Article of Capital Budgeting Survey Essay Example for Free

Article of Capital Budgeting Survey EssayThis re appear is motivated by 2 major factors (1) the all everyplace twenty year hiatus since the last sodding(a) review ofthe capital budgeting check up on literary works, and (2) past appeals to the finance academic community by researchers to explore drop downed areas ofthe capital budgeting make.In response, and using a four-stage capital budgeting process as a guide, the authors review the capital budgeting mass literaturefrom 1984 through 2008 and find that somewhat ofthe neglectedareas have infact been directly addressed. Unfortunately, the most prevalent focus of capital budgeting surveys continuesto be that ofthe selection stage. As a result, m either areas ofthe capital budgeting process noneffervescent remain relatively unexplored, providing numerous survey research opportunities.This research effort is motivated by two tnajor factors 1)the twenty year hiatus since the last thorough review of the capital budgeting s urvey literature, and 2) past observations and appeals made to the finance academic community byfellow researchers to explore neglected areas of the capital budgeting process through more focused and directed surveyresearch.Richard M. Burns is a prof of finance at the University of Alabama at Birmingham, AL Joe Walker is an Associate Professor of Finance at the University of Alabama at Birmingham, AL.The authors wish to thank the Editor and the anonymous referee for their many helpful comments and suggestions.78The first factor stands on its own as justification for anupdate of the capital budgeting survey literature. The lastcomprehensive reviews were made by researchers Scott andPetty (1984) and Mukherjee (1987) over twenty years ago.Regarding the game factor, almost three decades ago,Kim (1979) noted that too much emphasis was being placedon methods of ranking and selecting capital budgetingproposals. Scott and Petty (1984) besides noted the disproportional (unjustified) amoun t of time spent on aparticular stage (financial analytic thinking and project selection) Further, Gordon and Pinches (1984) generalizedthis complaint by arguing that the capital budgetingprocess must(prenominal) be viewed in its entirety. Mukherjee (1987)agreed that further survey efforts need to be devoted to understanding the entire process.To address these two factors, the authors have erectda authorized review of the capital budgeting survey studiesover the past twenty-four years. The results are describein a four-stage capital budgeting frame snuff it that allows amore elabo rate and clear assessment of the appeals by pastresearchers. As a result, fertile areas for future appliedresearch in the area of capital budgeting survey work aremore easily identified and summarized.The organization of this paper is as follows. In Section Ia four-stage capital budgeting process will be identified and used throughout the balance ofthe paper. It provides a useful framework to evaluat e in more detail the most prominentcapital budgeting survey literature reviews of the past, tohighlight neglected areas of capital budgeting research, and to organize past appeals for future research in this area. In Section II this four-stage process will also be used to describe the procedures used in performing the capital budgeting79BURNS WALKER CAPITAL BUDGETING SURVEYS THE hereafter IS NOWsurvey literature update over the 1984-2008 period. SectionIII will continue to use this framework to present the detailed findings while Section IV will provide an overall summary.Finally, Section V will present conclusions, comments, andinsights for future survey research.I. Past Reviews and Appealsappears on an executives desk and all that isneeded is for the manager to choose the project(s)with the highest expected payoff. However, asmost managers quickly learn, this is not the case.Further, once projects are chosen, the evaluationof an individual projects subsequent performanceis usua lly either ignored or often unsuitablyhandled.Our contention is that the capitalbudgeting process must be viewed in its entirety,and the informational needs to support effectivedecisions must be builtinto the firms decisioncomprehensive reviewssupport system.In the corporate financecapital budgeting surveyliteraturethecapitalThe lastbudgeting process has beenwere made by researchers Scottdescribed in terms of fourThe two most operativestages 1) identification,attempts to assess theand Petty (1984) and Mukherjee2) emergence,3)balance of research among(1987) over twenty years ago.selection, and 4) control.these four stages were thoseThe identification stageof Scott and Petty (1984)comprises the overall process of project idea generation and Mukherjee (1987), both of which occurred come up over including sources and submission procedures and the twenty years ago. Scott and Petty provided a synthesis of earlier surveys ofincentives/reward system, if any.The development stageinvolves t he initial screening process relying primarily erect American firms and organized their analysis based on a upon cash flow union and early screening criteria. The three stage classification 1) project definition and cash flow selection stage includes the detailed project analysis that estimate 2) financial analysis and project selection, and results in acceptance or rejection of the project for funding. 