q13. What is your firm’s total debt to total asset ratio?

To avoid to bring inconvenience to the respondents, I modified the question to total debt to total asset ratio.

N/A Q14. Does your firm pay dividend? If not, skip. If do, please indicate the importance of the following factors in deciding dividend policy

Q14 is added into the survey, as I also want to touch on the companies’ pay out policy.

Q15. Please fill in one square that best describes your company.-Foreign sales-Ownership: private and public-Pay dividend-Shares owned by top 3 officers-Regulated utility

Q15. Please fill in one square that best describes your company.-Deleted “foreign sales” question-Ownership: listed co., state-

owned co., other unlisted co-Deleted pay dividend question-Deleted “shares owned by top

3 officers” -Deleted “regulated utility”

question

I deleted foreign sales and share owned by top 3 officers, as I expect many companies are not public companies, I also do not want to make them to think that we are tapping into their confidential information. I modified the ownership question, as I cannot find an exact word for public company. In North America, public company mostly refers to publicly traded (listed) company. In China, the concept of public company is not clearly defined. I modified the question so that it won’t confuse the managers.

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Appendix B: Capital Budgeting Findings

Theory or Concept(Adapted from G&H’s survey for

comparative purpose)Survey Results of the Survey in China Theory supported

or not?

Trade-off theory

Optimal capital structure exists where marginal benefit of debt equals marginal cost of financial distress.

√Corporate interest deduction important (2.82).√Cash flow volatility important (2.68).√Expected distress/bankruptcy costs important (2.68).√Maintaining financial flexibility important (2.76).×Personal taxes not important to debt financing (1.33)

Supported

Companies have target debt ratios

A static version of the trade-off theory implies that companies have an optimal, target debt ratio

√29.0% have strict or somewhat strict debt ratio.×16.1% have no target debt ratio.×54.8% have flexible debt ratio.×Maintaining a target debt ratio not important to common stock decision (1.71).×Increasing stock prices important in common share decision (3.14).×Changes in common share price not important to debt decision (1.34).√Same-industry debt ratios moderately important to debt decision (1.97).

Not Supported

The effect of transactions costs on debt ratios

Transactions costs can affect the cost of external funds.Companies avoid or delay issuing or retiring security because of issuance/ recapitalization cost43.

√Transactions cost moderately important for debt policy (1.55).√Transactions cost moderately important for delaying debt issue decision (2.17).√Recapitalization cost moderately important for retiring debt decision (2.19).

Moderately Supported

Pecking-order theory of financing hierarchy

Financial securities can be undervalued due to informational asymmetry between managers and investors. Companies should use securities in reverse order of asymmetry: use internal funds first, debt second, convertible securities third, equity last.

√Frequency in use of funds: Retained earnings (3.21), Debt (2.94), Common Stock (1.17), Convertible (0.68).√Financial flexibility important in debt policy (2.76).√Issue debt when internal fund not sufficient (3.12).√Issue equity when internal fund not sufficient (2.57).√Stock price moderately important for equity issue (2.00).√With insufficient fund, issue debt first, then equity (2.78).√With cash surplus, pay debt first, then repurchase equity (2.75). ×Inability to obtain funds from debt, convertibles or other sources not important to equity issue (0.57).×Undervalued equity not important for debt decision (1.26).

Supported

43 E.O. Fisher, R. Heinkel & J. Zechner; Dynamic Capital Structure Choice: Theory and Tests; Journal of Finance 44; 19-40

51

Stock price timing: Recent increase in stock price presents a “window of opportunity” to issue equity44. If stock undervalued due to informational asymmetry, issue after information release and ensuring stock price increase45.

√Issue common share when stock price has risen (3.14).

Supported

Credit ratings: Companies issue short-term if the expect their credit rating to improve46.

√Credit rating important to debt decision (2.97)√Expectation of improving credit rating moderately important to short-term debt decision (2.28).

Supported

Interest rates: Do absolute coupon rates or relative rates between long- and short-term debts affect when debt is issued?

√Low interest rates important to debt issue (2.70).√Low short-term interest rates important to short-term debt issue (2.76).√Expectation of long-term debt to decline moderately important to short-term debt issue (2.00).

Supported

Management entrenchment: Entrenched CEOs seek to avoid high debt ratio

√CEO tenure is insignificantly negatively related to debt ratio with correlation of –0.157.

