Burns

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Capital-Budgeting Surveys: The Future Is Now

Richard M. Burns, Professor of Finance

Joe Walker, Associate Professor of Finance

UAB School of Business

Birmingham, Al 35294

The authors wish to thank the editor and the anonymous referee for their

many helpful comments and suggestions.

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Capital-Budgeting Surveys: The Future Is Now

Abstract

This research is motivated by two major factors: (1) the over twenty year

hiatus since the last thorough review of the capital budgeting survey literature,

and (2) past appeals to the finance academic community by researchers to

explore neglected areas of the capital budgeting process. In response, and

using a four-stage capital budgeting process as a guide, the authors review the

capital budgeting survey literature from 1984 through 2008 and find that some of

the neglected areas have in fact been directly addressed. Unfortunately, the

most prevalent focus of capital budgeting surveys continues to be that of the

selection stage. As a result, many areas of the capital budgeting process still

remain relatively unexplored, providing numerous survey research opportunities.

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I. Introduction

This research effort is motivated by two major factors: (1) the twenty year

hiatus since the last thorough review of the capital budgeting survey literature,

and (2) past observations and appeals made to the finance academic community

by fellow researchers to explore neglected areas of the capital budgeting process

through more focused and directed survey research.

The first factor stands on its own as justification for an update of the

capital budgeting survey literature. The last comprehensive reviews were made

by researchers Scott and Petty (1984) and Mukherjee (1987) over twenty years

ago.

Regarding the second factor, almost three decades ago, Kim (1979) noted

that too much emphasis was being placed on methods of ranking and selecting

capital budgeting proposals. Scott and Petty (1984) also noted the

“…disproportionate (unjustified) amount of time [spent] on a particular stage

(financial analysis and project selection) …” Further, Gordon and Pinches (1984)

generalized this complaint by arguing that “…the capital budgeting process must

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 provided a current review

of the capital budgeting survey studies over the past twenty-four years. The

results are reported in a four-stage capital budgeting framework that allows a

more detailed and clear assessment of the appeals by past researchers. As a

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result, fertile areas for future applied research in the area of capital budgeting

survey work are more easily identified and summarized.

The organization of this paper is as follows. In Section II a four-stage

capital budgeting process will be identified and used throughout the balance of

the paper. It provides a useful framework to evaluate in more detail the most

prominent capital budgeting survey literature reviews of the past, to highlight

neglected areas of capital budgeting research, and to organize past appeals for

future research in this area. In Section III this four-stage process will also be

used to describe the procedures used in performing the capital budgeting survey

literature update over the 1984-2008 period. Section IV will continue to use this

framework to present the detailed findings while Section V will provide an overall

summary. Finally, Section VI will present conclusions, comments, and insights

for future survey research.

II. Past Reviews and Appeals

In the corporate finance capital budgeting survey literature the capital

budgeting process has been described in terms of four stages: (1) identification,

(2) development, (3) selection, and (4) control.1 The identification stage

comprises the overall process of project idea generation including sources and

submission procedures and the incentives/reward system, if any. The

development stage involves the initial screening process relying primarily upon

cash flow estimation and early screening criteria. The selection stage includes

the detailed project analysis that results in acceptance or rejection of the project

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for funding. Finally, the control stage involves the evaluation of project

performance for both control purposes and continuous improvement for future

decisions. All four stages have common areas of interest including personnel,

procedures, and methods involved, along with the rationale for each.

All four stages are critical to the overall process, but the selection stage is

arguably the most involved since it includes the choices of analytical

methods/techniques used, how the cost of capital is determined, how

adjustments for projects risks are assessed and reflected, and how, if relevant,

capital rationing affects project choice. The selection stage has also been the

most investigated by survey researchers, particularly in the area of selection

techniques, resulting in a relative neglect of the other stages. This in turn has led

to appeals to future researchers to consider the other stages in their survey

research efforts. As Gordon and Pinches (1984) note:

Most of the literature on the subject of capital budgeting has emphasized the selection phase, giving little coverage to the other phases. Instead, it is usually assumed that a set of well-defined capital investment opportunities, with all of the informational needs clearly specified, suddenly appears on an executive’s desk and all that is needed is for the manager to choose the project (s) with the highest expected payoff. However, as most managers quickly learn, this is not the case. Further, once projects are chosen, the evaluation of an individual project’s subsequent performance is usually either ignored or often inappropriately handled. Our contention is that the capital budgeting process must be viewed in its entirety, and the informational needs to support effective decisions must be built into the firm’s decision support system (p.3).

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The two most significant attempts to assess the balance of research among

these four stages were those of Scott and Petty (1984) and Mukherjee (1987),

both of which occurred well over twenty years ago.2

Scott and Petty provided a synthesis of earlier surveys of large American

firms and organized their analysis based on a three stage classification: (1)

project definition and cash flow estimation (2) financial analysis and project

selection, and (3) project implementation and review. Citing Gitman and

Forrester (1977), they noted that:

… project definition and cash flow estimation is considered the “most difficult” aspect of the capital budgeting process. The financial analysis and project selection stage, which receives the most attention in the literature, is considered the least difficult of the three stages …

Also covering surveys of large American corporations, Mukherjee (1987)

agreed that there had been too much survey focus on the selection stage and not

enough on the other stages as well as the overall capital budgeting process.

Paraphrasing that paper’s recommendations, it called for more research into

specific questions relevant for each stage. For example, in stage 1, future

surveyors were urged to investigate the reward systems, procedural aspects, and

the organizational structure of the firm. In stage 2, more research was suggested

on the topics of divisional vs. corporate biases, strategic considerations, cash

flow estimation details, data details, cannibalization, risk, and inflation. Even

within the more widely-studied Stage 3, neglected areas were identified such as

the rationale for the various methods used, how firms compute their cost of

capital, the low rate of risk recognition, the associated low rates of risk

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adjustment and assessment sophistication, capital rationing (and the low usage

of linear programming), and the details of authorization levels. Finally, with

regard to Stage 4, more research was encouraged into the details of

performance evaluation, how the company follows up on such evaluation, the

details of expenditure control procedures, and the reward system for

performance.3

How well these appeals have been answered with subsequent survey

research is the primary focus of this paper. In the next section the authors

describe the procedures employed to assess the effectiveness of these appeals

made over twenty years ago.

