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Reflective and cognitive International

capital
perspectives on international budgeting
capital budgeting
Avo Schönbohm and Anastasia Zahn 167
Department of Business and Economics,
Received 19 February 2013
Berlin School of Economics and Law, Berlin, Germany Revised 27 February 2014
20 December 2014
16 February 2015
Accepted 1 March 2015
Abstract
Purpose – The purpose of this paper is to develop a framework for an enlightened management and
governance praxis against a backdrop of cognitive and motivational biases promoting a reflected
international capital budgeting decision process. Furthermore, societally relevant questions are raised
whether these biases might have an effect on various stakeholders in public–private partnerships.
Recurring failures of international business investments motivate reflective, cognitive and
socio-constructivist perspectives on the international capital budgeting process.
Design/methodology/approach – Based on an interdisciplinary literature review and substantiated
by empirical studies, the cognitive biases and flaws of the international capital budgeting process are
discussed making use of a five-stage process scheme. The article applies the interpretative paradigm
and regards the international capital budgeting process stages as a socio-political process of reality
construction and critically assesses the motives of its actors. Consequently, the authors develop and
discuss three principle-based behavioural rationalisation factors.
Findings – International capital budgeting is not a process of rational choice but of social construction
of reality. Reflective prudence, critical communication and independence are three rationalisation
factors which could, if applied along the five stages of the international capital budgeting process,
systematically lead to de-biasing and thus enhance the performative praxis of international investment
decisions.
Research limitations/implications – The international capital budgeting process deals with the
construction of future scenarios under uncertainty and assessment of potential success and failure of
future projects. The defined (or any other) rationalisation factors are subject to cultural biases and can
naturally not guarantee successful investment projects. Although the success of the application of
various de-biasing tactics was empirically confirmed, the aggregated rationalisation factors of the
paper have not been tested.
Practical implications – The paper is aimed at enhancing the reflective understanding and the
performative praxis of the international capital budgeting process. The practical recommendations
aggregated in the rationalisation factors are explicitly elaborated for international business
practitioners.
Social implications – Societally relevant questions are raised whether systematic biases have an
effect on various stakeholders in international public–private partnerships. Especially in large
investment projects, where capturing private value might be boosted by actively exploiting biases of the
public decision makers, active stakeholder engagement could enhance the social and ecological value of
investments.
Originality/value – The article provides a rare interdisciplinary literature review on cognitive biases
critical perspectives on
in the international capital budgeting process. It critically reflects the social construction of it various international business
Vol. 12 No. 2, 2016
pp. 167-188
The authors express their gratitude for the valuable and constructive comments they have © Emerald Group Publishing Limited
1742-2043
received from the anonymous reviewers. DOI 10.1108/cpoib-02-2013-0006
CPOIB stages and its social repercussions and develops practical rationalisation factors for an enhancement of
the international capital budgeting process as a performative praxis.
12,2
Keywords Corporate governance, Stakeholder, International investment, Multinational companies,
Critical management, International business
Paper type Conceptual paper

