Game Theoretic Real Option Research Articles

Strategic investment in power generation and transmission under a feed-in premium scheme: a game theoretic real options analysis

The spread of renewable energy has been accelerated by investment in power generation and transmission systems under environmental policy support such as a feed-in premium (FIP) scheme. This study examines the decision-making of the transmission system operator (TSO) and the power generation company (GENCO), where the TSO maximizes social surplus by investing in transmission lines, and the GENCO maximizes its profit by investing in power generation facilities. Specifically, the TSO decides the investment timing, while the GENCO decides the capacity. We develop a real options model to analyze the equilibrium investment timing and capacity under uncertainties in a framework of game between TSO and GENCO. We consider several scenarios in which the GENCO invests in non-renewable energy (NRE); invests in renewable energy (RE) with FIP; and invests in RE with its installation cost reduction. Our results indicate that FIP and the installation cost reduction of RE affect the equilibrium decision in a different manner. We find that FIP tends to be more welfare-enhancing than the reduction of RE installation cost when the degree of uncertainty is larger. We also demonstrate that social surplus can be increased without FIP if the installation cost of RE is reduced sufficiently in the future.

Private investment and public stimulus: a bargaining model

ABSTRACT Local governments often provide tax-subsidy programs to attract corporate investment. Using a game-theoretic real options model between a firm and a government, this paper aims to explore the interaction between the government’s tax-subsidy policy and the firm’s investment and financing decisions. The optimal incentive policies are derived for cooperative and non-cooperative bargaining settings between a government and a firm. We show that it is optimal for the government to offer a tax-subsidy combination in the cooperative setting. However, this is not true for the non-cooperative setting, in which the optimal policy is to only levy taxes with no investment subsidy. Whereas firms always have an incentive to rely on debt financing in the non-cooperative setting, firms are reluctant to issue debt in the cooperative setting. Finally, it is generally optimal for the government to collect taxes at a lower rate in the case of high risk high-tech enterprises.

Designing optimal M&A strategies under uncertainty

The recent surge in M&A activities highlights firms’ motivation to gain or maintain market leadership. Along with the unparalleled volume of M&As, more and more firms favor establishing acquisition programs that lead to multiple subsequent M&As over time. In this paper, we study the entrance in a market by means of M&A when different strategies to acquire a prominent incumbent are available to the acquirer. In particular, the firm might opt for a big leap, where it acquires the prominent incumbent; the alternative is to design an acquisition program that allows moving in small steps by acquiring a minor company first and the larger prominent player later on. We employ a dynamic game-theoretic real options model to investigate the effect of uncertainty and synergies on the strategy choices and also consider alternative contract designs for the acquisition program, such as hostile, friendly or mixed. Our findings reveal that firms prefer acquisition programs to big leap strategies when the industry exhibits high levels of uncertainty and can occur even when the acquisition of the first target destroys value. Moreover, some acquisition programs profit from a first-mover pass-through where the acquirer can jointly utilize his first-mover advantage when negotiating with multiple targets. Finally, novel testable hypotheses are derived from the model.

The interaction of debt financing, cash grants and the optimal investment policy under uncertainty

Significant progress has been made toward understanding a levered firm's optimal investment policy under uncertainty. To date, however, not much work has concentrated on the time scale trade-off and collectively held real options. We employ a game-theoretic real option model between a firm and a government to analyze the effect of uncertainty and investment stimulus in the form of cash grants on optimal investment timing, financing and investment scaling. We find that the jointly held real option between the firm and the government leads to underinvestment, regardless of whether the firm has the possibility to issue debt. Subsidies, however, reduce the level of underinvestment. Notably, the results indicate that even though levered firms receive less support, they invest more than unlevered firms. This challenges recent findings that a firm's optimal investment level is not affected by the way it finances a project. Similarly, we find that for realistic parameter constellations the levered firm's optimal investment threshold can be higher than that of its unlevered counterpart. This indicates that the availability of tax shield benefits does not necessarily serve as an incentive to invest earlier. Finally, we show that the effect of cash flow uncertainty on the equilibrium level of grants is ambiguous and triggers the switch from a subsidy to non-subsidy regime.

Symmetric equilibrium strategies in game theoretic real option models with incomplete information

This paper considers a real options model with incomplete information in a duopoly setting. I show that even in the presence of a first-mover advantage, there are circumstances in which the preemption region is eroded entirely and the only equilibrium strategy is of simultaneous-type: both players should exercise together or not at all. This outcome arises if the price paid by a player from exercising the option simultaneously with his competitor (over exercising alone as a Stackelberg leader) is low. Such an outcome has not been previously recognised in the literature. The underlying information structure has been applied in a one-firm setting to a range of different contexts of late, all of which have competitive pressures in practice. As such, the existence of this equilibrium under certain conditions ought to be recognised.

