Strategic Exercise of Real Options:

Investment Decisions in Technological Systems

 

Kevin Zhu

University of California, San Diego

 

John P. Weyant

Stanford University

 

Journal of Systems Science and Systems Engineering, 2003, Vol. 12, No. 3, pp. 257-278.

 

Abstract

 

Viewing investment projects in new technologies as real options, this paper studies the effects of endogenous competition and asymmetric information on the strategic exercise of real options. We first develop a multi-period, game-theoretic model and show how competition leads to early exercise and aggressive investment behaviors and how competition erodes option values. We then relax the typical full-information assumption found in the literature and allow information asymmetry to exist across firms. Our model shows, in contrast to the literature that payoff is independent of the ordering of exercise, that the sequential exercise of real options may generate both informational and payoff externalities. We also find some surprising but interesting results such as having more information is not necessarily better.

 

 

Key words:

Technology investment, competition, real options, game theory, dynamic games, incomplete information, technological systems, and technology innovation.