Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acqusition
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Transcript of Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acqusition
Real Options and Investment Mode: Evidence from Corporate Venture Capital and Acqusition
Tony W. Tong, Yong Li
Presenter: Wen ZHENG
Tony W. Tong is an assistant professor of management of the Leeds School of Business at the University of Colorado. He received his Ph.D. from The Ohio State University. His current research applies real options theory to study firms’ corporate development activities such as alliances, acquisitions, and corporate venture capital.
Yong Li is an assistant professor of the School of Management at the State University of New York at Buffalo. He received his Ph.D. from the University of Illinois at Urbana–Champaign. His current research applies real options theory to study investment under uncertainty and venture capital.
Authors
Contents
Discussion
Empirical
Theory and Hypothesis
Introduction
Problem Statement
• The paper draws from real options theory to compare CVC and acquisition empirically
Introduction
Theory
Empirical
Discussion
Problem Statement
• The paper draws from real options theory to compare CVC and acquisition empirically
Investment modes that are important tools that firms can employ to further their external business development and corporate growth initiatives.
Introduction
Theory
Empirical
Discussion
Problem Statement
• The paper draws from real options theory to compare CVC and acquisition empirically
CVC is the investment of corporate funds directly in external start-up companies.
It involves an investing firm taking a minority equity stake in a private entrepreneurial company (Gompers and Lerner, 1998).
Introduction
Theory
Empirical
Discussion
Introduction
Theory
Empirical
Discussion
Real Option View
CVC Acquisition
Expand Flexible to make sequence investment
One-time deal and few sequential investment
possibility
Abandon Flexible to liquidate its investment
Difficult to divest a company
DeferFlexible to defer
deciding to expand or abandon
High commitment and little deferral option
Option
Mode
Real options become more salient in CVC investments compared to acquisitions under conditions of uncertainty
Uncertainty
Hypothesis 1 (H1). The greater the level of uncertainty, the more CVC is preferred over time.
An increase in the exogenous uncertainty enhance the value of all types of real options.
Option to expand and abandon adjust and reverse active reduce downside risk and capture upside should the environment develop favorably.
Option to defer Limit exposure to market uncertainty
Introduction
Theory
Empirical
Discussion
Contingent Effect of Uncertainty
Irreversibility
Growth Opportunity
Competition
Positive relationship between uncertainty and preference for
CVC over acquisition
Introduction
Theory
Empirical
Discussion
Contingent Effect of Uncertainty
Hypothesis 2 (H2). The greater the level of irreversibility, the stronger the positive relationship between uncertainty and the preference for CVC over acquisition.
Irreversible: resale value < cost
Irreversible resale value sensitive to uncertainty Value of Option
Acquisition is harder to reverse than CVC
Introduction
Theory
Empirical
Discussion
Contingent Effect of Uncertainty
Hypothesis 3 (H3). The greater the level of growth opportunities, the weaker the positive relationship between uncertainty and the preference for CVC over acquisition
Growth opportunity Opportunity cost of waiting
Indecision loss of profit streams in the present or future periods
Downside loss can be less valuable when there is significant upside potential
Introduction
Theory
Empirical
Discussion
Contingent Effect of Uncertainty
Hypothesis 4 (H4). The greater the level of competition, the weaker the positive relationship between uncertainty and the preference for CVC over acquisition
Extent that growth opportunities shared Strategic value of commitment
Competitive investment Strategic value of commitment >flexibility value of deferring
CVC provides flexibility to defer, while acquisitions signal commitment to potential rivals.
Introduction
Theory
Empirical
Discussion
Sample• Sample: Public firms (Compustat) • Year: 2003-2005
– Coverage of private acquisitions would become more accurate and extensive since 2003
• CVC: First-round CVC investments– Valuable real options– On a similar footing with acquisitions
• Acquisition: Acquisition of private targets• Acquisition started as CVC
– Exercise of the options that are embedded in the initial CVC investment
Introduction
Theory
Empirical
Discussion
Variables and Measures
Introduction
Theory
Empirical
Discussion
Dependent Variable CVC vs. Acquisition
1 if investment is structured as CVC investment, 0 if structured as an acquisition.
