Contributions to Management Science Baliira Kalyebara Sardar M.N. Islam Corporate Governance, Capital Markets, and Capital Budgeting An Integrated Approach Contributions to Management Science For furthervolumes: http://www.springer.com/series/1505 ThiSisaFMBlankPage Baliira Kalyebara (cid:129) Sardar M.N. Islam Corporate Governance, Capital Markets, and Capital Budgeting An Integrated Approach BaliiraKalyebara SardarM.N.Islam SchoolofCommerceandLaw SchoolofBusiness CentralQueenslandUniversity VictoriaUniversity Rockhampton,Queensland Melbourne,Victoria Australia Australia ISSN1431-1941 ISBN978-3-642-35906-4 ISBN978-3-642-35907-1(eBook) DOI10.1007/978-3-642-35907-1 SpringerHeidelbergNewYorkDordrechtLondon LibraryofCongressControlNumber:2013941870 #Springer-VerlagBerlinHeidelberg2014 Thisworkissubjecttocopyright.AllrightsarereservedbythePublisher,whetherthewholeorpart of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation,broadcasting,reproductiononmicrofilmsorinanyotherphysicalway,andtransmissionor informationstorageandretrieval,electronicadaptation,computersoftware,orbysimilarordissimilar methodologynowknownorhereafterdeveloped.Exemptedfromthislegalreservationarebriefexcerpts inconnectionwithreviewsorscholarlyanalysisormaterialsuppliedspecificallyforthepurposeofbeing enteredandexecutedonacomputersystem,forexclusiveusebythepurchaserofthework.Duplication ofthispublicationorpartsthereofispermittedonlyundertheprovisionsoftheCopyrightLawofthe Publisher’s location, in its current version, and permission for use must always be obtained from Springer.PermissionsforusemaybeobtainedthroughRightsLinkattheCopyrightClearanceCenter. ViolationsareliabletoprosecutionundertherespectiveCopyrightLaw. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publicationdoesnotimply,evenintheabsenceofaspecificstatement,thatsuchnamesareexempt fromtherelevantprotectivelawsandregulationsandthereforefreeforgeneraluse. While the advice and information in this book are believed to be true and accurate at the date of publication,neithertheauthorsnortheeditorsnorthepublishercanacceptanylegalresponsibilityfor anyerrorsoromissionsthatmaybemade.Thepublishermakesnowarranty,expressorimplied,with respecttothematerialcontainedherein. Printedonacid-freepaper PhysicaisabrandofSpringer SpringerispartofSpringerScience+BusinessMedia(www.springer.com) Foreword The task of investment appraisal for efficient allocation of resources in project selection and capital budgeting has been an enduring central theme in economics and business for a long period of time. The objective of this book, Corporate Governance, CapitalMarketsandCapitalBudgeting:An Integrated Approach, is to develop a multi-disciplinary approach that integrates the impacts of multi- dimensional factors and objectives of corporate governance, capital markets and capital budgeting to evaluate long-term investments for appropriate investment appraisal. The authors of this book have successfully managed to achieve this objective through examining two case studies of Tom.com Group in Hong Kong andWorldAirwaysintheUSrespectively.Theresultsofthestudyclearlypresent verypracticalsolutionsaboutthecapitalbudgetingprocesswhichbothacademics and practitioners should embrace. The approach incorporates different multiple objectives to maximize firm value which undoubtedly improves on the existing investmentappraisalprocess.Thedevelopedapproachcangenerallyandeasilybe adoptedinallcapitalbudgetingprocessesandframeworks. In this modern economy that relies on information technology to operate effi- ciently, the traditional discounted cash flow techniques used in capital budgeting arenolongeradequatetohandletheimpactsofmulti-dimensionalmarketforceson capitalbudgetingdecisions.Thisbookistimelyasamulti-disciplinaryapproachto capitalbudgetingandisnecessaryforachievingefficiencyinresourceallocationin thecurrenteconomicenvironment. After observing the profound impacts of Asian financial crisis in 1977 and the GlobalFinancialCrisis(GFC)in2007ontheglobalknowledgeeconomy,ingeneral, andtheoperationsofthee-commercesectorandtheairlineindustry,inparticular,the authors envisaged the need for writing a book that could improve on the existing investment appraisal techniques. The economic impact caused by the dot.com bubbleburstin2000andtheGFConthee-commercesectorandtheairlineindustry iswellknown.Anumberofdot.comcompaniessuchasBoo.com,Pets.com,etc.and airlinecompaniessuchasTransWorld and American WestAirlines inthe USand AnsettandCompassAirlinesinAustraliacollapsed. v vi Foreword The new integratedapproach toinvestment appraisal developedby the authors has a wide range of positive implications and for the e-commerce sector and the airline industry for avoiding corporate crises and collapses. Throughout the book the integration of the impacts of multi-dimensional factors and objectives of corporategovernance,debtequityratio,agencycosts,riskmanagementandinterest ratesoncapitalbudgetingdecisionmakingisfullyexploredandanalysed.Alsothe impactofinterestratesonthechoiceofborrowing,discountrates,andthecostof capital in investment appraisal, project selection and capital allocation is fully explained. This book makes a significant contribution to the literature on investment appraisalandcapitalbudgetingdecision-making,ingeneral,andinthee-commerce sector andtheairline industry,inparticular.Ibelievethattheauthorshave devel- oped an excellent approach in the determination of capital budgeting decisions. Therefore, I strongly recommend this book to all readers interested in efficient allocationofresources,capitalinvestment,andpublicpolicyformulation.Thebook should benefit university students, researchers, academics and practitioners in the areas of economics, finance, banking, investment appraisal and financial management. ProfessorPeterDawkins