Nicos Koussis

Real R&D options with time-to-learn and learning-by-doing

We model R&D efforts to enhance the value of a product or technology before final development. Such efforts may be directed towards improving quality, adding new features, or adopting technological innovations. They are implemented as optional, costly and interacting control actions expected to enhance value but with uncertain outcome. We examine the interesting issues of the optimal timing of R&D, the impact of lags in the realization of the R&D outcome, and the choice between accelerated versus staged (sequential) R&D. These issues are also especially interesting since the history of decisions affects future decisions and the distributions of asset prices and induces path-dependency. We show that the existence of optional R&D efforts enhances the investment option value significantly. The impact of a dividend-like payout rate or of project volatility on optimal R&D decisions may be different with R&D timing flexibility than without. The attractiveness of sequential strategies is enhanced in the presence of learning-by-doing and decreasing marginal reversibility of capital effects.

A stochastic model with interacting managerial operating options and debt rescheduling

We develop a stochastic continuous time trade-off model with optimal capital structure that incorporates managements selection of optimal investment timing and switching between full-scale operations, reorganization and rescheduling and termination of operations (liquidation). We show that the presence of a firms option for debt rescheduling reduces firm value by reducing the managements ability to raise debt. This negative impact on debt capacity is reduced in the presence of higher switching costs incurred by shareholders when seeking bankruptcy protection and debt rescheduling. Larger anticipated debt reduction in rescheduling results in the management (acting in the shareholders’ interests) delaying returning to active full-scale operations which results in larger debt risk and credit spreads. On the positive side, more significant anticipated debt reduction in rescheduling results in reduced agency costs between shareholders and debt holders.

Product Development with Value-Enhancing Options

We study path-dependent value-enhancing managerial actions with random outcome. These actions are either uncertainty revealing actions like research, experimentation, and early versions (pilot projects) or actions that are expected to increase value like attribute enhancing development options and advertising that have however an uncertain outcome. Actions are costly (costs may be partially reversible), sequential and implemented by management at optimal time. We derive two-stage analytic formulas and we use them to study product development with optimal timing of product versions and sequencing of value enhancing actions. We also analyze a multi-period version of the problem using a numerical lattice solution. Individual research/exploration actions are more important when the project is at the money (projects near zero NPV) and less important for low or high values of project value. In a multi-stage setting exploration actions are often important even in very in-the-money projects when follow on actions exist that can enhance the expected value of the project. With path-dependency, early actions can become more valuable when they enhance the impact or reduce the cost of later actions.

Debt Maturity Choices, Multi-stage Investments and Financing Constraints

We develop a dynamic investment options framework with optimal capital structure and analyze the effect of debt maturity. We find that in the absence of financing constraints short-term debt maximizes firm value. In contrast with most literature results, in the absence of constraints, higher volatility may increase initial debt for firms with low initial revenues, issuing long term debt that expires after the investment option maturity. This effect, which is due to the option value of receiving the value of assets and remaining tax savings, does not hold for short term debt and firms with high profitability, where an increase in volatility reduces the firm value. The importance of short-term debt is reduced in the presence of non-negative equity net worth or debt financing constraints and firms behave more conservatively in the use of initial debt. With non-negative equity net worth, higher volatility has adverse effects on the firm value, while with debt financing constraints higher volatility may enhance firm value for firms with relatively low revenue that have out-of-the-money investment options.

Real Options with Random Controls, Rare Events, and Risk-to-Ruin

Situations involving real investment options in the presence of multiple sources of jump risk, and controls are analyzed. Randomly arriving jumps include also the special cases of jump-to-ruin on the underlying asset, or on the contingent claim. Management has available impulse-type controls with random outcome. The analytic solutions when available, and a Markov-Chain numerical approach for solving more general investment decision problems are demonstrated