The use of real options valuation methodology in enhancing the understanding of the impact of climate change on companies

Abstract

AbstractClimate change has in recent years gathered traction on the business, political and social agenda. From the business perspective, research has shown that climate change impacts on company value are uncertain, significant and strategically important. The challenge therefore is for the business community to apply financial valuation models that support the incorporation of the climate change impacts in strategic planning. However, the commonly used discounted cash flow techniques in capital budgeting are seen as failing to address the high levels of uncertainties inherent in climate change impacts. Real options thinking has been touted as having the potential to enhance understanding of these impacts via its direct handling of uncertainty, although not much research has been done to demonstrate this. Using an illustrative case study, this research presents an argument for introducing the real options approach, a new method for valuing options of future strategic action by companies in a setting that exhibits climate change impacts. The objective of this research is to contribute to the literature on strategic tools for addressing climate change and ultimately offer some management insights that can narrow the gap between finance theory and business practice. Copyright © 2009 John Wiley & Sons, Ltd and ERP Environment.