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 sidesand between theory and practiceremains embarrassingly large. This book synthesizes cutting-edge developments in corporate finance and related fieldsin particular, real options and game theoryto 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.
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About the Author
Han T. J. Smit is HAL Professor of Private Equity at Erasmus University in Rotterdam. Lenos Trigeorgis has been the Bank of Cyprus Chair Professor of Finance at the University of Cyprus and Visiting Professor of Finance at the University of Chicago. His book Real Options is a classic in the field.
Read an Excerpt
Strategic InvestmentReal Options and Games
By Han T.J. Smit Lenos Trigeorgis
PRINCETON UNIVERSITY PRESSCopyright © 2004 Han T.J. Smit and Lenos Trigeorgis
All right reserved.
Chapter OneCorporate Finance and Strategic Planning: A Linkage
Life can be understood backward, but ... it must be lived forward. - Soren Kierkegaard (1813-1855)
This chapter takes a first step toward closing the gap between traditional corporate finance theory and strategic planning. To put issues in a broad perspective, figure 1.1 summarizes three approaches to strategic planning and their impact on the market value of the firm. This conceptual framework aligns the design of an investment strategy with the value of the firm. Consider the various sources of economic or market value a firm can create. As shown in the left-hand column, the market value of a firm is not completely captured by the expected cash flow generated by the tangible assets that are currently in place (measured by NPV). Stock market prices partly reflect a firm's strategic growth potential. This value derives from investment opportunities that the firm may undertake in the future under the right circumstances, and is sensitive to competitive moves. The strategic option value of a firm can be vulnerable not just to the actions of incumbents, but also to the unanticipated entry of new rivals with entirely new technologies that can modify the competitive landscape in which the firm operates.
Investment appraisal methods should capture the components of flexibility and strategic value, as they may contribute significantly to the firm's market value in an uncertain competitive environment. The flexibility and strategic considerations of importance to practicing managers can now be brought into a rigorous analysis in a fashion consistent with the tenets of modern finance and the maximization of shareholder value. The right-hand column in figure 1.1 shows the valuation approach based on insights from real options and game theory, which captures additional flexibility and strategic value not measured by cash flow benefits per se. This approach considers growth opportunities to be a package of corporate real options that is actively managed by the firm and may be affected by competitors actions and by new technologies. If a firm's investment decisions are contingent upon and sensitive to competitors' moves, a game-theoretic treatment can be helpful. Competitive strategies should be analyzed using a combination of option valuation and game-theoretic industrial organization principles, as the two may interact.
To link corporate strategy with the value creation of the firm, one should identify the investment opportunity's value drivers. These value drivers provide an interface between the quantitative project valuation methodology and the qualitative strategic thinking process, focusing on the sources of value creation in strategic planning. The second column in figure 1.1 suggests that to understand total strategic value creation, one must examine, not only the traditional value drivers that focus on why a particular investment is more valuable for a company than for its competitors, but also the important value drivers for capitalizing on the firm's future growth opportunities, and how strategic moves can appropriate the benefits of those growth opportunities, as well as limiting risk if unfavorable developments occur.
This broader framework provides deeper insights for competitive strategic planning. As the strategies of firms in a dynamic, high-tech environment confirm, adaptability is essential in capitalizing on future investment opportunities and in responding appropriately to competitive moves. Adapting to, or creating, changes in the industry or in technology is crucial for success in dynamic industries.
The rest of this chapter is organized as suggested by the columns of figure 1.1. Starting from the left with shareholders' (market) value, and the components of this value observed from stock prices in financial markets, we reason back to the origins of this value in the real (product) markets and to corporate strategy. The market value components are discussed in section 1.2. Section 1.3 reviews the relevant valuation approaches, and the need for an expanded NPV criterion. Games are used to capture important competitive aspects of the strategy in a competitive environment. The value drivers of NPV, flexibility value, and strategic value, are discussed in section 1.4, relating the qualitative nature of competitive advantage and corporate strategy with quantifiable value creation measures for the firm. Section 1.5 discusses the options and games approach to capturing value creation in corporate strategy.