3) project implementation and review. Citing Gitman and Finally, the control stage involves the evaluation of project Forrester (1977), they noted that project definition and cash flow estimation isperformance for both control purposes and continuousconsidered the most difficult aspect ofthe capitalimprovement for future decisions. tout ensemble four stages havebudgeting process. The financial analysis andcommon areas of interest including personnel, procedures,project selection stage, which receives the mostand methods involved, along with the rationale for each.attention in th e literature, is considered the least alone four stages are critical to the overall process, butdifBcult ofthe three stages the selection stage is arguably the most involved since itincludes the choices of analytical methods/techniques used,Also covering surveys of expectant American corporations,how the cost of capital is determined, how adjustments for Mukherjee (1987) agreed that there had been too much projects risks are assessed and reflected, and how, if relevant, survey focus on the selection stage and not plenty on the capital rationing affects project choice.The selection stage other stages as well as the overall capital budgeting process. has also been the most investigated by survey researchers, Paraphrasing that papers recommendations, it called for particularly in the area of selection techniques, resulting in more research into special(prenominal) questions relevant for each stage. a relative neglect ofthe other stages.This in turn has led to For example, in stage 1 , future surveyors were urged to appeals to future researchers to consider the other stages in investigate the reward systems, procedural aspects, and the their survey research efforts. As Gordon and Pinches (1984) organizational structure ofthe firm. In stage 2, more research notewas suggested on the topics of divisional vs. corporateMost of the literature on the subject of capitalbiases, strategic considerations, cash flow estimationbudgeting has emphasized the selection phase,details, data details, cannibalization, risk, and inflation. giving little coverage to the other phases. Instead,Even within the more widely-studied point 3, neglectedit is usually assumed that a set of well-definedcapital investment opportunities, with all of theinformational needs clearly specified, suddenly o t e that these two reviews are only three years apart based on state-supportedation See Gordon and Pinches (1984) and Mukherjee (1987). Scott and Petty (1984) use a similar 3-stage process. It is interesting to note, however, that an even earlier survey by Gitman and Forrester (1977) had used a 4-stage analysis.date, and that the latter does not cite the former, likely due to publication lags. As noted in the procedures section, this paper uses the Mukherjee format. Furthermore, the title of this paper derives from Mukherjees title.80areas were identified such as the rationale for the variousmethods used, how firms compute their cost of capital, thelow rate of risk recognition, the associated low rates of risk adjustment and assessment sophistication, capital rationing(and the low usage of linear programming), and the detailsof authorization levels. Finally, with regard to Stage 4, more research was encouraged into the details of performanceevaluation, how the company follows up on such evaluation,the details of expenditure control procedures, and the reward system for performance.How well these appeals have been answered withsubsequent survey research is the primary focus o f thispaper. In the next section the authors describe the procedures employed to assess the effectiveness of these appeals madeover twenty years ago.II. ProceduresConsistent with the reviews by Scott and Petty (1984)and Mukherjee (1987), the following criteria were used tochoose capital budgeting survey articles for inclusion in this review the surveys had to involve large US firms, they hadto be broad-based (not focused on one particular industry),and they had to be published in mainline academic journalspost-1984. Using these criteria resulted in the selection of the 19 capital budgeting surveys included in find1. The Figure provides, in chronological disposition, the survey year (which in all cases differs from the publication year), authors, research method, usable responses and the referencesurveyed.Each of these 19 survey articles was then thoroughlyexamined in an effort to identify the stages and areaswithin each stage that the survey covered. The results ofthis process a re reported in Figure 2 and consistent withMukherjees (1987) chronological ordering in a tabular formindicating areas of investigation within the four stages oftheThese more specific questions are largely paraphrased from Mukherjee (1987) and are not fully exhaustive. The interested reader is, of course, encouraged to read this very thorough article in its entirety. The initial search using Proquest (ABI Inform) specifying capital budgeting surveys in scholarly journals after January 1, 1984, yielded over two hundred results.However, the great majority were published in the non-mainline journals, including many strictly practician (trade journal) outlets and /or were focused on a particular country or industry and thus eliminated by the screening criteria. To insure against missing articles due to any limitations ofthe ABl database, the authors checked the references ofthe surviving articles, and in addition, conducted a manual search ofthe most cited finance journals tables of cont ents and the reference sections of the various survey articles plant.JOURNAL OF APPLIED finance ISSUES 1 2, 2009capital budgeting process.It should be noted that the Figures herein were slightlyaltered from