1. REAL OPTIONS: TAKING STOCK AND LOOKING AHEAD
Li, James, Madhavan & Mahoney Advances in Strategic Management, 24, 31–66

2. Why real options?
Myers (1984) emphasizes that it is difficult for the traditional NPV or discounted cash flow (DCF) method to play a role in strategic planning because of the DCF’s inability to evaluate the time-series interactions between investments that involve high-growth, intangible assets.

3. Independent var.
Project level
Independent var.
Firm level
Dependent var.

4. Investment decisions

5. Common real options Option to wait-to-invest Option to abandon/switch
Flexibility, additional information
Decreased exogenous uncertainty
Option to abandon/switch
Remedy NPV rule
Irreversibility, value for alternative use(s)
Option to grow
1st : create options; 2nd: exercise options
Follow-on project

6. Extensions Portfolio of options Competition & investment
Similar projects are less likely to be picked
Marginal value of an option in a correlated project is sub-additive
Competition & investment
Depends on rival (game theory), preemption
Endogenous uncertainty & learning
While exogenous uncertainty postpones investment
Exit decisions & hysteresis
Zone of inaction, optical inertia in which firms maintain status quo
Keep informed

7. Nucor case Nucor net value: $340M A new steel plant: $280M+$30M
Real options
Purpose
Value
Option to wait
Learning
Low
Growth option
Follow-on projects
High
Option to abandon
High (irreversibility is low)
Source: Harvard case: Nucor at a Crossroads by Ghemawat & Stander

8. Research questions
Abandon option: on exit decisions and on the relationship between abandonment options and investment/ firm market value
Option to wait: Multiple sources of uncertainty
Competitive dynamics in option creation & exercise
Commitment vs. flexibility
Learning and firm heterogeneous resources
Interacting options, portfolio of real options
Substitute, complementary options
The presence of the abandonment option has the effect of truncating the downside of the distribution of future cash flows, and thereby reduces the economic value of the wait-to-invest options.

9. Organization & governance

10. Organization & governance
Choice of investment modes
Uncertainty: integration vs. market
Learning: collaboration vs. acquisition
Option rights in collaborative ventures
greater endogenous uncertainty also implies greater opportunities for learning through collaboration

11. Research questions
How asymmetric learning may provide opportunities for “trading” option rights
Cognitive, incentive and organizational issues in application of real option theory
Real option values differ for each firm

12. Valuation & performance

13. Valuation & performance
Performance implications
strategies that are consistent with real options theory may not always result in superior economic performance.

14. Research questions
Besides value creation, “costs” of option creation & exercise
Contingencies influence value creation