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

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.