III. Procedures

Consistent with the reviews by Scott and Petty (1984) and Mukherjee

(1987), the following criteria were used to choose capital budgeting survey

articles for inclusion in this review: the surveys had to involve large U.S. firms,

they had to be broad-based (not focused on one particular industry), and they

had to be published in mainline academic journals post-1984. Using these

criteria resulted in the selection of the nineteen capital budgeting surveys

included in Exhibit 1 below 4. The exhibit provides, in chronological order, the

survey year (which in all cases differs from the publication year), authors,

research method, usable responses and the audience surveyed.

[ Insert Exhibit 1 about here]

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Each of these 19 survey articles was then thoroughly examined in an

effort to identify the stages and areas within each stage that the survey covered.

The results of this process are reported in Exhibit 2 and consistent with

Mukherjee’s (1987) chronological ordering in a tabular form indicating areas of

investigation within the four stages of the capital budgeting process.5

It should be noted that the exhibits herein were slightly altered from

Mukherjee’s original format to better focus on selected issues that were identified

specifically as areas of neglect. For example, the category of “techniques” was

divided into “techniques used” and “reasons for techniques used”. Similarly, the

risk category was divided into “risk recognition”, “risk assessment”, and “risk

adjustment”.

IV. Findings by Stage

A quick perusal of Exhibit 2 reveals an obvious concentration of “checks”

in Stage 3 (selection) similar to the previous findings of Mukherjee. Although a

careful look at some of the stage categories individually indicates that several

neglected areas have been researched over the period, there is still an obvious

and relative lack of research into Stages 1, 2, and 4.

[Insert Exhibit 2 about here]

To further assess the effectiveness of the research appeals, the analysis

and reported results in this section will be ordered by the four stages. Summary

comments are provided only on those surveys which provide a significant

contribution to a previously neglected area of capital budgeting survey research.

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As a result, the findings of Bierman (1993), Gilbert and Reichert (1995), Payne,

Heath, and Gale (1999), and Ryan and Ryan (2002) are not summarized.

A. Stage 1: Identification

Suggested areas of study 6 within this stage include how project 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, and if there

is an incentive system for rewarding good ideas.

Unfortunately, there has never been an in-depth survey focused on this

stage, leaving no question that it remains strongly neglected. The only

contribution of a minor nature to this topic is the incidental finding by Stanley and

Block (1984). They found that in over 80% of the responding firms that capital

budgeting proposals originated bottom up (vs. top down), and that the decision-

making process was centralized.

B. Stage 2: Development

Suggested areas of study within this stage include the extent of screening

of project ideas, how ideas get turned into proposals, the level of review, the

screening criteria, and the role of project size and organizational structure.

Perhaps more importantly, this stage also focuses on firm data-gathering efforts,

viz., the extent to which companies use accounting vs. cash flow data, the details

of how the data is estimated, the responsible personnel, and the decision support

system.

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Overall, good progress has been made in stage 2 research, especially in the

areas of cash flow estimation, forecasting, and the origination of biases in those

processes. For example, Pruitt and Gitman (1987) specifically identified and

investigated Stage 2. In so doing, they provided a deeper understanding of

capital budgeting forecast biases and cash flow estimation. They specifically

found that:

• 80% of high-ranking financial officers perceived both a pronounced

upward bias in the revenue forecasts and a less-pronounced downward

bias in the cost forecasts, both of which compounded the profitability

forecast error.

• Over two-thirds of the officers felt these biases arose due to intentional

overstatement or lack of experience.

• Among the other third of officers who did not attribute bias to these two

main reasons (and who provided their identity), follow-up telephone calls

revealed (1) psychological explanations (e.g., myopic euphoria, mass

psychology, group polarization, and salesmen optimism) or (2) erroneous

information emanating from upper level management and provided to

forecasting personnel.

• The officers said they handled such biases by adjusting the cash flow

estimates downward on an informal basis, although specifically how this

adjustment was made was not addressed.

Pohlman, Santiago and Markel (1988), in a direct response to the appeal by

Scott and Petty (1984), provided the first in-depth look at the cash flow estimation

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practices by surveying the Fortune 500. Among other important findings, they

discovered that:

• About 67% of their survey respondents employed a person to specifically

supervise their cash flow estimation.

• Firms with more leverage and higher capital intensities were even more

likely to have such a specialized person.

• 85% of their respondent companies used systematic, company-wide,

standard procedures in estimating cash flows (which were used even

more in higher risk firms).

• 78% had standard forms and worksheets for their cash flow forecasts, and

65% had a standard model.

• In addition to considering production, marketing, financial, and economic

factors such as inflation, firms combined judgment with their quantitative

forecasts.

One of the more noteworthy points of their research was the emphasis on the

importance of information systems processes and their role in forecast accuracy.

Gordon and Pinches (1984), in fact, had earlier emphasized that the decision

support system or information system was the key to development and other

stages of capital budgeting.

C. Stage 3: Selection

Suggested areas of study within this stage include: the personnel

involved, the techniques used – the rationale and conflict priority and the details

of WACC and hurdle rate determination, risk analysis, capital rationing, and

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project approval. Since, as stated earlier, this stage is arguably the most

involved, the results are provided in the subheadings below.

1. Personnel

Suggested areas of study on personnel issues include determining who or

which department analyzes capital expenditures, how many people are involved

in the process, and who makes the final decision, among other topics. No

research in this area was noted over the last two decades as well as previously.

