The main aim of this paper is to analyze the use of capital budgeting techniques by companies in two different economic blocs at two different levels of economic development, namely West Africa and Europe, in a comparative perspective to see whether economic development matters in the choice of capital budgeting techniques. Although many papers in the past have investigated the use of capital budgeting techniques in economic development, very few studies show a comparative perspective comparing a more developed economy with a developing economy to establish whether capital budgeting practices differ significantly between companies in the two economic blocs and whether these differences can be explained by differences in levels of economic development.
BACKGROUND
Capital budgeting tools are some of the vital inputs in the decision-making process when embarking on investment projects. A very thorough analysis, scrutiny, implementation and monitoring of such projects could yield the pre-defined results for the people of the country.
According to Dayananda et al (2002), the capital budgeting practices are used to make investment decisions so as to increase shareholders value. Capital budgeting is primarily concerned with sizable investments in long-term assets, Brealey & Myers (2003). These assets may be tangible items such as property, plant or equipment or intangible ones such as new technology, patents or trademarks. Investments in processes such as research, design, development and testing - through which new technology and new products are created - may also be viewed as investments in intangible assets (ibid).
Dayananda et al (2002) argued that irrespective of whether the investments are in tangible or intangible assets, a capital investment project can be distinguished from recurrent expenditures by two features. One is that such projects are significantly large. The other is that they are generally long-lived projects with their benefits or cash flows spreading over many years. Sizable, long-term investments in tangible or intangible assets have long-term consequences (ibid). This implies that today's investment will determine the overall corporate strategic position over many years. These capital investments also have a considerable impact on the future cash flows of the organization and the risk associated with those cash flows. Capital budgeting decisions thus have a long-range impact on the strategic performance of the organization and are also critical to its success or failure.
The main aim of this suggested research is to analyze the use of capital budgeting techniques by companies in both West Africa and West Europe from a comparative perspective to see whether economic development has an impact on the choice of which technique to use.
Over the years, initiatives have been made to improve the developing progress of Africa nations. Many projects shift from contributor nations like the United Kingdom and the United States into African countries to help enhance the life of the individuals. However, these initiatives have not been able to improve African countries from abject hardship and indebtedness to the West. Various projects that are focused towards the reduction of hardship are normally finished with no changes in the life of the individuals. These projects, in my view, have not been scrutinized to evaluate their abilities of meeting some stated target.
Capital budgeting involves making investment decisions concerning the financing of capital projects by organisations. Making a good investment decision is important since funds are scarce and the investment is expected to add to the value of the organisations especially in Less Developed Countries (LDCs) and Third World poor nations. Capital investment decision is thus one of the requirements, if properly applied, can help accelerate economic development. All countries of the sub-Saharan Africa expend an upward of 13.5 billion U.S dollars per annum on foreign debt payment to rich foreign creditors, World Bank report (2005). Many countries in the third world borrowed huge sums of money in expectation that interest rates would remain stable. Many African countries accepted these loans for political and economic stabilization in the post independence era, however prominent problems such as corruption make these loans ineffective to save the recipients countries from their economic woes.
These debt-trapped nations were under-developed and their debt crisis further plunge them into deeper economic crisis and abject poverty due to excessive borrowing. Most executives of these developing countries have the selfish tendency of mismanaging the various project assigned to them. Some managers of the projects are eager to satisfy their personal needs before thinking of the implementation of whatever projects has been assigned to them. This leads to poor budgeting, poor monitoring and hence poor implementation of the project. Governments of the nations have to then borrow more funds in order to complete and maintain the existing projects. Due to the fact that these loans were thoughtlessly accepted, and collected by most African governments, they had neither little implications for development nor benefit for the masses.
Finally the unreliable market prices in the world's market for agricultural products and low-technologically manufactured goods, which make it particularly difficult for African countries to diversify and increase exports to hard currency markets, thus making it difficult for them to earn their way out of the debt trap.
