Essays on Emerging Applied Methodologies for the Valuation of Technology

1. Essays on Emerging Applied Methodologies for the Valuation of Technology PhD Summer Project Suvankar Ghosh

2. 3 Essays • An Adoption Decision Model for Emerging Capital Budgeting Methodologies • A Real Options Approach to Enterprise Integration Investments • A Nested Options Model for Cellular Manufacturing Today’s Talk is Mainly About Paper 1

3. Status of the Essays

4. Overview of Adoption Model Paper • Build a theoretical model for the acceptance by industry of new capital budgeting methodologies such as Real Options Analysis (RO) and Economic Value Added (EVA) • Key model constructs • Perception of theoretical soundness • Perception of practical applicability • Methodology Adoption Model is analogous to TAM • Formulate measures of the sentiment of academic and practitioner communities. Sentiments are computed by scoring academic and practitioner articles • Propositions of Methodology Acceptance Model (MADM) and empirical sentiment data to conclude if EVA or RO is more likely to be embraced

5. Motivation • Businesses are unhappy with the tools they have to measure their investments in IT or manufacturing technology • Historical methodologies for appraising capital investments have major shortcomings • Net Present Value (NPV) • Internal Rate of Return (IRR • Return on Investment (ROI) • Payback Period • Companies are turning to new approaches such as EVA and RO

6. Two New Methodologies • EVA – Economic Value Added • Originated in the industry • Popularized by Stern-Stewart • Real Options Analysis (RO) • Originated in the Black-Scholes theory of pricing of financial options • Applied to the pricing of real assets • Both EVA and RO have been around since the 1990s • Applied to appraising capital investments in many industries • biotech, oil and gas, telecommunications

7. EVA – Basic Definitions • EVA = NOPAT – COC • NOPAT is Net Operating Profit After Tax • COC is the Cost of all Capital

8. Real Options • Based on the application of the classic Black-Scholes options pricing model to real assets • An investment opportunity is an option on an underlying asset

9. Methodology Acceptance Decision Model (MADM) Theoretical Soundness of Methodology Attitude to Methodology Likelihood of Acceptance Practical Applicability of Methodology

10. Key Lemma on Relative Acceptance Likelihood • Methodology A has greater likelihood of adoption than methodology B if A is superior to B in one of the two dimensions of theoretical soundness and practical applicability and at least as good as B in the other dimension.

11. Operationalizing the Model • Define proxy variables for the constructs of Theoretical Soundness and Practical Applicability • Sentiment of the academic community as expressed in publications in academic literature is the proxy for theoretical soundness • Sentiment of the practitioner community as expressed in practitioner literature is proxy for practical applicability • Score the academic and practitioner article depending on whether they are favorable or unfavorable to the methodology +3 Very Favorable, +2 Favorable, +1 Partly Favorable, 0 Neutral, -1 Partly Unfavorable, -2 Unfavorable, -3 Very Unfavorable

12. Sample • Sample academic and practitioner articles on EVA and ReOA from 1992 to 2005 • 25% sample of the 56 quarters in 1992-2005 • Sample drawn from EBSCO electronic databases -- a major vendor of information services • Business Source Premier – 1,100 peer-reviewed business journals • Academic Search Premier – 3,600 peer-reviewed journals • Total of 87 articles on EVA and ReOA which were content-analyzed and scored

13. Data Analysis • A two-element vector of sentiment based on article scores for each methodology • 14 instances of the sentiment vector for ReOA and EVA • Perform MANOVA analysis to test various hypotheses about the interest levels in ReOA and EVA Academic Sentiment Practitioner Sentiment

14. Results • Manova Omnibus test H1: There is no difference between ReOA and EVA in the overall sentiment considering both academic and practitioner sentiment Result: Hypothesis was easily rejected at α=0.05 Wilk’s Lamda was 18.62 with p-value of less than 0.0001 • Univariate “Protected F” tests H2: There is no difference in the academic sentiment between EVA and ReOA Result: We cannot reject this hypothesis at α=0.05. F-value is 1.59 with p-value of 0.218

15. Results (cont.) • H3: There is no difference in the practitioner sentiment between EVA and ReOA • Result: Hypothesis is rejected at α=0.05, F-value is 32.11 with p-value of less than 0.0001 Overall Findings from Analysis of Sentiment • There is a difference in the overall sentiment between EVA and ReOA, and the practitioner community is the driver of this difference

16. Conclusions • EVA appears to have a better likelihood of adoption compared to RO. Also it appears as practitioner interest in EVA increases, that is fostering an acceleration of academic interest in EVA • Firms should first adopt EVA and then RO • Migrating to EVA-based financial system however is not easy • Implementation challenges can be formidable • Could lead to losing sight of other critical elements to survival like cash flow • Critical success factors include management commitment, effective corporate governance system, and comprehensive training • EVA training programs are not cheap and can cost anywhere from $250,000 to $1M depending on size of company • RO bears watching. Efforts underway to simplify RO for practitioners such as making it more NPV-like in how its is operationalized (Feinstein and Lander, 2002)