Incentives and monitoring: impact on the financial and non-financial orientation of capital budgeting

Abstract

While investment decisions may be financial decisions, there is a growing recognition that they are also often non-financially based decisions. This study reports findings focused on the project selection stage of capital budgeting, which has the objectives of exploring for: (1) the relative degree of emphasis decision-makers attach to a financial and nonfinancial orientation in capital budgeting; and (2) the role, if any, that two agency theory variables have on the relative degree of emphasis: a personal incentive for project go-ahead; and monitoring of project outcomes through a post-audit. Design/methodology/approach-Discrete choice experiments (DCEs) are used and framed in a between-subjects 2 (personal incentive) x 2 (monitoring) design. DCEs are well-suited to research questions which examine some tension between competing alternatives. For example, trade-offs involving the relative degree of emphasis decision-makers attach to a financial and non-financial orientation in capital budgeting. Findings-In the absence of a personal incentive and monitoring, decision-makers attach a significant degree of emphasis to cash inflows and cash outflows, both financial factors, and one strategic non-financial factor being improvement in the position of the firm vis-à-vis competitors in capital budgeting. However, when decision-makers receive a personal incentive from project go-ahead, they attach a lower degree of emphasis to cash outflows. Alternatively, when there is monitoring through a post-audit and a personal incentive, decision-makers attach a higher degree of emphasis to cash outflows. Practical implications-Decision-makers attach a significant degree of emphasis to only a relatively narrow band of attributes in making a capital budgeting decision, which is true in both the absence of and in the presence of the agency conditions. There is also little support for the view that there is any higher degree of emphasis attached to a financial orientation vis-àvis a non-financial orientation. A particularly important finding relates to the overarching goal of monitoring through a post-audit. One view is that it should foster more accurate forecasting by making forecasters aware that their efforts will be reviewed. However, the findings of this study appear to be more supportive of a view that post-audits might lead agents to become more conservative or even shy away from projects. Originality/value-The study makes contributions to the growing field of research which has the objective of exploring for the relative degree of emphasis decision-makers attach to a financial and non-financial orientation in capital budgeting. In particular it extends the prior research through its investigation of the role that two agency theory variables play in the relative degree of emphasis decision-makers attach to a financial and non-financial orientation: a personal incentive for project go-ahead; and monitoring of project outcomes through a postaudit.

Controllability of performance measures and managerial performance: the mediating role of fairness

“…Our findings here in respect to the intervening mechanism (i.e. mediating role of the perceived fairness of the performance evaluation system) through which controllability leads to improved managerial performance contradicts and provides a potential explanation for the previous literature, which maintains that the controllability principle is irrelevant and/or detrimental in respect to employee outcomes (Bourguignon and Chiapello, 2005; Manzoni, 2002; Simons, 2007; Simons and Dávila, 2020; Turner and Coote, 2018). Accordingly, our findings provide a significant theoretical insight into the relationship between the controllability of performance measures and managerial performance and, therefore, it is recommended that future studies may look to further extend this literature by considering the mediating role of alternative cognitive perceptions in this relationship.…”

“…However, while the principle of controllability is advocated, the interdependencies between different business units and the dynamic business environment make it difficult to only employ controllable performance measures to evaluate managers’ performance (Moers, 2006). In addition, the evaluation of performance solely based on controllable performance measures discourages managers from exerting effort towards managing uncontrollable or partially controllable factors (Turner and Coote, 2018; Burkert et al , 2011), such as those associated with an unpredictable and challenging external business environment. Similarly, Simons and Dávila (2020, p. 3) suggest that controllability can be harmful as it inhibits managers who do not control “sufficient resources to achieve their new goals […] [from becoming] more creative and entrepreneurial in finding ways to unlock value”.…”

The effects of the credit selection criteria on non-performing loans

“…After the financial crisis, banks become more dependent on financial statements or information about the local economy or the sector in which the firm operates (Godbillon-Camus and Godlewski, 2005; Petersen and Rajan, 2002), information found in the other internal report (Brunner et al , 2000; Schneider and Church, 2008; Sultanoglu et al , 2018), and information available in the central credit register regarding the relation of the company with the entire banking system (Jappelli and Pagano, 2002). In accordance with Turner and Coote (2018), decision-makers give a significant degree of emphasis to cash inflows and cash outflows, and to financial factors regarding the capital budgeting of a company. Indeed, the availability of information being in balance sheets, financial statements or credit register allows the adoption of standardized criteria in the creditworthiness assessment (Kaur and Lodhia, 2019) and, as consequence, an improvement of credit quality and the reduction of the amount of NPLs (Jappelli and Pagano, 2002).…”

Funding and facilitating innovation

“…One problem for managers confronted with various pieces of information is distinguishing what information is diagnostic and what is nondiagnostic. This discernment becomes particularly difficult in capital budgeting decisions, as the capital budgeting literature suggests that various types of information, such as financial, nonfinancial, and subjective criteria, as well as the various sources of information, could potentially be relevant for decision makers (Chow and Van der Stede 2006;Chen 2008;Turner and Coote 2018).…”

“…For many firms, capital budgeting decisions are a complex process because (1) information stems from a variety of sources, (2) different types of information need to be processed, and (3) uncertainty about underlying parameters hinders reliable assessments (Chow and Van der Stede 2006;Chen 2008). The finance literature generally advocates to rely on net present value (NPV) analysis in capital budgeting decisions as an aggregate of all decision-relevant information (Myers 1984;Ross 1995;Banker et al 2004), yet it is evident that in practice decision makers consider other information as well (Cardinaels and van Veen-Dirks 2010;Turner and Coote 2018). In my study, I concur that NPV is the deterministic decision measure and that any other information is either (1) redundant because it is already contained in the NPV analysis, or (2) uncorrelated with the desired outcome; hence, I refer to it as nondiagnostic information.…”