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What corporate finance problem is the article addressing? What method of study (qualitative, quantitative, or mixed study) does the authors use to address the problem? What are the significant findings or ideas of the study? What is the conclusion of the study? Do the findings support the conclusion? What are the strengths and limitations of the study? Make a proposal for future research on the topic that needs to be investigated. Applied Economics and Finance Vol. 3, No. 2; May 2016 ISSN 2332-7294 E-ISSN 2332-7308 Published by Redfame Publishing URL: http://aef.redfame.com 15 Capital Budgeting Theory and Practice: A Review and Agenda for Future Research Lingesiya Kengatharan 1 1 Department of Financial Management, University of Jaffna, Sri Lanka. Correspondence: Lingesiya Kengatharan, Department of Financial Management, University of Jaffna, Sri Lanka. Received: December 21, 2015 Accepted: January 14, 2016 Available online: February 4, 2016 doi:10.11114/aef.v3i2.1261 URL: http://dx.doi.org/10.11114/aef.v3i2.1261 Abstract The main purpose of this research was to delineate unearth lacunae in the extant capital budgeting theory and practice during the last two decades and ipso facto become springboard for future scholarships. Web of science search and iCat search were used to locate research papers published during the last twenty years. Four criteria have been applied in selection of research papers: be an empirical study, published in English language, appeared in peer reviewed journal and full text research papers. These papers were collected from multiple databases including OneFile (GALE), SciVerse ScienceDirect (Elsevier), Informa - Taylor & Francis (CrossRef), Wiley (CrossRef), Business (JSTOR), Arts & Sciences (JSTOR), Proquest ,MEDLINE (NLM), and Wiley Online Library. Search parameters covered capital budgeting, capital budgeting decision, capital budgeting theory, capital budgeting practices, capital budgeting methods, capital budgeting models, capital budgeting tools, capital budgeting techniques, capital budgeting process and investment decision. Thematic text analyses have been explored to analyses them. Recent studies lent credence on the use of more sophisticated capital budgeting techniques along with many capital budgeting tools for incorporating risk. Notwithstanding, it drew a distinction between developed and developing countries. Moreover, factors impinging on choice of capital budgeting practice were identified, and bereft of behavioral finance and event study methodological approach were highlighted. More extensive studies are imperative to build robust knowledge of capital budgeting theory and practice in the chaotic environment. This research was well thought out in its design and contributed by stating the known and unknown arena of capital budgeting during the last two decades. This scholarship facilitates to academics, practitioners, policy makers, and stakeholders of the company. Keywords: Capital budgeting theory and practices, capital budgeting tools for incorporating risk, discount rate 1. Introduction Predominantly, area of capital and capital budgeting of financial management have been attracted many researchers during the last five decades and the seminal studies culminated with presenting many theories (e.g., Markowitz,1952; Modigliani & Miller,1958; Markowitz,1959; Miller & Modigliani,1961; Fama,1970; Black & Scholes,1973; Ross, 1976; Roll,1977; Myers,1977; Myers,1984; Jensen,1986; Ritter,1991;Graham & Harvey, 2001; Myers,2003; Halov & Heider,2004; Atkeson & Cole,2005;) and models (e.g.,Markowitz,1952; Sharpe,1963; Sharpe,1964; Linter,1965; Roll,1977) time to time. Notwithstanding, due to the globalization, environmental changes and cutting edge advanced technological developments, theories and models developed in the past do not applicable today and many of them are criticized and their applicability in practice is intriguing (e.g., Malkiel, 2003; Bornholt, 2013). A curious instance illustrated by Brounen, de Jong and Koedijk (2004) is that ‗Nobel Prize winning concepts like the capital asset pricing model and capital structure theorems have been praised and taught in class rooms, but to what the extent to these celebrated notions have also found their way into corporate board rooms remains somewhat opaque‘ (p.72). ‗Traditional capital budgeting methods have been heavily criticized of discouraging the adoption of advanced manufacturing technology and thus undermining the competitiveness of Western firms‘ (Slagmulder, Bruggeman & Wassenhove, 1995, p.121). In a similar vein, many research scholars on their seminal scholarships argued that there are gaps in theory of capital budgeting and its applicability (e.g., Mukheijee & Henderson, 1987; Arnold & Hatzopoulos, 2000; Graham & Harvey, 2001; Cooper, Morgan, Redman & Smith, 2002; Brounen et al., 2004; Kersyte, 2011). Firms operating in a dynamic environment must respond to changes to beat competitors and to sustain, survive and grow in markets (Ghahremani, Aghaie & Abedzadeh, 2012). 