168
1. Introduction: politics and flawed perceptions in international capital
budgeting
International business is driven by international and foreign direct investment decisions
of multinational enterprises that are made under conditions of risk, uncertainty and
insufficient information (Aharoni et al., 2011). This often results in foreign direct
investment not meeting expectations or, succinctly stated, failures (Koko and Zejan,
1996). Recent spectacular examples such as the disastrous Deepwater Horizon
investment of BP (The Economist, 2013a) or the unsuccessful investments of the German
steel-maker ThyssenKrupp in American and Brazilian steel mills (The Economist,
2013b) show the dire repercussions of ill-informed investments based on wrong risk
assessments or flawed market perceptions (Heinz and Tomenendal, 2012). International
public–private partnership infrastructure projects like the Cross City Tunnel in Sydney
(Haughton and McManus, 2012) are special cases of international investment decisions
which often have not fulfilled expectations and are mingling private and public interests
(Mahoney et al., 2009). International capital budgeting or investment decisions have
thus substantial impact on companies’ long-term financial performance (Beddingfield,
1969; Atkinson et al., 1997; Eggers, 2012) as well as on the well-being of the local
economic, social and ecological systems (Bardy et al., 2012; Wang et al., 2013).
It is no new insight that corporate investment decisions are not purely rational, but
dependent on individual and psychological factors (Keynes, 1936, pp. 97-98). In
multinational enterprises these decisions are subject to power negotiations
(Blaszejewski, 2009) of subsidiaries or individuals (Gammelgaard, 2009). There has been
articulate frustration that neither capital budgeting theory nor the scientific model has
offered practitioners valuable advice (King, 1974). Bounded rationality concepts (Simon,
1976, 1986) have gained recognition in the field of international business (Birkinshaw
and Ridderstråle, 1999). Thaler (1999) argued that in the near future, finance and
behavioural finance would merge into one respected domain since there cannot be
“non-behavioural” finance (Thaler, 1999). However, 15 years later, even though
behavioural finance is not as disputed, it still lacks a generally recognised definition, a
unified framework and a theoretical core (De Bondt et al., 2008). Furthermore, literature
on international business tends to see the companies as rational decision makers and
neglects to recognise those in management – and their human character – as the true
decision makers (Aharoni, 2011; Devinney, 2011). Behavioural research, which focuses
on how individuals make decisions and influence other individuals (Birnberg and
Ganguly, 2012), has stayed a research niche in accounting. It sharply differentiates itself
from mainstream accounting or management accounting research. One particular form
of this research area consists of studying systematic biases in decision making
(Kahneman and Tversky, 1973), developing links among decision making, cognitive
science and management/finance/accounting (Peters, 1993) as well as depicting
heuristics presented under the titles of behavioural accounting or finance (Schönbohm
and Zahn, 2012). However, despite the growing popularisation of cognitive biases, most
of the accounting literature ignores the influence of behavioural biases on the International
international capital investment decision-making process (Kahneman, 2012). capital
From an interpretative perspective, capital budgeting might be regarded more as a budgeting
process of reality construction than as a rational choice (Morgan, 1988), or a
“fabrication” (Latour, 1999) or “manufacturing of rationality” (Cabantous and Gond,
2011). The social construction (Berger and Luckmann, 1966) of rational choice is bound
to cultural definitions about the right approach to deal with social dilemmas 169
(Trompenaars and Hamden-Turner, 1997) and is also influenced by ideological settings:
The whole capital budgeting process in multinational enterprises might be regarded as
a tool transporting financial and thus “capitalist” biases (Walle, 1990), focussing on a
singular financial dimension (Marcuse, 1964) in decision making.
Critical and interpretative perspectives on international capital budgeting have
remained marginal and exclusively academic (Miller and O’Leary, 2007). This paper
contributes to closing this gap by answering the following research questions:
RQ1. What are the main biases in international investment projects?
RQ2. What are suitable tactics to create a framework for alternative rational
decision making (Cabantous and Gond, 2011) for an enlightened management
and governance praxis against a backdrop of cognitive and motivational
biases?
Furthermore, societally relevant questions are raised as to whether these biases might
have an effect on various stakeholders of the investment decisions (Turan and Needy,
2013). This is especially the case in large investment projects, where capturing private
value (Kivlenience and Quelin, 2012) in interdependent, public and private interests
might be boosted by actively exploiting the biases of public decision makers. Active
stakeholder engagement could thus enhance the social and ecological value of
international investments (Agudo-Valiente et al., 2015; Burchell and Cook, 2013).
This article provides international capital budgeting practitioners with an
alternative and dialectical view on investment decisions and behavioural rationalisation
factors as well as recommendations for the stages of the capital budgeting process
beyond the rational (financial) choice paradigm (Kuhn, 1996).
The capital budgeting process is regarded as a financially driven “performative
praxis” (Cabantous and Gond, 2011) to identify opportunities and justify substantial
resource allocations for an uncertain future such as foreign direct investments,
operational investments or public–private partnerships. The application of investment
tools such as net present value calculations serve as “rationality carriers” (Cabantous
and Gond, 2011) to transcend a fundamentally socio-political interaction into a
“rational” process.
In an initial step, insights from behavioural corporate finance and implications on
capital budgeting from the behavioural accounting view are synthesised and enriched
by the body of literature stemming from the international business research stream.
Researchers highlight the importance of managerial behaviour in decision making
especially when talking about international capital investment, either in the form of
fund allocation to a foreign subsidiary, FDI, or internationalisation, especially with new
experiences (e.g. a first internationalisation) or during the earlier stages of capital
budgeting decision making (Sykianakis, 2007; Aharoni et al., 2011; Kalinic et al., 2014).
CPOIB The first step draws on empirical studies to substantiate the characteristics of the stages
12,2 and the cognitive biases typically applied.
In a second step, this article applies the interpretative paradigm and regards the
international capital budgeting process stages as a socio-political process of reality
construction and critically assesses the motives of its actors. The reflective social
constructionist perspective on capital budgeting does not accept the notion of rational
170 (financial) choice but concentrates on a complex, socially rich process of storytelling,
reality construction, market making and justifications (Ardley, 2006; Miller and
O’Leary, 2007). Therefore, the process becomes the key angle for understanding and
amending international capital budgeting decision-making processes from a financial
“performative praxis” (Cabantous and Gond, 2011) to an enlightened management and
governance praxis.
Consequently, the authors develop and discuss three principle-based behavioural
rationalisation factors (reflective prudence, critical communication and independence)
for the five stages of the international capital budgeting process. This merges various
pieces of micro-advice from the literature oriented towards practitioners with
management and board responsibilities and adds to the isomorphic rationality of
international capital budgeting praxis (DiMaggio and Powell, 1983). In addition, it
shows the reflective awareness of practitioners and researchers of social and ecological
dimensions of international investment projects.

2. Stages of the international corporate budgeting process

For reasons of framing, the capital budgeting process is divided into five different
stages, following Maccarrone (1996) and contrasts with a plethora of different
approaches (Burns and Walker, 2009; Ducai, 2009; Kalyebara and Ahmed, 2011;
King, 1974; Pinches, 1982): identification and filtering, selection, authorisation,
implementation, performance measurement and control. The five stages are an idealised
form of an existing “performative praxis” from an Anglo-Saxon perspective, culturally
defined by a relatively low power distance and low uncertainty avoidance (Hofstede and
Hofstede, 2005).

2.1 Stage 1: identification and filtering of investment proposals

This stage is regarded as sensitive since it provides fundamental information crucial for
the whole process (Sykianakis, 2007; Kalyebara and Ahmed, 2011). The creative process
of generating an investment idea, framing it into a compelling investment story and
building a convincing business report in line with the overall strategy of the
organisation in a given environmental context, evades pure analytical reasoning and
can be at best analysed by narrative research (Ardley, 2006). Project ideas can, on the
one hand, either emerge bottom-up, identified by (foreign subsidiary) operations
management, or top-down, such as strategic investment proposals by senior
headquarter management. Foreign subsidiary managers are often able to suggest
strategically viable decisions, but they need to build up strong credibility to be able to
promote their ideas with the headquarters’ management (Birkinshaw and Ridderstråle,
1999; Bouquet and Birkinshaw, 2008). On the other hand, investment ideas can be driven
by an opportunity or by a need for an investment, e.g. for replacement or expansions.
After the identification of proposals, these undergo a preliminary screening and filtering
among others for inconsistencies with strategic goals, inadequate hurdle rate, risk levels
and feasibility. Interestingly, around 70 per cent of firms accept investment proposals International
which do not meet the required hurdle rate for strategic considerations (Kalyebara and capital
Ahmed, 2011), because of the opportunity to be the first in a new market (Sykianakis,
2007) or due to possible legal constraints, etc. This indicates that many companies
budgeting
already deliberately deviate from a formalistic financial rationality at this stage.

