Capital budgeting techniques and financial performance: a comparison between SMEs and large listed firms

Abstract

Modern-day firms, both small and medium enterprises (SMEs) and large listed firms (LLFs) practice distinct investment appraisal approaches known as conventional and sophisticated capital budgeting techniques. Despite these prominent developments, the extant literature is yet to empirically examine the impact of these approaches on the financial performance (FP) of respective firms. This study aims to analyze and compare the impact of conventional and sophisticated capital budgeting techniques on the FP of SMEs and LLFs. Following the logic of real option and contingency theories, the payback method and average/accounting rate of return are conceptualized as conventional whereas, net present value, internal rate of return, and profitability index are used as sophisticated capital budgeting techniques. The associated data of 500 Indonesian firms between 2011 and 2020 was obtained and analyzed using the generalized method of moments (GMM) technique. After addressing multicollinearity and heterogeneity issues, the preliminary findings indicate that conventional capital budgeting techniques are not a significant predictor of the FP of SMEs. Conversely, it is observed that sophisticated capital budgeting techniques have a strong and positive effect on the FP of LLFs. The robustness checks confirmed that sophisticated capital budgeting techniques are the significant predictors of the FP of both SMEs and LLFs. The findings of this study are novel and contribute to validating the use of sophisticated capital budgeting techniques for SMEs and LLFs of emerging economies to realize optimal financial outcomes of their investments.

Keywords

• Capital budgeting
• sophisticated capital budgeting
• financial performance
• SMEs
• listed firms
• investment decisions