Finance: A Capital Idea

Article excerpt

Investment in machinery and plant is so obviously a "good thing" that little thought appears to be given to how companies budget for it, or to how they assess the benefits of the expenditure. Though some individuals - such as the US business writer and academic Robert Kaplan - have expressed concern about certain capital budgeting techniques, there have been few developments in the area for about 30 to 40 years. All of which was sufficient reason to convince Peter Miller, of the London School of Economics, and Ted O'Leary, of the National University of Ireland, that the issue was worthy of investigation, especially since recent years had seen a trend towards new methods of manufacturing.

This transition entails "substantial and closely co-ordinated changes in a wide range of an organisation's activities". A movement of this type could be expected to lead to modifications in capital budgeting practices. But, though there has been much discussion of the changes in manufacturing in general, there has been little empirical analysis of the implications for capital budgeting.

So starting from the position that they would discover what companies actually did about these sorts of issues (as opposed to what the textbooks suggested they did), the two accountancy academics carried out a four- year study of Caterpillar, the US-based manufacturer of earth-moving vehicles, that focused on a factory modernisation programme that began in the Eighties. The research, which is due to be published in a specialist journal next year, suggests that it is better to invest in an entire system than just to buy a single piece of machinery. This is support for the concept of "complementarity relations", an economist's term that essentially means synergies. At its simplest, this means "there is no point in fiddling about on the margins; you should buy into a whole system or not bother", says Miller. But it can also encompass questions that tend not to get answered - such as why organisations buy new machines rather than investing in training. The significance of this, suggests Miller, is that it has the potential to "affect fundamentally the way people think about capital expenditure". But though he and his research partner believe they have discovered useful insights into the ways in which capital investment appraisal is being changed, they still have a number of questions about what they regard as a fundamental area of accounting. …