2.2 Stage 2: selection

The most promising investment proposals are examined at this stage including
171
projections of cash flows, risk, demand for and cost of capital, timing of investments,
personnel involved and a first implementation plan (Burns and Walker, 2009; Kalyebara
and Ahmed, 2011). As an ideal result, the most promising projects are selected and
forwarded to top management for approval and authorisation. From an interpretative
perspective, it sounds simplistic to compare the highly uncertain future cash flow
streams of two projects that are completely unrelated in nature and make a selection
based on an algorithm generating a marginal net present value difference without
considering social and ecological impacts (Hebb et al., 2010). Furthermore, empirical
evidence exists indicating that decisions are being made even prior to the thorough
financial examination of international investment proposals. In these cases, strategic
and market considerations or information provided through managers’ social networks
make the same commit to an investment idea in a subconscious way (Aharoni, 1966,
2011; Aharoni et al., 2011; Cheng, 2010; Kalinic et al., 2014; Sykianakis, 2007). Thus,
financial analysis results might be calculated in the hope of proving the already taken
decision since, according to Arnold and Hatzopoulos (2000), evidence of calculations is
not sufficient for rational decision making within the rational (financial) choice
paradigm. However, the application of the calculations form part of the fabrication of a
rational process, in which the players apply “commodities of rationality” (Cabantous
and Gond, 2011) created by academics, consultants and practitioners to socially justify
the investment process.

2.3 Stage 3: authorisation

Excellent projects might not be authorised if they do not appear at the right time, are not
presented by the right person in the right manner or – in the ideal case – do not match the
funding capacities or strategic goals of a given organisation. King (1974) argues that
capital budgeting, especially in large organisations, is a process taking place in different
points of time and space, and if this process is suitable, i.e. stimulating creative thinking,
then, typically, the project is accepted. This is especially the case with investment
proposals made to the corporate headquarters from foreign subsidiaries (Birkinshaw
and Ridderstråle, 1999; Bouquet and Birkinshaw, 2008). For international projects, the
perceived risk of a country plays a significant role (Hayakawa et al., 2011). After all,
projects perceived as the most justifiable are authorised for implementation. The
financial tools applied form part of the fabrication of a rational decision and exhibit how
a social “engineering process” (Cabantous and Gond, 2011) provides “rational” support
to various actors in the company including the board of directors.

2.4 Stage 4: implementation

In the implementation phase, a detailed implementation plan is set up and disseminated
down the organisation, since the implementation itself is essentially the task of
operations management while being monitored by senior management. This stage can
CPOIB follow the common practice of project management. That means, first, that a work
12,2 breakdown structure with different work packages and individual activities/tasks with
respective owners, time frames and budgets has to be installed. Finally, milestones are
set (Project Management Institute, 2008) and a project management committee is
created in charge of planning, implementing and reporting (Kalyebara and Ahmed,
2011). However, still not enough research is being pursued here for an integrated view of
172 strategy and capital budgeting management (Pinches, 1982; Turner and Guilding, 2012).

2.5 Stage 5: performance measurement and control

A project’s performance can be monitored shortly before and after the start of the
implementation to detect and counteract previously unforeseen problems. Also,
monitoring during the implementation assists detecting overruns in timing and
expenditures so that problems can be addressed adequately. And finally, a post-audit
mainly gathers lessons for the coming projects but also, in a limited way, examines the
quality of forecasts made by project initiators (André et al., 2011). To audit the outcome,
usually, financial estimates are compared to actual results (Kalyebara and Ahmed,
2011). Post-audits are performed by 76 per cent to 85 per cent of corporations; however,
for most of the companies, they are neither regular nor risk-adjusted or thoroughly
documented (Gordon and Myers, 1991), and often, companies do not collect all the data
required for a thorough post-audit (Bennouna et al., 2010), thus making it a
one-dimensional evaluation, ignoring the social and ecological impact of investments.

3. Behavioural implications of cognitive biases in the international

capital budgeting process
The capital budgeting approach as a financial performative praxis has recently been
enriched by calls for incorporating the cognitive, organisational and institutional
dimensions of decision making (Biondi and Marzo, 2011; Cheng, 2010; Gervais, 2010;
Iyer et al., 2012). The main driver for this development has probably been the desire of
scholars and business executives to elaborate a “rational” method of decision making
and predicting future cash flows, which mirrors today’s complex adaptive economic
world better than the traditional approach (Mouck, 2000). Cognitive biases are, in this
view, accepted as flaws in the rational functioning of managers or form part of the praxis
of “manufacturing rationality” (Cabantous and Gond, 2011).
The international capital investment decision-making process is a dynamic social
process with mutual influence from several individuals/interested parties (Aharoni,
1966). Moreover, the decision making takes place in conditions of uncertainty due to lack
of information, time and a limited capacity of the human mind. Nevertheless, individuals
strive to decide rationally even though they can only apply rationality after having
greatly simplified their available choices (Aharoni, 2011; Devinney, 2011). Due to the
aforementioned factors, individuals are subject to bounded rationality and thus can
never arrive at an optimal decision (Kahneman and Tversky, 1973). On top of this, only
utilising financial decision models is no longer in line with societal expectations on
sustainable company behaviour (Turan and Needy, 2013). Table I lists and briefly
explains the main cognitive biases and their impact on the corporate capital budgeting
process.
In the following sections, the most relevant families of cognitive biases in the
investment process will be explained and applied along the stages of the international
 Bias Explanation Impact

