Investment and Abandonment Decisions with Uncertain Price and Cost

Choi, Yoon Jung; Lee, Seok Weon

doi:10.1111/1468-5957.00310

Cited by 5 publications

(3 citation statements)

References 12 publications

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“…SeeMcDonald and Siegel (1986) andDixit and Pindyck (1994) for detailed explanations of the relation between risk and irreversible investment under an option-theoretic framework. Empirical evidence supporting this contention can be found inChoi and Lee (2000),Bulan (2005) and Grullon et al (2008), among others. C 2014 John Wiley & Sons Ltd…”

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confidence: 81%

The Impact of Ambiguity on Managerial Investment and Cash Holdings

Neamtiu¹,

Shroff²,

White³

et al. 2014

Business Fin & Account

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Standard finance theory suggests that managers invest in projects that, in expectation, produce returns that justify the use of capital. An underlying assumption is that managers have the information necessary to understand the distributional properties of the payoffs underlying the decision. This paper examines firm investment behavior when managers are likely to find it more challenging to develop expectations of payoffs, namely during periods of increased macroeconomic ambiguity. In particular, we examine how macroeconomic ambiguity -proxied by the variance premium (Drechsler, 2010) and the dispersion in forecasts of corporate profits from the Survey of Professional Forecasters (Anderson et al., 2009) -impacts managerial capital investment and cash holdings. Consistent with ambiguity theory, we find that macroeconomic ambiguity is negatively associated with capital investment and positively associated with cash holdings. These results are robust to alternative explanations related to risk, investor sentiment, and economic conditions. Moreover, consistent with recent theoretical real options literature, we find that ambiguity reduces the value of investment opportunities, while risk increases the value of such opportunities. Overall, these findings provide initial empirical evidence on the economic distinction between ambiguity and risk with respect to managerial investment and cash holdings. 1 IntroductionWithin a firm, the allocation of capital to its highest value use is one of the most important roles of a manager. The central determinant of successful capital allocation is the precision with which a manager is able to identify cash flow prospects and apply appropriate discount rates for the respective investment decisions. Typically, the investment literature assumes that managers know, or behave as if they know, the probability distributions of the cash flows and discount rates related to potential projects. In other words, although project payoffs are ex ante unknown, managers feel confident in their assessment of investment payoff probabilities.Recent theoretical work by Nishimura and Ozaki (2007), however, argues that managers facing a decision regarding irreversible investment may not always have complete confidence in their perceived payoff probability measures. As Nishimura and Ozaki (2007) state, managers "might think other probability measures perturbed from the original one are also possible." This uncertainty regarding investment payoff-characterized by a set of probability measures rather than a single probability measure-is defined as ambiguity, or Knightian uncertainty. 1 The intuition developed in Nishimura and Ozaki (2007) draws from the large theoretical and experimental literature on ambiguity (e.g., Ellsberg, 1961;Bewley, 1986;Gilboa and Schmeidler, 1989), which builds on Knight (1921). 2 The purpose of this paper is to examine the impact of ambiguity on managerial investment and cash holding decisions. The ambiguity literature suggests that, in the presence of ambiguity, 1 ...

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confidence: 81%

The Impact of Ambiguity on Managerial Investment and Cash Holdings

Neamtiu¹,

Shroff²,

White³

et al. 2014

Business Fin & Account

View full text Add to dashboard Cite

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“…Dixit and Pindyck (1994) introduce two sources of uncertainty, namely, cost and investment revenue, in their model of optimal investment strategy. Choi and Lee (2000) analyze investment and abandonment decisions in the presence of uncertain price and cost. Morellec and Zhdanov (2005) examine a real option model of mergers with random fundamental value and unknown amount of synergy for public shareholders.…”

Section: Literature Reviewmentioning

confidence: 99%

Optimal Timing and Terms in a Vertical Merger With Two Sources of Uncertainty

Chen

Zhang²,

Lin

2020

J of Financial Research

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In this article we provide the optimal timing and equilibrium terms of a vertical merger with two sources of uncertainty in the production chain, namely, marginal cost of raw material and price level of final product. By eliminating monopoly power and transaction cost in the production process between upstream and downstream firms, a vertical merger can increase social welfare, which is consistent with the literature. The optimal threshold of a vertical merger is negatively correlated with transaction cost in the intermediate product market. Vertical mergers also accelerate when merging provides natural hedging for the postmerger firm, that is, when the correlation between the two uncertainties increases.

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“…Tsekrekos considered the problem assuming that the underlying process follows a mean reverting process, and Zhang studied the problem assuming that the underlying process follows a geometric Lévy process. Choi and Lee researched the problem with uncertain costs.…”

Section: Introductionmentioning

confidence: 99%

An entry‐exit model involving construction and abandonment periods

Zhang

2019

Math Methods in App Sciences

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We analyze, using the optimal stopping theory, the entry‐exit decision on a project, which takes time to be constructed and abandoned. We obtain the closed‐form expressions of optimal start time of entry, optimal start time of exit, and the maximal expected present value of the project. In addition, we examine the effects of construction and abandonment periods on the optimal start times of entry and exit.

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Investment and Abandonment Decisions with Uncertain Price and Cost

Cited by 5 publications

References 12 publications

The Impact of Ambiguity on Managerial Investment and Cash Holdings

The Impact of Ambiguity on Managerial Investment and Cash Holdings

Optimal Timing and Terms in a Vertical Merger With Two Sources of Uncertainty

An entry‐exit model involving construction and abandonment periods

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