Adjustment by size effect on the cost of equity: Pending practice in capital budget in Colombia

Abstract

This research identifies and analyzes the implications of capital budgeting techniques implemented by large, medium and small companies, related to the use and calculation of the discount rate - emphasizing in the cost of equity, adjusting it with a size premium and the calculation method of the latter- differentiating between the procedure of family and non-family businesses and the types of projects. Additionally, the same procedure is used for the viability indicators of the projects given their relevance in capital budget. For this, a descriptive analysis accompanied by contingency tables is made to a group of 182 Colombian companies. The results show that (i) only 14% of SMEs that evaluate their projects (93) adjust the discount rate with a size premium, (ii) procedures to define capital budget are more informal in family companies, (iii) expansion and replacement projects are more evaluated by family businesses, while mergers and acquisitions are more evaluated by non-family businesses, and (iv) there is little transfer of knowledge from the academy to the company. 

Authors

Downloads

Download data is not yet available.

Keywords

Author Biographies


, Universidad de Antioquia

Full-time Professor, Faculty of Economic Sciences, Universidad de Antioquia, Medellín, Colombia. Economist, Universidad Autónoma Latinoamericana, Colombia, Doctor (c) in Business Management, Universidad de Valencia, Spain. Research Group in Finances (GiFi), Category B, Universidad de Antioquia, Colombia.


, Universidad de Antioquia

Full Professor, Faculty of Economic Sciences, Universidad de Antioquia, Medellín, Colombia. MA in Business Management, Universidad de Antioquia, Colombia, Doctor in Engineering, Industry and Organizations, Universidad Nacional, Colombia. Research Group in Finances (GiFi), Category B, Universidad de Antioquia, Colombia.


, Universidad de Antioquia

Financial Lab Consultant, Universidad de Antioquia, Medellín, Colombia. MA in Business Management, Universidad de Antioquia, Colombia.

References

Arnold, G. C., & Hatzopoulos, P. D. (2000). The theory-practice gap in capital budgeting: Evidence from the United Kingdom. Journal of Business Finance and Accounting, 27(5-6), 603-626. https://doi.org/10.1111/1468-5957.00327

Asness, C., Frazzini, A., Israel, R., Moskowitz, T. J., & Pedersen, L. H. (2018). Size matters, if you control your junk. Journal of Financial Economics, 129(3), 479–509. https://doi.org/10.1016/j.jfineco.2018.05.006

Banz, R. W. (1981). The relationship between return and market value of common stocks. Journal of Financial Economics, 9(1), 3-18. https://doi.org/10.1016/0304-405X(81)90018-0

Barry, C. B., Goldreyer, E., Lockwood, L., & Rodríguez, M. (2002). Robustness of size and value effects in emerging equity markets, 1985-2000. Emerging Markets Review, 3(1), 1–30. https://doi.org/10.1016/S1566-0141(01)00028-0

Batra, R., & Verma,S. (2017). Capital budgeting practices in Indian companies. Management Review, 29(1), 29-44. https://doi.org/10.1016/j.iimb.2017.02.001

Bennouna, K., Meredith, G. G., & Marchant, T. (2010). Improved capital budgeting decision making: Evidence from Canada. Management Decision, 48(2), 225–247. https://doi.org/10.1108/00251741011022590

Berrone, P., Cruz, C., Gómez-Mejía, L.R., & Larraza-Kintana, M. (2010). “Socioemotional Wealth and Corparate Responses to Institutional Pressures: Do family Controlled firms Pollute Less?”. Administrative Science Quarterly, 55(1), 82-113. https://doi.org/10.2189/asqu.2010.55.1.82

Block, S. B (1977). Capital budgeting techniques used by small business firms in the 1990s. The Engineering Economist,42(4), 289-302. https://doi.org/10.1080/00137919708903184

Block, S. B (1999). A Study of Financial Analysts: Practice and Theory. Financial Analysts Journal, 55(4), 86-92. https://doi.org/10.2469/faj.v55.n4.2288

Brickley. S.Z. (2006). Managerial Economics and Organizational Architecture, (3rd ed.). China: McGraw-Hill.

Brigham, E. F. (1975). Hurdle Rates for Screening Capital Expenditure Proposals. Financial Management, 4(3), 17-26. https://doi.org/10.2307/3665186

Brigham, E. F., & Ehrhardt, M. C. (2002). Financial Management: Theory and Practice (10th ed.). Ohio, USA: Thomson/South-Western.

