Strategic Investment: Real Options and Games

Strategic Investment: Real Options and Games

Strategic Investment: Real Options and Games

Strategic Investment: Real Options and Games


Corporate finance and corporate strategy have long been seen as different sides of the same coin. Though both focus on the same broad problem, investment decision-making, the gap between the two sides--and between theory and practice--remains embarrassingly large. This book synthesizes cutting-edge developments in corporate finance and related fields--in particular, real options and game theory--to help bridge this gap. In clear, straightforward exposition and through numerous examples and applications from various industries, Han Smit and Lenos Trigeorgis set forth an extended valuation framework for competitive strategies.

The book follows a problem-solving approach that synthesizes ideas from game theory, real options, and strategy. Thinking in terms of options-games can help managers address questions such as: When is it best to invest early to preempt competitive entry, and when to wait? Should a firm compete in R&D or adopt an accommodating stance? How does one value growth options or infrastructure investments? The authors provide a wide range of valuation examples, such as acquisition strategies, R&D investment in high-tech sectors, joint research ventures, product introductions in consumer electronics, infrastructure, and oil exploration investment.

Representing a major step beyond standard real options or strategy analysis, and extending the power of real options and strategic thinking in a rigorous fashion, Strategic Investment will be an indispensable guide and resource for corporate managers, MBA students, and academics alike.


I used to think I was indecisivebut now
I’m not so sure
— Anonymous

I.1. About This Book

In this book we present a new perspective on strategic investment, drawing on and synthesizing new valuation methods from finance, such as real options, and basic concepts from industrial organization and game theory. This book on new approaches to strategic valuation aims at both a professional and an academic audience. We synthesize cutting-edge ideas on strategic valuation, which are communicated in accessible language and illustrated with examples and applications. Our approach will be helpful to professional managers and students of strategy in developing a conceptual framework and choosing the tools for strategic investment decisions. Such an applied orientation provides critical insight into both the opportunities and the potential pitfalls of strategy implementation.

The gap between finance and corporate strategy remains embarrassingly large, as academics and practitioners alike have recognized for some time now. the most important managerial decisions —in terms of both the size of expenditures and their impact on the future of the firm — are strategic decisions, yet they are the least well understood and often are made without the discipline of rigorous analysis. For such strategic decisions, the traditional discounted-cash-flow (DCF) approach is often shortsighted. Strategic thinking and capital budgeting should be combined explicitly when firms make capital investments to gain strategic advantage. Traditional methods of appraising projects do well when valuing bonds, deciding on maintenance or replacement, or determining other passive investments in a stable environment where a stream of cash flows can be well specified. These methods, however, have serious shortcomings in valuing investments when management has the ability to control future cash flows and revise future decisions, particularly when current investment may interact with future investments (growth options), may

Special thanks to Mikhael Shor of Vanderbilt University for identifying some of the quota
tions appearing in the chapter headings in this book.

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