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Real options theory analyzes the value of managerial flexibility to adapt and revise future decisions to capitalize on favorable future investment opportunities or to limit downside losses from adverse market developments, which is vital to long-term corporate success in an uncertain and changing marketplace. Managerial flexibility manifests in terms of a set of corporate real options on whether to defer or stage investment, expand or grow, contract, abandon and switch use, or otherwise alter a capital commitment. Real options theory brings the theory of financial options from the capital markets to the realm of corporate investment decisions and strategic decision making under conditions of uncertainty. Real options are seen as opportunities (without an obligation) to acquire (dispose or reposition) real assets on possibly favorable terms. These terms depend on adjustment (or switching) costs, imperfect competition or other imperfections in product or factor markets. But whereas in the case of financial options the investor has the right to acquire (or sell) a financial asset (e.g., shares of stock) as the underlying security, in real options the underlying is a “real” asset whose expected future cash flows are linked to new product development via investing in an R&D program or the exploitation of a patent, the construction and subsequent scale up of a manufacturing plant in the home country, new foreign market entry and the growth or shifting of foreign subsidiary operations within the network of a multinational company (MNC), and so forth. Real options theory has thus extended options thinking (and methods) from the financial markets, where options are based on tradable contracts with specified terms, to real assets, tangible or intangible. Tangible or physical real assets underlying real options might include R&D and patents; land or real estate; natural resources, such as oil, gas, or mineral reserves; manufacturing plants; and strategic acquisitions; intangibles include brand and reputation, unique business processes, flexible human capital, and knowledge developed in joint ventures or other cooperative agreements.

The field of international business is fundamentally concerned with the implications of managerial actions that affect multinational risk and performance outcomes. While portfolio diversification and real options theory are often used to describe the outcomes of multinational investment, existing work often confuses the actions and predictions proposed by these theories. This is concerning, as the two theories emphasize different causal mechanisms, managerial actions, and conceptions of risk and performance. Whereas portfolio theory argues that passive management affects symmetric outcomes, such as variance in returns by attaining a well-diversified portfolio, real options theory posits that managers actively shift subsidiary resources to affect asymmetric outcomes, such as upside potential or downside risk by monitoring and responding to environmental changes affecting the portfolio. This paper disentangles these two theories by focusing on unique predictions from real options theory – that geographic dispersion of MNE activities is associated with asymmetric outcomes, that this association is contingent on management being aware of real options logic, and that these effects are moderated by the degree of market uncertainty. Our findings confirm these predictions and suggest differences in the types of managerial strategies and actions required to effectively implement these distinct theories of the MNE.

Profiting from innovation typically involves a choice between commercializing a patented technology in the product market to exploit proprietary advantage (i.e., competition) or licensing the techn...

The last quarter century has witnessed substantial growth in applications of real options theory (ROT) to international business (IB) research. In this review, we explicate the core ROT concepts in the IB context and discuss the contributions of ROT-based research to three core IB issues: timing and scale of market entry or exit, entry mode and governance form, and the role of multinational networks. Based on our review, we propose a holistic ROT view of the multinational enterprise that synthesizes the insights of existing studies. Finally, to move the field forward, we highlight key questions and challenges in current ROT-based work, provide a more precise definition of exogenous and endogenous uncertainty, suggest empirical designs to test unique ROT predictions, and explore areas where ROT can be combined with other theoretical perspectives to better understand IB phenomena.

This study contributes to our understanding of what accruals capture and how they relate to the distribution of future returns. It examines the past and future growth components of accruals and shows that, whereas past growth is negatively associated with idiosyncratic skewness, future growth is positively associated with it. In addition, although both past and future growth are negatively associated with future returns, the association is more pronounced for past growth when volatility is lower, but for future growth when volatility is higher. The study also shows that the association between the future growth component and future returns reverses in the long run, whereas the association between past growth and future returns does not. This paper was accepted by Shivaram Rajgopal, accounting.

