Research Notes and Commentaries Real Options in Equity Partnerships Timothy B. Folta and Kent D. Miller (2002) Strategic Management Journal

Research Questions and Gaps Why collaborations sometimes end in acquisitions of partners? Whether option theory is useful for predicting sequential equity commitments in partner firms? What are the effects of external uncertainty on equity purchase? Research gaps Buyouts of research partners have not been explained by previous research Neither main nor moderating effects of uncertainty have been explicitly examined in prior empirical real option research with the field of strategic management

Two-stage Compound Options (Kogut 1991) Valuable information & contractual, operational ,managerial links Controlling interest $ initial equity stake Call option $$$ Further investment Growth Option (2nd stage) Buyout Option (1st Stage) $$$ Invest to expand

Theory and Hypotheses When to exercise an option? Black-Scholes (1973) model: valuing the partner buyout option Option will be exercised when the value of the underlying asset (S) exceeds the exercise price (X) by more than the value of holding the option (C): 𝑆−𝑋=𝐶(𝑆,𝑋,σ,𝑇) S: $(NPV + Option) X: $(exercise option) C: $(holding the option) σ: uncertainty of S T: the time length of deferral

Exercise Buyout Option Theory and Hypotheses Increased partner $(NPV +current learning opportunity + future growth opportunity )  buyout H1 H2 High uncertainty  buyout less likely H3 Exercise Buyout Option low uncertainty + high $  buyout H4 More proprietary  buyout H5 High uncertainty + less proprietary  buyout (preempt rivals) Growth options more unique (fewer rivals) buyout (technology substitutability) H6

Theory and Hypotheses high uncertainty H5 high H4 Proprietary H2 H3 H1 valuation low high

Research Design Data The North Carolina Biotechnology Center (NCBC) Actions Database and Bioscan 4 subfields: therapeutics, diagnostics, agriculture, and supplier/specialty chemical 285 minority equity partnerships (22 terminated by purchases the ownership level to 50% 87 dissolved, 35 acquired by 3rd parties, 141 still in effect at the end of 1999 )

Research Design Model & method Two different kinds of buyout events Method: maximum likelihood using STATA Two different kinds of buyout events 1st dependent variable: hazard rate of acquiring a majority stake (“1”  ≥50%) 2nd dependent variable: hazard rate of acquiring an additional stake (“1”  any purchases of equity after the initial ownership level) λ 𝑡 = lim 𝑞 𝑡,𝑡+∆𝑡 ,∆𝑡→0 λ 𝑡 =exp⁡( 𝛼 ′ 𝑋 𝑡 ) q: discrete probability of an event between t and 𝑡+∆t λ 𝑡 : an exponential function of independent variables 𝑋 𝑡 : a vector of parameters capturing the effects of the variables on the rate of subsequent equity investment

Variable measurement Firm value Uncertainty Proprietary Difference in the number of public offerings since the initiation of the equity partnership Uncertainty 26-week standard deviation of weekly returns for each of the four biotechnology subfield indices Proprietary Number of equity partners: the log of he number of established firms with equity partnership outstanding in the target firm in the previous months Number of rivals: total number of firms having stated their involvement in any of Bioscan’s 123 biotechnology product areas Control variables License (1,0) Option (1,0) The number of commercial alliances The number of private equity placements The number of biotechnology sectors Firm age Alliance experience of the established firm

Empirical Results Contl() H2 H4 H6 is not supported H3 H5

Empirical Results H1 and H3 are supported using the subfield value valuation measure, but not using the number of public offerings valuation measure low uncertainty Sample mean High uncertainty

Empirical Results The likelihood of partial buyouts decreases steeply for low uncertainty, but the rate of acquiring additional equity increases for high uncertainty  H4 High uncertainty Sample mean low uncertainty

Conclusion Conceptual level Empirical study Although delaying commitment is optimal for financial options, there may be opportunity costs to waiting to exercise real options – firms may forgo cash flows or opportunities to learn, or they may be preempted by rivals Nonproprietary  strong incentive to exercise an option, particularly as the underlying growth option becomes more valuable Empirical study Partner buyouts are more likely with lower uncertainty Firm valuation(reflected in subfield value) has a strong positive effect on the decision to bur more equity in the partner, and even stronger in the present of low uncertainty More proprietary + low uncertainty more likely to exercise a buyout option More shared Buyout options + high uncertainty  quicker buyout decision Moderating role of uncertainty in preemptive buyout decisions: firms appear to move quickly to capture the value associated with nonproprietary options as uncertainty increases

Discussion In the empirical explanation part, the paper used subfield value to represent for the firm value, which is different from the previous statement of measurement, but the empirical result shows that by using the number of public offerings * uncertainty has statistical significance, so I would like to see the authors offer more information about the result and the measurement change.