Real Options and Strategy

Lenos Trigeorgis

Executive Training & Conferences

© 2005 Real Options Group

 Objectives
 Why useful to know about real
options
 Recognizing real options
 NPV and managerial flexibility
 Types of real options
 Valuing real options (principles)
 Competition & strategy
 Benefits of real options
 Areas of application
Real Options/Flexibility Under
Uncertainty

Flexible Plans
Uncertain Opportuniti
Expected plans es
ty
long-term
strategy

Strat flexibility
egy
information
competition

volatile new capabilities

Current state Desired future states
Time markets

action plan
 Recognizing Real Options

Example: Flexible Airline Ticket

right (but not obligation) to take a particular flight

 pay more for an open ticket because it allows
flexibility
- can change date of travel or destination
 price difference between a flexible and fixed ticket
reflects the
option value
- additional value of flexibility to (adapt your plans
to) change
flexibility
 Recognizing Real Options

Real Options Ingredients

 flexibility, choice or right (but not obligation) to
do
something (take a contingent course of action) only
if beneficial
- upside-enhancing actions if circumstances prove
favourable
- downside loss-limiting actions if they prove
unfavorable

 specified cost to exercise the right


option
uncertainty - range of possible (value) outcomes
NPV and Managerial Flexibility

E( C t )

Traditional E ( NPV ) = V − I = ∑ t −I
(1 + k )
E C(t)
∑ 1( + k t) − I

Expected scenario of cash flows

over prespecified life (discount ed
at risk – adjusted rate, e.g., from
CAPM) k =r +β(rM −r )

Treating projects as independent,

make immediate accept/reject
decision
NPV and Managerial Flexibility
(cont.)

As if passive management; irrevocable
commitment to implied “operating strategy”
 In reality, management can depart from
original operating strategy/revise later
decisions (e.g. defer, expand, abandon)
 Managerial flexibility as a collection of
E C(t)
∑ 1( + k t) − I

corporate real options

 Conventional NPV does not adequately
account for options/flexibility due to
discretionary character/ dependence on
future events uncertain at present

Expanded (Strategic) NPV = Passive NPV +

Real Option Value
 Traditional NPV: Limitations


Cannot properly account for active
management (flexibility to adapt)

 Ignores “strategic” value considerations

E C(t)
∑ 1( + k t) − I

With uncertainty and managerial flexibility, NPV

(DCF ) is inadequate to properly capture the
asymmetries/ nonlinearities in the cash-flow
distribution and the changing project risk profile
or discount rates (across time and various
states)
 Past Attempts toward
Flexibility
Managers understand resource
allocation is a dynamic (and non-
linear) process

Sensitivity analysis
 Scenario planning (correlated)
 Simulation (Monte Carlo)
 Decision (Tree) Analysis
 “Fudging” the discount rate in DCF
 Who sponsors (“champion”); “strategic”
value
Incorporating Flexibility (Now)

Real options can capture the value of

managerial operating flexibility and
“strategic” value
Real options can occur naturally or may
be built in /acquired (at cost)
 Acquiring Real Options
A firm may acquire real options
through
 Ownership of natural resources (real estate,
oil field…)
 Technological Knowhow
 Reputation / Brand name
 Strategic alliances / Market position
Organizational capabilities / Infrastructure,
employees
 Intellectual property rights (patents, licenses,
leases…)
 Some Common Types
(Examples)
1. Defer
2. Staging/Abandon
3. Expansion (Growth)
4. Shut Down and Restart
5. Switch (Operating Flexibility)
6. Multiple Options (Portfolios)
7. Interacting Options
Categorizing (Common) Real
Options
Example 1 – Deferral Option
(Oil company E&P license)

Context
- North Sea oil company acquired a number of licence
blocks
- E&P rights to explore and produce oil over next 8
years
- at prevailing energy prices, most energy blocks
unprofitable
(high development costs)

oil E&P
 Common Real Options

Example 1 – Deferral Option

 Real Options Approach

- some blocks may be uneconomic to develop now
but could hold significant value in future should oil
prices rise
- oil company has flexibility to decide optimal timing to
develop
- develop (exercise option) when prices rise sufficiently
to make production profitable

timing
 Common Real Options

Example 1 – Deferral Option

Development
Rights
INVEST

Develop Operate Operate volatile oil prices

development
 Common Real Options

Example 2 – Staging/Abandon
Option
(Pharma R&D)
Context
- Pharma R&D investment structured in multiple
stages and full of uncertainties
(a) technological uncertainty (to invent safe and
effective
products)
(b) market uncertainty (probable demand for the
drug)

pharma R&D
 Common Real Options

Example 2 – Staging/Abandon
Option

Stage 1: Stage 2: Yes

Yes Yes Stage 3: Launch
Initial Development/
Marketing Drug
Research Clinical Trials
No No No

Uncertainty: Uncertainty:
technologically Abandon Uncertainty: Abandon demand Abandon
feasible? safe product? for drug?