2. Rationale for Selection Techniques

Suggested topics for study in this area include determining why some

techniques are preferred over others by practitioners. As emphasis, Mukherjee

(1987, p. 44) said, “…past surveys did not directly take up the matter of rationale

behind these practices with surveyed firms.” Burns and Walker (1997) directly

cited the 1987 Mukherjee article as the catalyst for their research effort and

focused on the “why” of capital budgeting practices by surveying the Fortune

5OO firms on the detailed reasons for their choice of techniques and the reasons

for any changes in the emphasis of those techniques over time. Highlights of

their findings include:

• The rationale for the continued use of simple payback was its ease of

computation and also its usefulness as an adjunct to discounted cash

flow measures as both a measure of liquidity and risk.

• The accounting rate of return was used primarily for reconciliation for

financial statement reporting and because it was often the basis for

performance appraisal and bonus incentives.

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• The Internal rate of return and net present value were used primarily

because of their use of time value of money considerations and also

because of their use of cash flow measures (as opposed to accounting

income measures). The internal rate of return measure seemed easier

to understand and compute, but net present value was seen as more

reliable.

• The profitability index and the modified internal rate of return were not

used as much as finance textbooks would imply. The profitability index’s

attractiveness was its use in capital rationing situations, and the modified

internal rate of return’s attractiveness was its more realistic reinvestment

rate assumption.

• The most common way of learning about capital budgeting techniques

was through formal education.

Other studies did look at inferential types of rationales for selection

techniques, such as size of firm vs. sophistication of techniques used, but none

directly asked practitioners “why”.

3. WACC

Suggested areas of research in this category include the extent to which

firms use hurdle rates to make project selections, whether or not firms use the

same hurdle rate to evaluate all projects, how the hurdle rate is defined and why,

and how firms arrive at the particular numbers they calculate. Some very

important work on the why and how of the cost of capital and hurdle rates has, in

fact, occurred. For example, Stanley and Block (1984) looked at a variety of

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capital budgeting topics involving U.S. firms within a multinational context, and in

the area involving the cost of capital they found that:

• 49% of respondents used the parent company’s cost of capital, 32% used

the project cost of capital, and some used both.

• The cost of capital was adjusted for expected changes in foreign

exchange rates by 34% of firms in order to adjust their foreign currency

debt.

Porterba and Summers (1995) directly surveyed the chief executive officers of

the Fortune 1000 to provide a deeper understanding of how hurdle rates were

measured and used. They found that:

• Hurdle rates were higher than standard analysis would suggest.

• Most firms had more than one hurdle rate, and they varied their hurdle

rates with the projects being considered.

• Some managers made a distinction between the cost of capital and hurdle

rates as a way of adjusting for biased estimates of projects’ profitability.

In an oft-cited article on this topic, Bruner, Eades, Harris and Higgins (1998)

answered the research call by examining how firms computed their cost of

capital (WACC). Using a telephone survey to target twenty seven highly

regarded corporations and ten leading financial advisers, and examining seven

best selling textbooks, the authors found evidence of a general alignment among

the three groups on the use of common theoretical frameworks and basic

methods of estimation. In particular, they found that:

• DCF was the dominant investment-evaluation technique

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• WACC was the dominant discount rate

• Market weights were used, not book weights

• The after-tax debt cost was based on marginal tax rates, not average

rates

• CAPM was the dominant equity model

• There was wide variation in the inputs to the models and major

disagreements with respect to how to apply CAPM

Gitman and Vandenberg (2000) did an update on an earlier cost of capital

survey (Gitman and Mercurio, 1982) and found that:

• 93% of firms used the capital asset pricing model to find their cost of

equity.

• Project size and payback were the main factors in assessing project risk.

• Firms used target weights vs. book weights.

• Firms used after-tax debt costs.

• One counter-intuitive result was that fewer firms in the follow-up survey

seemed to be using formal procedures than previously, including the post

audit phase.

4. Risk Analysis

Suggested areas of study within the risk analysis category include how

risk is actually defined in a capital budgeting context; how risk is recognized,

assessed, and reflected; why there is such low usage of sophisticated risk

analysis methods such as the sensitivity, scenario, and Monte Carlo analyses;

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and how improvements could be made in obtaining the necessary input from

management for improving existing risk models or building new ones.

For example, in reference to how risk is characterized or identified, in

Graham and Harvey’s (2001) survey, the respondents recognized market risk,

but they also identified other risk factors such as interest rate, size, inflation, and

foreign exchange rate risk. In adjusting for risk, Graham and Harvey found that

more than half of the firms did not adjust WACC (average firm risk) to reflect

specific project risk, especially when evaluating international projects. Stanley

and Block (1984) and Shao and Shao (1996) found that firms were using risk-

adjusted cash flows more often than risk-adjusted discount rates, a noticeable

change from previous survey findings. Trahan and Gitman (1995), however,

reported mixed results in this regard. Gitman and Vandenberg (2000) found that

39% of firms also adjusted their rates vs. adjusting their cash flows to adjust for

risk while 21% do both. Finally, they found that 16% of the firms grouped

projects into risk classes, and 77% differentiated project risk. Shao and Shao

(1996) found that sensitivity analysis was the dominant assessment technique.

Then, regarding the low usage of sophisticated risk analysis methods,

Trahan and Gitman (1995) looked at barriers to the use of sophisticated financial

decision-making techniques to find that they were perceived as: (1) not practical,

(2) relying upon unrealistic assumptions, (3) difficult to explain to top

management, and (4) difficult to apply. Also, in response to a unique inquiry into

what risk analysis subjects firms would like to know more about, they found that

23% wanted to learn more about sensitivity analysis, decision trees, and

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computer simulation, and the upward bias in cash flow estimates. The next

highest response category was only 5%, comprised of firms wanting to learn

more about management subjective estimates.

Although some progress has been made in the identification, assessment,

and adjustment of risk, as well as explaining the low usage of sophisticated

methods, none of the studies looked at the details of the actual process of

obtaining the necessary input from management to improve existing risk

assessment and adjustment models or to build new ones. Note again the

desirability of more research on the decision support system which was

commented upon at the end of the section on Stage 2.