The concerns of the developed nations may be to no avail if these less developed nations do not take steps that will help relief their situation. The capital investment decision is thus one of the most critical and crucial decisions that any country or organisation can take to achieve economic development-thus by adding economic value. Since economic development depends on the multiplicity of viable corporate organisations and enterprises in the country, the approach adopted here is to demonstrate how capital budgeting, as an investment decision can help African countries promote corporate organisational growth by using acceptable techniques to identify viable projects. In other words, capital budgeting is an integral part of the corporate plan of an organisation, which reflects the basic objectives of an organization. The capital investment decision involves large sums of money and may introduce a drastic change in companies as well as the whole economy, when it is well scrutinised. For instance, acceptance of a project may significantly change a company's operation, profitability and create more jobs within the country. These changes might also affect investors' evaluation of a company (Osaze, 1996:40-44).
PROBLEM STATEMENT
Capital budgeting decisions is one of the decision-making areas of a financial manager that involves the commitment of large funds in long-term projects or activities, and these projects have a huge impact on the country's economic development.
RESEARCH OBJECTIVES
This study therefore aims to:
Examine the importance of capital investment decisions; the basic steps in making capital investment decisions and the techniques used in evaluating capital investment projects so that the overall country's economy can grow from the corporate sector investments.
Establish whether capital budgeting practices differ significantly between companies in the two economic blocs and whether these differences can be explained by differences in levels of economic development.
Show that the use of sophisticated techniques by both corporate and governmental CFOs will help in the development efforts of Africans and other poor nations.
What is the link between capital budget techniques used in the private sector between two economic blocs and the resulting outcomes & the use of capital budgeting tools in the public sector of these two countries.
LITERATURE REVIEW
Economic development in Africa
Economic development in Africa has not been steady. In fact, when compared to the situation in the Western countries like Europe, the conclusion is that countries of the third world are either qualified as undeveloped or mildly put underdeveloped. African scholars have tended to heap the blame on the Europeans; saying that colonialism or neo-colonialism is the bane of Africa's economic woes. This notion is referred to by Onigbinde (2003:21-25), as the "Original Sin Fallacy". The present economic woe of underdeveloped countries (UDCs) according to this fallacy is that UDCs' condition is original "in relation to a so-called non-achievement, the present condition of the underdeveloped world is a historical product of capitalist expansion (ibid).
The crisis of underdevelopment in Africa is also captured in the "Africa at the Doorstep of Twenty-First Century" by Adebayo Adedeji as sited by Onigbinde, 2003. According to him, African within the world is, …poverty increased in both the rural and urban areas: real earning fell drastically; unemployment and underemployment rose sharply; hunger and famine became endemic; dependence on food aid and food imports intensified; disease, including the added scourge of AIDS, decimated population and became a real threat to the very process of growth development; and the attendant social evilsrime delinquency, there is a mess vengeance (Onigbinde, 2003: 78-79) .
The United States Assistance for International Development (USAID), 1988-1992 (cited from Onigbinde, 2003:79-80), stated among other things that, "approximately 180 million of sub-Saharan Africa's 500 million people could be classified as poor, of whom 66.7 percent, or 120 million, are desperately poor. By every international measure, be it per capital income ($330), life expectancy (51 years), or the United Nation's Index of Human Development (0.255 compared to 0.317 for South Asia, the next poorest region), Africa is the poorest region in the world", Onigbinde 2003.
The solution to all these problems lies in the fact that firms are to embark on projects that would give rise to company's value which will by extension enhancing the desired economic development for the country. In the course of achieving these development efforts, the company's activities become more complex and corporate management assumes a sound financial position in the handling of problems and decisions therein. In his study of "The obstacles to investment in Africa…", Professor Peter Montiel of the World Bank concluded among other things that "One set of explanations is based on the view that investment projects with high economic rates of return are not as plentiful in Africa as the simple neoclassical growth paradigm would seem to imply. One argument is that for a variety of reasons, aggregate production functions may be characterized by lower levels of productivity in Africa than in creditor countries. An alternative or complementary story is based on generalizing the aggregate production function to include roles for human capital, public capital, and institutional capital" Montiel (2006). He continued to say "These effects raise questions about the abundance of investment opportunities yielding high economic rates of returns in Africa at the present time", (ibid). This conclusion suggests that, though not abundant, investment opportunities with high returns exist in African countries and when applied properly, it could bring economic growth to Africa. One of the best ways to scrutinize these opportunities is by using various techniques like the capital budgeting techniques, to access the profit potentials.
