Capital Budgeting Practices and Complementarity Relations in the Transition to Modern Manufacture: A Field Based Analysis

Abstract

This paper provides a descriptive and qualitative study of how capital budgeting practices at Caterpillar Inc. were redesigned to accommodate a shift from mass production technologies to modern manufacturing systems. We describe how the firm's capital budgeting practices shifted from considering incremental asset purchase proposals to considering proposals to purchase sets of diverse but mutually reinforcing assets ("investment bundles"). We draw on Milgrom and Roberts (1990, 1995) argument that investment in modern manufacture will be value-maximizing only if firms coordinate their capital spending across diverse but mutually reinforcing types of assets to economize on Edgeworth complementarities. Our description of the shift in Caterpillar's capital budgeting practices illustrates how one firm produced an operational model of complementarity relations.

JEL Classification: G31, L23, M40, M46