Optimal exercise of jointly held real options: A Nash bargaining approach with value diversion

Abstract

This paper provides a two-stage decision framework in which two or more parties exercise a jointly held real option. We show that a single party's timing decision is always socially efficient if it precedes bargaining on the terms of sharing. However, if the sharing rule is agreed before the exercise timing decision is made, then socially optimal timing is attained only if there is a cash payment element in the division of surplus. If the party that chooses the exercise timing can divert value from the project, then the first-best outcome may not be possible at all and the second-best outcome may be implemented using a contract that is generally not optimal in the former cases. Our framework contributes to the understanding of a range of empirical regularities in corporate and entrepreneurial finance.

Mergers and Acquisitions Strategy under Imperfect Information: A Mixed-payment Model

“…We obtain the optimal ξ using the Nash bargaining approach. Banerjee, Güçbilmez and Pawlina [3] develop a model of the optimal real options exercise using the Nash bargaining approach. Based on Banerjee, Güçbilmez and Pawlina [3], we set the optimization function as…”

Vertical Flexibility, Outsourcing and the Financial Choices of the Firm

“…If it wants to go back to internal production it must bear each time a fixed cost. While in our model we go through the privately optimal (hence, variable) extent of OS contingent upon the capital structure adopted, in the Benaroch et al (2012) paper the main question is about the optimal switching from (complete) OS to backsource and 6 For instance Apple has recently increased the OS of some inputs while reducing and bringing back home other inputs. See for further examples: The Economist (2011, 2013), Forbes (2012).See also empirical assesments in Klein (2005) and Rossini and Ricciardi (2005).…”

“…Size of the investment, timing of the exercise of the option and rule concerning the sharing of returns of the investment have to be established jointly by the firm and by the financial investor. According to Banerjee et al (2014) it is inefficient to specify a sharing mode before the venture is carried out. Bakhtiari and Breunig (2014), at firm level on longitudinal data, assess OS as a device to smooth demand uncertainty.…”

“…Yet, we shall see that this is not always the case whenever the cost of flexibility and the related financial aspects are properly taken into account. Our investigation is prompted by broad casual observation and press reports 6 showing that most firms change over time their vertical production structure, expanding and/or subsequently reducing (or the other way round) the extent of OS of inputs 7 . For instance in the automotive industry most brands adopt partial OS, i.e., concomitant internal production and purchase of engines and other intermediate products from external sources.…”

“…In Banerjee et al (2014) the investment in a new technology, such as a flexible vertical process, financed by an external subject is seen as a joint option. Size of the investment, timing of the exercise of the option and rule concerning the sharing of returns of the investment have to be established jointly by the firm and by the financial investor.…”