An Empirical Insight into the Theory and Practices of Capital Budgeting in Pakistan

The study explores the different stages of the capital investment decision process and empirically investigates these stages’ mediating role. We have used firms, managers, and economic attributes as independent variables. Likewise, ROA, ROE, and EPS are used as proxies for measuring firm performance, which is the dependent variable. A survey was conducted through a self-developed questionnaire for non-financial listed firms of the Pakistan Stock Exchange (PSX). The questionnaire comprises of two parts. The first part is related to managers and firm attributes. The second part covers the nine steps of the Capex Appraisal Model (CAM). PLS-SEM was used to investigate the objectives of the study. Moreover, the results support the applicability of CAM in the corporate sector of Pakistan. For this purpose, 27 hypotheses were empirically tested, of which 21 were found to be significant. However, 6 hypotheses were not supported. The findings suggest that the “Capex Appraisal Model” is a useful approach for the corporate sector of Pakistan. Thus, firms should properly evaluate Capex decisions to enhance performance in the long run.


Introduction
Capital investment decisions are crucial for firm performance and future growth. Many past studies have acknowledged that firms have limited resources; therefore, their development and sustainability depends on how the top management invests in long term projects (Klammer et al., 1984). The capital investment appraisal process is complicated. A few studies have suggested six steps, while other studies have recommended the nine-steps approach. Despite the debate, the capital investment appraisal process should enhance firm performance and sustainable growth (Peterson & Fabozzi, 2002).
A finance manager in a firm makes a host of decisions that fall under three broad categories, i.e., investment decisions, financing decisions, and dividend decisions. Both short-term and long-term investment decisions affect firm performance, but capital investments substantially affect growth and sustainability. Therefore, firms need to use a well-structured appraisal framework for capital investment. Kakiya and Bosire, (2019) suggests that capital investment is a strategic decision. Factors that contribute to this strategic decision include experience, market conditions, and economic situation. While making capital investment decisions, firms should take steps necessary for sustainable growth and competitive advantage. An appropriate capital budgeting technique helps firms to rank multiple investments according to their efficiency and returns. Many past studies acknowledge that successful firms use capital budgeting techniques to make investments in long term projects that are financially viable and match the company's vision (Kim, 1981;Gordon & Pinches, 1984;Scott & Petty, 1984;Mukherjee, 1987;Lumby & Jones, 1999;Burns & Walker, 2009). Mubashar & Tariq (2019) argue that a firm's top management must explore, analyze, select, and make long-term capital investments. They should also align capital investment decisions with the organization's vision and mission. This alignment helps to maximize shareholder wealth. Moreover, Bodhanwala (2018) suggests that capital investment is necessary for an organization's sustainable growth. It is irrelevant whether a firm uses its own resources or borrowed resources. Gordon and Pinches (1984) suggests that the utilitarian perspective supports a firm's long-term strategic decisions. Firms that adhere to sustainable strategies related to the code of ethics, sustainable environment, ecological balance, retention of human resources, and socially responsible behavior may benefit immensely. Also, these sustainable practices enhance a firm's reputations and promote better management practices (Michelon et al., 2020).
Previous research on capital budgeting in developed countries have mostly focused on selecting an investment project (Burns & Walker, 2009). Similarly, Baig and Khalidi (2020) argue that only a few studies on capital budgeting are available in South Asia, and none of them have used a complete evaluation process framework. Thus, the study has examined the mediating role of the appraisal process on firm performance by extending the Capex Appraisal Model (CAM) (Baig & Khalidi, 2020). This study has used managers, firms, and economic attributes as independent variables, and ROA, ROE, and EPS as proxies for measuring firm performance, which is the dependent variable.
Perhaps this is the first comprehensive study that has examined the complete appraisal process based on Capex Appraisal Model (CAM). The findings not only contribute towards the body of knowledge but would also help firms to improve their appraisal process. The results may also inspire researchers from Pakistan and other South Asian countries to use this model in their studies.

