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Strategic Growth Options

  • Nalin Kulatilaka

    (School of Management, Boston University, Boston, Massachusetts 02215)

  • Enrico C. Perotti

    (University of Amsterdam and CEPR, 1018 WB Amsterdam, The Netherlands)

We provide a strategic rationale for growth options under uncertainty and imperfect competition. In a market with strategic competition, investment confers a greater capability to take advantage of future growth opportunities. This strategic advantage leads to the capture of a greater share of the market, either by dissuading entry or by inducing competitors to "make room" for the stronger competitor. As a result of this strategic effect, payoffs are in a rough sense more convex than in the case of no investment in a growth option. When the strategic advantage is strong, increased uncertainty encourages investment in growth options: higher uncertainty means more opportunity rather than simply larger risk. If the strategic effect is weak, the reverse is true. On the other hand, an increase in systematic risk discourages the acquisition of growth options. Our results contradict the view that volatility is a strong disincentive for investment.

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File URL: http://dx.doi.org/10.1287/mnsc.44.8.1021
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Article provided by INFORMS in its journal Management Science.

Volume (Year): 44 (1998)
Issue (Month): 8 (August)
Pages: 1021-1031

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Handle: RePEc:inm:ormnsc:v:44:y:1998:i:8:p:1021-1031
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  1. Dixit, A., 1988. "Entry And Exit Decisions Under Uncertainty," Papers 91, Princeton, Department of Economics - Financial Research Center.
  2. Richard J. Gilbert., 1988. "Mobility Barriers and the Value of Incumbency," Economics Working Papers 8895, University of California at Berkeley.
  3. Dixit, Avinash K., 1978. "A Model of Duopoly Suggesting a Theory of Entry Barriers," The Warwick Economics Research Paper Series (TWERPS) 125, University of Warwick, Department of Economics.
  4. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, Oxford University Press, vol. 101(4), pages 707-727.
  5. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716.
  6. Dixit, Avinash, 1979. "The Role of Investment in Entry-Deterrence," The Warwick Economics Research Paper Series (TWERPS) 140, University of Warwick, Department of Economics.
  7. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "An Intertemporal General Equilibrium Model of Asset Prices," Econometrica, Econometric Society, vol. 53(2), pages 363-84, March.
  8. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
  9. Hartman, Richard, 1972. "The effects of price and cost uncertainty on investment," Journal of Economic Theory, Elsevier, vol. 5(2), pages 258-266, October.
  10. Robert S. Pindyck, 1986. "Irreversible Investment, Capacity Choice, and the Value of the Firm," NBER Working Papers 1980, National Bureau of Economic Research, Inc.
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  12. Elie Appelbaum & Chin Lim, 1985. "Contestable Markets under Uncertainty," RAND Journal of Economics, The RAND Corporation, vol. 16(1), pages 28-40, Spring.
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