Quarterly publication of the Multinational Finance Society, a non-profit corporation     ISSN 1096-1879

Supply Chain Coordination and Performance Management with Real Options Based Relationships
(Multinational Finance Journal, 2010, vol. 14, no. 3/4, pp. 153–188)

Blake Johnson
Stanford University, USA

A company’s operating capabilities, performance and risk are determined by its supply chain, the complex set of activities spread across internal functions and external partners that together enable it to deliver its products. Supply chains have traditionally been coordinated with deterministic plans together with inventory buffers added to accommodate uncertainty. More recently, substantial investments have been made in supply chain information sharing, collaboration, and responsiveness initiatives to enable supply chains to react more rapidly to the outcomes of key sources of uncertainty as they become known. To date, however, capabilities that enable supply chain uncertainty to be identified and evaluated before the fact, and its performance impact proactively quantified and managed, have been absent, and as a result offer the potential for significant further improvements in performance and control. Implementation of such approaches is made difficult, however, by the complex, operational nature of supply chain activities, the multiple sources of uncertainty typically present, and the often competing or conflicting objectives and asymmetric information of the multiple firms or functions whose activities must be coordinated. To address these challenges a two part approach is present. The first addresses optimal management of individual firms or functions, while the second presents mechanisms for effective coordination between them. Negotiated, bilateral, contingent performance commitments – effectively contracts with multiple embedded real options – are shown to be necessary to convey the information, incentives, and allocation of risk required to identify and execute appropriate strategies across the supply chain and across the range of prospective future sund demand outcomes to which it is exposed. 

Keywords: Supply chain, Performance management, Risk management, Flexibility

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Corporate Finance and the (In)efficient Exercise of Real Options
(Multinational Finance Journal, 2010, vol. 14, no. 3/4, pp. 189–217)

Bart M. Lambrecht
Lancaster University Management School, U.K.
Grzegorz Pawlina
Lancaster University Management School,U.K.

This paper considers real options within a continuous-time corporate finance context. We analyze whether these real options are exercised effciently, and what the underlying sources of inefficiency are. In particular we consider the role of incomplete information, competition, search costs and financing constraints on investment decisions. We also analyze the stockholder-bondholder and the manager-stockholder agency problems, and their effect on a firm's investment and closure policies. (JEL: C61, D81, G31)

Keywords: real options, product market competition, costly search, financing constraints, agency problem

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Continuous-Time Option Games: Review of Models and Extensions
(Multinational Finance Journal, 2010, vol. 14, no.3/4, pp. 219–254)

Marco Antonio Guimarães Dias
PUC-Rio, Brazil
José Paulo Teixeira
PUC-Rio, Brazil

This paper discusses a selected literature on continuous-time option games models, providing new insights and extensions. The paper analyzes both symmetrical and asymmetrical duopoly under uncertainty, including issues like preemption, non-binding collusion, perfect-Nash equilibriums, first-mover advantage, mixed strategies, probability of mistake with simultaneous exercise, competitive advantage effect, etc. In the first model, the demand follows a stochastic process, whereas in the second model the exchange rate follows a stochastic process. This paper presents two equivalent ways to calculate the leader and follower values and thresholds, the differential and the integral methods. The paper extends the Joaquin and Buttler’s model by considering mixed strategies in asymmetric duopoly and other extensions. (JEL: G31, G12, C72, C73)

Keywords: option games, real options, game theory, duopoly under uncertainty, preemption.

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Asymmetric Information and Irreversible Investments: an Auction Model
(Multinational Finance Journal, 2010, vol. 14, no. 3/4, pp. 255–289)

Jøril Mæland
Norwegian School of Economics and Business Administration, Norway

The owner of a real option does not have the necessary expertise to manage the investment project and needs to contract with an expert in order to exercise the real option. The potential managers (the experts) have private information about their respective cost of investing in the project. The project owner organizes an auction in which the experts participate. The winner of the contract is the expert who can exercise the investment project at the lowest cost. The optimal contract is incentive compatible, i.e., it induces the winner to follow the investment strategy preferred by the project owner. It is shown that private information increases the project owner's cost of exercising the option, which may lead to under-investment. The inefficiency due to under-investment decreases in the number of experts participating in the auction. (JEL: G31, D82, G13)

Keywords: real options, investment strategy, private information, auction.

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Investor Valuation of the Abandonment Option: Empirical Evidence from UK Divestitures 1985-1991
(Multinational Finance Journal, 2010, vol. 14, no. 3/4, pp. 291–317)

Ephraim Clark
Middlesex University Business School and GERME Esa/Esc Lille, U.K.
Magid Gadad
The Academy of Graduate Studies, Tripoli
Patrick Rousseau
Université Aix-Marseille, France

This paper looks at divestitures by 144 UK firms listed on the London Stock Exchange from 1985 to 1991 and investigates whether and how accurately investors price the firm’s option to abandon assets in exchange for their exit value. Theory prices this real option as an American style put and the model we test includes the major features of the abandonment option literature: stochastic firm value, stochastic exit value, intermediate cash flows and uncertain project life. It also includes random events that can short circuit the optimal timing of the divestiture and trigger abandonment prematurely. The empirical implications are that investors do price the abandonment option but that they price it imperfectly because the exit price is private information. There is evidence that the effects of the timing factor are accurately priced and that the probability of forced premature abandonment figures in the option pricing. (JEL: G13, G33, G35, M41)

Keywords: real options, abandonment, divestiture, premature abandonment, abnormal returns

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