Your comments are well taken. I have been in many situations where executives, particularily senior ones, have embeddd mental models of how their business works – not taking into account the inevitable evolution in their industries. In these situations, financial analysis may be viewed more as a confirmation of their intuition than as an input.

I wonder, Scott, how much of this is due to short term horizon of some executives and how much is due to executive egos. In past decades executive compensation systems tended to reward short term performance and ignore long term competitiveness. Such systems could inhibit executives from spending capital to increase long term gains – especially if replacement capital also entailed the write-off of prematurely retired assets. But I think most executive compensation systems have been tweaked to reduce such short term bias.

An equally difficult problem has been the emotional ties executives have to existing operations and capital. One man I worked for – one of the most admired CEO's in the U.S. – was unable in the 80's to let go of a failed pet project draining hundreds of millions from his otherwise outstanding company. IMO, it was a matter of saving face. The Space Shuttle Challenger disaster gave him an out. He was able to blame the demise of his project on the inability to launch satellites, a critical success factor. Zapmail's demise wasn't an example of a disaster forcing a capital expenditure for new technology, but rather a disaster enabling a redeployment of resources.

Sorry, I forgot about my comment here. You can find Hanson's general argument about the problems with health care in Cato Unbound:

http://www.cato-unbound.org/2007/09/10/robin-hanson/cut-medicine-in-half/

I'm having trouble finding the data he uses to support the particular claim that new treatments are often ineffective. I believe he's using the RAND study and other aggregate studies that find no significant correlation between better health and health spending after a certain point, and extrapolating that new treatments and equipment are likely to be expensive.

I thought about the whole natural disaster thing a little more. (Forgive me if someone already said this; this blog generates a lot of comments these days!) Like I said before, disasters don't discriminate between old and new capital. They're equal-opportunity destroyers, barring some major exceptions–obviously newer buildings tend to have better safety standards than older buildings, but the vast majority of capital replacement we're talking about isn't on this scale. The reporter could still be right if, in fact, businesses are biased to not replace capital often enough. There could still be enough old vs. new capital that a natural disaster prod could fix a market failure. This would also depend on the rate of disaster. One every year would have a much worse effect on capital substitution than one every ten years.

But imagine you're a shopkeeper. You know that disasters don't discriminate. You also know (approximately) the rate of natural disaster in your area. You think you can refurbish your shop, change out your capital, and thereby better serve your customers. Do you? It depends on the risk of a disaster hitting the new capital versus the profit you would make from serving your customers. If you live on the Florida coast, it might be very risky to go ahead and make the capital substitution.

In this case, natural disasters aren't the cure for a market failure of capital substitution–they're the cause. The shopkeeper is absorbing the risk by losing some profit, while customers are absorbing the risk by shopping in a less efficient store. Seems to me that they're all spending the right amount, now that the cause is uncertainty rather than bias. It's as efficient a solution you can get in such a case. I think it's reasonable to believe this is more likely than a bias against capital substitution.

A weather event destroys capital. The exisitng physical capital is destroyed by the weather, the financial capital of insurance is destroyed by having to replace the physical capital. The insurance capital is invested before being payed as a claim. Once it is payed it no longer finances another market determined worthy investment. There is less capital.

In the broken window analogy. The glass maker benefits when an window of a shop is broken but the shop owner has less money after replacing the window. The suit maker has fewer sales because the shop owner buys a window instead of a new suit. Opportunity cost!

That being said, there is a very good article in HBR by Clayton Christensen about "innovation Killers – How Financial Tools Destroy Your Capacity to Do New Things"

One of the misapplictions of finance is to use fixed and sunk costs unwisely. He uses the steel industry as an example. Some integrated steel makers refused to innovate because of their embedded capital. This does not relate directly to the weather example unless we assume that some industries are slow to innovate because of the misapplication of financial principles and get a nudge from mother nature. But of course their insurance rates will increase and must pay either way.

I agree that revenue projections are almost always wrong, but not always on the high side. Projecting the behavior of customers (revenue) is generally more difficult than predicting the behavior of the internal organization (costs). We should expect sales and marketing estimates to be less reliable, and they are, as you point out.

Positive NPV investments are missed, but probably due to conscious decisions as often as due to incorrect estimates. Most organizations just do not have the resources to pursue every proposal. Prioritizing capital spending opportunities is a critical job for the large company.