5. Capital Rationing

Suggested areas of recommended research in this area include the financial

environment in which the decisions are made, why the application of

management science tools has remained low, whether capital rationing is “soft”

or “hard”, and the specific reasons behind capital rationing (e.g., to correct

project proposal biases). Mukherjee and Hingorani (1999) referred to the 1987

Mukherjee article as the motivation for their research effort in surveying the

Fortune 500 concerning the why of capital rationing. They found that capital

rationing is not simply the irrational manifestation that textbooks frequently imply

but was instead a reaction to real problems that managers face. Several of their

important findings in this regard included:

• The main reason for capital rationing was a reluctance to issue external

financing.

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• Firms’ senior management was highly risk averse and therefore used

capital rationing to avoid accepting projects with high downside risk and to

correct for middle managers’ optimistic forecast biases.

• Capital rationing was seen as “soft” in nature, and there was a

conspicuous absence of tools (e.g., constrained maximization) used when

capital rationing was present.

Further, Gitman and Vandenberg (2000) found yet other considerations in the

use of capital rationing:

• 23% engaged in capital rationing in order to maintain a target earnings per

share or price to earnings ratio

• Capital rationing occurred only about 40% of the time, less than the 60%

occurrence found in earlier studies.

• The dominant cause of capital rationing among 60% of the respondents

was a debt limit imposed by management.

Thus, notable progress has been made on the nature of and rationale for capital

rationing.

6. Project Approval

Suggested areas of study within this subheading include the extent of the

autonomy of divisional managers (since project acceptance does not mean

implementation, even though few projects are rejected at this stage of formal

analysis), the role of divisional managers, the interface between strategies,

capital investment and operating decisions, and the role of divisional manager in

each of those categories.

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For the most part, in the last two decades little research has been done on

the topic of project approval. The one exception to this is the Gitman and

Vandenberg (2000) study showing that firms in the 1997 follow-up survey

employed more formal processes for project approval, especially for large

outlays, than those in the 1980 study (Gitman and Mercurio, 1982).

Before leaving this discussion on Stage 3 (selection), it is important to

mention the more recent survey work on real options as an important

enhancement to the NPV selection technique through its contribution to risk

assessment. Interestingly, at the time the appeals were made, real options

analysis had not yet even been considered as an addition to capital budgeting

methods in practice and certainly not in survey research efforts.7 Clearly, real

options analysis is prominent among decision method considerations today in the

academic arena, and one could argue that any survey research done in the area

of real options usage in the capital budgeting process during this period of review

should be noted. However, the category of real options was not included

separately in Exhibit 2 since it was not a part of the original appeals. Instead, in

Exhibits 2 and 3, real options survey contributions were checked under the

categories of “listing techniques used” and “risk assessment.”

Two earlier surveys over the review period asked about real options

incidentally. Burns and Walker (1997) included two questions on the frequency

and kinds of strategic options in the context of discovering reasons for accepting

a negative NPV project. They found a relatively infrequent use of such options,

and mostly for reasons of maintaining market share or allowing for operating and

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managerial flexibility. Ryan & Ryan (2002) found in their survey of selection

techniques that almost 90% of firms rarely or never used real options as a capital

budgeting tool. But overall, none of the surveys before 2001 focused on real

options analysis.

Copeland and Antikarov (2001) suggested that real options would

dominate the capital budgeting process within the next decade, and this spurred

two surveys dedicated to real options usage. Triantis and Borison (2001)

interviewed 39 individuals from 34 companies in 7 different industries and

concluded that, “…real options will serve …as a general way of thinking” [and

that] ”there is an overwhelming … unanimous feeling … [that real options help

managers make better investment decisions…].” Block (2007), motivated by the

predictions of Copeland and Antikarov (2001), polled the Fortune 1000 to

determine the extent to which these companies had adopted real options

analysis as a complement to traditional analysis. Out of 279 respondents only 40

(14.3%) used real options in the capital budgeting process. The users were

primarily in industries where sophisticated analysis is generally more common

such as technology, energy and utilities. Thus, the survey found that the use of

real options was limited, although somewhat higher than that found in prior

studies. A more positive finding was that 43.5% of the non-users said that there

was a good chance they would consider the use of real options in the future.

Reasons cited by the respondents for non-use included a lack of top

management support, the requirement of too much sophistication, and the

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excessive risk-taking encouraged by the use of real options. The interested

reader is encouraged to read this article and the cited references.

D. Stage 4: Control (Post-audit and Performance Appraisal)

Suggested areas of study within this stage include research into: how

project performance is evaluated, by whom, how it is done, what happens when

expected and actual results differ, whether there is an expenditure control

procedure, whether management is rewarded or punished for such

discrepancies, and if so, how? The control stage received some significant

attention, particularly in the early part of the review period.

For example, Gordon and Myers (1991) surveyed executives and capital

budgeting directors of large U.S. industrial firms and found that:

• 76% of their survey respondents had performed post-audits over the

previous 10 years

• However, a much smaller percentage of those audits were not effective

according to criteria which involved (1) the need to be regular and

periodic, (2) the use of risk-adjusted discount rate cash flow techniques,

and (3) documented policies and procedures.

• They also found that the use of the post audit varied highly according to

the use or non-use of established procedures by asset base - that

strategic assets (e.g., expansion projects) received the most post-audits,

administrative assets (e.g., replacement projects) received the next most,

and operating assets (e.g., minor office equipment) received the fewest.

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• They confirmed the “bad news” that post-auditing is far from being a

standard part of the capital budgeting process.

• Their “good news,” however, was the increasing awareness and use of the

need for post-auditing.

Using the data from this same study, Myers, Gordon and Hamer (1991)

compared (sophisticated) experimental groups vs. (naïve) control groups. They

found that firms increased their performance when using sophisticated

(discounted cash flow based) audit procedures.

