Do Managers follow the Shareholder Value Principle when applying Capital Budgeting Methods?

This paper presents a comprehensive comparison of theory and practice of the most established capital budgeting methods in Germany based on our survey results. For this purpose we have sent questionnaires to CEOs and CFOs of all companies listed in the German all share index (CDAX) to find out which capital budgeting methods are currently used by German managers and how accurately they apply them. We cover with our survey not only the most important capital budgeting methods classified in the three groups of fundamental capital budgeting methods, risk adjustment methods and valuation methods but also other relevant fields of corporate finance like cost of capital and capital structure. We confront some of our survey results with prior German and recent international studies to obtain an insight into current domestic developments and to gauge how up-to-date German managers are in an international context. Based on these findings, we are able to examine whether executives follow the shareholder value principle when applying capital budgeting methods. We regress the most prominent corporate performance figures, return on equity and total investment return on the application frequency of particular capital budgeting methods to assess whether the usage of such methods has an impact on performance. To the best of our knowledge our paper is the first to exploit this approach. We conclude that German managers do not seem to follow the shareholder value principle when applying capital budgeting methods. Furthermore, we show that executives seem to be hesitant to implement residual income valuation methods as a key tool for the ex post performance measurement of a company. Finally, we provide evidence that the usage of capital budgeting methods and their proper application has a much greater impact on corporate performance than observable personal characteristics of top managers and fundamental properties of their companies.