1. Real options: Taking stock and looking ahead
Yong Li, Barclay James, Ravi Madhavan and Joseph Mahoney
Advances in Strategic Management (2007)
Presented by Daniela Pedraza Novak

2. Real Options Theory
Theoretical explanation for why firms may make investment decisions that differ from what the net present value (NPV) approach would prescribe
Growth, abandonment and switching options
Real Options
Rights but not obligations to take some action in the future
Create economic value by generating future decision rights
Confer managers flexibility when facing uncertainty
Useful in the absence of sufficient information

4. Taking Stock: Applications of Real Options Theory
Option to Wait-to-Invest
Options to Abandon and Switch
Growth Options
Interaction of Options

5. Option to Wait-to-Invest
Provides strategic flexibility to defer the investment until additional information is received with the passage of time
Option is more valuable with high exogenous uncertainty
Option to Abandon and Switch
“Put Option”
Gives firms the right to abandon an investment if market conditions get worse or switch when conditions are adverse
Value increases with the salvage value and future uncertainty

6. Interaction of Options
Growth Option
“Call Option”
Allows firms to make additional subsequent investments
Multi-stage projects
1st stage: create --- 2nd stage: exercise
Interaction of Options
“Project value”
The incremental value of each additional option is usually not equal to its economic value in isolation
Value is attenuated by “substitute” but enhanced by “complementary” options

7. Extension of Real Options Theory of Investment
Portfolio of Options
Firm decisions as bundles of real options
R&D as “creating real options”
Competition and investment
Competition complicates investment decisions
Anticipation of rivals’ investment matters
Endogenous uncertainty and learning
Reduced through strategic investments
May encourage firms to invest
Cost uncertainty  Technical (+) & Input cost (-)
Exit decisions and hysteresis
Delaying exit may be rational under uncertainty and irreversibility
Valuable when restarting costs are high (Sunk costs)

8. Organization and Governance
How should firms invest and organize activities?
Preferred investment modes under uncertainty:
Joint Venture (collaboration) > acquisition or internal development
Market-like mechanism > integration
In collaborative ventures
Option value of acquiring or selling the venture depends on:
Divergent economic valuations of the venture ex ante
Divergence of ex post valuations

9. Valuation and Performance Implications
Real options theory is fundamentally a theory of economic valuation
Takes the value of managerial flexibility into account
Economic value of a firm derives from assets in place growth options
Performance implications
Technological competence (holding patents) in uncertainty  higher market value
IJVs have positive impacts on growth option values
Multinationals have greater flexibility in shifting value chains, compared to domestic-only firms

10. Looking Ahead: The Future of Real Options

11. Areas of future research
Real Options, Learning and Heterogeneity
Different investment patterns
Real Options and Game Theory Integration
Real options are usually shared, and their economic value may be eroded by competition
Real Option Theory on Exit/Abandonment Decisions
Inaction (exit delay)
Uncertainty and irreversibility
Organizational Portfolio of Projects and Businesses
Firms often manage a portfolio of projects simultaneously or sequentially
Effects of Uncertainty
Ambiguity in the sources of uncertainty

12. Areas of future research
Options Theory as a complementary approach to Transaction Cost Theory
Contractual issues for uncertain investments
Costs of creating and exercising options
Flexibility
Too costly to obtain
Venture Capital and Entrepreneurship
Clarify mixed empirical results

13. Issues in Implementation and Questions
Finding an options pricing model whose assumptions match those of the project being analyzed
Determining the proper measures for the variables
Solving it mathematically
Promising questions
Who controls the decision rights to the option?
What changes in the firm’s processes are needed to manage real options?
What changes in the organization are needed to capture the option value?