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http://ku-primo-prod.hosted.exlibrisgroup.com/primo_library/libweb/action/search.do?ct=facet&fctN=facet_domain&fctV=Wiley+Online+Library&dscnt=0&vl(2382325UI3)=articles&scp.scps=scope\%3A(KU_LMS_DS)\%2Cscope\%3A(KU_SFX_DS)\%2Cprimo_central_multiple_fe&vl(2382324UI0)=title&tab=local&dstmp=1344374492039&srt=rank&vl(2382326UI4)=eng&mode=Advanced&vl(1UIStartWith1)=contains&indx=1&tb=t&vl(freeText0)=Capital\%20budgeting&vl(D2382154UI2)=20-YEAR&vid=KU_VU1&fn=search&title1=1&frbg=&vl(9943083UI1)=any&ct=facet&dum=true&vl(1UIStartWith0)=contains&Submit=Search&pcAvailabiltyMode=true&vl(freeText1)= Applied Economics and Finance Vol. 3, No. 2; 2016 16 which can invariably involve large sums of money over the long period (e.g.,Peterson & Fabozzi, 2002, Cooper et al., 2002; Dayananda, Irons, Harrison, Herbohn & Rowland, 2002) and these decisions are critical in managing strategic change and sustaining long term corporate performance (Emmanuel, Harris & Komakech, 2010). Capital investment decision can be acquisitions, investing new facilities, new product development, employing new technology and adoption of new business processes or some combination of these (Emmanuel et al., 2010). Capital budgeting investment decisions are critical to survival and long term success for firms due to many factors and those factors are commonly named as uncertainty. The global financial crisis is epitomized this truth. One of the most intractable issues confronted by researchers is how to identify, capture, and evaluate uncertainties associated with long term projects (Haka, 2006). Sources of uncertainty range from the mundane (cash flow estimation, number and sources of estimation error, etc.) to the more esoteric (complementarities among investments, options presented by investment opportunities, opportunity cost of investments, etc.) (Haka, 2006). Since capital investment decision deals with large sum of fund, scrupulous attention has been given in making decision. ‗Capital budgeting is as the procedures, routines, methods and techniques used to identify investment opportunities, to develop initial ideas into specific investment proposals, to evaluate and select a project and to control the investment project to assess forecast accuracy‘(Segelod,1997). Albeit there are number of capital budgeting methods assist in making decision, number of other uncertainty factors have deleterious penetration into making capital budgeting decision. Nowadays, complex methods are used for making capital budgeting decision rather purely depends on theories of capital budgeting because of uncertainty and other contingency factors (Singh, Jain &Yadav, 2012; Zhang, Huang &Tang, 2011; Kersyte, 2011; Bock & Truck, 2011; Byrne & Davis, 2005;Cooper et al, 2002; Arnold & Hatzopoulos, 2000; Mao, 1970; and Dickerson, 1963). After the advent of full-fledged globalization and in the era of cutthroat competition (Verma, Gupta & Batra, 2009), advanced developments in technologies, other macro environmental factors and demographic factors are intruding into capital budgeting practices (Verbeeten, 2006). In a world of geo -political, social as well as economic uncertainty, strategic financial management is of process of change, in turn requiring a re- examination of the fundamental assumption (e.g, efficient market hypothesis, Fama,1970) that cut across traditional boundaries of the financial management (Hill, 2008). With limited credit and other sources of financing in today‘s uncertain and challenging economic environment, also required to be scrupulously evaluated the profitability and successfulness of proposed capital investments and allocate limited capital is more vital than ever (Kester & Robbins, 2011). Over the last 20 years, there have been many changes and challenges in making financial decision due to the global financial crisis, fluctuations in value of money, advanced technology, interest rate, exchange rate and inflation rates‘ risks and dramatic changes in economic and business environment both in national as well as in global markets. Thus, there is need to re- examine and re- study for re-building capital budgeting practices since it has considerable impact on investment decision making. The investment decision making is not a simple or straightforward approach, the risk is an important element in making investment decision. There are number of risk techniques employed by companies for evaluating investment projects. However, there is problem in setting up theoretical model and applying that model into practice (e.g: Arnold & Hatzopoulos, 2000; Digkerson, 1963). Thus, the theory is not purely able to apply at all times. Sometimes theories developed in the past do not applicable today. There is no doubt, over the last two decades corporate practices regarding capital budgeting practices have not been static, diverged from the theories. This study presents systematic review on capital budgeting practices literature published in the last two decades. The systematic review of literature is referred to as principally justified by the manner in which the reviewer proceeds, stage by stage, with full transparency and explicitness about what is (and what is not) done, typically using a protocol to guide the process (Young, Ashby, Boaz & Grayson, 2002, p.220). Through this review, updating information about the capital budgeting techniques which being used by firms and to compare the current usage of various techniques, methods with those found in previous studies. This study is thus accumulatively builds a robust knowledge in the area of capital budgeting practices and identifying unearth gaps will become springboard for future research. Therefore, this research guides the researchers to reflect on and assess where they are in an area of capital budgeting practices and guide future research directions. 