Real Options: Taking Stock and Looking Ahead

Abstract

We discuss recent developments in real options theory and its applications to strategic management research, examine the potential difficulties in implementing real options in theory and practice, and propose several areas for future research. Our review shows that real options theory has provided important insights into investment and exit decisions as well as into the choice of investment modes. In addition, extant research studies have contributed substantially to our understanding of whether and how organizations can benefit from real options. Future research that addresses difficulties in applications will further advance both real options theory and practice in strategic management. REAL OPTIONS: TAKING STOCK AND LOOKING AHEAD ABSTRACTWe discuss recent developments in real options theory and its applications to strategic management research, examine the potential difficulties in implementing real options in theory and practice, and propose several areas for future research. Our review shows that real options theory has provided substantial insights into investment and exit decisions as well as into the choice of investment modes. In addition, extant research studies have contributed significantly to our understanding of whether and how organizations can benefit from real options. Future research that addresses difficulties in applications will further advance both real options theory and practice in strategic management. We call for future generations of research to enhance the impact of real options as an emerging dominant conceptual lens in strategic management.

Venture capitalists' decision to withdraw: The role of portfolio configuration from a real options lens

“…Finally, our study sheds further light on VCs' decision making in financing entrepreneurship. We hope this study will encourage further tests of real options theory as an important theoretical tool for strategy and entrepreneurship (Li et al, 2007;Mahoney, 2005;Reuer and Tong, 2007;Trigeorgis, 1996). …”

“…Despite the prevalence and importance of portfolio investments (Cumming, 2006), extant research has yet to empirically examine the effect of portfolio configuration on venture capital project withdrawal. Scholars have been urged to apply real options theory to address important strategic portfolio problems, such as in the venture capital context (Li et al, 2007;Trigeorgis, 2005). Our study fills this research gap by analyzing how portfolio configuration influences venture capital withdrawal under uncertainty.…”

“…The call options embedded in an investment project generally arise from managerial discretion to delay the start or expansion of the project (e.g., Dixit and Pindyck, 1994), whereas the embedded put options generally arise from managerial discretion to withdraw from or downscale the project, particularly when the investment in the project can be staged (Trigeorgis, 1996). While real options theory has emerged as an important guiding tool for strategy and entrepreneurship (Li et al, 2007;Mahoney, 2005), research studies that question the theory's boundary of applicability suggest that the employment of real options theory as a guide for the adoption of investment projects may be value destroying if decision makers face difficulty in extricating themselves from failing projects due to wrong incentives or behavioral biases. Adner and Levinthal (2004) specifically call for further empirical work to investigate whether firms make project withdrawal decisions in a way that is consistent with real options theory.…”

Entrepreneurs’ Capital Budgeting Orientations and Innovation Outputs: Evidence From Australian Biotechnology Firms

“…Roadmaps to understanding this orientation proffered by Li et al (2003) and Oriani and Sobrero (2008) and our own review suggest that investment and divestment decisions based on ROR are predicated on various heuristics or decision rules under uncertainty. That is, entrepreneurs would vary in the extent to which they exhibit an ROR orientation, depending on their reliance on these heuristics.…”

“…As our literature review failed to find any single measure of an ROR orientation, we constructed the components of ROR orientation based on the theory developed earlier here, as supported by the literature on real options (Leslie and Michaels, 1997; Li et al, 2003;Trigeorgis, 1996). Respondents to our survey were asked to variously agree or disagree with the following ROR related statements on a scale of 1-7 (1 -strongly disagree, 2 -disagree, 3 -slightly disagree, 4 -neutral, 5 -slightly agree, 6 -agree, 7 -strongly agree).…”