Strategic Investment - Real Options and Games

by Smit, Han T. J.; Trigeorgis, Lenos

ISBN13: 9781400829392

ISBN10: 1400829399

Pub. Date: 2008-06-01

Publisher(s): Princeton Univ Pr

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Summary

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.

List of Figures	p. xi
List of Tables	p. xvii
List of Boxes	p. xix
Acknowledgments	p. xxi
Introduction: Strategic Investment as Real Options and Games	p. xxiii
Introduction: About This Book	p. xxiii
Real Options and Games: Linking Corporate Finance and Strategy	p. xxiv
An Overview of the Book	p. xxviii
Approaches to Strategic Investment
Corporate Finance and Strategic Planning: A Linkage	p. 3
Introduction	p. 3
The Market Value of Growth Opportunities	p. 5
From NPV to an Expanded (Strategic) NPV Criterion	p. 8
Value Drivers of NPV, Flexibility Value, and Strategic Value	p. 13
Value Drivers of NPV	p. 14
Drivers of Flexibility or Growth Option Value	p. 21
Drivers of Strategic Value and Strategic Moves	p. 24
Value Creation in Strategic Planning	p. 32
Conclusions	p. 33
Strategic Management: Competitive Advantage and Value Creation	p. 35
Introduction	p. 35
Views of Value Creation of the Firm	p. 38
Industry and Competitive Analysis	p. 40
Strategic Conflict and Game Theory	p. 43
Internal, Resource-Based View of the Firm	p. 45
Dynamic Capabilities	p. 49
Options and Games: A Linkage Approach	p. 51
Competitive Advantage and Industry Evolution	p. 53
Competitive Advantage in the Early and Growth Stages	p. 54
Competitive Advantage in Mature Businesses	p. 58
Creative Destruction and Adaptation as Source of Advantage	p. 60
Portfolio Planning of Growth Opportunities	p. 68
Boston Consulting Group Matrix	p. 70
Exercise Timing of Options: The Tomato Garden Analogy	p. 72
Real-Options Growth Matrix	p. 76
Conclusions	p. 90
Corporate Real Options	p. 93
Introduction	p. 93
Options Valuation	p. 94
Basic Nature of Options	p. 98
From Financial to Real Options Valuation	p. 100
Overview of Common Real Options	p. 106
The (Simple) Option to Defer	p. 110
Options to Expand or Contract	p. 114
The Option to Abandon for Salvage or Switch Use	p. 116
The Option to Temporarily Shut Down	p. 119
Options to Switch Inputs or Outputs	p. 122
Prototype Examples: Valuing an R & D Program and a Mining Concession	p. 123
Valuing a Research and Development Program	p. 124
Valuing a Mine Concession (License) Using Certainty-Equivalent Valuation	p. 127
An In-Depth Case Application: Valuing Offshore Oil Concessions in the Netherlands	p. 134
Stages of Offshore Petroleum Development on the Dutch Continental Shelf	p. 134
Valuation Based on Replication in Financial Markets	p. 138
Main Insights	p. 149
Summary and Conclusions	p. 154
Binomial Option Valuation	p. 156
Games and Strategic Decisions	p. 163
Introduction	p. 163
The Rules of the Game	p. 171
A Taxonomy of Basic Games	p. 181
Time to Launch under Competition (Symmetric Innovation Race)	p. 184
Asymmetric Innovation Race and Preemption	p. 186
Simultaneous Innovation Race When the Opponent's Capabilities Are Unknown	p. 189
Competitive Reactions in Quantity versus Price Competition	p. 191
Quantity Competition	p. 191
Price Competition	p. 198
Type of Competitive Reaction: Strategic Substitutes versus Complements	p. 200
Two-Stage Games: Strategic Value of Early Commitment	p. 202
Direct versus Strategic Effects of Investment Commitment	p. 203
Strategic Effect, Tough or Accommodating Positions, and Type of Competition	p. 205
Summary and Conclusions	p. 208
A Chronology of Game Theory Developments	p. 210
Competitive Strategy and Games Chapter	p. 5
Simple Strategic Investment Games	p. 217
Introduction	p. 217
A Road Map for Analyzing Competitive Strategies	p. 218
One-Stage Strategic Investments	p. 222
Two-Stage (Compound) Options: The Case of Proprietary R & D	p. 226
