Dr. V. N. Bedekar Institute Of Management Studies - RESEARCH … · 2014. 7. 26. · Dr. V. N....
Transcript of Dr. V. N. Bedekar Institute Of Management Studies - RESEARCH … · 2014. 7. 26. · Dr. V. N....
RESEARCH MONOGRAPH
Trends In Finance
Seminar On: 7 th Feb 2015
Vidya Prasarak Mandal’s
Dr. V. N. Bedekar Institute of Management Studies, Thane DR VN BRIMS
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We, as a team for monograph publication on Trends in finance wholeheartedly
acknowledge the support and valuable contributions of all, those who have directly or
indirectly provided inputs in different forms for this publication
Dr. P .M. Kelkar, Dean, DR V N BRIMS
Mr. Nityanand Bhangale, Nomura Services India Ltd
Mr. Ashwinikumar Sharm , Ex-Deputy MD,SBI
Mr. Sandip Bhavsar, Librarian, D R V N BRIMS
Ms. Dipali Hindalekar, Library Assistant , DR V N BRIMS
Ms. Ketki Mistry, DR V N BRIMS
Editorial Team:
Dr. Amit Oak, Director, DR V N BRIMS
Dr.Guruprasad Murthy, Director General, DR V N BRIMS
Ms Smita Jape, Assistant Professor, DR V N BRIMS
Mr.Pushkar Parulekar Assistant Professor, DR V N BRIMS
Ms.Suman Mathur, Assistant Professor, DR V N BRIMS
ACKNOWLEDGEMENT
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Dr. Amit Oak, Director, DR V N BRIMS ........................................................................................ 2
Dr.Guruprasad Murthy, Director General, DR V N BRIMS ........................................................... 2
Ms Smita Jape, Assistant Professor, DR V N BRIMS ..................................................................... 2
Mr.Pushkar Parulekar Assistant Professor, DR V N BRIMS .......................................................... 2
Ms.Suman Mathur, Assistant Professor, DR V N BRIMS .............................................................. 2
1-GENESIS, TRENDS IN FINANCE .......................................................................................... 11 2-PROLOGUE .............................................................................................................................. 16
2.1 MAXIMISING SHAREHOLDERS WEALTH .................................................................. 18
2.2 OPTIONS TO IMPROVE ROI ........................................................................................... 20
2.3 IMPROVE ROI - INCREASED SALES ............................................................................ 20
2.4 IMPROVE ROI - COST MANAGEMENT ........................................................................ 21
2.5 FINANCIAL EPISODES, EVENTS AND EXPERIENCES ............................................. 27
2.6 IRRATIONAL EXUBERANCE ......................................................................................... 27
2.7 PRICING AT LOUIS VUITTON ........................................................................................ 28
2.8 PRICING OF ONIONS IN MAHARASHTRA ................................................................. 28
2.9 FARM PRODUCTS IN EUROPE AND OTHER COUNTRIES ....................................... 28
2.10 PRICING OF MONEY IN SWITZERLAND ..................................................................... 29
2.12 HERD MENTALITY IN THE STOCK MARKET - HARSHAD MEHTA ....................... 30
2.13 DEVAS MULTI MEDIA SHARE ....................................................................................... 30
2.14 OTHER ACADEMIC ADVANCEMENTS IN FINANCE ................................................ 31
2.15 FINANCE AS AN ART....................................................................................................... 33
2.16 WARREN BUFFET ............................................................................................................ 33
2.17 WALL STREET CRASH (1929) AND GLOBAL MELTDOWN (2008) .......................... 34
SECTION – I ................................................................................................................................ 41 3-RESERVE BANK OF INDIA (RBI) DATA ANALYSIS- MEDIUM AND LARGE PUBLIC
LIMITED COMPANIES IN INDIA FROM 1950-51 TO 1996-97 ............................................. 41 ...................................................................................................................................................... 41
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3.1 AN – OVERVIEW .............................................................................................................. 41
3.2 TRENDS OBSERVED THROUGH COMMON SIZE BALANCE SHEET & P& L
ACCOUNT..................................................................................................................................... 46
3.3 DEFINITION OF 'COMPOUND ANNUAL GROWTH RATE - CAGR‘ (CONCEPT
USED IN INDEXING) .................................................................................................................. 46
3.4 TRENDS OBSERVED THROUGH INDEXING BALANCE SHEET & P& L
ACCOUNT..................................................................................................................................... 50
3.5 GRAPHICAL OBSERVATIONS ...................................................................................... 51
3.6 BREAKEVEN POINT (BEP) ANALYSIS ........................................................................ 51
3.7 REGRESSION ANALYSIS BASED ON CORPORATE FINANCIAL PERFORMANCE
MODEL .......................................................................................................................................... 63
3.7.1 Calculations and Assumptions ..................................................................................... 64
3.7.2 Calculation of Return on Equity based on book profit (ROE) .................................... 64
3.7.3 Calculation of Return on Equity based on Cash Profit (Cash ROE) ........................... 65
3.7.4 Calculation of Return on Capital Employed based on Book Profit (ROCE) ............... 65
3.7.5 Calculation of Return on Capital Employed based on Cash Profit (Cash ROCE) ...... 66
3.7.6 P/V Ratio (PV Ratio) ................................................................................................... 66
3.7.7 Margin of Safety based on book profit (MOS) ............................................................ 66
3.7.8 Margin of Safety based on cash profit (Cash MOS) .................................................... 67
3.7.9 Turnover Ratio (ATR) ................................................................................................. 67
3.7.10 Financial Leverage ....................................................................................................... 67
3.7.11 Tax Impact or Tax Leverage ........................................................................................ 67
3.7.12 Net Profit Margin based on Book Profit ...................................................................... 68
3.7.13 Net Profit Margin based on Cash Profit ....................................................................... 68
3.7.14 Operating Profit Margin based on Book Profit ............................................................ 68
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3.7.15 Operating Profit Margin based on Cash Profit ............................................................ 68
3.7.16 Regression Analysis ..................................................................................................... 68
3.7.17 Output of Regression Analysis ................................................................................... 69
3.7.18 Summary of 10 equations ........................................................................................... 78
SECTION- II ................................................................................................................................. 79
4-CMIE DATA - FIVE SECTORS DATA ANALYSIS VIZ. MANUFACTURING, MINING,
ELECTRICAL, 'CONSTRUCTION AND REAL ESTATE' AND 'NON-FINANCIAL' SECTORS
FROM 1992-93 TO 2012-13 THROUGH ‗REGRESSION ANALYSIS‘................................... 79
...................................................................................................................................................... 79
4.1 AN OVERVIEW ................................................................................................................. 80
4.2 SUMMARY OF MULTIPLE REGRESSION ANALYSIS OUTCOME ........................ 110
4.3 SUMMARY OF MULTIPLE REGRESSION ANALYSIS OUTCOME ........................ 111
4.4 SUMMARY OF MULTIPLE REGRESSION ANALYSIS OUTCOME ........................ 112
4.5 COMPARISONS BETWEEN THE STUDIES DONE ON RBI (SECTION I ) AND
CMIE (SECTION II) DATA ....................................................................................................... 113
4.5.1 Factors Common to RBI & CMIE data for 5 industries ............................................ 113
4.5.2 Difference in RBI & CMIE data for 5 industries ....................................................... 114
SECTION-III .............................................................................................................................. 115 5-LITERATURE REVIEW ........................................................................................................ 115 .................................................................................................................................................... 115
5.1 REVIEW OF PUBLISHED RESEARCH ........................................................................ 116
5.2 A REVIEW OF RESEARCH PAPERS -A PROFILE ..................................................... 120
5.2.1 Topic: Financial Objectives of Business: Research Papers (1) ................................. 120
5.2.2 Topic: Financial Leverage: Research Papers (2-8) .................................................... 121
5.2.3 Topic: Capital Investment Decisions-Research papers 9—10 ................................... 124
5.2.4 Capital Structure - Research Papers — 14-20 .......................................................... 129
5.2.5 Cost of Equity -- Research Papers 21-23 .................................................................. 141
5.2.6 Dividend policy- Research Papers - 24-25 ................................................................ 144
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5.2.7 Corporate Decision making Research Papers 26-29 .................................................. 148
5.2.8 DETAILED REVIEW OF RESEARCH PAPERS (23) AND THESIS (2) .............. 153
STUDENT SECTION-IV ........................................................................................................... 184 6-STUDY OF ARTICLES ON ―SURPLUS CASH A MORE SERIOUS PROBLEM THAN CASH
DEFICIT‖ ................................................................................................................................... 184 .................................................................................................................................................... 184
6.1 IS SURPLUS CASH A MORE SERIOUS PROBLEM THAN CASH DEFICIT? .......... 184
6.1.1 PSUs must use surplus cash or give them to others to invest: FM ............................ 185
6.1.2 PM to meet PSU chiefs to discuss plans for investing cash surplus .......................... 185
6.1.3 RIL earns nearly Rs. 8,000 crore from treasury operations ....................................... 186
6.2 GLOBAL PICTURE ......................................................................................................... 187
STUDENT SECTION-IV ........................................................................................................... 189
7- INDIA INC. BEATS CHINESE PEERS IN FINANCIAL HEALTH ................................... 189 .................................................................................................................................................... 189
7.1 INDIA INC. BEATS CHINESE PEERS IN FINANCIAL HEALTH ............................. 189
STUDENT SECTION-IV ........................................................................................................... 192 8- CMIE –DATABASE INDIA INC SECTOR-WISE FINANCES .......................................... 192
.................................................................................................................................................... 192
8.1 CMIE – DATABASE INDIA INC SECTOR-WISE FINANCES ................................... 192
8.2 RETURN ON TOTAL ASSETS (ROTA- %) .................................................................. 193
8.3 CMIE – DATABASE INDIA INC SECTOR-WISE FINANCES: AN OVERVIEW –
2012-13......................................................................................................................................... 194
8.4 CMIE – DATABASE INDIA INC SECTOR-WISE FINANCES: AN OVERVIEW –
2012-13......................................................................................................................................... 195
8.5 CMIE – DATABASE INDIA INC SECTOR-WISE FINANCES - AN OVERVIEW .... 197
8.5.1 Manufacturing Sector -1993-94 to 2012-13 .............................................................. 197
8.5.2 Mining Sector -1993-94 to 2012-13 .......................................................................... 198
8.5.3 Electrical Sector -1993-94 to 2012-13 ....................................................................... 198
8.5.4 Construction-Real Estate Sector -1993-94 to 2012-13 .............................................. 199
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8.5.5 Non-Financial Sector -1993-94 to 2012-13 ............................................................... 199
SECTION-V ............................................................................................................................... 200 9-INDUSTRY SPEAK ............................................................................................................... 200 .................................................................................................................................................... 200
9.1 TRENDS IN INVESTMENT BANKING INDUSTRY – INDUSTRY SPEAK ............. 201
...................................................................................................................................................... 201
9.2 TRENDS IN BANKING INDUSTRY – INDUSTRY SPEAK ....................................... 203
10 GLIMPSES PRE-BUDGET 2014 .................................................................................. 208
.................................................................................................................................................... 208 Error! Not a valid embedded object.$..................................................................................... 210 10 BIBLIOGRAPHY ............................................................................................................ 211
...................................................................................................................................................... 211
10 BIBLIOGRAPHY ............................................................................................................ 213
...................................................................................................................................................... 213
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List of Table/Figures/Charts Table 2.1 Focus Areas for Research in Finance- Researchers and Journal ................................. 38 Table 3.1 Common Size Financial Statement Analysis ............................................................... 44 Table 3.2 Common Size P& L account........................................................................................ 45 Table 3.3 Indexing Financial Statement- Balance Sheet ............................................................ 48
Table 3.4 Profit and Loss Account............................................................................................. 49 Table 3.5 Profit after Tax Distribution to Shareholders as equity dividend & saving as retained
earnings 52 Graph 3.6 Dividend and Retained Earnings ................................................................................. 52 Table 3.7 Marginal Tax Rate ......................................................................................................... 53
Graph 3.8 Reduction in tax rate indicating year wise ................................................................... 53 Table 3.9 Depreciation as a percentage of Gross Block .............................................................. 54
Graph 3.10 Percentage depreciation charged by Indian INC ......................................................... 54 Table 3.11 Gross Profit Margin ..................................................................................................... 54
Graph 3.12 Gross Profit Margin has improved drastically in post liberalization years .................. 55 Table 3.13 Net Profit Margin ....................................................................................................... 55
Graph 3.14 Net Profit Margins .......................................................................................................... 56 Table 3.15 Interest Cost ................................................................................................................. 56 Graph 3.16 Interest Cost ................................................................................................................. 56
Table 3.17 Long term Debt to equity Ratio ................................................................................... 57 Graph 3.18 Indian Corporate .......................................................................................................... 58
Table 3.19 Salary Cost as a percentage of Total Cost ................................................................... 58
Graph 3.20 Money spent by Indian Public limited companies on salary as proportion .................... 59
Graph 3.21 Liquidity to Profitability ............................................................................................. 59 Graph 3.22 Indian companies have shifted from current assets to fixed assets .............................. 59
Table 3.23 Liquidity to Profitability .............................................................................................. 60 Graph 3.24 Cash & inventory levels ............................................................................................... 60 Table 3.25 Liquidity to Profitability - Current Ratio ..................................................................... 61
Graph 3.26 Current Ratio ............................................................................................................... 61
Figure 3.27 Regression Analysis Based On Corporate Financial Performance Model ............... 63 Table 3.28 Return on Equity (ROE) .............................................................................................. 69 Table 3.29 ANOVA table .............................................................................................................. 70 Table 3.30 Coefficient Matrix ........................................................................................................ 72
Table 3.31 Correlation Matrix ........................................................................................................ 73
Table 3.32 Cash ROE as a function of CPM, ATR and CE to NW ............................................... 73
Table 3.33 ROCE as a function of OPM and ATR ........................................................................ 74 Table 3.34 Cash ROCE as a function of Cash OPM and ATR ...................................................... 74 Table 3.35 ROCE as a function of PV Ratio, MOS and ATR ....................................................... 75 Table 3.36 Cash ROCE as a function of PV Ratio, Cash MOS and ATR ..................................... 76
Table 3.37 ROE as a function of PV Ratio, MOS, ATR, CE to NW, PBT/EBIT, Tax Leverage . 76 Table 3.38 Cash ROE as a function of PV Ratio, Cash MOS, ATR, CE to NW, PBT/Cash EBIT,
Tax Leverage ..................................................................................................................................... 76 Table 3.39 ROE as a function of ROCE, CE to NW, PBT/ EBIT, Tax Leverage ......................... 77
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Table 3.40 Cash ROE as a function of Cash ROCE, ATR, CE to NW, PBT/ EBIT, Tax Leverage
77 Table 3.41 Multiplier matrix .......................................................................................................... 78 Table 4.1 Cash Profit ROE as a function of CPM, ATR & CE to NW – Manufacturing ........... 81
Table 4.2 Book Profit ROE as a function of NPM, ATR & CE to NW ...................................... 82 Table 4.3 Cash Profit ROCE as a function of Cash OPM & ATR .............................................. 83 Table 4.4 Book Profit ROCE as a function of OPM & ATR....................................................... 83 Table 4.5 Cash Profit ROE as a function of PV Ratio, CashMOS, ATR, PBT/Cash EBIT &
PAT/PBT 84
Table 4.6 Book Profit ROE as a function of PV Ratio, MOS, ATR , PBT/EBIT & PAT/PBT .. 84 Table 4.7 Cash Profit ROCE as a function of PV Ratio, CashMOS & ATR .............................. 85
Table 4.8 Book Profit ROCE as a function of PV Ratio, MOS & ATR ..................................... 86 Table 4.9 Cash Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT ...................... 86 Table 4.10 Book Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT ..................... 87 Table 4.11 Cash Profit ROE as a function of CPM, ATR & CE to NW- Mining ......................... 87
Table 4.12 Book Profit ROE as a function of NPM, ATR & CE to NW ...................................... 88 Table 4.13 Cash Profit ROCE as a function of CashPM & ATR .................................................. 88
Table 4.14 Book Profit ROCE as a function of OPM & ATR....................................................... 89 Table 4.15 Cash Profit ROE as a function of PV Ratio, CashMOS, ATR , PBT/CashEBIT &
PAT/PBT 89
Table 4.16 Book Profit ROE as a function of PV Ratio, MOS, ATR , PBT/EBIT & PAT/PBT .. 90 Table 4.17 Cash Profit ROCE as a function of PV Ratio, CashMOS & ATR ............................. 91
Table 4.18 Book Profit ROCE as a function of PV Ratio, MOS & ATR ..................................... 91 Table 4.19 Cash Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT ...................... 92
Table 4.20 Book Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT ....................... 93 Table 4.21 Cash Profit ROE as a function of CPM, ATR & CE to NW- Electrical...................... 93
Table 4.22 Book Profit ROE as a function of NPM, ATR & CE to NW ...................................... 94 Table 4.23 Cash Profit ROCE as a function of Cash OPM & ATR .............................................. 94 Table 4.24 Book Profit ROCE as a function of OPM & ATR....................................................... 95
Table 4.25 Cash Profit ROE as a function of PV Ratio, CashMOS, ATR , PBT/EBIT &
PAT/PBT 95
Table 4.26 Book Profit ROE as a function of PV Ratio, MOS, ATR , PBT/EBIT & PAT/PBT .. 96 Table 4.27 Cash Profit ROCE as a function of PV Ratio, CashMOS & ATR ............................. 96
Table 4.28 Book Profit ROCE as a function of PV Ratio, MOS & ATR ..................................... 97 Table 4.29 Cash Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT ...................... 98 Table 4.30 Book Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT ....................... 98
Table 4.31 Cash Profit ROE as a function of CPM, ATR & CE to NW- Construction ................ 99 Table 4.32 Book Profit ROE as a function of NPM, ATR & CE to NW ...................................... 99 Table 4.33 Cash Profit ROCE as a function of Cash OPM & ATR ............................................ 100 Table 4.34 Book Profit ROCE as a function of OPM & ATR..................................................... 101
Table 4.35 Cash Profit ROE as a function of PV Ratio,Cash MOS, ATR , PBT/CashEBIT &
PAT/PBT 101 Table 4.36 Book Profit ROE as a function of PV Ratio, MOS, ATR, PBT/EBIT & PAT/PBT . 102 Table 4.37 Cash Profit ROCE as a function of PV Ratio, CashMOS & ATR ............................ 102 Table 4.38 Book Profit ROCE as a function of PV Ratio, MOS & ATR ................................... 103
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Table 4.39 Cash Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT .................... 103 Table 4.40 Book Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT ..................... 104 Table 4.41 Cash Profit ROE as a function of CPM, ATR & CE to NW- Non-Financial Services
105
Table 4.42 Book Profit ROE as a function of NPM, ATR & CE to NW .................................... 105 Table 4.43 Cash Profit ROCE as a function of Cash OPM & ATR ............................................ 106 Table 4.44 Book Profit ROCE as a function of PM & ATR ...................................................... 106 Table 4.45 Cash Profit ROE as a function of PV Ratio, CashMOS, ATR , PBT/EBIT &
PAT/PBT 107
Table 4.46 Book Profit ROE as a function of PV Ratio, MOS, ATR , PBT/EBIT & PAT/PBT 107 Table 4.47 Cash Profit ROCE as a function of PV Ratio, CashMOS & ATR ........................... 108
Table 4.48 Book Profit ROCE as a function of PV Ratio, MOS & ATR ................................... 109 Table 4.49 Cash Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT .................... 109 Table 4.50 Book Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT ..................... 110 Table 4.51 Manufacturing Sector -Multiplier Matrix ................................................................. 110
Table 4.52 Mining Sector -Multiplier Matrix .............................................................................. 111 Table 4.53 Electrical Sector -Multiplier Matrix........................................................................... 111
Table 4.54 Construction -Real Estate Sector -Multiplier Matrix ................................................. 112 Table 4.55 Non-Financial Sectors - Multiplier Matrix ................................................................ 112 Table 5.1 Summarized Table of an Overview of Research Papers Studied .............................. 116
Table 7.1 India and China Relative to the world (Percentage Shares) ...................................... 189 Table 7.2 Ratios of India and China .......................................................................................... 190
Table 8.1 CMIE – Database India Inc Sector-Wise Finances .................................................... 192 Graph 8.2 CMIE – Database India Inc Sector-Wise Finances .................................................... 193
Table 8.3 Sector Wise Return On Total Assets (ROTA- %) ..................................................... 193
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1-GENESIS, TRENDS IN FINANCE
Dr. Amit Oak, Director, DR VN BRIMS
India‘s financial markets have evolved and undergone structural change during the course of the
economic reforms. The Indian economy shifted to higher growth trajectories during the same
period. The Indian securities market proved the harbinger of the modern Indian financial markets.
The rapid strides made (of course, some dictated by time and circumstances) have helped the Indian
Financial market emerge as a benchmark for the rest of the world.
This study seeks to trace the development of the Financing of India INC structure during the period
from Indian Independence that is 1947 to 1991, (that is the Pre Liberalization) and 1991 onwards to
till date (Post Liberalization), as is evident from the flow of funds accounts.
The extant literature describes the modern flow of funds accounts as representing a systematic
record of net transactions involving financial instruments during a given period of time. The flow of
funds accounts are a branch of social accounting of a country. All the economic transactions in a
monetized economy involve the exchange of financial claims among the participants. (Source RBI
database and the CMIE database)
The flow of funds accounts serve as a useful analytical tool in many respects:
Identification of individual sectors having financial surpluses or deficits,
Determination of the causes of these surpluses/deficits,
The financing of the deficits and, thereby,
The inter-sectoral linkages,
Tracing the growth of important economic institutions, such as the mutual funds,
Identification of the pattern of financing of the capital stocks,
Assessment of the impact of monetary policy actions, to name the a few
In this study, we restrict ourselves to profiling the Indian Financial Markets, as seen through the
financial development ratios derived from the flow of funds accounts of the Indian economy. The
data to be studied is sought from the Reserve Bank of India and the CMIE.
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According to the Reserve Bank of India (RBI), flow of funds accounts is a set of accounts which
depicts the inter-sectoral flow of funds among major sector s of the economy ‗from whom to
whom‘ basis. The RBI has been publishing the flow of funds accounts of the country since
December 1950-51. The data for India, pertain to one year, the financial year.
The published accounts pertaining to the period 1951–52 to 1996-97 are available in the several
issues of the RBI‘s monthly Bulletin. In the Indian economy, the institutional units, i.e., the
economic entities capable of engaging in transactions with other units, are grouped into six categories, viz., (i) banking sector; (ii) other financial institutions; (iii)private corporate business; (iv) government sector; (v) rest of the world; and (vi) household sector.
Financial assets and liabilities are classified under ten major categories of financial instruments,
viz., (i) currency;
(ii) de-posits;
(iii)investments;
(iv) loans and advances;
(v) small savings;
(vi) life funds;
(vii) provident funds;
(viii) trade debts;
(ix) foreign claims not elsewhere classified; and (x) other claims not elsewhere classified. The data from the database of the CMIE (Economic Outlook) under study is pertaining to the
period 1996-97 to 2012-13.
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This study seeks to trace the development of the Financing of India INC during the period
mentioned above, as is evident from the flow of funds accounts. Wherever the reporting period has
overlapped, we have taken into account the latest data. The data on the indicators of India‘s
financial development would be presented in the subsequent sections of study.
Financial claims issued by the economic agents are classified as primary issues and secondary
issues. Primary issues are the claims issued by non-financial sector or the ultimate borrowers.
Claims issued by the financial intermediaries, on the other hand, are called secondary issues. The
flow of funds accounts provide data on financial claims which can be further analyzed to assess the
depth and maturity of the financial markets.
The study would be made in-depth tracing and then identifying the trends in the Finance in the
India INC since independence. The study would be carried out over the period of next year and the
findings would be presented at the Annual Seminar to be held in the next Academic year (2014-15)
The overall resource(Financial) management via the route of Return on Investments and specific
aspects of Financial Liquidity, Profitability, Asset utilization would be taken into consideration and
the impact of the same on the financial structure of the economy as a whole would be studied and
taken in to consideration.
Following activities have been identified to design the study. Study of the database (Secondary Sources) namely the Reserve Bank of India Fund Flow
statements released through their monthly publications and the data base released by the Center for
Monitoring the Indian Economy Study of the already published research papers, articles and PhD thesis. About 28 research papers
spreading from around 1973 till date would be analyzed and the findings would be listed pertaining
to the theme. Study of the academic books and articles, budgetary data of the India INC since independence
would be also carried out to find out the correlation of the RBI and CMIE data bases for the defined
period. An analysis of the findings would be shown on the following ground. The ratio techniques would
be used to interpret the raw data.
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The financial ratio is an indicator of the rate of financial development in relation to economic
growth. The study
would be composed of the calculation and interpretation of the following ratios for aforesaid data. •Return on Equity (ROE) •Return on Capital Employed (ROCE) •Financial Leverage •Profit Volume Ratio (P/V Ratio) •Margin of Safety (MOS) •Turnover ratio
The data would be analysed during the course of study on the following lines as an explanation. The financial operations ratio refers to two aspects of treasury management in particular and
financial management in general. The relevant ratios include
(Profit Before Tax/Operating Profit) * 100 This ratio calculation would indicate the extent to which profit is depressed on account of interest.
The judicious use of debt and competitive pricing of funds is key to success.
(Capital Employed/Net worth) * 100 This ratio calculation indicates the mix of finance that is Debt: Equity The calculation of tax management would indicate the role of taxes in depressing profit after tax.
Successful tax planning will help transmission of profit before tax to share holders in increasing
proportion. The treasury management team and the line managers have to coordinate to time
investment decision to suit the cut off points prescribed by income tax authorities to claim
depreciation and other deductions. This measure reflects the relation between financial development and the growth of physical
investment. The trends in all the financial development ratios, thus, reflect the gradualist approach
in the economic re-forms that India embraced.
The broad outline of the study would be organized and presented in a Research Monograph to be
published on April 14, 2014. The objective of this research monograph is to present an analysis of
broad trends in the financing of development in India.
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The story line in corporate finance has remained remarkably consistent over time. Talking about
story lines allows me to set the theme of this Research Monograph. This Research Monograph
would bring out a story, which essentially summarizes the corporate finance view of India INC.
It would classify all decisions made by any business into three broad groups decisions on where to
invest the resources or funds that the business has raised, either internally or externally (the
investment decision), decisions on where and how to raise funds to finance these investments (the
financing decision), and decisions on how much and in what form to return funds back to the
owners (the dividend decision).
This monograph should be read as a prelude to the forthcoming research volume where a
substantial data and substantiation of data would be carried out bringing out the different aspects
and the changes in the trends of finance.
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2-PROLOGUE
Dr. Guruprasad Murthy, Director General , DR VN BRIMS
”Money is the most important thing in the world. It
represents health, strength, honour, generosity and beauty
as conspicuously and undeniably as the want of it
represents illness, weakness, disgrace, meanness and
ugliness.”
George Bernard Shaw (1856-1950)
Every branch of knowledge has its fundamental discovery. In
mechanics it is the wheel, in science fire, in politics the vote.
Similarly, in economics, in the whole commercial side of man’s
social existence, money is the essential invention on which all
the rest is based.
- Sir Geoffrey Crowther(1907-1972)
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This monograph on Trends in Finance (TIF) studies different dimensions of ‗management of
finance‘ in India INC over the years. TIF, in other words, is an exploration of different approaches to
financial management given different data bases, as also the implications of the same. In fact, financial
management is the art and science of managing resources (physical and financial, animate and
inanimate) of an enterprise with the purpose of getting the best possible result-resource ratio to
continuously meet the expectations of all stakeholders of any enterprise. The idea is to ensure that
scarce resources are allocated effectively and efficiently to competing ends and where competing ends
are limited and resources are in surfeit, the challenge is to identify the most productive competing
end/s and also newer productive opportunities, which can absorb the resources in excess (Exhibit 2)1.
Thus, the end result of effective financial management is seen as efforts which can bring success to
any enterprise by making ―two blades of grass grow where only one grew before‖. Translating this
lofy thought of the American philosopher Jonathan Swift into action, into the field of finance, it refers
to the ability to get the best possible output (physical / financial) for any given input or using the least
input (physical / financial) for any given output. Ideally, the rate of output should go on increasing and
the rate of input should be on the decline so that the result - resource ratio catapults to higher and
higher levels of attainment, above and beyond historic levels, into seamless heights through ‗stretch
goals.‘ In financial terms, it means that the ratio of profit (output) / investment (input), commonly
referred to as return on investment (ROI) (%) should be well sustained at all times and, of course,
always placed above the minimum acceptable rate of return*2.
Thus, the ways and means of attaining and maintaining higher and higher ROI, open to management,
are simultaneously many and limited, a contradiction of terms, nevertheless true. The limited options
1 &2*The minimum acceptable rate of return is also referred to as the modicum or target rate of return which is a
fundamental standard of financial performance against which the outcomes of managerial actions are assayed. The minimum acceptable rate of return refers to the marginal cost of capital against which the marginal efficiency of capital of various management actions are to be assayed. Incidentally the minimum acceptable rate of return (R) is always defined as R >ko where ko is the cost of capital. Depending on the state of the health of business and a host of other factors, R may be pitched at or near ko or much above ko. In any case R should never be below ko.
2
Monograph-Trends in Finance Page 18
open can be vividly gauged with the help of the simplest version of the Du Pont ROI chart presented
below:
Exhibit 1
R .O .T. A.
2.1 MAXIMISING SHAREHOLDERS WEALTH
Corporate financial policy, all over the world, accepts maximizing shareholder value as a key
objective. There have been several refinements to this thought and the expression shareholder value is
often replaced by stakeholder value, corporate wealth, market value, economic value added et al.
A study conducted by Pandey and Bhatt (1990) of 57 Indian Companies3showed that maximizing the
market value of enterprise is not necessarily the key objective of Indian business. According to the
study, four important goals are pursued viz. ensuring the availability of funds, maximizing growth,
maximizing operating profits before interest and taxes and maximizing the rate of return on
investment. According to another study conducted by ManojAnand (2002)4, the important corporate
financial objectives, in rank order of importance, are: maximizing EBIT / EPS, maximizing the spreads
between ROI and WACC (EVA), maximizing the spread between CFROI and WACC (CVA),
maximizing market value added (MVA) of the firm and reduction in the side costs in the form of
conflicts amongst various stakeholders.
3 Pandey, I. M., and Ramesh Bhat. “Signifance of Financial Goals pursued by Companies in India: Survey Findings.”
Journal of Financial Management & Research - International Review of Finance July-December (1990). 4 Anand, Manoj. “Corporate Finance Practices in India: A Survey.” Vikalpa 27. 4 October-December. 2002
Return on Total Assets (ROTA) = (Net Profit / Total Assets x 100)
= x (times
)
Sales
Total Assets
x 100 Net Profit
Sales
Monograph-Trends in Finance Page 19
Exhibit 2
Surfeit cash (liquidity), a serious problem faced by enterprise from time to time, provides a
challenge to enterprise to sustain profitability in the wake of excess cash or cash related assets and
given the indisputable dictum of finance viz. ‗liquidity and profitability are at loggerheads‘. For
example, Infosys has been hounded by analyist and investors to deploy its excess cash, year on
year basis, to either invest productively or reward shareholder. For the year ended 31st March,
2011, Infosys had a cash balance of Rs. 129 billion equivalent to USD 3.3 bn (circa). Of course,
this is chicken feed in relation to the huge balances maintained by mega companies in the US. For
example: Apple with USD 75.87 billion cash is richer than the US Treasury which has only USD
73.76 billion. Incidentally, Microsoft another US based ICT company has cash reserve of USD 40
billion (29/07/2011). 40 PSUS in India are sitting on a pile of cash of Rs. 2 lakh, crores. Even
capital intensive units BHEL, Bharat Electornics, Siemens and Alstom Projects have huge cash
reserves. The total cash pile of BSE 500‘s Richie Rich has grown to Rs. 128,500 crores, a 14.3%
increase over last year‘s figure. (ET Bureau, 12/07/2011).
10 Indian companies including RIL, Infosys, Coal India, Cairn India and ONGC are carrying a
cash of Rs. 2.3 Lakh crores. RIL alone carries 33% of the said cash pile, which is nearly 20% of
the company‘s revenue. Infosys with Rs. 20,591 crores is carrying 61% of its annual sales amount.
Cash accumulation adversely affects return on equity and tends to be value dilutive unless a
company can continuously and successfully postulate successor projects which can absorb the
surplus cash productivity that is to say projects where internal rates of returns exceeds the
minimum acceptable rate of return. Otherwise, companies tend to deploy surplus cash into
financial assets, possibly gilt eddged returns, leading to diluted return on equity (%). Thus,
Infosys is earning just 6 to 7 per cent yield on financial assets against the cost of equity capital at
12-14 per cent. Accordingly, Infosys return on equity has gone down rather significantly over the
years due to excessive liquidity. The top 10 firms listed on NASDAQ suffer from a cash pile of $
117.6 billion (over Rs. 6 lakh crores).
