The value of managerial flexibility is assessed empirically using data on prices, unit costs, ore extraction, grade, reserves, and metal output for a panel of twenty one Canadian copper mines. A real-option model is estimated and solved to yield the value of the project as well as the option value that is associated with flexible operation. Most previous empirical researchers have considered the initial-investment decision but have neglected the possibility of flexible operation thereafter. Moreover, although they have assumed that price is stochastic, they have ignored cost and reserve uncertainty. Finally, they have modeled price as a geometric Brownian motion or other nonstationary process. Transition equations for three state variables, copper price, unit cost, and remaining reserves, are estimated here. Differences in assumptions compared to previous studies (stationary vs. nonstationary stochastic processes and flexible vs. inflexible operating policies) are found to lead to large differences in estimated project and option values.
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Paper provided by UBC Department of Economics in its series UBC Departmental Archives with number
98-02.
Find related papers by JEL classification: D21 - Microeconomics - - Production and Organizations - - - Firm Behavior G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy L72 - Industrial Organization - - Industry Studies: Primary Products and Construction - - - Mining, Extraction, and Refining: Other Nonrenewable Resources
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