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Capital Budgeting and Political Risk: Empirical Evidence
Author(s) -
Holmén Martin,
Pramborg Bengt
Publication year - 2009
Publication title -
journal of international financial management and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.818
H-Index - 37
eISSN - 1467-646X
pISSN - 0954-1314
DOI - 10.1111/j.1467-646x.2009.01028.x
Subject(s) - rule of thumb , capital budgeting , political risk , politics , economics , deliberation , capital (architecture) , economic capital , cost of capital , value (mathematics) , net present value , rendering (computer graphics) , payback period , public economics , microeconomics , business , financial economics , incentive , political science , production (economics) , geography , project appraisal , computer graphics (images) , profit (economics) , archaeology , algorithm , machine learning , computer science , law
Abstract This paper surveys and investigates Swedish firms' use of capital budgeting techniques for foreign direct investments. We document that the use of the theoretically correct net present value method decreases with the political risk in the host country, and that the use of the Payback method increases with the political risk. We conclude that in the presence of capital market imperfections, unsystematic and country‐specific political risks are important. Because these risks are difficult to estimate (rendering high deliberation costs) managers are inclined to use simple rules of thumb for their capital budgeting decisions. Our results can partly explain why surveys find that alternative methods such as the Payback method are frequently used despite their theoretical drawbacks.