SOURCE: Naidu, K. B. and S. Shinde. ―India Inc hold on to its cash.‖ Business Standard
(Mumbai) 7th
May, 2012.
A contrarian view states that India INC, which was sitting on a cash pile, is slowing reducing the
accumulation. High interest rates are forcing companies to shy from lenders, including banks to
meet the working capital needs of enterprise. The short-term financial needs of business are being
met by withdrawing deposits using cash accumulation and reducing borrowing as much as
possible. Further, excess cash is also deployed for debt-repayment and capital expenditure and
also to extinguish borrowings from abroad
Monograph-Trends in Finance Page 20
Exhibit 3
2.2 OPTIONS TO IMPROVE ROI
The options open to improve ROI are increased sales, reduced cost and management of assets
effectively and efficiently. One more option can be
inducted by classifying cost management into two options viz. managing variable costs and fixed costs
respectively.
Within these three (or four) options, management need to identify a myraid ways and means of
exploring the same to manage the top line (sales), middle line (costs) and bottom line (net profit) of an
enterprise.
2.3 IMPROVE ROI - INCREASED SALES
One of the options opened to improve the ROI of any enterprise is increased sales. Sales in financial
terms for any business are a product of number of units sold and the selling price per unit. Usually,
high volume necessarily means sacrifice in the margin. Companies which sell limited number of units
can afford to have improved or high margins. Essential commodities and consumer good items are
characterised by high volume and low margin. As against this, luxury items like Mercedes Car or
SURFEIT CASH - IDENTIFYING INVESTMENT OPPORTUNITIES
Philately is an important avenue which can absorb surplus liquid resources and also provide
competitive return on investment. It is estimated that as an asset class ‗philately‘ is very steady and
usually offers around 10% return on an annualised basis. It is said that about 25 odd high net worth
individuals, in India, are already using philately as an avenue of investments. The minimum
amount required for investing in a rare stamp is over Rs. 50 lakhs. Further, rare stamps can fetch
upto 1 million USD. It is interesting to note that there is a lot of interest in stamps from India. For
example, a ―1854 Four Annas Inverted Head‘ stamp fetched a record price for India. The stamp,
which was estimated to fetch GBP 18,000 - GBP 20,000 was sold for GBP 105,390 at an auction in
October, 2010 in London. ―This will soon hit a million pounds.‖
SOURCE: ―Trend spotting Philately emerges as high-return investment‖. The Times of India 30th
November, 2008: p. 21.
Monograph-Trends in Finance Page 21
Rolex watches would enjoy a higher margin and rather low volume. In addition to volume and selling
price per unit, the mix of sales plays an important role in deciding the aggregate revenue of a business.
Further, there is one more dimension and that is the currency in which the sales take place and the
status of that currency in terms of its strength vis-à-vis the local currency. All these factors taken
together, in addition to cost, result in a profit-volume-cost relationship for a business. Further, mere
increases in revenue do not contribute to the bottom-line of a business though marketing managers,
world over, entertain an illusory belief that more sales mean more profit. Hence, the theme ‗More
Revenue does not mean More Profits‘.
Exhibit 4
2.4 IMPROVE ROI - COST MANAGEMENT
Cost management (including cost cutting) is key to sustaining the bottom line of business.
Telepresence is a new cost cutting tool. In fact, Tata Consultancy Services has gone on
records, in its annual report 2008-09 to say that the costs of overseas travel have been reduced
after introduction of increased video-conferencing. Further, there is green policy effect - the
decrease in the company‘s carbon footprint. Though the economics of telepresence is not very
attractive as of today Tata Communications has pioneered the public room model to tackle the
HUL - MANAGING COST - PROFIT - VOLUME - MIX
―Buoyed by a mix of product price increases and volumes, fast-moving consumer goods (FMCG)
major Hindustan Unilever (HUL) posted an 18% growth in net profit at Rs. 754 crore for the
third quarter ended December, 31, 2011, compared to Rs. 638 crore in the corresponding period
last year, Net sales rose 16% to Rs. 5,853 crore from Rs. 5,027 crore during the period.‖
This is a good example of sales increase (16%) through better management of price increases,
product mix, volumes along with dynamic cost management through ―aggressive savings
programs coupled with judicious pricing‖. Personal products, oral care, beverages and packaged
foods grew in the range of 11 to 14%. However, the performance of Knorr soups was muted.
SOURCE:The Times of India (Mumbai) 7th
February, 2012.
Monograph-Trends in Finance Page 22
exorbitant installation cost. ―Customers can access the public rooms by paying just Rs. 6,000
- Rs. 7,500 per hour as part of a special promotional offer.‖ Thus, an otherwise cost or
expense centre is converted into a profit or investment centre.
Frugality has to be revered and not ridiculed. Frugality can be promoted if we create a culture
where simplicity is respected and not viewed as miserliness. Mahatma Gandhi‘s ventures in
simple living come to the fore, ―Governments must penalise the waste of resources, and
should create laws to ensure this. People will gradually develop habit of consuming only as
much as is necessary.‖
Tata Motors had posted a net loss of Rs. 500 crores in 2001. This was regarded as one of the
largest losses incurred by any company in one year. A remarkable turnaround took place
because of a unique cost management program which was called ‗cost erosion‘. Among other
initiatives the following were the important moves:
cross functional teams to implement and monitor cost erosion initiatives;
e-sourcing in lieu of traditional purchasing;
rationalising vendor profile. Infact the company moved towards a single vendor policy;
revamped organisational structure from a bureaucratic model to a collaborative,
camaraderie, driven mode. The turnaround took 5 years though.
Bollywood actors, big companies, luxury hotels, BPOs, bankers, socialites, husbands, wives
and lovers … all are tightening belts to battle the economic squeeze to combat the global
meltdown. The Times of India has identified 30 ways and means of cutting cost - atleast one
each for every alphabet of the English language that is to say A to Z5.
In October, 2008 following the global meltdown the CEO of Sony, Mr. Howard Stringer, said,
―We are selling a lot of television sets, more than ever, but we are not making money on
them, and that’s a by-product of a fixed-cost problem that we need to address.‖
5 Raaj, Neelam. andInsiya Amir, “A-Z of Cutting Costs.” The Times of India (Mumbai) 15th December, 2008.
Monograph-Trends in Finance Page 23
Exhibit 5
Thus the bottom line of a company depends on a proactive combination of topline (sales) and
middleline (costs). In Sony, again, cutting fixed cost meant shutting some plants and also cutting jobs
to increase profits with a view to bolster profitability. In Japan, in particular fixed costs are an issue.
80% of the sales are outside Japan and a sizeable proportion of production takes place within Japan.
Sony‘s, production costs are vulnerable to an appreciating Japanese Yen with a relatively high local
labour cost. However, sales are in currencies which are usually weaker than the Japanese Yen.
Production activity has to be hived off from Japan if the fixed costs are to be reduced. Thus, Sony had
to initiate a multipronged attack to sustain its ROI, post global meltdown, which included increased
revenue, reduced variable cost, reduced fixed cost and divestment of capital in Japan and reinvesting in
locations outside Japan due to the strength of the Japanese Yen.
COST MANAGEMENT - MAHARASHTRA
In several parts of Maharashtra due to shortage of power and labour, in rural and hilly areas,
construction labour is difficult to procure and workers are demanding higher wages. To combat the
labour shortage the Government of Maharashtra decided (2009) to hire donkeys to perform certain
tasks which include movement of ‗construction material, such as bricks, metal and sand from one
place to another.‘ The price of a donkey depends on its physique, height, colour, age and the
number of teeth. Donkeys from Kathewadi from Gujarat are the most expensive and are priced
between Rs. 10,000 - Rs. 15,000. This price is said to be nearly 50% higher than last year. In
Ahemdnagar district, in Maharashtra, Donkey Bazaars are held to auction Donkeys.
SOURCE:Marpakwar, Prafulla. ―Donkeys kick-start economy.‖ The Times of India (Mumbai) 18th
March, 2009.
Monograph-Trends in Finance Page 24
Exhibit 6
The multiple options open and the several permutations and combinations available to manage sales,
cost and profits are limited only by the genius of the people in an organisation6. However, the
challenges before managers at the helm of the affairs of any enterprise are to ensure that ―money
works for them rather than they working for money‖. Says Edmund Burke, ―If we command our
wealth we will be rich, if the wealth commands us we are poor indeed‖.
In the context of financial management in an enterprise the question arises as to how to make money in
particular and resources in general work for enterprise rather than the other way round. In an exchange
or money economy, all business transactions are reported in terms of money. Money measurement is,
among others, a universal and cardinal principle governing the financial and accounting process which
6 Improvements in ROI can be derived through a wide variety of options open to management given the said four
options. Within these four options there is a mix of several permutations and combinations involving ownership, creditor, income mix, control rights and a host of other factors in varying degrees, with possible permutation and combinations limited only by the ingeniuity of different markets and their stakeholders (factor, financial and output) and of those who manage the finanacial problems of an enterprise (See Solomon, Ezra. Theory of Financial Management. ColoumbiaUniversity Press, p. 28)
IMPACT OF THE SLIDING INR
The rupee has been depreciating continuously and stood at Rs 55.03 (21st May, 2012) to a USD. It
was Rs. 44.42 (5th
April, 2011) to a USD. If the slide of the rupee vis-à-vis the USD continues the
bottomline of India INC will be adversely affected. In fact, the rupee depreciation has adversely
affected corporate profits in recent times, and continues to do so. Though companies which have
large export sales may benefit due to the falling value of the rupee, yet if the import content of the
product or service is high on balance the gains are limited. Overall, India is a net importer which
would adversely affect the corporate sector profitability. If input cost of key items like petroleum
and related products go up the cost push effects will be seen on the bottomline of enterprise. Hence,
managing return on investment of a business cannot exclude identifying the role of exchange rate
variation and strength of the local currency with its associated impact on the financial health of
individual enterprise.
SOURCE: ―Rupee depreciation may impact corporate profits: Economits.‖ Business Standard 10th
May, 2012: p. 4
Monograph-Trends in Finance Page 25
generates several financial statements. Hence the couplet:
“Money is a matter of functions four:A medium, A Measure, A Standard and A
Store.”
Again as Aristotle (384 - 322 B.C.) has said ―Everything, then, must be assessed in money; for this
enables men always to exchange their services, and so makes society possible.‖
To make money work for business one has to understand the quantified statements expressed in money
terms and known as financial statements which usually include the following: (a) profit or loss account
for the period ending; (b) balance sheet as on or as of or as at a particular point of time; (c) cash flow
statement for the year ending; and (d) other supporting, supplementary, statements.
Since the common language of business is finance, most of the metrics are financial based. However, it
needs to be understood that the financial numbers are only a mirror image of the actual, physical,
events taking place in business. Hence, it is the reality of business operations and not the financial
ratios that need to be managed. If business operations are well managed automatically the ratios
expressed in financial terms will reflect the same. Further, though there are large number of ratios,
trying to get all the ratios simultaneously in one place to address issues faced by business is a rather
preposterous proposition. The truth is that the substratum of the knowledge base of finance can be
presented through a relatively small number of important financial measures through which it is
possible to appraise and assess the health of any business enterprise. Such measures are derived from
the inter-relationships that exist between the key areas of management viz. operations, investment and
financing cutting across operating excellence (sales, variable and fixed costs and capital employed)
and financial excellence (interest, tax and debt: equity management). Further, the key stakeholders to
be addressed include, among others, managers, owners and creditors. Thus, in a typical financial
model designed to meet shareholders welfare the relationship between overall (total) management
performance (return on equity) is literally a physically product of operating management performance
and financial management performance. While the former in turn is a physical product of the profit-
Monograph-Trends in Finance Page 26
volume ratio (%) i.e. (contribution margin / sales), margin of safety (%) i.e. (operating profit /
contribution margin) and turnover ratio (times) i.e. (sales/ total assets), the latter is a physical product
of interest management, tax management and management of debt:equity. These ratios help to capture
the functioning of the entire business to guide management in financial decision making in particular
and management decision making in general. The challenge lies not in computation but in
understanding the meaning of the outcomes and how the product of all outcomes, taken together,
present a holistic view of the health of an enterprise leading to synergistic, value creating, returns on
equity or earnings per share (%). The relationship between different ratios is presented below in
Exhibit 7:
Exhibit 7
CORPORATE FINANCIAL PERFORMANCE MODEL
OMP
Return on Capital Employed
FMP
Financial Leverage
x
P/V Ratio (%) = Contribution Margin
Sales x 100
Margin of Safety (%) = Operating Profit
Contribution Margin x 100
Turnover Ratio (Times) = Sales
Capital Employed
Profit before Tax Operating Profit
(%)
Capital Employed Owners Funds
(Times)
Profit after Tax Profit before Tax (%)
TMP = Total Management Performance
OMP = Operating Management Performance
FMP = Financial Management Performance
TMP = Return on Equity (ROE) = Profits after Tax Owners Funds
Monograph-Trends in Finance Page 27
In addition to the above model, and there are many more, TIF indicate the evolution, development and
use of important absolute measures like economic value added, enterprise value, market share (sales
volume and value) production (volume and value), number of employees (wage cost) and the like to
provide a further boost to the quality and also quantity of information generated and level of
knowledge regarding the health of any enterprise.
2.5 FINANCIAL EPISODES, EVENTS AND EXPERIENCES
TIF can also be explored by tracking and tracing financial episodes, events and experiences.
2.6 IRRATIONAL EXUBERANCE
The emergence of financial models such as the capital asset pricing model and the efficient market
hypothesis, alongwith many other financial models, have glorified the role of science as an input in the
management of finance at the macro and micro levels. Special courses like quantitative methods in
financial management, decision science, financial modelling and econometrics are the order of the day
in Universities and Business Schools all over the world. These scientific theories, usually based on
quantitative techniques, caged in quantitative models, attempt to explain the behaviour of market
forces in an objective and rational manner trying to keep emotions aside and also attempting to ignore
subjective elements like market sentiments and emotions of players, including ‗irrational
exuberance‘, in the stock and other markets.
Exhibit 8
IRRATIONAL EXUBERANCE
Irrational Exuberance describes a heightened state of speculative fervor. It is less intense than
the term ‗speculative mania‘ or ‗speculative orgy‘. Irrational exuberance thus means an
abundance or lavish availability of energy and enthusiasm for irrational behaviour. Eg: Herd
mentality during scams (Harshad Mehta scame 1992 and Ketan Parekh scam 2001), great
crashes including the sub-prime crisis in the US leading to the Sep, 2008 global crisis which
Allan Greenspan described as ‗once-in-a-century crisis‘.
Monograph-Trends in Finance Page 28
Several instances of irrational exuberance can be cited - thanks to the greed, perversion and ingenuity
of mankind and of course the erratic and volatile behaviour of markets:
2.7 PRICING AT LOUIS VUITTON7
Pricing dynamics operates in different directions. Products which are positioned as luxury items and
remain unsold are actually burnt. As Albert Bensoussan of Louis Vuitton, says ―Our prices remain
constant as we want our customers to feel they’ve paid the right price for the product. To put the
same product on sale would be shortchanging them6.”
2.8 PRICING OF ONIONS IN MAHARASHTRA
The volatility in onion prices shows the role of demand-supply factors in affecting the price level. On
18th
November, 2011, the average onion prices in Lasalgaon (village in Nashik, Maharashtra) was Rs.
900 per quintal and the average onion price was Rs. 2 per kilogram in markets of Nashik. In fact, in
October, 2011, the onion prices crashed below production cost and farmers were not able to recover
their cost of production. Suddenly, in January, 2011, the quantities which arrived in Lasalgaon,
regarded as Asia‘s largest market, fell from 50,000 quintals to 2,000 quintals. The prices soared from
Rs. 1700 per quintal in the first week to Rs. 6,229 per quintal by third week of December, 2011. It is
not untrue to say that from time to time when supply exceeds demand a reverse trend is seen and
farmers have to restrict the acreage under cultivation or literally destroy production to sustain farm
prices. Even in recent times the price of onions was ruling at Rs. 80/kg. and over a period of a 2-3
months slide down to less than Rs. 10/kg.
2.9 FARM PRODUCTS IN EUROPE AND OTHER COUNTRIES
Similarly, excess productions of farm products in Europe are purchased by the European Union to
ensure that farm prices do not crash further to the detriment of the farmer. The quantities involved are
rather huge - 30,000 tonnes of unsold butter, 100 thousand tonnes of skimmed milk powder and other
related farm products. In fact in the eighties the European Union had bought 1.23 million tonnes of
unwanted butter. On several occasions these perishable products are eventually dumped into the sea /
or just destroyed to support farm prices. The same is true of excess production (availability) of any
7 6SOURCE: Gupta, Aparna. “We burn our sold products !” Times News Network
Monograph-Trends in Finance Page 29
item viz. sugar in Cuba, coffee in Brazil, other farm products in different countries of the World from
time to time. Thus, excess of anything is an unmitigated nuisance. Overproduction lower global
demand and falling pries have caused glut in certain ‗farm oasis.‘ As mentioned in a World socialist
website, there is no solution to the farm crisis, however, within the framework of the capitalist market.
―A fundamental contradiction under the profit system is the accumulation of vast surpluses of
agriculture commodities which cannot be sold at a profit, side by side with, on a World scale,
enormous unmet social needs for food, clothing, and raw materials. Children starve in Africa and
India while American farmers go bankrupt for lack of buyers. This contradiction can only be
resolved when agriculture is integrated into a reorganized world economic system in which rational
planning, not private profit, is the driving force8.”
2.10 PRICING OF MONEY IN SWITZERLAND
What happens to products in physical form as mentioned above, happens to money in Switzerland and
in few other countries. Interest rates represent the price of money (loanable funds). Money from all
parts of the World flows into Switzerland. The bankers are not in a position to absorb the inflow and
deploy them into productive use. Hence, the Swiss Government from time to time identifies negative
interest rate policy as an effective strategy to tide over the crises. According to Bloomberg site, dated
1st December, 2011 the Swiss Government was thinking of capital control and negative interest rates as
possible tools for deployment. In recent times, the sovereign debt crises in Europe and the US debt
burden have prompted investors to move to safe assets such as the Swiss - Franc, the Japanese Yen and
gold. This is not the first time negative interest rates are surfacing as part of an instrument of monetary
policy. In the 70‘s the Swiss bank imposed negative interest rates on foreign accounts to deter inflows
and in 2008 short-term Swiss market rates turned negative for a brief time. The same scenario
prevailed in Japan in the late 90s. According to the Wall Street Journal February, 2, 2012 investors are
looking for havens where they can park their assets safely and are willing to pay a price for the same.
Negative yields on short term government debt have happened regularly because investors do not see
alternate, safe assets. In January, 2012 Germany sold Euro 3.9 bn of 5 months bill with a negative
8 SOURCE: World Socialist Website 1998-2012.
Monograph-Trends in Finance Page 30
yield of .0122%.
2.11 IRRATIONAL EXUBERANCE AGAIN – THE STOCK MARKETS - KGN
INDUSTRIES:
On Tuesday, 20th
May, 2008 a circular announced the re-listing of KGN industries and the exchange
circular had initiated a caveat ‗cautioning trading members not to enter orders at unrealistic prices‘.
KGN industries are engaged in the business of trading in agro commodities like castor seeds, edible
oils like soyabean oil, palm oil, non edible oils like petroleum products, lubricants, used oil.
On Wednesday, 21st May, 2008, morning, when the markets opened the KGN scrip sky rocketed from
Rs. 72 to Rs. 55,000 (a 76,288% increase) breaking the previous record of MMTC which was the most
expensive scrip on the bourses at Rs. 27,050. To plug further aberrations the authorities suspended the
trading in the scrip at 12.20 pm as a ―pro-active surveillance measure‖. KGN industries were known
as Royal Finance, till it was delisted in February, 2001 when the last traded price was Rs. 11. However,
on Wednesday, 21st May, 2008 morning, Memon, a businessman who is the main promoter of KGN
industries was worth around Rs. 12 Crores. When the stock prices rose to Rs. 66,000 he was worth Rs.
5,600 Crores (that is to say a mind boggling 46,566% increase in the stock of wealth).
2.12 HERD MENTALITY IN THE STOCK MARKET - HARSHAD MEHTA
Harshad Mehta who came to be known as a big bull was the prime mover of the ACC share which rose
from Rs. 200 to Rs. 9,000 (approx.) on the Bombay Stock Exchange - a 4,400% rise in price (early
1992). The ACC share was expected to reach Rs. 10,000. Mr. Mehta used the replacement cost theory,
as a ploy, to explain the reason for the high level bidding. His contention was that older companies
should be valued on the basis of the opportunity cost principle that is to say the amount of money that
would be needed to establish a similar company. Of course, Mehta‘s illicit methods of manipulating
the stock market were exposed on 23rd
April, 1992 by Ms. SuchetaDalal.
2.13 DEVAS MULTI MEDIA SHARE
Devas Multimedia Share of Rs. 10 rose to Rs. 1 Lakh in 2008 (an absurd but true increase of
9,99,900% increase): It is said that a controversial lucrative contract with ISRO led to such a
Monograph-Trends in Finance Page 31
staggering valuation. The said contract came under the scanner for review and was cancelled.
However, because of the controversial contract Devas was able to get Rs. 1.14 lakh premium on its
share worth Rs. 10 when it divested stake to Deutsche Telekom in 2008.
2.14 OTHER ACADEMIC ADVANCEMENTS IN FINANCE
There are other academic advancements in the field of finance which is supposed to have greatly
improved decision making processes by bringing objectivity and neutrality to decision making.
However, there is at least one flaw in the diamond. Track records of investors have shown that the
efficient market hypothesis does not always work and once men, supposedly rational animals, become
bulls or bears, irrationality hold the fort and subjectivity and irrational exuberance alongwith herd
mentality, rule the waves. For example: the stock market crashes such as the tragic 1929, (black
Thursday) crash, that triggered the great depression (1930), the October, 1987 crash (black Monday)
which saw the Dow Jones industrial average fall by more than 22% and the Harshad Mehta Scam
(1992) when P/E ratios catapulted to astronomical levels, all defy reason. Even today, P/E ratios of
shares of Indian companies are said to be higher than their counterparts in other continents. According
to a Business Standard study, the average price-to-earnings (P/E) ratio of the 30-scrip Bomaby Stock
Exchange benchmark is currently just above the historical average of 15. However, this is on the
higher side as compared to key world indices. Currently, (March, 2012) the Sensex P/E is 14.81
against the current 15.62., ―The European and US markets are comparatively cheap, trading at a P/E
of 12-13 times earnings for calendar year 2011 and eight to 13 times for CY 11.‖9
9 8 “Sensex remains expensive against world market.” Business Standard 9th March, 2012 .
Monograph-Trends in Finance Page 32
Exhibit 9
Again, the recent September, 2008 crash of stock markets due to the failure of big
financial institutions in the US and other parts of the World led to the closure of the
stock markets World over. All these aforesaid episodes, events and experiences
remind mankind again and again of irrational exuberance. In the words of John
Maynard Keynes, who had said many years ago, “the heart knows reasons that
reason cannot know”10.
10 Dillard, Dudley. The Economics of John Maynard Keynes: The Theory of a Monetary Economy. Kessinger
Publishing, 1st March, 2005:p. 152
John Maynard Keynes had further said in his general theory of employment, “Speculators may do no harm as
bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on
a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities
GLOBAL MELTDOWN - 15TH
SEPTEMBER, 2008
15th September was one of the worst days in the financial history of the World when
the U.S. stock markets plunge was the worst since 2001.
Dow Jones closed below 11,000 for the first time.
Markets in Europe, Asia and Russiacollapsed or were on the brink of a total
breakdown.
The Mumbai Sensex was down from a high of 20,301 on 1st January, 2008 to 13, 531
on 15th September 2008. The lowest was 7697 on 27th October, 2008.
The Financial Tsunami struck the World rather badly and the major investment banks
viz. Lehman Brothers, Merrill Lynch, Bear Sterns and Fannie Mae and Freddie Mac
vanished.Lehman Brothers, a 158-year-old bank filed for federal bankruptcy protection
lost 94% of its market value by 15th September 2008 after record losses from investments
tide to mortgages. Bank of America snapped Merrill Lynch for 50 billion USD in an all
stock transaction.
IMMEDIATE IMPACT: Global stock market capitalization had declined by 41% during2008, from USD 55.2
trillion to USD 32.6 trillion.
The international labour organization (ILO) has predicted loss of 50 million jobs on
worldwide basis.
“The social object of skilled investment should be to defeat the dark forces of time and
ignorance which envelope our future” - John Maynard Keynes (1883-1946).
Monograph-Trends in Finance Page 33
2.15 FINANCE AS AN ART
To the extent that sentiments, emotions, intangibles and imponderables are brought into the decision
making process, finance can be viewed as an art. When the proportion of domination of irrationality
changes and irrational exuberance prevails, no formulae, however sound, can really help. Hence, the
emergence of a new discipline called behavioural finance, to stem, if not totally avoid, the hazards of
‗irrational exuberance‘.
Exhibit 10
2.16 WARREN BUFFET
Even within this debate on whether finance is an art or a science there is at least one person in the
World who has developed the right balance between skills sets to manage finance both in a scientific
manner and also the artistic way. Warren Buffet has been able to consistently outperform stock markets
for long periods of time and is identified as one of the richest American whose wealth owes it origin
primarily to long term equity investments. Of course, the fact that only a few investors can beat the
market does not offer much credibility to the efficient market hypothesis. Nevertheless, managing the
finances on the stock market and being a successful equity investor requires an understanding of the
science behind the farrago of numbers and the art behind cherry picking in the stock market from an
of a casino, the job is likely to be ill-done.” - The General Theory of Employment, Interest and Money, Atlantic
Publishers &Dist, 1st Jan., 2006:p. 142
BEHAVIOURAL FINANCE
A field of finance which uses psychology based theories to explain irrationality in the stock market.
It is assumed that the information structure and the characteristics of players in the market
systematically influence individual investment decision making as well as market outcomes.
Behavioural finance is a missing link between the assumption of the rational economic man in
economics (efficient market hypothesis included) and the actual behaviour of man which is based
inter-alia on irrationality too. The perfect rational investor / or consumer is an el Dorado par
excellence.
Behavioural finance is an attempt to fill the gap.
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assortment of alternative equity or other financial instruments. A wise investor has to be confident as a
rational contrarian rather than part of irrational herd behaviour. Of course, much has been written on
Warren Buffet‘s mode of operation viz. how does he do it? And what is Warren Buffet‘s investing
style? The debate as to whether the field of finance is an art or a science will continue. Management of
Finance is an admixture or hybrid of both, the proportionality of art vis-à-vis science or vice-versa,
being a question of judgement and also constrained and conditioned by style - eventually style is the
man. Whether it‘s a financial analysts or a line manager posit in the role of a decision maker using the
outcome of financial analysis or an investor wanting to maximise wealth in the markets (real estate,
stock, commodity, metals et al.) - wherever one goes or whatever one does, the art and science of
financial management or the science and art of financial management should be a part of the
knowledge base of any individual. Thus, managing money or finance is not applicable with respect to
India INC only. Even if money making is an art one can be an efficient and effective money maker
provided they are well aware of the subject matter of analysis and interpretation of financial
statements. However, so long as human beings are at the helm of affairs of business, the human
element shall continue to be a part and parcel of decision making.
2.17 WALL STREET CRASH (1929) AND GLOBAL MELTDOWN (2008)
In October 1929, Irving Fisher famously proclaimed that stock prices had reached ―a permanently
high plateau‖. Just days later, Wall Street crashed. Further, in November, a well-known Professor from
Yale University issued a fresh prognosis - ―the end of the decline of the stock market will probably
not be long, only a few days more at most‖. Well, the Dow raced to hit its lowest of the century on
July 8, 1932 not returning to the pre-1929 levels until two and a half decades.
There was a report by the IMF on Global Financial Stability in April, 2006 which read as follows:
―There is growing recognition that the dispersion of credit risk by banks to a broader and more
diverse group of investors ... has helped make the banking and overall financial system more
resilient…. The improved resilience may be seen in fewer bank failures and more consistent credit
provision. Consequently, the commercial banks may be less vulnerable today to credit or economic
shocks.‖ It is by now well-known that just two years later the global meltdown sent shockwaves across
the globe, with the chain reaction, following the collapse of the Lehman brothers (September, 2008).
Monograph-Trends in Finance Page 35
The whole concept of dispersion of credit risk had not made the financial system more resilient. On the
contrary, it has made it more vulnerable to the vagaries and vicissitudes of business. There was a
general mood of depression and uncertainty was the order of the day. In a book by Robert Skidelsky,
he says, ―intellectual failure of the economics profession‖11
is the main cause of the crises. This is
where Keynesian thought makes all the difference. He distinguished between risk and uncertainty.
Risk12
is something which can be captured, in a quantified manner, by assigning probabilities through
cardinal or ordinal values. If managing business was only about risk management, quantitaive
measures alone could help. The cardinal and ordinal values could be addressed. However, life in
general and business too, has to encounter uncertainty which is known as ―unknown probability‖ or
―irreducible uncertainty‖. This uncertainty is intrinsic to capitalism. To that extent mankind is
fatalistic and ―none of us has a precise inkling of what the future has in store.‖ Thus the main flaw in
the new classic economics is the failure to capture uncertainty in financial modelling which is in
vogue. The efficient market hypotheses looks only at risk and all the risks are assumed to eventually
reflect a normal bell curve. The risk is then assumed to be distributed smoothly within the precincts of
the bell curve. However, this is preposterous.
Outcomes of events cannot be captured through a science (statistics) which assumes that most
distributions, if not all, viz. binomial, poisson, chi-square f, t and perhaps many other distributions all
tend towards the normal distribution13
. As mentioned by Harish Damodaran, ―All the modern bank
11 Skidelsky. Robert, Keynes - The Return of the Master, Allen Lane, September, 2009. 12 While tradition approaches distinguish between risk and uncertainty in statistical lingo and modern
management try to understand volatility, uncertainty, complexity and ambiguity in its combined format as VUCA yet the hard fact is risk entails the chance of ‘loss of capital’, willingness and ability to bear loss of capital is risk.
13 Approximately normal distributions occur in many situations, as explained by the central limit theorem. When
the outcome is produced by a large number of small effects acting additively and independently, its distribution will be close to normal. The normal approximation will not be valid if the effects act multiplicatively (instead of additively), or if there is a single external influence which has a considerably larger magnitude than the rest of the effects.
I can only recognize the occurrence of the normal curve — the Laplacian curve of errors — as a very abnormal phenomenon. It is roughly approximated to in certain distributions; for this reason, and on account for its beautiful simplicity, we may, perhaps, use it as a first approximation, particularly in theoretical investigations. — Pearson (1901) Measurement errors in physical experiments are often modeled by a normal distribution. This use of a normal distribution does not imply that one is assuming the measurement errors are normally distributed,
Monograph-Trends in Finance Page 36
risk management models (including the disastrous Black-Scholes option pricing formula) based
themselves on “normal distribution‖,ignoring the possibility of extreme events. Small wonder, they
failed and landed us in the mess we are in, from which we are, hopefully, now emerging.‖ Hence, it
is necessary to remember that management of finance is not mere formulae driven. Such a learning
would make information evaluators and decision makers cogs in a wheel and compel ‗opertaion
robots‘. Human assets are rendered defunct pro tanto. Thus, it is necessary to note that formulae are
only a mariners compass providing direction. Tools and Techniques which facilitate analysis and
interpretation of financial statements are necessary but not sufficient. At best these tools and
techniques are like a star which helps to steer the ship of enterprise.
―And all I ask is a tall ship, And a star to steer her by‖ - John Masefield
However the challenges of decision making have to be assumed by human beings. As well said by
Dr. K. S. Basu,
―By its very definition decision-making starts where formulae end and where judgement has to be
exercised, the imponderable has to be evaluated the intangible has to be assessed.‖
Trends in Finance is an attempt to study the following:
relationship between different items in terms of the proportions they bear to the totals
(income) in the case of profit and loss account and total assets / liabilities in the case of
balance sheet
indexation of key items in the principal financial statements viz. profit and loss account and
balance sheet
graphical presentation for visual exhibition of the trends in key parameters
rather using the normal distribution produces the most conservative predictions possible given only knowledge about the mean and variance of the errors.
Monograph-Trends in Finance Page 37
thinking of the academic world, as presented in 29 papers and3 theses, across the seven
continents on different aspects of financial management viz. leverage, capital structure,
capital budgeting, cost of capital, dividend policy and corporate financial decisions.
Again trends in finance attempts to capture relationship between different factors indicated in
Exhibit 7. The end results, namely ROE on a book profit and cash basis, which are known in
statistical parlance as ‗dependent variables‘ are studied for their dependency on the different
factors indicated in Exhibit 7. A knowledge of the relationships between these different
factorshelps to guide management in formulating various strategies and concerned policies
which can provide answers to the following questions:
Given a target ROE (dependent variable) what is the extent of control enterprise have on the
factors (independent variables) combining to contribute to the target after knowing the
sensitivity of the independent variables and their prowess to respond positively to
management‘s target accomplishment.