Sentiment/ Cultural bias Long-term investment decisions are a social dilemma due Rationality, as a social convention about acceptably
beliefs to uncertainty, which are solved differently in different dealing with an uncertain future, changes within cultures
cultures Misunderstandings and conflicts due to the enforcement of
Different cultures have different approaches to deal with certain cultural standards
uncertainty and power within an organization
Financial bias Reduction of multi-dimensional decisions with economic, Decision making justification is only directed at
ecological and social impacts on a financial rational choice shareholders
Underestimation of non-financial risks and opportunities Negative social and ecological impact for stakeholders
might go unnoticed
Over-confidence Overestimation of own knowledge, abilities (e.g. to control Overinvestment due to an understatement of project cost
risk), possibilities, precision of information, value of own and time and overstatement of revenues
company More investment into new projects, products and markets
Underestimation of risk (highest in the least Preference for internal over external financing and for debt
equity-dependent firms)–in capital budgeting, essentially over equity
the same as optimism
Anchoring and Beliefs rely on the first piece of information without Decision making based on partially/entirely wrong
availability bias adjustment afterwards information
Overweighting of easily/readily accessible information
Over reliance on stereotypes and /or recent time-series or
events
Ethno-centrism Preoccupation of corporate headquarter managers with Rejection, delay or request for greater justification of
their own identity and a belief in its superiority over others project initiatives coming from foreign subsidiaries
Missing profitable foreign investment opportunities
Mental Categorisation and valuing of financial outcomes (a Euro Tendency to treat a new risk separately from existing ones
accounting does not equal a Euro based on circumstances or perceived Three mental incomes: current income, current wealth,
country risk) future income
Escalation of Justifying further investments in a special project is based Ignorance of sunk costs
commitment on accumulated prior investments and not on updated cost- “Throwing good money after bad”
benefit analysis Procrastination to stop failed projects and reluctance to
Assuming a possible ex-post regret of a wrong investment loss realization
Partition Allocating available corporate funds rather equally over Subsidizing poorly performing or non-profitable divisions/
dependence the business of the firm by division, nation or region subsidiaries
Omitting promising investment projects

Table I.
173
budgeting
capital
International

budgeting process
Overview of main

international capital
their impact on the
cognitive biases and
CPOIB capital budgeting process. The section closes with a discussion of the political
12,2 dimensions of the international capital budgeting process.

3.1 Cultural bias

Cultural bias in capital budgeting is the tendency to interpret social situations and
decision-making processes by standards inherent to the national culture of individuals
174 (Douglas, 1982). This includes assumptions about logical validity, acceptability of
evidence or taboos. In other words, the rationality of the capital budgeting process as
such does not naturally travel beyond cultures. The notion of “rational choice” or the
agreed on “performative praxis” is bound to cultural definitions about the right
approach to deal with social dilemmas (Trompenaars and Hamden-Turner, 1997), such
as the necessity to invest without assurance about the outcome of an investment against
the backdrop of an uncertain future. Cultural insensitivity could thus lead to
misunderstandings and conflicts.

3.2 Financial bias

Interestingly enough, the financial bias is rarely discussed and only few alternatives
such as triple bottom line investment models are presented (Turan and Needy, 2013).
The standard financial bias reduces the international capital budgeting decision to a
one-dimensional decision based on future cash flow projections, which is in line with
shareholder interests. Social and ecological impacts of the decision are not explicitly
regarded. The performative praxis of the international capital budgeting process is
mainly driven to serve shareholders’ interests. This ideological bias is dominant, since it
reduces managers to one-dimensional decision makers (Marcuse, 1964). Although
quantitative models for a balanced stakeholder consideration in capital budgeting are
possible (Turan and Needy, 2013), they have neither found their way into the
performative praxis of capital budgeting nor into the governance by supervisory
boards.
The subsequent biases mainly deal with the assessment of financial dimensions. The
greater part of literature on the topic of behavioural corporate capital budgeting inspects
the bias of overconfidence and biases related to it in different types and stages of
projects (Malmendier and Tate, 2005; Baker et al., 2007; De Bondt et al., 2008; Gervais,
2010; Biondi and Marzo, 2011). In the international context, the availability bias, even
though not explicitly named so by the international business researchers, is widely
present (Sykianakis, 2007; Aharoni, 2011; Aharoni et al., 2011; Kalinic et al., 2014) and
closely related to overconfidence. Mental accounting and escalation of commitment to
failing projects are also specific cognitive flaws in the process and will be treated
afterwards.