The Capital Budgeting Decision
Capital budgeting decisions are among the most important decisions the financial manager of a company has to deal with. Capital budgeting refers to the process of determining which investment projects result in maximisation of shareholder value, Dayananda et al, 2002. Generally speaking, there are four main capital budgeting techniques the manager may use when evaluating an investment project. In fact, there are other techniques that could have been considered, such as sensitivity analysis, real options, book rate of return, simulation analysis, etc. (Graham and Harvey, 2001, pp.196-197). However, the most well known techniques will be focused on to keep the study simple. The net present value (NPV) and internal rate of return (IRR) methods are considered to be discounted cash flow (DCF) methods. The payback period (PB) and average accounting rate of return (ARR) methods are so called non-DCF methods, Brealey and Myers, 2003.
From a pure theoretical point of view the NPV is considered to be the most accurate technique to evaluate projects. Yet, it is also the most sophisticated of the four, followed by the IRR method. Both non-DCF methods are considered to be less accurate, of which the PB method is the least sophisticated (ibid). In the past, several studies of capital budgeting practices have been carried out. Most studies focus on companies in the U.S. Comparing survey results of capital budgeting practices in the U.S. over time generally seems to show that the analytical techniques used by executives have increased in terms of sophistication. For example, in one of the earliest studies reporting the results of questionnaires on capital budgeting practices, Klammer (1972) shows that in 1959, based on a sample of 184 large U.S. companies, 19 percent indicated that they used DCF methods as their primary method to evaluate projects. The majority of companies used either PB (34 percent of the total sample) or ARR methods (34 percent) as their primary method of evaluation. In 1970, the picture had changed drastically: DCF methods were used by 57 percent of the companies; 26 per cent used ARR and only 12 percent used PB as their primary method of project evaluation (ibid). In a later study, Hendricks (1983) reports that in 1981 76 percent of the companies in his sample studied used DCF methods as their primary tool. Only 11 percent stated they used the PB method as their primary tool. Trahan and Gitman (1995) show that, based on a 1992 survey of 58 of the Fortune 500 large companies and 26 of the Forbes 200 best small companies, most companies used DCF methods as their primary evaluation tool, although these methods were more important for the large companies (88 percent for NPV and 91 percent for IRR) than for the small companies (65 and 54 percent for NPV and IRR respectively).
A recent study by Graham and Harvey (2001), a comprehensive survey published on capital budgeting practices (using answers from a 1999 survey among 392 Chief Financial Officers (CFOs) of companies in the U.S. and Canada) showed that the NPV and IRR techniques are the most frequently used capital budgeting techniques. Their survey reported that 75 percent of the CFOs always use NPV and 76 percent always or almost always use the IRR method. Their survey results also show, however, that even though over time the use of the PB method has declined as a primary tool for project evaluation, it remains to be an important secondary instrument CFOs normally use. According to Hendricks (1983), in his 1981 survey 65 percent of the companies in his sample used PB as a secondary measure. Trahan and Gitman (1995) show that in 1992, 72 percent of the large and 54 percent of the small companies used PB as one of the evaluation tools. In the 1999 survey of Graham and Harvey (2001) 57 percent indicated they use the PB method as one of their evaluation tools.
The general picture that emerges from the previous short discussion also emerges from survey studies based on other U.S. as well as U.K., European and Australian companies (Gitman and Forrester (1977); Schall, et al. (1978); Kim and Farragher
(1981); Shao and Shao (1996); Pike (1996) and Brounen, et al. (2004) ; Freeman and Hobbes (1991) and Truong, et al. (2005); Herst, et al. (1997) and Brounen, et al.
(2004). A comparison of the results of these survey studies also showed an increasing sophistication with respect to the use of evaluation techniques over time. At the same time, however, it seems that companies in European countries report lower rates of the use of DCF techniques as compared to U.S. companies.