Two-Stage Investments with Endogenous Competition	p. 229
Competition in Last (Production) Stage: Contrarian versus Reciprocating Competition	p. 229
Competition in Innovation Investment: Time-to-Market Races and Strategic Alliances	p. 242
Cooperation in the First Stage: Joint R & D Ventures	p. 247
Summary and Conclusions	p. 251
Flexibility and Commitment	p. 255
Introduction	p. 255
The Basic Two-Stage Game	p. 258
Equilibrium Quantities, Prices, and Payoff Values	p. 260
Valuation of Competitive Strategies	p. 262
Numerical Examples of Different Competitive Strategies under Contrarian versus Reciprocating Competition	p. 268
Competitive R & D Strategies under Quantity Competition	p. 268
Goodwill/Advertising Strategies under Price Competition	p. 278
Summary and Conclusions	p. 285
Reaction Functions, Equilibrium Actions, and Values in Different Market Structures under Quantity or Price Competition	p. 289
Value Dynamics in Competitive R & D Strategies	p. 295
Introduction	p. 295
Literature on R & D Options	p. 296
The Basic Two-Stage R & D Game	p. 298
Critical Demand Zones/Sensitivity	p. 300
Technical R & D Uncertainty, Stochastic Reaction Functions, and Asymmetric Information with Signaling	p. 309
Technical R & D Uncertainty (under Symmetric Information)	p. 309
Imperfect/Asymmetric Information and Stochastic Reaction Functions	p. 311
Signaling Effects	p. 313
Learning Experience Cost Effects	p. 315
Competition versus Cooperation in R & D	p. 319
Summary and Conclusions	p. 322
Applications and Implications Chapter	p. 8
Case Applications	p. 329
Introduction	p. 329
Strategic Games in Consumer Electronics	p. 346
Winner Takes All versus Strategic Alliances in the Launch of Video Recorder Systems	p. 346
The Competition versus Coordination Game of the High-Density Disk	p. 350
Buy-and-Build Platform Acquisition Strategies	p. 352
Classifying Acquisitions Based on Options and Games	p. 353
Growth Option Value in a Buy-and-Build Strategy	p. 356
Competition in a Buy-and-Build Strategy	p. 360
Infrastructure Investment: The Case of European Airport Expansion	p. 366
Infrastructure Investment and Aviation Developments	p. 367
Infrastructure Valuation as an Options Game	p. 370
Implementation in the Case of Schiphol Airport	p. 382
Conclusions and Implications	p. 389
Continuous-Time Models and Applications	p. 393
Introduction and Overview	p. 393
Continuous-Time Version of Smit-Trigeorgis Framework	p. 396
Equilibrium Output and Values	p. 397
Strategic Entry Decisions	p. 401
Equilibrium Entry and Critical Demand Thresholds	p. 405
Benchmark Cases: Symmetric Competition and Monopoly	p. 408
Strategic Investment Timing under Uncertainty	p. 408
Strategic Interactions and the Timing of Investment	p. 408
Innovation with Uncertainty over Completion and Time Delays	p. 411
Exercise Strategies under Incomplete Information with Applications	p. 414
Entry and Preemption under Incomplete Information	p. 414
Applications	p. 416
General Equilibrium Investment Strategies under Imperfect Competition and Asymmetric Information	p. 419
Equilibrium Investment Strategies under Imperfect Competition	p. 419
Investment Strategies under Asymmetric Information	p. 421
Conclusions	p. 423
Derivation of Option-Pricing Differential Equation	p. 425
Discounted Profit Flow and Value Function	p. 427
Sequential Stackelberg Leader-Follower Entry	p. 428
Overview and Implications	p. 429
Introduction	p. 429
Linking Corporate Finance and Strategic Planning	p. 429
An Expanded Valuation Framework to Capture Flexibility and Strategic Value	p. 431
Implications of the Strategic Options and Games Framework	p. 439
Timing Games for Simple Commercial Options	p. 440
Investment Games Involving Strategic Options	p. 442
Empirical Implications	p. 445
References	p. 447
Index	p. 461
Table of Contents provided by Publisher. All Rights Reserved.