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Summary of Graham and Harvey (JFE, 2001)

Survey study - 4,440 companies, 392 CFOs (9% response rate)

Relate findings to company characteristics and CEO attributes

Objectives: Abandon or modify existing theories based on evidence. Develop new theories from evidence.
Educate practitioners.

A. Investment Decisions

Large companies use NPV method more. Small companies use Payback method more.

Options approach?

B. Cost of Capital

Use CAPM, average past returns, multi-beta CAPM

CAPM properly used? - Rubinstein (JF, 1973)

Many companies use firm risk, not project risk

CAPM relevant at all? - Fama and French (1992)

Multi-beta risk factors - Adjust discount rate or cash flows?

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C.
Capital Structure

Consider financial flexibility and credit ratings when issuing debt.

Consider EPS dilution and recent share price appreciation when issuing equity.

Static trade-off theory - Scott (JF, 1976), Kim (JF, 1978)

Benefits: corporate tax shelter (MM, 1958, 1963) Costs: bankruptcy & distress costs, personal tax (Miller 1976)

Packing-order theory - Myers and Majluf (JFE, 1984)

Use external funds only when internal funds are not sufficient (Because external funds are always more expensive because of information asymmetry.)

For external funds, use debt first, convertibles, and then common stock

Implication:

1. Financial slack is important. Firms seek to maintain financial slack to avoid the need for expensive external funds in case profitable investment opportunities arise.

2. Need for financial slack is greater for firms with greater information asymmetry. Not supported (see Table 6, dividend).

3. Equity undervaluation affects debt/equity decision. Not supported (see Table 9).

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Market timing - Window of opportunity - Loughran and Ritter (JF, 1995). Supported (see Table 8a).

Signaling theory - Ross (BJE, 1977). Not supported (see Table 8h, Table 9b)

Underinvestment - Myers (JFE, 1977). See Table 6n, Table 9d, Table lId

Asset substitution - Fama and Miller (1972), Jensen and Meckling (JFE, 1976). Not supported (seeTable II!).

Free cash flows - Jensen (AER, 1986). Not supported (see Table 6m)

Information models - Myers and Majluf (1984). Not supported (see above)

Product market - Titman (1984). Not supported (see Table 6i)

Control contests - Stultz (1988). Some support (Table 8j)

EPS dilution - See Fig. 7