1.2. The Market Value of Growth Opportunities
In a dynamic environment, strategic adaptability is essential in capitalizing on favorable future investment opportunities or responding appropriately to competitive moves. A firm's growth opportunities and its strategic position in the industry are eventually reflected in stock market prices. Of course, not all stocks generate the same earnings stream or have the same growth potential. Growth stocks (e.g., in biotech, pharmaceuticals, or information technology) typically yield high price-earnings and market-to-book ratios. In fact, it is precisely the intangible and strategic value of their growth opportunities that determines most of the market value of high-tech firms in a continuously changing environment. As box 1.1 suggests, a proper analysis of this strategic growth option value is more difficult than price-earnings ratios or other multiples might imply. An underlying theory that can explain this market valuation is now available if we consider the strategic option characteristics of a firm's growth opportunities. There is indeed a clear appreciation in the market for a firm's bundle of corporate real options (present value of growth opportunities, or PVGO).
Table 1.1 shows that industries with higher volatility and (market, firm-specific, or total) risk (and as we will see, more option value) - such as information technology, pharmaceuticals, and consumer electronics - tend to have more valuable growth opportunities and a higher proportion of PVGO to price on average (above 80%) than other industries - such as transportation, chemicals, and electric power (below 60%). The former industries involve more unexpected technological changes and competitive moves; as the firm's (or the industry's) dynamic path unfolds, management must be better prepared to learn, adapt, and revise future investment decisions. The market appropriately rewards with higher market valuations those firms better able to cope with change, capitalizing on the upside potential while mitigating downside risk.
Growth firms (e.g., leading firms in information technology, pharmaceuticals, and consumer electronics) tend to have a higher option value component (PVGO) than income stocks, for two reasons. First, they tend to operate in more volatile industries (characterized by more frequent technological innovations and a more intensely competitive environment), with the higher underlying volatility being translated into higher (simple) option value. Second, they tend to have a greater proportion of compound (multistage or growth) options as opposed to simple (cash-generating) options, which amplifies their option value (being options on options). This higher (growth) option value, in turn, is translated into higher market valuations, which may appear excessive from the perspective of standard DCF valuation methods.
Figure 1.2 shows competitive strategies and relative market (price) performance over a two-year period in various high-tech industries. Panel A shows Microsoft's strategic moves and superior market performance in comparison to Netscape and other computer software rivals; panel B shows superior market performance by Intel and Sun Microsystems in comparison to IBM, Hewlett-Packard, and other computer hardware rivals; panel C shows Texas Instruments and Philips' performance relative to Sony, Time Warner, Matsushita, and other rivals in consumer electronics. We later provide specific examples of intelligent strategic decisions made by some of these leading companies.
1.3. From NPV to an Expanded (Strategic) NPV Criterion
In corporate finance, value creation for the firm's shareholders is the accepted criterion for making investment decisions or selecting business alternatives. A standard assumption is that financial markets are efficient and that the prices of all traded securities adjust rapidly to reflect relevant new information. When unanticipated information about a firm's investment opportunities or profits comes out in the financial markets, investors bid prices up or down until the expected return equals the return on investments with comparable risk. Under the assumption of a perfectly competitive financial market, all investors will apply the same risk-adjusted required return to discount the expected cash flows in valuing a particular asset. Standard valuation methodologies, such as NPV, aim at selecting investments that, to create value for existing shareholders, yield an expected return in excess of the return required in financial markets from assets of comparable risk.
