Investment In Real Assets Research Articles

Real assets, financial assets, liquidity and the lemon problem

AbstractReturn obtained by diversification is based on average quality. Similarly, under asymmetric information, the price at which an asset can be sold reflects the average quality of assets. Therefore, 4under some conditions, sale of an asset under asymmetric information is a useful alternative to diversification. This idea is developed with a model that incorporates a liquidity shock. One key result is that investment in real assets is higher under asymmetric information than under symmetric information. The model can explain why the ratio of real assets to financial assets is higher in emerging economies than in developed countries.

Managing human assets in an uncertain world: applying real options theory to HRM

While many authors have proposed a firm's human resources as an asset that can provide value and competitive advantage, the SHRM field has tended to ignore the fact that assets have associated uncertainties and risks. The real options view provides a theoretical framework for how firms manage uncertainties associated with investments in real assets. We apply this logic to analyse the uncertainties associated with human assets and discuss how firms manage these uncertainties through HR ‘options’ which are capabilities generated by some HR practices and their combinations. We discuss these practices and develop an options model for managing different types of uncertainties.

The Discount Rate in Emerging Markets: A Guide

There is considerable controversy about the correct discount (or “hurdle”) rate to use when performing valuations of investments in real assets in emerging markets. The topic is particularly relevant because of the growing need to evaluate privatizations, direct private acquisitions, and greenfield investments in new productive facilities throughout the world.This article argues that the traditional practitioners' approach of building a country risk premium into the discount rate is generally inappropriate, mainly because country risk is not the same for all projects nor is it totally systematic. Moreover, there is no reason for the discount rate to be closely related to the spread on the government bonds of the country concerned. The author also points out that, in determining the appropriate discount rate, what is important is not the segmentation of the market, but the extent to which the investor is locally or globally diversified. The article accordingly reviews a selected group of models for calculating discount rates for both segmented and integrated markets. Adjustments to the valuation procedure are also suggested for cases in which investors are not well diversified or the investment is illiquid.

Investment in real assets and information acquisition: the OCE preferences case

An agent optimizes over real investment and investment in information acquisition while maximizing a two-period utility that captures his ordinal certainty equivalent (OCE) preferences. Optimal investment is characterized and the impact of risk and time preferences on it is investigated.

Investment in Real Assets and Information Acquisition: The OCE Proferences Case

An agent optimizes over real investment and investment in information acquisition while maximizing a two-period utility that captures his ordinal certainty equivalent (OCE) preferences. Optimal investment is characterized and the impact of risk and time preferences on it is investigated.

REAL OPTIONS: STATE OF THE PRACTICE

In the mid‐1980s, financial economists began building option‐based models to value corporate investments in real assets, laying the foundation for an extensive academic literature in this area. The 1990s saw several books, numerous conferences, and many articles aimed at corporate practitioners, who began to experiment with these techniques. Now, as we approach the end of 2001, the real options approach to valuing real investments has established a solid, albeit limited, foothold in the corporate world.Based on their recent interviews with 39 individuals from 34 companies in seven different industries, the authors of this article attempt to answer the question, “How is real options being practiced, and what impact is it having in the corporate setting?” The article identifies three main corporate uses of real options—as a strategic way of thinking, an analytical valuation tool, and an organization‐wide process for evaluating, monitoring, and managing capital investments. For example, in some companies, real options is used as an input into an M&A process in which rigorous numerical analysis plays only a small role. In such cases, real options contributes as a qualitative way of thinking, with little formality either in terms of analytical rigor or organizational procedure. In other firms, real options is used in a commodity trading environment where options are clearly specified in contracts and simply need to be valued. In this case, real options functions as an analytical tool, though generally only in specialized areas of the firm and not on an organization‐wide basis. In still other companies, real options is used in a technology or R&D context where the firm's success is driven by identifying and managing potential sources of flexibility. In such cases, real options functions as an organization‐wide process with both a broad conceptual and analytical core.The companies that have shown the greatest interest in real options generally operate in industries where large investments with uncertain returns are commonplace, such as oil and gas, and life sciences. Major applications include the evaluation of exploration and production investments in oil and gas firms, generation plant investments in power firms, R&D portfolios in pharmaceutical and biotech firms, and technology investment portfolios in high‐tech firms.While the approaches to implementation are quite varied, there appears to be a common path to the successful adoption of real options. The key steps of the adoption process are: (1) conducting pilot projects; (2) getting buy‐in from senior‐level and rank‐and‐file managers; (3) codifying real options through expert working groups, specialist training, and customization; and (4) institutionalizing and integrating real options firm‐wide. After citing best practices for each of these four steps, the authors close by predicting that a “network” effect and acceptance by Wall Street will serve as catalysts for more widespread corporate use of real options.

