International investment decisions under uncertainty: Contributions of real options theory and future directions

Abstract

We undertake a critical literature review to facilitate academic dialogs regarding decisions under uncertainty in international business settings and highlight the growing focus on international investments as conveyers of real options. Our literature review (1) provides a systematic overview of uncertainty types considered in this literature, real options identified as particular to international investments, and valuation approaches used and (2) highlights key methodological approaches used for testing real options models applied to international investments, and the controversies in this regard. This study draws on the above to shed light on important avenues for future research including (a) the need for more fine-grained and diverse measures of uncertainty in the international context, (b) an emphasis on clarifying the value effects of combinations of real options, and (c) the necessity of further consideration of the costs of options along with the value.

Exploring the Link of Real Options Theory with Dynamic Capabilities Framework in Open Innovation-Type Merger and Acquisition Deals

“…As we begin to think in options terms, each M&A deal can be viewed as a bundle of corporate growth options to acquire competencies (resources and capabilities) that extend over the long term (Smit and Trigeorgis 2004). Based on the real options theory, growth options can enhance competitiveness and bring sustainable competitive advantages to the firms in the future (Song et al 2015). In this vein, recent research by Shen et al (2020) justified that CEOs prefer to cater the capital market through high-risk and high-reward investments, such as M&As.…”

Exploring ERP-enabled Technology Adoption: A Real Options Perspective

“…The initial investment gives a firm the ability to partially commit to an investment and to defer certain decisions until information become clearer. The framework for real options is based on the understanding that, in the face of high uncertainty, one postpones the commitment until one knows a substantial part of the uncertainty (Song, Makhija, & Kim, 2015). Real options analysis explicitly accommodates uncertainty by making it possible for firms to adjust investment decisions during the course of the investment lifecycle as information becomes available (Krychowski & Quelin, 2010).…”

Relative exploration orientation and real options reasoning: survey evidence from Denmark

“…In contrast to the static assumptions used in resource allocation regimes such as NPV (Bowman and Hurry, 1993; Dixit and Pindyck, 1994), ROR firms do not assume deterministic futures and will invest in projects sequentially and with low initial commitment which allows a firm to reduce downside risk if the events unfold unfavorably, but maintains the option of taking advantage of future opportunities, if events unfold favorably (Ipsmiller et al , 2019; Li and Chi, 2013; Vassolo et al , 2004). As such, the theory suggests that there is value in deferring full commitment to an investment project until the underlying uncertainty is resolved (Song et al , 2015). We operationalize sequential low commitment with items intended to assess the degree to which management uses uncertainty to assess the size of capital commitments (slc1 and slc2), as well as the effect of resolving uncertainty on exercising options (slc3).…”

“…While the NPV technique fundamentally assumes that the project will be launched and then left on its own, ROR expects managers to take an active role throughout the lifetime of the project, where managers exert an ongoing effort to respond to changing conditions to maximize the assets’ potential (Barnett, 2005). If such management of options is not executed or if management misuses its discretion over investment decisions, the theoretical value of real options may never be realized (Barnett, 2008; Coff and Laverty, 2008; Song et al , 2015). As such, a key part of ROR is to establish practices that produce the knowledge necessary to adapt to uncertainty (Driouchi and Bennett, 2012) and a flow of information that reduces uncertainty (Janney and Dess, 2004; McGrath and Nerkar, 2004).…”

“…According to Adner (2007), this escalates the chance that managers are convinced that an opportunity is worthy of continuation rather than abandonment. To mitigate such effects, ROR firms should set explicit boundaries for real options to ensure that managers abandon options that are no longer worth pursuing (Song et al , 2015). We operationalize reallocation by the extent to which management clearly specifies an asset’s embedded options prior to investment in the said asset (real1), the extent to which circumstances for abandonment (real2) and further capital allocation (real3), are specified ex-ante of option acquisition.…”