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Real Options in an Aymmetric Duopoly: Who Benefits from your Competitive Disadvantage

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  • Pawlina, G.
  • Kort, P.M.

    (Tilburg University, Center for Economic Research)

Abstract

This paper considers the impact of investment cost asymmetry on the value and optimal real option exercise strategies of firms under imperfect competition.Both firms have an opportunity to invest in a project enhancing (ceteris paribus) the profit now.We show that three types of equilibria exist and derive critical levels of cost asymmetry separating the regions in which they prevail.The presence of strategic interactions leads to counter-intuitive results.First, depending on the level of asymmetry, a marginal increase in the investment cost of the firm with the cost disadvantage can increase this firm's own value.Second, such a cost increase can result in a decrease in value of the competitor.Moreover, we discuss the welfare implications of the optimal exercise strategies and show that the presence of identical firms can result in a socially less desirable outcome than if one of the competitors has a significant investment cost disadvantage.Finally, we prove that profit uncertainty always delays investment, even in the presence of a strategic option of becoming the first investor.

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2001-95.

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Date of creation: 2001
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Handle: RePEc:dgr:kubcen:200195

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Web page: http://center.uvt.nl

Related research

Keywords: options; duopoly; capital budgeting; social welfare; investment;

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  1. Decamps, J.-P. & Mariotti, T., 2000. "Irreversible Investment and Learning Expternalities," Papers 00-534, Toulouse - GREMAQ.
  2. Guiso, L. & Parigi, G., 1996. "Investment and Demand Uncertainty," Papers 289, Banca Italia - Servizio di Studi.
  3. Nalin Kulatilaka & Enrico C. Perotti, 1998. "Strategic Growth Options," Management Science, INFORMS, vol. 44(8), pages 1021-1031, August.
  4. Grenadier, Steven R, 1999. "Information Revelation through Option Exercise," Review of Financial Studies, Society for Financial Studies, vol. 12(1), pages 95-129.
  5. Fudenberg, Drew & Tirole, Jean, 1985. "Preemption and Rent Equilization in the Adoption of New Technology," Review of Economic Studies, Wiley Blackwell, vol. 52(3), pages 383-401, July.
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  7. Reinganum, Jennifer F, 1981. "On the Diffusion of New Technology: A Game Theoretic Approach," Review of Economic Studies, Wiley Blackwell, vol. 48(3), pages 395-405, July.
  8. Mason, R. & Weeds, H., 2000. "Networks, options and preemptions," Discussion Paper Series In Economics And Econometrics 0013, Economics Division, School of Social Sciences, University of Southampton.
  9. Han T. J. Smit & L. A. Ankum, 1993. "A Real Options and Game-Theoretic Approach to," Financial Management, Financial Management Association, vol. 22(3), Fall.
  10. Williams, Joseph T, 1993. "Equilibrium and Options on Real Assets," Review of Financial Studies, Society for Financial Studies, vol. 6(4), pages 825-50.
  11. Wesley M. Cohen & Daniel A. Levinthal, 1994. "Fortune Favors the Prepared Firm," Management Science, INFORMS, vol. 40(2), pages 227-251, February.
  12. Enrico Perotti & Silvia Rossetto, 2000. "Internet Portals as Portfolios of Entry Options," Tinbergen Institute Discussion Papers 00-105/2, Tinbergen Institute.
  13. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, December.
  14. 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.
  15. Stefanie Kleimeier & William L. Megginson, 2000. "Are Project Finance Loans Different From Other Syndicated Credits?," Journal of Applied Corporate Finance, Morgan Stanley, vol. 13(1), pages 75-87.
  16. 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.
  17. 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.
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