EXPLOITING UNCERTAINTY—INVESTMENT OPPORTUNITIES AS REAL OPTIONS: A NEW WAY OF THINKING IN ENGINEERING ECONOMICS

A new trend in corporate planning is to exploit uncertainty by taking investment opportunities as real options. This options approach is to complement the conventional net present value (NPV) criterion in evaluating risky investments. In this paper, we take a broad look at the real options approach to various engineering economic decision problems, laying out how it provides an immediate and important perspective on value creation in an uncertain world. Unlike financial options, real options analysisdeals with investments in real assets, which is one of the primary interest areas in engineering economics. For that reason, we believe that any advancement in the real options decision framework will benefit the field of engineering economics.

Valuation of Investments in Real Assets with Implications for the Stock Prices

A general model for the valuation of natural resource investments is formulated and analyzed within a stochastic control theoretic framework. Using dynamic programming, the value of such an investment with a general payoff function is determined under the assumption that the commodity price process is given by a stochastic differential equation. The analysis results in closed form analytic solutions which can easily be computed and exhibits qualitatively different optimal behaviors, depending on parameter values. Implications for stocks and options are also considered.

The Information Content of Corporate Offerings of Seasoned Securities: An Empirical Analysis

American corporations raised approximately $287.84 billion annually between 1980 and 1991 through public issues of debt and equity. This paper analyzes the post-issue operating performance of both debt and equity issuers, controlling for factors which have been shown to explain post-issue firm operating performance, such as free cash flow, performance run up, and investment in real assets. If finds that security offering announcements convey negative information about the future operating performance of the issuer.

Real options in practice: an exploratory survey of how finance officers deal with flexibility in capital appraisal

Dissatisfaction with discounted cash flow techniques has lead to a growing literature focusing on the value of managerial flexibility in handling real asset investments, a subject area known as real options. This paper describes an exploratory survey of senior finance officers in industrial firms, examining the significance that real options assumed in their investment decisions, whether their firms had established pro- cedures for assessing real options, and whether their intuitions were consistent with what theory prescribes.We found that, while real options commonly occurred and were generally significant in determining how decision-makers regard an investment, there was wide variation between individual decision-makers in their perception of real options. Most respondents could recall an example of a real option with which they had dealt, and in about half the cases the option had been necessary for the associated investment to be sanctioned. Few firms have procedures to assess options in advance. Real options may not always be desirable since, in the eyes of at least some respondents, they can reduce organizational commitment to a project. Very few decision-makers seemed to be aware of real option research but, mostly, their intuitions agreed with the qualitative prescriptions of such work.

The investment decisions of individuals and firms

This paper presents a model of investment in which it is assumed that both individuals and firms maximize the probability of long-run survival (PLRS). For individuals, the decision variable is the fraction of wealth placed in risky securities, whereas, for firms, it is the rate of investment in real assets. For both, a high mean rate of growth in net worth is a necessary condition for a high probability of long-run survival.

Risk, piety, and the Islamic investor

Conventional Western finance theory considers two dimensions of investment: risk and return. Ethics are ignored, and a conventional investor will accept any investments that are not actually illegal. Investment may be indirect, i.e. into various kinds of financial asset, or direct, i.e. into real assets or into a business. Conventional Western finance theory analyses these separately: portfolio theory deals with investment in ordinary shares, preference shares and bonds, with little attention to real assets; business finance theory deals with investment in real assets, as carried out by conventional limited liability firms. In contrast to the Western investor, however, the Islamic investor must also take into account the ethical aspects of his investment, and the types of economic activity in which he invests. The insights of conventional finance theory apply to Islamic investment, but the restrictions which apply to the Islamic investor mean that Islamic investment differs from conventional