Explanatory Variables Exogenous uncertainty
Volatility of industry stock market indices Irreversibility
Asset intangibility Growth Opportunities
Market-to-book ratio Level of competition
One-minus-industry concentration ratio
Variables and Measures
Introduction
Theory
Empirical
Discussion
Control Variables (Investment Firms) Size
Nature log of the firm’s total assets in million dollars. R&D intensity
R&D expenditure as a percentage of sales. Profitability
Return on sales: income before extraordinary items as a percentage to sales
Firm’s experience in CVC versus acquisition Logged the ratio of one plus the number of CVC
investments to one plus the number of CVC acquisition.
Variables and Measures
Introduction
Theory
Empirical
Discussion
Control Variables (Investee’s industry) Industry profitability
Sum of the income before extraordinary items for all of the firms in the industry in which the investee resides as a percentage of industry sales
Industry R&D intensity information asymmetry The amount of R&D expenditures for all of the business
in the industry as a percentage of industry sales IP regime
Carnegie Mellon Survey of Research and Development
Variables and Measures
Introduction
Theory
Empirical
Discussion
Control Variables (Investor investee dynamic level) Inter-industry investment
1 when the investor and the investee operate in two different three-digit SIC industries, and 0 otherwise.
Different State geographic location 1 when the investor and the investee are located in two
different state, 0 otherwise. Control Variables (Investee characteristics)
Investee age Take log of subtract value between the founding year
from the current year Investee size
Take the log of the number of employees.
Methodology
Introduction
Theory
Empirical
Discussion
Two Stage Probit model First Stage Sample selection model
Distinguish firms that undertook CVC investments or acquisitions from firms that undertook neither investment
P( Undertake CVC or acquisition)= f ( size, profitability, R&D intensity, capital intensity , financial leverage)
Second Stage The choice of CVC versus acquisition
P(Undertake CVC)= f ( Uncertainty, Uncertainty* irreversibility, Uncertainty*Growth opportunities, Uncertainty* competition, Control Variable)
ResultsDescriptive Statistics and Correlation Matrix
Introduction
Theory
Empirical
Discussion
ResultsHeckman Regression Results
Introduction
Theory
Empirical
Discussion H1
ResultsHeckman Regression Results
Introduction
Theory
Empirical
DiscussionH2
ResultsHeckman Regression Results
Introduction
Theory
Empirical
DiscussionH3
ResultsHeckman Regression Results
Introduction
Theory
Empirical
Discussion
H4
ResultsHeckman Regression Results
Introduction
Theory
Empirical
Discussion
ResultsHeckman Regression Results
Introduction
Theory
Empirical
Discussion
ResultsHeckman Regression Results
Introduction
Theory
Empirical
Discussion
ResultsHeckman Regression Results
Introduction
Theory
Empirical
Discussion
ResultsHeckman Regression Results
Introduction
Theory
Empirical
Discussion
ResultsHeckman Regression Results
Introduction
Theory
Empirical
Discussion
ResultsResults including investee age and investee
sizeIntroduction
Theory
Empirical
Discussion
ResultsRobustness check
Another measure of uncertainty Regress industry sales over five years against time and
then used the standard error of the regression coefficient divided by the mean of industry sales to develop a standardized proxy of uncertainty for each industry and year.
Another measure of irreversibility Industry inverse leverage
Explore the sensitivity of the findings to alternative models Technological innovation Companies outside
of the high-tech realm Minority acquisition
Introduction
Theory
Empirical
Discussion
Conclusion
• When an investment is surrounded by high levels of market uncertainty, maintaining flexibility becomes more important, and firms attach greater value to the real options embed in initial CVC investments vis-à-vis acquisition.
• The value of real options under uncertainty is contingent upon several factors that may either increase or decrease such value and therefore my shape firms’ choice between CVC and acquisition. (Irreversibility and Growth opportunity)
Introduction
Theory
Empirical
Discussion
Future Research Plan• Focus on only two investment mode
Other investment mode like alliance, joint ventures
• Take the investing firm’s perspective to examine investment mode choice From the perspective of both the investor and the investee
• Focus on creation of option Option creation + option implementation
Introduction
Theory
Empirical
Discussion