IDEAS home Printed from https://ideas.repec.org/p/jmp/jm2017/pzo81.html
   My bibliography  Save this paper

How vertical relationships and external funding affect investment efficiency and timing?

Author

Listed:
  • Dimitrios Zormpas

Abstract

In this paper we consider a potential investor who contemplates entering an uncertain new market under two conditions: i) a prerequisite for the project to take place is the purchase of a discrete input from an upstream firm with market power and ii) the completion of the investment is conditional on the participation of an investment partner who is willing to bear some of the investment cost receiving compensation in return. Using the real option approach, we find that the involvement of any of the two alien agents causes the postponement of the completion of the investment and we discuss how these timing discrepancies are reflected on the value of the option to invest in the project. We next analyze the synchronous effect of outsourcing and external funding both in a non-cooperative and in a cooperative (Nash bargaining solution) game-theoretic setting and we show how the endogeneity of the sunk investment cost affects the timing and the value of the option to invest in projects characterized by uncertainty and irreversibility.

Suggested Citation

  • Dimitrios Zormpas, 2017. "How vertical relationships and external funding affect investment efficiency and timing?," 2017 Papers pzo81, Job Market Papers.
    • Handle: RePEc:jmp:jm2017:pzo81
    as

    Download full text from publisher

    File URL: https://ideas.repec.org/jmp/2017/pzo81.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. repec:mfj:journl:v:16:y:2010:i:3-4:p:219-254 is not listed on IDEAS
    2. Huisman, K.J.M. & Kort, P.M. & Pawlina, G. & Thijssen, J.J.J., 2003. "Strategic Investment Under Uncertainty : Merging Real Options with Game Theory," Discussion Paper 2003-6, Tilburg University, Center for Economic Research.
    3. Azevedo, Alcino & Paxson, Dean, 2014. "Developing real option game models," European Journal of Operational Research, Elsevier, vol. 237(3), pages 909-920.
    4. Morellec, Erwan & Zhdanov, Alexei, 2005. "The dynamics of mergers and acquisitions," Journal of Financial Economics, Elsevier, vol. 77(3), pages 649-672, September.
    5. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, April.
    6. Jonathan P. O'Brien & Timothy B. Folta & Douglas R. Johnson, 2003. "A real options perspective on entrepreneurial entry in the face of uncertainty," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 24(8), pages 515-533.
    7. Jeffrey J. Reuer & Tony W. Tong, 2007. "Corporate investments and growth options," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 28(8), pages 863-877.
    8. Alvarez, Luis H.R. & Stenbacka, Rune, 2007. "Partial outsourcing: A real options perspective," International Journal of Industrial Organization, Elsevier, vol. 25(1), pages 91-102, February.
    9. Banerjee, Shantanu & Güçbilmez, Ufuk & Pawlina, Grzegorz, 2014. "Optimal exercise of jointly held real options: A Nash bargaining approach with value diversion," European Journal of Operational Research, Elsevier, vol. 239(2), pages 565-578.
    10. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    11. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 101(4), pages 707-727.
    12. Di Corato, Luca & Moretto, Michele & Rossini, Gianpaolo, 2017. "Financing flexibility: The case of outsourcing," Journal of Economic Dynamics and Control, Elsevier, vol. 76(C), pages 35-65.
    13. Cvitanic, Jaksa & Radas, Sonja & Sikic, Hrvoje, 2011. "Co-development ventures: Optimal time of entry and profit-sharing," Journal of Economic Dynamics and Control, Elsevier, vol. 35(10), pages 1710-1730, October.
    14. Phanish Puranam & Harbir Singh & Saikat Chaudhuri, 2009. "Integrating Acquired Capabilities: When Structural Integration Is (Un)necessary," Organization Science, INFORMS, vol. 20(2), pages 313-328, April.
    15. Chevalier-Roignant, Benoît & Flath, Christoph M. & Huchzermeier, Arnd & Trigeorgis, Lenos, 2011. "Strategic investment under uncertainty: A synthesis," European Journal of Operational Research, Elsevier, vol. 215(3), pages 639-650, December.
    16. Billette de Villemeur, Etienne & Ruble, Richard & Versaevel, Bruno, 2014. "Investment timing and vertical relationships," International Journal of Industrial Organization, Elsevier, vol. 33(C), pages 110-123.
    17. Marco Antonio Guimaraes Dias & Jose Paulo Teixeira, 2010. "Continuous-Time Option Games: Review of Models and Extensions," Multinational Finance Journal, Multinational Finance Journal, vol. 14(3-4), pages 219-254, September.
    18. Lukas, Elmar & Mölls, Sascha & Welling, Andreas, 2016. "Venture capital, staged financing and optimal funding policies under uncertainty," European Journal of Operational Research, Elsevier, vol. 250(1), pages 305-313.
    19. Rita Gunther McGrath & Atul Nerkar, 2004. "Real options reasoning and a new look at the R&D investment strategies of pharmaceutical firms," Strategic Management Journal, Wiley Blackwell, vol. 25(1), pages 1-21, January.
    20. Mulherin, J. Harold & Boone, Audra L., 2000. "Comparing acquisitions and divestitures," Journal of Corporate Finance, Elsevier, vol. 6(2), pages 117-139, July.
    21. Jing Li & Charles Dhanaraj & Richard L. Shockley, 2008. "Joint venture evolution: extending the real options approach," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 29(4), pages 317-336.