Corporate Investment and Dividend Decisions under Differential Personal Taxation

This paper explores implications of differential personal taxation for corporate investment and dividend decisions. The personal tax advantage of dividend deferral causes sharehold? ers to generally prefer greater investment in real assets under internal as opposed to exter? nal financing. Furthermore, dividend deferral is shown to be costly at the corporate level, causing shareholders in different tax brackets at times to disagree over optimal investment and dividend policies under internal financing. The profitability of internally-financed se? curity investment is shown to depend on a security's tax status and shareholders' tax brackets. However, externally-financed security purchases are unprofitable from a tax standpoint. This paper explores the relation between cash dividend payouts and firm investment in real assets, given a personal tax disadvantage to dividends, an is? sue that has received scant attention in the finance literature. In contrast to the prior work of Auerbach (1979), (1984), this study formally introduces differen? tial personal tax rates and uncertainty, demonstrates the personal tax disadvan? tage of early dividend payouts, and analyzes both the impact of a diminishing returns to scale technology for firm investment in real assets and the impact of double corporate taxation for firm investment in financial claims. The model de? veloped here yields several predictions for corporate dividend and investment decisions that are consistent with those derived from the existing agency and signalling models,1 as well as several additional predictions. A key property of this paper's model is a firm's limited ability to costlessly defer the payout of earnings as a cash distribution to shareholders, whether

Managerial Preference, Asymmetric Information, and Financial Structure

ABSTRACTIf firm performance affects managers' wealth or reputation, preferences of managers dominate firms' financing decisions. When information about real asset investment is symmetric, managers finance exclusively with equity. If managers know more about asset quality than do investors and if managers are sufficiently risk averse, they signal high‐quality projects with debt. Increases in collateral value decrease risky debt use. Increases in interest rates that do not change productive opportunities increase debt use. The explanation for these and further results is based on underpricing of equity and overpricing of debt at the margin.

Estimates of Cost of Capital to Selected Indian Industries

The estimation of cost of capital to any firm or enterprise is crucial in determining the cut-off point while appraising prospective investment opportunities or for choosing the discount rate for the valuation of cash flows. The term 'cost of capital' may be defined as the minimum prospective yield rate that a proposed investment in real assets has to offer to make it worthwhile from the standpoint of the current owners of the firm.

Liquidity preference under uncertainty: A model of dynamic investment in illiquid opportunities

Whereas frictionless exchange markets provide a high degree of liquidity for financial assets, investments in real assets and productive capacity may be very costly to modify, and thus effectively irreversible in the short-run. This paper addresses the problem of an investor (individual or enterprise) who must allocate a limited resource to productive investments over time. Investment opportunities arrive in a random sequence and are irreversible in the short-run: thus investment decisions are made under uncertainty as to future opportunities (which may have to be foregone). The analysis demonstrates that a rational investor will demand a higher return on long-lasting opportunities than on those which are instantaneously reversible. The liquidity premium increases with the average duration of the non-liquid investments.

SOME OBSERVATIONS ON RISK‐ADJUSTED DISCOUNT RATES

IT IS COMMON PRACTICE to attempt to assess the relative attractiveness of proposed investment projects by adjusting the capitalization rates applied to project cash flows, for the perceived riskiness of the flows; the greater the risk, the higher the discount rate. Alternatively, projects thought to contain substantial risks may be required to surmount more stringent internal rate of return hurdles-these being directly related to cash flow unpredictability. Such procedures, while by no means the only approaches to comprehending project risk, are also the most frequently taught in school of business. They are sanctioned, in principle, by the lessons of the Capital Asset Pricing Model-which establishes that, in a competitive securities market peopled by well-diversified investing entities, there will be a positive linear relationship between the yield required on an asset and that asset's contribution to portfolio risk [7] [9] [13]. Hence, the greater the (systematic) risk involved, the larger the market-required (expected) return. The associated capital budgeting prescription thereupon is a risk-adjusted discount rate. There are, of course, some troublesome aspects to this approach. The major one is the leap from the basically single-period format of the CAPM to the inherently multi-period nature of the great bulk of real-asset investment opportunities. It is not entirely clear that the CAPM scenario inevitably legitimizes the application of risk-adjusted project yield criteria in the multi-period case, although there is support for that position [21 [8]. A risk-adjusted discount rate also implies certain possibly bothersome assumptions about the inter-period pattern of risk resolution [10]. Nonetheless, risk-adjusted rates are widely used and widely recommended despite these caveats. Even if they are considered only as approximations to value measurement-as surrogates for the underlying securities market responses to projects-they appear to have gained acceptance as the most practical enbodiment