Abstract
Business sustainability and real options are closely connected, as real options are managerial flexibility that allows organizations to adapt to changes in their environment, thus making the organization more robust and economically sustainable. Studies in real options theory abound, yet there is still a lack of evidence on whether people make decisions consistently with the predictions made by real options models. We run a laboratory experiment to study the role of option value and the laboratory time required to resolve uncertainty in individuals’ decision to price and adopt an option to wait. Specifically, we compare decision makers’ choices in two investment scenarios: One with a short time to maturity (implying a low option value), and another with a longer time to maturity (implying a high option value). In the lab, both scenarios are implemented with the waiting time of twenty and sixty minutes. Our results show that decision makers deviate from the theoretical predictions, recognizing the benefit of waiting, when the value of the option is higher, or when the waiting time is shorter. Our study does not only bring more insights into real options adoption at the individual level, but also emphasizes the great potential of behavioral and experimental approach to bridge the gap between theory and practice in the real options literature.
Highlights
Managers often have to make investment decisions under uncertain conditions in order to grow their businesses
In the low option value 20 treatment, there is a significantly higher number of subjects of Type 3 than in the low option value 60 treatment. There is no such difference between the high option value 20 treatment and high option value 60 treatment. These findings suggest that only when the option values are calibrated on a 1-year time, the waiting laboratory real-time represents a crucial factor on subjects’ investment decisions
Our study focuses on examining the investment decision-making process at the individual level
Summary
Managers often have to make investment decisions under uncertain conditions in order to grow their businesses. Investments are typically surrounded by uncertainty over future rewards, questions about their irreversibility, and the possible availability of new relevant information about them later on. Under these real-world conditions, scholars have recognized the superiority of real options thinking and the approach of using real options analysis (ROA) over the classical net present value (NPV) approach in supporting investment decision-making. The main difference between ROA and NPV is that NPV does not take into consideration the different types of managerial flexibility to adjust to any future changes that might occur [1,2]. The value of the option to wait has been discussed previously in this journal in the context of having inter-temporal flexibility in starting a rental housing investment [13], the method used in the paper is the same we have adopted here
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