1.1 Objective of the study Examining empirical research on capital budgeting practices to date has been very useful in explaining importance of capital budgeting practices for the long time success of the business organization. Nowadays, complex methods are used for making capital budgeting decision rather purely depends on theories of capital budgeting. Advanced developments in technologies, other macro environmental factors and demographic factors are intruding into capital budgeting practices and thus some of the theories become out of use in well developed countries (e.g: payback period). Thus, the main aim of this research is to demonstrate unearth gaps in the existing capital budgeting practices literature and to suggest the directions for the future research .It will further attempt to Applied Economics and Finance Vol. 3, No. 2; 2016 17 - Explain the capital budgeting theories and practices in different countries and demonstrate the disparities between theories and practices of capital budgeting - Identify the factors that determine use of capital budgeting practices of a country or firm 1.2 Problem Statement During the past twenty years (1993-2013), the theory of capital budgeting has been characterized by the many increased applications on the basis of risk and uncertainty resulting from global economic, technological and advanced educational changes e.g: inflation risk, interest rate and exchange rate risk. Capital budgeting is the backbone of the financial management. Modern financial management theory generally assumes that the primary objective of a firm is to maximize the wealth of its owners (Atrill, 2009). Uncertainty and risk are the major influence in making investment decision and thus Mao (1970) says ‗a central aspect of any theory of capital budgeting is the concept of risk‘ (p.352). In order to implement the objective of modern financial management theory, ‗financial executives need criteria for choosing between alternative time patterns of project evaluations within his planning horizon (Mao, 1970). There are complexities in making investment decision and the theory could not always applicable in all situations. Problem statement of this study is how far capital budgeting theory differentiates with practice and to demonstrate the nature of the gaps in existing capital budgeting literature. 1.3 Research Questions On the basis of background of research, the following research questions have been developed as the way to attain research objectives.  What are the capital budgeting theories and practices used by firms? Are there any disparities between the capital budgeting theories and practices? If so how?  What are the factors determines the use of capital budgeting practices? Are there different across countries? If so how?  What are the gaps in the existing capital budgeting literature? 2. Methodology The main objective of this study is to find out gaps in extant capital budgeting literature during the past 20 years of study. The methodology covers research philosophy, research approach, research strategy, methods of data collection and data analysis. These entire methodological spheres used throughout the research have been below discussed in details. 2.1 Research Philosophy One of the dominant philosophical concepts is the ‗ontological assumption‘ that enquires about nature of reality, and any study absence of this assumption would be treated as blinded (Easterby-Smith, Thorpe & Lowe, 2002, p. 27). This research assumes that capital budgeting practices are different across firms/ nations and the ways of looking at capital budgeting practices are not same at all the time. It can be further articulated that even when there are number of capital budgeting theories, we cannot expect similar application at all situations and thus it is subject to changes. Thus, the ontological assumption is of constructionism. Constructionist ontology‘s view that world is being internally constructed and both individually and collectively generate meaning where we are not sure about what is real! Consequently, people guess reality of the world with the experience of external indicators. Another important philosophical assumption is the epistemological assumption. It enquires about what should be taken as acceptable knowledge in a particular field (Easterby-Smith et al., 2002). The traditional practices do not applicable in the contemporary borderless global businesses and thus try to understand the factors determine the use of capital budgeting practices. It guides how can we understand and determine capital budgeting practices in different context and in different geographical location. The knowledge can be attainable by text analysis with subject methods. Thus, it offers what is already known about capital budgeting practices and captures the gaps in extant literature by systematically reviewing literature. This research takes interpretive approach on epistemology for answering research questions. The reality is not independent of individual thought and thus all the research findings are not similar with one another (Blaikie, 2007). Thus, this multiple reality is called ‗subjectivism‘. Findings could vary in different context such as nature of measurement tools, geographical location, company‘s size, organizational practices, types of sectors and form of methodology used. Thus, this research is organized by collecting relevant literature review and interpreting concepts of relationship between researchers and research. Inductive approach is thus suited by exploring thematic text analysis. 2.2 Research approach The research strategy leads to design qualitative research approach. This research covered sufficient researches carried Applied Economics and Finance Vol. 3, No. 2; 2016 18 out during the past two decades in the area of capital budgeting. This research analyzed past literature by identifying relevant themes and then thematic text analysis was employed. Thus, this research is ‗subjective‘ and adopts inductive approach in order to answering research questions. 