Jointly Held Investment Options and Vertical Relationships
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Jointly Held Investment Options and Vertical Relationships Dimitrios Zormpas1
© The Author(s) 2020
Abstract We find the optimal time for exercising a jointly held investment option. When the input market is competitive, the investment can take place earlier, later, or exactly when the optimal investment threshold is reached depending on how the option holders interact and on the bargaining power distribution. When instead the input supplier has market power, the game-theoretic framework downstream is shown to be of secondary importance. The timing effect that is attributed to the vertical relationship is always prevailing, which dictates the inefficient postponement of the investment. Keywords Investment analysis · Nash bargaining · Real options · Vertical relations JEL Classification C61 · D92 · G30
1 Introduction Innovation is an important factor for a company’s success and a crucial explanation for observed differentials in performance (McGrath and Nerkar 2004). Consequently, a fundamental problem that a firm faces has to do with the decision to invest in a new product or technology. These managerial decisions are characterized by risky, irreversible and lumpy investments that are often beyond the resources of a single firm (Chesbrough and Schwartz 2007). As a result, an investment partner is frequently sought (Kogut 1991; Scott 1996). According to Quinn (2000), using partnerships “companies have lowered innovation costs and risks by 60% to 90%, while similarly decreasing cycle time and leveraging their internal investments by tens to hundreds of times”. Investment partnerships might take the form of joint ventures, venture capital investments, strategic alliances, or mergers. Irrespective of the exact nature of the * Dimitrios Zormpas [email protected] 1
Department of Economics and Management, University of Brescia, C.da S. Chiara, 50, 25122 Brescia, Italy
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partnership, the reasons that motivate it are common: When joining forces with another firm, a potential investor anticipates financial returns and/or future growth opportunities.1 The real options approach is a standard framework for the analysis of such opportunities. It builds on the idea that the option to undertake an investment that is characterized by uncertainty and irreversibility is analogous to an American call option on a real asset. Hence, the potential investor needs to factor in that, at the time of the investment, he forgoes the option to reconsider the investment decision at some future time point when the uncertainty will be, naturally, partly resolved.2 This means that apart from the investment cost, there is also an opportunity cost that the investment needs to pay for. The standard real options model does not account for investment partnerships. However, there is a growing body of papers that analyze investments that involve two or more parties that can generate a surplus by jointly exercising an investment option. In spite of the differences in their analyses, what these papers shar
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