Elmar Lukas

Earnouts in mergers and acquisitions: A game-theoretic option pricing approach

This paper presents a valuation approach for merger and acquisition (M&A) deals employing contingent earnouts. It is argued that these transactions have option-like features, and the paper uses a game-theoretic option approach to model the value of such claims. More specifically, the paper examines the impact of uncertainty on the optimal timing of M&A using earnouts, and it also investigates the impact of uncertainty on the terms of the earnout. Optimal earnout and initial payment combinations are endogenously derived from the model, and testable hypotheses are developed. The theoretical contribution of this paper is a dynamic decision-making model of the invest-to-learn option generated upon investment in an acquisition. The paper also offers practical implications for the design of acquisitions employing earnouts.

Timing and eco(nomic) efficiency of climate-friendly investments in supply chains

Emission trading schemes such as the European Union Emissions Trading System (EUETS) attempt to reconcile economic efficiency with ecological efficiency by creating financial incentives for companies to invest in climate-friendly innovations. Using real options methodology, we demonstrate that under uncertainty, economic and ecological efficiency continue to be mutually exclusive. This problem is even worse if a climate-friendly project depends on investing in of a whole supply chain. We model a sequential bargaining game in a supply chain where the parties negotiate over implementation of a carbon dioxide (CO2) saving investment project. We show that the outcome of their bargaining is not economically efficient and even less ecologically efficient. Furthermore, we show that a supply chain becomes less economically efficient and less ecologically efficient with every additional chain link. Finally, we make recommendations for how managers or politicians can improve the situation and thereby increase economic as well as ecological efficiency and thus also the eco-efficiency of supply chains.

Integrated Strategic Planning of Global Production Networks and Financial Hedging Under Uncertain Demands and Exchange Rates

In this paper, we present a multi-stage stochastic programming model that integrates financial hedging decisions into the planning of strategic production networks under uncertain exchange rates and product demands. This model considers the expenses of production plants and the revenues of markets in different currency areas. Financial portfolio planning decisions for two types of financial instruments, forward contracts and options, are represented explicitly by multi-period decision variables and a multi-stage scenario tree. Using an illustrative example, we analyze the impact of exchange-rate and demand volatility, the level of investment expenses and interest rate spreads on capacity location and dimensioning decisions. In particular, we show that, in the illustrative example, the exchange-rate uncertainty cannot be completely eliminated by financial hedging in the presence of demand uncertainty. In this situation, we find that the integrated model can result in better strategic planning decisions for a risk-averse decision maker compared to traditional modeling approaches.

Venture capital, staged financing and optimal funding policies under uncertainty

Our paper presents a dynamic model of entrepreneurial venture financing under uncertainty based on option exercise games between an entrepreneur and a venture capitalist (VC). In particular, we analyze the impact of multi-staged financing and both economic and technological uncertainty on optimal contracting in the context of VC-financing. Our novel approach combines compound option pricing with sequential non-cooperative contracting, allowing us to determine whether renegotiation will improve the probability of coming to an agreement and proceed with the venture. It is shown that both sources of uncertainty positively impact the VC-investors optimal equity share. Specifically, higher uncertainty leads to a larger stake in the venture, and renegotiation may result in a dramatic shift of control rights in the venture, preventing the venture from failure. Moreover, given ventures with low volatility, situations might occur where the VC-investor loses his first-mover advantage. Based on a comparative-static analysis, new testable hypotheses for further empirical studies are derived from the model.

Hedging mean-reverting commodities

This paper uses the expected utility framework to examine the optimal hedging decision for commodities with mean reverting price processes. The derived results show that when commodity prices follow a mean reverting process, the optimal hedge ratio differs significantly from the classical results found under standard geometric Brownian motion. Hence a failure to accommodate mean reversion when it exists can lead to systematic biases in hedging and investment decisions respectively.

Technological-induced information asymmetry, M&As and earnouts: stock market evidence from Germany

To date, a few empirical studies exist that investigate the use of earnout contracts in mergers and acquisitions (M&As). However, two limitations can be attested. First, the studies predominantly investigate earnouts in Anglo-American economies and it is questionable whether we can generalize on these findings for other economies. Second, while earnouts have become an increasingly popular way of coping with information asymmetries and reducing the risk of overpayment in takeovers, less is known about what really drives the design of such contracts. To answer these questions, we conduct an event study that examines abnormal returns for different M&A contracts for a cross-industry sample of German acquirers. The novel aspect of this article is that we explicitly present a theoretical model to discuss the effect of technological-induced information asymmetries on the design of earnout contracts. While we find support for the fact that capital markets favour the use of earnouts when uncertainty and the buyer’s ability to reduce technological-induced information asymmetry is high, a too-long earnout period specified in the contract appears to be detrimental.

When and how much to invest? Investment and capacity choice under product life cycle uncertainty

While empirical research indicates that innovations typically follow a product life cycle that is subject to uncertainty in many industries, endless cash flow growth is still at the heart of most papers guiding investment decisions under uncertainty. This paper studies the effect of an uncertain technological life cycle on the decision to invest in new product introduction, taking into account the combined effects of flexible investment timing and optimal capacity choice. Based on a numerical example referring to investment decisions in facilities for the production of electric vehicle batteries, we find that the optimal investment threshold follows an S-curve over the product life cycle and derive the optimal capacity choice for the given investment decision.

Small- and Medium-sized Enterprises (SMEs) in internationally operating R&D networks: recent findings and trends

Much research has been dedicated to R&D within cooperations and networks. However, little is known about the role of Small- and Medium-sized Enterprises (SMEs) in R&D networks in international settings. Although the relevance of SMEs as a source of innovation in international cooperations is generally confirmed in the literature, it is assumed that the inherent challenges SMEs have to cope with in such a setting are worth having a closer look at. Traditionally, SMEs are concerned with R&D processes, which are to a large extent defined by the conditions of locally operating partners. However, R&D which is conducted in an international setting is bound to have different requirements. Thus, it is regarded as very promising to examine how SMEs act at the interface of a local and global involvement. The paper seeks to identify the recent trends and challenges SMEs are confronted with in globally operating R&D networks.

MANAGING CREDIT RISK WITH CREDIT DERIVATIVES

Credit risk is one of the most important forms of risk faced by national and international banks as financial intermediaries. Managing this kind of risk through selecting and monitoring corporate and sovereign borrowers and through creating a diversified loan portfolio has always been one of the predominant challenges in bank management. The aim of our study is to examine how a risky loan portfolio affects optimal bank behavior in the loan and deposit markets, when derivatives to hedge credit risk are available. In a stochastic continuous-time framework a hedging model is developed where the bank management can use derivatives to hedge credit risk. Optimal loan, deposit and hedging strategies are then studied. It is shown that the magnitude and the direction of hedging are determined by the bank managers preferences, the corresponding risk premium and the variance of the loan rate and its hedging instrument respectively.

Sequential International Joint-Ventures and the Option to Choose

The purpose of this study is to formalize the optimal choice of market entry strategy for an individual multinational enterprise (MNE) from a dynamic perspective. It is argued that incorporating a suitable treatment of irreversibility, uncertainty and flexibility related to a MNEs investment decision gives further insights to the expansion, dissolvement, and optimal timing of international joint ventures (IJVs). The evolutionary process of the value of the foreign direct investment can be interpreted as a compound complex chooser option. The results suggest that uncertainty, size of equity share and future investment/divestment opportunities play an important role when it comes to transit from export to the first phase of the foreign direct investment commitment. The paper underscores the importance of modeling the dynamics of market entry and helps to refine the application of real options in the alliance context by providing a closed-form solution in continuous time to value