2.3 Research strategy Research strategy tells about how research should be designed for answering a set of developed research questions and consequently research aims are attained. As this research covers last twenty years of research papers carried out in the area of capital budgeting from 1993 to 2013, this study adapts research strategy of longitudinal research design. However, the collection of literature covers broad areas including different sectors, different locations/countries and different size of firms. Thus, the systematic literature review sometimes takes comparative research design as well. 2.4 Data collection methods Web of science search and iCat search were used to locate research papers published during the last twenty years. Web of science is a mass search engine linking with mass database covering more than 10000 journals and 110 000 conference proceedings. However, all most all the databases (online the full text of electronic resources) have been covered by iCat search which is subscribed and launched by Kingston University, London. Kingston University library‘s access service was exploited for collecting all the research papers. Search parameters includes capital budgeting, capital budgeting decision, capital budgeting theory, capital budgeting practices, capital budgeting methods, capital budgeting models, capital budgeting tools, capital budgeting techniques, capital budgeting process and investment decision. Initially, there are 363 research papers identified during the last 20 years. Of them, 201 research papers were screened and considered for this research to be reviewed based on the following criteria. - An empirical study (i.e., sampling process, measurement , analysis): 363 papers were identified - Published in English language: Of 363, 264 were published in English. - Should be published in peer reviewed journal : Of 264, 239 were published in a peer reviewed journals - Full text research papers: Of 239, 201 papers were full text journal These papers were collected from following databases: OneFile (GALE), SciVerse ScienceDirect (Elsevier), Informa - Taylor & Francis (CrossRef), Wiley (CrossRef), Business (JSTOR), Arts & Sciences (JSTOR), MEDLINE (NLM), SpringerLink, Wiley Online Library , Inderscience Journals , ERIC (U.S. Dept. of Education), Sage Publications (CrossRef), INFORMS Journals, Health Reference Center Academic (Gale), University of Chicago Press Journals, Emerald Management eJournals, Directory of Open Access Journals (DOAJ),IngentaConnect, IEEE (CrossRef). All these papers were spread over across many journals including Journal of Banking and Finance, The Journal of Finance, Journal of Accounting and Economics, Management Decision, Journal of Cleaner Production, Journal of Financial Economics, Management Science, European Journal of Operational Research, Accounting Review, Journal of Economic Behavior and Organization, Long Range Planning, Energy Policy, Accounting, Organizations and Society, Computers and Mathematics with Applications. 2.5 Data analysis As discussed, at the outset, Miles and Huberman‘s (1984) proposed strategy was carried out that involves collection, reduction, displays and conclusions. Based on the set criteria, 363 research papers were reduced to 201 and they analyzed using a coding procedure. Initially, collected research papers were grouped into themes or topics. Theme represents the focused area of research and it is selective coding on grounded theory (Corbin & Strauss, 1990). Themes were in terms of current theory and practices of capital budgeting, factors influencing on capital budgeting practices/ determinants of capital budgeting practices, capital budgeting methods/ models, supplementary tools for the capital budgeting methods, influences of capital budgeting practices on investment decisions, component of capital budgeting process, capital budgeting stages, and global capital budgeting practices. A thematic analysis was employed to capture key themes and concepts in chosen research papers. In doing so, open coding, as suggested by Strauss and Corbin (1998), was adopted. The analysis was focused on the concepts related to capital budgeting practices and theories, research design, research sampling techniques, research approach, year of publication, nature of industry and so on. The results of this analysis were presented below. 3. Results 3.1 Multi-disciplinary concepts of capital budgeting During the past twenty years, a total of 202 research papers appeared in peer reviewed indexed journals were identified across many academic journals. Majority of the papers appeared in Engineering Economist (N= 32) yielding 15.92\% followed by Managerial Finance (27), Public Budgeting & Finance (16), Financial Management(9), Journal of Banking and Finance (8), Journal of Business Finance & Accounting (6), Accounting Education(5), Management Accounting http://ku-primo-prod.hosted.exlibrisgroup.com/primo_library/libweb/action/search.do?ct=facet&fctN=facet_domain&fctV=OneFile+(GALE)&dscnt=0&vl(2382325UI3)=articles&scp.scps=scope\%3A(KU_LMS_DS)\%2Cscope\%3A(KU_SFX_DS)\%2Cprimo_central_multiple_fe&vl(2382324UI0)=title&tab=local&dstmp=1344374492039&srt=rank&vl(2382326UI4)=eng&mode=Advanced&vl(1UIStartWith1)=contains&indx=1&tb=t&vl(freeText0)=Capital\%20budgeting&vl(D2382154UI2)=20-YEAR&vid=KU_VU1&fn=search&title1=1&frbg=&vl(9943083UI1)=any&ct=facet&dum=true&vl(1UIStartWith0)=contains&Submit=Search&pcAvailabiltyMode=true&vl(freeText1)= …