Managers’ Incorporation of the Value of Real Options into their Long-Term Investment Decisions: An Experimental Investigation

April 30, 2010 @ 10:30 am – 12:00 pm America/New York Timezone
60 Luckie St NW Atlanta
Georgia 30303

ALC 432 – from 10.30am – 12.00pm

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While academic and practitioner literature has advocated the use of real options in firms’ longterm investment appraisal processes, few studies have examined the extent to which real options are incorporated into decisions when they are available for decision-making. Using two experiments, we examine supervising managers’ reliance on real options values in their decisions about funding for subordinates’ long-term investment project proposals. We predict and find with Experiment 1 that when making funding decisions, supervising managers rely less on the value of real options than on the value of a project’s planned implementation path. We predict and find with Experiment 2 that, holding information constant, a simple accounting change influences supervisors’ reliance on real options values in their funding decisions: they rely more on the real options components of project value when the amount is aggregated with (rather than displayed separately from) the value of the projects’ planned implementation paths in a financial summary of subordinates’ proposals. We provide evidence of the process underlying how the financial summary affects funding decisions – specifically, it does so by influencing perceptions of the relative accuracy of the planned path and real options components of value. Results for both experiments hold after controlling for participants’ knowledge of discounted cash flow and real options valuation and perceptions of risk in subordinates’ projects.