In the alternative given the sensitivity of the factors (independent variables) contributing to
the target how should management practice target setting exercise.
There are sections in this study:
SI – analysisusing RBI database (1956 to 1996) – financials of medium and large public limited
companies
II – analysis using CMIE database (1993 to 2013)– financials of 5 sectors viz. manufacturing,
mining, electricity, construction and real estate and non-financial.
III – a review of research papers in the area of corporate finance published in peer reviewed,
globally recognised, Journals in the area of finance and accounting spanning the globe.
A separate study has been conducted in this behalf in the US regarding the focus of researches and
top research Journals in the US in the area of Finance as shown below in Table. It can be observed
from the table that researchers and research journals are focusing attention in the main on asset
pricing theories, capital market efficiency, term structure of interest rates and inflation option theory
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in that order.These journals have focussed their attention to 16 topics excluding a category called
‗other‘ as shown in Table below:
Table 2.1 Focus Areas for Research in Finance- Researchers and Journal
FOCUS AREAS FOR RESEARCH IN FINANCE- RESEARCHERS AND JOURNAL
An Overview
All Nos. Are in Percentage (%) Focus of Researchers on Research
Areas
Focus of Important
Journals on Different Research
Areas Research Areas
Asset Pricing Theories 8.07 7.6
Capital Markets Efficiency 7.82 7.5
Capital Structure and The Cost of Capital 4.72 4.3
Option Theory 6.11 6.0
Finance and Economic Theory 5.13 5.3
Term Structure of Interest Rates and Inflation 6.78 6.8
Related Topics in Information Economics 5.27 4.5
International Finance 5.36 5.8
Mergers, Bankruptcy and Re-organisation 3.48 3.5
Dividend Policy 2.85 2.7
Portfolio Selection and Performance 3.84 4.0
Research and Education in Finance 2.1 2.6
Futures Markets 2.69 2.6
Taxation and Regulations 4.04 3.8
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Preference Models and Preference Under Uncertainty 6.8 7.0
Agency Theory 2.03 1.8
Others 22.91 24.3
Total 100 100
N.B.: The above findings are based on a research on 1840 research papers published
in leading research journals in the US viz. Journal Of Finance, Journal Of Financial
and Quantitative Analysis, Journal of Business Finance and Accounting, Financial
Analysts Journal over the ten years period (1980-89) on 16 research areas excluding a
category called 'others'.
It will be interesting for future researches to conduct a study of the above nature with respect to
India and assess the position w.r.t. the focus of researchers and peer reviewed research journals in
the area of finance and accounting.
However a word of caution is in order, using the historic experience of the 1929 October stock
market crash in the US, the global meltdown of 2008 so fresh in the memories of the whole world.
Hence it is not caution but abundant caution which must guide management of finance in all walks
of life in the broader interest of the society at large without disturbing entrepreneurial boldness,
imagination and initiative.
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SECTION – I
3-RESERVE BANK OF INDIA (RBI) DATA ANALYSIS- MEDIUM AND
LARGE PUBLIC LIMITED COMPANIES IN INDIA FROM 1950-51 TO
1996-97
Mr. Pushkar Parulekar, Assistant Professor, DR VN BRIMS
3.1 AN – OVERVIEW
This section has explored has explored through the Reserve Bank of India(RBI) database from
1950-51 to 1997-98 a study of the following aspects governing financial management of large and
medium sized public limited companies of India INC. Thus, the study addresses the following
aspects of financial management:
1. The profit and loss account and balance sheet of India INC in an alternate format viz.
common size statement indicating the proportions which various items bear to the total
assets, liabilities and total income of the respective years concerned financial statement.
Total Income has been equated to 100 and the other relevant important factors are expressed
This section analyses , Reserve Bank of India (RBI) data-
Medium and Large Public Limited Companies in India from
1950-51 to 1996-97 through following methods :
Common size Financial Statement (Profit and Loss
Account , Balance Sheet)
Indexation of the Financial Statements
Graphical Analysis
Regression Analysis
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as a number relative to Total income. Similarly Total Assets and Liabilities are equated to
100 and other major components of Assets and Liability side are expressed as a percentage
to total. The above analysis are being done starting year 1950-51 at a frequency of every ten
years till 1990-91. Last time frame is of 6 years.(i.e. from 1990-91 to 1996-97).
2. The indexation of the financial statements viz. the profit and loss account and balance sheet
of India INC by assuming 1950-51 year as the base year equal to 100. Thus, over the period
interval of 10 years the growth in the individual items of assets / liabilities as well income /
expenses can be easily identified. Last time frame is of 6 years.(i.e. from 1990-91 to 1996-
97). Thus, over the time period of 10 years the extent of growth in the individual items of
assets / liabilities as well income / expenses can be easily identified.
3. The financial statements have also been presented using the fixed variable cost classification
after careful consideration of the behavior of individual item of expense to enable the
computation of important profit planning indicators like PV ratio, Margin of Safety (MOS),
and other related indicators.
4. The result resource ratio (Return on Investment i.e. ROI) from various angles viz. Return on
Equity (ROE), Return on Capital Employed(ROCE) and its components mainly the profit
margin ratio as well as the asset turnover ratio have also been computed to facilitate
observation of the trend of the said ratios.
5. With a view to generate authentic and reliable information from the database so as to add to
our knowledge on the behavior as well as interplay of various financial parameters like
ROE, Net Profit Margin(NPM), Asset Turnover Ratio(ATR), Debt to Equity (Capital
Employed to Net worth i.e. CE to NW), PV ratio, MOS, Profit before Tax (PBT) / Earnings
Before Interest and Tax (EBIT) and Tax leverage a rigorous statistical analysis was
performed using the Multiple Regression analysis along with the testing for authenticity
through confidence level measurement technique viz. F-test and R2. The above analysis
have helped to identify answers to the following questions:
Given ROE on the left hand side of an equation and other parameters like NPM,
ATR and CE to NW on the right hand ratio through the following equation ROE
(Y) = -0.19 (α)+ 2.59*Net Profit Margin (NPM)(X1) +0.08* Asset turnover ratio
(ATR) (X2) +0.04*Capital Employed to Net worth (CE to NW) (X3) the extent of
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the sensitivity of ROE, the dependent variable (Y), has been ascertained and
quantified.
There are 10 equations in all which include six equations relating to ROE and four
equations on ROCE on the left hand side on a book / cash profit basis.
On right hand side on independent variables such as NPM, Cash Profit Margin
(CPM), Operating Profit Margin (OPM), Cash Operating Profit Margin (Cash
OPM), ATR, CE to NW, PV Ratio, MOS, Cash MOS, PBT/EBIT, PBT/Cash EBIT,
Tax Leverage have been considered.
The summary of the outcomes of the multiple regression analysis has been finally
presented in a multiplier matrix to provide an overview of the dependency of the left
hand side parameter viz. Return on Equity (ROE) or Return on Capital Employed
(ROCE) either on book profit or cash profit basis and the aforesaid right hand side
parameters.
6. A graphical analysis of the database have also been done to present a visual overview of
certain trends of key parameters Breakeven Point (BEP) Analysis, Profit After Tax
Distribution to Shareholders, Marginal Tax Rate, Gross Profit Margin, Net Profit Margin,
Interest Cost, Long term Debt to Equity Ratio, Salary Cost as a percentage of Total Cost,
Constituents of Current Assets as percentage of Total Assets.
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Table 3.1 Common Size Financial Statement Analysis
Number of companies 750 1333 1650 1651 2131 1930
ASSETSGross fixed assets 62 71 73 68 67 65
Land 5 3 2 1 2 2 Buildings 14 14 12 9 9 6
Plant and machinery 37 49 53 49 48 45 Capital work-in-progress 0 0 2 4 5 8 Furniture, fixtures and office equipments 0 0 0 2 1 1
Others 6 6 5 2 2 2 Depreciation 28 29 33 30 26 18
Net fixed assets 34 43 41 37 41 47Inventories 32 31 32 33 24 15
Loans and advances and other debtor balances 14 16 20 23 25 26
Investments 9 5 3 2 5 8Advance of income-tax 3 0 0 0 0 0 Intangible assets 1 0 1 1 1 1Cash and bank balances 7 5 4 4 3 3
TOTAL 100 100 100 100 100 100
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Number of companies 750 1333 1650 1651 2131 1930
CAPITAL AND LIABILITIES
Share Capital Paid-up capital 38 28 22 13 8 7
of which Preference 8 5 2 1 0 0
Reserves and surplus 19 20 16 17 21 34
Provisions 7 7 4 5 2 2
Borrowings 19 29 38 36 43 39Trade dues and other current liabilities 16 16 19 29 26 19
Miscellaneous non-current liabilities 1 0 0 0 0 0
TOTAL 100 100 100 100 100 100
1996-971990-911960-61ITEM 1950-51 1970-71 1980-81
Table 3.2 Common Size P& L account
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Number of companies 750 1333 1650 1651 2131 1930
INCOME
Sales 85.52 94.92 96.05 95.68 94.34 95.73 Increase (+) or decrease(-) in 0.00 0.00 0.00 0.00 0.00 0.00 value of stock of finished goods 0.00 0.00 0.00 0.00 0.00 0.00 and work-in-progress 0.00 3.83 2.01 1.91 1.85 0.59Other income 1.86 1.24 1.74 2.01 3.29 3.19Non-operating surplus(+)/ deficit(-) 0.00 0.00 0.21 0.40 0.52 0.49Closing stock 12.62 0.00 0.00 0.00 0.00 0.00
Total 100.00 100.00 100.00 100.00 100.00 100.00
Profit at various levelsGross profits 8.18 10.12 10.22 9.42 10.61 12.10 Interest 0.60 1.47 3.02 3.68 5.47 5.72Operating profits 7.58 8.64 7.20 5.74 5.14 6.37Non-operating surplus(+)/deficit(-) 0.00 0.00 0.21 0.40 0.52 0.49Profits before tax 6.55 8.64 7.40 6.14 5.66 6.86Tax provision 2.59 3.33 3.09 2.69 1.83 1.91Profits after tax 3.96 5.31 4.31 3.45 3.82 4.95 (a) Dividends 2.44 2.87 1.85 1.25 1.41 1.76 (a) Dividends Preference 0.00 0.32 0.16 0.07 0.01 0.03 (b) Profits retained 1.52 2.12 2.30 2.13 2.40 3.17
ITEM 1950-51 1996-971990-911980-811970-711960-61
3.2 TRENDS OBSERVED THROUGH COMMON SIZE BALANCE SHEET & P& L
ACCOUNT
Paid up capital has gone down indicating lack of fresh issue of equity when compared with
overall growth in the balance sheet.
Use of Debt as a source of finance has gone up.
Resererves and Surplus have increased their weightage in balance sheet.
Gross Fixed Assets have increased their weightage in balance sheet.
Depriciation weightage has reduced in balance sheet.
Current Asset weightage has reduced substanstially in balance sheet.
3.3 DEFINITION OF 'COMPOUND ANNUAL GROWTH RATE - CAGR‟ (CONCEPT
USED IN INDEXING)
The year-over-year growth rate of an investment over a specified period of time.
The compound annual growth rate is calculated by taking the nth
root of the total percentage growth
rate, where n is the number of years in the period being considered.
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This can be written as follows:
(Source: www.investopedia.com)
CAGR isn't the actual return in reality. It's an imaginary number that describes the rate at
which an investment would have grown if it grew at a steady rate. You can think of CAGR as
a way to smooth out the returns. (Source: www.investopedia.com)
For example, Gross Fixed Assets (GFA) worth Rs.62 Cr in the year ending March 1951 have
grown to Rs.205 Cr in March 1961 by growing 229%.Similarly, The growth between 1961 to
1971 was 181%. The growth between 1971 to 1981 was 168%. The growth between 1981 to
1991 was 401%. The growth between 1991 to 1997 was 202%.
In this scenario, CAGR would be the ratio of ending value of GFA to beginning value GFA
(Rs.23303 Cr/ Rs.62 = 375) raised to the power of 1/46 (since 1/ No. of years = 1/46), then
subtracting 1 from the resulting number:
375 raised to 1/46 power = 1.138. (This could be written as 375^ (1/46)).
1.138 - 1 = 0.138
Another way of writing 0.138 is 13.8%.
Thus, CAGR for GFA over the period of 46 years was equal to 13.98%, representing the
smoothed annualized gain in GFA.
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Table 3.3 Indexing Financial Statement- Balance Sheet
Number of companies 750 1333 1650 1651 2131 1930CAPITAL AND LIABILITIESShare Capital Paid-up capital 38 81 174 306 926 2386 9.4%Ordinary 30 68 155 284 907 2296
Preference 8 13 19 22 19 90
Reserves and surplus 19 56 128 395 2374 12067 15.1%
Provisions 7 20 30 108 208 626 10.4%Borrowings 19 82 298 815 4967 13869 15.3%Trade dues and other current liabilities 16 47 152 655 3028 6902 14.0% Sundry creditors 0 0 111 441 1755 4419 Others 0 0 41 189 507 660 Miscellaneous 0 0 0 0 0 0 non-current liabilities 1 1 1 1 4 0 TOTAL 100 287 784 2280 11507 35852 13.6%
CAGR over 46
years1996-971990-911960-61ITEM 1950-51 1970-71 1980-81
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Number of companies 750 1333 1650 1651 2131 1930
ASSETSGross fixed assets 62 205 576 1541 7726 23303 13.8%
Land 5 8 13 30 247 605 Buildings 14 40 94 199 995 2277 Plant and machinery 37 140 411 1128 5512 16196 Capital work-in-progress 0 0 14 90 588 3007 Furniture, fixtures and office equipments 0 0 0 39 171 433 Others 6 17 43 55 212 785Depreciation 28 82 256 689 2974 6538 12.6%
Net fixed assets 34 123 319 852 4753 16765 14.4%Inventories 32 89 250 762 2792 5368 11.8%Loans and advances and other debtor balances 14 45 156 515 2917 9206 15.1%Investments 9 14 20 40 589 2951Advance of income-tax 3 0 0 0 0 11Other assets 1 3 8 23 70 471Cash and bank balances 7 13 31 89 386 1082 11.7% TOTAL 100 287 784 2280 11507 35852 13.6%
CAGR over
46 years
1980-81 1996-971990-911960-61ITEM 1950-51 1970-71
Table 3.4 Profit and Loss Account
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Number of companies 750 1333 1650 1651 2131 1930
INCOME
Sales 85.5 246.1 711.5 2527.2 10020.3 24123.8 13.0%CAGR 11.1% 11.2% 13.5% 14.8% 15.8% Increase (+) or decrease(-) in 0.0 0.0 0.0 0.0 0.0 0.0 value of stock of finished goods 0.0 0.0 0.0 0.0 0.0 0.0 and work-in-progress 0.0 9.9 14.9 50.4 196.3 149.7Other income 1.9 3.2 12.9 53.1 349.4 804.4 14.1%Non-operating surplus(+)/ deficit(-) 0.0 0.0 1.5 10.6 55.5 122.5Closing stock 12.6 0.0 0.0 0.0 0.0 0.0
0.0 0.0 0.0 0.0 0.0 0.0 Total 100.0 259.2 740.8 2641.3 10621.4 25200.3 12.8%CAGR 10.0% 11.1% 13.6% 14.9% 15.5%Total Cost 91.8 233.0 665.0 2392.6 9494.6 22151.4 12.7%CAGR 9.8% 11.1% 13.7% 14.8% 15.2%Profit at various levelsGross profits 8.2 26.2 75.7 248.7 1126.8 3048.9 13.7% Interest 0.6 3.8 22.4 97.1 581.1 1442.6 18.4%Operating profits 7.6 22.4 53.3 151.6 545.7 1606.4 12.3%Non-operating surplus(+)/deficit(-) 0.0 0.0 1.5 10.6 55.5 122.5Profits before tax 6.6 22.4 54.8 162.2 601.1 1728.8 12.9%Tax provision 2.6 8.6 22.9 71.1 194.9 480.6 12.0%Profits after tax 4.0 13.8 31.9 91.1 406.3 1248.4 13.3% (a) Dividends 2.4 7.4 13.7 33.0 150.0 443.1 12.0% (a) Dividends Preference 0.0 0.8 1.2 1.7 1.3 6.8 (b) Profits retained 1.5 5.5 17.0 56.3 255.0 798.4 14.6%
CAGR over
46 years
1996-971990-911980-811970-711960-61ITEM 1950-51
3.4 TRENDS OBSERVED THROUGH INDEXING BALANCE SHEET & P& L
ACCOUNT
1. Higher CAGR for total income (12.8%) as compared to cost (12.7%)
2. Highest CAGR is interest cost (18.4%) indicating increased use of debt.
3. Above point can be explained as borrowing have gone up at CAGR of 15.3% against total
liabilities CAGR of 13.6%
4. More profits retained as compared to growth in profits
5. Less Provisions for dividends
6. Higher CAGR in Reserves & Surplus.
7. Lower CAGR in inventories & cash as compared total balance sheet.
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3.5 GRAPHICAL OBSERVATIONS
Trends observed in the financial management for Medium and Large Public Limited Companies in
India from 1950-51 to 1996-97
3.6 BREAKEVEN POINT (BEP) ANALYSIS
Then BEP as a percentage of Sales & Total Income was calculated. (As shown in table 1.5 and
graph 1.1)
Fixed Cost was assumed to be 30% of the Total Cost for the purpose of the analysis.
Table 1.5
Mean Median Minimum Maximum
% Sales 79.5% 77.7% 70.0% 95.9%
% Total Income 74.4% 74.7% 66.0% 82.1%
Graph 1.1
Over the years BEP as a % of Sales has come down mainly on account of better contribution
margin. Better Contribution margin is due to higher percentage increase in sales as against the
percentage increase in cost.
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Table 3.5 Profit after Tax Distribution to Shareholders as equity dividend & saving as retained earnings
Retained Profit as % of PAT 8.3% 73.6% 46.1% 43.0%
Dividend Paid as % PAT 26.1% 90.3% 51.7% 53.5%
Minimum Maximum Average Median
(Other than these two preferences dividend was the third element where profit was distributed)
There is shift from paying dividends in favor of retained earnings. This show over the year‘s
companies saw more opportunities for growth. Hence considering the reinvestment opportunities
they retained distributable profits rather than distributing dividends.
Graph 3.6 Dividend and Retained Earnings
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Table 3.7 Marginal Tax Rate
Minimum 18.4%
Maximum 60.5%
Mean 42.7%
Median 43.8%
Reduction in tax rate indicating more money in the hands of corporate to expand. It also indicates
less government intervention.
Graph 3.8 Reduction in tax rate indicating year wise
Higher Tax Rate meant lesser incentive to show higher Book Profit. So it made sense for India INC
to show have higher Cash Profit,( i.e. PAT+ Depreciation ) by charging higher rates of depreciation
on fixed assets as shown in the next graph.
Also PAT or the book profit is looked at more keenly by non-promoter equity investors but there
were limited avenues to raise money by the way of equity. So there was limited incentive for most
companies to show higher book profits. These facts are augmented by the increase in net profit &
gross profit margin over the years. Particularly in Post liberalization era when equity as source of
finance opened up in big way. This is seen from the debt to equity graph which has dipped
drastically from 1990-91 onwards.
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Table 3.9 Depreciation as a percentage of Gross Block
Mean 41.5%
Median 42.0%
Minimum 27.8%
Maximum 48.4%
Graph 3.10 Percentage depreciation charged by Indian INC
Over the years lower depreciation is charged by Indian INC has gone down as there was more
incentive to show Book Profit rather than keeping it as Cash Profit.
Table 3.11 Gross Profit Margin
Time Frame 1950-51 to 1996-97 1950-51 to 1990-91 1991-92 to 1997-98
Mean 10.0% 9.6% 12.5%
Median 9.8% 9.6% 12.1%
Minimum 7.2% 7.2% 11.4%
Maximum 14.2% 11.4% 14.2%
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Graph 3.12 Gross Profit Margin has improved drastically in post liberalization years
Table 3.13 Net Profit Margin
Time Frame 1950-51 to 1996-97 1950-51 to 1990-91 1991-92 to 1997-98
Mean 3.9% 3.6% 5.5%
Median 4.0% 3.7% 5.2%
Minimum 1.4% 1.4% 3.7%
Maximum 7.8% 5.6% 7.8%
Net Profit Margins have shown similar trend to GPM‘s. Increase in margins was mainly on account
of cost reduction in salary cost. This could have been due to better productivity and more use of
technology.
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Graph 3.14 Net Profit Margins
Table 3.15 Interest Cost
Parameter Mean Median Minimum Maximum
Interest Cost as a percentage of Sales 3.4% 3.2% 0.7% 7.0%
Interest Cost as a percentage of Gross Profit 34.3% 33.9% 6.8% 70.6%
Interest Cost has gone up indicating clear shift from equity to debt as a source of capital. Same can
be substantiated by the next graph of debt to equity ratio.
Graph 3.16 Interest Cost
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Table 3.17 Long term Debt to equity Ratio
Mean 0.93
Median 0.96
Minimum 0.34
Maximum 1.58
There is clear shift in favor of debt by the Indian Corporate over the years. It could be due to the
fact that cost of debt or interest rates would have gone down over the years. However as per
www.allbankingsolutions.com benchmark bank rate went from 3.5% in 1950-51 to 11% in 1990-
91. So there was no incentive to take the debt in terms of reduction in interest cost.
The reasons for preference of leverage could be:
Earning Power could be more than cost of debt
Cost of Equity might be higher than Debt
Limited scope of equity as a source of capital
Interest rates could be expected rise over the years so
take loan as early as possible so that cost of debt is
lower
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Graph 3.18 Indian Corporate
Table 3.19 Salary Cost as a percentage of Total Cost
Mean 12.9%
Median 13.5%
Minimum 7.5%
Maximum 18.2%
Money spent by Indian Public limited companies on salary as proportion to their total cost have
reduced over the years. This could be due to more use of fixed assets & more automation as the
technology has evolved. The above fact is even more substantiated by the consequent graph which
indicates use of more fixed assets as fraction of total assets and less current assets as a percentage of
total assets.
Reasons for reduction in Salary Cost could be:
Improved Productivity
Lesser Manpower
Technology
Creativity & Innovation
Competition
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Graph 3.20 Money spent by Indian Public limited companies on salary as proportion
Graph 3.21 Liquidity to Profitability
Mean Median Minimum Maximum
Current Assets to Total Assets 0.53 0.53 0.44 0.62
Net Fixed Assets to Total Assets 0.41 0.41 0.31 0.47
Indian companies have shifted from current assets to fixed assets in resource allocation indicating
less focus on liquidity & more focus on profit. The above fact is substantiated with the next graph
which indicates less inventories & cash being held as a fraction of total assets over the years.
This could be due to better collections and more friendly vendors.
They could have leveraged their goodwill in all markets to the advantage for the business.
Aggressive approach to working capital cycle including managing business with negative net
working capital as a strategy.
Graph 3.22 Indian companies have shifted from current assets to fixed assets
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Table 3.23 Liquidity to Profitability
Mean Median Minimum Maximum
Cash to Total Assets 4.2% 3.9% 2.6% 6.7%
Inventories to Total Assets 29.1% 31.1% 15.0% 37.2%
Over the years Indian companies have reduced their cash & inventory levels significantly. That is
augmented by the fact that current ratio has dipped significantly over the years.
Graph 3.24 Cash & inventory levels
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Table 3.25 Liquidity to Profitability - Current Ratio
Mean 2.54
Median 2.55
Minimum 1.88
Maximum 3.32
Current Ratio has reduced and replaced by higher ratio of Fixed Assets to Total Assets as shown in
Graph 3.26
Graph 3.26 Current Ratio
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Conclusion
1)Over the years Indian Government has supported Indian Industry by easy availability of
debt & reduction in taxes.
2)Promoters have become less conservative and have raised money through debt as a source
of Finance.
3)Promoters have started retaining more profits as they saw more investment opportunities
for their companies.
4)Profitability has improved over the years due to more aggressive policies such as
maintaining less inventory & current ratio.
5)Use of Fresh issue of Equity or of Preference Shares as a fund raising instrument has gone
down.
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3.7 REGRESSION ANALYSIS BASED ON CORPORATE FINANCIAL
PERFORMANCE MODEL Figure 3.27 Regression Analysis Based On Corporate Financial Performance Model
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3.7.1 Calculations and Assumptions
3.7.2 Calculation of Return on Equity based on book profit (ROE)
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ROE is expressed as a percentage indicates net profit returned as a percentage of shareholders
equity. The ROE is useful for comparing the profitability of a company to that of other firms in the
same industry.
PAT is before payment of equity and preference dividend for year N.
Average Equity or Net worth= (Paid-up capital of YearN + Paid-up capital of YearN-1+ Reserves and
surplus of YearN + Reserves and surplus of YearN-1)/2
e.g. PAT for year 1951-52 then Average Equity would consist of average of year 1950-51 and
1951-52.
There were 46 observations of ROE from 1951-52 to 1996-97.
3.7.3 Calculation of Return on Equity based on Cash Profit (Cash ROE)
ROE is expressed as a percentage indicates net profit returned as a percentage of shareholders
equity. The ROE is useful for comparing the profitability of a company to that of other firms in the
same industry.
PAT is before payment of equity and preference dividend and Depreciation for year N.
Average Equity or Net worth= (Paid-up capital of YearN + Paid-up capital of YearN-1+ Reserves and
surplus of YearN + Reserves and surplus of YearN-1)/2
e.g. PAT and Depreciation for year 1951-52 then Average Equity would consist of average of year
1950-51 and 1951-52.
There were 46 observations of Cash ROE from 1951-52 to 1996-97.
3.7.4 Calculation of Return on Capital Employed based on Book Profit (ROCE)
ROCE is expressed as a percentage indicates operating profit returned as a percentage of total
capital employed. The ROCE is useful for comparing the performance of a company to that of other
firms in the same industry.
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EBIT is before payment of interest and taxes for year N.
Average Capital Employed= (Total Assets of YearN + Total Assets of YearN-1-Current Liabilities of
YearN - Current Liabilities of YearN-1)/2
e.g. EBIT for year 1951-52 then Average Capital Employed would consist of average of year 1950-
51 and 1951-52.
There were 46 observations of ROCE from 1951-52 to 1996-97.
3.7.5 Calculation of Return on Capital Employed based on Cash Profit (Cash ROCE)
Cash ROCE is expressed as a percentage indicates (Operating profit + Depreciation) returned as a
percentage of total capital employed. The ROCE is useful for comparing the performance of a
company to that of other firms in the same industry.
EBIT is before payment of interest and taxes and depreciation for year N.
Average Capital Employed= (Total Assets of YearN + Total Assets of YearN-1-Current Liabilities of
YearN - Current Liabilities of YearN-1)/2
e.g. EBIT and Depreciation for year 1951-52 then Average Capital Employed would consist of
average of year 1950-51 and 1951-52.
There were 46 observations of ROCE from 1951-52 to 1996-97.
3.7.6 P/V Ratio (PV Ratio)
Contribution Margin = Sales- Variable Cost
Assumptions made: Raw material, components stores and spare consumed, power and fuel, Selling
Commission, Advertisement were taken as variable cost.
Based on RBI data from 1950-51 to 1980-81 it was assumed variable cost is 70% of the total cost.
There were 46 observations of P/V Ratio from 1951-52 to 1996-97.
3.7.7 Margin of Safety based on book profit (MOS)
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There were 46 observations of MOS from 1951-52 to 1996-97.
3.7.8 Margin of Safety based on cash profit (Cash MOS)
There were 46 observations of Cash MOS from 1951-52 to 1996-97.
3.7.9 Turnover Ratio (ATR)
Sales are for year N.
Average Capital Employed= (Total Assets of YearN + Total Assets of YearN-1-Current Liabilities of
YearN - Current Liabilities of YearN-1)/2
e.g. Sales for year 1951-52 then Average Capital Employed would consist of average of year 1950-
51 and 1951-52.
There were 46 observations of ATR from 1951-52 to 1996-97.
3.7.10 Financial Leverage
There were 46 observations of PBT/EBIT from 1951-52 to 1996-97.
There were 46 observations of PBT/ Cash EBIT from 1951-52 to 1996-97.
There were 46 observations of CE/NW from 1951-52 to 1996-97.
3.7.11 Tax Impact or Tax Leverage
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There were 46 observations of PAT/PBT from 1951-52 to 1996-97.
3.7.12 Net Profit Margin based on Book Profit
There were 46 observations of NPM from 1951-52 to 1996-97.
3.7.13 Net Profit Margin based on Cash Profit
There were 46 observations of Cash NPM from 1951-52 to 1996-97.
3.7.14 Operating Profit Margin based on Book Profit
There were 46 observations of OPM from 1951-52 to 1996-97.
3.7.15 Operating Profit Margin based on Cash Profit
There were 46 observations of Cash OPM from 1951-52 to 1996-97.
3.7.16 Regression Analysis
In statistics, regression analysis is a statistical process for estimating the relationships among
variables. The focus is on the relationship between a dependent variable and one or more
independent variables.
If there is just one independent variable (X) then it could simple linear regression In that case a
straight line explains relationship between dependent and independent variable(Y). I.e. Y = α+β1X
(Meaning Y is a function of X)
α = Constant Term (Y when X =0)
β1 = Slope (Beta coefficient) for X (i.e. for unit change in X1 Y will change β1 times)
However in case of multiple linear regressions there is more than one independent variable.
Y= α+β1X1+ β2X2+……. + βnXn
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Where,
α = Constant Term (Y when X1= X2= X3=0)
β1 = Slope (Beta coefficient) for X1 (i.e. for unit change in X1 Y will change β1 times)
β2 = Slope (Beta coefficient) for X2 (i.e. for unit change in X2 Y will change β2 times)
βn = Slope (Beta coefficient) for Xn (i.e. for unit change in Xn Y will change βn times)
There were 10 multiple regressions carried out. List of Independent and Dependent variables are as
follows:
Table 3.28 Return on Equity (ROE)
Y X1 X2 X3 X4 X5 X6
1 ROE NPM ATR CE to NW
2 Cash ROE Cash NPM ATR CE to NW
3 ROCE OPM ATR
4 Cash ROCE Cash OPM ATR
5 ROCE PV Ratio MOS ATR
6 Cash ROCE PV Ratio Cash MOS ATR
7 ROE PV Ratio MOS ATR PBT/EBIT CE/NW Tax Leverage
8 Cash ROE PV Ratio Cash MOS ATR PBT/Cash EBIT CE/NW Tax Leverage
9 ROE ROCE PBT/EBIT CE/NW Tax Leverage
10 Cash ROE Cash ROCE PBT/EBIT CE/NW Tax Leverage
Dependent
VariableFunction of Independent Variables
In case 1 of above analysis Return on Equity (ROE) is being considered as a dependent variable on
independent variables which are Net Profit Margin, Asset Turnover Ratio and Capital employed to
Net worth.
I.e. Y is Function of (X1, X2 , X3)
Y= Return on Equity (Dependent Variable)
X1= Net Profit Margin (Independent Variable 1)
X2= Asset Turnover Ratio (Independent Variable 2)
X3= Capital employed to Net worth (Independent Variable 2)
So, Y= α+β1X1+ β2X2+ β3X3
3.7.17 Output of Regression Analysis
Regression Statistics
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Multiple R 0.97
R Square 0.95
Adjusted R Square 0.94
Standard Error 0.01
Observations 46
Multiple R =0.97
Multiple R is Karl Pearson‘s coefficient of correlation. Number can be between -1 to +1. A number
close to +1 as in the above case indicates very strong correlation between dependent and
independent variable.
R Square =0.95 and Adjusted R Square =0.95
Adjusted R-square is a modification of R-square that adjusts for the number of terms in a model. R-
square always increases when a new term is added to a model, but adjusted R-square increases only
if the new term improves the model more than would be expected by chance. Since this a multiple
linear regression adjusted R square would be considered.
Significance of Adjusted R Square =0.95
R square can take any value between 0 to 1. (i.e.0 to 100%). R square is explained variation in
dependent variable due to independent variable. Adjusted R Square =0.95 indicates 95% of the
variation in Y i.e. ROE is explained by the independent variables considered. i.e. NPM (X1), ATR
(X2) and CE to NW (X3)
Standard Error = 0.01
The smaller the standard error, the more representative the sample will be of the overall population.
The standard error is also inversely proportional to the sample size; the larger the sample size, the
smaller the standard error because the statistic will approach the actual value.
Since the standard error is 0.01 sample of 46 observations can be considered to be consistent with
the population.
Observations = 46
Sample size = Observations =46. More the number better is the predictability towards the
population.
Table 3.29 ANOVA table
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Df SS MS F Significance F
Regression 3.00 0.04 0.01 250.16 0.00
Residual 42.00 0.00 0.00
Total 45.00 0.04
Regression df =3
df indicates degree‘s of freedom. In this case there are three independent variables which can take
the values independent of each other hence degree‘s of freedom is three.
Residual df = 42
Residual = Sample size - 1 – df
R square = 1- (Residual Sample Square / Total Sample Square)
Regression SS =0.04
These are the sum of squares of values of Y calculated using Y= α+β1X1+ β2X2+ β3X3 as per the
model.
