Financial Literacy of Managers and the Efficiency of Capital Allocation in Corporations in Mozambique A survey of Large Firms in Mozambique Preliminary Results – Please do not quote without authors’ permission Cláudia Custódio (NOVA SBE and CEPR) Diogo Mendes (NOVA SBE) Daniel Metzger (Stockholm School of Economics)
Motivation Management practices and GDP per capita are positively correlated. Financial practices are well documented for developed countries, little is known for developing countries. These countries have different economic and financial contexts, which may hamper the application of corporate finance theory. On the other hand financial literacy is well studied in developing countries at the household and entrepreneurial level but not at the managerial level and for large corporations. Contingency view : firms are adopting optimal financial practices but these differ firm by firm and across countries Or, is there a misalignment with developed countries?
Motivation – Policy implications Do companies in Mozambique adopt different financial practices from more developed economies such as the US? How do financial policies vary with firm and CEO characteristics in MZ? Policy implications Promotion of financial literacy programs at the executive level can contribute for the development of the private sector through optimal decision making (Investment policy, access to external markets, risk management … ) Need to adapt literacy programs and policies to local context Guide for financial industry development strategies
Why Mozambique? Mozambique is representative of sub-Saharan African developing countries, in terms of economic and financial contexts (2007 World Bank Enterprise Surveys: Mozambique) - 57% of the firms with more than 100 employees identify access/cost of finance as a major constraint, well above any other indicator such as corruption, taxation, and practices of informal sector. - Only 11.3% of investment is financed by banks and 0.8 by equity - An average 101% of the loan is requested as collateral
Why large corporations? Large firms control a larger fraction of assets in the economy and any efficiency gains are more likely to be economically relevant Companies in developing countries are expected to exhibit a large heterogeneity in financial policies (Bloom et al. (2012)); Mozambique ranks at the bottom of a management practice index (Lemos and Scur (2014)) Large firms can be better compared with their counterparts in developing countries, for instance with the US, for which similar data is available
What do we know already? Firm policies: Harvey and Graham(2002): How do CFOs make capital budgeting and capital structure decisions? Lins, Servaes and Tufano (2010): in less developed credit markets, lines of credit are larger and CFOs are less likely to view credit lines and cash as substitutes CEO characteristics and styles: Bertrand and Schoar (2003): Manager fixed effects explain a wide range of corporate decisions Kaplan, Klebanov and Sorensen (2008): CEO personal characteristics do play a role in firm performance Custódio and Metzger (2013): Financial expertise affects financial policies
What do we know already? Firm policies in developing countries: Lemos and Scur (2014): 89% of Mozambican firms score within the range of the bottom quartile of US firms in terms of management practices. Bloom et al. (2011): Consulting on modern practices promoted efficiency and boosted productivity (randomized control trial in India). Bloom et al. (2012): Countries like Brazil, China and India tend to be poorly managed. Nevertheless, there is substantial variation in management practices across organizations in every country.