Literature Review
A firm's main aim is to enhance its market value through rational financial decisions, including financing, dividend, liquidity, and investment decisions (Batra & Verma, 2014). Thus, capital budgeting decisions are an important facet of a firm's financial management strategy. Mintzberg et al. (1976) and Pinches (1982) have empirically examined the four-stage capital budgeting model, including identifying an investment opportunity, developing a general idea to a specific proposal, selecting a final project, and post-audit monitoring. The authors believe that this appraisal framework is an efficient tool for making investment decisions. They also recommend that future researchers should adopt this framework in their studies.
Similarly, Istvan (1961), Mao (1970), and Willam- Petty et al. (1975) examined the fourstage investment appraisal process. These studies found that investment decisions do not originate from top management but a firm's operations management process. Usually, one department of a firm does not evaluate all the aspects of the appraisal process. Most firms have specialized departments that assess specific elements of the appraisal process. Nurullah (2015) suggests that the aim of capital investment should be to acquire funds efficiently for long-term investment. Minzberg et al. (1976) suggest that long-term investment projects' selection and control enable a firm to gauge its future rationally. Firms use these funds to acquire long-term fixed assets, either tangible or intangible assets such as property, plant, equipment, copyright, and trademarks. Although these assets consume substantial financial resources, they provide significant benefits to a firm in the long run. Thus, it is concluded that capital investment decisions significantly affect firm value and are critical to sustainable growth. Bettinazzi et al. (2019) found that a firm's long-term investment is associated with its performance and strategic processes. Strategic processes include a firm's commitment to identify, select, and change the performance evaluation process, incentive system, capital expenditure, monitoring process, and logistics activities.
Similarly, Batra and Verma (2014) suggest that a firm's stakeholders are interested in evaluating a firm's prevailing competitive activities. Thus, firms interested in sustainable growth should adopt a well-structured appraisal process in their core business strategy. Researchers find that firms committed to enhancing their performance have to take strategic investment decisions. Such strategic decisions are necessary for providing growth and a competitive advantage to a firm. Many researchers stress that a firm's sustainability depends on its performance and implementing well-structured capital investment procedures.
Researchers also believe that it is necessary for firms to perpetually assess how new strategies are impacting their performance and sustainability. Many researchers suggest that firms must examine the gap between corporate goals and actual achievement. Researchers also suggest that it is necessary to evaluate an investment's financial and economic impact on firm performance. Besides other factors, the evaluation process depends on estimating future cash flows, risks, and uncertainties. Thus, capital expenditure is an important decision for financial managers. However, an efficient capital budgeting process depends on management's attitude towards such investments. Firms often have limited resources and many investment alternatives. Therefore, before making investment decisions, managers must consider factors that may influence capital budgeting practices. Likewise, scholars also suggest that capital investment decisions significantly depend on the company's growth rate. Thus, irrational capital investment decisions can adversely affect the future of a firm. Batra and Verma (2014) also suggest that large capital investment decisions are complicated because of many uncontrollable factors. Some of those uncontrollable factors are future cash flow, social, technological, economic, and political environment. Baig and Khalidi (2020) found that the external environment significantly affects the capital investment appraisal process. Therefore, firms should not ignore macroeconomic indicators (Schall et al., 1978;Chen, 1995). Manager's attributes, also known as behavioral attributes, also affect the investment appraisal process. Also, factors such as managers' qualifications, experience, and expertise affect the capital investment process (Pike, 1986). Many studies have documented that managers' attributes such as management style, age, and experience directly affect the capital investment process but indirectly affect organizational performance (Baule & Makes, 2014;Daunfeldt & Hartwig, 2014;Hakim & Shimko, 1995;Chen, 1995;Thiessen & Waterhouse, 1978;Schall et al., 1978;Carleton, Kendall & Tandon, 1974). Likewise, there are numerous firm characteristics which directly and indirectly influence the capital budgeting practices, including firm size, decentralization, monitoring, and control. Similarly, uncertainty is also an essential element that affects firm performance and capital investment process. This study has extended the Capex Appraisal Model (CAM) proposed by Baig and Khalidi (2020). This model has nine aspects of the capital investment appraisal process, i.e., idea generation, strategic planning, analysis, risk evaluation, selection, mode of finance, implementation, monitoring and control, and post-audit.