Vice-ChancellorandPresident VictoriaUniversity,Australia; Ex-SecretaryoftheVictorianGovernmentDepartmentofEducationand EarlyChildhoodDevelopment,Victoria,Australia; Ex-RonaldHendersonProfessor,andEx-DirectoroftheMelbourneInstituteof AppliedEconomicandSocialResearch,UniversityofMelbourne,Australia. Preface The objective of this study is to develop a mathematical model and a conceptual frameworkwhichintegratestheprinciplesofcorporategovernance,capitalmarkets and capital budgeting to maximise shareholder wealth. These different principles areappliedtotwocasestudies.Theresultsofthisstudyprovideusefulinformation about the investment appraisal process, incorporating multiple issues in capital budgeting decision making which cannot be achieved using the existing capital budgeting models and framework. The proposed framework can be applied in all capitalbudgetingexercisesandframeworks. With information technology pervading the current global environment, the traditional discounted cash flow techniques used in capital budgeting are not adequate to handle the interdisciplinary impacts of corporate governance, capital market,riskmanagement,accountingpracticesandregulationoncapitalbudgeting decisions.Therefore,thereisaneedfordevelopinganewintegratedframeworkfor modelling and analysing capital budgeting issues by simultaneously considering theseimpacts. Thepurposeofthisresearchistodevelopanewintegratedapproachorconcep- tual framework for investment appraisal which integrates the principles of corpo- rate governance, capital markets and risk management in a multi-criteria capital budgetingprocess. Thisresearchadoptsdecisionmakingandcapitalmarketresearchinanaccount- ingperspectiveinadiscountedcashflowanalysisandmulti-objectiveoptimisation modelling.Thisstudyusestwocasestudies.TheTom.comcasestudyisareal-life casestudy,whiletheWorld Airways casestudyisahypotheticalone.Intermsof datacollection,acasestudyapproachisinitiallytaken,usingareal-lifecasestudy involving an e-commerce company, http://www.tomgroup.com/investor/report. Data iscollectedfromthe annualreportsforthe last5yearsofitsoperations(see alsoRayportandJaworski(2002)).Thisstudyalsousesahypotheticalcasestudy, WorldAirways(Levary&Seitz1990),wheremultipleflightroutes,thepurchasing of wide and narrow-body airplanes, borrowing and lending money, debt capital, debt equity ratio and agency costs are all examined. This study uses a multiple objectivelinearprogrammingmodel,whichisbasedonacapitalbudgetingmodel vii viii Preface of Levary and Seitz (1990), and it is solved by Solver which is one of the add-in optionsinMicrosoft’sExcelsoftwareprogram. The results from this research provide an appropriate investment appraisal framework and an appropriate capital budgeting model. They show an improve- ment in NPV ranging from $1,835.11 to $1,865.35 million. The model integrates capitalmarketinteractions,riskmanagement,agencycostsandcashflowbasedon multiple criteria objectives as critical in an institutionalised capital budgeting process. It provides operational processes which can be applied by any organisationsmakingdecisionsincapitalinvestments. This new integrated approach to investment appraisal has wide implications for most industries, which make capital investments, in general; and for the e-commerce sector and the airline industry; in particular. This study supports the argument for the interdisciplinary nature of capital budgeting decisions that theintegrationofcorporategovernance,debtequityratio,agencycostsandinterest ratesaffectchoiceofborrowinganddiscountrate,costofcapital,projectselection and capital allocation which in turn impact on decisions in investment appraisal. Therefore,thereisaneedtorevisitthetheoryofcapitalbudgetingaspresentedin textbooksandadoptanintegratedmultidisciplinaryapproachtocapitalbudgeting. Financialmanagersshouldconsidertheimpactofmulti-criteriaobjectives,suchas cashflow,riskmanagement,interestratesandagencycostsasthenormratherthan theexceptioninthecurrenteconomywhichpredominatelyusesinformationtech- nologywhenmakinginvestmentappraisaldecisions. This study has developed a new integrated framework for modelling and analysing capital budgeting issues. The model integrates corporate governance principles using agency costs, capital markets interactions using interest rates, capitalbudgetingprinciplesusingpresentvalueandriskanalysisusingsensitivity andscenarioanalysis.Themodelconsidersmultiplecriteriaobjectivestoevaluate capital projects in general and projects in the e-commerce sector and the airline industryinparticular. The authors would like to express their sincere thanks to Siti Nuryanah, Margarita Kumnick, Gayathri Mekala, Ruchi Gupta and Neelam Maharaj for proofreadingthisbookandprovidingtheiracademicandeditorialcomments.The first author would liketoacknowledge the support, love andencouragement from hiswifeWinnieandsonAlbert.ThisbookisdedicatedtoApuuli(RIP)whotaught himthevalueofhardworkandeducation,andalsopreparedhimforthechallenges ofthisworld–thankyouApuuli.Theauthorstakeresponsibilityforalltheerrorsin thisbook. Queensland,Australia Dr.BaliiraKalyebara,PhD Melbourne,Australia Prof.SardarM.N.Islam,PhD,LL.B Academic Acknowledgement Theauthorsoweacknowledgementtotheauthorsandpublishersofthetwobooks wherethetwocasestudiesusedinthisstudywereobtained. 1. The information on the use offinancial multiples and discounted cash flows in the first case study: Tom.com Group Case was adopted from the company’s website and a book by Rayport, J.F and Jaworski, J. J (2002), Cases in e-Commerce,McGraw-HillHigherEducation,NewYork,NY10020. 2. The optimization model in the study is based on the second case study: World Airways Case that was adopted from a book by Levary, R. R and Seitz, N. E (1990),QuantitativeMethodsforCapitalBudgeting,South-WesternPublishing Co.,Cincinnati,OH. ix