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Valuing Joint Ventures Using Real Options

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Author Info
Ulrich Pape (ESCP-EAP European School of Management Berlin)
Stephan Schmidt-Tank (ESCP-EAP European School of Management Berlin)

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Abstract

As the valuation of strategic measures becomes increasingly important, relatively few articles have discussed the valuation methods pertained for joint ventures. This paper shows that real options contribute to a better valuation of joint venture projects through superior reflection of the value drivers compared to traditional valuation methodology. Particularly, the strategic value of a joint venture and the value of flexibility that stems from a less than full commitment can be determined using options valuation. Besides reviewing the basics of real options, the paper discusses the key levers of joint ventures and shows the power of real options in the valuation process. We apply four option types (option to defer, option to expand/acquisition option, option to innovate, and option to abandon) to an imaginary joint venture example and show how to use the Black/Scholes and binomial valuation techniques to value these options. Of the four option types, particularly the option to innovate is important, as it allows to reflect the strategic value of a joint venture generating future business opportunities. Despite its advantages, this valuation methodology also has some drawbacks that are discussed in the concluding section.

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Publisher Info
Paper provided by EconWPA in its series Finance with number 0503030.

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Length: 32 pages
Date of creation: 31 Mar 2005
Date of revision:
Handle: RePEc:wpa:wuwpfi:0503030

Note: Type of Document - pdf; pages: 32. Working Paper Nr. 7, ESCP- EAP Europäische Wirtschaftshochschule Berlin, September 2004.
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Web page: http://129.3.20.41

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Related research
Keywords: Joint ventures; real options; option valuation; Black/Scholes model; binomial option valuation;

Other versions of this item:

Find related papers by JEL classification:
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

This paper has been announced in the following NEP Reports:

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  1. Sydney D. Howell & Axel J. Jägle, 1997. "Laboratory Evidence on How Managers Intuitively Value Real Growth Options," Journal of Business Finance & Accounting, Blackwell Publishing, vol. 24(7&8), pages 915-935. [Downloadable!] (restricted)
  2. 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.
  3. Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March. [Downloadable!] (restricted)
  4. Paul W Beamish & John C Banks, 1987. "Equity Joint Ventures and Theory of the Multinational Enterprise," Journal of International Business Studies, Palgrave Macmillan Journals, vol. 18(2), pages 1-16, June. [Downloadable!] (restricted)
  5. Lenos Trigeorgis, 1993. "Real Options and Interactions With Financial Flexibility," Financial Management, Financial Management Association, vol. 22(3), Fall.
  6. J Michael Geringer & Louis Hebert, 1991. "Measuring Performance of International Joint Ventures," Journal of International Business Studies, Palgrave Macmillan Journals, vol. 22(2), pages 249-263, June. [Downloadable!] (restricted)
  7. Pennings, Enrico & Lint, Onno, 1997. "The option value of advanced R & D," European Journal of Operational Research, Elsevier, vol. 103(1), pages 83-94, November. [Downloadable!] (restricted)
  8. Majd, Saman & Pindyck, Robert S., 1987. "Time to build, option value, and investment decisions," Journal of Financial Economics, Elsevier, vol. 18(1), pages 7-27, March. [Downloadable!] (restricted)
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  9. McConnell, John J & Nantell, Timothy J, 1985. " Corporate Combinations and Common Stock Returns: The Case of Joint Ventures," Journal of Finance, American Finance Association, vol. 40(2), pages 519-36, June. [Downloadable!] (restricted)
  10. Peter J Buckley & Mark Casson, 1996. "An Economic Model of International Joint Venture Strategy," Journal of International Business Studies, Palgrave Macmillan Journals, vol. 27(5), pages 849-876, December. [Downloadable!] (restricted)
  11. Weeds, Helen, 2002. "Strategic Delay in a Real Options Model of R&D Competition," Review of Economic Studies, Blackwell Publishing, vol. 69(3), pages 729-47, July.
    Other versions:
  12. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring. [Downloadable!] (restricted)
  13. Linda Longfellow Blodgett, 1991. "Partner Contributions as Predictors of Equity Share in International Joint Ventures," Journal of International Business Studies, Palgrave Macmillan Journals, vol. 22(1), pages 63-78, March. [Downloadable!] (restricted)
  14. Lenos Trigeorgis, 2002. "Real options and investment under uncertainty: What do we know?," Research series 200205-3, National Bank of Belgium. [Downloadable!]
  15. Lander, Diane M. & Pinches, George E., 1998. "Challenges to the Practical Implementation of Modeling and Valuing Real Options," The Quarterly Review of Economics and Finance, Elsevier, vol. 38(3, Part 2), pages 537-567. [Downloadable!] (restricted)
  16. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June. [Downloadable!] (restricted)
  17. Pindyck, Robert S., 1990. "Irreversibility, uncertainty, and investment," Working papers 3137-90., Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
    Other versions:
  18. Tailan Chi & Donald J McGuire, 1996. "Collaborative Ventures and Value of Learning: Integrating the Transaction Cost and Strategic Option Perspectives on the Choice of Market Entry Modes," Journal of International Business Studies, Palgrave Macmillan Journals, vol. 27(2), pages 285-307, June. [Downloadable!] (restricted)
  19. Peter J Buckley & Mark Casson, 1996. "An Economic Model of International Joint Venture Strategy," Journal of International Business Studies, Palgrave Macmillan Journals, vol. 27(4), pages 849-876, December. [Downloadable!] (restricted)
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