1. Real Options and Investment Mode: Evidence from
Corporate Venture Capital and Acquisition
BA549A Session 7: Real Options
Tony W. Tong
Yong Li
Organization Science (2011)
presented by Eunkwang Seo

2. AGENDA Phenomenon to Study Corporate Venture Capital (CVC)
Recently, corporate venture capital has emerged as an important means for achieving growth and expansion.
CVS involves an investing firm taking a minority equity stake in a private entrepreneurial company.

3. AGENDA Research Question
Q. Why and when do firms choose CVC investments over acquisitions?
CVC investments and acquisitions can be viewed as alternative governance modes for external business development activities (Schildt et al., 2005; Keil et al., 2008).
The determinants to the choice between CVC and acquisition have not been examined yet, as compared to the choice between acquisition and alliances.
The purpose of this study is to explore the determinants in the view of real option theory.

4. Real Option View of CVC and Acquisition
THEORY & HYPOTHESES
Real Option View of CVC and Acquisition
CVC investments as real options
The option to grow: The CVC firm has the right but not the obligation to make a subsequent investment and increase the level of resource commitment.
The option to abandon: The CVC firm also has the right to liquidate its investment.
The option to defer: The CVC firm can defer making any definite decision concerning whether to expand or abandon.
Acquisitions are typically one-time deals and provide few sequential investment possibilities.
Although acquisitions can offer an abandonment option, the option is difficult and less likely to exercise.

5. Uncertainty and Choice between CVC and acquisition
THEORY & HYPOTHESES
Uncertainty and Choice between CVC and acquisition
Uncertainty favors Flexibility
In the presence of the options to grow, abandon, and defer, a CVC investment not only helps the firm to reduce downside risk but also position the firm to capitalize on the upside potential when the environment develops favorably.
Compared to CVC investments, acquisitions give the firm less flexibility to adjust or reverse its actions.
Therefore, under exogenous market uncertainty, firms will prefer CVC over acquisition.
Hypothesis 1. The greater the level of uncertainty, the more CVC is preferred over acquisition.

6. Contingent Effects of Uncertainty
THEORY & HYPOTHESES
Contingent Effects of Uncertainty
Irreversibility
Investments are irreversible when their resale value is less than their costs.
As irreversibility increases, the resale value decreases, and investment decision will become more sensitive to conditions of uncertainty (Dixit, 1989; Pindyck, 1991).
Thus, when an investment project involves high levels of irreversibility, the impact of uncertainty on the choice is strengthened.
Hypothesis 2. The greater the level of irreversibility, the stronger the positive relationship between uncertainty and the preference for CVC over acquisition.

7. Contingent Effects of Uncertainty
THEORY & HYPOTHESES
Contingent Effects of Uncertainty
Growth opportunities and competition
Delaying or staging investments may incur opportunity costs of waiting.
The value of real options is partially offset by growth opportunities and level of competition.
In these cases, speedy and timely commitments through acquisitions can provide strategic advantages.
Hypothesis 3. The greater the level of growth opportunities, the weaker the positive relationship between uncertainty and the preference for CVC over acquisition.
Hypothesis 4. The greater the level of competition, the weaker the positive relationship between uncertainty and the preference for CVC over acquisition.

8. METHODS Sample CVC investments Acquisitions
Using Venture Economics’ VentureXpert database
Focusing on first-round investments
The CVC sub-sample includes 546 investment deals by 99 investing firms during
Acquisitions
Using SDC database
Excluding buyouts, divestitures, restructuring, carveouts …
The sample includes 2,237 investment deals by 1,193 acquirers during
8 cases in which acquisitions are considered exercise of the options are excluded.
The acquisition sub-sample includes 2,229 M&A deals during the period.
Therefore, the final sample includes 2,775 investment deals.

9. RESULTS Measurement Dependent Variables Explanatory Variables
Binary choice variable: CVC vs. Acquisition
Heckman model to address potential sample selection bias: CVC or acquisitions vs. neither investment.
Explanatory Variables
Uncertainty: the volatility of industry stock market
Irreversibility: asset intangibility
Growth opportunities: the market-to-book ratio
Competition: one-minus-industry concentration ratio
Controls: various firm/industry-level controls.

10. RESULTS
H1 supported
H2 supported
H3 supported
H4 not supported

11. METHODS and CONCLUSION
Robustness Check
Alternative measures
Uncertainty: regression residuals of industry sales
Irreversibility: the industry inverse leverage, the liquidity index
Alternative models
Focusing on companies outside of high-tech realm
Multinomial regression with minority acquisitions
Conclusion
CVC investments as an alternative means for growth
CVC investments as a real option
Uncertainty is a key determinant to CVC investments over acquisition (flexibility).
Irreversibility and growth opportunities are boundary conditions.