Note that Pruitt and Gitman (1987), mentioned above in the Stage 2 review,

also looked at the post-audit process to find an upward bias that management

suspects. Especially pertinent in this regard was their finding that optimistic

forecasts were sometimes based on psychological factors such as myopic

euphoria, mass psychology, and group polarization effects. This ties in with the

Gordon and Myers (1991) and Myers, Gordon and Hamer (1991) analyses above

which both argued for a post-audit system with 4 objectives – a financial control

mechanism, a means to provide future information for capital budgeting, a means

to remove psychological and/or political impediments to effective capital

budgeting (e.g., abandoning an on-going project), and a way to eliminate the

psychological biases on future capital budgeting proposals (e.g., “pet” proposals).

In short, the post-audit should provide objective information on which to base

potentially unpopular decisions.

Pohlman, Santiago and Markel (1988), though mentioned earlier above in

reference to their Stage 2 contributions, found in the Stage 4 area that:

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• 75% of their firms compared actual and forecasted cash flows.

• Of these, 95% did it for initial investment outlays, and a full 100% for

operating cash flows.

• Only 68% of firms compared actual and forecasted cash flows for

salvage values due to the increased difficulty of that estimation.

• 68% of their firms achieved a 90% accuracy level of initial investment

outlays, but only 43% claimed a 90% accuracy level for operating cash

flows.

• 66% of their firms achieved a 90% accuracy level on salvage values.

This important research into the control stage has resulted in a deeper

understanding of this previously neglected area.

V. Overall Summary of Findings

In summary of the overall findings of this literature review, it is clear that

significant contributions have been made in the neglected stages of the capital

budgeting process over the 1984-2008 period of review. Although not all of the

cited studies can be directly attributed to the specific appeals,8 the appeals have

arguably had an important effect.

Looking back at Exhibits 1 and 2, however, reveals two troublesome

aspects of these findings. First, Exhibit 1 shows that over the review period

of this paper (using the actual survey year) all but one of these studies occurred

in the first eighteen years, and therefore only one occurred in the last seven

years. The average age of the studies, based on the actual survey year, is

approximately 16 years from the 2008 ending point of this review. In fact, three

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of the 19 studies just mentioned are over twenty years old. Thus, the results

show a steady stream of research (about one study per year) into some of the

neglected areas beginning shortly after the appeals, followed by a virtual

shutdown after 2002.

Second, a perusal of Exhibit 2 shows that over the past twenty years the

majority of the capital budgeting surveys have remained concentrated on the

selection stage, and the listing of techniques used continues to preoccupy

surveyors’ efforts. This includes the four studies that did not address any

neglected area specifically, and which therefore received no comments in the

results section.

Exhibit 3 below summarizes and compares the current study’s results

with the Mukherjee (1987) results for easier comparison.

[Insert Exhibit 3 about here

It can be seen that Stage 1 remains the most neglected with Stages 4 and

2 close behind. Even for Stage 3 research, in absolute number of studies, it too

has less research now than before, although in percentage terms there is even

more focus on the listing of techniques than before (18% > 14%), slightly more

on risk recognition and assessment (about a percent), and much more on the

cost of capital (12% > 7%, but again, only in percentage terms).

Before leaving this section, a few comments on international studies are in

order. As stated earlier, the capital budgeting surveys in this review were limited

to those involving only U.S. firms. All studies based on international firms were

screened from the list to facilitate comparisons and consistency with the earlier

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reviews and appeals. Most of the international studies identified in the initial

search would have been eliminated anyway due to their narrow focus on a

particular industry and/or publication in specialized practitioner outlets. However,

four research efforts were found that could be classified as mainline academic

surveys of large European firms with some noteworthy contributions to a few

neglected areas.

Sangster (1993) surveyed the largest 500 Scottish firms, but contrary to

the earlier American appeals, he merely focused on the cataloging and use of the

usual selection techniques and found that the frequency of use of the more

sophisticated methods had increased over time. Pike (1996) made a notable

contribution by answering Sangster’s call for time-series studies by arguably

performing the first extensive longitudinal study survey of U.K. firms from 1975 –

1992 at five-year intervals, showing that the greatest changes over that period

had occurred in the increasing sophistication of risk analysis and post-completion

audits. It is interesting to note that Pike, in turn, called for more real options

research as well as for more risk analysis investigation, and he also appealed for

more focused surveys in capital budgeting since the so-called theory/practice

gap was seen to be narrowing. In addition, Pike said, “…further general capital

budgeting status surveys would contribute little to the existing body of empirical

knowledge,” an echo of the earlier American conclusions reached by Scott and

Petty (1984), Gordon and Pinches (1984), and Mukherjee (1987).

Arnold and Hatzopoulos (2000) cited Pike (1996) in their survey of the

Times 1000 and delved into the neglected areas of cost of capital and hurdle

Page 26 of 38

rates, capital rationing, and risk assessment. They too appealed for future

research to include, “…other stages in the process which includes identification

of investment opportunities, the search for ideas, the development of proposals

into projects, the early screening to match with strategy and culture, the

implementation stage, [and the] control and review of performance…this will

provide a better understanding of the entire process.” Among other suggestions

for future research, they specifically called for more survey work on the firms’ use

of real options.

Finally, and to facilitate comparison, Brounen, de Jong and Koedijk (2004)

used the Graham and Harvey (2001) questions in their survey of firms in the

U.K., Netherlands, Germany, and France. They obtained 313 responses out of

6,500 mailouts of both public and private firms, but they found little difference in

U.S. and European capital budgeting practices. Furthermore, as in the original

U.S. study, there was no investigation into the neglected stages except for how

risk was characterized or identified.

Although these European surveys did make some minor contributions to

the neglected areas, more interestingly and importantly, they made independent

appeals to their readership similar to the earlier American survey studies serving

as the basis of this review. It seems that the European investigators realized that

they also were too focused on the selection stage to the detriment of learning

more about the neglected stages and the entire capital budgeting process.