Staging/gates
 Common Real Options

Example 3 – Expansion (Growth)

Option
(Bookseller Online)
Context
- leading retail bookseller interested in selling products
online
- company excited about the spectacular growth of the
Internet
but unsure about the economics (early online retailers
have seen
spectacular growth but also low negative cash flows)
- potential for cross selling into other areas (music,
software…)

B2C
 Common Real Options

Example 3 – Expansion Option

Retail book Exercising the first option

sales opens up numerous cross-
selling options
Sell
Books
Online
Uncertainties: Sell
Demand growth? Music
Competition? Online Sell
Capability? Software
Online

expansion
 Common Real Options
Example 4 – Shut Down & Restart
Option
(Energy Co’s Peak Power
Context Plants)
- US energy company investing in new, inefficient peak
power plants
(have 50-70% above-average marginal costs)
- cheaper to build than more efficient plants
- peaking plants extremely profitable in short periods
when electricity prices peak
- extreme volatility in power prices (can vary from $40 to
$7000/MWh)

peak power
 Common Real Options

Example 4 – Shut Down and

Restart

Operating marginal cost

Rights

Power Power Power volatile electricity price

On On On

Operating
 Common Real Options

Example 5 – Switch Option

(Multinational Auto Production)

Context
- US-based multinational auto producer considering
where
to base Latin American production facilities
supplying region
- concerned about exposure to
- exchange rate fluctuations
- changing labor costs and tax policies
- political uncertainty

auto
 Common Real Options

Example 5 – Switch Options

Produce Cars
in Brazil

Uncertainties:
Exchange Rate? Switch to
Labor costs? Argentina
Govt policies?

switch
 Common Real Options

Example 6 – Multiple (Portfolio)

Options
(Venture Capital)
Context
- Venture Capitalists manage portfolios of many
investment
opportunities
- Each individual opportunity has a small chance of a
very high
payoff (with expected return close to zero)
- Portfolio provides handsome returns (25-35%) due
to
flexibility to abandon failing projects while
expanding successful ones as uncertainty about the
venture gets resolved
venture
 Common Real Options

Example 6 – Multiple (Portfolio)

Options
Ideas Biz Plan OPTION TO EXERCISE Usual VC Statistics
t=0 t=1 t=2
Option 1 Successful 10% Success
Project 1 Option 2 venture 60% Breakeven
Option 3 30% Failure
Project 2 Breakeve (exit/ sale)
n
Project 3 Terminated 25-35% ROI

Project 4 Expected distribution Expected distribution of

of outcome for an outcome for a VC portfolio
individual venture
0 ROI

portfolios
 Understanding Real Options

Action Plan

Favourable
developments
underlying value

Expand
Uncertain

Continue
unfavourable
Abandon

Time

trigger states
Options /Asymmetry in NPV
Distribution

E C(t)
∑ 1( + k t) − I
Call Options on Stock vs. Real
Options
Stock Call Option Real Option
 Stock price  (Gross) PV of expected
cash flows
 Exercise price  Investment cost
 Time to expiration  Time until opportunity
disappears (patent, compet.
Stock return volatility entry)
 Riskless interest rate Project value (%)
 Dividends uncertainty
 Riskless interest rate
 Early operating cash flow
or competitive erosion
Industry Volatility and PVG0/Price
for Representative Industries
PVGO/P
INDUSTRY UNCERTAINTY
Market Model Risk free rate +
(σ )
2
6% premium
Information Technology 23% 84% 83%
Pharmaceuticals 14% 92% 83%
Consumer Electronics 26% 83% 70%
Food 6% 81% 72%
Banking 6% 81% 55%

Transportation 9% 62% 38%

Chemicals 6% 46% 47%
Electric power 4% 60% 48%

Source: Smit & Trigeorgis, Risk (1999)