Developers’ heterogeneity and real estate development timing options

PurposeThe purpose of this paper is to examine developers’ optimal development timing when developers are heterogeneous and have different marginal costs in a real estate development market.Design/methodology/approachThis study uses a multiple-player game theoretic real option model and provides tractable results of asymmetric development strategies from a two-stochastic-variable model. Anecdotal evidence and market observations are presented.FindingsStronger developers (with low marginal costs) exercise real estate development options earlier than weaker developers (with high marginal costs). However, the interval time between developments by stronger and weaker developers decreases in rental volatilities. Real estate with a high positive externality are developed earlier than real estate with a low or negative externality.Practical implicationsWeaker and smaller developers are advised to undertake projects having positive externalities from vicinities. Government agencies are recommended to use tools of zoning and urban planning to prioritise developments introducing positive externalities and to facilitate the growth of weaker and smaller developers. This may subsequently help reduce incentive for land banking and oversupply in real estate space market.Originality/valueThis research is probably the first to explicitly incorporate developers’ heterogeneous strength in real estate development timing options with multiple developers in a competitive market. It sheds additional insights into the understanding of potential problems of development cascades, under the interactive effects between exogenous policy changes and endogenous response from asymmetric developers.

Efficient non-cooperative bargaining despite keeping strategic information private

The preferred method for negotiating joint value-added activities, such as e.g. licensing, co-venturing or supply chain expansion, is cooperative bargaining, where agents act rationally and have perfect information, i.e., information sharing occurs. In such settings, however, stronger partner often insist on keeping their valuable information private and thus cooperative bargaining cannot occur due to the lack of information sharing. Though, non-cooperative bargaining is usually assumed to be inefficient. Based on a game-theoretic real options model, we develop a contractual solution that allows the proposer to keep its valuable information private while at the same time motivates the other partner to act in a timely and efficient manner, that is, to be Pareto-efficient.

ゲーム論的リアルオプションによる3社間の特許取得競争評価

ゲーム論的リアルオプションによる3社間の特許取得競争評価

Strategic Investments with Competition Under Uncertainty in the ASEAN/AEC: A Game-Theoretic Real Options Analysis

The Association of Southeast Asian Nations (ASEAN) intends to create the ASEAN Economic Community (AEC) as a single market, to be completed by 2020. The single market will boost the competition in both ASEAN’s internal and external markets, which will spur innovation. Creative innovation will change the production technology to generate enhanced value products and services. Generating this new technology requires R&D investment. This paper discusses the strategic investment decisions which businesses in ASEAN will have to face in a highly competitive environment under uncertain growth conditions, by systematically outlaying several plausible strategic investment outcomes. The game-theoretic real options approach is used to analyze the strategic timing and interplay of strategic investments between Thai and Malaysian consumer firms. In particular, it is used to analyze the valuation of the firms’ strategic investment payoffs.

On the investment–uncertainty relationship: A game theoretic real option approach

This paper examines the effect of uncertainty on investment timing in a game theoretic real option model. We extend the settings of the related recent literature on investment timing under uncertainty by a more general assumption, i.e. the investment is also influenced by the actions of a second player. The results show that a U-shaped investment–uncertainty relationship generally sustains even for infinite-lived investment projects and proper defined cash flows. However, timing of an investment occurs inefficiently late. Moreover, we show that the influence of uncertainty on the associated first-mover advantage becomes ambiguous, too.

Symmetric equilibrium strategies in game theoretic real option models

This paper considers the problem of investment timing under uncertainty in a duopoly framework. When both firms want to be the first investor a coordination problem arises. Here, a method is proposed to deal with this coordination problem, involving the use of symmetric mixed strategies.The method is based on Fudenberg and Tirole [Fudenberg, D., Tirole, J., 1985. Preemption and rent equalization in the adoption of new technology. Review of Economic Studies 52, 383–401], where it was designed within a deterministic framework. This paper extends the applicability of this method to a stochastic environment. The need for this is exemplified by the fact that ever more contributions in multiple firm real option models make unsatisfactory assumptions to solve the coordination problem mentioned above. Moreover, our approach allows us to show that in many cases it is incorrect to claim that, in equilibrium, the probability that both firms invest simultaneously while it is only optimal for one firm to invest, is zero.

ENTRY PATTERNS OVER THE PRODUCT LIFE CYCLE

We study a game-theoretic real options model of new market entry based on empirical evidence of demand for a new product growing over time and eventually falling. Yet, firms do not know ex ante when this will occur, which creates incentives to update information by delaying irreversible entry. By assuming that the construction of a new productive plant takes some time and is unobservable in the meantime, while operation in the market is not, we show that entry rates increase or decrease under certain conditions related to the rate at which flow profits decrease as more firms enter the industry.

A Dynamic Model of Corporate Acquisitions

Using a game-theoretic real option approach, this paper presents a model of corporate acquisitions. We incorporate imperfect information about synergy gains, strategic interaction among competing bidders, and between the successful bidder and the target firm. Assuming the absence of managerial motives, the model is able to explain some empirical regularities that have only been explained under the agency and hubris hypotheses. Undervaluation, asymmetric distribution of gains, and divestitures are a natural output in our model. This theoretical model suggests that controlling for industry characteristics is an important element in empirical research.