Page 27 of 38

VI. Conclusions

Over two decades ago, several prominent capital budgeting surveyors

urged the finance profession to rebalance and redirect its capital budgeting

research efforts away from merely cataloging what techniques firms used in their

Stage 3 (selection) processes. Instead, they urged future researchers to devote

more resources to studying Stage I (identification), Stage 2 (development), Stage

4 (control), and specific neglected areas in Stage 3 (selection) since these were

the most unexplored areas of capital budgeting. But did fellow researchers in the

field of capital budgeting hear the calls by Gordon and Pinches (1984), Scott and

Petty (1984), and Mukherjee (1987), among others, or otherwise discover

research opportunities in the neglected areas of the capital budgeting process?

The results of this study provide both good news and bad news. The

good news is that some researchers indeed directly answered the calls (see

footnote 8) and others apparently saw the need independently. As a result, there

have in fact been several quality survey research efforts into the neglected areas,

most notably those discussed in Section IV of this paper. The highlights include

the inquiries into cash flow estimation by Pruitt and Gitman (1987) and by

Pohlman, Santiago, and Markel (1988), the “why” of evaluation techniques by

Burns and Walker (1997), the why and how of capital rationing by Mukherjee and

Hingorani (1999), the detailed evidence on cost of capital practices by Bruner et.

al. (1998) and by Gitman and Vandenberg (2000), the investigation of risk

analysis practices by Trahan and Gitman (1995) and by Graham and Harvey

Page 28 of 38

(2001), and the in-depth studies of the control (post-audit) stage by Gordon and

Myers (1991) and Myers, Gordon, and Hamer (1991).

The bad news is two-dimensional. First, in spite of notable progress cited

in earlier years of this review, there has been a virtual hiatus in capital budgeting

survey research of U.S. firms generally over the most recent seven years.9

Secondly, the selection stage, with its emphasis on particular project evaluation

techniques, still dominated the survey topics over the entire review period. As a

result, there are many opportunities that still await surveyors to deeply delve into

the capital budgeting process by re-focusing their efforts towards the neglected

stages.

Opportunities include focusing on a particular stage (e.g. the relatively

unexplored identification stage), researching a phase within a stage (e.g. risk

analysis within the selection stage), or contributing detail to the overall four-stage

process. Using a “best practices” perspective similar to that of Bruner et al

(1998) could potentially provide a fertile approach. The more recent work in the

area of real options offers a rich opportunity to track the rationale and use of this

selection technique. For example, it is interesting to think about the

interrelationship between the control (post-audit) stage and the use of real

options at the selection stage because of the implied use of a post audit to

monitor the outcomes and alternatives over time.

One especially promising area of survey research is that of the decision

support system, a topic suggested by several authors but emphatically

advocated by Gordon and Pinches (1984), due to its impact on all four stages.

rrao

Highlight

rrao

Highlight

Page 29 of 38

As quoted earlier, future researchers should clearly avoid what Gordon and

Pinches say many past surveyors have done by assuming “… that a set of well-

defined capital investment opportunities, with all of the informational needs

clearly specified, suddenly appears on an executive’s desk and all that is needed

is for the manager to [select] the project (s) with the highest expected payoff.”

Given the tremendous advances in technology since 1984, the decision support

system should make a particularly interesting, fruitful and challenging area of

survey research. Finally, it would seem that with the blessings of the primary

business school accrediting agency for an increased volume of applied research

(AACSB International, 2008), that more progress in capital budgeting survey

research can be made in the future than has been seen in the past twenty four

years.

Page 30 of 38

Endnotes:

1 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.

2 Note that these two reviews are only three years apart based on

publication 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

Mukherjee’s title.

3 These 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.

4 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 practitioner (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 of the ABI database, the authors checked

the references of the surviving articles, and in addition, conducted a

Page 31 of 38

manual search of the most cited finance journals tables of contents and

the reference sections of the various survey articles found.

5 In the 1987 article, note that on Exhibit 4, the stages are described

somewhat differently from the discussion 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.

6 As in footnote 3 above, the following suggested areas of study for all four

stages are largely paraphrased from Mukherjee (1987), pp. 38 – 48.

7 As noted by Triantis and Borison (2001), “In the mid-1980’s academics

began [emphasis added] building option-based models to value

investments in real assets, laying the foundation for an extensive

academic literature in this area.” In particular, see their footnote no. 1 on

page 8.

8 Three of the current survey papers directly cite the appeals: Pohlman,

Santiago, and Markel (1988), Burns and Walker (1997), and Mukherjee

and Hingorani (1999).

9 For an interesting discussion of possible contributing factors to this hiatus,

see Baker and Mukherjee (2007) on the views of journal editors regarding

survey research in finance. Further, also see the AACSB International

(2008) report’s recognition of how applied research generally counts for

Page 32 of 38

less among tenure review committees and for annual compensation

purposes.

Page 33 of 38

References AACSB International, 2008, Final Report of the AACSB International Impact of

Research Task Force, Tampa. Arnold, Glen C. and Panos D. Hatzopoulos, 2000, “The Theory-Practice Gap in

Capital Budgeting: Evidence from the United Kingdom,” Journal of Business Finance and Accounting, 27 (5 and 6, June/July) 603-626.

Baker, H. Kent and Tarun K. Mukherjee, 2007, “Survey Research in Finance:

Views from Journal Editors,” International Journal of Managerial Finance, 3 (No. 1) p. 11 – 25.

Bierman, Harold, Jr., 1993, “Capital Budgeting in 1992: A Survey,” Financial

Management Letters, 22 (No. 3, Autumn), p. 24. Block, Stanley, 2007, “Are ‘Real Options’ Actually Used in the Real World?,” The

Engineering Economist, 52 (No. 3) 255-268. Brounen, Dirk, Abe de Jong and Kees Koedijk, 2004, “Corporate Finance in

Europe: Confronting Theory with Practice,” Financial Management, 33 (No. 4, Winter) 71-101.

Bruner, Robert F., Kenneth M. Eades, Robert S. Harris and Robert C. Higgins,

1998, “Best Practices in Estimating the Cost of Capital: Survey and Synthesis,” Financial Practice and Education, 8 (No. 1, Spring/Summer), 13-28.