Note: Volatility ( σ 2 ) is estimated as the variance of monthly returns; PVGO is

estimated by subtracting the discounted value (with the discount rate estimated from
the market model or the risk-free rate plus a 6% risk premium) of its perpetual stream of
earnings (under a no-growth policy) from its market price (6/30/98)
Valuing Real Options/Principles
A Generic Example
Opportunity to invest I = $104 (m) in a project (plant)
year
later (at t = 1) will have realizable value of either V+ = $1
= $60
(k = 0.20, r = 0.08) q=0.5 V +=
V= 100 180
0.5 V -=60

Under traditional NPV, gross value of project´s cash infl

V = [q V+ + (1 - q) V- ] / (1 + k)
= [.5 x 180 + .5 x 60] / (1 + .20) = 100
 Generic Project and “Twin Security”

q=0.5
V+=180, S+=36

V=?,
S=20
1-q=0.5
V-=60, S-=12
I=104, k= 20% (CAPM),
r=8% C
V =∑ t V: PV of project´s expected cash inflows
(1 +k ) t
S: “twin security” price
I: required investment outlay
E: value of investment opportunity to firm´s equityholders
NPV = V- k: discount rate (expected rate of return)
I r: risk–free interest rate
 p=0.4 V+=18
0
V=100
1-p V-
=60
Note also that (with risk-adjusted probability, p)

V = [p V+ + (1-p) V-] / (1 + r)
= [.4 x 180 + .6 x 60] / (1 + .08) = 100 (same)
 
 
Passive NPV = V – I = 100 – 104 = -4 (<0) Reje
 
 
Expanded (Strategic) NPV = Passive NPV + Real Option
 Risk-adjusted Probabilities

u=1.8 V+=180 S+=3

6
V=10
0 S
d=0.6 =20
V-=60 S-
=12
E(R) = r
p.u + (1-p).d = 1+ r p.S+ + (1-p)S- = S(1+ r)

p = [(1 + r) - d]/(u - d) = p = [(1 + r)S - S-]/(S+ - S-)

= [1.08 - 0.6]/(1.8 - 0.6) = [1.08×20-12]/(36-12)
= 0.4 = 0.4
 Option to
Defer
Suppose the firm has a one-year license
(patent/lease)
giving it exclusive right to defer for a year
Call (E)
p=0.4 V+=180 180-112=68
V=100
1-p V-=60 0
t =0 t=1
I=104

 Like call option on project value V with EX = I1 = 112

(with I0 = 104 assumed to grow in one year at 8% to I1 = 112)

E+ = max (V+ - I1, 0) = max (180 – 112, 0) = 68 (invest)

E- = max (V- - I1, 0) = max (60 – 112, 0) = 0 (do not invest)
With p = [(1 + r) S – S-] / (S+- S-) = [(1.08) 20 – 12] / (36 – 12) = 0.4

(vs. q = 0.5)
 
 
Total value of investment (expanded NPV with option to defer):
 
E0 = [p E+ + (1 – p) E-] / (1 + r)

= [ .4 x 68 + .6 x 0] / 1.08 = 25
 
 
Real Option Value (defer option/lease) = Expanded NPV – Passive NP
 
= 25 – (-4) = 29 (% of V)
 Option to Expand (Growth Option)
V+=180
p=0.4

V=100
1-p V-=60

Consider additional follow–on investment (expansion) if product does

better

Original investment opportunity thought of as initial (base) scale

project
plus call option on future (expansion/growth) opportunity: V +
max(eVOption
– Ie, 0) to invest additional Ie= $80 next year
which would double scale and value of project/plant (e =
1)

Now E = V + max(V - Ie, 0) = max(V, 2V - Ie)

 V+=180
V=100

V-=60

E+ = max(V+, 2V+ - Ie´) = max(180, 360 – 80) = 280

(expand/double scale)
 
E- = max (V-, 2V- - Ie´) = max (60, 120 – 80) = 60 (same/base
scale)
Value of investment opportunity (with follow on option to expand
 
E0 = [p E+ + (1-p) E-] / (1 + r) – I0
= [.4 x 280 + .6 x 60] / 1.08 – 104 = 33
 
Option to expand = 33 – (-4) = 37 (or 37% of V)
Options to Stage/Abandon &
Contract
Option to stage investment and abandon midstream, or contr
scale of
project´s operation by forgoing planned expenditures if product d
poorly
 