3.3 Overconfidence and availability bias

The Sydney Cross City Tunnel is just one example of how international public–private
partnership projects suffered from overconfident expectation that were never fulfilled,
as it was from the start underused and the operating company went bankrupt
(Haughton and McManus, 2012). Overconfidence is the overestimation of one’s own
knowledge, abilities (e.g. to control risk), possibilities, precision of information as well as
the value of one’s own company (De Bondt et al., 2008). Individuals with availability bias
tend to treat easily accessible or imaginable information as too important (De Bondt
et al., 2008). Bazerman and Moore (2009) argue that overconfidence is related to
confirmation heuristics since the human mind is better in searching memory for International
confirmative rather than dissenting evidence (Cheng, 2010). When investing capital
internationally, managers often value their own knowledge, experience and even
instinct as important and are thus prone to availability bias. Furthermore, evidence
budgeting
shows that international investments are repeatedly built upon information that
managers receive from the host country through own social networks. This “outside
influence” forces them to look abroad (Aharoni et al., 2011), which may lead to a 175
subconscious decision already made in the early identification stage of the process,
especially when backed up by the available information from strategic or market
analysis (Sykianakis, 2007) which often serves the purpose of minimising risks
(Aharoni, 2011). Thus, a decision to internationalise is the initial decision or the
self-generated anchor, which is not always adequately adjusted but rather perceived
infallible (Cheng, 2010). Hence, after deciding to internationalise, the financial analysis
will be accomplished, often as a mere justification or a determination of the investment
size (Sykianakis, 2007). Thus, the analysis may be conducted under wrong premises. To
conclude, it is arguable that the availability bias and confirmation heuristics reinforce
managers’ overconfidence.
Besides the identification phase, overconfidence also occurs in both the stage of
selection and partially the stage of authorisation. Especially with projects financed from
free cash flow, overconfident managers are found to overinvest due to an overestimation
of cash inflows and an underestimation of project time and cost (Baker et al., 2007;
Gervais, 2010). Thereby, multinationals tend to overinvest less than purely domestic
companies (Greene et al., 2009). Furthermore, overconfident managers tend to engage
more in mergers and acquisitions and strategic alliances than more critical managers.
The managers especially do so if they feel that their firm has benefited from such, or
their actions, thus they are the victim of the representativeness and self-attribution
biases (De Bondt et al., 2008) in addition to confirmation heuristics. Meanwhile, there is
robust data indicating that acquisitions tend to diminish the value of the acquiring firm,
at least as measured by the share price (Gervais, 2010). Rare and often non-qualitative
feedback reinforces the attribution bias preventing managers from learning from their
mistakes because international capital budgeting occurs infrequently (Gervais, 2010).
On the other hand, individuals in a state of high dispositional negative affect (i.e. stress,
fear or anger) are found to be more risk averse (Iyer et al., 2012).
Gervais (2010) and Brealey et al. (2011) suggest overconfidence contributes positively
to internal company processes through raised effort, commitment and persistence. This
parallels the self-fulfilling prophecy, which states that overconfidence motivates
individuals to work harder, resulting in the achievement of goals that would have
otherwise not been achieved.
Overconfidence seems to influence the whole capital budgeting process. In the
context of corporate internationalisation, managers often act based on their instincts
and take decisions prior to a proper investigation process (Aharoni, 1966, 2011; Aharoni
et al., 2011; Kalinic et al., 2014), which indicates a certain level of overconfidence. On the
upside, it provides a faster decision-making process since managers only rely on the
information they already have. However, it also increases the risk of a wrong investment
decision considerably. Furthermore, consistent with representativeness, self-attribution
and availability biases, managers, who have gained knowledge in a first
internationalisation process, take on higher amounts of risk in subsequent
CPOIB internationalisation attempts even though they internationalise in a more structured
12,2 way (Sykianakis, 2007; Aharoni, 2011; Sahgal, 2011). Thus, managers become even
more overconfident through experience instead of, as one would rather expect,
becoming more cautious. Overconfidence is interrelated with several other biases,
whereby they often mutually reinforce each other. Findings of Shimizu and Tamura
(2012) on the correlation between managerial traits and companies’ investment policies
176 are consistent with Gervais in the assumption that overconfident managers are more
likely to experience outstanding successes, e.g. with innovative products or
internationalisation. However, they are also more likely to suffer great failures as well
(Gervais, 2010), which can be explained by the lack of learning effects due to the absence
of proper post-auditing.
The bias of overconfidence can also occur at the authorisation stage. Since
overconfident managers perceive their company as undervalued, they are hesitant to
issue equity (Heaton, 2002). Hence, they tend to finance their projects from internal
equity reserves, which in turn has been found to be the main reason for capital rationing
(Mukherjee and Hingorani, 1999, p. 14). Another effect of overconfidence is the
understatement of the risks of many projects (Brealey et al., 2011). Moreover, based on
past experience (Iyer et al., 2012), the degree of everyone’s personal risk-seeking or
risk-aversion differs and thus influences the perception of a risk’s impact and
probability, crucial for assessment and anticipation of risks and creation of risk
responses. Nevertheless, many managers were found to be risk averse. They applied
capital rationing to reject projects they perceived as too risky (Mukherjee and Hingorani,
1999). However, in this attempt, managers indirectly created more upward biases in
cash flow estimation in the first place (Turner and Guilding, 2012). The strategic
importance and thus ranking of projects can similarly be affected by personal
preferences leading to possible distortion or the authorisation of a set of projects that is
less profitable than another possible set of projects would have been.

3.4 Mental accounting and escalation of commitment

Another widely examined and expensive failure of managers is the escalation of
commitment, i.e. holding on to unprofitable projects for too long, unprofitability being
observable in the implementation and control stages. In the case of ThyssenKrupp, the
steelmaker finally had to book a €5 billion loss in 2012 for the two above mentioned steel
mills. Three management board members had to resign and no dividend was paid. The
chairman of the supervisory board admitted that the board was too credulous and acted
too late (The Economist, 2013b).
Statman and Caldwell showed that mental accounting or framing intertwined with
the loss and regret aversions are important reasons for “throwing good money after
bad” to save poorly performing projects (Fennema and Perkins, 2008). Mental
accounting means that managers do not treat sunk cost as sunk. In their mental
accounts, they want to offset them by project revenues so that they can “close” the
account at least at zero, and not at a loss, thereby avoiding disappointment (Statman and
Caldwell, 1987). Loss aversion means that individuals do not want to make decisions
based on the outcomes of which they might be disappointed in the future. Thus,
managers try to “even out” losses by further investing in the project in the hope of a final
profit. This might eventually lead to the perpetuation of projects that have negative
social, ecological or reputational repercussions.
 Furthermore, investors’ positive reactions to announcements of cancelling bad International
projects (Statman and Caldwell, 1987) could be interpreted as another hint to managers capital
that they should quit a project earlier rather than later. Most often, mental accounting
together with loss aversion lead to even higher losses as managers assume a greater risk
budgeting
in avoiding a bigger loss by saving the project. This causes them to act highly
irrationally, initiating further expenditures on the failing project. An increasing amount
of complexity reinforces this behaviour (Aharoni, 2011). Hence, it can be argued that 177
escalation of commitment tends to be even greater in an international setting due to its
higher intercultural complexity. However, multinationals have been found to make
more value-enhancing capital budgeting decisions than purely domestic enterprises;
most efficient were those which were present in ten or more foreign countries (Greene
et al., 2009).
Furthermore, one might argue that overconfidence reinforces regret and loss
aversions, thus contributing to the escalation of commitment. The partition dependence
can produce another form of wrong escalation of commitment – commitment to badly
performing divisions or subsidiaries instead of their liquidation. However, due to
ethnocentrism, i.e. headquarters’ tendency to overrate home divisions or investments
vis-à-vis the foreign ones (Birkinshaw and Ridderstråle, 1999; Bouquet and Birkinshaw,
2008), partition dependence can be reversed causing negligence of international
divisions or subsidiaries among corporate managers in favour of homeland
subsidiaries.
It is to say that the great variety of competing research on the topic of escalation of
commitment shows that less is known than has been thought (Klimek, 1997). Until now,
no theorist has produced a clearly superior model of escalation of commitment. This
might stem from political reasons for escalation of commitment rather than cognitive.

