Does The Capital Budgeting Process Inhibit Corporate Competitiveness? (AIME PRIPRINT 98-64)

Capital investments are made for a variety of purposes, from providing incremental capacity at existing operations to developing and implementing new technologies intended to radically improve a company's capabilities. These projects generate very different business opportunities and create value in distinctive ways. For incremental improvements, the capital budgeting process assures at least a loose fit between short-term goals and readily available resources. However, the criteria used to evaluate capital projects often prevent a company from committing to more aggressive goals that lie beyond the firm's current abilities or resources. Such projects may not have clearly identifiable future cash flows, and the degree of interaction with other projects and the nature of the risk incurred may be difficult to estimate. Additionally, by focusing only on quantifiable benefits, the budgeting process often fails to recognize "soft" improvements such as increased operating flexibility or new knowledge generated by such projects. By rejecting these projects, the capital budgeting process may actually harm the company's future competitive position.