Tan Lee

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, 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.

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.

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.

How to design down-and-out barrier option contracts so that firms invest when it is socially efficient

This paper investigates how to design down-and-out barrier options contracts so as firms invest when it is socially efficient. A government initially offers a firm a privileged right to exercise an investment opportunity that exhibits external benefits to society, but will eliminate this opportunity if its prospects are sufficiently bleak. The firm will invest at the date further away from that is socially efficient if the firm either is less uncertain about the return of the investment or incurs lower investment costs, or the government owns a more valuable knock-out option. Consequently, under these three scenarios the government can efficiently either offer the firm a higher investment tax credit or impose the firm a higher lease fee for holding the option to invest.

Mutually exclusive investment with technical uncertainty

A firm, which faces technical uncertainty as in Pindyck (1993) can choose between two mutually exclusive investment projects, Projects 1 and 2. The added option to exercise Project 2 makes the firm less likely to exercise Project 1. An increase in the degree of technical uncertainty, the investment rate or the investment value upon completion for Project 2 encourages the firm to exercise Project 2 by increasing the trigger level of the expected cost of Project 2. This, however, ambiguously affects the firms incentive to exercise Project 1, as the firm would rather implement Project 1 (2) in a region where the expected cost of Project 2 is relatively high (low).