  Seen as put option on part (c%) of project (V) that can


contracted
or abandoned (V – Ic ) + Max(Ic – cV, 0) = Max(V – Ic, (1-c)V)
I0 = $50 now
$104 {
Ic = $58 (FV of $54) in year t = 1
 
Option to abandon project at t = 1 or halve scale (c = 0.5) and
value of project by defaulting on I c= 58
 V+=180
p=0.4

0.6 V-=60

E+ = max(V+ - Ic, 0.5 V+) = max(180 – 58, 90) = 122

(continue)
 
E- = max(V- - Ic, 0.5 V+) = max(60 – 58, 30) = 30
(contract/abandon)
 
 
Investment opportunity (with option to contract or abandon):
 
E0 = [.4 x 122 + .6 x 30]/1.08 – 50 = 12
 
 
Option to contract (default) = 12 – (-4) = 16
Competitive Strategies and Relative
Market Performance for High-Tech
Firms
A. Software
Microsoft´s strategic moves and superior market
performance
over Netscape and other computer
350

3
software
rivals
300 2 4
Microsoft
250

200
S&P 500 Computer
1 Index
Oracle Corp.
150
5
100
Netscape
50 Communications
6
0
10/18/95

11/22/95

12/27/95

12/11/96
4/10/96

3/26/97
9/13/95

1/31/96

5/15/96

6/19/96

7/24/96

8/28/96

10/2/96

11/6/96

1/15/97

2/19/97

4/30/97

8/13/97

9/17/97
3/6/96

6/4/97

7/9/97
8/9/95

Notes:
1. In August 1995 Netscape goes public in providing software for the Internet (all firms indexed at 100 on 8/9/95).
2. In March 1997 Microsoft allies with rival Hewlett-Packard to push its Windows NT program into corporate servers.
3. In April 1997 Microsoft agrees to buy WebTV, a start-up company that delivers Internet information directly to television sets.
4. In May 1997 Microsoft announces an all-out attack into the lucrative heavy-duty corporate computing market.
5. Also in May 1997 Oracle buys into Navio Communications, established by Netscape to develop Internet software for consumer electronics.
6. Netscape and Microsoft make further strategic moves to gain an advantage in their continuing battle over who will be the Internet standard bearer.
Through its superior strategic moves Microsoft gains a clear advantage over Netscape whose relative position is eroding.
COMPETITION & STRATEGY
1. High-tech firm with 1-yr license to wait for
commercial production
2. Impact of exogenous competitive entry (“dividends”)
3. Early investment to preempt (two-stage investment)
4. Should it invest in R&D to acquire proprietry option
to invest in more cost-effective commercial production
in stage 2?
5. Impact of endogenous competition in production
(stage 2) What difference if proprietary vs. shared
benefits, contrarian vs. reciprocating competitive
reaction?
6. What if compete in R&D (stage 1) sequentially
(innovation race with first-mover advantage?). What if
both invest simultaneously and get hurt?
7. Benefits of cooperating in R&D?
Passive NPV
No flexibility to deviate from expected:
Invest Now q=0.5 V+=180
V=100
1-q=0.5 V-=60
I=80
Invest now (commitment value) = NPV = V – I = 100 – 80 = 20 (>0)
(1 +r )V + −V −
p = =0.4
Investment cost: I = 80 Risk neutral prob.: V + −V −

Discount rate: k = 0.20

(Gross)Project value:

Risk-free rate: r =0 .08 p ×V + + (1 − p )V − 0.4 ×180 + 0.6 × 60

V= = = 100
1+ r 1.08
 Proprietary Opportunity (license)
Wait to invest under uncertainty
V+=180 C+=Max(V+-I,0) (Inves
q=0.5
=180 – 80 = 100
V=100 C
1-q=0.5 V-=60 C-=0 (Do not inves
t =0 t =1
I=80

