Joint Ventures and the Option to Expand and Acquire Bruce Kogut Management Science (1991), 37(1): 19-33 Presented by Julie Ao, Fall 2017

Summary Expand to new markets → Uncertain demand ← Initial investment (try out) Initial investment: buying the right to expand in the future Joint ventures are considered as the initial investment (real options) Real option: Real---investments on the balance sheet rather than financial capital Option---gives you the rights but not the obligations Benefits of joint ventures: Sharing risks Decreasing total investment Possible outcome: the party placing a higher value on the new capital buys out the other When will the venture be acquired? (Timing)

Real Options Value of investment depend on: Current cash flows Redeployment or future expansion = growth opportunities

Joint Ventures as Real Options To wait or to invest A joint venture is a bridge between the two options Making acquisitions has value to the acquirer: When net value of purchasing joint venture ≥ value of buying comparable assets elsewhere Even if not, still learn the true value of assets Timing of the acquisition is related to the signal that the valuation of the venture has increased Acquire when the perceived value to the buyer is greater than the exercise price Value of purchasing the remaining shares > price of purchasing them

Timing of Exercise The option to expand the investment ↔ the option to acquire the joint venture Why not wait when it is profitable to exercise the option? The option value is realized by investing in expansion The requirement to contribute further capital leads to difficult renegotiations Timing influenced by two considerations: Initial base rate forecast Value of the venture to each party Hypothesis: The venture will be acquired when its valuation exceeds the base rate forecast

Data Collection From both questionnaires and archival sources Questionnaire data: Samples included 92 ventures in the manufacturing industry located in the U.S. with at least one American firms in the joint venture. Dummy variables (R&D, Production and Marketing) are created from questionnaire data Secondary data: Bureau of census firm concentration ratio at the four-digit SIC level Two time-varying specifications from Department of Commerce data: Short-term annual growth rate Long-term annual residual error (differences between the estimated, base-rate predictor and the actual, realized value)

Results Hypothesis confirmed In concentrated industries, joint ventures appear to be used Ventures with R&D activities or marketing and distribution activities are more likely to be acquired Managers are sensitive to long-term intra-industry base rate than to short-term

Conclusion There is no significant relationship between dissolution and the two time-varying specifications It will rather pay to wait and see if the process generates more favorable outcomes Joint ventures are designed as options A signal that the venture’s value has increased should lead to an acquisition, but a signal that it has decreased should not lead to dissolution, as long as further investment is not required and operating costs are modest

Discussion Joint ventures are regarded as dyadic relationships. Both firms make initial investments and buy the rights to expand or acquire in the future. Then what factors determine who will be the acquirer? “Through the joint venture, the buying party has acquired the skills of the partner firm” (P. 22). Does the buying party really acquire the skills, which are the implicit knowledge of the partner firm?