Zhang, Zhou (2020) Applications of strategic real options in finance. PhD thesis, University of Warwick.

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Abstract

This thesis consists of three essays. In the first essay (Chapter 2) co-authored with A. Elizabeth Whalley, we incorporate optimism about future growth prospects into a real-options duopolistic setting. We show that optimism can change entry order: a more optimistic firm may enter first even if its competitor has higher profitability. Becoming a leader directly generates monopoly profits as extra benefit but potentially at a cost of losing some value of waiting. Furthermore, in contrast to the impact of optimism in non-competitive settings where optimism accelerates investment, a leader's optimism in duopolistic competition when it needs to enter pre-emptively could delay investment. Since optimism shortens the rival's monopoly period, it alleviates the pre-emption pressure from its rival which enables the firm to capture greater option value. Optimism can thus increase the firm's value even from a rational perspective.

The second essay (Chapter 3) is also co-authored with A. Elizabeth Whalley. In a duopoly entry game, we consider a delegated management problem where rational shareholders can hire managers with particular levels of optimism. We find that in equilibrium at most one form (i.e. the leader) would wish to hire an optimistic manager and that optimism is beneficial to the leader only when the two firms are close competitors. Defining a firm's first-mover advantage as its monopolistic profitability relative to duopolistic profitability, we find that the firm with relatively lower first-mover advantage compared to its rival would hire an optimistic manager and thus become the leader in equilibrium. Lower first-mover advantage implies the firm's monopoly profits account for a smaller portion of its value of being the leader. Therefore, its rival's optimism is less effective in discouraging the firm by reducing its leader's value.

The third essay (Chapter 4) is solo-authored which investigates the role of investment reversibility in determining the relation between product market competition and stock returns. We develop a unified real-option framework involving corporate investment and disinvestment decisions in a continuous-time Cournot-Nash equilibrium. The model predicts that stock returns are more negatively correlated with the level of competition when investment is more reversible. We use asset redeployability as a measure of investment reversibility and find robust empirical evidence supporting our theoretical prediction. This paper provides a new perspective (i.e. investment reversibility) to understand the competition-return relation which has mixed evidence in the existing literature.

Item Type:	Thesis (PhD)
Subjects:	H Social Sciences > HB Economic Theory H Social Sciences > HD Industries. Land use. Labor H Social Sciences > HG Finance
Library of Congress Subject Headings (LCSH):	Optimism, Profit, Duopolies, Competition, Real options (Finance), Capital investments
Official Date:	February 2020
Dates:	Date Event February 2020 UNSPECIFIED
Institution:	University of Warwick
Theses Department:	Warwick Business School
Thesis Type:	PhD
Publication Status:	Unpublished
Supervisor(s)/Advisor:	Whalley, A. Elizabeth ; Kim, Gi H. degree supervisor
Format of File:	pdf
Extent:	iv, 123 leaves : illustrations
Language:	eng

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