1 / 10

Real Options: Taking Stock and Looking Ahead

Real Options: Taking Stock and Looking Ahead. Young Li, Barclay James, Ravi Madhavan , & Joseph Mahoney 2007 Advances in Strategic Management. Article overview. A concentrated report on developments in ‘real options theory’ and how ‘real options’ ideas can effectively be used

byrd
Download Presentation

Real Options: Taking Stock and Looking Ahead

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Real Options: Taking Stock and Looking Ahead Young Li,Barclay James, Ravi Madhavan, & Joseph Mahoney 2007 Advances in Strategic Management

  2. Article overview • A concentrated report on developments in ‘real options theory’ and how ‘real options’ ideas can effectively be used • A discussion on the past, present, and potential future of Real Options Theory research and literature • Real Options Defined – • A Real Option is the right to undertake some action or decision in the future (i.e. the option to ‘make’, ‘abandon’, or ‘contract’, etc.)

  3. Review of Current Real Options Literature • Investment Decisions • Implications of common real options on investment strategies • Investment Mode Choices • The effects of real optionson governance and organization • Performance Implications • How real optionsanalysis and understanding affects valuation and performance

  4. Applications of Real Options Theory

  5. Investment and Divestment • Wait-to-invest • In cases of uncertainty and high irreversibility of investment, a firm may choose to invest later rather than immediately • Allows firm to wait for favorable conditions • Abandon and switch • Real Options theory proposes that the value of a put option increases with salvage value and future uncertainty • Adds divestment considerations to NPV analysis • Corporate growth • Decisions made not necessarily for immediate cash flows, but for value derived from potential future benefits and returns

  6. Investment and Divestment • Option Interactions • Additional options increase the value of investment projects • Substitutable options add flexibility to investments, increasing value • ‘Dueling’ options take place of each other but have differing value • Options Portfolios • Strategic decisions can be viewed as bundles of real options • R&D project portfolios can be viewed as a portfolio of options • Alliances can be viewed as ‘exploratory investments in real options’

  7. Investment and Divestment • Competitive Dynamics • Investments are made with the industry as a whole in mind • Options are weighed with first-mover advantage, competitive entry, sector monopoly/dominance, etc. • Uncertainty and Learning • In general, uncertainty increases the value of real options • Two types: • Exogenous – resolved with time, encourages waiting prior to investing • Endogenous – reduced by strategic investments, reveals learning opportunities and can encourage investing • Investments can be made by a firm to influence uncertainty to their advantage

  8. Organization and Governance • Choice of Investment Modes • Real options can affect a firm’s choice in investment modes • Real options weigh heavily on the ‘make or buy’ decision • Example - Exogenous technological uncertainty leads to a preference for equity collaboration over acquisition • Collaborative Ventures • Trading of real options between partners can create joint gains • Optimal equity shares of a joint venture can be determined by the real options each partner holds

  9. Valuation and Performance • Valuation • Risk-neutral probabilities of success are smaller for early-stage ventures & positively related to the number of prior financing rounds • Implied volatility is larger for early-stage ventures and are negatively related to the number of prior financing rounds • Performance Implications • Option pricing models may not readily apply to real investments (because of differences between real and financial options) • Businesses that link small options with large strikes will perform better than those who stay small or large • Firms with greater exit value and less specialized assets are worth more to investors

  10. The future of real options research • Investment • Real options/learning and resources and capabilities • Investment decisions from a real optionsperspective • Exit/abandonment decisions • Interactions between real options and option-like projects • Investment Mode Choices • Governance choice and contractual issues • Performance Implications • Real options theory and organizational performance • Cost of real optionscreation and exercise • Firm and industry-level influences on investment performance

More Related