Supported

Under-investment: Companies may pass up NPV>0 project because profits flow to existing bondholders. Can attenuate by limiting debt or using short-term debt47.

√Companies may restrict debt so that profits from new projects can be captured (1.73).√Companies may borrow short-term debt so that return from new projects can be capture (2.00)

Supported

Asset substitution: shareholders take on risky projects to expropriate wealth from bondholders48. Using convertible debt49 or short-term debt50 attenuates asset substitution, relative to using long-term debt.

√Borrow short-term debt reduces the chance of taking on risky projects moderately important (2.21).√Convertibles protecting bondholders against unfavorable actions by managers important (4).

Supported

Free cash flow can lead to overinvestment or inefficiency:Fixed commitments like debt payments commit free cash flow so management works hard and

×Using debt policy to ensure upper management works hard not important (1.24).

Not Supported

44 T. Loughran & J.R. Ritter; The New Issues Puzzle; Journal of Finance 50 (1995); 23-5245 D.J. Lucas & R.L. McDonald; Equity Issues and Stock Price Dynamics; Journal of Finance 45 (1990); 1019-104346 M.J. Flannery; Asymmetric Information and Risky Debt Maturity Choice; Journal of Finance 41 (1986); 19-3747 S.C. Myres; Determinants of Corporate Borrowing; Journal of Finance 5 (1977); 147-17548 M.C. Jensen & W. Meckling; Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics 3 (1976); 305-36049 R. Green; Investment Incentives Debt and Warrants; Journal of Financial Economics 13 (1984); 115-13650 S.C. Myres; Determinants of Corporate Borrowing; Journal of Financial Economics 5 (1977); 147-175

52

efficiently51.Product market and industry influences:

Debt policy credibly signals production decisions52. Sensitive-product companies use less debt so customers and suppliers do not worry about firm entering distress53. Debt ratios are industry-specific.

√Restricting debt so that customers not worried about firm going out of business important (2.64).√Debt level of same-industry companies moderately important (1.97).√Same-industry companies successfully using convertibles important (4.00).√Same-industry equity amount moderately important (1.86).

Supported

Tax Clientele in debt decision:×Personal tax on interest income not important in debt decision (1.33).×Non-taxable capital gain policy not important in equity decision (0.71).√Dividend tax rate moderately important in their dividend decisions (1.88).

Not supported

Maturity-matching: match maturity between assets and liabilities.

√Matching maturity of debt with life of asset slightly important (1.64).

Weakly supported

Corporate Control:

Capital structure can be used to affect the likelihood of success for takeover bid/control contest. Managers may issue debt to increase their effective ownership54.

√Diluting holding of certain shareholders slightly important in equity decision (1.57).√Debt ratio slightly important in anti-takeover (1.56).

Weakly Supported

Cash management: match cash outflows to cash inflows

√Long-term debt moderately important to minimize risk of refinancing (1.84).

Moderately Supported

Bargaining with employees: high debt allows effective bargaining with employee55.

×Debt policy not important in bargaining with employees (0.5).

Not Supported

Equity is riskier than debt financing.

×Equity is least risky source of fund (3.00).×Equity is cheapest source of fund (3.00)

Not Supported

Earning per share dilution √Earning per share dilution moderately important in equity decision (2.14).

Moderately Supported

51 M.C. Jensen; Agency Costs of Free Cash Flow, corporate Finance and Takeovers; American Economic Review 76 (1986); 323-33952 J.A. Brander & T.R. Lewis; Oligopoly and Financial Structure: the Limited Liability Effect; American Economic Review 76 (1986); 956-97053 S. Titman; The Effect of Capital Structure on a Firm’s Liquidation Decision; Journal of Financial Economics 13 (1984); 137-15154 M. Harris & A. Raviv; Corporate Control Contests and Capital Structure; Journal of Financial Economics 20 (1988); 55-8655 C. Chang; Capital Structure as an Optimal Contract between Employees and Investors; Journal of Finance 47 (1992); 1141-1158

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54

Appendix C: Survey InstrumentsSpecial Survey on Corporate Financial Policy

(Adapted from G&H’s Survey)When you choose, please put cursor in the square you want to choose and key in letter “V”.0：Never 1: Seldom 2: Once a while 3: Often 4: Always