Consider an investment opportunity in competitive real (product) markets characterized by costless entry and exit and homogeneous products. Early investment in such a project can produce only a temporary excess return. Competitors will eventually enter the industry and catch up. In the long run, equilibrium rates of return in competitive industries should be driven down to required returns. Most real markets, however, have significant entry barriers and are less competitive. In such imperfect real markets, it is possible for a firm to consistently earn excess returns that exceed the risk-adjusted return or the opportunity cost of capital. Firms can only earn excess returns because of some competitive advantage, such as achieving lower costs (e.g., as a result of absolute cost advantage or economies of scale) or earning a premium in product prices (e.g., as a result of product differentiation or monopoly power; see Porter 1980 and Shapiro 1991). Firms may also achieve higher returns because of more creative management, adaptive strategic planning, or organizational capabilities that enable it to better adapt to changes in the environment and to competitive moves.
In a DCF valuation, the project's expected cash flows, E(C[F.sub.t]) over a prespecified life (T) are discounted at a risk-adjusted discount rate k (derived from the prices of a twin traded security in the same risk class, typically from the Captial Asset Pricing Model, or CAPM) to arrive at the project's value [V.sub.0], that is,
[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII]. (1.1)
The net present value (NPV) is the above gross present value of discounted cash flows, [V.sub.0], minus the present value of the necessary investment cost outlay, [I.sub.0]. If positive, it represents the value creation for the shareholders undertaking this project.
With a standard NPV analysis, it is not practical to capture the full value of an investment strategy that involves real options. The NPV method implicitly assumes precommitment to future plans and defines an investment decision as a "now or never" proposition; it does not properly take into account the value of a wait-and-see strategy to make decisions as the value of the project evolves and uncertainty is revealed. Consider, for example, capacity expansion in the steel industry (see Dixit and Pindyck 1994, 8). If steel prices fall and the project turns out to be a bad investment, it may not be possible to recover the investment cost by selling the plant to another steel company (i.e., the investment may be irreversible). Such an irreversible decision should be made with caution, and flexibility in the timing of the investment becomes important. Managers should not invest immediately in such a project if they expect to earn just the opportunity cost of capital. In fact, timing flexibility in an uncertain environment gives management an incentive to wait until the project is more clearly successful, requiring a premium over the zero-NPV cutoff value, equal to the option value of deferment. This option value is analogous to an insurance premium because waiting may avoid the mistake of investing prematurely.
In fact, the opportunity to invest in a project is analogous to having a call option. Figure 1.3 illustrates this analogy. A call option gives its holder the right, by paying a specified cost within a given period, to exercise the option and acquire the underlying asset. If there are no opportunity costs of waiting or dividend-like benefits to holding the asset, the holder will postpone the decision to exercise until the expiration date (t). In the real-option case, the underlying asset is the present value of the cash flows from the completed and operating project, [V.sub.t], while the exercise price is the necessary investment outlay (at time t), [I.sub.t]. The ability to defer a project with an uncertain value, [V.sub.t], creates valuable managerial flexibility. If, during the later stage, market demand develops favorably and [V.sub.t] > [I.sub.t], the firm can make the investment and obtain the project's net present value at that time, NP[V.sub.t] = [V.sub.t] - [I.sub.t]. If, however, the project value turns out to be lower than originally expected ([V.sub.t] < [I.sub.t]), management can decide not to make the investment and its value is truncated at zero. In this case, the firm only loses what it has spent to obtain the option. The curve in figure 1.3 illustrates the current value of the option characterized by this truncated payoff. The value represented by this curve can be divided in two components, the static NPV of cash inflows and the timing flexibility component of value. The latter captures the premium over the zero-NPV threshold, representing the option value of deferment. This premium is generally lower if other options (besides the expected cash flows) may be generated from the project.
Investment decisions should thus be based on an expanded NPV criterion that incorporates, along with the direct NPV of expected cash flows from an immediate investment, the flexibility value of the combined options embedded in the project. That is,
Expanded NPV = passive NPV + flexibility (or option) value. (1.2)
An important next step in bridging the gap between traditional corporate finance theory and strategic planning is combining this real-options approach with game theory, taking into account competitive counteractions. For instance, the commercialization decision of Digital's Alpha chip was in fact greatly influenced by Intel's decisions regarding its Pentium processor; similarly, Philips' and Sony's strategy to commercialize the digital video disc was affected by competitive decisions by Toshiba and Time Warner, and vice versa. These decisions are better seen as strategic games against both nature and competition. Management's investment decisions are made with the explicit recognition that they may influence competitive reaction, which in turn impacts the value of the firm's investment opportunity.
