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REAL OPTIONS: TAKING STOCK AND LOOKING AHEAD

REAL OPTIONS: TAKING STOCK AND LOOKING AHEAD. Li, James, Madhavan & Mahoney. 2007. Advances in Strategic Management, 24, 31–66. Why real options?.

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REAL OPTIONS: TAKING STOCK AND LOOKING AHEAD

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  1. REAL OPTIONS: TAKING STOCKAND LOOKING AHEAD Li, James, Madhavan & Mahoney. 2007. Advances in Strategic Management, 24, 31–66

  2. Why real options? Myers (1984) emphasizes that it is difficult for the traditional NPV or discounted cash flow (DCF) method to play a role in strategic planning because of the DCF’s inability to evaluate the time-series interactions between investments that involve high-growth, intangible assets.

  3. Independent var. Project level Independent var. Firm level Dependent var.

  4. Investment decisions

  5. Common real options • Option to wait-to-invest • Flexibility, additional information • Decreased exogenous uncertainty • Option to abandon/switch • Remedy NPV rule • Irreversibility, value for alternative use(s) • Option to grow • 1st : create options; 2nd: exercise options • Follow-on project

  6. Extensions • Portfolio of options • Similar projects are less likely to be picked • Marginal value of an option in a correlated project is sub-additive • Competition & investment • Depends on rival (game theory), preemption • Endogenous uncertainty & learning • While exogenous uncertainty postpones investment • Exit decisions & hysteresis • Zone of inaction, optical inertia in which firms maintain status quo • Keep informed

  7. Nucor case • Nucor net value: $340M • A new steel plant: $280M+$30M Source: Harvard case: Nucor at a Crossroads by Ghemawat & Stander

  8. Research questions • Abandon option: on exit decisions and on the relationship between abandonment options and investment/ firm market value • Option to wait: Multiple sources of uncertainty • Competitive dynamics in option creation & exercise • Commitment vs. flexibility • Learning and firm heterogeneous resources • Interacting options, portfolio of real options • Substitute, complementary options

  9. Organization & governance

  10. Organization & governance • Choice of investment modes • Uncertainty: integration vs. market • Learning: collaboration vs. acquisition • Option rights in collaborative ventures • greater endogenous uncertainty also implies greater opportunities for learning through collaboration

  11. Research questions • How asymmetric learning may provide opportunities for “trading” option rights • Cognitive, incentive and organizational issues in application of real option theory • Real option values differ for each firm

  12. Valuation & performance

  13. Valuation & performance • Valuation • Performance implications • strategies that are consistent with real options theory may not always result in superior economic performance.

  14. Research questions • Besides value creation, “costs” of option creation & exercise • Contingencies influence value creation

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