1． How frequently does your firm use the following techniques when deciding which projects or acquisitions to pursue?Never Always Never Always0 1 2 3 4 0 1 2 3 4

a. Net Present Value (NPV) h. Profitability indexb. Internal Rate of Return (IRR) i. Accounting Rate of Return (or Book Rate

of return on Assets)c. Hurdle Rate j. Sensitivity analysis (Good vs. fair vs bad)d. Earning multiple approach k. Value at Risk or other simulation analysise. Adjusted Present Value l. We incorporate the “real option” of a f. Payback period projection When evaluating it.g. Discounted payback period m. Other: ____

――――――――――――――――――――――――――――――――――――――――――――――――――― 2． If your firm uses discount rates when evaluating a new project, please indicate how frequently your company uses the

following discount rates?Never Always Never Always

0 1 2 3 4 0 1 2 3 4a. the company’s weighted average of cost d. a risk-matched discount rate for this capital (WACC) specific projectb. cost of specific source of financing e. different discount rate for each componentc. division’s discount rate cash flow that has different risk profile

―――――――――――――――――――――――――――――――――――――――――――――――――――3． How frequently does your firm use the following sources of funds to finance a new project?

Never Always Never Always0 1 2 3 4 0 1 2 3 4

a. Retained earnings c. Debt b. Common stock d. Convertibles

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

We adjust： we adjust:Disc.C B Neither Disc.C BothN

a. risk of unexpected inflation f. foreign exchange riskb. interest rate risk (change in g. distress risk (probability of general level of interest rates) bankruptcy)c. term structure risk (change in h. size (small firms being riskier)

the long-term vs short term i. Market-to-book ratio (ratio ofInterest rate. MV of firm to BV of assets)

d. GDP or business cycle risk j. Momentum (recent stock performance)e. commodity price risk k. other____

D: discount; C: Cash flow; B: Both, N: Neither————————————————————————————————————

5． What factors affect your firm’s choice between short- and long-term debts? Not Very Not Very important important important important

0 1 2 3 4 0 1 2 3 4a. We issue short term when short term e. We expect our credit rating to improve, so

interest rates are lower than long term we borrow stort-term until it doesb. Matching the maturity of our debt f. Borrowing short-term reduces the chance with the life of our assets that our firm will want to take on riskyc. We issue short-term when we are waiting projects.

for long-term market interest rates to g. We issue long-term debt to minimize the decline. risk of having to refinance in bad times.d. We borrow short-term so that returns h. Other____

from new projects can be captured morefully by shareholders, rather than committingto pay long-term profits as interest to debtholders

—————————————————————————————————————

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6． Does your firm have a target range for your debt ratio?No target Flexible target range Somewhat tight target range Strict target range

―――――――――――――――――――――――――――――――――――――――――――――――――――7． What factors affect how you choose the appropriate amount of debt for your firm？

Not Very Not Very important important important important

0 1 2 3 4 0 1 2 3 4a. the tax advantage of interest deductibility j. we try to have enough debt that we are notb. the potential costs of bankruptcy, near- an attractive takeover target Bankruptcy, or financial distressc. the debt level of other firm in our industry

k. if we issue debt our competitors know we are very unlikely to reduce our output

d. our credit rating l. a high debt ratio help us bargain for e. the transactions costs and fees issuing debt concessions from our employeesf. the personal tax cost our investors face m. to ensure that upper management works

when they receive interest income hard and efficiently, we issue debt to makeg. financial flexibility (we restrict debt so we sure that a large portion of our cash flow have enough internal funds available to is committed to interest payments pursue new projects when they come along) n. we restrict our borrowing so that profitsh. the volatility of our earning and cash flows from new/future projects can be capturedi. we limit debt so our customers/suppliers are by shareholders and do not have to be

not worried about our firm going our of paid out as interest to debtholdersbusiness o. Other_____

―――――――――――――――――――――――――――――――――――――――――――――――――――8． What other factors affect your firm’s debt policy？

Not Very Not Very important important important important

0 1 2 3 4 0 1 2 3 4a. we issue debt when our recent profits e. we delay issuing debt because of transaction

are not sufficient to fund our activities costs and feesb. using debt gives investors a better f. we delay retiring debt because of impression of our firm’s prospects than recapitalization cost and fees issuing stock g. changes in the price of our common stockc. we issue debt when interest rates are h. when we have accumulated substantial profits, particularly low we pay debt first, then repurchase equity d. we use debt when our equity is under- i. When fund is not sufficient, we consider valued by the market debt first, then convertibles and common stock

