Forgoing the Flexibility of Real Options: When and Why Firms Commit to Investment Decisions

Authors


  • *I would like to thank Xavier Olleros, Veronique Ambrosini (BJM Associate Editor) and the BJM reviewers for their very helpful comments and suggestions.

Abstract

Real option investments benefit from the flexibility associated with the possibility of abandonment should investment returns prove insufficient. But a firm also benefits from making commitments that engender reciprocal commitments on the part of employees and partner firms, and that allow the firm to address markets that exhibit increasing returns with the speed and scale required for success. I investigate the conditions under which large firms commit to investments in small firm equity alliances and acquisitions, and find that large firms commit to relationships that they initiate and that are subject to a high degree of rivalry. Uncertainty was not a significant predictor of the choice to commit. My findings point to the discretionary nature of the choice to commit and to firms' willingness to commit to investment decisions, despite high uncertainty, during periods of strong growth.

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