INPUT MARKET ADVANTAGES

As suggested, when a firm has the capability to create, recognize, and/or value an option-producing investment, it might conclude that the value for a needed input is lower than the market value of that input. Theoretically, market values will reflect the value the "average" buyer should place on that asset. Given the identification of unique option cascades, one firm may pay less "per option" than competing bidders (as the cost of resource purchase is spread across the widely acknowledged and those options uniquely acknowledged by the firm). If, for example, the cost of adding a geologist to help map and estimate the location and size of an oil field is represented by his/her salary of $80,000 annually, but a firm can utilize these geologist more effectively due to superior engineering, surveying, access to capital, and so forth, the $80,000 salary will represent a more valuable investment to that firm than to less-endowed competitors.

RISK ACCEPTANCE

When a firm has the luxury of having a certain amount of slack available, it may be more willing to take calculated risks. For example, a firm with a very successful, revenue-producing product line might be more willing to take some risks on a new, risky project than a firm that doesn't have a "guaranteed" income from a successful product to fall back on. In other words, if a firm knows that it could absorb losses without those affecting the business in the long term, it might change the firm's willingness to take risks on new products.

Real options are also assets, similar to the successful product, and as such having options and knowing how to efficiently create and use options may change the firm's willingness to take risks on other, more risky options. For example, if a firm already owns several high-producing oil fields, it may change its consideration of a new project with a higher-than-usual risk. In other words, the ability and knowledge that the firm knows how to efficiently use real options may have altered its risk aversion, and the combination of the current assets of the firm and the firm's confidence in its own ability to manage real options may alter the firm's risk tolerance. The firm may feel like that it can take some "chances" because it has a certain amount of slack resources (e.g., cash from the revenue-producing asset, etc.) that will help absorb a negative shock if the new venture doesn't work out.

Conversely, firms that are less confident about their ability to follow a real options-based strategy may be less likely to take risks on projects that would require the efficient application of real options. In an extreme example, this might lead to the already successful firm taking more risks, and the less successful firm taking fewer risks. This in turn may increase the already existing variance in performance between the two companies.

PERCEIVED VALUE AND BENCHMARKING

Perceived value is often related to some sort of benchmark. For example, our own valuation of an asset is at least influenced by its market value; the perceived value deviates from the market but it will at least be influenced by how the market values the asset. We suggest that there are other benchmarks that will play a role when setting the perceived value of a real option. For example, it is possible that an asset becomes more valuable to us just because our competition "really wants it" and therefore signals that their perceived value of the asset is high; the signal could, for example, be an increased purchase price bid by that competitor. Surely, the book value of an asset doesn't increase just because a competitor wants it, but the market value is influenced. And is the market value not just a culmination of perceived values?

If we extend this concept of demand and supply, where more and more entities' perceived values might influence the market price of an asset, which would create a bubble (as we have seen numerous times between the tulip craze and the latest housing bubble), then the extension of this concept should also apply to option valuation. The perceived values of options are influenced by valuations held by other market participants. If competitions' value perceptions increase, so might our perceived value of that same option; this increase in valuation would then not solely be based on rational behavior but also on the intricacies of the relationship between the competitor and us. For example, if Google and Microsoft would try to secure and option for the same asset, then their rival relationship might influence their own internal (perceived) valuation of that option.

The realization that our own perceived value of an option is not just endogenous to the firm, but is also influenced by outside forces (such as the competitor) now opens this up for some gamesmanship. At one point, a firm might not even really want to purchase the real option, but continues to signal that it does just to increase the perceived value to the competitors and hence drive up the price. As such, the concept of perceived value is closely related to firm strategy.

If we know that our competitor's perceived value of an option increases upon our demonstration of interest, then this could result in a bidding war (and escalation of commitment). For example, one might observe this betting war with financial options when it comes to finding a new CEO for a firm, where usually the salary of these CEOs is relatively low, but the amount of options might decide where the CEO decides to go; thus, the firm with the highest option value becomes the winner in the competition for the CEO.

One could imagine that the same concept can apply to real options; two firms compete for the same resource and try to outbid each other, where the resource is an option on a real asset. One might find similar examples in professional sports, where not only salaries but also options are part of a player's or coach's compensation package. The much sought after no-trade clause, for example, is an option for the player (the option to decline a trade), while teams often have the option to pick up a player's contract.

In addition, the external force influencing the perceived value of an option may come from a regulatory entity. If, for example, the government sets new environmental standards pertaining to the extraction of oil, then a patent on a new technique to extract that oil might suddenly be perceived as more highly valued. All of this may suggest that the perceived value of a real option is influenced by exogenous forces.

To what degree is the perceived value of a real option driven by internal or external forces? This is an interesting question, and might depend on the specific situation, but in general one could imagine that it may have something to do with the firm's experience dealing with real options. If, for example, a firm is relatively new to the concept of real options, then it might trust outside advice or guidance more than if it had ample experience dealing with and valuing real options.

Also, the relative experience with real options, or lack thereof, might also impact the efficiency with which real options are created, recognized, and used. As such, Kogut and Zander43 found that if options are integrated, organizational routines and culture will adjust, raising the cost of abandoning the option. Bower and Christiansen44 found that when options are only used sporadically they will increase costs, pushing firms to kill them. In both cases it may be argued that a firm's experience with options may influence their perceived value of the said option.

 
< Prev   CONTENTS   Next >