Burns, Richard M. and Joe Walker, 1997, “Capital Budgeting Techniques Among

the Fortune 500: A Rationale Approach,” Managerial Finance, 23 (No. 9) 3-15.

Copeland, T and V. Antikarov, 2001, Real Options: A Practitioner’s Guide, New

York, Texere, LLC. Gilbert, Erika and Alan Reichart, 1995, “The Practice of Financial Management

among Large US Corporations”, Financial Practice and Education, 5 (No. 1, Spring/Summer) 16-23.

Gitman, Lawrence J. and J. R. Forrester, Jr., 1977, “A Survey of Capital

Budgeting Techniques Used by Major U.S. Firms,” Financial Management, 6 (No. 3, Fall), 66-71.

Gitman, Lawrence J. and V. A. Mercurio, 1982, “Cost of Capital Techniques

Used by Major U. S. Firms: Survey and Analysis of Fortune’s 1000,” Financial Management, 11 (No. 4, Winter), 21-29.

Page 34 of 38

Gitman, Lawrence J. and Pieter A. Vandenberg, 2000, “Cost of Capital

Techniques Used by Major U.S. Firms: 1997 vs. 1980,” Financial Practice and Education, 10 (No. 2, Fall / Winter) 53-68.

Gordon, Lawrence A. and Mary D. Myers, 1991, “Post-auditing Capital Projects:

Are You in Step with the Competition? ,” Management Accounting, 72 (No. 7 January) , 39-42.

Gordon, Lawrence A. and George E. Pinches, 1984, Improving Capital

Budgeting: A Decision Support System Approach, Reading Massachusetts, Addison-Wesley Publishing Company.

Graham, John .R. and Campbell R. Harvey, 2001, “The Theory and Practice of

Corporate Finance: Evidence from the Field,” Journal of Financial Economics, 60 (No. 2-3, May/June), 187- 243.

Kim, S. H., 1979, “Making the Long Term Investment Decision,” Management

Accounting, 60 (No. 9, March), 41-49. Mukherjee, Tarun K., 1987, “Capital-Budgeting Surveys: The Past and the

Future,” Review of Business and Economic Research, 22 (No.2, Spring), 37-56.

Mukherjee, Tarun K. and Vineeta L. Hingorani, 1999, “Capital-Rationing

Decisions of Fortune 500 Firms: A Survey,” Financial Practice and Education, 9 (No. 1, Spring / Summer), 7-15.

Myers, Mary D, Lawrence A. Gordon, and Michelle M. Hamer, 1991, “Post-

Auditing Capital Assets and Firm Performance: An Empirical Investigation,” Managerial and Decision Economics, 12 (No. 4, August ), 317-327.

Payne, Janet D., Will Carrington Heath and Lewis R. Gale, 1999, “Comparative

Financial Practice in the US and Canada: Capital Budgeting and Risk Assessment Techniques,” Financial Practice and Education, 9 (No. 1, Spring / Summer), 16-24.

Pike, Richard, 1996, “A Longitudinal Survey on Capital Budgeting Practices,” The

Journal of Business Finance and Accounting, 23 (No. 1, January) 79-92. Pohlman, Randolph A., Emmanuel S. Santiago, and F. Lynn Markel, 1988,

“Cash Flow Estimation Practices of Large Firms,” Financial Management, 17 (No. 2, Summer), 71-79.

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Porterba, James M. and Lawrence H. Summers, 1995, “A CEO Survey of U.S. Companies Time Horizons and Hurdle Rates,” Sloan Management Review, 37 (No. 1, Fall), 43-53.

Pruitt, Stephen W. and Lawrence J. Gitman, 1987, “Capital Budgeting Forecast

Biases: Evidence from the Fortune 500,” Financial Management, 16 (No. 1, Spring 1987), 46-51.

Ryan, Patricia A. and Glenn P. Ryan, 2002, “Capital Budgeting Practices of the

Fortune 1000: How Have Things Changed?,” Journal of Business and Management, 8 (No. 4, Fall ), 355-364.

Sangster, Alan, 1993, “Capital Investment Appraisal Techniques: A Survey of

Current Usage,” Journal of Business Finance and Accounting, 20 (3, April) 307-332.

Scott, David F., Jr. and J. William Petty, II, 1984, “Capital Budgeting Practices in

Large American Firms: A Retrospective Analysis and Synthesis”, The Financial Review, 19 (No. 1, May), 111-123.

Shao, Lawrence Peter and Alan T. Shao, 1996, “Risk Analysis and Capital

Budgeting Techniques of US Multinational Enterprises,” Managerial Finance, 22 ( No. 1), 41-57.

Stanley, Marjorie T. and Stanley B. Block, 1984, “A Survey of Multinational

Capital Budgeting,” The Financial Review, 19 (No. 1, March), 36-54. Trahan, Emery A. and Lawrence J. Gitman, 1995, “Bridging the Theory-Practice

Gap in Corporate Finance: A Survey of Chief Financial Officers,” The Quarterly Review of Economics and Finance, 35 ( No. 1, Spring), 73-84.

Triantis, A. and A. Borison, 2001, “Real Options: State of the Practice,” Journal

of Applied Corporate Finance, 14 (No. 2, Summer), 8-24.

