Strategic Investment - Real Options and Games

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Pub. Date: 2008-06-01
Publisher(s): Princeton Univ Pr
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Corporate finance and corporate strategy have long been seen as different sides of the same coin. Though both focus on the same broad problem, investment decision-making, the gap between the two sides--and between theory and practice--remains embarrassingly large. This book synthesizes cutting-edge developments in corporate finance and related fields--in particular, real options and game theory--to help bridge this gap. In clear, straightforward exposition and through numerous examples and applications from various industries, Han Smit and Lenos Trigeorgis set forth an extended valuation framework for competitive strategies. The book follows a problem-solving approach that synthesizes ideas from game theory, real options, and strategy. Thinking in terms of options-games can help managers address questions such as: When is it best to invest early to preempt competitive entry, and when to wait? Should a firm compete in R&D or adopt an accommodating stance? How does one value growth options or infrastructure investments? The authors provide a wide range of valuation examples, such as acquisition strategies, R&D investment in high-tech sectors, joint research ventures, product introductions in consumer electronics, infrastructure, and oil exploration investment. Representing a major step beyond standard real options or strategy analysis, and extending the power of real options and strategic thinking in a rigorous fashion, Strategic Investment will be an indispensable guide and resource for corporate managers, MBA students, and academics alike.

Table of Contents

List of Figuresp. xi
List of Tablesp. xvii
List of Boxesp. xix
Acknowledgmentsp. xxi
Introduction: Strategic Investment as Real Options and Gamesp. xxiii
Introduction: About This Bookp. xxiii
Real Options and Games: Linking Corporate Finance and Strategyp. xxiv
An Overview of the Bookp. xxviii
Approaches to Strategic Investment
Corporate Finance and Strategic Planning: A Linkagep. 3
Introductionp. 3
The Market Value of Growth Opportunitiesp. 5
From NPV to an Expanded (Strategic) NPV Criterionp. 8
Value Drivers of NPV, Flexibility Value, and Strategic Valuep. 13
Value Drivers of NPVp. 14
Drivers of Flexibility or Growth Option Valuep. 21
Drivers of Strategic Value and Strategic Movesp. 24
Value Creation in Strategic Planningp. 32
Conclusionsp. 33
Strategic Management: Competitive Advantage and Value Creationp. 35
Introductionp. 35
Views of Value Creation of the Firmp. 38
Industry and Competitive Analysisp. 40
Strategic Conflict and Game Theoryp. 43
Internal, Resource-Based View of the Firmp. 45
Dynamic Capabilitiesp. 49
Options and Games: A Linkage Approachp. 51
Competitive Advantage and Industry Evolutionp. 53
Competitive Advantage in the Early and Growth Stagesp. 54
Competitive Advantage in Mature Businessesp. 58
Creative Destruction and Adaptation as Source of Advantagep. 60
Portfolio Planning of Growth Opportunitiesp. 68
Boston Consulting Group Matrixp. 70
Exercise Timing of Options: The Tomato Garden Analogyp. 72
Real-Options Growth Matrixp. 76
Conclusionsp. 90
Corporate Real Optionsp. 93
Introductionp. 93
Options Valuationp. 94
Basic Nature of Optionsp. 98
From Financial to Real Options Valuationp. 100
Overview of Common Real Optionsp. 106
The (Simple) Option to Deferp. 110
Options to Expand or Contractp. 114
The Option to Abandon for Salvage or Switch Usep. 116
The Option to Temporarily Shut Downp. 119
Options to Switch Inputs or Outputsp. 122
Prototype Examples: Valuing an R & D Program and a Mining Concessionp. 123
Valuing a Research and Development Programp. 124
Valuing a Mine Concession (License) Using Certainty-Equivalent Valuationp. 127
An In-Depth Case Application: Valuing Offshore Oil Concessions in the Netherlandsp. 134
Stages of Offshore Petroleum Development on the Dutch Continental Shelfp. 134
Valuation Based on Replication in Financial Marketsp. 138
Main Insightsp. 149
Summary and Conclusionsp. 154
Binomial Option Valuationp. 156
Games and Strategic Decisionsp. 163
Introductionp. 163
The Rules of the Gamep. 171
A Taxonomy of Basic Gamesp. 181
Time to Launch under Competition (Symmetric Innovation Race)p. 184
Asymmetric Innovation Race and Preemptionp. 186
Simultaneous Innovation Race When the Opponent's Capabilities Are Unknownp. 189
