Posted by Kathryn Schwartz on January 22, 2014
Risk Analysis

In today’s dynamic business environment, efficient allocation of capital is the most important and challenging task for the modern decision- makers. As the business environment becomes increasingly volatile and competitive, the art of making good decisions is considered as more complex and significant than ever before. This enhances the importance of decision makers who take/involve themselves in strategic decisions (SDs). Strategic Investment Decisions (SIDs) are among the most important of all SDs that determine the overall direction of any business. Further, these decisions are the key drivers to the survival and success of a company (Kannadhasan and Nandagopal, 2008). A variety of techniques (viz. Payback, Accounting Rate of Return, Net present value, internal rate of return, and Profitability index) have been developed to assist in making SIDs which may be classified into naive and sophisticated techniques (Mark Freeman and Garry Hobes, 1991). The Net Present Value (NPV) and Internal Rate of Return (IRR) methods are considered to be the most sophisticated of all (Pike 1983; Klammer, 1972; Haka et al, 1985). However these two techniques are demonstrated under the conditions of certainty. The development of various risk analysis techniques has been necessitated by the uncertainty associated with cash flows, which are due to changes in the management’s expectations over time and arrival of new information (Klammeret al 1991, Dastgir 2005).

In practice, risk analysis techniques have been classified into formal and informal methods (Smith, 1994).There is an increasing trend in the use of formal risk analysis techniques in capital budgeting decisions due to the availability of computer software packages that can help in applying these techniques with ease(Pike, 1989)and availability of information (Ho and Pike, 1996). The extant literature shows that most of the manufacturing companies use more than one technique for analysing risk in their SIDs (for example, Pike 1996). Moreover, among the risk analysis techniques, sensitivity analysis (SA) technique is the most popular technique, followed by scenario analysis technique (Pike (1988 and 1996), Klammer et al (1991), Arnold and Hatzopoulos (2000), Farragher et al 1999, Farragher and Leung 1987, Kester and Chong 1998, Kester et al 1999, Jog and Srivastava 1995, Pandey 1989, Manoj Anand 2002, Ashish Kumar and Bhavin Shah 2006, ZakiOsemy 2001, Kannadhasan&Nandagopal (2010b)). Electronic commerce

However, most of the above mentioned studies had reported about the risk handling practices and the related problems as part of broad based surveys. Very limited studies have investigated the extent of the use of these techniques and their relationship with the organizational characteristics such as business strategy, information system, and environmental uncertainty, perceived company performance and so on. For example, Ho and Pike (1998) found that a number of key firm characteristics influence the extent of the use of risk analysis in Strategic investment decisions (SIDs). Similarly, Kannadhasan and Nandagopal (2010a, 2010b and 2010c) found that business strategy and information systems of a firm and company-specific factors influence the extent of use of Risk analysis techniques in Indian context respectively. From the capital budgeting literature, it is clear the perceived environmental uncertainty and perceived company performance also play a pivotal role in the extent of use of Risk analysis in SIDs; this study examines the same in automotive industry in India.

The automotive industry is capital intensive and characterised by large scale investment and subject to technology driven product cycles (Heitger et al 1999) which is similar to the characteristics of SIDs. Therefore, there is a requirement for capital expenditure projects in this industry. The automotive industry is also known as a volume driven industry which needs certain critical mass as a perquisite to retain/attract the consumers. This necessitates higher investment in R&D and new product development which is the life line for achieving and retaining the competitiveness within the industry. This in turn, depends on the company’s capacity and the speed of the company to innovate and upgrade (Kannadhasan and Nandagopal, 2010b). As a result, the company has to invest large amount of money that brings risk analysis into this context. Further, an increasing complexity of the business environment of automotive companies (say, technology changes, consumer preferences, intense competition, and so forth) operating in India has prompted increasing interest in risk analysis in SIDs in order to maintain the competitive position.

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