The strategic value of early commitment in influencing competitive behavior must therefore be offset by the flexibility or option value of waiting. In the expanded or strategic NPV framework, investment has two main effects on a firm's value compared to a wait-and-see strategy: (1) A flexibility or option-value effect. This reflects management's ability to wait to invest under uncertain conditions. Early investment, although enhancing the commitment value of future growth opportunities, sacrifices flexibility value compared to a wait-and-see strategy. (2) A strategic commitment effect. Early investment can signal a credible commitment that can influence competitors' investment decisions. In part II of this book we illustrate how to quantify these value components when determining the expanded NPV for various (R & D) investment strategies. Box 1.2 provides a simple numerical example of an option game.
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Table of Contents
List of Figures xiList of Tables xviiList of Boxes xixAcknowledgments xxiIntroduction: Strategic Investment as Real Options and Games xxiiiI.1. Introduction: About This Book xxiii I.2. Real Options and Games: Linking Corporate Finance and Strategy xxivI.3. An Overview of the Book xxviiiPart I: Approaches to Strategic InvestmentChapter 1Corporate Finance and Strategic Planning: A Linkage 31.1. Introduction 31.2. The Market Value of Growth Opportunities 51.3. From NPV to an Expanded (Strategic) NPV Criterion 81.4. Value Drivers of NPV, Flexibility Value, and Strategic Value 131.4.1. Value Drivers of NPV 141.4.2. Drivers of Flexibility or Growth Option Value 211.4.3. Drivers of Strategic Value and Strategic Moves 241.5. Value Creation in Strategic Planning 321.6. Conclusions 33Chapter 2Strategic Management: Competitive Advantage and Value Creation 352.1. Introduction 352.2. Views of Value Creation of the Firm 382.2.1. Industry and Competitive Analysis 402.2.2. Strategic Conflict and Game Theory 432.2.3. Internal, Resource-Based View of the Firm 452.2.4. Dynamic Capabilities 492.2.5. Options and Games: A Linkage Approach 512.3. Competitive Advantage and Industry Evolution 532.3.1. Competitive Advantage in the Early and Growth Stages 542.3.2. Competitive Advantage in Mature Businesses 582.3.3.Creative Destruction and Adaptation as Source of Advantage 602.4. Portfolio Planning of Growth Opportunities 682.4.1. Boston Consulting Group Matrix 702.4.2. Exercise Timing of Options: The Tomato Garden Analogy 722.4.3. Real-Options Growth Matrix 762.5. Conclusions 90Chapter 3Corporate Real Options 933.1. Introduction 933.2. Options Valuation 943.2.1. Basic Nature of Options 983.2.2. From Financial to Real Options Valuation 1003.3. Overview of Common Real Options 1063.3.1. The (Simple) Option to Defer 1103.3.2. Options to Expand or Contract 1143.3.3. The Option to Abandon for Salvage or Switch Use 1163.3.4. The Option to Temporarily Shut Down 1193.3.5. Options to Switch Inputs or Outputs 1223.4. Prototype Examples: Valuing an R & D Program and a Mining Concession 1233.4.1. Valuing a Research and Development Program 1243.4.2. Valuing a Mine Concession (License) Using Certainty-Equivalent Valuation 1273.5. An In-Depth Case Application: Valuing Offshore Oil Concessions in the Netherlands 1343.5.1. Stages of Offshore Petroleum Development on the Dutch Continental Shelf 1343.5.2. Valuation Based on Replication in Financial Markets 1383.5.3. Main Insights 1493.6. Summary and Conclusions 154Appendix 3.1. Binomial Option Valuation 156Chapter 4Games and Strategic Decisions 1634.1. Introduction 1634.2. The Rules of the Game 1714.3. A Taxonomy of Basic Games 1814.3.1. Time to Launch under Competition (Symmetric Innovation Race) 1844.3.2. Asymmetric Innovation Race and Preemption 1864.3.3. Simultaneous Innovation Race When the Opponent's Capabilities Are Unknown 1894.4. Competitive Reactions in Quantity versus Price Competition 1914.4.1. Quantity Competition 1914.4.2. Price Competition 1984.4.3. Type of Competitive Reaction: Strategic Substitutes versus Complements 2004.5. Two-Stage Games: Strategic Value