Page 36 of 38

Surveyed

Year(s)Survey Author(s) Method

Number of

Usable

Responses

Sample

1982Stanley & Block

(1984)questionnaire 121

CFO’s of Fortune 1000

multinationals

1986Pruitt & Gitman


VP Finance or Treasurer of

largest industrials in Fortune

500

1986

Pohlman,

Santiago, &

Markel (1988)

questionnaire 232 CFO’s of Fortune 500

1988Gordon & Myers


Executives and capital

budgeting directors of large US

industrials except utilities and

transportation

1988Myers, Gordon, &

Hamer (1991)questionnaire 282

Large public firms from FASB

Data Bank

1992 Bierman (1993) questionnaire 74 100 largest of Fortune 500

1990Porterba &

Summers (1995)questionnaire 160-228 CEO’s of Fortune 1000

1991Gilbert & Reichert


Fortune Magazine Directory

CFO's

1992Trahan & Gitman


CFO’s of Fortune 500 + Forbes

200

1992Shao & Shao


Managers of foreign

manufacturing subsidiaries of

US industrials

1992Burns & Walker

(1997)questionnaire 180 Fortune 500

1992-93Mukherjee &

Hingorani (1999)questionnaire 102 Fortune 500 CFO's

1994Payne, Heath, &

Gale (1999)questionnaire 155

USA and Canadian based

companies from S&P

Compustat database

1997

Gitman &

Vandenberg

(2000)

questionnaire 111 CFO’s from Fortune 1000

1999Graham & Harvey

(2001)questionnaire 392 CFO’s from FEI corporations

1999Triantis & Borison

(2001)interviews 39 executives of large companies

1999Ryan & Ryan

(2002)questionnaire 205 CFO’s of Fortune 1000

2005 Block (2007) questionnaire 40top-ranking officers of Fortune

1000

Exhibit 1: Surveys of Capital Budgeting of Large US Firms

1996-97 Bruner et al (1998) 7,27,10

7 best-sellling texts, 27

prestigious CFO's, 10 leading

financial advisors

telephone survey

Page 37 of 38

Sta

nle

y &

Blo

ck (

19

84

)

Pru

itt

& G

itm

an

(1

98

7)

Poh

lma

n,

San

tia

go

, &

Ma

rke

l (1

98

8)

Gord

on &

Mye

rs (

19

91)

Myers

, G

ord

on

, &

Ham

er

(19

91

)

Bie

rma

n (

19

93)

Port

erb

a &

Su

mm

ers

(19

95

)

Gilb

ert

& R

eic

he

rt (

19

95

)

Tra

ha

n &

Gitm

an

(19

95)

Sh

ao &

Sh

ao (

19

96

)

Burn

s &

Wa

lke

r (1

99

7)

Bru

ne

r et

al (1

99

8)

Mu

kh

erje

e &

Hin

go

rani

(19

99

)

Pa

yne

, H

eath

, &

Ga

le

(19

99

)

Gitm

an &

Va

nde

nb

erg

(200

0)

Gra

ham

& H

arv

ey (

20

01

)

Tri

antis a

nd

Bori

son

(2

00

1)

Rya

n &

Rya

n (

20

02

)

Blo

ck (

200

7)

N =

19

√ 1

0

0

0

0

√ 1

√ √ 2

√ √ 2

√ 1

0

√ √ √ √ √ √ √ √ √ √ √ √ √ √ 14

√ √ 2

√ √ √ √ √ √ √ √ 8

√ √ √ √ √ √ √ √ √ 7

√ √ √ √ √ √ 6

√ √ 2

√ √ 2

√ √ 2

√ √ √ √ √ √ √ √ 8

√ 1

√ √ √ √ 4

√ √ 2

√ √ √ 3

√ √ 2

II. Proposal Development

III. Selection of Projects

I. Idea Generation

Exhibit 2: Capital Budgeting Surveys* and the Four

Stages of Capital Budgeting as of 2008

D. Time Pattern of Origination

A. Level at Which screening Takes Place

B. Screening Process

* Surveys in this exhibit appear in chronological order of their publication.

A. Source of Origination

B. Reasons for Idea Origination

C. Process of Origination & Submission

D. Responsibility for Budget Preparation (personnel)

A. Classification of Projects for Economic Analysis

B. Personnel (Department) Responsible for Analysis

C1. Listing Techniques Used

C2. Reasons for Techniques Used

C. Cashflow Estimates (and forecasting)

D1. Risk recognition

D2. Risk assessment

D3. Risk adjustment

E1. Capital Rationing: How Extensive?

E2. Capital Rationing Rationale

E3. Capital Rationing Methods Used

F. Cost of Capital

D. Use of Evaluation (Punishment/Reward/Etc.)

G. Project Approval

A. Extent of Use of Post Audit

B. Personnel Involved/Procedure

C. Performance Measurement

IV. Control (or Performance Evaluation)

Page 38 of 38

No. % No. %

Stage 1: Idea generation

3 3% 1 1% A. Source of origination

1 1% 0 0% B. Reasons for idea origination

1 1% 0 0% C. Process of origination and submission

1 1% 0 0% D. Time pattern of origination

Stage 2: Proposal Development

2 2% 0 0% A. Level at which screening takes place

2 2% 1 1% B. Screening Process

3 3% 2 3% C. Cashflow estimates (and forecasting)

2 2% 2 3% II-D. Responsibility for budget preparation (personnel)

Stage 3: Selection of Proposals

4 4% 1 1%

3 3% 0 0%

15 14% 12 17%

0% 4 6%

12 11% 8 11%

9 9% 7 10%

11 10% 6 9%

5 5% 2 3%

4 4% 2 3%

3 3% 2 3%

7 7% 8 11%

3 3% 1 1%

Stage 4: Control (Performance Evaluation)

6 6% 4 6% A. Extent of use of post audit

2 2% 2 3% B. Personnel involved / procedures

4 4% 3 4% C. Performance measurement

2 2% 2 3% D. Use of evaluation (rewards / punishment)

100% 100%

105 70

Exhibit 3: Comparison of Mukherjee's 1987 results and 2008 update results

update (2008)

C1. Listing Techniques Used

Stages of Capital Budgeting Process

D1. Risk recognition

D2. Risk assessment

D3. Risk adjustment

Mukherjee (1984)

G. Project Approval

N

A. Classification of projects for economic analysis

B. Personnel (department) responsible for analysis

E1. Capital rationing: how extensive?

E2. Why capital rationing?

E3. Methods used

F. Cost of capital

C2. Reasons for Techniques Used

Documents

Burns