    22. David Benson & Rosemarie H. Ziedonis, 2009. "Corporate Venture Capital as a Window on New Technologies: Implications for the Performance of Corporate Investors When Acquiring Startups," Organization Science, INFORMS, vol. 20(2), pages 329-351, April.
    23. Bruce Kogut, 1991. "Joint Ventures and the Option to Expand and Acquire," Management Science, INFORMS, vol. 37(1), pages 19-33, January.
    24. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411-411.
    25. Michele Moretto & Gianpaolo Rossini, 2012. "Flexible Outsourcing[1]," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 33, pages 47-59, January.
    26. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
    27. Tony W. Tong & Yong Li, 2011. "Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acquisition," Organization Science, INFORMS, vol. 22(3), pages 659-674, June.
    28. Vareska Van de Vrande & Wim Vanhaverbeke, 2013. "How Prior Corporate Venture Capital Investments Shape Technological Alliances: A Real Options Approach," Entrepreneurship Theory and Practice, , vol. 37(5), pages 1019-1043, September.
    29. Bruce Kogut & Nalin Kulatilaka, 1994. "Operating Flexibility, Global Manufacturing, and the Option Value of a Multinational Network," Management Science, INFORMS, vol. 40(1), pages 123-139, January.
    30. Lambrecht, Bart M., 2004. "The timing and terms of mergers motivated by economies of scale," Journal of Financial Economics, Elsevier, vol. 72(1), pages 41-62, April.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Dimitrios Zormpas, 2021. "Jointly Held Investment Options and Vertical Relationships," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 58(4), pages 513-530, June.
    2. Lukas, Elmar & Thiergart, Sascha, 2019. "The interaction of debt financing, cash grants and the optimal investment policy under uncertainty," European Journal of Operational Research, Elsevier, vol. 276(1), pages 284-299.
    3. Han Smit & Enrico Pennings & Sjoerd Bekkum, 2017. "Real options and institutions," Journal of International Business Studies, Palgrave Macmillan;Academy of International Business, vol. 48(5), pages 620-644, July.
    4. Li, Yong & James, Barclay & Madhavan, Ravi & Mahoney, Joseph T., 2006. "Real Options: Taking Stock and Looking Ahead," Working Papers 06-0114, University of Illinois at Urbana-Champaign, College of Business.
    5. Sharon Belenzon & Victor Manuel Bennett & Andrea Patacconi, 2019. "Flexible Production and Entry: Institutional, Technological, and Organizational Determinants," NBER Working Papers 25659, National Bureau of Economic Research, Inc.
    6. Di Corato, Luca & Moretto, Michele & Rossini, Gianpaolo, 2017. "Financing flexibility: The case of outsourcing," Journal of Economic Dynamics and Control, Elsevier, vol. 76(C), pages 35-65.
    7. Feng Xu & Xin (Robert) Luo & Hongyun Zhang & Shan Liu & Wei (Wayne) Huang, 2019. "Do Strategy and Timing in IT Security Investments Matter? An Empirical Investigation of the Alignment Effect," Information Systems Frontiers, Springer, vol. 21(5), pages 1069-1083, October.
    8. Sharon Belenzon & Victor Manuel Bennett & Andrea Patacconi, 2019. "Flexible Production and Entry: Institutional, Technological, and Organizational Determinants," Strategy Science, INFORMS, vol. 4(3), pages 193-216, September.
    9. Jeffrey J. Reuer & Tony W. Tong, 2007. "Corporate investments and growth options," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 28(8), pages 863-877.
    10. Carol Alexander & Xi Chen, 2021. "Model risk in real option valuation," Annals of Operations Research, Springer, vol. 299(1), pages 1025-1056, April.
    11. Tarsalewska, Monika, 2018. "Buyouts under the threat of preemption," Journal of Banking & Finance, Elsevier, vol. 89(C), pages 39-58.
    12. M. Moretto & G. Rossini, 2015. "Vertical flexibility, outsourcing and the financial choices of the firm," Working Papers wp1009, Dipartimento Scienze Economiche, Universita' di Bologna.
    13. Ferreira, Ricardo M. & Pereira, Paulo J., 2021. "A dynamic model for venture capitalists’ entry–exit investment decisions," European Journal of Operational Research, Elsevier, vol. 290(2), pages 779-789.
    14. Bart M. Lambrecht & Grzegorz Pawlina, 2010. "Corporate Finance and the (In)efficient Exercise of Real Options," Multinational Finance Journal, Multinational Finance Journal, vol. 14(3-4), pages 189-217, September.
    15. Vareska Van de Vrande & Wim Vanhaverbeke, 2013. "How Prior Corporate Venture Capital Investments Shape Technological Alliances: A Real Options Approach," Entrepreneurship Theory and Practice, , vol. 37(5), pages 1019-1043, September.
    16. Puay Khoon Toh & Shiva Agarwal, 2023. "The option value in complements within platform‐based ecosystems," Strategic Management Journal, Wiley Blackwell, vol. 44(2), pages 576-609, February.
    17. 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.
    18. Song, Sangcheol, 2022. "Determining investment size and local embeddedness under host market uncertainty and growth rates," International Business Review, Elsevier, vol. 31(2).
    19. Choi, Jongmoo Jay & Ju, Ming & Trigeorgis, Lenos & Zhang, Xiaotian Tina, 2021. "Outsourcing flexibility under financial constraints," Journal of Corporate Finance, Elsevier, vol. 67(C).
    20. Pennings, Enrico, 2017. "Real options with ex-post division of the surplus," Journal of Banking & Finance, Elsevier, vol. 81(C), pages 200-206.

    More about this item

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:jmp:jm2017:pzo81. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: RePEc Team (email available below). General contact details of provider: https://ideas.repec.org/jmp.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.