Capital budgeting decision-making practices: evidence from Pakistan

Abstract

Purpose The purpose of this paper is to examine the current trends of capital budgeting practices (analysis techniques, discount rate estimations and risk assessment methods) among Pakistani listed firms and analyze the responses conditional on firms’ demographics and executive characteristics. Design/methodology/approach An online questionnaire was sent via e-mail to top 200 non-financial firms (in terms of market capitalization) listed on Pakistan Stock Exchange. Findings With a response rate of 35 percent, it is concluded that the theory–practice gap is low as Pakistani listed firms are using discounted cash flow methods of capital budgeting and preferring net present value over internal rate of return. Similarly, weighted average cost of capital is estimated using target value weights, and capital asset pricing model (with extra risk factors) is used to determine the cost of equity capital. For risk assessment, sensitivity analysis and scenario analysis are the dominant approaches; however despite the theoretical superiority, the use of real options is very low. Overall, investment decision responses significantly differ across firm’s demographics and executive characteristics. Practical implications Pakistani business schools need to address the low usage of advanced methods such as modified internal rate of return and real options among Pakistani listed firms. Originality/value This is the first comprehensive study on the topic in Pakistan and have highlighted the areas of capital budgeting where Pakistani firms’ practices deviates from finance theory.