Strategic Exercise of Real Options:

Investment Decisions in Technological Systems

Kevin Zhu

Graduate School of Management

University of California

Irvine, CA 92697-3125

http://www.gsm.uci.edu/~kzhu/

John P. Weyant

Stanford University

Stanford, CA 94305-4026

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.