In marketing, significant attention has been devoted to the study of drivers and outcomes of strategic flexibility drawing on real options theory. However, research that quantifies the specific value of flexibility reflected in a bundle of strategic real options is lacking. To remedy this gap, we develop a real options-based framework that takes account of brand expansion and extension options to value brand equity and retailer growth strategies. We show how to value the bundle of strategic real options associated with a flexible marketing strategic vision and how to assess the growth strategies related to the corporate brand of an international retailer. We apply our method to estimating the brand equity of Starbucks both under growth and adversity conditions. The results reveal that our method can more reliably incorporate the growth potential of the brand under uncertainty conditions. Comparisons with other brand valuation approaches are discussed. Our study helps clarify the links among management’s strategic plans, brand-based marketing strategies and share price, and allows to better monitor the impact of retailer strategic choices on long-term brand equity value.

We examine the relation of active options market trading and the (in)efficiency of corporate investment in terms of deviation from optimal investment levels. Past research considers the volume of options trading as contributing to firms’ informational efficiency. Investment efficiency is partly driven by information asymmetries between firm managers and capital providers, aggravating moral hazard concerns. We test whether the enhancement in firms’ information environment associated with higher volume of options trading activity is positively related to optimizing investment at the firm level. Our results indicate that the volume of options trading by firms is positively and significantly associated with firm-level investment efficiency. This relation is associated with the enhancement in the firms’ information environment stemming from active options trading. Overall, our findings suggest that the managerial skills associated with active trading in derivatives markets also benefit firms’ investment decisions through enhancing the optimal allocation of firm resources and investment efficiency.

Purpose of the study : How to best structure an IP licensing agreement taking account of embedded optionalities and other terms negotiated between licensor and licensee via a case study involving a prototypical options-based business model (biotech industry). Methodology : Binomial lattice simulation. Findings : It shows how IP management practices would change depending on who pays for the development costs, controls the continuation/development or abandonment option and thereby appropriates most of the embedded option’s value. It presents alternative (iso-value) menu licensing term choices (different combinations of royalty vs. fixed upfront fee or milestone payments) that are fair and optimal in properly accounting for the optionality embedded in RD (b) consider licensor and licensee perspectives in negotiating the terms of the IP licensing agreement, providing guidelines on how to determine its optimal remuneration structure reflecting a fair sharing of project value and embedded optionality among the parties; (c) offer a tool for IP portfolio management that helps a licensor prioritize internal R&D projects accounting for managerial flexibility and optimal licensing design under uncertainty.

We present a pricing model of bank bailout insurance guarantees against tail risk and empirical evidence that provides a rational explanation why big bank equities “underperform” relative to small banks during normal times while they “overperform” during crises. A new measure accounting for left-tail risk protection against losses conditional on a crisis explains the “underperformance” of large banks during normal periods. Over the long-term spanning several economic cycles, bank assets are fairly priced regardless of size. Our empirical evidence supports our model’s predicted pattern of excess bank return reversals across economic cycles following Too-Big-To-Fail (TBTF) bailout policy in 1984.

Research summary: Among the most difficult firm strategic choices is the trade-off between making a long-term commitment or holding off on investment in the face of uncertainty. To operationalize strategic management theory under demand, technological and competitive uncertainty, we develop a Strategic Net Present Value (NPV) framework that integrates real options and game theory to quantify value components and interactions at the interface between NPV, real options, and strategic games. Our approach results in new propositions clarifying the way learning-experience conditions, technological uncertainty, and proprietary information interact to tilt the balance in the interplay between wait-and-see flexibility and strategic commitment. As such, Strategic NPV adds to our understanding of the conditions where NPV, real options, or strategic thinking are more relevant. Managerial summary: This study develops and elucidates implementation of a new valuation construct, “Strategic Net Present Value (NPV),” that integrates real options and game theory to more accurately portray strategic decisions underlying management theory. Among the most difficult firm strategic choices in capital intensive industries, such as energy, mining, chip manufacturing, and infrastructure development, is the trade-off between making a long-term commitment or holding off on investment in the face of demand, technological, and competitive uncertainties. The study provides new insights on the way various conditions, such as learning-experience effects, technological uncertainty, and proprietary information, interact to tilt the balance in the interplay between commitment and wait-and-see flexibility. As such, Strategic NPV adds to our understanding of when NPV, real options, or strategic thinking matter more critically for decision making. Copyright © 2017 John Wiley & Sons, Ltd.