Brounen, D., De Jong A., & Koedijk, K. (2004). Corporate finance in Europe: confronting theory with practice. Financial Management, 33, 71-101. Retrieved from https://ep.eur.nl/handle/1765/1111

Bruner, R. F., Eades K. M., Harris, R. S., & Higgins, R. C. (1998). Best practices in estimating the cost of capital: Survey and synthesis. Financial Practice and Education, 8, 13-28. Retrieved from https://ntrda.me/2XVKI1G

Carney, M. (2005). Corporate governance and competitive advantage in family-controlled firms. Entrepreneurship Theory and Practice, 29(3), 249-265. https://doi.org/10.1111%2Fj.1540-6520.2005.00081.x

Chan, K. C., Chen, N. F., & Hsieh, D. (1985). An exploratory investigation of the firm size effect. Journal of Financial Economics, 14(3), 451-471. https://doi.org/10.1016/0304-405X(85)90008-X

Chrisman, J. J., Chua, J. H., Pearson, A. W., & Barnett, T. (2012). Family Involvement, Family Influence, and Family-Centered Non-Economic Goals in Small Firms. Entrepreneurship Theory and Practice, 36(2), 267-293. https://doi.org/10.1111/j.1540-6520.2010.00407.x

Damodaran, A. (2003). Measuring Company Exposure to Country Risk: Theory and Practice. Working paper. New York University. http://dx.doi.org/10.2139/ssrn.889388

Dayananda, D., Irons, R., Harrison, S., Herbohn, J., y Rowland, P. (2002). Capital Budgeting: Financial Appraisal of Investment Projects, Edinburgh: Cambridge University Press. Retrieved from https://bit.ly/2WhBeNF

Dean, J. (1952). Capital Budgeting : Top Management Policy on Plant , Equipment and Product. Southern Economic Journal, 19(1), 109–111. Retrieved from https://www.jstor.org/stable/1053981

Dickson, P.R. y Giglierano, J.J. (1986). Missing the Boat and Sinking the Boat: A Conceptual Model of Entrepreneurial risk. Journal of Marketing, 50 (3), 58-70. https://doi.org/10.1177/002224298605000305

Estrada, J. (2007). Mean-semivariance behavior: Downside risk and capital asset pricing. International Review of Economics and Finance, 16(2), 169–185. https://doi.org/10.1016/j.iref.2005.03.003

Fama, E. F. y French, K. R. (1992). The Cross-Section of Expected Stock Returns. The Journal of Finance, 47(2),427–465. https://doi.org/10.1111/j.1540-6261.1992.tb04398.x

Fama, E. F. y French, K. R. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33(1), pp. 3–56. https://doi.org/10.1016/0304-405X(93)90023-5

Fama, E. F. y French, K. R. (1998). Value versus Growth : The International Evidence. The Journal of Finance, 53(6), 1975–1999. https://doi.org/10.1111/0022-1082.00080

Fama, E. F. y French, K. R. (2015). A five-factor asset pricing model. Journal of Financial Economics, 116(1), 1–22. https://doi.org/10.1016/j.jfineco.2014.10.010

Family Firm Institute. (2014). Global Data Points. Retrieved from https://bit.ly/1WyWigc

Gitman, L. J., y Forrester, J. R. (1977). A Survey of Capital Budgeting Techniques Used by Major U.S. Firms. Financial Management, 6(3), 66–71. Retrieved from http://www.jstor.org/stable/3665258

Gómez- Mejía, L. R., Lazarra-Kintana, M., & Makri, M. (2003). “The Determinants of Executive Compensation in Family-Controlled Public Corporations”. The Academy of Management Journal, 46(2), 226-237. https://doi.org/10.5465/30040616

Gómez-Mejía, L. R., Haynes, K. T., Núñez-Nickel, M., Jacobson, K., & Moyano-Fuentes, J. (2007). Socioemotional Wealth and Business Risks in Family-controlled Firms: Evidence from Spanish Olive Oil Mills. Administrative Science Quarterly, 52(1), 106–137. https://doi.org/10.2189/asqu.52.1.106

Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: evidence from the field. Journal of Financial Economics, 60(2–3), 187–243. https://doi.org/10.1016/S0304-405X(01)00044-7

Hanaeda, H., & Serita, T. (2014). Capital Budgeting Practices: Evidence from Japan. Retrieved from http://dx.doi.org/10.2139/ssrn.2312264

Hermes, N., Smid, P., & Yao, L. (2007). Capital budgeting practices: A comparative study of the Netherlands and China. International Business Review, 16(5), 630–654.

https://doi.org/10.1016/j.ibusrev.2007.05.002

Hou, K., & van Dijk, M. A. (2018). Resurrecting the size effect: Firm size, profitability shocks, and expected stock returns. Retrieved from http://dx.doi.org/10.2139/ssrn.1005664

Ibbotson Associates. (2003). Stocks, Bonds, Bills and Inflation 2003 Yearbook. Chicago, USA: Valuation Edition, Ibbotson Associates.