Competitive Reactions in Quantity versus Price Competitionp. 191
Quantity Competitionp. 191
Price Competitionp. 198
Type of Competitive Reaction: Strategic Substitutes versus Complementsp. 200
Two-Stage Games: Strategic Value of Early Commitmentp. 202
Direct versus Strategic Effects of Investment Commitmentp. 203
Strategic Effect, Tough or Accommodating Positions, and Type of Competitionp. 205
Summary and Conclusionsp. 208
A Chronology of Game Theory Developmentsp. 210
Competitive Strategy and Games Chapterp. 5
Simple Strategic Investment Gamesp. 217
Introductionp. 217
A Road Map for Analyzing Competitive Strategiesp. 218
One-Stage Strategic Investmentsp. 222
Two-Stage (Compound) Options: The Case of Proprietary R & Dp. 226
Two-Stage Investments with Endogenous Competitionp. 229
Competition in Last (Production) Stage: Contrarian versus Reciprocating Competitionp. 229
Competition in Innovation Investment: Time-to-Market Races and Strategic Alliancesp. 242
Cooperation in the First Stage: Joint R & D Venturesp. 247
Summary and Conclusionsp. 251
Flexibility and Commitmentp. 255
Introductionp. 255
The Basic Two-Stage Gamep. 258
Equilibrium Quantities, Prices, and Payoff Valuesp. 260
Valuation of Competitive Strategiesp. 262
Numerical Examples of Different Competitive Strategies under Contrarian versus Reciprocating Competitionp. 268
Competitive R & D Strategies under Quantity Competitionp. 268
Goodwill/Advertising Strategies under Price Competitionp. 278
Summary and Conclusionsp. 285
Reaction Functions, Equilibrium Actions, and Values in Different Market Structures under Quantity or Price Competitionp. 289
Value Dynamics in Competitive R & D Strategiesp. 295
Introductionp. 295
Literature on R & D Optionsp. 296
The Basic Two-Stage R & D Gamep. 298
Critical Demand Zones/Sensitivityp. 300
Technical R & D Uncertainty, Stochastic Reaction Functions, and Asymmetric Information with Signalingp. 309
Technical R & D Uncertainty (under Symmetric Information)p. 309
Imperfect/Asymmetric Information and Stochastic Reaction Functionsp. 311
Signaling Effectsp. 313
Learning Experience Cost Effectsp. 315
Competition versus Cooperation in R & Dp. 319
Summary and Conclusionsp. 322
Applications and Implications Chapterp. 8
Case Applicationsp. 329
Introductionp. 329
Strategic Games in Consumer Electronicsp. 346
Winner Takes All versus Strategic Alliances in the Launch of Video Recorder Systemsp. 346
The Competition versus Coordination Game of the High-Density Diskp. 350
Buy-and-Build Platform Acquisition Strategiesp. 352
Classifying Acquisitions Based on Options and Gamesp. 353
Growth Option Value in a Buy-and-Build Strategyp. 356
Competition in a Buy-and-Build Strategyp. 360
Infrastructure Investment: The Case of European Airport Expansionp. 366
Infrastructure Investment and Aviation Developmentsp. 367
Infrastructure Valuation as an Options Gamep. 370
Implementation in the Case of Schiphol Airportp. 382
Conclusions and Implicationsp. 389
Continuous-Time Models and Applicationsp. 393
Introduction and Overviewp. 393
Continuous-Time Version of Smit-Trigeorgis Frameworkp. 396
Equilibrium Output and Valuesp. 397
Strategic Entry Decisionsp. 401
Equilibrium Entry and Critical Demand Thresholdsp. 405
Benchmark Cases: Symmetric Competition and Monopolyp. 408
Strategic Investment Timing under Uncertaintyp. 408
Strategic Interactions and the Timing of Investmentp. 408
Innovation with Uncertainty over Completion and Time Delaysp. 411
Exercise Strategies under Incomplete Information with Applicationsp. 414
Entry and Preemption under Incomplete Informationp. 414
Applicationsp. 416
General Equilibrium Investment Strategies under Imperfect Competition and Asymmetric Informationp. 419
Equilibrium Investment Strategies under Imperfect Competitionp. 419
Investment Strategies under Asymmetric Informationp. 421
Conclusionsp. 423
Derivation of Option-Pricing Differential Equationp. 425
Discounted Profit Flow and Value Functionp. 427
Sequential Stackelberg Leader-Follower Entryp. 428
Overview and Implicationsp. 429
Introductionp. 429
Linking Corporate Finance and Strategic Planningp. 429
An Expanded Valuation Framework to Capture Flexibility and Strategic Valuep. 431
Implications of the Strategic Options and Games Frameworkp. 439
Timing Games for Simple Commercial Optionsp. 440
Investment Games Involving Strategic Optionsp. 442
Empirical Implicationsp. 445
Referencesp. 447
Indexp. 461
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