Stern Stewart Journal of Applied Corporate Finance

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STERN STEWART JOURNAL OF APPLIED CORPORATE FINANCE

e recently conducted a comprehensive survey that analyzed the

current practice of corporate finance, with particular focus on the

areas of capital budgeting and capital structure. The survey results

enabled us to identify aspects of corporate practice that are

*This paper is a compressed version of our paper that was first published as "The Theory and Practice of Corporate Finance:

Evidence from the Field" in the Journal of Financial Economics, Vol. 60 (2001), and which won the Jensen prize for the best

JFE paper in corporate finance in 2001. This research is partially sponsored by the Financial Executives International (FEI)

but the opinions expressed herein do not necessarily represent the views of FEI. We thank the FEI executives who responded

to the survey. Graham acknowledges financial support from the Alfred P. Sloan Research Foundation.

1. In the original JFE version of this paper, we show that our sample of respondents is representative of the overall

population of 4,400 firms, is fairly representative of Compustat firms, and is not adversely affected by nonresponse bias. The

next largest survey that we know of studies 298 large firms and is presented in J. Moore and A. Reichert, "An Analysis of the

Financial Management Techniques Currently Employed by Large U.S. Corporations," Journal of Business Finance and

Accounting, Vol. 10 (1983), pp. 623-645.

consistent with finance theory, as well as aspects that are hard to reconcile with

what we teach in our business schools today. In presenting these results, we

hope that some practitioners will find it worthwhile to observe how other

companies operate and perhaps modify their own practices. It may also be useful

for finance academics to consider differences between theory and practice as

a reason to revisit the theory.

We solicited responses from approximately 4,440 companies and received

392 completed surveys, representing a wide variety of firms and industries.1 The

survey contained nearly 100 questions and explored both capital budgeting and

capital structure decisions in depth. The responses to these questions enabled

us to explore whether and how these corporate policies are interrelated. For

example, we investigated whether companies that made more aggressive use

of debt financing also tended to use more sophisticated capital budgeting

techniques, perhaps because of their greater need for discipline and precision

in the corporate investment process.

More generally, the design of our survey allowed for a richer understanding

of corporate decision-making by analyzing the CFOs' responses in

the context of various company characteristics, such as size, P/E ratio,

leverage, credit rating, dividend policy, and industry. We also looked for

systematic relationships between corporate financial choices and managerial

factors, such as the extent of top management's stock ownership, and

the age, tenure, and education of the CEO. By testing whether the responses

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VOLUME 15 NUMBER 1 SPRING 2002

varied systematically with these characteristics,

we were able to shed light on the implications of

various corporate finance theories that focus on

variables such as a company's size, risk, investment

opportunities, and managerial incentives.

The results of our survey were reassuring in

some respects and surprising in others. With respect

to capital budgeting, most companies follow academic

theory and use discounted cash flow (DCF)

and net present value (NPV) techniques to evaluate

new projects. But when it comes to making capital

structure decisions, corporations appear to pay less

attention to finance theory and rely instead on

practical, informal rules of thumb. According to our

survey, the main objective of CFOs in setting debt

policy was not to minimize the firm's weighted

average cost of capital, but rather to preserve "financial

flexibility"--a goal that tended to be associated

with maintaining a targeted credit rating. And consistent

with the emphasis on flexibility, most CFOs

also expressed considerable reluctance to issue

common equity unless their stock prices were at

"high" levels, mainly because of their concern about

dilution of EPS. (As we shall argue later, although

such reluctance to issue equity is likely to be

consistent with finance theory's emphasis on the

costs associated with "information asymmetry," the

extent