The Real Options Component of Firm Market Value: The Case of the Technological Corporation

Abstract

This paper tests whether stock prices reflect investor's expectations regarding the value of real options. The analysis is implemented based on a sample of 391 high-tech companies listed on main OECD stock markets during the period December 1994 through December 2000. Results confirm the predicted relation between the fraction of a firm's market value not accounted for by its assets-in-place, and a series of variables that are assumed to disclose its real options value, variables such as research and development activity, risk and skewness of stock returns, and size. The results are robust even after controlling for valuation date, sub-industry, country, and alternative measures of risk.

Growth options and acquisition likelihood in high tech

“…For example, Andres-Alonso, Azofra-Palenzuela, and Fuente-Herrero (2006) measure AIP as a perpetuity of free cash flow discounted by cost of capital. Bernardo, Chowdhry, and Goyal (2007) use a book value measure of AIP based on debt and equity.…”

“…Thus, we suggest R&D expenditures are a proxy for the unobservable assets within the firm, specifically related to its growth opportunities. Ho, Tjahjapranata, and Yap (2006), Andres-Alonso et al (2006) found that R&D investment had a positive impact on the growth opportunities of a firm. Oriani and Sobrero (2008) found that R&D was positively related to the market value of the firm.…”

Required Rates of Return for Corporate Investment Appraisal in the Presence of Growth Opportunities

“…The element of the share price due to growth opportunities, P g , is then derived as: Kester (1984Kester ( , 1986 and Brealey and Myers (2003) use this model to show (based on samples of eight to fifteen companies) that growth opportunities constitute a large fraction -often above one-half -of share value. Applying the Kester/Brealey&Myers model to larger samples, Danbolt et al (2002) 2 find growth opportunities on average to account for 56% of firm value based on a sample of 2,010 firm-years for large UK companies, while Andrés-Alonso et al (2006), applying a variant of the Kester/Brealey&Myers model to a sample of 391 high-tech companies listed in OECD markets, find the value of growth opportunities to average more than 75% of firm value.…”

Investment Timing when External Financing is Costly

“…6 6 See de Andres‐Alonso et al (2006) for an empirical study showing a significant contribution of real options relative to assets‐in‐place to a firm's market value, and Gu and Wang (2005) documenting the difficulties of analysts to correctly capture the value of intangible assets. …”

“…See deAndres-Alonso et al (2006) for an empirical study showing a significant contribution of real options relative to assets-in-place to a firm's market value, andGu and Wang (2005) documenting the difficulties of analysts to correctly capture the value of intangible assets. 7 This corresponds to the instantaneous credit spread of zero within classical structural credit risk models such asMerton (1974).…”