of Early Commitment 2024.5.1. Direct versus Strategic Effects of Investment Commitment 2034.5.2. Strategic Effect, Tough or Accommodating Positions, and Type of Competition 2054.6. Summary and Conclusions 208Appendix 4.1. A Chronology of Game Theory Developments 210Part II: Competitive Strategy and Games Chapter 5Simple Strategic Investment Games 2175.1. Introduction 2175.2. A Road Map for Analyzing Competitive Strategies 2185.3. One-Stage Strategic Investments 2225.4. Two-Stage (Compound) Options: The Case of Proprietary R & D 2265.5. Two-Stage Investments with Endogenous Competition 2295.5.1. Competition in Last (Production) Stage: Contrarian versus Reciprocating Competition 2295.5.2. Competition in Innovation Investment: Time-to-Market Races and Strategic Alliances 2425.6. Cooperation in the First Stage: Joint R & D Ventures 2475.7. Summary and Conclusions 251Chapter 6Flexibility and Commitment 2556.1. Introduction 2556.2. The Basic Two-Stage Game 2586.2.1. Equilibrium Quantities, Prices, and Payoff Values 2606.2.2. Valuation of Competitive Strategies 2626.3. Numerical Examples of Different Competitive Strategies under Contrarian versus Reciprocating Competition 2686.3.1. Competitive R & D Strategies under Quantity Competition 2686.3.2. Goodwill/Advertising Strategies under Price Competition 2786.4. Summary and Conclusions 285Appendix 6.1. Reaction Functions, Equilibrium Actions, and Values in Different Market Structures under Quantity or Price Competition 289Chapter 7Value Dynamics in Competitive R & D Strategies 2957.1. Introduction 2957.2. Literature on R & D Options 2967.3. The Basic Two-Stage R & D Game 2987.4. Critical Demand Zones/Sensitivity 3007.5. Technical R & D Uncertainty, Stochastic Reaction Functions, and Asymmetric Information with Signaling 3097.5.1. Technical R & D Uncertainty (under Symmetric Information) 3097.5.2. Imperfect/Asymmetric Information and Stochastic Reaction Functions 3117.5.3. Signaling Effects 3137.6. Learning Experience Cost Effects 3157.7 Competition versus Cooperation in R & D 3197.8 Summary and Conclusions 322Part III: Applications and Implications Chapter 8Case Applications 3298.1. Introduction 3298.2. Strategic Games in Consumer Electronics 3468.2.1. Winner Takes All versus Strategic Alliances in the Launch of Video Recorder Systems 3468.2.2. The Competition versus Coordination Game of the High-Density Disk 3508.3. Buy-and-Build Platform Acquisition Strategies 3528.3.1. Classifying Acquisitions Based on Options and Games 3538.3.2. Growth Option Value in a Buy-and-Build Strategy 3568.3.3. Competition in a Buy-and-Build Strategy 3608.4. Infrastructure Investment: The Case of European Airport Expansion 3668.4.1. Infrastructure Investment and Aviation Developments 3678.4.2. Infrastructure Valuation as an Options Game 3708.4.3. Implementation in the Case of Schiphol Airport 3828.5. Conclusions and Implications 389Chapter 9Continuous-Time Models and Applications 3939.1. Introduction and Overview 3939.2. Continuous-Time Version of Smit-Trigeorgis Framework 3969.2.1. Equilibrium Output and Values 3979.2.2. Strategic Entry Decisions 4019.2.3. Equilibrium Entry and Critical Demand Thresholds 4059.2.4. Benchmark Cases: Symmetric Competition and Monopoly 4089.3. Strategic Investment Timing under Uncertainty 4089.3.1. Strategic Interactions and the Timing of Investment 4089.3.2. Innovation with Uncertainty over Completion and Time Delays 4119.4. Exercise Strategies under Incomplete Information with Applications 4149.4.1. Entry and Preemption under Incomplete Information 4149.4.2. Applications 4169.5. General Equilibrium Investment Strategies under Imperfect Competition and Asymmetric Information 4199.5.1. Equilibrium Investment Strategies under Imperfect Competition 4199.5.2. Investment Strategies under Asymmetric Information 4219.6. Conclusions 423Appendix 9.1. Derivation of Option-Pricing Differential Equation 425Appendix 9.2. Discounted Profit Flow and Value Function 427Appendix 9.3. Sequential Stackelberg Leader-Follower Entry 428Chapter 10Overview and Implications 42910.1. Introduction 42910.1.1. Linking Corporate Finance and Strategic Planning 42910.1.2. An Expanded Valuation Framework to Capture Flexibility and Strategic Value 43110.2. Implications of the Strategic Options and Games Framework 43910.2.1. Timing Games for Simple Commercial Options 44010.2.2. Investment Games Involving Strategic Options 44210.3. Empirical Implications 445References 447Index 461
