HOW DO YOU WIN THE CAPITAL ALLOCATION GAME

Why do companies frequently make bad investment decisions and Continue to blunder, even after the weaknesses in their capital: budgeting ana lyses are evident? Because,;according to the authors; they don't integ rate capital budgeting into their overall strategy. Boquist et ai:. of fer a capital budgeting framework that has six key features: (1) it is dynamic, (2) it is integral to the firm's strategy, (3) it recognizes sequences of options, (4) it is cross-functional, (5) it aligns emplo yee compensation with capital allocation, and (6) it emphasizes perfor mance-based training. wealth. The authors' framework for dynamic capit al budgeting has three simultaneous steps: 1. Identify a status quo st rategy and how it must perform to maximize shareholder value, The stra tegy will help the company determine the trade-off in capital budgetin g between cycle time and risk. The more time and resources it commits to collecting information: about a project, the more it can learn abou t cash flows and the lower the risk. But it achieves this risk reducti on at the expense of a longer cycle lime. 2. Establish a system for ev aluating projects and preparing capital allocation requests that is co nsistent with the strategy. The system has four phases - a new idea ph ase, preliminary evaluation phase, business evaluation phase, and go-a head or reject phase - and three tollgates - strategic, preliminary, a nd business. For approval, a project must pass through all three tollg ates. 3. Develop a culture consistent with the strategy and the evalua tion system. The company's long-term commitment to the strategy should be evident to employees. Employees from ail functional areas should b e trained in the system's underpinnings.:The employee compensation sys tem should tie bonuses to performance measures that correlate with sha reholder Only by implementing an integrated framework, say the authors , can a company make intelligent investment decisions with long-term s trategy in mind.