Jyh-Bang Jou

Hedonic Models with Redevelopment Options Under Uncertainty

In the hedonic model, implicit market prices can be interpreted as the present values of rents per unit of each hedonic characteristic. But when rents rise, there may be substantial value associated with the option to redevelop to higher intensity per unit land value. In the presence of option value, we first demonstrate that hedonic linear regressions should include an additive nonnegative term for the value of the option. This term increases in the variance of the underlying stochastic process. If this term is omitted, then estimates of implicit market prices for desirable (undesirable) characteristics will be biased downward (upward). This prediction is supported by recent empirical studies. We further suggest that future empirical work can employ the nonlinear functional form derived from our theory.

Entry, financing, and bankruptcy decisions: The limited liability effect

Abstract A firm, which has a privileged right to undertake an irreversible investment project, simultaneously determines whether to exercise this project and also how many bonds to issue in the presence of demand uncertainty. The firm will not exercise the project until its net value from investing immediately equals its option value from delaying investment. The firm’s choice of debt levels balances the tax advantage of debt against a cost associated with the event of bankruptcy. The effects of uncertainty, asset specificity, and the costs to purchase capital later on a firm’s entry, financing, and bankruptcy decisions are examined and compared with those in the literature.

R&D investment decision and optimal subsidy

Publisher Summary A firm facing technological uncertainty must decide whether to purchase research and development (R&D) capital at each instant. R&D capital exhibits both irreversibility and externality through the learning-by-doing effect. The combination of irreversibility and uncertainty drives agents to be more prudent, that is the maxim better safe than sorry applies. This maxim is more important as uncertainty is greater, technology progresses at a lower pace, the externality is stronger, or a catastrophic event is less likely to occur. A firm ignoring the externality will both invest later and disinvest earlier than a social planner who internalizes the externality. An equal rate of investment tax credits should be given to both costlessly reversible investments and irreversible ones, and the same rate of taxation should be imposed on disinvestment. Asset characteristics such as irreversibility and uncertainty are irrelevant to the optimal tax incentives. It can be shown that asset durability is also unrelated to the optimal tax incentives if allows capital to be depreciating at a constant exponential rate. Nevertheless, it is common for a government to give more generous tax credits to either short-lived assets such as equipment than long-lived assets such as structures or high-technology industries that use capital assets with either a higher expected growth pace of technology or greater degree of technological uncertainty.

IRREVERSIBLE INVESTMENT DECISIONS UNDER UNCERTAINTY WITH TAX HOLIDAYS

This article investigates how a corporate tax holiday affects a firms incentive to invest when irreversibility interacts with uncertainty. The firm has a monopoly right to exercise a single, discrete, infinitely lived project. After exercising the project, at each instant, the firm receives one unit of output while incurring a fixed amount of operating and maintenance costs. The firm can temporarily and costlessly both shut down and resume its operation. A more generous tax incentive (i.e., a longer tax holiday or a lower corporate tax rate) will discourage a firms incentive to invest if the firms value from delaying investment is increased by more than its value of investing immediately. This is more likely to happen if capital assets either are shortlived or yield a return that is very volatile.

Irreversible Investment, Financing, and Bankruptcy Decisions in an Oligopoly

This paper examines a firms debt level, investment timing, and investment scale choices in a continuous-time model where the output price of a good that the firm produces depends on a stochastic demand-shift variable and the total industry supply of the good. Using the simple symmetric Cournot-Nash equilibrium assumption that all firms are identical and therefore follow the same financing and investment strategies, we show that competition decreases the output price and hence encourages a firm to wait for a higher demand level before it is profitable to invest. We also demonstrate how uncertainty, bankruptcy costs, and corporate taxation affect the firms financing and investment decisions.

Environment, Asset Characteristics, and Optimal Effluent Fees

This article investigates theissue of optimal effluent fees in a frameworkwhere waste emissions are abated by investingin capital of which the pay-off is uncertainand the cost is fully sunk. The stock of wasteemissions harms an individual firmsproduction, but the firm will underestimatethis external effect upon investing. Consequently, the firm will invest lesscapital, and thereby, pollute more than issocially desirable. The regulator, who can useeffluent fees to correct this, should imposelower effluent fees on irreversible investmentsthan on costlessly reversible ones whenuncertainty arises.

The agency problem, investment decision, and optimal financial structure

This article constructs a real options model in which a firm has a privileged right to exercise an irreversible investment project with a stochastic payoff. Supposing that the investment costs are fully sunk, a firm that exercises the investment option after debt is in place will then choose a better state to exercise this option as it issues more bonds. This debt-overhang phenomenon, however, benefits the firm since waiting is itself valuable. Accordingly, the firm will both exercise the investment option later and issue more bonds as compared with a firm that issues bonds upon exercising the investment option.

Corporate borrowing and growth option value: The limited liability effect

A firm issues bonds before undertaking a risky continuous investment project that is costly to later either expand or contract. The firm’s existing debt load causes it to install a smaller capacity because equity has limited liability. This lowers debt value, but such a cost should be borne by equityholders because debtholders will rationally anticipate equityholders’ future behavior. The firm’s choice of debt levels balances this agency cost against the tax shield benefit. As the firm incurs higher costs to later expand capacity, its growth option value becomes lower. The simulation results of this article are in line with Myers’ conjecture (1977), which states that a firm’s debt capacity is inversely related to its growth option value.

Buy to Scrape? The Hedonic Model with Redevelopment Options

In Rosen’s (1974) model, implicit market prices can be interpreted as the present values of rents per unit of each hedonic characteristic. But when rents rise, there may be substantial value associated with the option to redevelop the bundle of characteristics to higher intensity. In the presence of option value, hedonic regressions should include an additional non-negative term for the value of the option. If this option term is omitted, then estimates of implicit market prices for a positively valued characteristic will be biased downward. We use simulations to compare the standard hedonic regression to a nonlinear regression designed to produce consistent estimators of implicit prices and to estimate the value of the redevelopment option. The simulations show substantial downward bias even in the presence of small amounts of option value. Moreover, nonlinear estimation can do a good job of recovering the amount of option value and estimates of implicit market prices.

Optimal R&D investment tax credits under mean reversion return

Publisher Summary This chapter presents the mean-reverting process matters for research and development (R&D) investment decisions: no matter whether the external effect is internalized or not, as the speed of mean reversion increases, the incentive to invest is raised because the long-run variance of the technology-shift factor is dampened. The incentive to invest is raised because the long-run variance of the technology-shift factor is dampened. The return to R&D capital is driven by a technological factor that follows a mean-reverting process. R&D capital also exhibits both irreversibility and externality through the learning-by-doing effect. The optimal paths for R&D capital under both the decentralized and centralized economies are derived and then compared. It is found that an equal rate of investment tax credits should be given to both costlessly reversible investments and irreversible ones, and this common rate is unrelated to the parameters that characterize the mean-reverting process. When R&D capital exhibits externality, then market outcomes will be inefficient. The role of externality is to raise the optimal stock of R&D capital.