Jones, C. D., Makri, M. , & Gómez-Mejia, L. R. (2008). Affiliate directors and perceived risk bearing in publicly traded, family-controlled firms: the case of diversification. Entrepreneurship Theory and Practice, 32(6), 1007-1026. https://doi.org/10.1111/j.1540-6520.2008.00269.x

Bloch, A. Kachaner, N., & Stalk, G. (2012). What you can learn from family business. Harvard Business Review, 90(11), 102-106. Retrieved from https://hal-hec.archives-ouvertes.fr/hal-00743569

Kengatharan, L. (2018). Capital Budgeting Theory and Practice: A review and agenda for future research. American Journal of economics and business management. 1(1), 20-53. https://doi.org/https://doi.org/10.31150/ajebm.v1i1.5

Lessard, D. R. (1996). Incorporating Country Risk in the Valuation of Offshore Projects. Journal of Applied Corporate Finance, 9(3), 52-63. https://doi.org/10.1111/j.1745-6622.1996.tb00298.x

Maquieira, C. P., Preve, L. A., & Sarria-Allende, V. (2012). Theory and practice of corporate finance: Evidence and distinctive features in Latin America. Emerging Markets Review, 13(2), 118–148. https://doi.org/10.1016/j.ememar.2011.11.001

Maroyi, V., & Poll, H. M. (2012). A survey of capital budgeting techniques used by listed mining companies in South Africa. African Journal of business management, 6(32), 9279–9292. https://doi.org/10.5897/AJBM12.747

Nurullah, M., & Kengatharan, L. (2015). Capital budgeting practices: evidence from Sri Lanka. Journal of Advances in Management Research, 12(1), 55–82. https://doi.org/10.1108/JAMR-01-2014-0004

Pereiro, L. E., y Galli, M. (2000). La Determinación Del Costo Del Capital En La Valuación De Empresas De Capital Cerrado: Una Guía Práctica. Recuperado de http://marcelodelfino.net/files/paperwacc.pdf

Perlitz, M., Peske, T., & Schrank, R. (1999). Real options valuation : the new frontier in R & D project evaluation ? R&D Management, 29(3), 255-269. https://doi.org/10.1111/1467-9310.00135

Rigopoulos, G. (2015). A review on Real Options utilization in Capital Budgeting practice. International Journal of Information, Business and Management, 7(2), 1-16. Retrieved from https://bit.ly/2VGRVVI

Rouwenhorst, K. G. (1999). Local return factors and turnover in emerging stock markets. Journal of Finance, 54(4), 1439–1464. https://doi.org/10.1111/0022-1082.00151

Rubio, G. (1988). Further international evidence on asset pricing. The case of the Spanish capitalmarket.Journal of Banking and Finance, 12(2), 221–242. https://doi.org/10.1016/0378-4266(88)90037-4

Ryan, P. A., & Ryan, G. P. (2002). Capital Budgeting Practices of Fortune 1000 Firms: How Have Things Changed? Journal of Business & Management, 8(4), 355-364. Retrieved from https://bit.ly/2WektTP

Sharpe, W. F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. The Journal of Finance, 19(3), 425-442. https://doi.org/10.1111/j.1540-6261.1964.tb02865.x

Schulze,W. S., Lubatkin, M H., & Dino, R. N. (2003). Exploring the Agency Consequences of Ownership Dispersion among the Directors of Private Family Firms. The Academy of Management Journal, 46(2), 179-194. https://doi.org/10.5465/30040613

Singh, S., Jain, P. K., & Yadav, S. S. (2012). Capital budgeting decisions: evidence from India. Journal of Advances in Management Research, 9(1), 96–112. https://doi.org/10.1108/09727981211225671

Truong, G., Partington, G., & Peat, M. (2008). Cost-of-Capital Estimation and Capital-Budgeting Practice in Australia. Australian Journal of Management, 33(1), 95-121. https://doi.org/10.1177/031289620803300106

Van Dijk, M. A. (2011). Is size dead? A review of the size effect in equity returns. Journal of Banking and Finance, 35(12), 3263-3274. https://doi.org/10.1016/j.jbankfin.2011.05.009

Verbeeten, F. H. M. (2006). Do organizations adopt sophisticated capital budgeting practices to deal with uncertainty in the investment decision?: A research note. Management Accounting Research, 17(1), 106-120. https://doi.org/10.1016/j.mar.2005.07.002

Published
2020-09-16
| 89 |
How to Cite
Reina Gutiérrez, W., Moscoso Escobar, J., & Montoya González, C. (2020). Adjustment by size effect on the cost of equity: Pending practice in capital budget in Colombia. Cuadernos De Administración, 36(67), 126-142. Retrieved from https://cuadernosdeadministracion.univalle.edu.co/index.php/cuadernos_de_administracion/article/view/7896
Section
Research