Residual SS =0.002 (close to 0)
It is the difference between calculated value and actual value of Y.
Regression MS = 0.01
Residual MS = 0.005% (close to 0)
F statistics = 250.16 and its significance.
The column labeled F gives the overall F-test of,
Null Hypothesis, H0: β1 = 0, β2 = 0, β3 = 0 versus
Alternate Hypothesis, Ha: at least one of β1,β2 and β3 does not equal zero.
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F value calculated using FINV (F, 3, 42) at F =99.5% (i.e. confidence limit) we get Significance F
at 0.0236.
Since 0.0236 > 8.3030212047683E-27 (Close to 0) we will reject the null hypothesis.
Hence one can say with 99.5% confidence that at least one of the 3 independent variables will have
non-zero slope or the non-zero multiple with respect to dependent variable.
Table 3.30 Coefficient Matrix
Coefficients Standard Error t Stat P-value
Lower 95%
Upper 95%
Intercept -0.19 0.01 -15.90 0.00 -0.21 -0.17
NPM 2.59 0.10 26.59 0.00 2.40 2.79
Asset Turnover
0.08 0.01 12.81 0.00 0.06 0.09
CE to NW 0.04 0.00 10.76 0.00 0.04 0.05
From the above table one can say,
ROE (Y) = -0.19 (α) + 2.59*Net Profit Margin (NPM) (X1) +0.08* Asset turnover ratio (ATR) (X2)
+0.04*Capital Employed to Net worth (CE to NW) (X3)
i.e. β1=2.59, β2=0.08 and β3=0.04 and α =-0.19
i.e. For every 1% rise in NPM, ROE will go up by 2.59% assuming ATR and CE to NW remain
constant.
For every 1 time rise in ATR, ROE will go up by 0.08% assuming NPM and CE to NW remain
constant.
If all three i.e. NPM, ATR and CE to NW are zero then ROE will be -19% (i.e. intercept with y
axis)
Standard error is close to zero indicating close to 100% fit.
t-stat is coefficient divided by standard error. It is compared with p value close to 0 indicates that
with close to 100% confidence one can say dependent variable is dependent on each of the three
independent variables.
i.e. With very close to 100% confidence one ROE is dependent on NPM, ATR and CE to NW.
T-stat and p value are not relevant for α.
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Lower 95% andUpper 95%: This gives values for lower and upper end of respective independent
variables and the intercept with 95% values being covered between the ranges.
It assumes all these variables to be normally distributed with mean μ and standard deviation σ.
Values are (μ + 2* σ)
Table 3.31 Correlation Matrix
ROE NPM ATR CE to NW
ROE 1.00
NPM 0.63 1.00
ATR 0.20 -0.54 1.00
CE to NW 0.21 -0.48 0.52 1.00
Observations
Every variable dependent/independent has 1 as Karl Pearson‘s coefficient of correlation
with itself.
ROE is positively correlated with NPM, ATR and CE to NW but it is more positively
correlated with NPM at 0.63 as compared to 0.20 for ATR 0.21 for CE to NW.
Increase in CE to NW will lead to reduction in NPM; this can be due to increased interest
cost. (CE= NW + Debt)
As incremental debt would increase the interest outflow in absolute terms.
Also cost of debt increases as level of debt increases.
Increased interest cost would lead to reduced net profit and consequently net profit margin.
So a firm cannot have infinite leverage to increase CE to NW and hence the ROE as the
impact would be countered by reduction in NPM.
Increase in ATR will lead to reduction in NPM this can be due to low margin and more
volume approach by the company.
Similar analysis was carried out in the other nine cases and these are the summary of outputs for
them,
Table 3.32 Cash ROE as a function of CPM, ATR and CE to NW
Cash ROE=-0.36+0.13*ATR+2.48*CPM+0.10*(CE/NW)
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SUMMARY OUTPUT Correlation Matrix
Regression Statistics Cash ROE ATR CPM CE to NWMultiple R 0.98 Cash ROE 1.00
R Square 0.97 ATR 0.50 1.00Adjusted R Square 0.97 CPM 0.15 -0.66 1.00Standard Error 0.01 CE to NW 0.79 0.52 -0.28 1.00Observations 46.00
ANOVA
df SS MS F Significance F
Regression 3.00 0.09 0.03 445.87 0.00Residual 42.00 0.00 0.00Total 45.00 0.09
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Intercept -0.36 0.02 -20.75 0.00 -0.39 -0.32
Asset Turnover 0.13 0.01 16.22 0.00 0.12 0.15Cash Profit Margin 2.48 0.12 21.43 0.00 2.25 2.72CE to NW 0.10 0.00 21.05 0.00 0.09 0.10
Table 3.33 ROCE as a function of OPM and ATR
ROCE=-
0.12+1.2*OPM+0.10*ATR
SUMMARY OUTPUT Correlation Matrix
Regression Statistics ROCE OPM ATR
Multiple R 0.99 ROCE 1.00
R Square 0.99 OPM 0.57 1.00
Adjusted R Square 0.99 ATR 0.64 -0.26 1.00
Standard Error 0.00Observations 46.00
ANOVA
df SS MS F Significance F
Regression 2.00 0.03 0.02 2105.30 0.00Residual 43.00 0.00 0.00Total 45.00 0.03
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Intercept -0.12 0.00 -30.41 0.00 -0.13 -0.11
OPM 1.20 0.02 49.66 0.00 1.15 1.25Asset Turnover 0.10 0.00 53.40 0.00 0.10 0.11
Table 3.34 Cash ROCE as a function of Cash OPM and ATR
Cash ROCE=-0.16+1.21*Cash OPM+0.13*ATR
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SUMMARY OUTPUT Correlation Matrix
Regression Statistics Cash ROCE Cash OPM ATRMultiple R 1.00 Cash ROCE 1.00
R Square 0.99 Cash OPM 0.46 1.00Adjusted R Square 0.99 ATR 0.68 -0.33 1.00
Standard Error 0.00Observations 46.00
ANOVA
df SS MS F Significance F
Regression 2.00 0.05 0.02 2165.36 0.00Residual 43.00 0.00 0.00Total 45.00 0.05
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%
Intercept -0.16 0.01 -29.96 0.00 -0.17 -0.15Cash OPM 1.21 0.03 48.12 0.00 1.16 1.26Asset Turnover 0.13 0.00 58.33 0.00 0.13 0.14
Table 3.35 ROCE as a function of PV Ratio, MOS and ATR
ROCE= -0.51+1.26*PV Ratio+0.18*MOS+0.1*ATR
SUMMARY OUTPUT Correlation Matrix
Regression Statistics ROCE PV Ratio MOS ATRMultiple R 0.99 ROCE 1.00R Square 0.98 PV Ratio 0.52 1.00
Adjusted R Square 0.98 MOS 0.64 0.96 1.00Standard Error 0.00 ATR 0.64 -0.30 -0.16 1.00Observations 46.00
ANOVA
df SS MS F Significance F
Regression 3.00 0.03 0.01 632.93 0.00Residual 42.00 0.00 0.00Total 45.00 0.03
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%
Intercept -0.51 0.08 -6.20 0.00 -0.67 -0.34PV Ratio 1.26 0.26 4.88 0.00 0.74 1.78
MOS 0.18 0.06 3.06 0.00 0.06 0.31Asset Turnover 0.10 0.00 29.96 0.00 0.09 0.11
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Table 3.36 Cash ROCE as a function of PV Ratio, Cash MOS and ATR
Cash ROCE=-0.37+0.76*PV Ratio+0.32*Cash MOS+ 0.12* ATR
SUMMARY OUTPUT Correlation Matrix
Regression Statistics Cash ROCE PV Ratio Cash MOS ATR
Multiple R 0.99 Cash ROCE 1.00
R Square 0.98 PV Ratio 0.44 1.00
Adjusted R Square 0.98 Cash MOS 0.56 0.89 1.00
Standard Error 0.00 ATR 0.68 -0.30 -0.20 1.00
Observations 46.00
ANOVA
df SS MS F Significance F
Regression 3.00 0.04 0.01 595.61 0.00Residual 42.00 0.00 0.00Total 45.00 0.05
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Intercept -0.37 0.05 -7.26 0.00 -0.47 -0.27
PV Ratio 0.76 0.16 4.72 0.00 0.44 1.09Cash MOS 0.32 0.03 9.94 0.00 0.25 0.38Asset Turnover 0.12 0.00 34.58 0.00 0.11 0.13
Table 3.37 ROE as a function of PV Ratio, MOS, ATR, CE to NW, PBT/EBIT, Tax Leverage
ROE=-0.15-0.64*PV Ratio+0.59*MOS+0.07*ATR+0.06*(CE/NW)+0.34*(PBT/PBIT)-
0.01*Tax Leverage SUMMARY OUTPUT Correlation Matrix
Regression Statistics ROE PV Ratio MOS ATR CE to NW PBT/EBIT Tax LeverageMultiple R 0.99 ROE 1.00
R Square 0.98 PV Ratio 0.73 1.00Adjusted R Square 0.97 MOS 0.73 0.96 1.00Standard Error 0.00 ATR 0.20 -0.30 -0.16 1.00Observations 46.00 CE to NW 0.21 0.12 0.35 0.52 1.00
PBT/EBIT 0.27 0.20 -0.03 -0.52 -0.84 1.00Tax Leverage 0.53 0.54 0.51 -0.44 0.04 0.39 1.00
ANOVA
df SS MS F Significance FRegression 6.00 0.04 0.01 263.87 0.00Residual 39.00 0.00 0.00Total 45.00 0.04
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Intercept -0.15 0.17 -0.88 0.38 -0.50 0.20PV Ratio -0.64 0.57 -1.12 0.27 -1.78 0.51
MOS 0.59 0.14 4.22 0.00 0.31 0.87Asset Turnover 0.07 0.01 11.95 0.00 0.06 0.08CE to NW 0.06 0.01 6.77 0.00 0.04 0.08PBT/EBIT 0.34 0.03 11.73 0.00 0.28 0.40Tax Leverage -0.01 0.02 -0.75 0.46 -0.05 0.02
Table 3.38 Cash ROE as a function of PV Ratio, Cash MOS, ATR, CE to NW, PBT/Cash EBIT, Tax
Leverage
Cash ROE=0.28-2.91*PV Ratio+0.96*Cash MOS + 0.10*ATR+ 0.12*(CE/NW)
+0.29*(PBT/Cash PBIT) +0.23* Tax Leverage
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SUMMARY OUTPUT Correlation Matrix
Regression Statistics Cash ROE PV Ratio Cash MOS ATR CE to NW PBT/ Cash EBIT Tax LeverageMultiple R 0.99 Cash ROE 1.00
R Square 0.97 PV Ratio 0.50 1.00Adjusted R Square 0.97 Cash MOS 0.65 0.89 1.00Standard Error 0.01 ATR 0.50 -0.30 -0.20 1.00Observations 46.00 CE to NW 0.79 0.12 0.45 0.52 1.00
PBT/ Cash EBIT -0.53 0.01 -0.38 -0.27 -0.89 1.00Tax Leverage 0.28 0.54 0.42 -0.44 0.04 -0.10 1.00
ANOVA
df SS MS F Significance FRegression 6.00 0.09 0.01 231.95 0.00Residual 39.00 0.00 0.00Total 45.00 0.09
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Intercept 0.28 0.16 1.73 0.09 -0.05 0.60PV Ratio -2.91 0.61 -4.77 0.00 -4.14 -1.67
Cash MOS 0.96 0.13 7.55 0.00 0.70 1.21Asset Turnover 0.10 0.01 9.00 0.00 0.08 0.12CE to NW 0.12 0.02 7.82 0.00 0.09 0.15PBT/ Cash EBIT 0.29 0.04 8.16 0.00 0.22 0.37Tax Leverage 0.23 0.02 10.12 0.00 0.18 0.27
Table 3.39 ROE as a function of ROCE, CE to NW, PBT/ EBIT, Tax Leverage
ROE=-0.21+0.85*ROCE+0.25*(PBT/EBIT) +0.04*(CE/NW) +0.03*Tax Leverage
SUMMARY OUTPUT Correlation Matrix
Regression Statistics ROE ROCE PBT/EBIT CE to NW Tax Leverage
Multiple R 0.99 ROE 1.00
R Square 0.97 ROCE 0.78 1.00
Adjusted R Square 0.97 PBT/EBIT 0.27 -0.32 1.00
Standard Error 0.00 CE to NW 0.21 0.61 -0.84 1.00
Observations 46.00 Tax Leverage 0.53 0.10 0.39 0.04 1.00
ANOVA
df SS MS F Significance F
Regression 4.00 0.04 0.01 399.59 0.00Residual 41.00 0.00 0.00Total 45.00 0.04
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%
Intercept -0.21 0.02 -11.69 0.00 -0.25 -0.17ROCE 0.85 0.04 20.19 0.00 0.77 0.94PBT/EBIT 0.25 0.03 9.51 0.00 0.19 0.30
CE to NW 0.04 0.01 4.71 0.00 0.02 0.06Tax Leverage 0.03 0.01 2.24 0.03 0.00 0.06
Table 3.40 Cash ROE as a function of Cash ROCE, ATR, CE to NW, PBT/ EBIT, Tax Leverage
Cash ROE= -0.28+0.86*Cash ROCE+0.23*(PBT/EBIT)+0.11*(CE/NW)+0.02*Tax Leverage
Monograph-Trends in Finance Page 78
SUMMARY OUTPUT
Regression Statistics Cash ROE Cash ROCE PBT/EBIT CE to NW Tax LeverageMultiple R 0.99 Cash ROE 1.00
R Square 0.98 Cash ROCE 0.93 1.00Adjusted R Square 0.97 PBT/EBIT -0.41 -0.48 1.00
Standard Error 0.01 CE to NW 0.79 0.73 -0.84 1.00Observations 46.00 Tax Leverage 0.28 0.01 0.39 0.04 1.00
ANOVA
df SS MS F Significance F
Regression 4.00 0.09 0.02 408.08 0.00Residual 41.00 0.00 0.00Total 45.00 0.09
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%
Intercept -0.28 0.03 -10.57 0.00 -0.34 -0.23Cash ROCE 0.86 0.06 13.81 0.00 0.74 0.99PBT/EBIT 0.23 0.04 5.91 0.00 0.15 0.31
CE to NW 0.11 0.01 7.79 0.00 0.08 0.14Tax Leverage 0.02 0.02 0.80 0.43 -0.03 0.06
3.7.18 Summary of 10 equations
3.7.18.1 Multiplier Matrix
Multiplier matrix indicates dependent variable of left hand side is impacted by what magnitude for
a unit change in independent variable on right hand side assuming other independent variables to be
constant.
E.g. 1% increase in NPM will increase ROE by 2.59*1% times= 2.59% assuming ATR and CE to
NW remaining constant.
The extent of sensitivity is indicated by the multiplier number. E.g. ROE when expressed as a
function of NPM,ATR and CE/NW ratio is most sensitive to NPM with a multiplier of 2.59,
followed by ATR at 0.08 and is least sensitive to CE/NW ratio.
Table 3.41 Multiplier matrix
Si
mil
ar
obs
erv
Constant ROCE NPM CPM OPM Cash
OPM
ATR CE to
NW
PV
Ratio
MOS Cash
MOS
PBT/E
BIT
PBT/
Cash
EBIT
Tax
Levera
ge
ROE -0.19 2.59 0.08 0.04
Cash ROE -0.36 2.48 0.13 0.10
ROCE -0.12 1.20 0.10
Cash ROCE -0.16 1.21
ROCE -0.51 0.10 1.26 0.18
Cash ROCE -0.37 0.12 0.76 0.32
ROE -0.15 0.07 0.06 -0.64 0.59 0.34 -0.01
Cash ROE 0.28 0.10 0.12 -2.91 0.96 0.29 0.23
ROE -0.21 0.85 0.04 0.25 0.03
Cash ROE -0.28 0.86 0.11 0.23 0.02
Monograph-Trends in Finance Page 79
ation are being made
3.7.18.2 Observations
ROI (ROE/ROCE on Book Profit and Cash Profit basis) is more sensitive to margins as
compared to Asset utilization or the capital structure.
Even after generating twice the sales from same assets ROI will not change drastically.
That is because from the investors point of view be it Equity shareholder or debt holder
profit is the key factor.
Higher Sales may not make higher returns; as selling at a profit is more important than just
selling the product or the service.
E.g. Oil Marketing Companies and Aviation Industry. In both these cases sales have gone
up but profits have not gone up at the same rate of growth.
The Margins reflect the overall picture be it NPM or OPM on book profit or cash profit
basis.
Bottom-line is it is important to utilize your assets well and generate sales with a proper
mix of debt and equity in the capital structure. But it is more important to achieve sales
with same or higher profit margins so as to increase the ROI. However above argument is
countered by Economic value added (EVA) concept. EVA says generate sales as long as
operating profit from incremental sales is greater than the cost of capital associated with
it.
SECTION- II
4-CMIE DATA - FIVE SECTORS DATA ANALYSIS VIZ.
MANUFACTURING, MINING, ELECTRICAL, 'CONSTRUCTION AND
REAL ESTATE' AND 'NON-FINANCIAL' SECTORS FROM 1992-93 TO
2012-13 THROUGH „REGRESSION ANALYSIS‟
By Ms. Suman Mathur, Assistant Professor, DR VN BRIMS
Monograph-Trends in Finance Page 80
4.1 AN OVERVIEW
This section has explored, through the CMIE database from 1992-93 to 2012-13, the following five
sectors viz. Manufacturing, Mining, Electrical, 'Construction and Real Estate' and 'Non-financial'
sectors. The study addresses the following aspects of financial management:
The Profit and Loss (income) statement and balance sheet (assets and liabilities) of
the given sectors in an alternate format viz. common size statement indicating the
proportions which various items bear to the total assets, liabilities and total income of the
respective year's concerned financial statements. Total income has been equated to 100 and
other relevant important factors are expressed as a percentage to total income. Similarly
total assets and liabilities are equated to 100 and other major components of assets and
liabilities are expressed as a percentage for the period. The above analysis is carried out for
a period of 20 years- 1993-94 to 2012-13.
The financial statements have also been presented using the fixed- variable cost
classification after careful consideration of the behavior of individual items of expense to
enable the computation of important profit planning indicators like Profit-Volume (PV)
ratio, Margin of Safety (MOS) and other related indicators leading to return on investment
which includes operating, financial and total management performance for any particular
period.
Thus result resource ratio (Return on Investment i.e. ROI) from various angles viz. Return
on Equity (ROE), Return on Capital Employed(ROCE) and its components, the profit
This section analyses , CMIE data – five sectors data viz.
Manufacturing, Mining, Electrical, 'Construction and Real
Estate' and 'Non-financial' sectors from 1992-93 to 2012-13
through ‗Regression Analysis‘
Monograph-Trends in Finance Page 81
margin ratio as well as the asset turnover ratio, alongwith other financial indicators just
cited, have also been computed to facilitate study of the trend of the said ratios.
The study of 'Trends in Finance' to generate authentic and reliable information from
the database so as to add to our knowledge on the behavior as well as interplay of various
financial parameters. Thus given ROE, Net Profit Margin(NPM), Asset Turnover
Ratio(ATR), Debt to Equity through the ratio of Capital Employed to Net worth (CE to
NW), PV ratio, Margin of Safety (MOS), Profit before Tax (EBT) / Profit Before Interest
and Tax (EBIT) and tax leverage, and the permutation and combination thereof, a rigorous
statistical analysis was performed using the multiple regression analysis along with the
testing for authenticity through confidence levels measurement techniques viz. F-test and
R2. The above analyses have helped to identify answers to the following questions:
Given ROE on the left hand side of an equation and other parameters like NPM, ATR and CE to
NW on the right hand side through the following equation:
ROE (Y) = -0.33 (α)+ 0.64*Cash Profit Margin (CPM)(X1) +1.41*Asset turnover ratio
(ATR) (X2) +0.03*Capital Employed to Net worth (CE to NW) (X3)
the extent of the sensitivity of ROE, the dependent variable (Y), has been ascertained and
quantified. Thus, there are 10 equations for every sector which include :
(a) six equations relating to ROE on the left hand side on a book and cash profit basis
(b) four equations again on ROCE on left hand side
(c) the independent variables viz. NPM, Cash Profit Margin (CPM), Operating Profit Margin
(OPM), Cash Operating Profit Margin (Cash OPM), ATR, CE to NW, PV Ratio, MOS,
Cash MOS, PBT/EBIT, PBT/Cash EBIT, Tax Leverage, have all been placed on the right
hand side in various permutation and combination.
(d) the summary of the outcomes of the multiple regression analysis has been finally presented
in a multiplier matrix for each sector to provide an overview of the dependency of the left
hand side parameters viz. Return on Equity (ROE) or Return on Capital Employed (ROCE)
either on book profit or cash profit basis and the aforesaid right hand side parameters.
Table 4.1 Cash Profit ROE as a function of CPM, ATR & CE to NW – Manufacturing
ROE(Y)= -0.33+0.64*CPM+1.41*ATR+0.03*(CE/NW)
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Table 4.2 Book Profit ROE as a function of NPM, ATR & CE to NW
ROE(Y)= -0.16+0.67*NPM+0.53*ATR+0.02*(CE/NW)
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Table 4.3 Cash Profit ROCE as a function of Cash OPM & ATR
ROCE(Y)= -0.06+0.12*CashOPM+0.61*ATR
Table 4.4 Book Profit ROCE as a function of OPM & ATR
ROCE(Y)= -0.05+0.12*OPM+0.45*ATR
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Table 4.5 Cash Profit ROE as a function of PV Ratio, CashMOS, ATR, PBT/Cash EBIT & PAT/PBT
ROE(Y) = -0.68+1.58*PV Ratio+2.05*CashMOS-3.24*ATR-0.16*PBT/Cash EBIT +0.04*
(CE/NW) +0.00*PAT/PBT
Table 4.6 Book Profit ROE as a function of PV Ratio, MOS, ATR , PBT/EBIT & PAT/PBT
Monograph-Trends in Finance Page 85
ROE(Y)= -0.74+1.36*PV Ratio+2.29*MOS-2.77*ATR-0.05*(PBT/EBIT)+0.03*(CE/NW)
+0.00*(PAT/PBT)
Table 4.7 Cash Profit ROCE as a function of PV Ratio, CashMOS & ATR
ROCE(Y) = -0.14+0.34*PV Ratio+0.29*CashMOS+0.14*ATR
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Table 4.8 Book Profit ROCE as a function of PV Ratio, MOS & ATR
ROCE(Y)= -0.14+0.28*PV Ratio+0.31*MOS+0.14*ATR
Table 4.9 Cash Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT
ROE(Y)= -0.04+1.76*(EBIT/CE)+0.22*(PBT/EBIT)+0.00*(PAT/PBT)
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Table 4.10 Book Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT
ROE(Y) = -0.23+4.06*(EBIT/CE)+0.39*(PBT/EBIT)+0.01*(PAT/PBT)
Table 4.11 Cash Profit ROE as a function of CPM, ATR & CE to NW- Mining
ROE(Y)= -0.74+1.20*CPM+0.82*ATR+0.16*(CE/NW)
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Table 4.12 Book Profit ROE as a function of NPM, ATR & CE to NW
ROE(Y)= -0.43+1.13*NPM+0.48*ATR+0.10*(CE/NW)
Table 4.13 Cash Profit ROCE as a function of CashPM & ATR
Monograph-Trends in Finance Page 89
ROCE(Y)= -0.22+0.53*CashOPM+0.48*ATR
Table 4.14 Book Profit ROCE as a function of OPM & ATR
ROCE(Y)= -0.19+0.61*OPM+0.37*ATR
Table 4.15 Cash Profit ROE as a function of PV Ratio, CashMOS, ATR , PBT/CashEBIT & PAT/PBT
Monograph-Trends in Finance Page 90
ROE(Y) = -0.44+0.09*PV Ratio+0.98*CashMOS+0.66*ATR+0.09*(PBT/CashEBIT)+ 0.00*
(CE/NW) -0.01* (PAT/ PBT)
Table 4.16 Book Profit ROE as a function of PV Ratio, MOS, ATR , PBT/EBIT & PAT/PBT
ROE(Y)= -0.98+0.15*PV Ratio+0.56*MOS+0.51*ATR+0.23*(PBT/EBIT)+0.02*(CE/NW)
+0.49*(PAT/PBT)
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Table 4.17 Cash Profit ROCE as a function of PV Ratio, CashMOS & ATR
ROCE(Y)= -0.01-0.13*PV Ratio+0.60*CashMOS+0.32*ATR
Table 4.18 Book Profit ROCE as a function of PV Ratio, MOS & ATR
Monograph-Trends in Finance Page 92
ROCE(Y)= -0.24+0.07*PV Ratio+0.59*MOS+0.32*ATR
Table 4.19 Cash Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT
ROE(Y)= -0.09+2.27*(EBIT/CE)+0.04*(PBT/EBIT)-0.23*(PAT/PBT)
Monograph-Trends in Finance Page 93
Table 4.20 Book Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT
ROE(Y)= -0.18+2.59*(EBIT/CE)+0.11*(PBT/EBIT)-0.23*(PAT/PBT)
Table 4.21 Cash Profit ROE as a function of CPM, ATR & CE to NW- Electrical
ROE(Y)= -0.24+0.73*CPM+0.46*ATR+0.05*(CE/NW)
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Table 4.22 Book Profit ROE as a function of NPM, ATR & CE to NW
ROE(Y)= -0.11+0.74*NPM+0.22*ATR+0.02*(CE/NW)
Table 4.23 Cash Profit ROCE as a function of Cash OPM & ATR
ROCE(Y)= -0.10+0.34*CashOPM+0.34*ATR
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Table 4.24 Book Profit ROCE as a function of OPM & ATR
ROCE(Y)= -0.07+0.34*OPM+0.23*ATR
Table 4.25 Cash Profit ROE as a function of PV Ratio, CashMOS, ATR , PBT/EBIT & PAT/PBT
ROE(Y)= -0.44+0.51*PV Ratio+0.04*CashMOS+0.56*ATR+0.20*(PBT/CashEBIT)+
0.04*(CE/NW) +0.04*(PAT/PBT)
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Table 4.26 Book Profit ROE as a function of PV Ratio, MOS, ATR , PBT/EBIT & PAT/PBT
ROE(Y)= -0.25+0.15*PV Ratio+0.09*MOS+0.23*ATR+0.14*(PBT/EBIT)+0.01*(CE/NW)
+0.06*(PAT/PBT)
Table 4.27 Cash Profit ROCE as a function of PV Ratio, CashMOS & ATR
ROCE(Y)= -0.23+0.32*PV Ratio+0.16*CashMOS+0.43*ATR
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Table 4.28 Book Profit ROCE as a function of PV Ratio, MOS & ATR
ROCE(Y)= -0.16+0.16*PV Ratio+0.16*MOS+0.29*ATR
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Table 4.29 Cash Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT
ROE(Y)= -0.10+1.94*(EBIT/CE)+0.03*(PBT/EBIT)+0.05*(PAT/PBT)
Table 2.29
Table 4.30 Book Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT
ROE(Y) = -0.14+1.38*(EBIT/CE)+0.03*(PBT/EBIT)+0.06*(PAT/PBT)
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Table 4.31 Cash Profit ROE as a function of CPM, ATR & CE to NW- Construction
ROE(Y)= -0.35+1.69*CPM+0.51*ATR+0.06*(CE/NW)
Table 4.32 Book Profit ROE as a function of NPM, ATR & CE to NW
Monograph-Trends in Finance Page 100
ROE(Y)= -0.28+0.02*NPM+0.44*ATR+0.03*(CE/NW)
Table 4.33 Cash Profit ROCE as a function of Cash OPM & ATR
ROCE(Y)= -0.14+0.62*CashOPM+0.34*ATR
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Table 4.34 Book Profit ROCE as a function of OPM & ATR
ROCE(Y)= -0.11+0.61*OPM+0.28*ATR
Table 4.35 Cash Profit ROE as a function of PV Ratio,Cash MOS, ATR , PBT/CashEBIT & PAT/PBT
ROE(Y)= -0.53+0.14*PV Ratio+0.40*CashMOS+0.46*ATR+0.17*(PBT/CashEBIT)+0.06*
(CE/NW) +0.06*(PAT/PBT)
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Table 4.36 Book Profit ROE as a function of PV Ratio, MOS, ATR, PBT/EBIT & PAT/PBT
ROE(Y)= -0.57+0.21*PV Ratio+0.58*MOS+0.45*ATR+0.14*(PBT/EBIT)+0.03*(CE/NW)
+0.07*(PAT/PBT)
Table 4.37 Cash Profit ROCE as a function of PV Ratio, CashMOS & ATR
ROCE(Y)= -0.26+0.21*PV Ratio+0.41*CashMOS+0.33*ATR
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Table 4.38 Book Profit ROCE as a function of PV Ratio, MOS & ATR
ROCE(Y) = -0.26+0.20*PV Ratio+0.43*MOS+0.31*ATR
Table 4.39 Cash Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT
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ROE(Y)= -0.27+2.03*(EBIT/CE)+0.05*(PBT/EBIT)+0.16*(PAT/PBT)
Table 4.40 Book Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT
ROE(Y) = -0.23+2.09*(EBIT/CE)+0.02*(PBT/EBIT)+0.15*(PAT/PBT)
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Table 4.41 Cash Profit ROE as a function of CPM, ATR & CE to NW- Non-Financial Services
ROE(Y)= -0.28+1.69*CPM+0.23*ATR+0.07*(CE/NW)
Table 4.42 Book Profit ROE as a function of NPM, ATR & CE to NW
ROE(Y)= -0.16+0.02*NPM+0.12*ATR+0.04*(CE/NW)
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Table 4.43 Cash Profit ROCE as a function of Cash OPM & ATR
ROCE(Y) = -0.11+0.79*CashOPM+0.19*ATR
Table 4.44 Book Profit ROCE as a function of PM & ATR
ROCE(Y)= -0.08+0.77*OPM+0.15*ATR
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Table 4.45 Cash Profit ROE as a function of PV Ratio, CashMOS, ATR , PBT/EBIT & PAT/PBT
ROE(Y)= -0.56+0.64*PV Ratio+0.35*CashMOS+0.14*ATR+0.09*(PBT/CashEBIT)+0.08*
(CE/NW) +0.10*(PAT/PBT)
Table 4.46 Book Profit ROE as a function of PV Ratio, MOS, ATR , PBT/EBIT & PAT/PBT
Monograph-Trends in Finance Page 108
ROE(Y)= -0.32+0.15*PV Ratio+0.45*MOS+0.14*ATR+0.15*(PBT/EBIT)+0.02*(CE/NW)
+0.02*(PAT/PBT)
Table 4.47 Cash Profit ROCE as a function of PV Ratio, CashMOS & ATR
ROCE(Y)= -0.22+0.37*PV Ratio+0.38*CashMOS+0.17*ATR
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Table 4.48 Book Profit ROCE as a function of PV Ratio, MOS & ATR
ROCE(Y)= -0.20+0.23*PV Ratio+0.36*MOS+0.17*ATR
Table 4.49 Cash Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT
ROE(Y)= -0.06+1.02*(EBIT/CE)+0.02*(PBT/EBIT)+0.14*(PAT/PBT)
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Table 4.50 Book Profit ROE as a function of EBIT/CE, PBT/EBIT & PAT/PBT
ROE(Y) = -0.14+1.06*(EBIT/CE)+0.02*(PBT/EBIT)-0.13*(PAT/PBT)
4.2 SUMMARY OF MULTIPLE REGRESSION ANALYSIS OUTCOME
Table 4.51 Manufacturing Sector -Multiplier Matrix
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Table 4.52 Mining Sector -Multiplier Matrix
4.3 SUMMARY OF MULTIPLE REGRESSION ANALYSIS OUTCOME
Table 4.53 Electrical Sector -Multiplier Matrix
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Table 4.54 Construction -Real Estate Sector -Multiplier Matrix
4.4 SUMMARY OF MULTIPLE REGRESSION ANALYSIS OUTCOME
Table 4.55 Non-Financial Sectors - Multiplier Matrix
Interpretation of Multiple Matrix
Multiplier matrix indicates dependent variable of left hand side is impacted by what magnitude for
a unit change in independent variable on right hand side assuming other independent variables to be
constant.
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For example: 1% increase in CPM will increase ROE by 1.69*1% times = 1.69% assuming the
ATR, CE to NW remaining constant (as per the table 2.55).
In the Manufacturing sector ROI is more sensitive to ATR as compared to Margins. This could be
due to the fact that in general manufacturing sector works on lesser margins as compared to services
& is more regulated. Capital structure which is indicated by CE to NW ratio has hardly any
influence on ROI. ROI is least sensitive to capital structure which is consistent Modigliani and
Miller approach. ROI is also sensitive to MOS & PV ratio as compared to margins, ATR or the
capital structure.
In the Mining sector ROI is more sensitive to margin as compared to ATR. Capital structure which
is indicated by CE to NW ratio has hardly any influence on ROI. ROI is least sensitive to capital
structure which is consistent Modigliani and Miller approach. ROI is also sensitive to MOS as
compared to its sensitivity with respect to ATR & capital structure.