What People are Saying About This
In the study of investment decisions, it has been common to focus on either the financial or the strategic aspects of an investment. This admirable book combines the two perspectives, using the tools of real options and game theory. With its wide-ranging and eclectic assortment of theoretical models and case studies, the book will prove useful to students, practitioners, and researchers.
Robert L. McDonald, Erwin P. Nemmers Distinguished Professor of Finance, Kellogg School of Management, Northwestern University, author of "Derivatives Markets"
This book promises to have a very significant impact on the field of strategic management. For years, the field has struggled to find a way of reconciling two contradictory views: flexibility is good vs. commitment is good. Smit and Trigeorgis provide the framework and tools to evaluate when each strategy will create shareholder value. Very well written, the book provides a wealth of interesting examples. It will certainly be of interest to the strategy/investment analyst and MBA student.
Karel Cool, BP Chaired Professor of European Competitiveness, INSEAD
A tour de force. This book unifies two major strands of economic theory--real options and games--into a single, coherent framework, and then shows how these ideas can be applied to the formulation of corporate strategy. With deep knowledge, enlivened by zest and humor, the authors take the reader to the forefront of current thinking.
Carliss Y. Baldwin, William L. White Professor of Business Administration, Harvard Business School, coauthor of "Design Rules: The Power of Modularity"
This timely pioneering book by preeminent authorities in the field provides a powerful introduction to the combination of two important modern tools for investment decisions--real options and game theory. These tools are being increasingly used by consultants and firms. Smit and Trigeorgis show that it is possible to be straightforward and clear when analyzing real investments and framing business plans using sophisticated tools like real options and games. They bypass complexity and focus on intuition and applicability, providing a rich practical framework allowing the reader to analyze investment strategy with eagle-eyed wisdom. Even the most rigorous reader will recognize the power of simplicity in analyzing complex business problems and the richness of the case applications. It is the ideal text not only for undergraduate and MBA students but also for consultants and managers, who will finally get the first readable book on this topic.
Marco A.G. Dias, Petrobras
Strategic Investment: Real Options and Games provides a powerful synthesis of modern corporate finance and corporate strategy. Its arrival could not be more timely for the practice of strategic management. Cumulative developments in finance science and innovations in financial technology over the past three decades have had a profound impact on financial markets and financial institutions globally. However, their influence on the practice of strategic corporate finance has been far more limited. That is changing and as a consequence one can anticipate significant opportunities for innovation in strategic advice and its implementation in the impending future. Who better to prepare us for it than Han Smit and Lenos Trigeorgis, with their combined experiences as serious academic researchers, skilled consultants, and seasoned teachers? Their carefully constructed text uses actual case settings and hypothetical situations to exemplify the power of combining real options and game theory to clarify and quantify strategic analysis of the firm. Whether MBA student or seasoned professional, the reader is in for a treat: Bon Appetit!