3.5 Political dimensions of international capital budgeting

Biases have so far been presented as ethically neutral “flaws” in the reasoning of the
corporate actors involved in the corporate capital budgeting process. This is the view of
behavioural economics. However, there are various ethical lenses on the topic. On the
one hand, the financial bias can be understood as the performative praxis of the
capitalistic order. On the other hand, the biases might actually be power strategies for
the achievement of the managers’ personal objectives.
From an ideological point of view, the financial or “capitalist bias” (Walle, 1990)
offers room for criticism, since it solely or one-dimensionally (Marcuse, 1964) serves the
shareholders’ interest at the negligence or even the expense of other relevant
stakeholders (Turan and Needy, 2013). This is especially true in the foreign countries in
which the investments will have an impact on the economic, social and ecological
systems (Agudo-Valiente et al., 2015), which notably applies to less developed countries
(Bardy et al., 2012).
From a reflective perspective, it can be argued that many decision imperfections
within the performative praxis of international capital budgeting are not necessarily
neutral cognitive biases, but conscious or unconscious power strategies (Dörrenbächer
and Geppert, 2013) and game play by individual actors (Geppert and Dörrenbächer,
2014; Blaszejewski, 2009) and foreign subsidiaries in multinational enterprises applying
various negotiation tactics (Gammelgaard, 2009). Therefore, it is advisable to rethink
the intention of the players influencing the international capital budgeting process
CPOIB (Hutzschenreuter et al., 2010). Particularly important in the stages of identification and
12,2 selection is the fact that especially bottom-up originating ideas can be associated with
seeking benefits or a fast career growth. The overstatement of investment opportunities
in their respective home markets might, for example, be beneficial for the management
attention (Bouquet and Birkinshaw, 2008) and career perspectives of foreign subsidiary
managers. Pruitt and Gitman found that 80 per cent of top executives have spotted
178 upward biases in revenue forecasts and more subtle downward ones in cost forecasts.
Two third of them felt the biases were introduced either intentionally or through a lack
of experience (Pruitt and Gitman, 1987). Other studies associated such biases with
inaccurate information from top management as well as unintentional and often
unperceived inadequate managerial behaviour (Belkaoui, 1985; Bart, 1988; De Bondt
et al., 2008), thus confirming the bounded rationality of the neoclassical view itself.
Furthermore, a growing number of researchers indicate limits to the “unconstrained
opportunism assumption” of the agency theory: reciprocal behaviour and self-imposed
opportunism restraint to achieve fair outcomes (Schatzberg and Stevens, 2008).
In capital budgeting of multinational enterprises, the fear of subjective budget
reductions by top management during the year might create elevated revenue forecasts
channelling the executives’ attention toward an “even more promising project”
(Birkinshaw et al., 2006). A company’s formal and informal performance appraisal
schemes combined with the manager’s overconfidence might also lead to predictions of
elevated profits or short implementation time, especially with new products (Bart, 1988).
However, the other side of the coin of power politics in subsidiaries is that good
investment proposals from foreign subsidiaries have to fight the “corporate immune
system” (Birkinshaw and Ridderstråle, 1999) and ethnocentrism to get through.
Whether assuming the bounded rationality hypothesis or the political power view,
the lens of cognitive biases can enrich the comprehension of the social process of
international capital budgeting and add to a well-reflected decision-making process.

4. Recommendations for an enlightened management and governance

praxis
Perceiving the capital budgeting process in multinational enterprises as a performative
praxis is not an end in itself, but opens the discourse for prescriptive “rationality
engineering” (Cabantous and Gond, 2011): The descriptive knowledge of systematic
biases is integrated and transformed into recommendations for reality construction with
implications for management and governance bodies. Consequently, the following three
policies, diminishing the negative impacts of aforementioned behavioural biases are
proposed: reflective prudence, critical communication (cf. conventionalisation of
rationality) and independence (cf. commodification of rationality). They merge various
micro-tactics proposed by the literature into three principle-based strategies to deal with
cognitive biases in the international capital budgeting process to promote a financially,
socially and ecologically reflected international investment process.

