The Role of the Board of Directors in the Capital Budgeting Process - Evidence from S&P 500 Firms

36 Pages Posted: 1 Dec 2004

See all articles by Yaniv Grinstein

Yaniv Grinstein

Cornell University - Samuel Curtis Johnson Graduate School of Management; Interdisciplinary Center (IDC) Herzliyah; European Corporate Governance Institute (ECGI)

Efrat Tolkowsky

Technion-Israel Institute of Technology - The William Davidson Faculty of Industrial Engineering & Management

Date Written: November 2004

Abstract

We study the role of the board of directors of S&P 500 firms in the capital budgeting process. We find that boards, through their committees, play four main roles in this process. They review and approve large capital requests that the CEO brings, they review and approve annual budgets, they review and approve merger and acquisition transactions, and they monitor the performance of approved projects. We also find that the capital allocation process often involves allocating initial spending limit and reviewing any request beyond that limit. Boards establish committees to review capital requests and annual budgets in cash-rich firms and in low-growth industries, and the characteristics of these committees suggest that they have a monitoring role. These findings support the theoretical predictions of Harris and Raviv (1996, 1998), that firms should audit capital requests when the auditing costs are low and when the overinvestment problems are severe. Boards are more likely to establish committees to review merger and acquisition proposals in high growth industries, and the characteristics of these committees suggest that they have an advisory role rather than a monitoring role. Thus, our results suggest that capital budgeting mechanisms have a dual role: to alleviate conflicts of interest between agents and principals and to communicate principals' information to agents.

Keywords: Board of Directors, Capital Budgeting

JEL Classification: G31, G34

Suggested Citation

Grinstein, Yaniv and Tolkowsky, Efrat, The Role of the Board of Directors in the Capital Budgeting Process - Evidence from S&P 500 Firms (November 2004). EFA 2005 Moscow Meetings . Available at SSRN: https://ssrn.com/abstract=625141 or http://dx.doi.org/10.2139/ssrn.625141

Yaniv Grinstein (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Sage Hall
Ithaca, NY 14853
United States
607-255-8686 (Phone)
607-254-4590 (Fax)

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Efrat Tolkowsky

Technion-Israel Institute of Technology - The William Davidson Faculty of Industrial Engineering & Management ( email )

Haifa 32000
Israel

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