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Strategic real options under asymmetric information

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  • Graham, Jeffrey

Abstract

This paper studies the effect of private information on the capital allocation decisions of firms who operate under imperfect competition. I analyze two interactive firms, one with private information and the other without, who must decide when to undertake an irreversible and uncertain investment decision. Traditional non-strategic models of irreversible investment under uncertainty involve a single decision maker and result in an optimal period of delay before the investment is undertaken. In a strategic setting, firms must balance their desire to delay against competitive advantages from early investment. I find that an equilibrium may not exist within the standard continuous framework when the private information is over revenues. Moreover, when an equilibrium does exist the competitive pressures from the uninformed firm are weak. This is in contrast to existing models with asymmetric information over costs, where an equilibrium always exists and the competitive pressures remain strong (Hsu and Lambrecht, 2007). This work shows that the investment timing decision, and thus the value of the private information, is highly sensitive to the nature of incomplete information.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 35 (2011)
Issue (Month): 6 (June)
Pages: 922-934

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Handle: RePEc:eee:dyncon:v:35:y:2011:i:6:p:922-934

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Web page: http://www.elsevier.com/locate/jedc

Related research

Keywords: Real options Asymmetric information Investment Timing game Preemption;

References

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  1. Pawlina, G. & Kort, P.M., 2001. "Investment Under Uncertainty and Policy Change," Discussion Paper 2001-5, Tilburg University, Center for Economic Research.
  2. Guoqiang Tian, 2009. "The Existence of Equilibria in Games with Arbitrary Strategy Spaces and Payoffs: A Full Characterization," Levine's Working Paper Archive 814577000000000160, David K. Levine.
  3. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
  4. Lambrecht, Bart M., 2004. "The timing and terms of mergers motivated by economies of scale," Journal of Financial Economics, Elsevier, vol. 72(1), pages 41-62, April.
  5. Lambrecht, Bart & Perraudin, William, 2003. "Real options and preemption under incomplete information," Journal of Economic Dynamics and Control, Elsevier, vol. 27(4), pages 619-643, February.
  6. Grenadier, Steven R, 1996. " The Strategic Exercise of Options: Development Cascades and Overbuilding in Real Estate Markets," Journal of Finance, American Finance Association, vol. 51(5), pages 1653-79, December.
  7. Meng, Rujing, 2008. "A patent race in a real options setting: Investment strategy, valuation, CAPM beta, and return volatility," Journal of Economic Dynamics and Control, Elsevier, vol. 32(10), pages 3192-3217, October.
  8. Thijssen, Jacco J.J., 2008. "Optimal and strategic timing of mergers and acquisitions motivated by synergies and risk diversification," Journal of Economic Dynamics and Control, Elsevier, vol. 32(5), pages 1701-1720, May.
  9. Jacco Thijssen & Kuno Huisman & Peter Kort, 2006. "The effects of information on strategic investment and welfare," Economic Theory, Springer, vol. 28(2), pages 399-424, 06.
  10. Morellec, Erwan & Zhdanov, Alexei, 2005. "The dynamics of mergers and acquisitions," Journal of Financial Economics, Elsevier, vol. 77(3), pages 649-672, September.
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Citations

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Cited by:
  1. Huang, Bing & Cao, Jiling & Chung, Hyuck, 2013. "Strategic real options with stochastic volatility in a duopoly model," MPRA Paper 45731, University Library of Munich, Germany.
  2. Azevedo, Alcino & Paxson, Dean, 2014. "Developing real option game models," European Journal of Operational Research, Elsevier, vol. 237(3), pages 909-920.
  3. Chronopoulos, Michail & De Reyck, Bert & Siddiqui, Afzal, 2014. "Duopolistic competition under risk aversion and uncertainty," European Journal of Operational Research, Elsevier, vol. 236(2), pages 643-656.

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