Capital Budgeting: A 1990 Study Of Fortune 500 Company Practices

Abstract

Capital budgeting investment decisions are fertile ground for researchers because these decisions both involve the use of a large portion of a firms assets and require predictions of the future. Various techniques are used to analyze capital budgeting projects. Among these are (1) net present value (2) internal rate of return (3) payback and (40 several averaging methods. This paper seeks to determine what methods are currently used by major American firms to determine if the more theoretically correct methods are employed and how firms implement and monitor the techniques used. The authors surveyed the Fortune 500 Companies and received some surprising responses. Replies from firms indicated that most firms use the theoretically superior discounting methods when analyzing capital budgeting problems. However, almost 21% of the respondents stated that payback was their preferred method for analysis. The study further showed that payback, while popular, was used for relatively small projects. The study revealed one major area of concern which was that of review and feedback. Approximately 20% of the firms surveyed had no review mechanism and thus may be making poor decisions because of failure to adjust their models as business conditions change. In summary, the study has two surprising findings regarding capital budgeting. First, almost 21% of the responding firms used payback as the preferred method of analysis. While most of the projects where payback was applied were small, the wide acceptance of payback was surprising. Second, and perhaps of greater importance, was the failure by approximately 20% of the firms to employ a review procedure. Without such a procedure, those firms will be unable to adapt quickly to changes in the business environment.

Top Management Team Structure and Resource Reallocation Within the Multibusiness Firm

“…Based on our theoretical model, the process of resource reallocation is carried out by current executives within the TMT. While many organizational outcomes may take years to develop and lagged models are commonly used in organizational research, corporate budgets are typically executed on an annualized rolling basis (Cooper, Cornick, & Redmon, 1992), making contemporaneous measures of capital reallocation and BU influence the appropriate proxy. 3 We complement this analysis with two additional approaches: (1) a robustness test using semiparametric fixed effects for tobit and (2) an instrumental variables (IV) approach.…”

“…The 1-year lag of BU influence also meets the second condition of a valid IV because the prior year's level of BU influence does not affect the capital reallocation decisions of the individual firm, except through its effect on the firm's current level of BU influence within the TMT structure. Firms typically devise and implement their capital budgeting plans on an annualized basis (Cooper et al, 1992), where the contemporaneous levels of executive influence, not the levels of influence from prior years, are the primary drivers of the capital allocation process. Although the executives within the firm are obviously aware of prior levels of influence, in post hoc tests suggested by an anonymous reviewer, we find no evidence that prior TMT structures directly affect capital reallocation.…”

Using information generated by a discrete event simulation to evaluate real options in a research and development environment

“…The three most common techniques used are intemal rate of return, net present value, and payback (Baksh 1986;Cooper and Petry 1994;Cooper, Comick, and Redman 1992;Freeman and Hobbes 1991;Pike 1989). Of these three techniques, net present value provides the "best" answer.…”