Han T. J. Smit

A real options and game-theoretic approach to corporate investment strategy under competition

textabstractPresents a real options and game-theoretic approach to corporate investment strategy under competition. Analysis of aspects of competition in a microeconomic framework; Forecasting of operating cash inflows based on economic rents or excess profits; Implications of results obtained.

Investment Analysis of Offshore Concessions in The Netherlands

An oil field concession in The Netherlands provides an opportunity to examine a stage-by-stage valuation of a complex capital project, including the actual implementation of option-pricing methodology to value the real options in a natural resource project.

Valuing Infrastructure Investment: An Option Games Approach

To understand the recent trend toward privatization of infrastructure assets (e.g., airports), this article proposes a valuation methodology based on real options and game theory analysis that enables assessing when investors might overpay for infrastructure assets over standard discounted cash flow methods and when a premium is justified for their operating flexibility or strategic growth option value. While some infrastructure asset acquisitions may involve financial transactions whose value derives primarily from their expected cash flows, many of these infrastructure investments provide a platform and create the strategic context within which the firm can grow.

Playing at Serial Acquisitions

Behavioral biases can result in suboptimal acquisition decisions—with the potential for errors exacerbated in consolidating industries, where consolidators design serial acquisition strategies and fight escalating takeover battles for platform companies that may determine their future competitive position. To guide objective managerial judgment, and to rationally anticipate the irrational behavior of rival bidders or financial markets, this article proposes a modified option-game toolkit for serial acquisition strategy. It brings together insights from both strategy and finance, which quantify acquisition strategies, thus allowing executives to make rational intuitive decisions under uncertainty.

Return distributions of strategic growth options

In this study, we develop implications of imperfect competition on the return distribution of strategic growth options. We integrate real option theory with a Cournot-Nash framework in which two firms choose output levels endogenously and may have investment-timing differences. Simulations show that traditional option variables are significant determinants for the moments of the return distribution. In addition, uncertain preemption may introduce discontinuities in the payoff of the option that increase skewness and kurtosis. When first-mover advantages are crucial and sustainable, investment-timing differences between competitors can result in bimodal return distributions, where the firm with the first-mover advantage has a high probability of generating high returns.

Playing at acquisitions: Behavioral option games

It is widely accepted that a large proportion of acquisition strategies fail to deliver the expected value. Globalizing markets characterized by growing uncertainty, together with the advent of new competitors, are further complicating the task of valuing acquisitions. Too often, managers rely on flawed valuation models or their intuition and experience when making risky investment decisions, exposing their companies to potentially costly pitfalls. Playing at Acquisitions provides managers with a powerful methodology for designing and executing successful acquisition strategies. The book tackles the myriad executive biases that infect decision making at every stage of the acquisition process, and the inadequacy of current valuation approaches to help mitigate these biases and more realistically represent value in uncertain environments. Bringing together the latest advances in behavioral finance, real option valuation, and game theory, this unique playbook explains how to express acquisition strategies as sets of real options, explicitly introducing uncertainty and future optionality into acquisition strategy design. It shows how to incorporate the competitive dynamics that exist in different acquisition contexts, acknowledge and even embrace uncertainty, identify the value of the real options embedded in targets, and more. Rooted in economic theory and featuring numerous real-world case studies, Playing at Acquisitions will enhance the ability of CEOs and their teams to derive value from their acquisition strategies, and is also an ideal resource for researchers and MBAs.