In the Electricity sector ROI is more sensitive to margin as compared to ATR. Capital structure
which is indicated by CE to NW ratio has hardly any influence on ROI. ROI is least sensitive to
capital structure which is consistent Modigliani and Miller approach. ROI is relatively less sensitive
to MOS as compared to its sensitivity with respect to ATR & margins.
In the Construction- Real Estate sector ROI is more sensitive to ATR as compared to margins only
exception being Cash ROE & CPM. Capital structure which is indicated by CE to NW ratio has
hardly any influence on ROI. ROI is least sensitive to capital structure which is consistent
Modigliani and Miller approach. ROI is relatively more sensitive to MOS as compared to its
sensitivity with respect to ATR & margins.
In the Non- Financial services sector ROI is more sensitive to margin as compared to ATR. Capital
structure which is indicated by CE to NW ratio has hardly any influence on ROI. ROI is least
sensitive to capital structure which is consistent Modigliani and Miller approach. ROI is also
sensitive to MOS as compared to its sensitivity with respect to ATR & capital structure.
4.5 COMPARISONS BETWEEN THE STUDIES DONE ON RBI (SECTION I ) AND
CMIE (SECTION II) DATA
4.5.1 Factors Common to RBI & CMIE data for 5 industries
Sales represent effectiveness and profits measure effectiveness and efficiency.
From ROI perspective both effectiveness and efficiency are important.
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ROI is more sensitive to margins as compared to ATR or the leverage ratios for both pre and
post liberalization era.
4.5.2 Difference in RBI & CMIE data for 5 industries
In the post liberalization era sensitivity of ROI as a function of ATR has gone up as
compared to earlier. (CMIE Data)This could be due to increased competition and improved
consumption power; Companies need to generate more sales from the same assets due to
competitive pricing.
Pre liberalization era was dominated by license raj and monopolies which is reflected in RBI
data. Margins dominated the sensitivity of ROI in Pre liberalization era. As Sales were more
or less assured only concern were margins.ROI was less sensitive to ATR as there was
limited opportunity to generate higher sales with same assets.
Only exception to this is construction sector. Construction sector also follows the same
principles for ROI if one considers cash profit rather than book profit.
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SECTION-III
5-LITERATURE REVIEW
Ms. Smita Jape, Assistant Professor, DR VN BRIMS
This section presents a review of published
research:
29 Research Papers
2 Theses
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Table 5.1 Summarized Table of an Overview of Research Papers Studied
Category Area Research
Paper
Countries Year Of
Publications
A Financial
Objectives of
Management
Paper No 1 U.S. 2001
B Leverage Paper No 2-8 U.S.,INDIA,U.K,CANA
DA
FROM 1999-2013
C Capital
Budgeting
Paper No 9-13 U.S., INDIA, ,CANADA,
SOUTH AFRICA,
FROM 2005-2012
D Capital Structure Paper 14-20 US,INDIA,TAIWAN,CH
INA
CANADA
FROM 1975-2011
E Cost of capital Paper 21-13 U.S. UNITED ARAB OF
EMIRATES,U.K
FROM 1978-2012
F Dividend Policy Paper 24-25 U.S., INDIA, ,CANADA,
AFRICA
FROM 1978-2013
G Corporate
decision making
Paper 26-29 US,INDIA,
SOUTHWEST
ASIA,CANADA
FROM 2000-2013
H Thesis on
corporate
finance
TH No 1-2 U.S. FROM 2000-2013
5.1 REVIEW OF PUBLISHED RESEARCH
Literature review of trends in finance included a study of 29 research papers in the area of finance
with focus on financial objectives, leverage, capital budgeting, capital structure, cost of capital
dividend policy and corporate financial decisions .The 29 papers represent an admixture of thoughts
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from different continents of the globe, America (Canada and U.S), Europe (UK), Asia (India China,
Taiwan) and Africa. The breakup of research area cum geographic point of origin is as follows.
Sixteen (55) % of papers come from U.S. and Europe as against thirteen (45%)from Asia and
Africa respectively. To start with, the summarized table tries to capture an overview of papers
studied and present a synoptic view of things to follow. This is further followed by a tabular
version of literature review which indicates the name of research paper along with that of the
journal, along with year of publication, the hypothesis , research issues addressed, the quantitative
methods deployed and last but not the least the outcome of the study. Following the tabulation a
brief and laconic description of details of every research paper is presented.
While discussing the trends in finance an attempt has been made to organise the matter in a manner
which helps to decipher the trends, area wise rather than the sequence of papers 1-28. As a result we
are in a position to understand trends in finance in terms of, the broad issues in financial
management viz,
a. sources of finance( Capital structure, leverage, and cost of capital ) ,
b. uses of finance ( Capital budgeting dividend payout. and
c. other areas like corporate financial decisions including what should be financial objectives
and Research needs in corporate finance
d. a cross country comparison of the trends in finance with respect to areas chosen for study
e. a holistic view of the spirit underlying the trends in finance:
An exploration of this 29 research papers has resulted in an understanding of cross cultural
dimensions relating to research in finance as well as the practice of finance in the respective
countries and continents.
Thus the following facts emerge
Deployment of measures of acceptability to appraise the economic worthiness of investment
proposals varies from continent to continent.
In Africa sophisticated measures of acceptability like IRR and NPV are not yet in vogue
unlike the experience in other continents.
Further the 29 research papers takes the reader through an array of tools and techniques used
for research are T test ,F test, Simple,Mutiple regression, averages and measures of
dispersion, coefficient of correlation and variance ,Chi square Test Tobin skewhanson and
Monograph-Trends in Finance Page 118
Anderson, and phi Test. In addition exploratory studies were used to capture the practices of
financial management in different countries viz In another case Likert scale was also used
as a statistical measure.
Thus the nature, scope art and science of finance are presented in juxtapositions along with unique
inputs which corroborate and complement the outcome of 29 research papers or contradict to
present a contrarian view on a particular area studied.
In South Africa companies tend to adopt advanced risk techniques like ‗Sensitivity‘ analysis
along with the traditional methods like ‗Shorter Payback Period,‘ and ‗High Cut off rates‘ .For
the purpose of incorporating risk in investment decision, Sensitivity analysis and key tools like
Monte Carlo and Decision Tree approach have not yet attracted the fancy of corporate in Africa
.It is further observed that adjusting for inflation and arriving at inflation adjusted cash flow
have found an increasing prevalence but in contrast the otherwise acceptable IRR method,
Modifying IRR has limited role in the economic process.
The papers published In U.S. shows; the use of sophisticated techniques varies with the size
of the firm and with the type of project under consideration. The findings show an increase
in the use of risk analysis techniques and sophisticated management techniques like Linear
programming, Game theory, Simulation, Nonlinear programming, utility theory, Critical
path etc in Continent America which is not prevalent in other continents like Asia and
Africa.
Research papers in U,S, indicated use of real options technique to supplement NPV method
in capital budgeting ,is accepted as a current trend ,whereas papers in China suggests
NPV as still preferred option for capital budgeting decisions.
While comparing the trends in capital structure of different corporate in various continents further
findings supports that the average firms adjustment speeds towards target debt ratio have increased
in all South American countries over the period (1900-2004)of financial liberalization. On the
contrary, firms‘ adjustment speeds did not increase in Southeast Asian countries. Deviations from
target debt ratio are halved within 1.09 years in South America and 1.19 years in Southeast Asia,
suggesting speed of adjustment is relatively faster in South American countries than the -Southeast
Asian countries.
Monograph-Trends in Finance Page 119
The findings as per sectors are different in the way that financial risk -that is the risk arising out of
degree of financial leverage, it is well understood that proportion of debt fund provided by the long
term debt as well as by short-term debt is significantly related to the level of financial risk of the
firms under Cement, Food, Pharmaceutical, Information technology, Steel and Textile sectors.‖
Panel multiple regression results show that the maturity of the debt capital market has a significant
and positive influence on the firms' capital structure. In contrast, developments in the equity capital
market have an inverse impact on the debt ratios of property companies in real estate sector only.
The overall findings of dividend policy are interesting and suggest as follows;
Analysis of influence of tax regime changes shows that the tradeoff theory does not hold true in the
Indian context, as Indian corporate firms on average do not appear to have increased dividend
payments despite a tilt in tax regime in favor of more dividends. Trends indicate that the number of
firms paying dividend has shown down trend till 2002 and has risen subsequently and decreased
again in 2008. Average DPS on the other hand has shown a declined till 1999, and has shown
growth from 2002 to 2008. Average percentage DPR showed a more fluctuating pattern throughout
the period of study. Analysis also shows that only a few firms have consistently paid same levels of
dividend. Companies paying dividends regularly, have consistently paid higher payout as well as
higher average dividend compared to that of current payers. Initiators have always paid higher
levels of dividend yield compared to that of other payers. Industry trends indicate that firms in the
electricity, mining and diversified industries have paid higher dividends where as textile companies
have paid less dividends. The research finding establishes the validity of the Linter model in the
emerging Indian market. The findings establish the relationship between current dividend as
dependent variable and current earnings and past dividend as independent variables and results
show that Indian firm relies both on past dividend and current earnings in deciding the dividend
payout .The dividend policies are also influenced greatly by implications of market inefficiencies
,behavioral approach than were in earlier periods
Monograph-Trends in Finance Page 120
5.2 A REVIEW OF RESEARCH PAPERS -A PROFILE
5.2.1 Topic: Financial Objectives of Business: Research Papers (1)
Name of
Research
Paper
Name of
Journal /
Year of
publication
Hypothesis
/ Research
Questions
Quantitative
Models used
Outcome of study
1)"The
Theory
and
Practice
of
Corporate
Finance:
Evidence
From the
Field
Financial
Management
Association
International,
Ronald D.
Vol. 5, 20
US.
How it‘s
difficult for
CFOs to
decide
optimal
composition
of capital
structure
as
imbalance
of this can
affect
shareholders
in the long
run and can
give
benefits in
the short
run.
F TEST
LIKERT
Scale
T est
Multiple
regression
Analysis
A vast
majority of
companies
do use the
capital asset
pricing
model
(CAPM),
which they
didn't do 20
years ago."
The objective to maximize Earnings
Before Interest and Taxes (EBIT) and
Earnings Per Share (EPS) is very
important while making corporate
financial decisions .
The recent trend observed that
companies are relatively more
concerned about the maximization of
the spread between Return on Assets
(ROA) and Weighted Average Cost of
Capital (WACC), i.e. Economic Value
Added (EVA).as well as CVA (spread
between cash flow ROI and
WACC)which was not considered
significant during pre liberalization
period.
Monograph-Trends in Finance Page 121
5.2.2 Topic: Financial Leverage: Research Papers (2-8)
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative Models
used
Outcome of study
2)Ross model of
financial leverage
Journal of
financial and
quantitative
analysis 1978
M.Ross
Tests the
association
between
leverage and
the value of
the firm.
T test, F test,
Multiple regression
There is positive
association between
leverage and the
value of the firm.
3) Determinants of
Financial
Leverage:
Further Evidence
Chartered
Accountant,
29 (6), '451 -
456 (1980)
Bhat
Ramesh K.,
Addresses
the
relationship
between
financial
leverage and
operational
characteristics
Coefficient of
correlation, Variance
There is a positive
correlation
between financial
leverage and
operational
characteristics of a
firm viz size,
business risk, and
profitability.
Monograph-Trends in Finance Page 122
4Determinants of
Financial Leverage
and
Operating
Leverage,
Chartered
Accountant,
519-527
(1983).
Ventkateshan
Journal of
Chartered
accountant
1983'
Examines
the systematic
relationship
between
insider
(managers)
holding and
debt.
Mean, Regression,
Standard deviation,
Coefficient of
correlation
A high level of debt
increases the risk of
firms stock and
tends to drive out
shareholders,.
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
5) Determinants of
Capital Structure
Research
Journal in
Finance, 7, 1-
19 (1988) by
Friend and
Hasbrouck
Andy Chem,
Relationship
between
financial
leverage and
industrial
classification
T test, F test,
Multiple regression
There is Positive
relationship between
leverage and key
characteristics of the
firm viz dividend
payout and operating
leverage.
Monograph-Trends in Finance Page 123
6)The Impact of
Operating and
Financial Risk
Journal of
.Economics
and Finance
(1996
By Richard
Lord
Studied the
association
between
the degree of
operating
leverage,
and the ratio
of net profit
to firm value
Coefficient of
Correlation
Multiple regression
Financial risk
Found to be positively
correlated with
degree of operating
leverage and the ratio
of net profit to firm
value
7).How do
Investors Judge the
Risk of Financial
Items?
Accounting
Review, 80
(1), 221-242
(2005)
Lisa Koonce,
McAnally
and Mercer
How do
investors
perceive the
financial risk
Coefficient of
correlation and
Multiple regression
Financial leverage
while positively
related to total and
unsystematic risk,
does not appear to be
related to systematic
risk.
8)The Impact of
Financial Risk on
Capital Structure-
Decisions in
Selected Industries:
A Descriptive
Analysis-
Advances in
management
,2011
Raiyani
Jagdish
R.INDIA-
Volume 4
Is there any
impact of
financial risk
on capital
structure
decisions in
Indian
industries?
Mean, Regression,
Standard deviation,
Coefficient of
correlation,
Variance,
F TEST
Proportion of debt
fund provided by long
term debt as well as
short-term debt is
significantly related to
the level of financial
risk of the firms in
Cement, Food,
Pharmaceutical,
Information
Technology, Steel
and Textile sectors.‖
Monograph-Trends in Finance Page 124
5.2.3 Topic: Capital Investment Decisions-Research papers 9—10
5.2.3.1 Study of practices followed in corporate 11-13
Name of
Research
Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
Monograph-Trends in Finance Page 125
9)Capital
budgeting
practices
in South
Africa: A
review
South
.African
.Journal
.Business
.Manageme
nt
. 43(2), C
Correia
University
of Cape
Town,
Republic of
South
Africa
2012
Is capital
budgeting
consistent
with the
maximization
of
Shareholder
wealth in
South
Africa?
Descriptive
F TEST
Likert Scale
Test
Multiple
regression
Analysis
1)There has been growth in the use of
Net Present Value (NPV) method
2) The Internal Rate of Return (IRR)
technique remains the primary method
used in practice despite some serious
draw backs.
3) Larger companies are more likely to
use DCF methods.
4) There has been a significant growth
in the use of sensitivity analysis and
scenario analysis.
5) Increase in spending of capital
expenditures Showed increase in
returns to shareholders surveyed.
During the 1955-1975 period covered
by seven studies. Reported percentage
use of discounted cash flow techniques
rose from 9%" to 66%.
The use of discounting is highest for
expansion type
Projects. An expansion decision
involves a choice: should we or should,
we not move into expansion in this
country or product area? Sensitivity
analysis is the most widely adopted
risk evaluation method.
Monograph-Trends in Finance Page 126
10)
The Continuing
Increase in
the Use of
Sophisticated
Capital Budgeting
Techniques
Thomas P.
Klammer
Michael C.
Walker
California
Management
Review
Vol. XXVII.
No. 1, Fall
1984
, The Regents
of the
University of
California
― There is an
Increase in use
of sophisticated
capital
budgeting
Techniques in
industry‖
Results of three
separate
questionnaire surveys
dealing with
the capital budgeting
practices of large
firms conducted
in 1970, 1975, and
1980
Past trends indicate a
continued increase in the
use of sophisticated
capital budgeting
techniques by large firms
11)Survey and
analysis of capital
budgeting methods
Journal of
finance
March 2008
"Hanwen
Chen
Xiamen
University
by Schall,
LD; Sundem,
GL;
Geijsbeek, in
Whether the
"smarter‖
Investment
decisions are
resulting in
an increase in
productivity.
F TEST
Likert Scale
T est
Multiple regression
Analysis
Results show positive
increase in
productivity along with
more use of Capital
budgeting techniques
proved
smarter‖
investment decisions,
are resulting in an
increase in
productivity
Monograph-Trends in Finance Page 127
12)Research Paper:
Capital Budgeting
Practices in
Manufacturing
Sector in India
International
Journal Of
Commerce
and
Management
Monika
Verma
2010
1) There is a positive
association between
capital budget and use
of NPV whereas
capital budget is
negatively correlated
with use of payback
method
2)There is no
significant relation
between capital Budget
and IRR (Internal
Rate of
Return),ARR,(Annual
Rate of Return
PI,(Profitability Index)
and sensitivity analysis
Monograph-Trends in Finance Page 128
3)A Survey of
Capital Budgeting
Practices in
Corporate India
The Journal
of Business
Perspective l
Vol. 13 l No.
3 l July–
September
2009
Satish
Verma,
Sanjeev
Gupta and
Roopali Batra
1)Examining
the corporate
practices
regarding the
methods of
capital
budgeting
used for
evaluating
an
investment
proposal.
(ii)
Analyzing
the corporate
practices
regarding
risk
techniques of
capital
budgeting
used for
Adjusting
risk in
investment
proposals.
Comprehensive
primary survey
conducted in
companies in India
1)Respondent
companies mentioned
cost of debt as the best
discount rate followed
by the weighted
average cost of capital
preferred by 45%
companies followed by
rate of return and cost
of retained earnings
2) Sensitivity
analysis is the most
widely adopted risk
evaluation method.
3) Survey findings
indicate that decisions
regarding leasing is
increasingly being
included as part of the
capital budgeting
process with the
percentage rising from
55% in 1965 to 80% in
1980.
Monograph-Trends in Finance Page 129
5.2.4 Capital Structure - Research Papers — 14-20
5.2.4.1 Study of practices followed in Corporates--21-22
Name of
Research
Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
Monograph-Trends in Finance Page 130
14)Debt
Capacity
and Tests
of Capital
Structure
Theories
Journal of
Financial and
Quantitative
Analysis Vol.
45,
No. 5,2010,
pp.
1161–1187
Michael L.
Lemmon and
Jaime F.
Zender*
Studies
designed
to detect the
research question
―whether the
tradeoff theory
or the pecking
order theory best
describes the
financing choices
of corporations‖
Multiple
regression
coefficient of
correlation,
variance
1) The issuers
of significant
amounts of equity
are, on an average,
growing very
fast (average growth
in assets is49.8%
annually as compared
to 10.6% for
nonissuers) and
losing money average return
on assets
(ROA) is –0.024
compared to 0.107
for nonissuers).
2)Equity issuers
have relatively
low leverage prior
to the issue. *Group
of firms most likely
to be constrained
by debt capacity. Firms
facing debt capacity
constraints (generally small,
high-growth firms) see
significantly
less negative market
reactions to announcements
of
Monograph-Trends in Finance Page 131
Equity issues when compared
to unconstrained (generally
large, mature) firms. Overall,
the evidence suggests that the
frequent equity issues by
young, high-growth firms are
consistent with the existence of
debt capacity constraints and
do not contradict a version of
the pecking order that
recognizes limits to the use of
debt financing.
15)Financial
liberalization and
firms‘ capital
structure
adjustments
evidence from
Southeast Asia and
South America
Journal of
economics
and finance ,
Rashid
Ameer 2010
# Springer
H1:
Adjustment
costs are
important in
explaining
firms
adjustment
towards their
target debt
ratio
Mean,
Median,
Standard
Deviation,
Partial
Adjustment
model
The estimated adjustment
coefficients imply that on
average firms‘ adjustment
speeds towards target debt
ratio have increased in all
South American countries over
the period (1990-2004)of
financial liberalization. On the
contrary, firms‘ adjustment
speeds did not increase in
Southeast Asian countries.
Monograph-Trends in Finance Page 132
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
Deviations
from target debt ratio
are halved within
1.09 years in South
America and 1.19
years in Southeast
Asia, suggesting
speed of adjustment
is relatively faster
in South American
countries than
Southeast Asian
Countries.
Monograph-Trends in Finance Page 133
16) Multi objective
Capital Structure
Modeling: An
Empirical
Investigation of
Goal Programming
Model Using
Accounting
Proxies
Journal of
Accounting,
Auditing and
Finance2012
by Yamini
Agarwal1, K.
Chandrashekar
Iyer1, and
Surendra S.
Yadav
The study has
explored the
relationship
of leverage
ratio with
market
capitalization
and earnings
per share
(EPS).
Correlations
between
market
capitalization,
and EPS
Coefficient
of
correlation,
Sensitivity
Multiple
regression,
Jarque Bera
Test
A
quantitative
approach
using goal
programming
model is
deployed to
capture
multiple goal
before
enterprise.
1)Leverage ratios were
found to be highly
negatively correlated with
market capitalization, in
all industries except high
asset base industries like
capital goods, chemical and
petrochemical,
health care, metal and metal
products, oil and gas,
tourism, transport
equipment, transport
Services.
Monograph-Trends in Finance Page 134
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
Monograph-Trends in Finance Page 135
17) Where Did All
the Dollars Go?
The Effect of Cash
Flows on Capital
and Asset Structure
Journal of
Financial and
Quantitative
Analysis Vol.
46,
Sudipto
Dasgupta,
Thomas H.
Noe, and
Zhen Wang.
2011
The paper
studies the
sensitivity of
levels of cash
flow of the
firm with
respect to
investment
decisions
Coefficient of
correlation
regression
Tobins Q
1)A sensitivity of
investment levels to
cash flows indicates
that the cost of internal
finance is lower than
that of external finance
2)The variation in the
cost is attributed to
―agency cost ,agency
conflicts, or adverse
selection.
3) The firms follow
pecking order in use of
funds, First delivering,
saving cash, second
raising external
financing and then
lastly investing. In the
short term, the
noninvestment uses of
cash dominate. Firms
mainly reduce external
financing and add to
their cash balances.
However,
subsequently, firms
step up investment.
The so-called
unconstrained firms
step up investment
more by raising
additional external
funds and drawing
down their cash
Monograph-Trends in Finance Page 136
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
Constrained
firms also step up
Investment, but not as
much. These firms do
increase short-term
debt financing in
subsequent years, but
they do not increase
long -term debt. They
actually reduce equity
financing.
Monograph-Trends in Finance Page 137
18)Manager
Characteristics and
Capital Structure:
Theory and
Evidence
Journal of
financial and
quantitative
analysis vol.
46, 2011,
university of
Washington,
Sanjai
Bhagat, Brian
Bolton, and
Ajay
Subramanian
in
The paper
tests the
hypothesis
―Manager
characteristic
has an impact
on capital
structure in a
structural
model ―
Coefficient of
correlation
regression
P Hansen sargon
test ,Anderson
rubin est
1)It implements the
manager‘s optimal
contracts through
financial securities that
lead to a dynamic
capital structure, which
reflects the effects of
taxes, bankruptcy
costs, and manager-
shareholder agency
conflicts
2)Long-term debt
declines with the
manager‘s ability,
inside equity stake, and
the firm‘s long-term
risk, but increases with
its short-term risk.
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
Monograph-Trends in Finance Page 138
19)Debt and taxes
Nobel Prize-
winning
Franco
Modigliani
and Merton
Miller papers
in the 1950s
How to make
effective
capital
structure
decisions?
Coefficient of
correlation
regression
Asserts that companies
choose their capital
structure on the basis
of a trade-off between
the benefits of debt
(the tax deductibility of
interest payments) and
the drawbacks of debt
(higher interest
payments).
19b) Debt and
taxes
Miller, M.H.,
1977. Debt
and taxes.
Journal of
Finance 32,
261-275.
Has the trend
of capital
structure
corporate
decision
making has
been changed
over the
period of 20
years(1950-
1977)
Coefficient of
correlation
Phi test
Chi square test
―Maintaining financial
flexibility‖ — as the
most important factor
i.e, keeping debt levels
low in order to be
ready for unforeseen
opportunities but the
use of other practices
remain unchanged.
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
Monograph-Trends in Finance Page 139
20) How and When
Do Firms Adjust
Their Capital
Structures toward
Targets and if there
are adverse
selection costs
associated with
asymmetric
information
Journal of
Finance • vol.
Lxiii, no. 6 ,
2008
by Soku
Byoun-
Hypothesis
1) Small
firms and
firms without
bond ratings
adjust faster
when their
debt ratio is
above target
i) dividend-
paying firms
exhibit
a greater
tendency to
adjust their
capital
structure
toward the
target with a
financial
deficit/surplus
iii) firms with
better stock
performance
are slower to
adjust
iv) firms
with higher
operating
profits use
more debt
when they
have financial
deficits
F TEST
Test
Multiple regression
Analysis
Altman‘s z score
1)Most adjustments
occur when firms have
above-target (below-
target) debt with a
financial surplus
(deficit).
2) Firms move toward
the target capital
structure when they
face a financial
deficit/surplus—but
not in the manner
hypothesized by the
traditional pecking
order theory
The target debt level is
estimated by the
predicted
value from a cross-
sectional Multiple
regression each year,
where the total/long-
term debt divided by
book/market value of
assets is regressed on
the following
variables: industry
median debt ratio;
marginal tax rate;
operating income
divided by assets;
market-to-book ratio
of assets; log of book
value of assets;
Monograph-Trends in Finance Page 140
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
v) firms with
high MB use
less debt
when facing
financial
deficits
(because debt
is less
attractive to
high
growth firms
and/or equity
financing is
less
restrictive)
than do firms
with low
MB.
depreciation and
amortization divided
by assets; fixed assets
divided by assets;
research and
development (RandD)
expenditures divided
by assets; a dummy
variable for missing
RandD; cash dividends
divided by assets; and
Altman‘s Z-score.
TDE (total debt equity
represents the
deviation of
the total (long-term)
debt-to-asset book
(market) ratio from its
target.
Monograph-Trends in Finance Page 141
5.2.5 Cost of Equity -- Research Papers 21-23
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
Monograph-Trends in Finance Page 142
21)Equity
mispricing
adjustment costs
Journal of
Financial and
Quantitative
analysis Vol. 47,
2012,.University
of Washington,
By Richard S.
Warr, William
B. Elliott,
Johanna
Ko¨eter-Kant,
Does Equity
mispricing
creates an
impact on
the speed at
which firms
adjust to
their target
leverage
(TL) and is it
done in a
predictable
way
depending on
whether the
firm is over
or under
levered.
H1-When the
firm is
overvalued
in the market
the firm
adjusts more
rapidly
towards its
TL-
Mean, Median,
Multiple
regression
,Standard
deviation,
Coefficient of
correlation
Variance,
F TEST
Coefficient
If equity is
overvalued in the
market, the firm‘s
cost of issuing equity
is reduced, whereas
undervalued equity
results in a higher
cost of equity. As the
cost of issuing equity
is altered in this
fashion and the firm
exploits or faces these
costs, so the rate at
which the firm adjusts
toward a target debt
ratio depends on the
degree of equity
mispricing.
Monograph-Trends in Finance Page 143
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
22)Effects of Audit
Quality on
Earnings
Management
and Cost
of Equity
Capital: Evidence
from China*
Canadian
Academic
Accounting
Hanwen chen
Jeff eyun
chen,
Gerald j.
lobo,
University
of Houston
vol 28
2010
― The quality
of audit
creates an
effects on
earnings
management
―Is cost of
equity
capital more
pronounced
for SOEs.
(State owned
enterprises)
than
for NSOEs (
Not State
owned
enterprises
Regression
T test
State Owned
Enterprises and Not
State owned
enterprises
differ
in the nature
of their ownership,
agency relations,
and bankruptcy
risks, which
lead to differences
in the effectiveness
of auditing
in reducing
Financial reporting
and investors‘ pricing
of information
risk.
Monograph-Trends in Finance Page 144
23) Disagreement
and the Cost of
Capital
Journal of
Accounting
Research
Vol. 49
Robert
Bobert
Bloomfield
and
Paule,Fischer
March 2011
The paper
assess how
forms of
disagreement
among
investors
affect a
firm‘s cost of
capital.
Coefficient of
correlation
regression
Phi test
Chi square test
―Cost of capital is
driven not only by
investors‘ uncertainty
about the firm‘s future,
earnings performance,
but also by investors‘
uncertainty about the
evolution of beliefs,
which partly
determines the path of
price Theory of perfect
market.
5.2.6 Dividend policy- Research Papers - 24-25
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
Monograph-Trends in Finance Page 145
24) The interaction
of corporate
dividend policy and
capital structure
decisions under
differential tax
regimes
Journal of
Economic
Finance
2012
James Owers
The
interaction of
corporate
dividend
policy and
capital
structure
decisions
under
differential
tax regimes
is studied in
the paper .
Exploratory
1) When the dividend
tax rate exceeds the
capital gains tax rate,
dividend payout can
partially offset value-
enhancing effects of
leverage.
2) When the two rates
are close, dividend
payout loses its
moderating influence.
Monograph-Trends in Finance Page 146
25) Dividend
policy of Indian
corporate firms: an
analysis
,
Asia Pacific
journal of
research
in business
management
DR. Sanjay
J. Bhayani*
2010
The present
study
examines the
dividend
behavior of
Indian
corporate
firms over
the period
1997 – 2008
and attempts
to explain the
observed
behaviour
with the help
of trade-off
theory
Regression
pooled OLS
regressions
Results support the
Linter model.
1)Dividend stability of
firms in India show
that Indian firm relies
both on past dividend
and current earnings in
deciding the current
period‘s payment of
dividends.
2) Dividend trends in
India indicate that the
number of firms
paying dividend during
the study period has
shown down trend till
2002 and has risen
subsequently and
decreased again in
2008.
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
Monograph-Trends in Finance Page 147
3)Average DPS on the
other hand has shown a
declined till 1999, and
has shown
growth from 2002 to
2008. Average
percentage DPR
showed a more
fluctuating
pattern throughout the
period of study. The
results of Linter‘s
model to test for
dividend stability of
firms in India show
that Indian firms rely
both on past dividend
and current earnings in
deciding the current
period‘s payment of
dividends.
Monograph-Trends in Finance Page 148
5.2.7 Corporate Decision making Research Papers 26-29
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
26)Research Needs
in Corporate
Finance:
Perspectives
GabrielG .
Ramirez,D
avidA .
Waldman,
and DennisJ .
New York
Financial
Management
vol 20--1989
Addresses
perceptions
of important,
less-
addressed
problems in
corporate
finance in
order to
direct future
financial
research
Addressed
needs of
research in 4
areas
Operational
financing
long-term
financing
regulatory
Control and
ownership
Areas.
Coefficient of
correlation
Regression
Phi test
Chi square test
Concluded that
regulatory and long
term financing
problems are more
important and needs
more attention.
Monograph-Trends in Finance Page 149
27)corporate
financial decisions
an empirical study,
Investment and
Financing in the
Corporate Sector in
India
Tata
McGraw-Hall
Publishing
Co. Ltd. New
Delhi; pp160
Krishna
Murthy and
D. U. Sastry.
Tries to
understand
interesting
inter-
relationships
between the
triad
decisions of
investment,
financing and
dividends
Exploratory
research
data of financial
statements
1) Dividends get a first
claim and hence
retained earnings for
re-investment is
residual in character.
2) Dividend decisions
are autonomous of
investment decisions
and the availability of
external financing.
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
28)Adding
flexibility for NPV
method in capital
budgeting.
Global
conference
on business
and finance
proceeding
June 2012vol
7 by Chen
Jeng Hong
―Addressed
the research
question of
use of NPV
method to
supplement
the other
Exploratory
research
Data of financial
statements
1)NPV is the most
popular method
2) Large companies
tend to adopt
sensitivity analysis
method for
incorporating risk in
capital budgeting.
3)Use of real options
to supplement the NPV
will be future trend
Monograph-Trends in Finance Page 150
29)Recent
Developments in
Corporate Finance
Major evolutionary
trend
Edward Elgar
Jay R. Ritter,
editor
October 19,
2003
Journal of
Financial
Economics, a
Brennan
prize
Prize winning
paper
The paper
studies
various
trends in
corporate
finance
related to the
impact of
taxation on
corporate
decision
making,
especially in
the areas of
capital
structure ,
payout
policy
F Test
Likertscale
T test
Multiple regression
Analysis
The recent trend and
shift of corporate
finance decision
making towards four
important aspects
1)Impact of taxation
on corporate decision
making, especially in
the areas of capital
structure
2) Corporate
governance issues.
3) Willingness to adopt
behavioral approaches,
including a willingness
to assume that
informational
inefficiencies are an
important determinant
of managerial choices.
4) Implications of
market inefficiencies
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
Monograph-Trends in Finance Page 151
Thesis 1)Corporate
Finance in the
1990s Implications
of a Changing
Competitive and
Financial Context*
Thesis
By D.
Lessard
Massachusetts
Institute of
Technology
Addresses
following
questions
:1)changes
in financial
functions in
context of
changing
competitive
and financial
environment
2) when
creditors,
with the
higher
leverage
levels of
LBOs,(
leverage
buyouts)
have a clear
interest in
having firms
hedge their
cash flow
exposures.
Why more
covenant do
not include
hedging
requirements
also is a
puzzle ?
