Project Review and Administration
Effective project management does not end with the approval of a proposal. A project must be carefully monitored during its implementation phase to ensure that cost and time overruns are minimized. Once the project is commissioned, its performance must be periodically reviewed to assess whether it delivers the expected outcomes. In some cases, if the project consistently underperforms or external conditions change drastically, the possibility of abandonment must also be evaluated.
Key Facts of Project Review
1. Control of In-Progress Projects
Even though organizations put tremendous effort into selecting capital projects, many challenges arise during the implementation stage. Cost escalations, delays, and scope creep are common problems. To address these, two important control mechanisms are used:
- Establishment of internal control procedures: Clear guidelines, approval systems, and accountability structures ensure that resources are properly utilized.
- Regular progress reports: Periodic updates help managers compare actual performance with planned targets, allowing for timely corrective actions.
Example: A manufacturing company building a new plant may use weekly progress reports to track construction timelines, ensuring that delays are addressed before they escalate into major cost overruns.
2. Post-Completion Audits
Once a project is commissioned, it should not be left unexamined. A post-completion audit evaluates the project’s performance against initial expectations. This audit serves multiple purposes:
- Creates a documented record of experiences that helps in improving future decision-making
- Identifies individuals with strong planning and forecasting skills
- Highlights systematic biases in judgment, such as over-optimism in sales forecasts
- Introduces a healthy caution among project sponsors
- Provides a training platform for young executives who need exposure to real-world project outcomes
Example: If a company invested in a new IT system, a post-audit may reveal whether the system achieved promised efficiency gains, and what assumptions during planning turned out to be overly optimistic.
3. Abandonment Analysis
Capital expenditure management is dynamic, not static. Approving a project does not mean it must continue throughout its expected life. Market conditions, technology changes, or shifts in company strategy can make once-promising projects unviable.
The same techniques used to evaluate a new project like net present value (NPV) can also determine whether to continue or abandon an existing project.
Decision Rule:
- If the present value of abandonment > NPV of continuation → Abandon the project
- If the NPV of continuation > present value of abandonment → Continue the project
Behavioral Challenge: Managers may resist abandonment due to emotional attachment, fear of reputational loss, or sunk-cost fallacy. Rational decision-making, however, must prevail.
Example: A telecom company may abandon a failing service line when newer technology makes it obsolete, even if significant investment has already been made.
4. Administrative Aspects of Capital Budgeting
Capital budgeting involves a series of administrative steps that ensure investments are evaluated, approved, and monitored systematically. These include:
- Identification of investment opportunities – spotting viable projects in line with company goals
- Classification of investments – grouping projects by type, risk, or purpose
- Submission of proposals – formal presentation to decision-makers
- Decision-making – selecting projects based on financial and strategic criteria
- Preparation of capital budget and appropriation – allocating funds
- Implementation – execution of the project plan
- Performance review – assessing results against expectations
This structured approach ensures discipline and transparency in capital allocation.
5. The Agency Problem
Managers often enjoy significant autonomy in decision-making, which can lead to a conflict of interest between them and shareholders known as the agency problem.
Managers may be tempted to:
- Build large “empires” that enhance their power and status
- Pursue personal “pet projects” to showcase expertise
- Maximize perks and compensation instead of shareholder value
- Avoid high-effort or high-risk projects, even if they promise strong returns for shareholders
Mitigating Agency Costs:
- Monitoring: Regular oversight helps detect empire building, excessive perks, absenteeism, and fraud.
- Incentive compensation: Well-designed incentive plans align managerial goals with shareholder interests.
Key principles of an effective incentive plan include:
- Integration into total compensation structure
- Objective and measurable performance indicators
- Rewards based on relative performance (e.g., outperforming peers)
- Long-term incentives that encourage sustainable growth rather than short-term gains
6. Evaluating the Capital Budgeting System
The effectiveness of an organization’s capital budgeting system can be judged using several criteria:
- Results: Does the system lead to profitable, value-enhancing projects?
- Techniques: Are sound financial and analytical tools used?
- Communication: Is there clarity and transparency in reporting?
- Decentralization: Does the system allow decision-making at appropriate levels?
- Intelligibility: Are procedures easy to understand and implement?
- Flexibility: Can the system adapt to changing conditions?
- Control: Are there effective checks to avoid misuse of capital?
- Review: Are projects periodically evaluated for performance?
Conclusion
FAQ's
Why is project review important in capital budgeting?
Project review ensures that resources are being used effectively and that the project delivers the expected returns. It also helps identify potential risks, cost overruns, and performance gaps early, enabling corrective actions.
What is a post-completion audit and why is it necessary?
A post-completion audit assesses the actual results of a project compared to its original estimates. It is necessary because it provides learning for future projects, reveals biases in planning, and serves as a training tool for managers.
What is the agency problem in project administration?
The agency problem arises when managers prioritize personal goals (power, perks, pet projects) over shareholder wealth. It creates inefficiencies and reduces value creation unless monitored or incentivized properly.
What are the key steps in the capital budgeting process?
The steps include: identifying opportunities, classifying investments, submitting proposals, decision-making, budget preparation, implementation, and performance review.
