Abstract:
This paper considers a popular problem in investment, the best time and size of investment, using methods of real options in a cooperative game setting. Moreover, it shows a combination of real option theory to invest, with a competitive game between two movers in the growth of a general-use asset and cooperative game theory between two movers to catch a network effect. In the model, two firms have similar and interacting investment opportunities. There is a real option for both firms to postpone the investment until they have proper price and production states. There are benefits to a first mover who can create a facility according to its own conditions. Also, there is a useful network effect of operating synergy if the first mover successfully motivates the second mover to start production instantaneously by sharing the production facility. So, the first mover has to discover when to create, what capacity to create, and the best economic rent for using the facility. The second mover has to discover whether to use the first mover’s facility or create its own facility, and if it discovers to create its own, what time and size are better.
Machine summary:
Actually, this paper shows an equilibrium real options exercise game in which the investment cash flows are not exogenous to the firm, but endogenous in the purpose that the competitors behave according to the first-mover capacity selection and timing decisions.
By considering the firms’ behavior under a general setting of a sequential bargaining game of incomplete information on the existence of the positive externality, this paper shows that firms sometimes invest earlier than best and create excess production capacity not only for the preemptive result of a first mover benefit, but also for being able to derive rent from the follower.
In the literature on the real options, a "standard" real options game (ROG) model can be described as a model where the value of the investment is regarded as a state variable that follows a known process; time is examined as infinite and continuous; the investment cost is sunk, indivisible and fixed; firms are assumed to have plenty internal resources to make investments when it is best to do so; the investment game is played on a single project; the number of firms having the option to invest is usually two, and the emphasis of the analysis is bringing the firms’ value functions and particular investment threshold under the assumption that both firms are risk-neutral (Leung, C.
1 Some Real Options and Sequential Bargaining Game Models In the oil and gas, the airline, and the real estate industry, investments usually need large capital to create or buy a production facility.