Brounen et al (2004) replicate the Graham and Harvey (2001) survey in four European countries (U.K., France, Germany and the Netherlands; total sample was 313 companies) in 2002-2003 and find that for the U.K. companies in their sample 47 percent states that NPV is (almost) always used as a tool of evaluating projects, whereas 69 percent (almost) always use the PB. For the Netherlands these figures are comparable (70 and 65 percent, respectively); for France and Germany the figures are even lower (42-50 per cent and 44-51 percent, respectively).
Studies on Capital Budgeting Practices in Developing Countries
A few studies have reported survey evidence on capital budgeting practices in the Asia-Pacific region. These studies show a somewhat different picture. Wong, et al (1987) used information from a survey among a large number of companies in Malaysia, Hong Kong, and Singapore in 1985 and found that in these countries the PB method was the most popular primary measure for evaluating and ranking projects. For Malaysia this picture was confirmed in Han (1986). In a recent paper by Kester, et al. (1999), based on information from surveys of 226 companies in Australia, Hong Kong, Indonesia, Malaysia, The Philippines and Singapore in 1996- 1997, it was reported that the PB method was still an important method. Yet, DCF methods seem to have increased in importance as well. Excluding Australia from the sample of the countries studied, 95 percent of the companies in the five Asian countries indicated that they use the PB method and 88 per cent of them said they use the NPV method when evaluating projects. In terms of importance (on a scale from 1 to 5, where 1 = unimportant and 5 = very important) both methods are rated almost equally important (3.5 versus 3.4) (ibid). When comparing these results to the results of studies for companies in Western economies, these figures seem to be very high. Comparing the results of the study by Wong, et al. (1987) with those of Kester, et al. (1999) does seem to suggest that the level of sophistication of capital budgeting techniques has increased quite rapidly during a period of just one decade within the developing countries in Asia.
HYPOTHESIS
Most developed countries in Europe have achieved highs in today's competitive international market because they put money where it adds value. Investments are well scrutinised using various sophisticated techniques, both qualitative and quantitative, before final decision is arrived and such projects are well monitored until fully completed.
Most African Countries remain in the low economic growth and poverty zone because CFOs don't make use of technical tools to analyse various investment projects, which have significant impact on the economic development. These differences might be due to the level of education, technology and economic development between the two economic blocs.
It is therefore hypothesized that CFO's of European companies will use net present value (NPV) and internal rate of returns (IRR) methods more often than their counterparts in West Africa, whereas the opposite will be true for the pay back (PB) and accounting rate of returns (ARR) methods.
The reason why most third world countries capital investment decisions are not usually well articulated may be due to the fact that their governments do embark on white elephant projects that gulp huge sums of money and are useless in terms of utility to the people. The projects often are abandoned halfway and in some cases, are only executed on papers. The current efforts of some African governments like those of Ghana and Nigeria, towards privatisation of hitherto government-owned firms and corporations is an indirect concession to the fact that the former investment decision pattern of the national government is not equipped enough to alleviate their countries from poverty. In fact, most of the diversified companies have improved productivity and quality with enormous benefits to their countries.
It was argued above that the use of capital budgeting practices might be related to the level of economic development. A number of arguments were given to support this argument. First, financial markets have developed over time, making the use of DCF methods more applicable, convenient and necessary. Due to the development of financial markets (and especially stock markets) shareholder maximization has gained its importance, which has pressured CFOs of companies to use DCF methods over other, more simple and less accurate alternatives. Secondly, training and education of CFOs has improved over time, which may have enabled them to better understand and therefore use more sophisticated techniques. Thirdly, tools and software packages that help the CFO to determine which investments are beneficial to the company have become increasingly sophisticated, which may also have stimulated the use of more sophisticated techniques. Finally, the increased use of computer technology and the related reduction in the cost of technology may have stimulated the use of more sophisticated techniques.
RESEARCH APPROACH
Since this research is focused to explore the capital budgeting practices of companies in Europe and West Africa, it is necessary to obtain a substantially large sample size, which will assist in explanation of our research study. Survey research or the use of mail questionnaires has been useful to understand human behaviour and practices. They help in learning about people's knowledge, beliefs and preferences in order to assess the views the general population has (Kotler 2000). Since surveys requiring large samples are conducted using questionnaires to generate quantitative data, it enables useful generalizations to be made about people's behaviour, attitude and opinions (McCormack & Hill, 1997). Hence taking in consideration the type of data, the size of the sample and the aim of the study, this research will be based on email attachment questionnaire to identify what capital budgeting practices are prevailing in European and West African companies.