Mean,
Regression
Standard deviation,
Coefficient of
correlation
Variance,
F TEST
1)Financial function
must simultaneously
be differentiated and
yet integrated into a
variety of other
specialist domains,
which in turn calls for
an expert manager -
neither
an isolated technical
specialist or a "thin
veneer" generalist, but
one who can operate
in both domains.'
2)These changes have
created two often
opposing pulls on
financial management
.On the one hand, they
call for a deepening of
financial technology
and, hence, an increase
in the specialist nature
of financial
management.
Requirements for such
deepening include
extending risk
management from one
dimensional matching
to multi-dimensional
dynamic approaches
Monograph-Trends in Finance Page 152
Name of
Research Paper
Name of
Journal /
Year of
publication
Hypothesis /
Research
Questions
Quantitative
Models used
Outcome of study
2)Thesis
The theory of
corporate
finance—A
historical overview
Phd Thesis
Michael
Jenson
Harward
Business
school
A review of
the trends
and
development
of the
modern
theory of
corporate
finance.
Coefficient of
correlation
Regression
Phi test
Chi square test
The efficient market
hypothesis holds that a
market is efficient if it
is impossible
to make economic
profits by trading on
available information.
The thesis covers all
the study of all theories
evolved over a period
of 5oyears including
portfolio, efficient
market,
Monograph-Trends in Finance Page 153
5.2.8 DETAILED REVIEW OF RESEARCH PAPERS (23) AND THESIS (2)
GROUP TOPIC RESEARCH PAPERS
A Financial objectives Research Paper 1
B Leverage Research Papers 2,4,6,8,13
C Capital investment decisions Research Paper 9,12,13,14
Other paper (1)
D Capital structure ResearchPapers16,18,20,21,27
Other paper(1)
E Cost of capital Three other papers studied(3)
F
Dividend Policy Research Papers No 24,25
G Corporate Financial Decisions Research Paper 29,
Thesis 1 and 2
Monograph-Trends in Finance Page 154
The trends observed through key findings of the literature review are
as follows:
The objective to maximize Earnings Before Interest and Taxes
(EBIT) and Earnings Per Share (EPS) are very important while
making corporate financial decisions in business.
Companies are relatively more concerned about the
maximization of the spread between Return on Assets (ROA)
and Weighted Average Cost of Capital (WACC), Economic
Value Added (EVA) as well as Market Value Added (MVA)
which was not considered significant during pre liberalization
period.
The high growth firms, using sales as the basis, are
significantly more likely to use maximizing EVA as their
objective of financial management than low growth firms.
The firms with high growth in assets are giving significantly
more importance to the maximization of MVA as a corporate
objective than firms with low growth in assets
*Source: Economics and politics of corporate finance
&corporate control Cambridge university press200 pg 109
In India corporate objective
is largely biased towards
shareholders wealth
maximization philosophy.
The Kumar Mangalam Birla
Committee on corporate
governance in India in its
report observed that ― The
fundamental objective of
corporate governance is the
maximization or
enhancement of long term
shareholders value while
protecting the interest of
other stakeholders‖
Research Paper1: The
Theory and Practice of
Corporate Finance:
Evidence From the Field:
Financial Management
Association International,
Ronald D
Vol 5, 2002
*A contrarian view by German banker Carl
Firsternberg, offers an extreme version on
how shareholders were regarded by German
managers
*―Shareholders are impertinent because they
give their money to somebody else without
effective control over, what the person is
doing with it, and impertinent because they
ask dividend as a reward for their
stupidity .‖
A) Financial Objectives of Business:
I
I
I
Monograph-Trends in Finance Page 155
'Theory of maximizing shareholder value has done great harm
to businesses'
―I would argue that companies should go beyond their worship of shareholders
who often don‘t care about the company and jump in and out of owning its
stock. The theory of maximizing ―shareholder value‖ has done great harm to
businesses.
I have argued that smart companies must focus on the other stakeholders first –
customers, employees, suppliers and distributor.
Those companies that operate on the triple bottom-line — people, planning
and profits – will outperform those who only pursue profit”.
(Monday, August 27, 2012 - DNA Vivek Kaul
A) Financial Objectives of Business:
I
I
I
―We find among the excellent companies a few common attributes that unify
them despite their different values. First .....these values are almost always stated
in qualitative rather than quantitative terms. When financial objectives are
mentioned, they are almost always stated in ambitious but never precise Further
more financial and strategic objectives are never stated alone. They are always
discussed in the context of other things the company expects to do well .The
idea is that profit is a natural byproduct of doing something well, not an end
in itself.”
Source: Fundamentals of Financial Management by Brigham &Houston
Monograph-Trends in Finance Page 156
Profit maximization
doesn‟t make sense as a
corporate objective due
to three reasons
1) Maximizing profits?
Which years profits?
Shareholders might not
want the manager to
increase next years profit
at the expense of profits in
last years profits in later
years
2)A company may be able
to increase future profits
by cutting its dividend and
investing the cash. That is
not in the shareholders
interest if a company earns
only a few return on
investment.
3) Different accounts may
calculate profits in
different ways. So you
find the decision that
improves in one accounts
eyes will reduce them in
another‘s.
Fundamentals of Financial
management by Brigham
and Houstan pg No 24
Well managed companies have corporate eyes on
performance indicators other than ROI,RI,
Detailed costing variances, bottom line profits,
cash flow, earning per share. Peters and
Waterman argue that if companies performance
in buying raw materials making and selling their
products and looking after their workforce is
planned, monitored and controlled in a manner
which displays both aggression and sensitivity,
bottom line profits will look after themselves.
With an even more telling observation Peters and
Waterman condemned the obsession that some
companies have detail financial objectives.
In under performing companies they were
familiar with the only objectives that
management got animated about where the
ones that could be quantified- the financial
objectives such as earning per share and
growth measures. Ironically the companies that
seemed the most focused- those with the most
quantified statements of mission, with the most
precise financial target- had done less well
financially than those worth broader less precise,
more qualitative statements of corporate purpose
Financial management by Mayors Brearly (page
281)
• Economic Value Added (or EVA), a registered
trademark of the consulting firm, Stern Stewart & Co.,
is another close cousin of the NPV method.
• The EVA method begins the same way that NPV
does—by calculating a project‘s net cash flows.
• However, the EVA approach subtracts from those cash
flows a charge that is designed to capture the return
that the firm‘s investors demand on the project.
• EVA determines whether a project earns a pure
economic profit–a profit above and beyond the
normal competitive rate of return in a line of business.
*EVA=Spread across ROI ( Return on Investment) and
Monograph-Trends in Finance Page 157
Half of India's top firms have destroyed shareholder wealth since FY08For a majority of the value
destroyers; borrowings now exceed their market value, putting them in a debt trap
If retail investors are still shying away from equity markets, there is a solid reason. Nearly half of India‟s top
companies have destroyed shareholder value since the 2008 Lehman crisis. Their market capitalization has
failed to keep pace with expansion in their balance sheets. As many as 77 of the 155 BSE-200 companies
(excluding banking and financial ones) have either reported a decline in their market value since March
2008 or the rise in market capitalization has lagged the increase in capital employed in the business.
The proportion of value destroyers shoots up to 65 per cent if information technology (IT), FMCG and
pharmaceutical companies are excluded from the list. For a majority of the value destroyers (40 out of 77),
borrowings now exceed their market value, putting them in a debt trap.
“A company‟s return on capital employed (ROCE) is the sum of return on equity and return on borrowed
capital, minus interest cost. So when ROCE starts falling, managements try to juice it up by increasing
borrowings. But, if an economic downturn gets prolonged, like it happened after the global financial crisis of
2008, many companies find themselves in a vicious cycle of falling returns and market value and rising
indebtedness,” explains Nitin Jain, head, capital markets, Edelweiss Capital.
Topping the list of companies whose market value has lagged balance-sheet expansion since March 2008 is
Reliance Industries (RIL).
On the positive side, TCS is the biggest value creator, followed by ITC, Infosys, Sun Pharma (Rs 85,000
crore) and Hindustan Unilever.
In the past five years, RIL‟s balance sheet (sum of shareholders‟ equity and borrowings) has increased at a
compound annual growth rate (CAGR) of 15.7 per cent to Rs 2.90 lakh crore at the end of March 2013, from
around Rs 1.40 lakh crore in 2006-07. During this period, its market capitalization declined over Rs 51,000
crore. In other words, RIL‟s market value should have been at least Rs 2.02 lakh crore higher to justify the
growth in its equity and debt during the period. The story is the same for Bharti Airtel, the balance sheet of
which quadrupled during the period as it bought more 3G and 4G spectrum in auctions and acquired Zain
Africa in 2010 for over $10 billion. The company‟s market capitalization, however, declined nearly Rs
22,000 crore during the period, destroying shareholder value in the process. Government-owned Coal India
is an example of a company that destroyed wealth despite being a debt-free entity. The biggest problem are
companies in capital-intensive sectors like telecom, power, construction & infrastructure, metals, mining
and oil & gas. These companies continue to accumulate liabilities, despite a visible decline in return ratios
beginning 2007-08.
Reliance Industries‟ ROCE declined to 10.2 per cent in 2012-13 from 17.2 per cent in 2007-08, while Bharti
Airtel‟s RoCE fell to 7.5 per cent in 2012-13 from 24.5 per cent in 2007-08, as profitability failed to keep
pace with rising balance sheet. RoCE . “Value destruction is common in capital-intensive sectors during an
economic downturn.
Business India Krishna Kant February 19, 2014
Monograph-Trends in Finance Page 158
There is a positive relationship between leverage and key
characteristics of the firm viz size, business risk,
profitability and dividend payout.
The role of leverage in market capitalization and EPS is
studied and negative correlation is observed between
leverage and market capitalization .However EPS is
positively correlated with leverage
With regard to financial risk that is the risk arising out of
degree of financial leverage, it is observed that proportion
of debt fund provided by the long term debt as well as by
short-term debt is related to the level of financial risk .
Financial risk variables, particularly risk followed by
volatility in ROE, have significant effect on determining the
additional variation in use of debt financing in business
through long-term sources among firms.
* There is positive correlation between financial leverage and
unsystematic risk, however it does not show any correlation to
systematic risk
.
Research Paper:4
Determinants of Capital
Structure Research
Journal in Finance, 7, 1-
19 (1988) by Friend
and Hasbrouck Andy
Chem
Research
Paper2:Determinants of
Financial Leverage:
Chartered Accountant, 29
(6), 451 -456 (1980)Bhat
Ramesh K.
B) Area :Leverage
* Portfolio or market risk – the variability in
shareholders returns. Investors can significantly reduce
their variability in earnings by holding carefully selected
investment portfolios. This is sometimes called „relevant‟
risk, because only this element of risk should be
considered by a well-diversified shareholder
Financial leverage is increased by issuing more debt,
thereby incurring more fixed-interest charges and
increasing the variability in net earnings. this is the risk,
over and above business risk, which results from the use
of debt capital.
Research Paper 8:
The Impact of Financial
Risk on Capital
Structure-Decisions in
Selected Indian
Industries: A Descriptive
Analysis- Raiyani
Jagdish R.India -
Volume 4 Advances in
management ,2011
Monograph-Trends in Finance Page 159
Pecking order theory describes that managers select capital with the
following preferences like internal finance, debt, and equity
(Myers and Majluf, 1986) The paper assumes that managers do not
seek any optimal level of leverage while making corporate financial
decisions.
Mahindra &Mahindra (M&M)
M &M is a federation of companies with a decentralised approach to treasury
management. There are some companies that Group Finance is mandated to support
from a treasury perspective. However, typically each subsidiary company has its
own CFO who is responsible for day-to-day management of cash and risk.
One Mahindra-Win Win Proposition
. Corporate treasury acts as the facilitator of these arrangements, identifying
and executing on opportunities for intercompany borrowing and lending. Cash
remains within the group, there is a balance sheet advantage, risk is eliminated,
and there are no guarantees or covenants required for external lenders.
Source : V.S. Parthasarathy, Group CIO, EVP – Group M&A, Finance and
Accounts, Member of the Group Executive Board, Mahindra & Mahindra
:-―Financial risk is an Umbrella term for multiple types of
risk associated with financing, including financial transactions
that include company loans in risk of default. Risk is a term
often used to imply downside risk meaning the uncertainty of a
return and the potential for financial loss
Monograph-Trends in Finance Page 160
“Investment thus defined includes, the increment of capital
equipment, whether it consists of fixed capital, working capital
or liquid capital and significant differences of definitions (apart
from the difference between the investment and net investment
)are due to exclusion from investment of one or more of these
categories.”
John Maynard Keynes( The general theory of employment )
The results of the surveys and findings of the research papers clearly
show that firms are increasingly using "sophisticated" capital
budgeting project appraisal techniques taught in business schools.
However these techniques are not uniformly applied and they are not
always the sole basis for decision making.
Increasing number of companies use discounted cash flow
methods like NPV and IRR for measuring the economic
worthiness of Investment proposals. Assessment of risk is
finding an important place in economic evaluation process.
Sensitivity analysis and methods like Monte Carlo and
Decision Tree approach has not yet attracted the fancy of the
corporate world..
Adjusting for inflation and arriving at inflation adjusted cash
flow have found an increasing prevalence.
Modifying IRR has limited role in the economic process
The use of sophisticated techniques obviously varies with the
firm and with the type of project under consideration. The
findings also show an increase in the use of risk analysis
techniques and management techniques (Linear
programming, Game theory, Simulation, Nonlinear
programming, utility theory, critical path etc .
Research Paper : 10
The continuing increase
in use of Sophisticated
Capital Budgeting
Techniques California
Management Review
Vol. XXVII. No. 1, Fall
1984
Research Papers : 9
Capital budgeting
practices in South
Africa: A review C.
Correia, University of
Cape Town, Republic of
South Africa
S.Afr.Journal .Business
.Management.2012,
43(2)
C) Area :Capital Investment
Decisions
Monograph-Trends in Finance Page 161
― There are also situations where the yield method may lead to different
decisions from those obtained by using the present value procedure. Thus the
measure of investment worth may give different rankings to the same set
of mutually exclusive Choices will be seriously deficient. In this light the
fact that the two discounted cash flow measures of investment worth may give
different rankings to the same set of exclusive investment proposals becomes
of considerable importance‖
(Source:Bierman and Smidt,The Capital Budgeting Decison,p.39
Thus it is interesting to note the observation of Bierman and Smidt
―The yield method gives less correct recommendations for mutually exclusive
investments than those that result from the application of the present value
method because it reflects the average rather than the incremental cash flows.
―
Source:Bierman and Smidt, The Capital Budgeting Decision,pg 41.)
Capital budgeting is very obviously a vital activity in business. Vast
sums of money can be easily wasted if the investment turns out to be
wrong or uneconomic. It builds on the concept of the future value of
money which may be spent now.
It does this by examining the techniques of net present value, internal
rate of return and annuities. The timing of cash flows are important in
new investment decisions.. One problem which plagues developing
countries is "inflation rates" which, in many cases even is double digit
However there may be cases where inflation can become a serious
proposition as it reaches to three digit inflation for .eg Countries like
Argentina, Zimbabwe and Germany where the inflation had reached to
three digit.
Source: Financial Management by Prasanna Chandra
Monograph-Trends in Finance Page 162
There is a Positive association between capital budget of
firm and use of NPV where as it is negatively correlated
with payback Method. However there is no correlation
between capital Budget and use of IRR, ARR, PI, and
sensitivity analysis
Payback and IRR are complementary to each other
There is a change in trend towards increased adoption of
sophisticated discounted capital budgeting practices like
NPV, IRR as compared to the non-discounted capital
budgeting techniques. However, among the traditional
techniques, Payback Period Method is still preferred in
majority of companies as a supplement to the DCF
techniques.
Majority of the companies in India, use the Weighted
Average Cost of Capital (WACC) for calculating the
Cost of Capital, which is used as a discount or cut off rate
or Minimum Acceptable Rate of Return
The study conducted by Pandey (1989) examined the capital
budgeting policies and practices of firms in India and
Research Paper : 13
Capital Budgeting
Practices in Corporate
India The Journal of
Business Perspective l
Vol. 13 l No. 3 l July–
September 2009Satish
Verma, Sanjeev Gupta
and Roopali Batra -3
For respect to future periods, we are focused to
deal with highly uncertain and merely conjectural
data.
Under these circumstances it is not only easily
understandable but even from the economic stand
point commendable the most people do not
attempt to repeat, for case after case and for year
after year ,the tedious and at the same time
deceptive calculation of the claims of present and
future. Source :Eugene Von Bohm-Bawark
Research Paper: 12
Capital Budgeting
Practices in
Manufacturing
Sector in India A
review ,International
Journal Of
Commerce and
Management
Monika Verma
2010
Research Paper 14:
Debt Capacity and Tests
of Capital structures
Theories by Michael
L.Lemmon and Jaime
Zender in Journal of
Financial and
Quantitative analysis
vol45,2010 University
of Washington 3
Monograph-Trends in Finance Page 163
compared them with those of U.S.A. and U.K. The study
reveals that payback period method is most widely used
followed by IRR as a capital budgeting technique. The
project risk is assessed through sensitivity analysis and
conservative forecasts.
Further it is observed from literature study of papers and
industry practices followed that the degree to which capital
budgeting tools used, is higher for large firms than for
small firms.. It is further noticed that firms incorporate risk
either by ‗Adjusting the discount rate‘ ‗shortening the
payback period‘ or with the help of methods like ‗Capital
Asset Pricing Model‘. that develops beta ―which identifies
the extent of risk of individual source of finance algorithm
quantified measures.
The trend shows that small corporations use Payback Period
or Accounting Rate of Return as their primary method of
project choice.
Large companies mostly use discounted cash flow methods
like IRR and not NPV The findings do not support the fact
that ―DCF dominant companies outperform non-
DCF dominant companies.‖( C. Correia ,2012 )
Discounted Cash Flow technique is used more often for
Capital Expenditure Decisions than decisions related to Lease
vs. Buy ,Acquisition Analysis ,Stock Selection Tool
,Minimization of Cost Function Inventory Management
,Cash Management ,Security and Portfolio Analysis
,Working Capital Management, and Financial Leverage
Decisions
The outcome of this paper supports the previous
findings that that net present value (NPV) method is very
Research Paper :
Adding flexibility for
NPV method in capital
budgeting. By Chen Jeng-
Hong1 Source: published
in Global conference on
business and finance
proceedings; Jun2012,
Vol. 7 --2
The use of capital budgeting
decisions observed from 1975 till
2013 shows following trend (Based
on industry practises )
Research Paper :26
Research Needs in
Corporate Finance
Perspectives from
financial managersby
Gabriel G.Ramirez
David A Walman and
Dennis J.New York
Management
Association
International
Adding flexibility for
NPV method in
capital budgeting
global conference on
business and finance
proceeding June
2012vol 7 by Chen
Jeng Hong
Monograph-Trends in Finance Page 164
popular and widely used by firms in capital budgeting in practice. The main
disadvantage of approach is that, it lacks flexibility and the firm needs to make the decision
today, in spite of uncertain factors that the project may face in the future. Hence use of real
options technique to supplement NPV method in capital budgeting will be the future trend.
For the purpose of incorporating risk in investment decision, companies tend to adopt
advanced risk techniques like ‗Sensitivity‘ analysis along with the traditional methods like
‗Shorter Payback Period,‘ ‗High Cut off rates‘ etc.
―Planning and control of capital expenditures is
the basic executive function ,Since
management is originally hired to take control
of stockholders fund and to maximize their
earning power therefore the there is problem of
administering management s trust ship over
capital ―
Managerial Economics Chapter 10Capital
Budgeting by Joel Dean Pg No569
Capital Budgeting ch 10 pg no551
C) Area: Capital Investment
Decisions
Source Financial Management by Dr.Guruprasad Murthy
Monograph-Trends in Finance Page 165
Leverage ratios were found to be negatively correlated
with market capitalization, in all industries except high
asset base industries like capital goods, chemical and
petrochemical, health care, metal and metal products, oil and
gas, tourism, transport equipment, transport services.
The most apparent effect of adverse selection costs is a firm‘s
preference for internal funds. Accordingly, in the presence of
adverse selection costs, firms may have target debt levels and
still prefer internal funds over costly external ones (Leary and
Roberts (2005) and Strebulaev (2007)).Indeed, there is evidence
that firms have target debt ratios but also prefer internal
financing to external financing (Hovakimian, Opler)
Many companies follow Capital structure as a function of a
trade-off between the tax deductibility of interest payments and
the risk of bankruptcy,
The trade-off theory of capital structure states that a firm selects
an optimal target leverage (TL) ratio that trades off the relative
costs and benefits of debt. Empirically, however, it is well
documented that firms deviate from their TL ratios and do not
rapidly adjust back to their target if they face costs to do so. If
the cost of issuing equity is altered in this fashion, and if the
firm exploits or faces these costs, then the rate at which the firm
adjusts toward a target debt ratio depends on the degree of
equity mispricing.
Long term debt declines with the manager‘s ability inside equity
stake and the firm‘s long term risk but increases with its short term
risk. Short term debt declines with the manager‘s ability and with
short term risk while it increases with equity ownership
1) Most adjustments occur when firms have above-target
(below-target) debt with a financial surplus (deficit).
Firms move toward the target capital structure when
They face a financial deficit/surplus but not in the manner
hypothesized by the traditional Pecking order theory
18)Manager Characteristics
and
Capital Structure:
Theory and Evidence
Journal of Financial and
Quantitative analysis vol. 46, 2011,
University of Washington,
Sanjai Bhagat, Brian Bolton
and Ajay Subramanian
journal of financial and quantitative
analysis vol. 46, 2011, university of
Washington,
Sanjai Bhagat, Brian Bolton, and Ajay
Subramanian in
D) Area :Capital Structure
Research Paper:16
Multiobjective Capital
Structure Modeling: An
Empirical Investigation
of Goal Programming
Model Using Accounting
Proxies by Yamini
Agarwal1, K.
Chandrashekar Iyer1,
and Surendra S. Yadav
in Journal of Accounting
Research Paper 20 :“How
& When do firms adjast
their Capital Structure
towards their target bY
Suku Buyon
Journal of Finance
Vol1,XIII.no6 2008
Monograph-Trends in Finance Page 166
Equity mispricing impacts the speed at which firms adjust to their
target leverage (TL) and does so in predictable ways depending on
whether the firm is over or under levered. For example, firms that are
above their TL should therefore issue equity (or retire debt) and
adjust more rapidly towards their target when their equity is
overvalued. However, when a firm is undervalued but needs to
reduce leverage, the speed of adjustment is much slower.
The findings support the role of equity mispricing as an important
factor that alters the cost of making capital structure adjustments.
However, when a firm is undervalued but needs to reduce leverage,
the speed of adjustment is much slower. The findings support the
role of equity mispricing as an important factor that alters the cost of
making capital structure adjustments.
A study on the capital structure policies of the private corporate
sector in India presents some very interesting results .The private
corporate enterprises do not have scope for further mobilization of
debt capital in view of the aggressive debt equity ratio.
Preference for short term debt in lieu of long term financing.
Private corporate enterprise had aggressive debt equity ratio
and therefore relatively poor debt service coverage ratio.
The CFOs give more importance to the decisions based on financial
flexibility. and EPS dilution and considers these as the main factors
in the decision to issue stock, But many academics argue that
company value is independent of the number of shares utstanding
and hence EPS dilution is not a decision making factor.
,
Research Papers :21
Equity Mispricing and
Leverage Adjustment
Costs byRichard S.
Warr, William B.
Elliott,Johanna Koeter-
kant
Journal of Financial and
Quantitative analysis
Vol. 47, 2012,.University
of Washington
Research Paper : 27
"The Theory and
Practice of Corporate
Finance: Evidence
From the Field" How
CFOs really Practice
Finance Ronald D.
Watson, Vol. 5,
Financial Management
Association
International
Capital Structure -
Private Corporate
Enterprises Research
Study- Brajkishor
(1951-74), Raut and
Swain (1992-97) Jain
and other (1995-98)
and Suresh Babu and P.
K. Jain (1980-94)
Monograph-Trends in Finance Page 167
.
Cash levels for Indian borrowers relative to their interest commitments fell to a five-year low after
the central bank raised interest rates a record 13 times since March 2010 to combat inflation and as
operating profits declined, Standard and Poor‘s Indian unit Crisil Ltd said in a report this month.
Corporate earnings will probably post the biggest drop in three years in the fiscal year ending March,
according to analysts‘ estimates.‖ compiled by Bloomberg.
Debt- Equity ratio – After 1993, number of companies showed
substantial increase upto 2004. In 1993, 85% of the companies
were having a maximum debt-equity ratio of 3:1. Till 2004, the
said percent increased to 88% indicating that more and more
companies preferred reasonable and manageable debt-equity
ratios not exceeding 3:1. Infact after 2005, better managed
companies have shown preference for equity rather than debt in
spite of tax advantage in debt finance.
D) Area: Capital Structure
Debt trap looms in convertible bonds
Indian firms may see borrowing costs more than quadruple after the 25% decline
in the Sensex last year--2008
Indian companies with a record $5.3 billion (Rs.27,400 crore today) of convertible
bonds due this year may see borrowing costs more than quadruple after the worst
performance among the world‟s 10 biggest stock markets.
u Reliance Communications Ltd (R-Com), Suzlon Energy Ltd and Tata Steel
Ltd, sold one-third of the total debt, according to data compiled by Bloomberg.
Their shares are trading as much as 88% below the bond conversion prices. Should
they choose to issue debt that can‟t be converted into equity to meet repayments,
companies will face an average yield of 6.94% on dollar-denominated bonds, a
HSBC Holdings Plc index shows, compared with 1.55% on convertible notes,
according to Barclays Capital
u “Companies are heading into a debt trap,”” Raj Kothari, a convertible bond trader
at Sun Global Investments Ltd, said in a phone interview from London on 4
January. “Companies have no option but to repay the debt.
data.Source: Bloomberg, Feb ,2010
u
Source: Analysis and Interpretation of Financial
Statements by Dr.Guruprasad Murthy,2014,
Cash levels for Indian borrowers fell to a five-year low after the
central bank raised interest rates a record 13 times
Monograph-Trends in Finance Page 168
Source: Business Standard 4th
December 2013
PSUs with tallest cash stalk
Monograph-Trends in Finance Page 169
India Inc may find the going tough on Profitability Street
Interest Costs Seen As A Concern For Cos As They Get Set For Year-End
Number Crunching
A dipstick study by ET shows that an economy, which is firing on all cylinders, will push India Inc‘s capacity
utilization into top gear. But, at the same time, there is a possibility that profitability ratios will be dented. And
already, doubts are being raised if corporate India will be able to maintain its 30% return on capital employed.
For the year ended March 31, 2006, the BSE-30 companies had a return on capital employed at 29.54%.
Analysts are in consensus that this number will be down to 27%. The silver lining being — this is on account of
higher capital employed and not because of lower growth in operating profits. Even if operating profits grow at
around 20%, capital employed will grow much faster than that. This will pull down profitability..
Over the past six quarters, sales and profits have moved up continuously on a quarter-on-quarter basis at around
6% and this rate will be maintained for the quarter ended March 2007 as well. Sales growth for 2006 will be higher
than the 20% growth reported in the previous year.
Interest costs are a prime concern, but, in terms of total profitability they will not eat into corporate margins.
Over the past two years, interest costs have shown an escalating trend. It has been able to gallop faster than sales
and profits. Since December 2004, profits and sales of the Sensex 30 club are up 26% and 25%, respectively, but
interest costs are up 28%.
The saving grace is that operating profit margins have not been affected. The rise in interest costs is not so huge
in absolute terms. Interest as a percentage of operating profit is actually on the decline and this may protect the
margins. The interest cover ratio, which states the ability of companies to pay interest costs, is at 4.21 times.
This is in line with the average of 4.25 for the past eight quarters and analysts expect that interest costs should not
be an issue.
Lotus Mutual Fund chief investment officer Tridib Pathak says, ―Interest costs have gone up but that should not
really be the issue. Debt: equity ratios are on the decline as companies are using other sources of finance for their
requirements. I‘m not worried on this front as corporate have planned their fund requirements properly.” Debt
equity ratio has fallen to 0.63:1 from 0.86:1. Since March 2003, debt as a means of finance has gone up 40%,
while net worth has gone up 92%. Requirement of funds have been financed more through equity than debt.
But the total deployment of funds, be it equity or debt, because of a sharp spike upwards threatens to spoil
the party for Corporate India.
By [email protected] Times of India
Since December 2004, profits and sales of the Sensex 30
club are up by 26% and 25%, respectively, but interest
costs are up upto 28%
Higher capital employed and lower growth in
operating profits
Monograph-Trends in Finance Page 170
Investments are made during the first period and
commitments to paying high dividends in the second period.
The reputation effect is also supported by the fact that firms
in financial distress are reluctant to cut dividends.
When the dividend tax rate exceeds the capital gains tax rate,
dividend payout can partially offset value-enhancing effects
of leverage. When the two rates are close, dividend payout
loses its moderating influence.
Analysis of influence of tax regime changes shows that the
tradeoff theory does not hold true in the Indian context, as
Indian corporate firms on average do not appear to have
increased dividend payments despite a tilt in tax regime in
favor of more dividends.
Trends indicate that the number of firms paying dividend
during the study period has shown down trend till 2002 and
has risen subsequently and decreased again in 2008. Average
DPS on the other hand has shown a declined till 1999, and
has shown growth from 2002 to 2008. Average percentage
DPR showed a more fluctuating pattern throughout the period
of study.
Analysis also shows that only a few firms have consistently
paid same levels of dividend. Of the payers, regular payers
have consistently paid higher payout as well as higher
average dividend compared to that of current payers.
Initiators have always paid higher levels of dividend yield
compared to that of other payers. Industry trends indicate that
firms in the electricity, mining and diversified industries have
paid higher dividends where as textile companies have paid
less dividends.
The research finding establishes the validity of the Linter
model in the emerging Indian market. The findings establish
the relationship between current dividend as dependent
variable and current earnings and past dividend as
independent variables and results show that Indian firm
relies both on past dividend and current earnings in deciding
the dividend payout
Research Paper 24
The interaction of
corporate dividend policy
and capital structure
decisions under differential
tax regimes
Research Paper 25:
Dividend policy of indian
corporate firms: an
analysis Dr. Sanjay
j.Bhayani
Asia Pacific Journal Of
Research in Business
Management
E)Area :Dividend policy ---
Monograph-Trends in Finance Page 171
Implications of market inefficiencies, behavioral approach than were in earlier periods.
E) Area :Dividend policy
Lintner, 1956 Dividends are irrelevant; all that matters are the firm‘s investment opportunities.
Rational behavior (more wealth being preferred to less, indifference between cash payments and share
value increases) and perfect certainty (future investments and profits are given) are assumptions of the
theory.
Modigliani and Miller, 1961;
classical study on dividend policy-- dividends represent the primary and active decision variable in
most situations. a model of partial adjustment to a given payout rate .
Bhattacharya (1979) builds a two-period model with two types of firms.
Investments are made during the first period; their expected profitability is known to management, but
not to outside investors. In order to signal the quality of their investment, the managers of good. Firms
(managers are assumed to act in the interest of initial shareholders) will commit to paying high
dividends in the second period. Since attracting outside financing (during the second period) is
expensive due to transaction costs, considered the case of perfect capital markets (no transaction costs
or tax differentials, no pricing power for any of the participants, no information asymmetries or costs),
Kumar 1988 a signaling model –
This model uses taxes as the main cost of dividends;
High dividends are a signal of undervalued shares (high firm quality) - shareholders will have to pay
taxes on them, but they retain a proportionately higher share in the firm, which is valuable to them.
The opposite is true if the firm is overvalued.
Miller andsRock 1985 builds a model that explains dividend smoothing -
Dividends once again signal a firms quality (productivity), but, since they are over invested in the
firm, managers will try to under invest by underreporting a firms productivity.
Kumar 1988 Kumar shows that firms will tend to cluster around optimal dividend levels. Agency
theory suggests that dividends can be used as a means to control a firm‘s management. Distributing
dividends reduces the free cash flow problem and increases the management‘s equity stake. The
question remains why the shareholders would not use debt or share repurchases instead
Shleifer (2000) find that in countries with better shareholder rights firms pay proportionally more
dividends. But there is no evidence that in countries with low investor protection, management will
voluntarily commit itself to pay out higher dividends and to be monitored more frequently by the
market
Allen and Michaely 2002). Fudenberg and Tirole (1995) build a model
that shows that, when managers are risk-averse and more recent information has a higher weight in
assessing their performance, there will be both dividend and earnings smoothing. Another agency
problem is that between shareholders and debt holders. The risk that shareholders will expropriate debt
holders by paying themselves excessive dividends has led to the often encountered covenants
restricting dividend policy in bond contracts. The reputation effect is also supported by the fact that
firms in financial distress are reluctant to cut dividends (DeAngelo and DeAngelo 1990).
The table below indicates, the manner in which theories related to
dividend have been changed over the period of years form 1956to 2012.
Monograph-Trends in Finance Page 172
In Case of Reliance Industries Ltd(Annual Report of 2008-9),The
Company declared a dividend of Rs 13 per share for the financial
year 2009.