Conceptual Framework
This study's conceptual framework is based on the literature review and a newly developed Capex Appraisal Model (CAM) (Baig & Khalidi, 2020). This framework suggests that the appraisal process steps have a mediating effect between "managers' attributes, economic attributes, firm attributes, and firm performance. " We have illustrated the conceptual framework in Figure 1.

Hypotheses from the Capex Appraisal Model
Based on the Capex Appraisal Model, we have proposed 27 mediating relationships empirically tested through the Smart PLS software. We have developed the proposed model Capex Appraisal Model (CAM) through constructivist grounded theory (Baig & Khalidi, 2020).

Variables Measurement
The measurement of the dependent, mediating, and independent variables of the study are discussed in the following sections. Haka et al., (1985) report that many studies have measured firm performance through profitability. Many research scholars have found a strong relationship between firm performance and the capital budgeting process (for instance; Vadeei et al., 2012;Farragher et al., 2001;Pike, 1984;Kim, 1981;Klammer, 1984). Therefore, ROA (Return on Assets); ROE (Return on Equity), and EPS (Earning per share) are used in this study to measure firm performance.

Independent Variables
In this study, we have three independent variables. Past researchers highlighted the direct and indirect influence of these variables on firm performance (Baule & Makse, 2014;Daunfeldt & Hartwig, 2014;Hakim & Shimko, 1995;Chen, 1995;Tiessen & Waterhouse, 1978;Schall et al., 1978;Carleton, Kendall & Tandon, 1974). The data related to managers' attributes and firms' attributes have been collected through a self-developed questionnaire. The study has used GDP growth rate, inflation rate, and employment rate averages as the proxy of economic attributes.

Manager's Attributes
The nine mediating relationships derived from the Capex Appraisal Model are: H1a: The idea generation stage "mediates the relationship between the manager's attributes" and firm performance.
H1b: Strategic planning stage "mediates the relationship between the manager's attributes" and firm performance.
H1c: Analysis stage "mediates the relationship between the manager's attributes" and firm performance.
H1d: The risk evaluation stage "mediates the relationship between the manager's attributes" and firm performance.
H1e: The selection stage "mediates the relationship between the manager's attributes" and firm performance.
H1f: The mode of finance stage "mediates the relationship between the manager's attributes" and firm performance.
H1g: Implementation stage "mediates the relationship between the manager's attributes" and firm performance.
H1h: The monitoring and control stage "mediates the relationship between the manager's attributes" and firm performance.
H1i: Post-audit stage "mediates the relationship between the manager's attributes" and firm performance.

Economic Attributes
H2a: Idea generation stage "mediates the relationship between economic attributes" and firm performance.
H2b: Strategic planning stage mediates "the relationship between economic attributes" and firm performance.
H2c: The analysis stage mediates "the relationship between economic attributes" and firm performance.
H2d: Risk evaluation stage "mediates the relationship between economic attributes" and firm performance.
H2e: The selection stage "mediates the relationship between economic attributes" and firm performance.
H2f: Mode of finance stage "mediates the relationship between economic attributes" and firm performance.
H2g: Implementation stage "mediates the relationship between economic attributes" and firm performance.
H2h: Monitoring and control stage "mediates the relationship between economic attributes" and firm performance.
H2i: Post audit mediates the "relationship between economic attributes" and firm performance.

Firm Attributes
H3a: Idea generation stage "mediates the relationship between firm attributes" and firm performance.
H3b: Strategic planning stage "mediates the relationship between firm attributes" and firm performance.
H3c: The analysis stage "mediates the relationship between firm's attributes" and firm performance.

H3d: Risk Evaluation stage "mediates the relationship between firm attributes" and firm performance
H3e: The selection stage "mediates the relationship between firm attributes" and firm performance.
H3f: Mode of finance stage "mediates the relationship between firm attributes" and firm performance.
H3g: Implementation stage "mediates the relationship between firm attributes" and firm performance.
H3h: Monitoring and control stage "mediates the relationship between firm attributes" and firm performance.
H3i: Post audit stage "mediates the relationship between firm attributes" and firm performance.

