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The Economic Value of Flexibility When There is Disagreement

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  • Boot, Arnoud W A
  • Thakor, Anjan

Abstract

We develop an economic theory of ‘flexibility’, which we interpret as the discretion or ability to make a decision that others disagree with. We show that flexibility is essentially an option for the decision-maker, and can be valued as such. The value of the flexibility option is decreasing in the extent to which the decision-maker’s future decision-relevant opinion is correlated with the opinions of others who may be able to impede the decision. We argue that flexibility drives economic decisions in a significant way. The applications we consider are: the entrepreneur’s choice of flexibility in the initial mix of financing raised; the use of flexibility to understand differences in security design and the firm’s security-issuance decision; the impact of flexibility on the use of collateral in lending; the role of flexibility in capital budgeting decisions; the effect of flexibility considerations in the design of contracts in a principal-agent setting; the interpretation of ‘power’ and conformity in organizations in the context of flexibility; and the choice between private and public ownership in the context of flexibility.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3709.

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Date of creation: Jan 2003
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Handle: RePEc:cpr:ceprdp:3709

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Keywords: corporate finance; Managerial decision-making;

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References

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Cited by:
  1. Arnoud W.A. Boot & Anjan V. Thakor, 2003. "Disagreement and Flexibility: A Theory of Optimal Security Issuance and Capital Structure," Tinbergen Institute Discussion Papers 03-001/2, Tinbergen Institute.
  2. Blau, Benjamin M. & Fuller, Kathleen P., 2008. "Flexibility and dividends," Journal of Corporate Finance, Elsevier, vol. 14(2), pages 133-152, April.
  3. Mark Pyles & Donald Mullineax, 2008. "Constraints on Loan Sales and the Price of Liquidity," Journal of Financial Services Research, Springer, vol. 33(1), pages 21-36, February.

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