Tony W. Tong, Yong Li Presenter: Wen ZHENG

 Tony W. Tong is an assistant professor of management of the Leeds School of Business at the University of Colorado. He received his Ph.D. from The Ohio State University. His current research applies real options theory to study firms’ corporate development activities such as alliances, acquisitions, and corporate venture capital.  Yong Li is an assistant professor of the School of Management at the State University of New York at Buffalo. He received his Ph.D. from the University of Illinois at Urbana–Champaign. His current research applies real options theory to study investment under uncertainty and venture capital.

Contents Discussion Empirical Theory and Hypothesis Introduction

The paper draws from real options theory to compare CVC and acquisition empirically Introduction Theory Empirical Discussion

The paper draws from real options theory to compare CVC and acquisition empirically  Investment modes that are important tools that firms can employ to further their external business development and corporate growth initiatives. Introduction Theory Empirical Discussion

The paper draws from real options theory to compare CVC and acquisition empirically  CVC is the investment of corporate funds directly in external start-up companies.  It involves an investing firm taking a minority equity stake in a private entrepreneurial company (Gompers and Lerner, 1998). Introduction Theory Empirical Discussion

Introduction Theory Empirical Discussion CVCAcquisition Expand Flexible to make sequence investment One-time deal and few sequential investment possibility Abandon Flexible to liquidate its investment Difficult to divest a company Defer Flexible to defer deciding to expand or abandon High commitment and little deferral option Option Mode Real options become more salient in CVC investments compared to acquisitions under conditions of uncertainty

 Hypothesis 1 (H1). The greater the level of uncertainty, the more CVC is preferred over time.  An increase in the exogenous uncertainty enhance the value of all types of real options.  Option to expand and abandon  adjust and reverse active  reduce downside risk and capture upside should the environment develop favorably.  Option to defer  Limit exposure to market uncertainty Introduction Theory Empirical Discussion

Irreversibility Growth Opportunity Competition Positive relationship between uncertainty and preference for CVC over acquisition Introduction Theory Empirical Discussion

 Hypothesis 2 (H2). The greater the level of irreversibility, the stronger the positive relationship between uncertainty and the preference for CVC over acquisition.  Irreversible: resale value < cost  Irreversible  resale value  sensitive to uncertainty  Value of Option  Acquisition is harder to reverse than CVC Introduction Theory Empirical Discussion

 Hypothesis 3 (H3). The greater the level of growth opportunities, the weaker the positive relationship between uncertainty and the preference for CVC over acquisition  Growth opportunity  Opportunity cost of waiting  Indecision  loss of profit streams in the present or future periods  Downside loss can be less valuable when there is significant upside potential Introduction Theory Empirical Discussion

 Hypothesis 4 (H4). The greater the level of competition, the weaker the positive relationship between uncertainty and the preference for CVC over acquisition  Extent that growth opportunities shared  Strategic value of commitment  Competitive investment  Strategic value of commitment >flexibility value of deferring  CVC provides flexibility to defer, while acquisitions signal commitment to potential rivals. Introduction Theory Empirical Discussion

Sample: Public firms (Compustat) Year: – Coverage of private acquisitions would become more accurate and extensive since 2003 CVC: First-round CVC investments – Valuable real options – On a similar footing with acquisitions Acquisition: Acquisition of private targets Acquisition started as CVC – Exercise of the options that are embedded in the initial CVC investment Introduction Theory Empirical Discussion

Introduction Theory Empirical Discussion  Dependent Variable  CVC vs. Acquisition  1 if investment is structured as CVC investment, 0 if structured as an 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

Introduction Theory Empirical Discussion  Control Variables (Investment Firms)  Size  Nature log of the firm’s total assets in million dollars.  R&D intensity  R&D expenditure as a percentage of sales.  Profitability  Return on sales: income before extraordinary items as a percentage to sales  Firm’s experience in CVC versus acquisition  Logged the ratio of one plus the number of CVC investments to one plus the number of CVC acquisition.

Introduction Theory Empirical Discussion  Control Variables (Investee’s industry)  Industry profitability  Sum of the income before extraordinary items for all of the firms in the industry in which the investee resides as a percentage of industry sales  Industry R&D intensity  information asymmetry  The amount of R&D expenditures for all of the business in the industry as a percentage of industry sales  IP regime  Carnegie Mellon Survey of Research and Development

Introduction Theory Empirical Discussion  Control Variables (Investor investee dynamic level)  Inter-industry investment  1 when the investor and the investee operate in two different three-digit SIC industries, and 0 otherwise.  Different State  geographic location  1 when the investor and the investee are located in two different state, 0 otherwise.  Control Variables (Investee characteristics)  Investee age  Take log of subtract value between the founding year from the current year  Investee size  Take the log of the number of employees.

Introduction Theory Empirical Discussion  Two Stage Probit model  First Stage  Sample selection model  Distinguish firms that undertook CVC investments or acquisitions from firms that undertook neither investment P( Undertake CVC or acquisition)= f ( size, profitability, R&D intensity, capital intensity, financial leverage)  Second Stage  The choice of CVC versus acquisition P(Undertake CVC)= f ( Uncertainty, Uncertainty* irreversibility, Uncertainty*Growth opportunities, Uncertainty* competition, Control Variable)

 Descriptive Statistics and Correlation Matrix Introduction Theory Empirical Discussion

 Heckman Regression Results Introduction Theory Empirical Discussion H1

 Heckman Regression Results Introduction Theory Empirical Discussion H2

 Heckman Regression Results Introduction Theory Empirical Discussion H3

 Heckman Regression Results Introduction Theory Empirical Discussion H4

 Heckman Regression Results Introduction Theory Empirical Discussion

 Heckman Regression Results Introduction Theory Empirical Discussion

 Heckman Regression Results Introduction Theory Empirical Discussion

 Heckman Regression Results Introduction Theory Empirical Discussion

 Heckman Regression Results Introduction Theory Empirical Discussion

 Heckman Regression Results Introduction Theory Empirical Discussion

 Results including investee age and investee size Introduction Theory Empirical Discussion

 Robustness check  Another measure of uncertainty  Regress industry sales over five years against time and then used the standard error of the regression coefficient divided by the mean of industry sales to develop a standardized proxy of uncertainty for each industry and year.  Another measure of irreversibility  Industry inverse leverage  Explore the sensitivity of the findings to alternative models  Technological innovation  Companies outside of the high-tech realm  Minority acquisition Introduction Theory Empirical Discussion

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 embed in initial CVC investments vis-à-vis acquisition. The value of real options under uncertainty is contingent upon several factors that may either increase or decrease such value and therefore my shape firms’ choice between CVC and acquisition. (Irreversibility and Growth opportunity) Introduction Theory Empirical Discussion

Focus on only two investment mode  Other investment mode like alliance, joint ventures Take the investing firm’s perspective to examine investment mode choice  From the perspective of both the investor and the investee Focus on creation of option  Option creation + option implementation Introduction Theory Empirical Discussion