Are projects boosted to get approved? : evidence from two decades of investment appraisal

Abstract

A central goal of Finance is to allocate resources to the best projects, with rates of return that exceed the opportunity cost of funds. Importantly, though, empirical challenges have made that most of this financial research concentrates on the hurdle rates and cost of funds, leaving the black box of project preparation and appraisal as a relatively unexplored area. In this paper, we explore more than 28,000 publicfunded investment projects between 1997 and 2021, which were prepared and evaluated in multiple rounds, receiving NPV and IRR. First, we find that the project’s IRR distribution tends to have bunching just above the hurdle rate used as a cutoff for investment. This excess of mass was not an inherent property of the projects because when the pre-announced hurdle rate changed, the bunching also changed. We find evidence that projects closer to the hurdle rate tend to have longer iteration processes before receiving a passing IRR. Also, under some circumstances, they exhibit higher overrun costs and lower completion delays on the execution. We also find evidence that the technical capacities of project preparation units relate to fewer iterations before getting a passing IRR1 . Overall, our evidence is coherent strategic models of project preparation and appraisal, either through ”IRR management” (a parallel to earnings management, but for project appraisal) or a dynamic process of strategic ”revise and resubmit” before the passing grade. The discussion suggests some implications for the design of project preparation processes.