4.1 Reflective prudence

Reflective or self-reflective prudence in capital budgeting means, on the one hand, to be
aware of the classical decision biases everyone is subjected to – cf. conventionalisation
of rationality (Cabantous and Gond, 2011) – and, on the other hand, to diligently generate
the data needed to make a decision. This reflective prudence should be well
institutionalised and framed into a standard procedure, which all international International
investment proposals in question have to undergo in accordance with the engineering of capital
rationality (Cabantous and Gond, 2011). The transformation of lofty visions and
ambitious plans under uncertainty into cash in- and outflows with defined risk profiles
budgeting
qualifies as “manufacturing of rationality” (Cabantous and Gond, 2011). This applies
even stronger to international capital investments since here several other factors such
as country risk, exchange rate fluctuations and a different local environment with 179
different stakeholders have to be considered (Hayakawa et al., 2011). Some managers
might even improve their decision-making skills by the creation of awareness for
psychological biases alone (Russo and Schoemaker, 1992). Thus, it is advisable to
perform special trainings with investment project participants to partially address the
cognitive biases and develop good meta-knowledge, which is, according to Russo and
Schoemaker, a “teachable and learnable” skill (Russo and Schoemaker, 1992). Fennema
and Perkins found that factors such as training and experience positively influence
managers in their investment decisions involving sunk cost considerations. Training, in
this case, meant a sufficient amount of managerial accounting courses, while experience
was seen as adequate professional experience in working with investment projects
including sunk cost principles (Fennema and Perkins, 2008). The two aforementioned
authors suggest that individuals with either one or both preconditions are more likely to
make investment decisions leading to satisfactory financial results.
Reflective prudence also manifests itself in a diligent data gathering and an
assumption clarification phase. Gathering, filtering, analysing and applying suitable
information for decision making is crucial. Stakeholder dialogues can integrate social
and environmental dimensions (Hebb et al., 2010; Agudo-Valiente et al., 2015; Turan and
Needy, 2013). This phase, however, should not be regarded as a way to generate an
objective truth about the future. Reflective prudence counteracts the availability and
representativeness bias during identification and assessment of investment proposals.
Moreover, it has an effect during implementation and controlling of investments.
Finally, reflective prudence institutionalises areas of self-reflection within the capital
budgeting process: a critical self-assessment might be a productive way to enhance
personal bias management. The potential list of cognitive control techniques for the
overconfidence has been explored before by Russo and Schoemaker (1992).
Furthermore, through feedback, overconfidence and self-attribution can be lowered,
leading to less biased decision making for future projects bringing reflective prudence to
the control stage as well. An important role of the supervisory board or other governing
bodies is to de-bias management decision making. Therefore, the board members could
benefit from cognitive and behavioural bias trainings.
Put in a nutshell, self-reflective consciousness about cognitive biases enhances the
international capital budgeting process and should be trained and integrated into the
capital budgeting process and its governance.

4.2 Critical communication

Communication is a multidimensional phenomenon. It should start with training about
the investment process and meta-knowledge about classical decision biases, as
discussed above. Since objectivity is hard to be achieved, inter-subjective story
development becomes the key. The danger of closed loops and groupthink might
exchange individual biases for even more dangerous group biases (Eisenhardt and
CPOIB Kahwajy, 1997; Horton, 2002). Even emotional group dynamics might negatively affect
12,2 capital budgeting decisions (Kida et al., 2001).
The critical communication about a potential investment project should include
extensive and comprehensive communication in the form of standardised reports as
well as review and feedback meetings. It should include the outcome of discussions with
relevant stakeholders including non-governmental organisations and labour
180 representatives (Burchell and Cook, 2013). Procedural fairness and formal and informal
contracts in public–private partnerships are perceived to be important factors for the
success of cooperative investment project success (Zhe and Ming, 2010). The
communication of the potential pitfalls and risks involved and a reflected statement
about the self-assessment of cognitive biases would most certainly enrich the project
selection and decision process. Actively addressing the questions of ethnocentrism,
overconfidence and mental accounting as well as an open analysis of the intentionality
and potential career implications of the international investment project promoter could
lead to an institutionalised de-biasing of the process. The simple comparison of net
present values, from a behavioural or social constructivist perspective, does not suffice
to decide on an investment project (Arnold and Hatzopoulos, 2000). Critical
communication provides transparency about the actions of the project co-workers and
the reasons behind them. Top management should refrain from communicating hurdle
rates or short payback periods, even though it is found to be common in striving to
reduce overconfidence (Pruitt and Gitman, 1987; Gervais, 2010). Senior managers should
ask the project proponents for justification of their proposals, i.e. explanation of their
judgment through thorough calculation as well as literal description. This practice has
been found to make decision makers and the proposers of projects more self-critical
about their judgment process and, as a result, lead to more adequate and less biased
decision making (Fennema and Perkins, 2008). Encouraging feedback and appropriate
performance measurement and compensation schemes should be installed (Turner and
Guilding, 2012; Pinches, 1982; Iyer et al., 2012), albeit this might be challenging across
borders. The system should reward only behaviours that benefit the company and
should present financial and non-financial indicators (Bart, 1988). A reward system
should first and foremost reward the provision of correct information by the managers,
and it should reward early disclosure over a late one. Furthermore, while negative
feedback can also be motivating, one has to use it with great caution. Negative feedback
on self-esteem, for example, was found to distort the assumptions and estimates of the
concerned person in question (Belkaoui, 1985). Feedback should be performed on a
regular basis and anonymously by means of software, which increases honesty,
especially from subordinates towards superiors and in an international headquarter-
subsidiary relationship.
Furthermore, it is advisable to agree on a set of goals to be reached within e.g. the next
six months. Both behavioural finance and behavioural accounting scholars agree on the
controllability principle: managers should not be held liable for performance that is
subject to factors outside of their control (Bart, 1988; Atkinson et al., 1997). Statman and
Caldwell (1987) empirically found that escalation of commitment is less expressed when
the subjects do not feel anxious due to the possibility of punishment by upper
management for inappropriate performance of the project.
Escalation of commitment is the main danger when implementing investment
projects since it aggravates the failure of a project, thus possibly threatening the
very existence of the company. Real options are considered to provide better International
decision making than net present value alone due to increased flexibility and quality capital
of information (Denison, 2009). Furthermore, they seem to decrease the escalation of
commitment since managers are confronted with the abandonment option already in
budgeting
the selection stage.
Critical communication can be interpreted as the natural outflow of the
consciousness of the cognitive and political biases that the actors in the capital 181
budgeting process have. By structuring the capital budgeting with built-in critical
communication, some pitfalls of cognitive biases might be amended.

