Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acquisition Tony W. Tong & Yong Li (2011) Organization Scienc, 22(3): Jae Kyun Yoo BADM 549: Strategy Research Seminar (Fall 2014)

Authors Tong, T. W., & Li, Y Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acquisition, Organization Science, 22(3): Associate Professor (Leeds School of Business, University of Colorado) Ph.D. from Fisher College of Business (Ohio State University) M.A. from Fisher College of Business (Ohio State University) M.Sc. From NUS Business School B.A. from Shanghai Institute of Foreign Trade Yong Li Tony W. Tong Associate Professor (University at Buffalo, SUNY) Ph.D. from University of Illinois at Urbana- Champaign M.B.A. from University of Queensland

Introduction Tong, T. W., & Li, Y Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acquisition, Organization Science, 22(3):  Research on examining firms’ CVC investments in comparison with acquisitions has been much less worked on compared to independent studies of each.  The paper aims to fill this gap by empirically comparing CVC and acquisition as two investment modes and by investigating when firms prefer to undertake CVC investments versus acquisitions.  The paper draws from real options theory to develop hypotheses on the determinants of the choice between CVC and acquisition.

A Real Options View of CVC Investments and Acquisitions These differences suggest that CVC investments are embedded with greater real options and offer more flexibility than acquisitions. Tong, T. W., & Li, Y Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acquisition, Organization Science, 22(3): CVC InvestmentAcquisition ExpandThe right but not the obligation to make a subsequent investment. Typically one-time deals and provide few sequential investment possibilities. AbandonOption to liquidate its investment. Difficult to divest a company. DeferOption to defer making any definitive decision concerning whether to expand or abandon. Represent high commitment and provide little deferral option.

Uncertainty and the Choice Between CVC and Acquisition Hypothesis 1 (H1). The greater the level of uncertainty, the more CVC is preferred over acquisition.  Uncertainty creates a disincentive for firms to make one-time and hard-to-reverse commitment that is often required in acquisitions.  By contrast, the various real options obtained from initial CVC investments will become more valuable under conditions of uncertainty. Tong, T. W., & Li, Y Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acquisition, Organization Science, 22(3):

The Contingent Effects of Uncertainty Hypothesis 2 (H2). The greater the level of irreversibility, the stronger the positive relationship between uncertainty and the preference for CVC over acquisition.  Irreversible Investments: Resale Value < Cost  Irreversibility ↑  Resale Value ↓  Sensitive to Uncertainty  Value of Option ↑ Tong, T. W., & Li, Y Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acquisition, Organization Science, 22(3):

The Contingent Effects of Uncertainty (cont.) Hypothesis 3 (H3). The greater the level of growth opportunities, the weaker the positive relationship between uncertainty and the preference for CVC over acquisition.  Delaying or staging investments in the presence of growth opportunities may incur opportunity costs of waiting.  Whereas CVC investments allow the firm to defer commitments and adopt a wait-and-see strategy, acquisitions enable the firm to commit resources in a speedy way to capitalize on the growth opportunities. Tong, T. W., & Li, Y Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acquisition, Organization Science, 22(3):

The Contingent Effects of Uncertainty (cont.) Hypothesis 4 (H4). The greater the level of competition, the weaker the positive relationship between uncertainty and the preference for CVC over acquisition.  To the extent that growth opportunities are shared, speedy investments can help the firm avoid missing out the opportunities, and timely commitment can also gain the firm strategic advantages. Tong, T. W., & Li, Y Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acquisition, Organization Science, 22(3):

Data  Sample Public firms between CVC: First-round CVC investments. Acquisition: Acquisition of private targets. Acquisitions started as CVC (exercise vs purchase).  Variables Dependent Variable: CVC vs. Acquisition Explanatory Variables:  Exogenous uncertainty (volatility of industry stock market indices)  Irreversibility (asset intangibility)  Growth Opportunities (market-to-book ratio)  Level of Competition (One-minus-industry concentration ratio) Control Variables: size, R&D intensity, profitability, firm’s experience in CVC vs. acquisition, industry profitability, industry R&D intensity, IP regime, interindustry investment, different state, investee age, investee size, two year dummy variables Tong, T. W., & Li, Y Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acquisition, Organization Science, 22(3):

Results Tong, T. W., & Li, Y Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acquisition, Organization Science, 22(3): Hypothesis 1 supported Hypothesis 2 supported Hypothesis 3 supported Hypothesis 4 not supported

Conclusions Tong, T. W., & Li, Y Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acquisition, Organization Science, 22(3):  When an investment is surrounded by high levels of market uncertainty, maintaining flexibility becomes more important, and firms attach greater value to the real options embedded in initial CVC investments vis-à-vis acquisition.  The findings show that investment irreversibility will further increase firms’ propensity toward CVC, whereas growth opportunities facing the investment will weaken the preference for CVC under uncertainty.

Future Research Tong, T. W., & Li, Y Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acquisition, Organization Science, 22(3):  Consider other activities, such as alliances and joint ventures, which can also be used to further firms’ external corporate development initiatives.  Investigate investment mode choice from the perspectives of both the investor and the investee.  Extend our focus on option creation at the initial investment stage to option implementation at the postinvestment stage.