Real options and institutions

This article shows how growth options are affected by two types of external uncertainty: Transactional uncertainty that stems from institutional voids and increases transaction costs, and economic uncertainty that arises from the business environment. We theorize that these two types of uncertainty have opposing effects: A firm’s growth option value (proportional to firm value) is negatively associated with transactional uncertainty, but positively associated with economic uncertainty. In an empirical study, we directly compare firm-level growth option values across 34 countries and indeed find that economic uncertainty and various institutional measures for transactional uncertainty correlate in opposite directions with the value of growth opportunities. Interestingly, in countries with lower transactional uncertainty, the economic uncertainty in the business environment is more strongly related to proportional growth option value. The link between a country’s institutions and firms’ proportional growth options value is also moderated by firm size. The implication of our study is that institutions, such as property rights, business regulations, and contract enforcement are important preconditions for companies to appropriate growth option value under economic uncertainty. Our findings may help public policymakers in devising strategies for institutional development in their country, and corporate executives in assessing institutional factors when managing their company’s growth options.RésuméCet article montre comment les options de croissance sont influencées par deux formes d’incertitude externe : l’incertitude transactionnelle qui provient des vides institutionnels et qui accroît les coûts de transaction, et l’incertitude économique qui est liée à l’environnement des affaires. Nous supposons que ces deux formes d’incertitude produisent des effets opposés : la valeur des options de croissance d’une entreprise (proportionnelle à la valeur d’entreprise) est négativement associée à l’incertitude transactionnelle, mais elle est positivement associée à l’incertitude économique. Sur la base d’une étude empirique, nous comparons directement les valeurs des options de croissance au niveau de la firme dans 34 pays et nous trouvons en effet que l’incertitude économique et des mesures institutionnelles variées concernant l’incertitude transactionnelle sont corrélées de manière opposée à la valeur des opportunités de croissance. Il paraît intéressant de noter que dans les pays avec une incertitude transactionnelle plus faible, l’incertitude économique dans l’environnement d’affaires est plus fortement liée à la valeur proportionnelle des options de croissance. Le lien entre les institutions d’un pays et la valeur proportionnelle des options de croissance d’une entreprise est aussi modéré par la taille de la firme. Notre étude a pour implication que les institutions, comme les droits de propriété, les réglementations du milieu d’affaires et l’exécution des contrats, constituent des conditions préalables importantes pour les entreprises s’approprient la valeur des options de croissance face à l’incertitude économique. Nos résultats peuvent aider les responsables des politiques publiques à élaborer des stratégies pour le développement institutionnel de leur pays, et les dirigeants d’entreprises à évaluer les facteurs institutionnels lorsqu’ils gèrent les options de croissance de leur entreprise.ResumenEste artículo muestra como las opciones de crecimiento son afectadas por dos tipos de incertidumbre externa: La incertidumbre transaccional que proviene de vacíos institucionales y aumenta los costos de transacción, y la incertidumbre económica que surge del entorno del negocio. Teorizamos que estos dos tipos de incertidumbre tienen efectos opuestos: El valor de la opción de crecimiento de una empresa (proporcional al valor de una empresa) es asociado de manera negativa con la incertidumbre transaccional, pero asociado positivamente con la incertidumbre económica. En un estudio empírico, comparamos directamente los valores de las opciones de crecimiento a nivel de la empresa en 34 países y de hecho encontramos que la incertidumbre económica y varias medidas institucionales para la incertidumbre transaccional se correlacionan en una dirección opuesta con el valor de las oportunidades de crecimiento. Curiosamente, en países con baja incertidumbre transaccional, la incertidumbre económica en los entornos empresariales es relacionada de una forma más fuerte al valor de opción de crecimiento proporcional. El vínculo entre las instituciones de un país y el valor de las opciones de crecimiento proporcional es también moderado por el tamaño de la empresa. La implicación de nuestro estudio es que las instituciones, como los derechos de propiedad, las regulaciones empresariales, y la ejecución de los contratos son precondiciones importantes para que las empresas se apropien el valor de la opción de crecimiento bajo incertidumbre económica. Nuestros hallazgos pueden ayudar a formuladores de políticas públicas en concebir estrategias para el desarrollo institucional en sus países, y a los ejecutivos corporativos en evaluar factores institucionales cuando gestionan las opciones de crecimiento de la empresa.ResumoEste artigo mostra como as opções de crescimento são afetadas por dois tipos de incerteza externa: incerteza transacional que decorre de vazios institucionais e aumenta custos de transação e incerteza econômica que surge do ambiente de negócios. Nós teorizamos que esses dois tipos de incerteza têm efeitos opostos: o valor da opção de crescimento de uma empresa (proporcional ao valor da empresa) está negativamente associado com a incerteza transacional, mas positivamente associado à incerteza econômica. Em um estudo empírico, comparamos diretamente os valores de opções de crescimento no nível de empresa em 34 países, e constatamos que a incerteza econômica e várias medidas institucionais para incerteza transacional se correlacionam em direções opostas com o valor das oportunidades de crescimento. Curiosamente, em países com menor incerteza transacional, a incerteza econômica no ambiente de negócios está mais fortemente relacionada com o valor da opção de crescimento proporcional. A ligação entre as instituições de um país e o valor das opções de crescimento proporcional das empresas também é moderada pelo tamanho da empresa. A implicação do nosso estudo é que as instituições, tais como direitos de propriedade, regulações de negócios e observância de contratos, são pré-condições importantes para que as empresas se apropriem do valor da opção de crescimento sob incerteza econômica. Nossos resultados podem ajudar formuladores de políticas públicas na elaboração de estratégias para o desenvolvimento institucional em seu país e executivos de empresas na avaliação de fatores institucionais ao gerenciar as opções de crescimento de suas empresas.概要本文介绍了增长期权是如何受到两种类型的外部不确定性影响的:由制度空隙产生的并增加交易成本的交易不确定性,和源于商业环境而产生的经济不确定性。我们推论,这两种类型的不确定性有相反的作用:一个公司的增长期权价值(与公司价值成比例)与交易不确定性负相关,但与经济不确定性正相关。在一项实证研究中,我们直接比较在34个国家企业层面的增长期权价值并的确发现,经济不确定性及交易不确定性的各种制度措施与增长机会的价值反相关。有趣的是,在交易不确定性较低的国家,商业环境经济不确定性与比例增长期权价值更密切相关。一个国家的制度和公司的比例增长期权价值之间的联系受企业规模影响。我们研究的启示是: 制度,如产权、商业规则、合同的执行是公司在经济不确定性下获得增长期权价值的重要先决条件。我们的发现可能有助于公共政策制定者为其国家的制度发展,和为企业高管在管理其公司增长期权时评估体制因素制定战略。