The company‘s Annual Report says ― the dividend payout and
recommended bonus have been formulated keeping in view the
company‟s need for capital for its growth plan s through
internal accruals to the maximum and the ability to serve the
enhanced capital.”
E) Area : Dividend policy Industry
practice
The reason why shareholders believe that bonus issuing companies
giver higher returns are as follows:
Market expectations of an increase in cash flow to the investors because of the
increase in dividend rate
.Increase in liquidity: as the post bonus share price reduces (in the Indian
context) the shares are inviting to the investors. (Liquidity for a stock can be
measured in terms on the number of transactions within a particular time frame ).
The number of transactions post bonus increases for most of the companies issuing
bonus shares.
Bonus issuing companies have gradually decreased their returns as compared to
the non-bonus issuing companies.
Monograph-Trends in Finance Page 173
Multi-nationals earlier were not allowed to repatriate profits to their parent company.
Therefore the only options left for them were to either issue bonus shares or give dividends
at a very high rate. Post liberalization these companies preferred to give dividends.
Conclusively most of the companies prefer a bonus issue and since the rate of dividend
offered post-bonus does not reduce, the cash dividend increases. Also an interesting fact that
emerges is
the companies that have issued a bonus have been able to generate higher
Returns than companies that don‘t issue bonuses.
Summarized article from The Economic Times of January 13th
2003
titled ‟Rediscovering Dividends,‟ by U. R. Bhat that shows the
preference of the market for capital appreciation is as follows.
Capital gains rather than dividends have been the key attraction to investors
over the years. Investors have held the belief that companies can utilize"
better than investors ―the surplus post tax profit. Therefore the argument
those companies re-investing cash are believed to be the companies to be
with.
The management should take care that the surplus is utilized in the interest
of the shareholders and not empire building and unrelated diversifications.
The Modigliani Miller theorem has had very few exceptional practical
cases. Low payout ratios do not in any case indicate higher future returns. In
fact higher payout ratios have indicated better future prospects.
Thus the payout could ideally be increased and the investment amount
required to be generated through debt or equity. However if the
management strives for achieving a debt-free capital structure then the
financial leverage to increase ROE would be lost.
The misapprehension that equity costs less than debt has been the result of
risk free returns being higher than equity returns. In an uncertain market
where timing the market had been essential for generating high" returns for
appreciating capital paying higher dividends could offer as an advantage for
valuation of stocks.
If value creating investments opportunities are not available at acceptable
levels of risk, the management should serve the interest of the shareholders
by increasing the dividend payout.
Monograph-Trends in Finance Page 174
A summary of an article - ‟Corporate Dividends & Rationality,‟by
A.V. Rajwade on dividends and rationality of markets is as follows.
It questions the taxation of dividends in the hands of the investor and
argues for dividends and capital appreciation being substitutable in a
rational market.
"The argument often put forward for taxing dividends is that since
dividends paid out of post-tax profits, why should they be taxed again in
the hands of shareholder?
The US is only one of the four OECD countries which taxes dividend
income in the hands of the recipient fully. The UK taxes dividends only if
the recipient falls in the higher tax-paying bracket. Germany considers
only half of the dividend income as taxable and Japan it seems taxes
dividends at a much lower rate.
Mutual funds, for the purpose of escaping the tax, offered an option of
either bonus units or dividends on the investment. Investors were bound
to prefer bonus units as bonus units were taxable but at a much lower rate.
investors are rewarded with either dividends or capital appreciation.
The CAPM model argues that fair value of equity in a company is the
present value of the future dividend as well as the terminal value.
This holds that the company would not be affected by declaring dividends
as the higher the dividend the lower the terminal value of the firm and
vice-versa.
IT companies usually require resources for growth thus these companies
are not friendly toward declaring dividends.
Logically there is no difference between declaring dividends and not
doing the same to use the money to buyback shares from the market.
With respect to short term preference there is a difference between
declaring dividends and capital appreciation. Dividend declaration
requires the managements‘ emphasis on profitability whereas capital
appreciation is market based. Tax-free dividends would be to the
advantage of the shareholders.
It is impractical for a borrower company to declare dividends. At the same
time cash rich companies instead of investing surpluses in low return, risk
free securities should handover the excess to the shareholders else it
would be diluting ROE and hence EPS.
If markets were rational i.e. if the value of the shares would appreciate to
the extent dividends were not declared, the investors would be indifferent
to capital gains or dividend income. The dividends received could be used
to appreciate the investment by buying more shares of the same company
or the increase in share price should take care of the capital appreciation,
provided markets are rational."
Monograph-Trends in Finance Page 175
The change in perfect efficient market conditions
assumptions of theory—agency cost ,asymmetry information
Cost of capital is driven not only by investors‘ uncertainty
about the firm‘s future, earnings performance, but also by
investors‘ uncertainty about the evolution of beliefs, which
partly determines the path of prices.
Firms experience a lower cost of capital if investors perceive
that other investors are ignoring relevant disclosures
(perceived errors of omission),and higher cost of capital if
investors perceive that others are responding to irrelevant
disclosures (perceived errors of commission).
The panel Regression results show that the maturity of the
debt capital market has significant and positive influence on
the firms' capital structure. In contrast, developments in the
equity capital market have an inverse impact on the debt
ratios of property companies
A sensitivity of investment levels to cash flows indicates that
the cost of internal finance is lower than that of external
finance
The research finding paper gives evidence that the
association between earnings and the cost of debt decreases
as audit fees increase.
There is no evidence that auditor fees directly affect the
cost of debt for the noninvestment-grade firms, but
finding suggests that the association between earnings
and the cost of debt decreases as non audit fees
increase.
Research Papers :23
Disagreement and the
Cost of Capital Robert
Bobert Bloomfield &
Paule, Fischer in Journal
of Accounting Research
Vol. 49 March 2011
Research Paper :
Auditor Fees and Cost of
Debt dan s. dhaliwal*
cristi a. gleason* shane
heitzman*kevin d.
Melendrez
Research Papers :Auditor
Fees and Cost of Debt dan
s. dhaliwal* cristi a.
gleason* shane
heitzman*kevin d.
Melendrez
Research Papers :Auditor
Fees and Cost of Debt dan
s. dhaliwal* cristi a.
gleason* shane
heitzman*kevin d.
Melendrez
Research Papers :Auditor
Fees and Cost of Debt dan
s. dhaliwal* cristi a.
Research Paper
Agency cost ,growth
options debt
maturity in Indian
corporate sector
Jan 2014 Imdian
Journal of Finance
F-Area :Cost of capital &cost of debt
Monograph-Trends in Finance Page 176
F-Area : Cost of capital &cost of debt
Industry Practice
High capital cost to impact credit quality of Indian companies'
Global consulting and ratings firm Moody‘s on Thursday said a weak rupee and high cost of borrowings will
impact credit quality of several Indian blue chip companies, especially state-run Indian Oil Corporation, and
private sector companies including Tata Steel and Tata Power.
In its report titled ―Higher borrowing costs, weak rupee will pressure Indian corporate credit metrics‖, Moody‘s
said ―Increased borrowing costs and the weak rupee will pressure the credit quality of rated Indian non-financial
companies.‖
The agency highlighted that the 14 non-financial companies that it rates in India have a combined debt of `2.2
lakh crore ($32 billion) which is maturing in the fiscal ending March 2014. Out of this, over 50 per cent is
denominated in foreign currency.
The report further said depreciation of the Indian rupee will lead to revaluation of debt issued in US dollars, which in turn will put pressure on some covenants.
It said interest rates in India will likely rise further amid measures by the RBI to tighten liquidity and bolster the
rupee.―Interest rates for foreign currency borrowings will also increase in light of the US Federal Reserve‘s
decision to taper its bond-buying programme,‖ the report said.
Referring to IOC, Tata Steel and Tata Power Company, Moody‟s said these companies are highly leveraged
over the next 12 months and face a steeper increase in interest costs. “We believe they will be able to
refinance their maturing debt, but possibly at higher credit spreads than on existing debt,” the report said.
On ONGC, RIL, TCS and GAIL, it said they operate with large cash balances, which provide a buffer .
By ENS Economic Bureau - NEW DELHI 13th September 2013 10:25 AM
Monograph-Trends in Finance Page 177
Financial managers and investors don‘t operate in a vacuum—they make
decisions within a large and complex financial environment ,This
environment includes financial markets and institutions ,tax and regulatory
policies and the sate of the economy .The environment both defines the
available financial alternatives and affects the outcomes of various
decisions. Therefore it is crucial that financial managers and investors have a
good understanding of the environment in which they operate.
Good financial decisions require good estimates of movements in the
economy, interest rate and the stock market but figuring out what likely
to happen is no trivial matter. Throughout most of the 1990s the financial
environment was extremely favorable. The stock market registered
impressive gains, the economy was strong and both interest rate as well as
inflation was low.
The underlying financial environed has been undergoing tremendous
changes, including breakthroughs in technol.ogy, increased globalization and
shifts in regulatory environment. All of these factors have presented
financial managers and investors with opportunities, but opportunities
accompanied by substantial risk Source: Thesis
`
G) Area: Corporate Decision Making
Citigroup Inc. was created in 1998 when Citigroup and Travelers group (which included
the investment firm Salomon Smith Barney) merged. Citigroup today operates in 100
Countries has roughly 200 million customers and 2.30000 employees .and holds more
than trillion dollars worth of assets .
Citigroup was created because of three important trends
1)A regulatory change made it possible for a U.S.corporation to be engaged in
commercial banking, investment banking and insurance
2) Increased globalization made it desirable to follow their clients and operate in many
countries
3) Changing Technology led to increased economies of scale and scope, both of which
helped spur a rapid consolidation of the financial services Industry.
Financial Management by Myers & Brealey pg no 117
Monograph-Trends in Finance Page 178
The positive & significant coefficient on growth options
reveals the severity of agency problems in Indian corporate
sector.
The debt equity conflicts over the exercising of growth
options are mitigated by not issuing short term debt. The
maturity matching, debt with collaterals, covenants and long
term debt with call and sinking fund provisions are
appropriate strategies used for mitigating agency problems.
Trends and changes in theories of finance ---shift from pecking order
trade off to contingency needs of an enterprise
Heading1958, Modigliani and Miller have pioneered the
theory of capital structure; consensus has been established
that the capital structure has a significant impact on firm
value (Akhtar, 2005).
Agency cost is also an important cost (Jensen and
Mackling,1976, Myers, 1977), which associates with
negating the conflict of interest between, creditors and
shareholders (Sayeed, 2011).
.
Thesis 3 :The Theory of
Corporate Finance: A
Historical Overview
Michael C. Jensen*
Clifford W. Smith,
Thesis :The Modern
Theory of Corporate
Finance Michael C.
Jensen and Clifford W.
Smith, Jr.,Editors(New
York: McGraw-Hill
Inc., 1984) pp. 2-20
G)Area: Corporate Decision Making
Monograph-Trends in Finance Page 179
―
Publication: The Economic Times Mumbai; Date: Jan 28, 2014; Section: Economy; Page:
India Inc Can‘t Keep Up with IT‘s Hot Pace
ET INTELLIGENCE GROUP MUMBAI
The impressive earnings show so far in the December quarter, led largely by an upbeat
information technology sector, appears to be waning as a rising number of companies from
other sectors have started reporting lack lustre performances.
Net sales at the aggregate level for a sample of 141 companies, excluding companies from
banking & financial services industry (BFSI) and the oil & gas sector, rose by 12% during
the quarter to December 2013 compared with the year ago period. This was slower than the
14.5% increase in the previous quarter. Operating profit and net profit, on the other
hand, grew at a five-quarter high rate of 22% and 21%, respectively. This shows that
non-IT firms continued to cut costs to retain profit margins at a time when revenue growth
is hard to come by due to slack in overall demand.
Last week, a sample of 44 non-BFSI companies had reported a strong growth of 23% in
revenue and 36% in net profit from the year ago dominated by better growth from software
services companies which had accounted for 82% of aggregate sales of the sample and as
much as 90% of net profit. Results of manufacturing companies have started portraying a
picture of a more growth. The share of IT companies at the end of January 24 has fallen to
46% in sales and 59% in net profit. The sample companies were able to retain operating
margin at over 22.6% during the December quarter on a sequential basis helped by a
moderation in expenses relative to sales.
The efficient management of operating costs has been a key feature of the earnings season
so far. For instance, aggregate net sales of 10 capital goods companies that declared
results for the quarter to December fell by 5% but operating profit and net profit rose
by 16% and 14%, respectively. Similarly, for the 12 textile manufacturers in the sample,
sales rose by 5% while net profit doubled from the year ago. The performance of auto and
auto ancillary companies has been disappointing so far. The 18 companies from this sector
reported a drop of over 9% in revenue and a double digit fall in net profit at the aggregate
level.
Aggregate net sales decreased, but
operating profit,& net profit increased
Monograph-Trends in Finance Page 180
The Strange interesting History of the Theory of Finance : Peter L.
Bernstein
The collection of theoretical ideas sometimes known as Modern Portfolio Theory, or what I call Capital Ideas,
was composed by a dozen or so men over a period of just 21 years, starting with Harry Markowitz's "Portfolio
Selection" in 1952 and ending with the publication of the Black-Scholes-Merton options pricing model in 1973.
There was no such thing as finance theory before 1952, and there has been no meaningful
addition to the theory of finance since 1973. In the late 1980s, when I began interviews for my book. Capital
Ideas, all these men were still alive and available to talk with me. Nothing in the history of ideas comes close to
matching that bunching of theoretical innovation. Before I go on to support that assertion, a brief overview
is appropriate. Every member of this group worked in the ivory towers, far from the tumults of Wall Street. Some
of them had never owned a share of stock when they did their most important theoretical work. Yet these Capital
Ideas continue to reverberate in the financial markets of today and in the world of portfolio management in more
ways than any of these men could possibly have predicted. Indeed, all the survivors in that group are now active,
implementing theory in the real world of capital markets and investing. Let me recount how this bunching of
theoretical innovation in such a short period of time is unique in intellectual history. Consider, for example, the
history of astronomy and gravity, broadly conceived. There were 169 years between the birth of Copernicus
and the birth of Isaac Newton and 237 years between Newton's birth and Einstein's.That means a span of
406 years from Copernicus to Einstein. Not much opportunity for interchange of ideas among these
enormously important innovators!
Overlaps are more frequent in economics, but close relationships have been rare.
Economics, as we know it, was launched in 1776 with Adam Smith's Wealth of Nations.
David Ricardo was born a few years earlier, in 1772, and was only 18 when Smith died in 1790. Ricardo and
Malthus did overlap and were close friends. Ricardo died in 1823,
while Malthus died nine years later in 1834. At that point, John Stuart Mill, who was born in 1806, was 28 years
old. Mill overlapped with Alfred Marshall, who was born in 1842, but Mill was past his prime by the time
Marshall was productive. Marshall, 41 years senior to John Maynard Keynes, was Keynes's teacher at
Carnbridge, but he had been dead for 12 years when Keynes published his masterpiece. The General Theory of
Employment, Interest, and Money, in 1936 (and probably a good thing, too, because Keynes is harsh on
his old master in this book).
Thus, 160 years would pass between the publication of Wealth of Nations and The General Theory. There
was
nothing during that long span of time to match the clustering of innovative theoretical ideas among a tiny
group of scholars during the 21 years between 1952 and 1973. The story of fmance theory has another twist.
At any point, the line of succession could have been broken, including at the very start.
Harry Markowitz's interest was in operations research. He applied it to investing only after he happened to strike
up a conversation with a stock broker. Bill Sharpe's primary interest had been in transfer pricing— the way
corporations price internal transactions—until Markowitz lured him into asset pricing
Eugene Fama had planned to teach French and play football and baseball. If Fischer Black had not discovered
fmance as a result of meeting Jack Treynor at Arthur D. Little, this whole story might have had a very different
ending. Myroti Scholes turned down a chance to go into his family's publishing business, while Bob Merton, a
mathematician Was lucky enough to work as a research assistant to Paul Sarjiuelson, for whom finance was a
hobby he referred to as "Sunday painting." If any one of these individuals had stayed with his original interests
instead of yielding to the siren call of finance, the way we work today and the research areas we pursue might
look very different from what is actually the case.
Source :Journal OF Finance
Monograph-Trends in Finance Page 181
One major trend is the
integration of industrial
Organization theories into motivations for
Mergers and acquisitions.
The second major trend is the continued refinement
of ideas related to the impact of taxation on
corporate decision making, especially in the
areas of capital structure and payout policy, and
also in the area of executive compensation.
Sharp departure from prior paradigm is the
increased focus on law and finance, especially on
Corporate governance issues.
The next departure is evidenced by many
authors‘ willingness to adopt behavioral
approaches, including a willingness to assume
that informational inefficiencies are an important
determinant of managerial choices.
Implications of market inefficiencies are more profound
than were, in the earlier periods.
ResearchPapers :Agency
costs, growth options,
debt maturity in Indian
corporate sector– Jan
2014 (Indian Journal Of
Finance
Research Papers
29:Recent
Developments in
Corporate Finance
Major evolutionary
trend Journal of
Financial Economics,
a Brennan prize Prize
winning paper
Research Paper 29-
Recent Developments
in Corporate Finance
Major evolutionary
trend, Edward Elgar
Jay R. Ritter, editor
October 19, 2003
Journal of Financial
Economics,
Monograph-Trends in Finance Page 182
HCL TECH -The Big Leap
Fastest compounded annual growth rate (CAGR) in dollar-denominated
revenue during five years to September 2013,when compared with larger
peers, including TCS ,Infosys, and Wipro. With higher
growth came better profitability, higher cash flows and a stronger balance
sheet, putting HCL Tech on the ET 500 list of fittest companies
Company grew through organic & inorganic routes to improve profitability
―Clients were no more in the growth phase. Their businesses and IT budgets were
shrinking. We had two options: either to be pessimistic ourselves and cut
investments in new initiatives or to ride the downward wave by investing more and
find growth amidst pessimism, ―said Anant Gupta, president and CEO of HCL
Technologies,
explaining the dilemma in the aftermath of the financial crisis that hit western
economies in 2008.No points for guessing the choice it made, given that HCL Tech
reported the fastest compounded annual growth rate (CAGR) in dollar-denominated
revenue during five years to September 2013,when compared with larger peers,
including TCS,Infosys ,and Wipro. With higher growth came better profitability,
higher cash flows and a stronger balance sheet, putting HCL Tech on the ET 500 list
of fittest companies. Like other IT vendors ,HCL Tech gave customers what they
were demanding software services to run existing operations at lower cost. Unlike
most other vendors, however, it also gave clients an option to invest these cost
savings in solutions that would improve overall process efficiency in the long term.
A major roadblock in this strategy was the lack of size and scalability in enterprise
application solutions. To address this, former CEO Vineet Nayar acquired European
enterprise solutions player Axon in the middle of 2008,a bold move amid the
uncertain demand scenario in the West. Due to higher investment in the total
outsourcing model, its operating margin shrank to a low of 14% in the trailing 12
months to June 2011 from about 18% three years before. But,as business volumes
increased with the new model, the proportion of revenue that did not depend upon
the addition of headcount also increased. As a result, the margin shot up to 21.3% in
the year to September. The challenge for Gupta,who took over from Nayar a year
ago, is to stay competitive amid ever-changing technologies.HCL Tech is well
placed for the future,Gupta said. For long, we have preserved two values very dearly
trust and transparency with clients and our policy to put employees first. These go
beyond our business strategies and form the basis of a sustainable corporate culture,
he said.(by RANJIT SHINDE in Economic Times 21st Jan2014
Monograph-Trends in Finance Page 183
.
Too much cash-“Corporate Cash-------
-Journal of Finance
Monograph-Trends in Finance Page 184
SECTION-IV
STUDENT SECTION-IV
6-STUDY OF ARTICLES ON “SURPLUS CASH A MORE SERIOUS
PROBLEM THAN CASH DEFICIT”
Ms. Apurva Rajadhyaksha and Ms. Vaishnavi Patil
MMS first year (2013-15 batch) DR VN BRIMS
6.1 IS SURPLUS CASH A MORE SERIOUS PROBLEM THAN CASH DEFICIT?
Liquidity and Profitability are at logger heads. Reinvestment opportunities are not easy to find
hence 9 companies must have pipeline of successor project to absorb surplus funds from time to
time viz.
Look out for more investment opportunities
Philately, Paintings, and other works of art
Mergers and Acquisitions
Aggressive investment in Research and development
Identify Investment Havens
Buyback of shares
Real estate investment
Scouting for credit worthy corporate borrowings
Acquisitions in foreign countries, looking for good bargains like purchase of
Business in Europe during global Meltdown e.g. TCS, Infosys, and many others.
Retire debt
Deploy cash into sister units.
Monograph-Trends in Finance Page 185
6.1.1 PSUs must use surplus cash or give them to others to invest: FM
Finance Minister P. Chidambaram asked Cash-rich Central Public Sector Enterprises (CPSEs) to
invest their surplus cash or give others for purpose of investment. Presently, excess funds of some
public sector units (PSUs) are estimated at around Rs. 2.8 lakh crore. The government is working
out guidelines for utilisation of such surplus funds with a view to boost investment and promote
growth. Department of Public Enterprises (DPE)has suggested various investment options including
mutual funds, term deposits, treasury bills and government securities for PSUs.
PSU‘s can deploy their surplus funds in 2 ways –
Either invests their excess funds or pay higher dividend so that surplus funds could be help to fuel
growth and create jobs.
By proper utilisation of surplus cash the country's economy is projected to grow between 6.1 and
6.7 per cent in the current fiscal year.
6.1.2 PM to meet PSU chiefs to discuss plans for investing cash surplus
The problem of surplus cash is so very serious that even the Prime Minister met the PSU‘s chiefs
convincing them of the need to jump-start India's investment cycle with their vast cash surpluses.
The PSU‘s chiefs said that they want to invest but it is difficult as no optimistic assumptions can be
made due to uncertain market demand for new capacity.
They would also red-flag the onerous new public procurement law moving through Parliament
which would make big-ticket purchases for any expansion and even operational expenses by PSUs
a lot slower and trickier from a commercial perspective.
Steel maker SAIL and even capital goods producers like Bharat Heavy Electricals limited (BHEL),
the country's top turbine maker, are not keen on expanding their core business.
They are producing twice that their requirements which floods the market with an excess of goods.
Thus supply exceeds demand and therefore they are exploring other sectors like transportation,
renewable energy, water systems, defence and nuclear energy.
Monograph-Trends in Finance Page 186
The Prime Minister's Office had directed cash-rich PSUs such as NTPC, Power Grid Corporation,
Oil India BSE, Indian Oil Corporation and NPCIL to invest their excess funds or pay higher
dividend so that the cash could be deployed to drive growth and create jobs elsewhere in the
economy.
6.1.3 RIL earns nearly Rs. 8,000 crore from treasury operations
Sitting on a huge cash pile of nearly Rs. 83,000 crore, polyester-to-petroleum-to-retail
conglomerate has earned close to Rs. 8,000 crore through its treasury operations -- investments of
surplus funds in financial markets -- during the last fiscal year.
Announcing its FY13 annual results, billionaire Mukesh Ambani-led RIL said last week that it had
an "other income" of Rs. 7,998 crore, while its net income grew 32 per cent to Rs. 21,003 crore.
While net profit inched up by a paltry 4.8 per cent in the year, its treasury profit jumped by 29 per
cent to Rs. 7,998 crore from Rs. 6,192 crore in FY12.
The company was sitting on cash mound/ cash equivalent of a staggering Rs. Rs. 82,975 crore,
while its debt stood at Rs. 72,427 crore at the end of the fiscal year 2012-2013.
The company said it is debt-free on a net basis as of March-end.
Reliance is not alone in this. There are at least nine companies which are sitting on a pile of cash
amounting to Rs.1,76,675.46 Cr. These companies are NMDC, Infosys, Coal India etc.
Monograph-Trends in Finance Page 187
6.2 GLOBAL PICTURE
Companies With More Cash
Than US.
As in the Picture on your left,
US treasury has $32 Billion in
its account. Whereas the 9
S&P500 Companies has cash
and short-term investments
more than what the US Treasury
has.
General Electric (GE) has almost
3 times as much readily
accessible cash as the US
Government.
Now looking at the global picture, even there the scenario is
same as in India. Apple has piles of cash with itself (one of
the global company out of the nine companies which has
more cash than U.S. government).The amount is so huge
that it is humorously suggested that Apple can use one of
the following 10 options to use their staggering surplus cash
viz.
Establish a manned lunar base and keep it running for
8.5 years - cost $35 billion initially then $7.35 billion
annually.
Buy all 63000 worldwide apple Employees $1 million
mansion with change for a couple of Bentleys each.
Go to McDonald‘s and buy everyone in the world 2
big Mac meals 1 vanilla ice-cream cone and a
chocolate chip cookie
Turn yourself into tony Montana and buy one third of
all the illegal drugs in the world
Hire the entire Russian armed forces for two years. –
cost $52.7 billion Use it for good and evil
Hire the rolling stones ($8 million per night) and
make them play every night for the next 34 years
Donate it to United Nations and end world hunger for
over three years. Cost $30 billion a year
Buy 95,238,095,238 Hershey‘s chocolate bars ($1.05
each). Melt them down and cover the whole of
Singapore in chocolate with enough chocolate rain
left to coat Monaco 32 times over.
Buy all 32 NFL team ($32 billion). All 30 MLB teams
($15 billion) all 30 NHL teams ($7 billion). All 30
NBA teams ($11 billion). The 25 most valuable
soccer clubs ($13 billion). Cover the costs of all 12
formula 1 teams for the next 5 years ($6 billion) and
host the Olympic games ($16 billion - London)
Attempt to clone Steve jobs. At $75000 per embryo
and a success rate similar to dolly the sheep (1 in 277)
the attempt would produce 4813 baby Steve‘s.
Companies With
More Cash Than US.
As in the Picture on
your left, US
treasury has $32
Billion in its
account. Whereas
the 9 S&P500
Companies has cash
and short-term
investments more
than what the US
Treasury has.
General Electric (GE)
has almost 3 times
as much readily
accessible cash as
the US Government.
Monograph-Trends in Finance Page 188
Monograph-Trends in Finance Page 189
STUDENT SECTION-IV
7- INDIA INC. BEATS CHINESE PEERS IN FINANCIAL HEALTH
Mr. Pratik Pujari
MMS first year (2013-15 batch) DR VN BRIMS
7.1 INDIA INC. BEATS CHINESE PEERS IN FINANCIAL HEALTH
Table 7.1 India and China Relative to the world (Percentage Shares)
In this article, there is an analysis which is made on the basis of combined figures for companies
(excluding banking & financial ones) on the BSE 200 & the Shanghai SSE 180 indices. In the news
item which one presented below for comparison of two – India and China.
News in Business Standard- Monday, 10th
March 2014
INDIA INC. BEATS CHINESE PEERS IN FINANCIAL HEALTH
Indian firms much better return on equity and operating margins – Krishna
Kant- Mumbai
Monograph-Trends in Finance Page 190
Table 7.2 Ratios of India and China
Ratios India China
Return on Net Worth 14.3% 10.2%
Operating Margins 15.6% 11.4%
Debt – Equity Ratio 1.5% 1%
Asset Turnover Ratio 100 Times 87 Times
Market Capitalization to Total Debt 2.5 Times 1.5 Times
Formulas of above ratios are given below:-
1. Return on Net Worth = (Adjusted Profit After Tax – Preference Dividend) /
Equity Shareholders‘ Funds
2. Operating Margins = Operating Income / Net sales
3. Debt – Equity Ratio = Total Debt / (Equity share Capital + Preference Share Capital)
4. Asset Turnover Ratio = Net Sales / total Assets
5. Market Capitalization to Total Debt = Market Capitalization / Total Debt
Comments
Chinese companies have aggressively expanded their capacity across sectors over the past
few years but their capacity utilization has declined with reduction in demand after Lehman
crisis.
The problem of excess capacity is visible in low asset turnover ratio.
Chinese companies consists only 50% of their total debt in the form of traditional long term
and short term borrowings. Whereas 87% of Indian companies‘ total debt has been consists
in the form of traditional long term and short term borrowings.
According to analysts, this because of a lack of service sector companies in China. India has
more service sector companies. In contrast Chinese market is dominated by manufacturing
companies.
Chinese companies‘ interest cost was 3.6% in the calendar year 2012, against 6.1% for
Indian companies in 2012/13. This enabled Chinese firms to spend a lower portion of their
operating profit on debt servicing than Indian companies.
However, Chinese companies have higher borrowing capacity due to much lower interest
rates than India.
Monograph-Trends in Finance Page 191
Conclusion
Basically Chinese economy is much ahead of Indian economy. China as a country is much more
progressive than India. We can see in the above Table 1, that showed GDP, Export of goods and
Services and also Purchasing Power Parity remarkably high as compare to India. In this article it is
mentioned that only few ratios of Indian Companies which has given by analysts are better than
Chinese Companies. But in reality, there has been huge difference in Indian Companies and
Chinese Companies.
Monograph-Trends in Finance Page 192
STUDENT SECTION-IV
8- CMIE –DATABASE INDIA INC SECTOR-WISE FINANCES
Ms. Kalyani Bapat
MMS first year (2013-15 batch) DR VN BRIMS
8.1 CMIE – DATABASE INDIA INC SECTOR-WISE FINANCES
Table 8.1 CMIE – Database India Inc Sector-Wise Finances
All Sectors (Manufacturing, Mining, Electrical, Construction-Real Estate and Non-Financial Sector)
Year Count Total Assets Current Assets Sales Profit Before
Tax Profit After Tax
PAT/ total
assets * 100
sales/total
assets ROI
1993-94 4,102 10,602,949.80 3,417,390.30 4,610,647.10 251,883.00 192,270.60 1.813 0.435 0.789
1994-95 5,485 13,165,328.10 3,908,757.60 5,921,201.80 458,250.10 381,801.90 2.900 0.450 1.304
1995-96 7,079 16,488,015.10 4,623,496.60 7,378,978.60 519,291.80 411,565.10 2.496 0.448 1.117
1996-97 7,472 19,288,242.10 5,403,283.00 8,424,250.10 516,399.30 363,107.40 1.883 0.437 0.822
1997-98 7,335 22,252,137.10 6,093,224.70 9,072,328.10 549,038.80 379,608.10 1.706 0.408 0.696
1998-99 7,828 25,542,115.40 6,852,647.10 10,098,402.90 464,832.00 308,644.50 1.208 0.395 0.478
1999-00 8,630 28,873,570.00 7,438,817.40 11,944,006.30 578,398.30 379,839.00 1.316 0.414 0.544
2000-01 8,986 32,250,308.30 7,884,772.60 13,798,309.30 597,415.70 363,620.20 1.127 0.428 0.482
2001-02 9,330 36,812,843.80 8,764,769.70 14,787,693.10 792,931.20 471,574.20 1.281 0.402 0.515
2002-03 10,373 41,437,751.70 9,636,427.00 17,055,318.40 1,166,608.80 723,003.50 1.745 0.412 0.718
2003-04 13,124 47,852,641.70 11,104,498.90 20,193,036.20 1,846,594.50 1,263,938.50 2.641 0.422 1.115
2004-05 15,156 55,404,243.80 13,216,258.60 24,438,561.40 2,322,476.50 1,682,796.40 3.037 0.441 1.340
2005-06 17,134 66,110,088.00 15,683,448.30 28,460,127.80 2,843,834.30 2,084,054.80 3.152 0.430 1.357
2006-07 18,292 82,338,386.60 19,678,243.30 35,563,095.70 3,976,023.00 2,908,007.40 3.532 0.432 1.525
2007-08 19,225 104,527,210.90 24,888,539.00 42,528,274.10 4,924,564.10 3,537,402.50 3.384 0.407 1.377
2008-09 21,013 128,567,427.90 29,409,328.10 50,925,587.10 4,173,774.70 2,904,910.70 2.259 0.396 0.895
2009-10 23,049 148,576,291.70 32,156,126.30 54,028,057.90 5,165,384.10 3,576,186.90 2.407 0.364 0.875
2010-11 22,274 171,437,431.20 37,568,856.20 62,585,286.00 5,980,135.30 4,157,484.20 2.425 0.365 0.885
2011-12 14,013 186,819,778.70 38,828,790.30 68,738,568.90 5,588,361.70 3,815,648.10 2.042 0.368 0.751
2012-13 9,079 201,778,826.90 39,097,569.80 70,125,529.60 5,778,509.50 3,987,494.50 1.976 0.348 0.687
Grand Total
248,979 1,440,125,589 325,655,245 560,677,260 48,494,707 33,892,959 44 8 18
Monograph-Trends in Finance Page 193
Graph 8.2 CMIE – Database India Inc Sector-Wise Finances
8.2 RETURN ON TOTAL ASSETS (ROTA- %)
Table 8.3 Sector Wise Return On Total Assets (ROTA- %)
Sectors 1993-94 2012-13
MANUFACTURING 0.347 7.157
MINING 3.656 13.640
ELECTRICAL 0.821 4.611
CONSTRUCTION & REAL ESTATE -0.003 5.570
NONFINANCIAL SERVICE 0.455 5.379
Monograph-Trends in Finance Page 194
8.3 CMIE – DATABASE INDIA INC SECTOR-WISE FINANCES: AN OVERVIEW –
2012-13
All Sectors (Manufacturing, Mining, Electrical, Construction-Real Estate and Non-Financial Sector)
SALES TOTAL ASSETS
Sectors Rs. Million Rank
MANUFACTURING 40144374.3 1
MINING 2299968.4 5
ELECTRICAL 3228020.6 3
CONSTRUCTION &
REAL ESTATE 2600593.3
4
NONFINANCIAL
SERVICE 10574109.6
2
NETWORTH GROSS PROFIT Sectors Rs. Million Rank
MANUFACTURING 14395790.0 1
MINING 2840802.6 4
ELECTRICAL 3603042.4 3
CONSTRUCTION &
REAL ESTATE 2231618.9
5
NONFINANCIAL
SERVICE 7460333.7
2
PROFIT AFTER TAX (PAT) PROFIT BEFORE TAX (PBT) Sectors Rs. Million Rank
MANUFACTURING 1407110.2 1
MINING
669693.6
2
ELECTRICAL 194092.2 3
CONSTRUCTION &
REAL ESTATE 145297.4
4
NONFINANCIAL
SERVICE 118665.3
5
Sectors Rs.