Opportunity to invest provided by license (call

option):
C=
p × C + + ( 1 − p) × C − .4 × 100 + .6 × 0
= = 37
1+ r 1.08
Shared Opportunity
Invest now if can preempt
competition
A. Impact of exogenous competitive entry:
reduced option value (50% cash-flow
“dividends”)
V+=180
p=0. (C+)’=90-
(V )’=90 +
4 40=50
V=100
V-=60 1-p
(C-)’=Max(30-
(V-)’=30 40,0)=0
Wait (call option with “dividends”):
.4 × ( 90 − 40) + .6 × 0
C' =
1.08
= 18.5 (half of 37)
 Shared opportunity
Invest now if can preempt competition
B. Invest now/ exercise early (e.g., build excess plant
capacity) to preempt competitive erosion or capture
cash-flow “dividends”

V+=180

V=100

V-=60

Invest now: V - I = 100 - 80 = 20 (> 18.5)

Simultaneous Investment Timing
Game
Compete/invest early (prisoners’ dilemma)

Firm B
Extensive form
Wait Invest
Invest (10,10)*
B (share NPV=20)
Invest Wait (18.5,18.5) (0,20)
Wait (20,0)
A Firm A
Invest (0, 20)
Wait
B Invest (20,0) (10,10)*
(18.5,18.5)
Wait
(share 37)
A: Invest regardless of B (dominant)
B: Invest regardless of A
But better if wait
Two-stage (Growth) Investment
R&D/ infrastructure/ growth option

V++ = 324
V+ =
180
p=0.4
V = 100 V+- =
1-p 108
V -
=
I = 30 60
I
III = 80 V-- = 36
Stage I Stage II
t=0 t=1 t=2
NPV * = NPV I + Option II
NPV = NPV I + NPV II
 .4 (180 − 80 ) + .6 × 0 
 − 80 .5 × 180 + .5 × 60  = −30 +  
= −30 +  +   1.08 
 1.08 1.20 
= −30 + ( −74 + 100) = −30 + 26 = −4 ( < 0) = −30 + 37 = + 7 ( > 0)
Competitive Strategies (Dog)
Depend on type of investment (proprietary
vs. shared) and competitive reaction
(contrarian vs. reciprocating)

COMPETITION
Contrarian Reciprocating
(fixed market value) (altered market value)
e.g., Quantity competition e.g., Price competition

1 2
Proprietary commiting and flexible and inoffensive
offensive
(capture most of Preemptive commitment Non-provoking (-) effect
total market value) (+) effect

PIONEER 4
commiting and
3
flexible and offensive
(A) Shared inoffensive
Vulnerable (-) effect Cooperative
(share total
commitment (+) effect
market value)
(+) effect
 Proprietary (2/3) / Contrarian
(1) V +
p
*
V
Invest in R&D 1-p V- *
(offensive strategy to preempt )
High Demand (V+=180) Low Demand (V-=60)
Firm B
Wait Invest Wait Invest
1 2 1 2

Wait (81, 25) (0,100) Wait (10,0)* (0,-20)

Firm A 3 4 3 4

Invest (100,0) (80,20)* Invest (-20,0) (0,-20)

Nash (A invest, B invest)

 0.4 × 80 + 0.6×10   0.4 × 20 + 0.6 × 0 
NPVB* = 0 + 
NPVA* = −30 + ;  = − 30 + 35 = 5  1.08
=7

 1.08 
IIA = 30; IIIA = 40; III = IIIA + IIIB = 80 (if preemption IIIA = IIIB = 80)
 (-1/4)
Do not invest in R&D (avoid rivalry and
price war)

High Demand (V+=180) Low Demand (V-=60)

B
Wait Invest Wait Invest
1 2 1 2

Wait (61,15) (0, 100) Wait (10,0)* (0,-20)

A 3 4 3 4

Invest (100,0) (50,5)* Invest (-20,0) (-10,-25)

 0.4  50  0.6 10   0.4 × 5 + 0.6 × 0 

NPVA*  30      30  24  6   0 NPVB* = 0+  ≈2
 1.08   1.08 
 Shared (1/2) / Reciprocating
(+1/4)
Invest in R&D (expanded pie from
coordination)

High Demand (V+=180) Low Demand (V-=60)

B
Wait Invest Wait Invest
1 2 1 2

Wait (75,75) (0, 100) Wait (10,10)* (0,-20)

A 3 4 3 4

Invest (100,0) (73,73)* Invest (-20,0) (-3,-3)

Nash (A invest, B invest) Shared (coordination):

wait  0.4 × 73 + 0.6 × 10 
NPVA* = −30 +   = − 30 + 33 = +3 NPVB* = 0 + 33 = +33
 108
. 
 Shared (1/2) /Contrarian (1)
Do not invest (avoid subsidizing aggressive
rival)