Data and Methodology Initial sample: companies in “The Top 100 Companies in Mozambique” KPMG report from 2010 to 2014 Representative list of the largest companies in Mozambique Used by local and foreign investors, public administration and other institutions Relevant general and financial data as revenues, balance sheet decomposition, new investment, number of employees and new investments Survey with CEOs and CFOs of largest firms in Mozambique (Summer 2015) Invitation sent to companies that showed up at least once in any of five reports Personal (face-to-face) interview with CEOs and/or CFOs (approx. 30 minutes) The survey included managers’ personal characteristics, financial decision process (capital budgeting and capital structure), and other firm indicators
Data and Methodology – Survey Respondent characteristics – Gender, age, nationality and educational background – Previous work experience, position in the company and tenure Capital budgeting and Capital structure (Graham and Harvey (1999)) – Capital budgeting and valuation techniques, estimation of cost of capital – Estimation and usage of discount rates, adjustment for different risks factors – Appropriate debt level, choice between short- and long-term debt and excess cash Other company indicators – Share of foreign investment – Subsidiary or existence of divisions – Perception about cost and availability of credit
Sample
Firm Characteristics – Revenue MOZ US 54.4% 42.5% 27.5% 23.5% 18% 16.9% 8.5% 7.5% 0.6% 0.6% <25 25 - 99 100 - 499 500 - 999 >1000 $ Millions
Firm Characteristics– ROA (%) 35.1% 20.9% 15.5% 14.2% 10.8% 3.4% <0 0 - 5 5 - 10 10 - 25 25 - 50 >50 EBIT/Assets
Firm Characteristics – Debt Ratio (%) 38.9% 30.9% 18.1% 6.7% 5.4% 0 - 25 25 - 50 50 - 75 75 - 100 >100 Debt/Assets
Firm Characteristics – Sectors Construction, 6.8% Energy and natural resources, 10.2% Sales, 10.2% Transportation and Warehousing, 6.8% Agriculture and Fishing, 3.4% Communications, 3.4% Services, 17% Other, 11.9% Hotel and Bank, financial Restaurants, 3.4% services and Industry, 17% insurance, 20.3% Food and Beverages, 1.7%
Other Firm Characteristics 63.2% 54.3% 30.4% 15.8% Credit Foreign Divisions Subsidiary of a Constrained Shareholders different company
Executives – Current Position 161 CFO, 33 59 CEO, 26 Total Surveyed
Executives - Age and Gender MOZ US Male Female 49% 10% 35% 29% 25% 23% 23% 13% 90% 3% <40 40-49 50-59 >59 Years
Executives - Nationality South Africa Other 7% 10% MOZ 51% Portugal 32%
Executive Characteristics - Tenure MOZ US 51 38 37 32 25 17 <4 4-9 >9 Years
Results
Valuation Techniques MOZ US 76% 75% 68% 64% 60% 58% 57% 57% 56% 52% 47% 39% 39% 38% 33% 30% 27% 20% 12% 11% Internal Net Present Hurdle Rate Payback Sensitivity Earnings Discounted Accounting Profitability Adjusted Rate of Value Period Analysis Multiple Payback Rate of Index Present Return Approach Period Return Value
Cost of Capital Estimation MOZ US 74% 42% 39% 34% 21% 21% 19% 18% 16% 16% 14% 7% CAPM Historical returns CAPM with extra Disc. dividend/ Investors' Regulatory 'risk factors' earnings M. requirements decisions
Discount Rates and Risk Factors MOZ US 74% 69% 60% 54% 53% 49% 49% 45% 44% 42% 38% 34% 33% 30% 25% 19% Interest Rate Foreign GDP or Unexpected Size risk Commodity Term Distress risk Risk exchange business inflation price risk Structure risk cycle risk Risk
Determinants of Financial Leverage MOZ US 82% 79% 73% 60% 59% 57% 53% 48% 48% 45% 45% 40% 34% 28% 28% 27% 23% 21% 19% 19% 16% 16% 15% 13% 7% 5% 5% 2% 2% 0%
Summary of Main Results Valuation techniques: • NPV and IRR are the most used technique in the US and are also used by a majority of managers in MOZ. • Payback and sensitivity analysis rank in the top 3 most used techniques in MOZ. • Discounted payback is used more often in the US. • Accounting rate of return appears also as a very important metric in MOZ. Estimation of cost of equity: • A much lower percentage of managers estimate the cost of equity in MOZ. • Among those who do, many rely on investors’ requirements (42%). • Only 21% of firms estimate it through CAPM, while in US this value is much higher (74%). • CAPM with extra risk factors is used as much as CAPM in MOZ
Summary of Main Results Adjusting discount rates for additional risk factors: • Foreign exchange rate dominates all other risk factors in MOZ. • Interest rate risk and unexpected inflation are also a concern for managers in MOZ. • Managers in MOZ adjust for more risk factors in general than managers in the US Estimating the appropriate amount of debt: • Credit rating, financial flexibility are both the most important factors in US and MOZ. • In MOZ managers limit debt so that their costumers/suppliers do not concern about their firms going out of business (73% compared to 19% in US). • Transaction costs associated to debt are more relevant in MOZ, as the potential cost of distress. • Only 45% sees debt as alternative to internal funds.
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