4.3 Independence
The best way to avoid individual and group biases is to integrate independent views
into the project assessment and decision team; this might, from a constructivist
point of view also help “commodifying rationality” (Cabantous and Gond, 2011).
Thereby, the personal, cultural, national and professional backgrounds of the
various members must be considered, which is especially true for international
projects. Ethnocentrism can naturally be best avoided by a multi-cultural decision
team. Besides, team members’ and (designated project) managers’ overconfidence
can be measured based e.g. on Malmendier and Tate (2005). Consequently, the right
mix of (behavioural) competencies for the implementation and supervision of the
project can be provided. Internal or external auditors (Russo and Schoemaker, 1992)
and advisors representing relevant stakeholders (Agudo-Valiente et al., 2015;
Burchell and Cook, 2013) might, for example, enrich the team or support the
management from the identification phase onwards. A special committee in charge
of assumption evaluation and feasibility analysis of investment proposals,
including finance or managerial accountant staff, and the above-mentioned external
advisors might enhance transparency and provide another layer of rationality and
objectivity correcting for proposers’ overconfidence biases.
A problem of self-control explains aversion to termination of failing endeavours.
Even though rules are good means of counteraction, since their implementation or
obedience would again fall to the biased manager, distinct organisational structures
are needed to fight over-investment and escalation of commitment (Statman and
Caldwell, 1987). Such structures can be benchmarks of financial or reputational
losses that trigger the cessation nearly automatically. One benchmark can be
present termination value equal to sunk cost. Mentally, the account then closes at
zero without loss, making it easier for the concerned person to cope with. For
assessment of the present termination value, regular net present value
reconsiderations must be introduced by someone who is not personally responsible
for the project (Statman and Caldwell, 1987), e.g. from the internal auditing
department, consulting personnel or someone who reports to the Board of Directors
and not to the management. The financial manager should be empowered to enforce
project dissolution, overruling, if necessary, the project manager.
Altogether, not enough attention seems to be paid to project evaluation, especially to
post-auditing (Statman and Caldwell, 1987; Burns and Walker, 2009; Denison, 2009;
Kalyebara and Ahmed, 2011). Thus, it might be useful to actually make it a standard
behaviour. The control stage is about gathering, analysing and providing objective
information for “potentially unpopular decisions” now and in the future (Burns and
CPOIB Walker, 2009). Hence, information support systems must be established, potentially
12,2 engaging relevant stakeholders (Driessen et al., 2013). However, not only information
technology but also interpersonal communication can be helpful. Personal, formal and
informal meetings among project managers, financial controllers and external advisors
are advisable to enhance general understanding. Nevertheless, the controller has to
retain his neutrality.
182 Irrational managers can especially impact an organisation with weak corporate
governance (Baker et al., 2007). The establishment of strong and independent corporate
governance is thus important in all process stages. However, it is particularly important
in the authorisation stage to provide transparency as well as to enforce reflective
prudence and critical communication.
It goes without saying that the defined (or any other) rationalisation factors cannot
guarantee successful investment projects neither on a national nor on an international
scale. Although the success of the application of various de-biasing tactics was
empirically confirmed, the aggregated rationalisation factors of the paper have not been
subjected to rigorous testing, yet.

5. Conclusion and research outlook

International capital budgeting is not a process of rational choice but of the social
construction of reality (Morgan, 1988). The present paper provides international capital
budgeting practitioners and academics with a reflective view on investment. Therefore,
the term capital budgeting was defined and the stages of the capital budgeting process
were identified, namely identification, selection, authorisation, implementation and
performance control. The underlying areas of behavioural finance, behavioural
accounting and behavio, ur in international business were contrasted. Finally, a social
constructivist perspective was integrated. Section 3 presented the main biases: the
cultural, financial and cognitive biases and their behavioural implications on
international capital budgeting, such as the reasons for over-investment and escalation
of commitment to failing projects. Section 4 discussed the policies reflective prudence,
critical communication and independence, providing practical recommendations for
international capital budgeting practitioners.
Behaviour in international capital budgeting still offers a broad field of research
opportunities. Apart from the more explicit integration of stakeholders’ influence,
possible streams of investigation include empirical studies on the influences on the
capital budgeting processes including culture (on a broad international scale), size of the
company (e.g. surveys of small and medium-sized enterprises) and gender (contrasting
implications of gender-biased behaviour such as e.g. degrees of overconfidence). Also,
studies on the subject of this paper performed within companies might provide results
well mirroring the corporate reality. Further investigations on biases which have not yet
received considerable attention such as cultural bias, representativeness, availability,
anchoring, mental accounting (Baker et al., 2007), managerial traits (Gervais, 2010;
Shimizu and Tamura, 2012) and real options or opportunity cost, in case of project
cancelation, could be undertaken.
A next practical step could be the development and empirical testing of a
self-assessment test based on insights from this paper and enriched by other studies
such as those of Shimizu and Tamura (2012) and Malmendier and Tate (2005).
 The international capital budgeting process in multinational enterprises deals with International
the construction of future scenarios under uncertainty and the assessment of the capital
potential success and failure of future projects. The defined (or any other) budgeting
recommendations can naturally not guarantee successful investment projects. However,
the practical recommendations to implement the policies of reflective prudence, critical
communication and independence might diminish the effect of cognitive, emotional and
political biases and thus enhance the economic, social and environmental impact of 183
international investment decisions. In any case, it could contribute to a more reflective,
if not enlightened, management and government praxis.

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About the authors

188 Avo Schönbohm is Business Administration Professor with focus on Management Accounting at
the Berlin School of Economics and Law. Before joining the University in 2010, he had worked in
various assignments in the industry, including the responsibilities as Internal Audit Manager and
Vice President Strategic Planning. His current research focusses on enhancing corporate decision
making, corporate governance and corporate gamification. Avo Schönbohm is the corresponding
author and can be contacted at: [email protected]
Anastasia Zahn is a former Master student of Accounting and Controlling at the Berlin School
of Economics and Law currently working at DB Mobility Logistics AG Berlin.

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