High Demand (V+=180) Low Demand (V-=60)

B
Wait Invest Wait Invest
1 2 1 2

Wait (53,53) (0, 100) Wait (5,5)* (0,-20)

A 3 4 3 4

Invest (100,0) (50,50)* Invest (-20,0) (-10,-10)

 0.4  50  0.6  5  NPVB* = 0 + 21 = +21

NPVA*  30      30  21  9 (< 0);
 1.08 
Sequential R&D Investment Race
Invest to preempt (first mover 2/3 or time-
to-market)

Firm B
Invest (22,-17) Wait Invest
4
B 1 2
Invest Wait (16,16)
Wait (35,0) 3 (0, 35)
A
Invest (0, 35) 2 Firm A
Wait 3 4

B (35,0)* (22,-17)
(16,16 1 Invest
Wait
)
A invests; given that, B waits
Winner takes all
Simultaneous R&D Investment
Battle
Invest prematurely (prisoners’ dilemma)

Firm B
Wait Invest
1 2

Wait (16, 16) (0, 35)

Firm A 3 4

(35, 0) (2, 2)*

Invest

Invest prematurely;
both get hurt (worse than wait)
Cooperate in Technology
Investment

Joint R&D Ventures

Firm B
Wait Invest
1

Wait (22,22)*

Firm A 4

(17,17)
Invest

Save (share) costs; better appropriate (jointly)

option value of waiting
 Benefits of Real Options
Valuation
 Helps systematize the analytical process
 
 Structures problem to uncover important
aspects and provide deeper insight
 
·    Focuses on the primary uncertainties and
value drivers
·    Captures the value of optionality and
strategic thinking
 
 Much benefit derives from the structuring
process itself (beyond the evaluation results)
 Provides a common language for communication
among
different functions (R&D, finance, strategy,
marketing)

 Provides intuition, that may sometimes challenge

conventional thinking, e.g.,
 
•     Higher volatility may increase value
•     Accepting negative-NPV projects or delaying
positive-NPV ones may be rational/justified
 
 Provides better interface between capital budgeting,
strategic planning, incentives and control systems
AREAS WITH USEFUL OPTION
APPLICATIONS

 R & D (new products/processes) &

innovation

·     Industries: high-tech, computers & semiconductors,

pharma, bio-tech, chemicals, other growth industries
with multiple stages, product generations or
applications
 
·     Options: staging (time-to-build) and
growth/expansion options (multi-staged investment)
 Infrastructure (platform/capabilities)

 
Info.-technology network (e.g., to develop
capabilities to expand more efficiently),
ports/airports/railroads/road network, power plants
(e.g., electricity), corporate core capabilities to
adapt
 
. Industries: transportation, info./telecom,
energy etc.
 
·     Options: compound options, portfolios of
options
 Strategy and competition

Growth options to acquire foothold in new/foreign

markets (e.g., in Greece to enter EU),
sourcing/multinational network operations (switch
labor, exchange rates, human capital), strategic
acquisitions (new market or technology),
goodwill/brand name, joint ventures to build network/
relationships (e.g., in India, China), patent
races/product standard

. Industries: new/foreign/emerging markets, M&As,

goodwill intensive, electronics,
pharmaceuticals, detergents, airlines etc

·     Options: growth (compound)/expansion options,

abandonment options, switch/exchange
options, competitive games etc.
Flexible manufacturing (multiple
inputs/outputs)

 
• Industries: energy (e.g., power plants using diverse
fuel inputs), autos (CAD/CAM), toys, consumer
electronics, fashion, info. technology, flexible
publishing
 
•   Options: options to switch/exchange
Intellectual/property rights

  Patents, leases, movie rights, software licenses,

goodwill/ brand name etc.

·  Industries: high-tech, pharmaceuticals, biotech,

software, media/entertainment, publishing etc.
 
·     Options: wait to invest, compound/expand options
etc.
 Performance
measurement/compensation

Develop more dynamic economic value added

(EVA)–like measures consistent with option-based
expanded-NPV, integrating capital budgeting with
strategic planning and control; develop conditional
control targets (e.g., ROA, growth) contingent on
exercise of major future options; recognize agency
conflicts (e.g., expansion) and distortions in
optimal exercise policies and design corrective
incentive contracts