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Abandonment Options and Information System Design

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  • Anil Arya

    (The Ohio State University)

  • Jonathan Glover

    (Carnegie Mellon University)

Abstract

We study a principal-agent model of moral hazard in which the principal has an abandonment option. The option to abandon a project midstream limits a firm's downside risk. From a consumption (production) perspective, the option is clearly beneficial. However, from an incentive perspective, the option can be costly. Removing the lower tail of the project's underlying cash flow distribution also eliminates the information it contains about an agent's (unobservable) productive input. In addition, there is also the issue that the option holder cannot always (ex ante) commit to the precise circumstances under which the option will be exercised. These concerns introduce an interaction in the valuation of the abandonment option and information system. In particular, the manner in which information is coarsened and the direction of the flow of information are critical design parameters that affect option value.

Suggested Citation

  • Anil Arya & Jonathan Glover, 2003. "Abandonment Options and Information System Design," Review of Accounting Studies, Springer, vol. 8(1), pages 29-45, March.
    • Handle: RePEc:spr:reaccs:v:8:y:2003:i:1:d:10.1023_a:1022695705845
    DOI: 10.1023/A:1022695705845
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    References listed on IDEAS

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