The Capital Budgeting Process: Theory and Practice

Abstract

Survey evidence in a four-stage framework for the capital budgeting process reveals that many capital budgeting practices differ from what the relevant theory prescribes. Much of the gap, however, can be explained by deficiencies in the theory itself, suggesting new directions for ongoing capital budgeting research.

Do organizations adopt sophisticated capital budgeting practices to deal with uncertainty in the investment decision?

“…To select the organizations, three criteria are used: (1) sales have to exceed D 25m; (2) total assets have to exceed D 20m; and (3) costs for personnel have to exceed D 15m. The survey is sent to the chief financial officers of the selected organizations since previous research indicates that the finance department is generally involved in the capital budgeting decision (see Northcott, 1992;Mukherjee and Henderson, 1987). It is expected that these senior financial executives are fully conversant both with the capital budgeting practices as well as with the factors hypothesized to affect the application of SCBP.…”

“…Considerable attention has been devoted to investigating the methods and techniques used in evaluating and selecting investment projects (see, for example, Segelod, 1998;Sangster, 1993;and Mukherjee and Henderson, 1987 for an overview) but little attention has been given to the determinants of those choices. There is, however, some limited evidence that firm-specific conditions will influence the efficacy of using sophisticated capital budgeting practices (Chatterjee et al, 2003;Ho and Pike, 1998;Haka, 1987).…”

Corporate Financial Management: Time to Change the “Cost of Capital” Paradigm?

“…Within the paradigm of over-arching strategy , the firm's ''normal'' tactical and implementing activity takes place over a range of departments : engineers , marketing and production departments make crucial investment decisions (Mukherjee and Henderson , 1987 ;Petty et al 1975 ;Ross , 1986) . Investment proposals are naturally screened for their ''strategic fit'' .…”

“…At this stage , ultimate endorsement of an investment proposal is likely viewed as an endorsement of the proposer(s) (Pike and Wolfe , 1988 , pg . 11) , or as a reflection on the track record , prestige and / or political influence of the proposer(s) / department (for example , Mukherjee and Henderson , 1987 ;Ross , 1986) . McAulay (1996) emphasises the role that managerial credibility has to play in capital investment appraisal by quoting one Financial Director :…”

Post-completion auditing of capital investments and organizational learning

“…3 For different capital investment process models, see e.g. Northcott (1992), Mukherjee and Henderson (1987), and Pike and Neale (2003). The common feature in all of them is that the control phase is always presented as the final and concluding phase.…”