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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. Gilbert, Richard, 1988. "Mobility Barriers and the Value of Incumbency," Department of Economics, Working Paper Series qt52q9j63w, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  2. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
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  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.
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