―――――――――――――――――――――――――――――――――――――――――――――――――――――9． Does your firm estimate the cost of equity capital? (If no, please skip to next question)

If yes, how do you determine your firm’s cost of equity capital? Never Always Never Always

0 1 2 3 4 0 1 2 3 4a. using average historical returns on d. whatever our investors tell us they require common stock e. by regulatory decisionsb. using Capital Asset Pricing Model f. back up from discounted dividend/earningsc. using the CAPM but including some model, eg. Price=Div/(Cost of Cap-growth) extra risk factors g. other____

―――――――――――――――――――――――――――――――――――――――――――――――――――――10． Has your firm seriously considered issuing convertible debt? If no, please skip to the next questionIf yes, what factors

affect your firm’s decisions about issuing convertible debt? Not Very Not Very important important important important

0 1 2 3 4 0 1 2 3 4a. convertibles are an inexpensive way to e. avoiding short-term equity dilution

issue delayed common stock f. our stock is currently undervaluedb. protecting bondholders against unfavor- g. ability to call or force conversion of

able actions by managers or shareholders convertible debt if we need toc. convertibles are less expensive than h. to attract investors unsure about the riskiness straight debt of our companyd. other firms in our industry successfully i. other_____ use convertibles

————————————————————————————————————————11． Has your firm seriously considered issuing common stock? If no, please skip to the next question

If yes, what factors affect your firm’s decisions about issuing common stock?

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Not Very Not Very important important important important

0 1 2 3 4 0 1 2 3 4a. if our stock price has recently risen, the g. issuing stock gives investors a better

Price at which we can issue is high impression of our firm’s prospect than b. stock is our least risky source of funds issuing debtsc. common stock is our cheapest source h. our investor don’t pay capital gain tax of funds (relative to dividend tax they have to pay)d. maintaining a target debt/equity ratio i. diluting the holding of certain shareholderse. using a similar amount of equity as is j. the amount by which our stock is under-

used by other firms in our industry valued or overvalued by the marketf. whether our recent profits have been k. inability to obtain funds using debt,

sufficient to fund our activities convertibles, or other sourcesl. earning per share dilutionm. other_____

———————————————————————————————————――12． What is your firm’s approximate Price/Earning Ratio ： ___ (Please skip to next question if your firm is not a listed

company)――――――――――――――――――――――――――――――――――――――――――――――――――

13． What is your firm’s total debt to total asset ratio:____――――――――――――――――――――――――――――――――――――――――――――――――――

14． Does your firm pay dividend? If not, skip. If do, please indicate the importance of the following factors in deciding dividend policy.

Not Very Not Very important important important important

0 1 2 3 4 0 1 2 3 4a. Consistent with historical policy i. Investor’s dividend tax rateb. Stability of future earnings j. Attracting institutional investorsc. Impact on stock price k. Cost of raising new fundd. To meet certain regulation requirements l. Availability of extra cashese. Influence of institutional investors m. Merger and acquisition strategyf. Availability of good investment opportunity n. The possibility that paying dividend indicate g. Attracting retail investors We are running low on profitable investmenth. Policy of competitors or other in our industry o. Others____

――――――――――――――――――――――――――――――――――――――――――――15． Please fill in one square that best describes your company.

Sales Revenue Industry Ownership CEO Education

<10 million Retail and wholesale Listed Company High School

10-50 mil Mining, construction State Owned Company Undergraduate

50-100 mil Manufacturing Other Unlisted Company MBA

100-500 mil Transportation/Energy Non-MBA masters

500mil-1billion Communication/Media CEO tenure > Masters

1billion-2billion Bank/Finance/Insurance <4 years

2billion-5billion Tech (software/biotech) 4 – 9 years Age of CEO

>5billion other > 9 years <40 50-59

40-49 >60

―――――――――――――――――――――――――――――――――――――――――――――――――――――16． Do you wish to have a Chinese version of the survey paper? If you do, please provide your or you trusted person’s email

address here_______

Thanks again for completing the survey! I really appreciate it.

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