SAMPLING
The sample will consist of 225 European and 120 West African listed and non-listed companies.
Convenience sampling would be used because it will allow me to obtain basic data and trends regarding this study without the complications of using randomized sampling.
This sampling technique is also useful in documenting that a particular quality of a substance or phenomenon occurs within a given sample. Such studies are also very useful for detecting relationships among different phenomena.
DATA COLLECTION
The data for the analysis will be obtained by using the results of structured questionnaires. The questionnaires will be sent to 225 European and 120 West African listed and non-listed companies during a given period of time.
Saunders et al. (2003) state that the validity and the reliability of the data you collect, as well as the response rate you achieve, depend, to a large extent, on the design and the structure of your questionnaire. In this study, the questionnaire design is approached in two ways:
First, adopt questions used in other questionnaires;
Second, develop questions by the researcher.
The questionnaires will consist of a number of multiple choice questions related to capital budgeting practices of companies, questions specifying firm characteristics, such as size, foreign sales and industry, as well as questions asking for the age and educational background of the respondent.
With regards to the questions related to capital budgeting practices the companies would be asked to indicate the frequency of the use of different project evaluation techniques (running from 0 to 4, where 0 = never and 4 = always). To increase the chances of getting responses from companies the survey would be kept as short as possible. Questions used to measure variables such as budgetary goal clarity and difficulty, budgetary participation, managerial performances are directly adopted from other research. The consistency of questions with previous literature is necessary if we intend to replicate or to compare research findings with another study. It is also more efficient and time-saving than developing your own questions, provided that you can still collect the data you need to answer the research questions and to meet the research objectives.
For some questions, both positive and negative statements are used. The answer of respondents can then be checked once again by re-reading and comparing both questions. For example, questions regarding goal difficulty are stated as both "I do not have too much difficulty in reaching my budget goals. They appear to be fairly easy" and "My budget goals are quite difficult to attain." This can also improve the internal consistency of questionnaire design. However, some questions, such as budget planning and control, budgetary sophistication, and some items of firm performance are developed by the researcher. This is determined by the nature of the data which need to be collected. With regards to the types of the questions, the questionnaire includes a combination of open-ended questions and closed-ended questions (Dillman, 2000).
Open questions are used in the first section of the questionnaire to obtain general information from a company. For instance, "what is your position in your company?" is an open-ended question. The last section of questionnaire uses closed questions. Those questions either offer the respondent a list of answers, of which he/she can choose, or a Likert-scale rating to ask the respondent how strongly he/she agrees or disagree with a statement or series of statements
The same set of questions will be sent to the European and West African companies. The questions will all be structured in English and sent via post. To increase the level of response, two reminders will be sent to the companies: the first one will be sent two weeks after the original questionnaires were posted and the second three weeks after the original questionnaire post. All the reminders would be sent via email.
The questionnaire is set to be completed by the companies' CFO's or any person in financial authority.
DATA ANALYSIS
In this study, parametric statistics are the major technique of statistical analysis. To analyze the impact of the formal budgeting process on enterprise performance, regression methods, (and especially linear regression) are the major statistical methods.
The rationale for using regression methods are: firstly, almost all variables in the present study are measured by interval/ratio scales; secondly, if the sample size is sufficient, regression is undoubtedly a more powerful way to test the correlation between two or more variables than other statistical methods like non-parametric tests.
LIMITATIONS OF THE STUDY
The interpretation of survey data presents some limitations as discussed in Aggarwal (1980). While the survey was mailed to the CFO, the responses are the opinion of an individual which may not completely reflect the firm's position. It is possible the responding person may not be the best to assess the capital budgeting process. There is also potential concern about a non-response bias. While the survey technique is not without flaws, it has been generally accepted as a reasonable proxy given the time and personal constraints in large corporations.
Time and cash flow is another limitation as I am a full time student.