Robert C. Merton, Harvard Business School and Nobel Laureate in Economic Sciences
This excellent book builds bridges across two dimensions. First, it synthesizes the real options approach to capital investment and game-theoretic analysis of strategic interactions. Second, it spans sophisticated theory and business practice. Academics as well as business managers can learn from it and enjoy its wonderfully clear exposition.
Avinash Dixit, author of "Lawlessness and Economics"
"Strategic Investment: Real Options and Games provides a powerful synthesis of modern corporate finance and corporate strategy. Its arrival could not be more timely for the practice of strategic management. Cumulative developments in finance science and innovations in financial technology over the past three decades have had a profound impact on financial markets and financial institutions globally. However, their influence on the practice of strategic corporate finance has been far more limited. That is changing and as a consequence one can anticipate significant opportunities for innovation in strategic advice and its implementation in the impending future. Who better to prepare us for it than Han Smit and Lenos Trigeorgis, with their combined experiences as serious academic researchers, skilled consultants, and seasoned teachers? Their carefully constructed text uses actual case settings and hypothetical situations to exemplify the power of combining real options and game theory to clarify and quantify strategic analysis of the firm. Whether MBA student or seasoned professional, the reader is in for a treat: Bon Appetit!"Robert C. Merton, Harvard Business School and Nobel Laureate in Economic Sciences
"This excellent book builds bridges across two dimensions. First, it synthesizes the real options approach to capital investment and game-theoretic analysis of strategic interactions. Second, it spans sophisticated theory and business practice. Academics as well as business managers can learn from it and enjoy its wonderfully clear exposition."-Avinash Dixit, author of Lawlessness and Economics
"A tour de force. This book unifies twomajor strands of economic theoryreal options and gamesinto a single, coherent framework, and then shows how these ideas can be applied to the formulation of corporate strategy. With deep knowledge, enlivened by zest and humor, the authors take the reader to the forefront of current thinking."Carliss Y. Baldwin, William L. White Professor of Business Administration, Harvard Business School, coauthor of Design Rules: The Power of Modularity
"In the study of investment decisions, it has been common to focus on either the financial or the strategic aspects of an investment. This admirable book combines the two perspectives, using the tools of real options and game theory. With its wide-ranging and eclectic assortment of theoretical models and case studies, the book will prove useful to students, practitioners, and researchers."Robert L. McDonald, Erwin P. Nemmers Distinguished Professor of Finance, Kellogg School of Management, Northwestern University, author of Derivatives Markets
"This book promises to have a very significant impact on the field of strategic management. For years, the field has struggled to find a way of reconciling two contradictory views: flexibility is good vs. commitment is good. Smit and Trigeorgis provide the framework and tools to evaluate when each strategy will create shareholder value. Very well written, the book provides a wealth of interesting examples. It will certainly be of interest to the strategy/investment analyst and MBA student."Karel Cool, BP Chaired Professor of European Competitiveness, INSEAD
"This timely pioneering book by preeminent authorities in the field provides a powerful introduction to the combination of two important modern tools for investment decisionsreal options and game theory. These tools are being increasingly used by consultants and firms. Smit and Trigeorgis show that it is possible to be straightforward and clear when analyzing real investments and framing business plans using sophisticated tools like real options and games. They bypass complexity and focus on intuition and applicability, providing a rich practical framework allowing the reader to analyze investment strategy with eagle-eyed wisdom. Even the most rigorous reader will recognize the power of simplicity in analyzing complex business problems and the richness of the case applications. It is the ideal text not only for undergraduate and MBA students but also for consultants and managers, who will finally get the first readable book on this topic."Marco A.G. Dias, Petrobras