Investment Incentives (Survey) (Hansard, 14 December 1970)

§ Mr. John Davies

The Ministry of Technology, in association with members of Manchester Business School, carried out a pilot survey on the effectiveness of investment incentives in the first half of 239W 1970. The purpose of the survey was to discover whether a full-scale survey would be worth conducting; and, if it were, to determine the best approach.

A systematic random sample of 300 companies was obtained by taking one manufacturing company in five with net assets of over £5 million, one in ten with assets of between £5 million and £500,000, and a smaller sample of companies in the non-manufacturing sectors of industry. These 300 firms received a questionnaire by post, and a response rate of about 40 per cent. was obtained; a representative selection of some 45 of the firms which had and had not replied were later interviewed. An additional sample of some 25 companies who did not receive the questionnaire was also approached directly for interviews, and a response rate of about 75 per cent. was obtained.

The pilot survey showed that it is difficult to establish how far companies' decisions may have been influenced by investment incentives, so that any larger survey could be expected to be of limited value for policy-making. Despite the size of sample and response rate, the survey produced much information of value on the factors entering into a company's investment decisions, and on the methods of investment appraisal used.

A full report will be made available later, but the following are the main impressions gained from the pilot survey.

(i) About 30 per cent. of investment may not be appraised at all, perhaps a third of this because some firms do not use any formal methods of appraisal, and the remainder because many firms do not appraise small projects or replacements. Much of the remaining 70 per cent. of investment is appraised by more than one method of calculating returns on investment. Overall roughly equal proportions of investment are appraised by the three main methods—discounted cash flow, accounting rate of return on capital, and the pay-back period. About two-thirds of all investment is done by companies which make some use of D.C.F. techniques, and about a fifth by companies which use only the other methods. Companies almost always allow for the effects of taxation and tax allowances in their D.C.F. calculations; they usually make other 240 calculations pre-tax, but sometimes take indirect account of the effects of tax allowances.
(ii) A large part, perhaps three-quarters, of investment may be done by companies in which managerial factors constrain investment to some extent. Such factors include a lack of satisfactory proposals or of adequate staff to manage projects which seemed potentially profitable.
(iii) There often seems to be no precise cut-off, in terms of the expected return, between acceptable and unacceptable proposals for investment. The calculations of profitability tend to be only one of several factors influencing a company's decisions; the other factors may often relate to the validity of the assumptions behind the calculations, but they make decisions much more than a matter of calculating the expected returns and comparing them with the company's target rate of return. It is this characteristic of investment decisions which makes the effect of investment incentives very difficult to establish, especially in retrospect.
(iv) The effects of the investment incentive differential in favour of the development areas is especially difficult to judge when investment decisions involve many factors. Any further survey, however large, might therefore fail to provide firm evidence on the effects of the differential. So far as the evidence of the pilot survey goes, firms doing more than half of all investment may have increased their investment in the development areas as a result of the regional differential; the size of the increase cannot be estimated, but generally appears to have been small.
(v) Firms were asked how they rated the incentive effect on investment of free depreciation, a 20 per cent. investment grant, and a 30 per cent. investment allowance. (It was explained that these options were chosen because they have the same effect of profitability.) About 60 per cent. of firms, doing the same proportion of investment, put free depreciation as their first choice. About 20 per cent. of firms, doing 35 per cent. of investment, ranked investment grants first. The remainder preferred investment allowances. It appeared that the main 241 reasons given for preferring free depreciation were administrative simplicity and quick benefits to liquidity.