Methodology
The study is quantitative in nature. The study has used a questionnaire for collecting data on investment appraisal practices. We have derived the questionnaire from the newly developed Capex Appraisal Model (CAM) (Baig and Khalidi, 2020). The study has also collected the data from listed companies of the Pakistan Stock Exchange. PSX firms belong to 36 distinct industries/sectors.

Population and Sample Size
Pakistan Stock Exchange companies are listed and segmented into 36 sectors. We have not considered the financial sector in our sample. The financial sector comprises around 125 firms, which includes banks, insurance, and leasing companies. Questionnaires were emailed and posted to 320 companies, and we received data from 135 listed companies in Pakistan. We did not consider 15 cases as they were blank questionnaires, had significant missing values, and inadequate responses. Thus, the sample size was 120. CFOs, finance executives, and other professionals have busy schedules; consequently, they were reluctant to fill the questionnaire. Therefore, the response rate was 37.5%, which is similar to previous studies. For instance, Hanaeda and Serita (2014) received a 6.2% response as they targeted 3618 CFOs; Bennouna et al., (2010) received an 18.4% response rate from the 478 CFOs; Truong et al., (2008) obtained 24.48% response from 256 CFOs; Hermes et al. (2007) received a response of 17% from dutch firms. Trahan and Gitman (1995) obtained a 12% response from 700 CFOs.

Respondents Profile
We approached those firms that maintain accurate information of the capital investment appraisal process. The responses are summarized in Table 1.

Statistical Analysis through Smart PLS
The study has used the two-steps approach for data analysis. In the first stage, we tested the measurement model based on reliability, validity, and discriminant validity. In the second stage, we tested the structural model for generating results related to the proposed hypotheses.

Reliability and Validity
The results related to reliability and validity are illustrated in

Discriminant Validity
The discriminant validity is evaluated by using the Fornell and Larcker (1981) criterion. The results are exhibited in Table 3. The results suggest that the "square root of AVE is greater than Pearson correlation values, suggesting the constructs are "unique and distinct. "

Coefficient of Determination (R-squared) & Adjusted R-Squared
The coefficient of determination (R 2 ) value shows the proportion of dependent variable variance explained by the model (Hair et al., 2011). The coefficient of determination (R-squared) and adjusted R-squared values are illustrated in Table 4. The results suggest that adjusted R-square values range from 0.336 to 0.848. Post audit (R 2 =0.394) and strategic planning (R 2 =0.394) have low values, and the rest variables have medium to high predictive values (Hair Jr et al., 2016).

Path Coefficients
We have determined the path coefficient values by using bootstrapping functions. The results are presented in Table 5, showing beta values, t values, and P values. Our results support all the hypotheses except six hypotheses: H2c, H2d, H2g, H2i, H3d, and H3i.

Conclusion
The study found that the appraisal process has a mediating effect on firm performance in 21 hypotheses out of 27 hypotheses. Thus, we infer that long-term corporate sustainability is an important aspect of the Capex appraisal process. This study reveals that attributes of finance executives and firms are crucial for any finance manager. This study has collected data from individuals working in the corporate sector and make decisions related to capital investments. It also includes individuals who were formally part of a team involved in making capital investment decisions. The study has measured managers' attributes based on their current position, educational background, age, and experience.
Similarly, firm attributes consist of four major elements, i.e., respondent companies related sectors, number of employees, size of the annual capital budget, and firm ownership. Moreover, these attributes indicate corporate professionalism and the ability to evaluate capital investment decisions. Firm size is reflected through the annual capital budget and the number of employees. Most of the surveyed firms have domestic ownership, and their capital investment policies are prepared and approved locally. The study has analyzed nine mediating relationships on the manager's attributes, and the results support all of them. In these relationships, the independent variable was manager attributes, stages in the CAM were mediating variables, and firm performance was the dependent variable. Similarly, we have formulated nine mediating hypotheses on economic attributes, of which the results do not support four hypotheses: H2c, H2d, H2g, and H2i. In these relationships, the independent variable was economic attributes, stages of CAM were mediating variables, and firm performance was the dependent variable. We also formulated nine mediating relationships on firms' attributes, of which the results do not support two hypotheses: H3d and H3i. In these relationships, the independent variable was firm attributes, stages of CAM were mediating variables, and firm performance was the dependent variable.