Similar bidders in takeover contests

When bidders in a corporate takeover have related resources and post-acquisition strategies, their valuations of a target are likely to be interdependent. This paper analyzes sequential-entry takeover contests in which similar bidders have correlated private valuations. The level of similarity affects information content of bids and bidding competition. Our model predicts that expected acquisition prices and the probability of multiple-bidder contests are the highest for intermediately similar bidders. We test these predictions in laboratory experiments in which we control the similarity between bidders. The experimental data confirm the non-monotonic effects of similarity on prices and on the frequency of multiple-bidder contents

Toehold Acquisitions as Behavioral Real Options

Dealmakers tend to neglect uncertainty when making acquisition decisions, rushing into deals that eventually fail to deliver the anticipated synergies. Cause for this uncertainty neglect can be found in behavioral biases that cloud executive decision making. Acquirers should more often use minority stakes as a toehold to test full acquisitions and to guard themselves against the negative effects of uncertainty. An extended valuation toolkit that requires more managerial attention to uncertainty and behavioral pitfalls can help executives to better identify and value the benefits of minority stake strategies as an alternative to controlling acquisitions in uncertain situations.

Learning Effect in Toehold Acquisitions

Despite their claimed advantages, toehold strategies have rarely been adopted in recent corporate takeovers and do not seem to increase acquirer returns. Are toeholds ineffective and becoming obsolete? We show that this is not the case. We find that toeholds are preferred for executing difficult takeovers. After controlling for such endogeneity in toehold-based acquisitions, toeholds do increase returns to acquirers. Moreover, the performance of toehold strategies improves over time due to more selective and more effective acquisition of toeholds. We find that this time trend is in part explained by learning-by-doing from past toehold acquisitions.Despite their claimed advantages, toehold strategies are rarely used in recent corporate takeovers and do not seem to increase acquirer returns. Are toeholds becoming obsolete because of their apparent ineffectiveness? We show that the answer is no. We find that toeholds are preferred for executing difficult takeovers. After controlling for such endogeneity in toehold-based acquisitions, toeholds do increase returns to acquirers. Moreover, the performance of toehold strategies improves over time due to more selective and more effective acquisition of toeholds. We find that this time trend is in part explained by learning-by-doing. Acquirers learn from their previous toehold experience to be more selective with respect to the circumstances when to execute a toehold strategy and then choose a more effective toehold size.