Browsing by Subject "real options"

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  • Nordlund, Toni (2003)
    Venture capital is in general terms an outside investment to a start-up business that hasstrong gro~rth opportunities but no access to capital markets. We study the rationalvaluation of such investments by constructing a model where a venture project is in atraditional fashion implemented as a cooperation between two complementary parties. Theinvestor, or the venture capitalist, keeps the project running by supplying equity capital,while the entrepreneur collaborates by supplying unique human capital. The key factor in themodel is that the infusion of capital is staged, so that the venture capitalist in the capacity ofan inside investor exercises strategic discretion to periodically rescreen the current state ofthe project along with the future prospects. If the project turns out a failure, the venturecapitalist exits immediately with a zero scrap value. His primary objective is however to findthe optimal timing for an initial public offering (IPO), where the accumulated equity stake issold in the market. It follows that the rational valuation emerges as an optimal stoppingprob em, which is approached by means of real options. Drawing on the optimality principle of dynamic programming and the general stoppingtheory, the rational value and the optimal stopping rule are derived in detail. The concepts ofregularity and an excessive majorant are introduced as elemental building blocks in theanalysis. It is in fact shown that the rational value conforms to a specific smallest excessivemajorant that incorporates in a simple way the time-to-build element created by the stagingof capital infusion. As a novelty in the venture-financing literature, we also introduce theconcept of a near-optimal stopping rule in conjunction with the optimal rule. Near-optimalitysimply means that a rule may call for stopping even if the time-to-build element implicit in theventure project is larger in value than the gain obtainable by immediate stopping. Both theoptimal rule and near optimal rules are made use of to study some absorbing aspects ofventure financing. We for example establish the effect of entrepreneurial exit options on theoptimal stopping behaviour of the venture capitalist, and on the rational real-option value. Equipped with the optimal rule, the study lastly derives sufficient conditions under whichstopping, and an IPO in particular, is not optimal to the venture capitalist. The starting point for the study is provided by the following references.Shiryayev, A. N. (1978): Optimal Stopping Rules. Springer-Verlag. Harrison, J.M., and Kreps, D.M. (1979): Martingales and Arbitrage in Multip riod SecuritiesMarkets. Journal of Economic Theory, vol. 20, pp. 381-408. Trigeorgis, Lenos (1996): Real Options: Managerial Flexibility and Strategy in ResourceAllocation. The MIT Press.
  • Alvarez, Luis H. R.; Stenbacka, Rune (2003)
    1
    We apply a real options approach to develop a general characterization of the dynamics of the capital accumulation process in the presence of technological progress. In particular, we delineate circumstances under which the present technology represents a compound real option, which incorporates as valuable embedded options the opportunity of successive updating of the technology to superior future technologies with a stochastic pattern of arrival timings. We also show that part of the extended option value created by technological progress is channelled through expansions of the investment volumes, which are shifted towards earlier timings.
  • Alvarez, Luis H. R.; Stenbacka, Rune (2003)
    4
    We apply a real options approach to develop a general characterization of a firm’s optimal organizational mode. We find that the optimal exercise threshold for the establishment of (partial) in-house production is an increasing function of the underlying market uncertainty. However, contrary to common business wisdom, we show that increased market uncertainty induces a higher optimal proportion of in-house production once the investment threshold is reached and once this threshold prescribes partial in-house production.
  • Alvarez, Luis H. R.; Stenbacka, Rune (Hanken School of Economics, 2002)
    4
    We apply a real options approach to analytically characterize the option value of adopting an intermediate technology. We design an asymmetric duopoly model to delineate how the opti- mal adoption timing of an intermediate technology depends on the embedded upgrading options available to the ¯rm itself and to its future rival. Focusing on di®usions we develop explicit rep- resentations demonstrating that the threshold of adopting an intermediate technology depends negatively (positively) on the leader's (follower's) upgrading intensity. For geometric Brownian motion we explicitly characterize the iso-incentive curves keeping the leader's incentives of adopt- ing the intermediate technology invariant.
  • Alvarez, Luis H. R.; Stenbacka, Rune (Hanken School of Economics, 2004)
    5
    We design a compound real options model, which determines the timing of takeovers and characterizes the distribution of the associated surplus. We delineate a relationship between the imperfections in the market for corporate control and the takeover incentives. We character- ize a critical bargaining power below which the compound takeover option is never exercised. This critical threshold is a decreasing function of the expected primary takeover gain and the embedded divestment gain and an increasing function of the implementation uncertainty. With implementation uncertainty the relationship between volatility and takeover timing depends on the functional form of the pro¯t °ow.