Mukherjees original format to better focuson selected issues that were identified specifically as areas of neglect. For example, the category of techniques wasdivided into techniques used and reasons for techniquesused. Similarly, the risk category was divided into riskrecognition, risk assessment, and risk adjustment.III. Findings by StageA quick perusal of Figure 2 reveals an obviousconcentration of checks in Stage 3 (selection) similar tothe previous findings of Mukherjee. Although a carefullook at some of the stage categories one by one indicatesthat several neglected areas have been researched over theperiod, there is still an obvious and relative lack of research into Stages 1, 2, and 4.To further assess the effectiveness ofthe research appeals,the analysis and reported results in this section will be ordered by the four stages. Summary comments are provided onlyon those surveys which provide a significant contributionto a previously neglected area of capital budgeting surveyresearch. As a result, the findings of Bierman ( 1993), Gilbert and Reichert (1995), Payne, Heath, and Gale (1999), andRyan and Ryan (2002) are not summarized.A. Stage 1 acknowledgementSuggested areas of study within this stage include howproject proposals are initiated, whether the proposal process is on-going or on an only-when-needed basis, at what level projects are generated, whether there is a formal process for submitting ideas, how that process works when present, andif there is an incentive system for rewarding good ideas.*Unfortunately, there has never been an in-depth surveyfocused on this stage, go forth no question that it remainsstrongly neglected. The only contribution of a minor natureto this topic is the incidental finding by Stanley and cease (1984). They found that in over 80% of the respondingfirms that capital budgeting proposals originated bottom upIn the 1987 article, note that on Figure 4, the stages are described somewhat differently from the intervention in the paper itself Specifically, in the body of the paper, the four stages are (1) identification, (2) development, (3) selection, and (4) the post-audit. But in the table, the 4 stages are idea generation, proposal development, selection of projects, and control or performance evaluation.As in footnote 3, the following suggested areas of study for all four stages are largely paraphrased from Mukherjee (1987)..81BURNS WALKER CAPITAL BUDGETING SURVEYS THE FUTURE IS NOWFigure 1. Surveys of Capital Budgeting of Large US FirmsSurveyedYear(s)Survey Author(s)MethodNumber ofUsableResponses1982Stanley Block(1984)questionnaire1211986Pruitt Gitman(1987)questionnaire1211986Pohlman,Santiago, Markel(1988)questionnaire2321988Gordon Myers(1991)19881992199019911992Myers, Gordon, Hame r(1991)Bierman (1993)Porterba Summers (1995)Gilbert Reichert(1995)Trahan Gitman(1995)SampleCFOs of Fortune 1000multinationalsVP Finance or Treasurer oflargest industrials in Fortune vitamin DCFOs of Fortune 500questionnaire282questionnaire282questionnaire74Executives and capitalbudgeting directors of large USindustrials except utilities andtransportationLarge public firms from FASBData Bank100 largest of Fortune 500questionnaire160-228CEOs of Fortune 1000questionnaire151Fortune Magazine DirectoryCFOsquestionnaire84CFOs of Fortune 500 + Forbes200Managers of foreignmanufacturing subsidiaries ofUS industrials1992Shao Shao(1996)questionnaire1881992Burns Walker(1997)questionnaire180Fortune 5007,27,107 best-sellling texts, 27prestigious CFOs, 10 leadingfinancial advisors1996-97 Bruneretal(1998) telephone survey1992-93Mukherjee Hingorani(1999)questionnaire102Fortune 500 CFOs1994Payne, Heath, Gale (1999)questionnaire155USA and Canadian basedcompanies from SPCompustat databasequestionnai re111CFOs from Fortune 1000questionnaire392CFOs from FEI corporationsinterviews39executives of large companiesquestionnaire205CFOs of Fortune 1000questionnaire40top-ranking officers of Fortune100019971999199919992005Gitman Vandenberg(2000)Graham Harvey(2001)Triantis Borison(2001)Ryan Ryan(2002)Block (2007)z II O)(2002) ueAy ? uBAyo(0O)a(0ai2i2ou.ao(0(OO)IO)o3OQareU3D) O6B)UB9 UBLULOdS(8861.) StJeiM(Z86l.)ueaJiOSHn.id(W6l)00ia88UBisL Idea GenerationA. Source of OriginationB. Reasons for Idea OriginationC. Process of Origination SubmissionD. condemnation Pattern of Origination1II. ProposalDevelopmentA. Level at Which screening Takes PlaceB. Screening ProcessC. Cashflow Estimates (and forecasting)D. Responsibility for Budget Preparation (personnel)lll. Selection of ProjectsA. Classification of Projects for Economic compendiumB. Personnel (Department) Responsible for AnalysisC1. Listing Techniques UsedC2. Reasons for Techniques UsedDl. Risk recognitionD2. Risk assessmentD3. Risk a djustmentEl. Capital Rationing How enormous?E2. Capital Rationing RationaleE3. Capital Rationing Methods UsedF. Cost of CapitalG. Project ApprovalIV. Control (or Perfonnance Evaluation)A. Extent of Use of Post examineB. Personnel Involved/ProcedureC. Performance MeasurementD. Use of Evaluation (Punishment/Reward/Etc.)1* Surveys in this exhibit appear in chronological order of their publication.82JOURNAL OF APPLIED FINANCE ISSUES 1 2, 2009ooooCMo(ooz) iooia6jaquapueA S UBLUIJO(0002)(66609B0 S MIB9H auBd(666 OUBJo6uH S aajaLjni-?-y-7-? -y(1.002) uosuog pue suueui-?y(1.002)SWBH S lUBMBJO7-?-?-?-?-y-?(866l.)Ba.iaunjg-?CO t -y(66l)J8lieM8SUjng(966l)oeLS8OBs-y(9661.) uBUjJio S UBUBJi-y(S66l.)weM0aysjaqi9-y(9661-)sjauiujns s eqjapod-?-ym(661.) ueuuaig-y-y5a.nO(1-661-)jaoiBH S uopjoo sjaA/y-yy-y(1.661.) sja/l8uopjoo-yy-y-y-?-?-yy-y-yto-y00