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

2. 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)

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

4. 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

5. 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

6. 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)

7. 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

8. 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

9. 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?