Million Rank
MANUFACTURING 39195792.4 1
MINING 5344290.4 5
ELECTRICAL 10750622.1 3
CONSTRUCTION &
REAL ESTATE 6738070.0
4
NONFINANCIAL
SERVICE 19987284.9
2
Sectors Rs.
Million Rank
MANUFACTURING 4094844.3 1
MINING 1711224.6 3
ELECTRICAL 943967.2 4
CONSTRUCTION &
REAL ESTATE 609225.1
5
NONFINANCIAL
SERVICE 1923809.3
2
Sectors Rs.
Million Rank
MANUFACTURING 1959691.0 1
MINING 917205.7 2
ELECTRICAL 310676.1 4
CONSTRUCTION &
REAL ESTATE 203784.1
5
NONFINANCIAL
SERVICE 394196.6
3
Monograph-Trends in Finance Page 195
8.4 CMIE – DATABASE INDIA INC SECTOR-WISE FINANCES: AN OVERVIEW –
2012-13
All Sectors (Manufacturing, Mining, Electrical, Construction-Real Estate and Non-Financial
Sector)
PROFIT MARGIN RATIO (%) ASSET TURNOVER RATIO (TIMES)
Sectors PAT/ Sales
X 100 Rank
MANUFACTURING 3.505 4
MINING 29.118 1
ELECTRICAL 6.013 2
CONSTRUCTION & REAL ESTATE
5.587 3
NONFINANCIAL SERVICE 1.122 5
RETURN ON TOTAL ASSETS (%) RETURN ON NET WORTH (%)
Sectors
PAT/ Total
Assets X 100
Rank
MANUFACTURING 3.590 2
MINING 12.531 1
ELECTRICAL 1.805 4
CONSTRUCTION & REAL ESTATE
2.156 3
NONFINANCIAL SERVICE 0.594 5
NETWORTH TURNOVER RATIO (Times) RETURN ON INVESTMENT RATIO (%)
Sectors Sales/Net
Worth Rank
MANUFACTURING 2.789 1
MINING 0.810 5
ELECTRICAL 0.896 4
CONSTRUCTION-REAL ESTATE
1.165 3
NONFINANCIAL SERVICE 1.417 2
Sectors Sales/Total
Assets
Rank
MANUFACTURING 1.024 1
MINING 0.430 3
ELECTRICAL 0.300 5
CONSTRUCTION &
REAL ESTATE 0.386
4
NON FINANCIAL
SERVICE 0.529
2
Sectors
PAT/Net
Worth X
100
Rank
MANUFACTURING 9.774 2
MINING 23.574 1
ELECTRICAL 5.387 4
CONSTRUCTION &
REAL ESTATE 6.511
3
NONFINANCIAL
SERVICE 1.591
5
Sectors ROI Rank
MANUFACTURING 367.683 2
MINING 539.284 1
ELECTRICAL 54.210 4
CONSTRUCTION &
REAL ESTATE 83.226
3
NONFINANCIAL
SERVICE 31.409
5
Monograph-Trends in Finance Page 196
RANKING BY SIZE
Sectors Sales Total
Assets Net
Worth Gross Profit
PAT PBT Rank Total
Final Rank
MANUFACTURING 1 1 1 1 1 1 6 1
MINING 5 5 4 3 2 2 21 4
ELECTRICAL 3 3 3 4 3 4 20 3
CONSTRUCTION &
REAL ESTATE
4 4 5 5 4 5 27 5
NONFINANCIAL
SERVICE
2 2 2 2 5 3 16 2
RANKING BY PERFORMANCE
Sectors
Profit Margi
n
Asset Turnove
r
ROTA
RONW
Net Worth
Turnover
ROI
Rank
Total
Final Rank
MANUFACTURIN
G 4 1 2 2 1 2 12 4
MINING 1 3 1 1 5 1 12 4
ELECTRICAL 2 5 4 4 4 4 23 2
CONSTRUCTION
& REAL ESTATE 3 4 3 3 3 3 19 3
NONFINANCIAL
SERVICE 5 2 5 5 2 5 24 1
RANKING BASED ON SIZE AND PERFORMANCE
Sectors Size Performance
MANUFACTURING 1 4
MINING 4 4
ELECTRICAL 3 2
CONSTRUCTION & REAL
ESTATE 5 3
NONFINANCIAL SERVICE 2 1
N. B. Lower the rank assigned better the performance.
Monograph-Trends in Finance Page 197
8.5 CMIE – DATABASE INDIA INC SECTOR-WISE FINANCES - AN OVERVIEW
All Sectors (Manufacturing, Mining, Electrical, Construction-Real Estate and Non-Financial
Sector) 1993-94 to 2012-13
Items PAT / total assets * 100 (%) Sales / total assets (Times) ROTA (%)
Mean 3.635 0.966 3.631
Median 4.070 0.975 3.853
Minimum 0.347 0.801 0.331
Maximum 7.157 1.151 8.002
8.5.1 Manufacturing Sector -1993-94 to 2012-13
Items PAT / total assets * 100
(%)
Sales / total assets
(Times) ROI (%)
Mean 3.635 0.966 3.631
Median 4.070 0.975 3.853
Minimum 0.347 0.801 0.331
Maximum 7.157 1.151 8.002
Monograph-Trends in Finance Page 198
8.5.2 Mining Sector -1993-94 to 2012-13
Items PAT / total assets * 100 (%) Sales / total assets (Times) ROI (%)
Mean 8.770 0.506 4.530
Median 9.862 0.529 4.976
Minimum 3.656 0.317 1.345
Maximum 13.640 0.621 7.800
8.5.3 Electrical Sector -1993-94 to 2012-13
Items PAT / total assets * 100 (%) Sales / total assets (Times) ROI (%)
Mean 2.525 0.32 0.789
Median 2.58 0.324 0.728
Minimum 0.821 0.243 0.315
Maximum 4.611 0.385 1.35
Monograph-Trends in Finance Page 199
8.5.4 Construction-Real Estate Sector -1993-94 to 2012-13
Items PAT / total assets * 100 (%) Sales / total assets (Times) ROI (%)
Mean 2.374 0.443 1.073
Median 1.972 0.431 0.927
Minimum -0.003 0.376 -0.001
Maximum 5.570 0.529 2.901
8.5.5 Non-Financial Sector -1993-94 to 2012-13
Items PAT / total assets * 100 (%) Sales / total assets (Times) ROI (%)
Mean 3.189 0.704 2.368
Median 3.626 0.719 2.738
Minimum 0.455 0.529 0.254
Maximum 5.379 0.941 4.285
Monograph-Trends in Finance Page 200
SECTION-V
9-INDUSTRY SPEAK
This section includes Industry Speak:
Trends in Finance – Banking Industry
Trends in Finance – A View
Monograph-Trends in Finance Page 201
9.1 TRENDS IN INVESTMENT BANKING INDUSTRY – INDUSTRY SPEAK
Author - Mr. Nityanand Bhangale
The primary activity of investment banks is client servicing, which includes helping clients raise
equity capital by underwriting initial public offerings and facilitating private placement of shares,
raising debt capital, facilitating mergers and acquisitions, and managing investments. Investment
banks are also involved in activities such as proprietary trading, investing, and the development and
sale of equity and debt products.
Investment banking industry deals with the capital assets and cash within the economy. This
industry has grown leaps and bounds in last 40-50 years. Since 1960 till 2008 world economy has
shown tremendous growth in terms of GDP, global trades and cross border flows. Along with the
growth of world economy and globalization of the world cross border capital flows increased
multifold and due to this investment banking industry expanded immensely in terms of size and
value.
This industry has created huge wealth for the all the stakeholders including shareholders, clients
and employees. Based on this growth industry has attracted best of the talent across the world.
However things have changed drastically post 2008 for the industry, post Lehman bankruptcy. In
last 5 years revenue pools have been down significantly and regulatory burden has gone up
multifold. Industry is working today with lot of restrictions in terms how to deal with clients, how
to capitalize the balance sheet, how businesses should be organized and how the transactions have
to be executed. All these changes have put significant restriction on the leverage and brought the
ROE (return on equity) significantly down. As per some industry reports, it was very common for
most of the players to have ROE of 20-25% during 2007/08, these returns have more than halved
and are currently in the range of 8-10%. Most of the players are struggling to keep the ROE above
the cost of equity. The sector has been impacted by the market conditions along with regulatory
changes.
Regulators are pushing the industry towards being more transparent and reduce the risk exposure to
unregulated market areas. Banks needs to get more capital while reducing the leverage and risk
taking. There are restrictions on using the customer assets for business purpose. All these changes
are changing the way business is conducted and the returns generated from the business.
Monograph-Trends in Finance Page 202
Over the counter (OTC) derivatives products are one of the major contributors to the banks bottom-
line and this is also one of the major product line which creates risk for the banks. Regulators all
over the world are coming out with various regulations such as Dodd Frank Act in the US and
European Markets Infrastructure Regulation (EMIR) in Europe to ensure that OTC derivatives are
standardized, traded on electronic platforms, cleared centrally, collateralized sufficiently and
reported to the regulators. This will make margins shrink in these products.
In last 2-3 years all the global investment banks have gone through huge cost cutting initiatives.
However, these banks could not improve their return on equities because the interest rates have
gone down with greater percentages as the global economy is dwindling and trade volumes and
capital flows have also reduced significantly.
In order to stay profitable and create value for its investors banks need to take drastic steps, only
after cost reduction will not help, they also have to look at their business models and bring the
change in the culture of the people. In order to make things happen banks are working on many
fronts,
- Currently most of the banks are asset aligned and some of them are trying to think cross
assets, merging trading platforms or client servicing infrastructure across asset classes.
- Pushing the costs further down through various initiatives
- Allocating all available resources prudently across all business functions
- Focus on client franchise across segments
- Focus on balance sheet light businesses
- Re align derivatives booking and legal entity structure to optimize capital
- Move towards use of common industry utilities or outsourcing to reduce post trade
processing costs
Interestingly business models are so complex that it will take multiyear strategy to complete these
changes and ensure profitability of the business. Considering the current business model and
product focus of each player, no two players can have same strategy and each bank has to find it‘s
own solution to the current issues. It will be interesting to see what different kind of models develop
over next 2-3 years and what shape this industry takes.
TRENDS IN FINANCE – INDUSTRY SPEAK
The content in this article are the views of the author. Although, the author is an employee of
Nomura Services India Private Limited, the content in the article or the views of the author
should not be construed as those being of Nomura and Nomura is not responsible or liable for
any content of the article or the views of the author expressed therein. The expression
"Nomura" refers to Nomura Services India Private Limited together with its affiliates.
Monograph-Trends in Finance Page 203
9.2 TRENDS IN BANKING INDUSTRY – INDUSTRY SPEAK
Author - Mr. Ashwini Sharma
The announcement by US Federal Reserve on December 18 that it will lower the monthly pace of
asset purchases by US $ 10 billion to US $ 75 billion starting in January 2014 was a major
economic and financial event bound to affect the global markets particularly in the emerging
economies with weak fundamentals. The Government of India and the Reserve Bank of India
proactively in the recent period to ensure better macroeconomic management and reduce financial
volatilities. This has helped in improving global investor sentiments and several investment houses
turned overweight on India in November-December 2013, even while being underweight on
emerging markets for their portfolio allocation calls for 2014. Nonetheless, with domestic demand
remaining sluggish and investment activity hesitant, the economy does not appear to be out of the
woods, yet. While recessionary headwinds are feeding into corporates‘ and banks‘ balance sheets,
there are some signs that slippages are starting to come off. By now, markets appear to have priced-
in much of the upside and the tipping point could come around the forthcoming general elections. If
political risks are well-managed and a renewed political commitment to reforms is seen to be in
place, both financial markets and the real sector could gain. In the interim, a closer and continuous
monitoring of potential risks and pre-emptive policy action appears to be the need of the hour.
The announcement by US Federal Reserve was expected to be the trigger for substantial impact on
the global financial markets. However, its pressure on bond and equity markets across the globe
was not to the anticipated extent. The Indian markets this time took the announcement more
stoically and better than other emerging markets than the May 22 tapering announcement as the
interim period had been utilized to re-build buffers. The return of capital flows and better
performance on the trade front appears to have abated the pressures on the Indian rupee. But in
future, commitment to reforms and political outcomes will shape the markets.
Rupee remains range-bound in Q3 of 2013-14
The rupee had depreciated sharply, hitting a historic low in end-August when Fed first announced
its taper intention in May 2013, however, unlike that time, the impact of the actual tapering decision
on December 18 on the rupee was not significant. In fact, Q3 of 2013-14 was marked by low
exchange rate volatility with a small appreciation of 0.3 per cent (based on average exchange rate of
Q3 over Q2). In contrast, in Q1 and Q2 the exchange rate was volatile and the rupee depreciated by
3.2 per cent and 10.1 per cent, respectively. Exchange rate stability was to a large extent propelled
by introduction by RBI of a Forex swap window for the public sector oil marketing companies.
Postponement of tapering by the Fed and a lower Current Account Deficit during Q2 of 2013-14
Monograph-Trends in Finance Page 204
also helped. The Forex buffers built by FCNR(B) deposits and banks‘ overseas foreign currency
borrowings also instilled further confidence.
Monetary Policy measures normalization soften Money market rates
Rates in the money market were range-bound during the early part of July 2013. However, as the
rupee depreciated sharply, the RBI responded with a series of policy measures during July-August
to tighten liquidity and contain exchange rate
volatility. The net effect of these measures led to a significant rise in money market rates across the
spectrum. As markets gradually returned to normalcy, the Reserve Bank effected a calibrated
unwinding of its exceptional measures. As a result, money market rates gradually softened during
Q3 of 2013-14. Having utilized the interim period to build buffers, when the actual path of tapering
was announced in December 2013, the markets were not unduly concerned. From a high of 9.97 per
cent in September 2013, weighted average call rates declined to 8.16 per cent in December 2013. A
similar magnitude of decline was witnessed in the CBLO rate as well. Money market rates have
witnessed some hardening since the second half of December, on the back of tighter liquidity
conditions emanating from advance tax outflows. After initial softening, money market rates
remained elevated during January 2014 so far, reflecting tight liquidity conditions arising out of
elevated government balances with the Reserve Bank and rise in currency in circulation.
Increase in CD issuance
CD issuances was impacted by the tightening in money market rates with the weighted average
effective interest rate (WAEIR) peaking to 11.2 per cent in the early part of September 2013. As
markets returned to normalcy and liquidity conditions improved, rates declined whereas volumes
increased.
Gradual improvement in CP issuance
As in the case with CDs, in response to the exceptional measures by the Reserve Bank of India,
issuance of CPs by firms hit a two-year low, in July 2013. The weighted average discount rate
(WADR) also touched a high of 11.9 per cent at end-August 2013. As the calibrated unwinding
took hold, the volume of issuances picked up and rates declined. Accordingly, the outstanding
amount of CPs also increased.
G-sec yields remained firm in Q3 of 2013-14
The effect of the announcement on May 22, 2013 and the subsequent measures by the Reserve
Bank firmed up government yields to a significant extent. As markets stabilised, the Reserve Bank
announced a cautious unwinding of its earlier measures. More specifically, taking cues from the
OMO purchase auction and a 50 bps reduction in the MSF rate on October 7, 2013, G-sec yields
softened. However, the yields hardened during November 2013 led by a hike in the repo rate by 25
bps on October 29, 2013, better than expected US non-farm payroll numbers and higher domestic
Monograph-Trends in Finance Page 205
inflation numbers for October 2013. The G-sec yields softened to some extent towards the end of
the month on OMO auction announcement and introduction of new benchmark security.
Yields hardened again in December 2013 on higher domestic inflation numbers for November 2013
and the US Fed tapering announcement, despite getting some support after the policy rate was left
unchanged in the mid-quarter review on December 18, 2013. Thus, during Q3 of 2013-14, G-sec
yields remained firm. However, in the start of Q4 of 2013-14, the yields have softened on better
inflation numbers for December 2013 and on announcement of OMO purchase auction and 28-day
term repo auction. During the year thus far, the government has completed 93 per cent of its overall
borrowings (96 per cent on a net basis) for the year volatility. The net effect of these measures led
to a significant rise in money market rates across the spectrum. As markets gradually returned to
normalcy, the Reserve Bank effected a calibrated unwinding of its exceptional measures. As a
result, money market rates gradually softened during Q3 of 2013-14. Having utilised the interim
period to build buffers, when the actual path of tapering was announced in December 2013, the
markets were not unduly concerned. From a high of 9.97 per cent in September 2013, weighted
average call rates declined to 8.16 per cent in December 2013. A similar magnitude of decline was
witnessed in the CBLO rate as well. Money market rates have witnessed some hardening since the
second half of December, on the back of tighter liquidity conditions emanating from advance tax
outflows. After initial softening, money market rates remained elevated during January 2014 so far,
reflecting tight liquidity conditions arising out of elevated government balances with the Reserve
Bank and rise in currency in circulation.
Monograph-Trends in Finance Page 206
Increase in CD issuance
CD issuances was impacted by the tightening in money market rates with the weighted average
effective interest rate (WAEIR) peaking to 11.2 per cent in the early part of September 2013. As
markets returned to normalcy and liquidity conditions improved, rates declined whereas volumes
increased.
Gradual improvement in CP issuance
As in the case with CDs, in response to the exceptional measures by the Reserve Bank of India,
issuance of CPs by firms hit a two-year low, in July 2013. The weighted average discount rate
(WADR) also touched a high of 11.9 per cent at end-August 2013. As the calibrated unwinding
took hold, the volume of issuances picked up and rates declined. Accordingly, the outstanding
amount of CPs also increased.
G-sec yields remained firm in Q3 of 2013-14
The effect of the announcement on May 22, 2013 and the subsequent measures by the Reserve
Bank firmed up government yields to a significant extent. As markets stabilised, the Reserve Bank
announced a cautious unwinding of its earlier measures. More specifically, taking cues from the
OMO purchase auction and a 50 bps reduction in the MSF rate on October 7, 2013, G-sec yields
softened. However, the yields hardened during November 2013 led by a hike in the repo rate by 25
bps on October 29, 2013, better than expected US non-farm payroll numbers and higher domestic
inflation numbers for October 2013. The G-sec yields softened to some extent towards the end of
the month on OMO auction announcement and introduction of new benchmark security.
Yields hardened again in December 2013 on higher domestic inflation numbers for November 2013
and the US Fed tapering announcement, despite getting some support after the policy rate was left
unchanged in the mid-quarter review on December 18, 2013. Thus, during Q3 of 2013-14, G-sec
yields remained firm. However, in the start of Q4 of 2013-14, the yields have softened on better
inflation numbers for December 2013 and on announcement of OMO purchase auction and 28-day
term repo auction. During the year thus far, the government has completed 93 per cent of its overall
borrowings (96 per cent on a net basis) for the year.
Inflation indexed bonds launched
The Reserve Bank of India, in consultation with the Government of India launched Inflation
Indexed Bonds (IIBs) for institutional investors, with inflation protection to both principal and
coupon, on June 4, 2013. IIBs have been issued seven times during 2013-14 so far, with an
outstanding amount of `65 billion.
Subsequently, a special series of IIBs for retail investors (such as individuals, trusts and
universities), namely Inflation Indexed National Saving Securities-Cumulative (IINSS-C), was
Monograph-Trends in Finance Page 207
launched on December 23, 2013. The inflation compensation in this product has been linked to the
combined consumer price index [CPI base: 2010=100] and the interest rate comprises of two parts:
a fixed rate of 1.5 per cent per annum plus an inflation rate based on CPI, with a lag of three
months. The initial response to the new product has been somewhat limited with a subscription of
`603 million till January 25, 2014. As retail investors need more time to understand the product, the
last date for application to the scheme has been extended to March 31, 2014.
Equity market stages a recovery
After initial gains during the early part of the year, the Fed taper announcement had disrupted
global stock markets. During May 22 - August 30, the Sensex and Nifty declined as FIIs withdrew
US$ 13 billion from domestic debt and equity markets. As normalcy returned, the stock market also
recovered. The BSE Sensex and Nifty both increased by over 9 per cent during the third quarter as
compared to a decline in both these indices during the previous quarter. Buoyed by the
demonstrated resilience after the December 18 Fed announcement, key stock market indices rallied
on account of buying by FIIs. However, in line with global sell-offs, Indian equity market witnessed
selling pressure in January 2014 thus far.
FII investments in equity witness a revival
As confidence returned to the markets, FII investments also witnessed a revival. Earlier, FIIs were
net sellers in the debt segment. In December 2013, FIIs turned net investors in the debt segment as
well. Mutual funds, however, continued to remain net sellers in the equity segment, but net buyers
in the debt segment.
Primary equity market continues to remain lackluster
Low earnings growth in the corporate sector and slowdown in investment demand weighed
adversely on the primary equity market. The total amount raised through public and rights issues
was about 90 per cent of the amount raised during the corresponding period of the previous year.
Twenty four of the 25 IPOs during 2013-14 so far were by SMEs who mobilised`2.5 billion.
Resource mobilization by mutual funds also remained low.
House price pressures that abated in Q1 of 2013-14 have shown some signs of increase in Q2. The
y-o-y increase in the Reserve Bank House Price Index (Base year = 2010-11) at the all-India level
was 15.0 per cent in Q2 of 2013-14 as compared to 13.8 per cent in the preceding quarter.
In short, Indian financial markets continue to be better placed as global investor sentiments
improve, but uncertainties remain.
Acknowledgement: RBI website
Monograph-Trends in Finance Page 208
10 GLIMPSES PRE-BUDGET 2014
Modi promises a second revolution The
times of India 17/5/2014
FII inflows hit $20
billion in six months, all
eyes on Budget TNN |
Jul 7, 2014, 05.53AM Watch: Price Rise
Pinches - Where
Are 'Achche Din
Top 1% in India
owns 8-9% of
national income
,Rockstar
economist Thomas
Piketty says
Book on Capital in
the twenty first
century has put the
spotlight on
Thomas Picketty
Towards economic freedom "
Parliamentary polls of 1977 and this
year are the two most important
elections in the Indian History. The
former was referendum on political
freedom and later on economic
freedom Times of India 5/7/2014
Times of India 5/7/2014
Is socialism dead in India?
Despite major strides in
economic reform over the past
30 years, major aspects of the
Indian economy retain a
smothering level of government
involvement. Narendra Modi‘s
popularity suggests India could
witness a permanent shift away
from the past
India cheapest major economy;
Australia most expensive: Survey
TOI 12 May 2014 high inflation
rate, India is the cheapest major
economy in the world, according
to a survey of global pric
Every Third Indian poor Says
new poverty formula: But the
pace of poverty redaction quicker
in the three years to 2011-12
Business standard July 07
2014Rangarajan panel confirms
decline in poverty
Every Third Indian poor
Says new poverty formula:
But the pace of poverty
readiction quicker in the
three years to 2011-12
Business standard July 07
2014
Monograph-Trends in Finance Page 209
Reserve Bank of
India's (RBI)
liquidity coverage
guidance is credit
positive for banks ,
Moody's Investors
Service has said.
RBI has issued the
final Basel III
framework on
liquidity standards,
including
guidelines on the
minimum liquidity
Revamped inflation bonds with
higher returns soon: a bid to
move retail investors away from
gold and real estate into financial
instruments, Reserve Bank of
India will soon come out with a
new inflation indexed bond that
will be more attractive to
individuals, RBI TOI 12 Jun 2014,
Sebi relaxes IPOs, OFS
norms to boost primary
markets A change in
shareholding norms is
seen as a measure to
encourage companies to
sell shares and attract
retail investors
Livevemint 9 july 14
�Sebi relaxes IPOs, OFS
norms to boost primary
marketsA change in
shareholding norms is
seen as a measure to
encourage companies to
sell shares and attract
retail investors –
Livevemint 9 july 14
�Sebi relaxes IPOs, OFS
norms to boost primary
marketsA change in
shareholding norms is
seen as a measure to
encourage companies to
sell shares and attract
Monetary prices and asset
prices -The S&P 500 index
of equity prices in U.S.was
at a record high last week
gaining 200%since early
2009.DAX,the Index of
German equities is at an all
time high .The FTSE,all
world index is also at a
record high--live mint
19june 14
Budget 2014:
Factories Act
revamp may signal
labour law
reforms
The Indian market has
underperformed its EM peers in
the past one month Business
standard July 8 ,2014
Digitized
signature –
Novel solution
that enables
organizations to
conduct business
transactions or
agreements over
electronic
devices and
provides
digitised
signatures with
maximum legal
assurance
Development of 10 metro stations
with state-of-the-art facilities
Temperature-controlled storage
for fruits and vegetable Ready-to-
eat meals to be introduced in
phased manners, CCTVs to
monitor cleanliness of stations,
Gowda say
Monograph-Trends in Finance Page 210
$
Stop press
Monograph-Trends in Finance Page 211
10 BIBLIOGRAPHY
References:
[01] Anand, Manoj (2002). ‗Corporate Finance Practices in India: A Survey‗, Vikalpa, Vol. 27, No.
4
[02] Bhaduri, Saumitra N. (2002). ‗Determinants of Corporate Borrowing : Some Evidence from
the Indian Corporate Structure‘, Journal of Economics and Finance, Vol. 26, No. 2
[03] Damodaran, Aswath (2002). ‗Corporate Finance‘, 2nd Edition, John Wiley and Sons
[04] Graham J and Harvey C R (2001). ‗The Theory and Practice of Corporate Finance: Evidence
from the Filed‘, Journal of Financial Economics, Vol 60, Nos 2 and 3
[05] Lintner J (1956). ‗Distribution of Incomes of corporations among dividends, retained earnings
and taxes,‗American Economic Review, Vol. 46
[06] Pitabas Mohanty (1999). ‗Dividends and Bonus Policies of Indian Companies: An Analysis‘,
Vikalpa,Vol 24 No. 4
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Lucas, D.J., McDonald, R.L., 1990. Equity issues and stock price dynamics, Journal of Finance 45,
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Mayers, D., 1998. Why firms issue convertible bonds: the matching of financial and real investment
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McDonald, R.L., 1998. Real options and rules of thumb in capital budgeting, in Brennan, M.J.,
Trigeorgis, L., (Eds.), Innovation, Infrastructure, and Strategic Options. Oxford University Press,
London.
Miller, M.H., 1977. Debt and taxes. Journal of Finance 32, 261-275.
Modigliani, F., Miller, M.H. 1963. Corporate income taxes and the cost of capital: a correction.
American
Economic Review 53, 433-443.
Moore, J.S., Reichert, A.K., 1983. An analysis of the financial management techniques currently
employed by large U.S. corporations. Journal of Business Finance and Accounting 10, 623-645.
Myers, S.C., 1977. Determinants of corporate borrowing. Journal of Financial Economics 5, 147-
175.
Myers, S.C., 1984. The capital structure puzzle. Journal of Finance 39, 575-592.
Myers, S.C., Majluf, N., 1984. Corporate financing and investment decisions when firms have
information that investors do not have. Journal of Financial Economics 13, 187-224.
Opler, T.C., Pinkowitz, L., Stulz, R., Williamson, R., 1999. The determinants and implications of
corporate cash holdings. Journal of Financial Economics 52, 3-46.
Opler, T.C., Titman, S., 1998. The debt-equity choice, Unpublished working paper, Ohio State
University.
Pinegar, J.M., Wilbricht, L., 1989. What managers think of capital structure theory: a survey.
Financial
Management 18, 82-91.
Poterba, J., Summers, L., 1995. A CEO survey of U.S. companies' time horizon and hurdle rates,
Sloan Management Review, Fall, 43-53.
Monograph-Trends in Finance Page 213
10 BIBLIOGRAPHY
References:
[01] Anand, Manoj (2002). ‗Corporate Finance Practices in India: A Survey‗, Vikalpa, Vol. 27, No.
4
[02] Bhaduri, Saumitra N. (2002). ‗Determinants of Corporate Borrowing : Some Evidence from
the Indian Corporate Structure‘, Journal of Economics and Finance, Vol. 26, No. 2
[03] Damodaran, Aswath (2002). ‗Corporate Finance‘, 2nd Edition, John Wiley and Sons
[04] Graham J and Harvey C R (2001). ‗The Theory and Practice of Corporate Finance: Evidence
from the Filed‘, Journal of Financial Economics, Vol 60, Nos 2 and 3
[05] Lintner J (1956). ‗Distribution of Incomes of corporations among dividends, retained earnings
and taxes,‗American Economic Review, Vol. 46
[06] Pitabas Mohanty (1999). ‗Dividends and Bonus Policies of Indian Companies: An Analysis‘,
Vikalpa,Vol 24 No. 4
[07] Puritt, Stephen W and Gitman, Lawrence J. (1991). The Interaction between the Investment,
Financingand Dividend Decisions of Major U.S. Firms, The Financial Review, Vol. 26, No. 3
[08] Rao Cherukuri U (1996). ‗Capital Budgeting Practices of Indian and a select south east Asian
countries‘,ASCI Journal of Management, Vol. 25
[09] Ryan, Patricia A. and Ryan, Glenn P. (2002). ‗Capital Budgeting Practices of Fortune 1000:
How have Things Changed?‘, Journal of Business and Management, Vol. 8, No.4
[10]Sen, Dilip Kumar, Jain, Sugan C., Bala, Swapan Kumar (2002). ‗Financial Management Tools:
A Brief Study of their Applicability in the Changing Industrial Environment of Bangladesh‘,
Journal of Accountingand Finance, Vol. 16, No. 1
[11] Sharpe, William F (1964). ‗Capital Asset Prices: A theory of Market Equilibrium under
conditions of risk‘,Journal of Finance, Vol. 19
K. Krishna Murthy and D. U.Sastry; Published by Tata McGraw-Hall Pulishing Co. Ltd. New
Delhi; pp160
Database: CMIE,RBI DATABASE
Monograph-Trends in Finance Page 214
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Loughran, T., Ritter, J.R., 1995. The new issues puzzle, Journal of Finance 50, 23-52.
Lucas, D.J., McDonald, R.L., 1990. Equity issues and stock price dynamics, Journal of Finance 45,
1019-1043.
Mayers, D., 1998. Why firms issue convertible bonds: the matching of financial and real investment
options. Journal of Financial Economics 47, 83-102.
McDonald, R.L., 1998. Real options and rules of thumb in capital budgeting, in Brennan, M.J.,
Trigeorgis, L., (Eds.), Innovation, Infrastructure, and Strategic Options. Oxford University Press,
London.
Miller, M.H., 1977. Debt and taxes. Journal of Finance 32, 261-275.
Modigliani, F., Miller, M.H. 1963. Corporate income taxes and the cost of capital: a correction.
American
Economic Review 53, 433-443.
Moore, J.S., Reichert, A.K., 1983. An analysis of the financial management techniques currently
employed by large U.S. corporations. Journal of Business Finance and Accounting 10, 623-645.
Myers, S.C., 1977. Determinants of corporate borrowing. Journal of Financial Economics 5, 147-
175.
Myers, S.C., 1984. The capital structure puzzle. Journal of Finance 39, 575-592.
Myers, S.C., Majluf, N., 1984. Corporate financing and investment decisions when firms have
information that investors do not have. Journal of Financial Economics 13, 187-224.
Opler, T.C., Pinkowitz, L., Stulz, R., Williamson, R., 1999. The determinants and implications of
corporate cash holdings. Journal of Financial Economics 52, 3-46.
Opler, T.C., Titman, S., 1998. The debt-equity choice, Unpublished working paper, Ohio State
University.
Pinegar, J.M., Wilbricht, L., 1989. What managers think of capital structure theory: a survey.
Financial
Management 18, 82-91.
Poterba, J., Summers, L., 1995. A CEO survey of U.S. companies' time horizon and hurdle rates,
Sloan
Management Review, Fall, 43-53.
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