REAL OPTIONS PRACTICES IN CAPITAL INVESTMENT DECISIONS: AN EXPLORATORY SURVEY OF LISTED COMPANIES OF PAKISTAN

  • Umair Baig
  • Dr. Manzoor Anwar Khalidi
Keywords: Real options analysis, capital budgeting, investment appraisal process

Abstract

The study aims to explore the role of the real options practices to an appraisal of capital investment decisions. We deployed the Binary logistic regression technique to test the hypotheses of the study. For the binary model, two equations were developed having two dependent variables, first the use of real options, and the second the real options familiarity. The independent variables of the study were the annual capital budget, Capex time, Net profit margin, and R&D. The finding showed listed companies relied on discounted cash flow techniques (DCF). A very few were practising real options only for supplement and to support results from other methods. The real options require too much sophistication and lack of top management support is the major reason for not using real options. The use of real options having a significant relation to the Annual Capital Budget, Net Profit Margin, and R & D, Capex time. Real options Familiarity having a significant relationship with Net Profit Margin and R & D and insignificant with Annual Capital Budget. DCF method is rigid and cannot incorporate the uncertain future and upcoming opportunities. Corporate and academia are suggested to concentrate on real options practised to make the right decision for the corporate, industry, and country progress.

Author Biographies

Umair Baig
Umair Baig is PhD- Scholar of PAF-Karachi Institute of Economics & Technology, Pakistan. E-mail: umaiirbaig@gmail.com
Dr. Manzoor Anwar Khalidi
Dr. Manzoor anwar khaildi is Vice- Chancellor, Barrett Hodgson University E-Mail: makhalidi@gmail.com

References

Abel, A. B., & Eberly, J. C. (2012). Investment, valuation, and growth options. The Quarterly Journal of Finance, 2(01), 1250001.
Alexander, C., & Chen, X. (2019). Model risk in real option valuation. Annals of Operations Research, 1-32.
Amram, M., & Kulatilaka, N. (1999). Real options: Managing strategic investment in an uncertain world, harvard business school press, boston, ma, 1999. Amram and Kulatilaka.
Arnold, G. (2008). Corporate financial management. Pearson Education.
Arnold, G. C., & Hatzopoulos, P. D. (2000). The theorypractice gap in capital budgeting: evidence from the United Kingdom. Journal of business finance & Accounting, 27(56), 603-626.
Atari, S., Bakkar, Y., Olaniyi, E. O., & Prause, G. (2019). Real options analysis of abatement investments for sulphur emission control compliance. Entrepreneurship and Sustainability Issues, 6(3), 1062-1087.
Baker, H. K., Dutta, S., & Saadi, S. (2011). Management Views on Real Options in Capital Budgeting. Journal of Applied Finance, 21 (1), 18-29.
Baker, H. K., Singleton, J. C., & Veit, E. T. (2011). Survey research in corporate finance: bridging the gap between theory and practice. Oxford University Press.
Block, S. (2005). Are there differences in capital budgeting procedures between industries? An empirical study. The Engineering Economist, 50(1), 55-67.
Block, S. (2007). Are “real options” actually used in the real world?. The engineering economist, 52(3), 255-267.
Botteron, P. (2001). On the practical application of the real options theory. Thunderbird International Business Review, 43(3), 469-479.
Brennan, M. J., & Schwartz, E. S. (1985). Evaluating natural resource investments. Journal of business, 135-157.
Busby, J. S., & Pitts, C. G. C. (1997). Real options in practice: an exploratory survey of how finance officers deal with flexibility in the capital appraisal. Management Accounting Research, 8(2), 169-186.
Copeland, T. E., & Keenan, P. T. (1998). Making real options real. The McKinsey Quarterly, (3), 128.
Copeland, T., & Antikarov, V. (2001). Real options (No. BOOK). New York: Texere.
Davis, G. A. (1996). Option premiums in mineral asset pricing: are they important?. Land Economics, 167-186.
Dixit, A. K., Dixit, R. K., & Pindyck, R. S. (1994). Investment under uncertainty. Princeton university press.
Du Toit, M. J., & Pienaar, A. (2005). A review of the capital budgeting behaviour of large South African firms. Meditari: Research Journal of the School of Accounting Sciences, 13(1), 19-27. Ehrhardt, M. C.; Brigham, E. F. (2016) Corporate finance: A focused approach. Cengage learning.
Epstein, M. J., & Buhovac, A. R. (2014). Making sustainability work: Best practices in managing and measuring corporate social, environmental, and economic impacts. Berrett-Koehler Publishers.
Geddes, R. (1999). ‘Methodes d’evaluation retenues pour les transactions’’. Capital Finance, 472, 20.
Herath, H. S., & Park, C. S. (2002). Multi-stage capital investment opportunities as compound real options. The Engineering Economist, 47(1), 1-27.
Hodder, J. E., & Riggs, H. E. (1987). Pitfalls in Evaluating Risky Projects: Harvard Business Review. 研 究 技 術計画 , 2(4), 483.
Holmes, T. (1998). How Important Is Variety and Returns to Scale; What Can We Learn from Local Demand. Mimeo, University of Minnesota.
Horn, A., Kjærland, F., Molnár, P., & Steen, B. W. (2015). The use of real option theory in Scandinavia’s largest companies. International Review of Financial Analysis, 41, 74-81.
Kester, W. C. (1984). Today’s options for tomorrow’s growth. Harvard Business Review, Vol. 62, No. 2. pp. 153- 160. Kulatilaka, N., & Marks, S. G. (1988). The strategic value of flexibility: Reducing the ability to compromise. The American Economic Review, 78(3), 574-580.
Luehrman, T. A. (1998). Investment opportunities as real options: Getting started on the numbers (pp. 3-15). Boston: Harvard Business Review.
Lynch, B. (2002). Maximising FM? s contribution to shareholder value Part I: Can the capital expenditure process for fixed assets be improved?. Journal of facilities management, 1(1), 48-55.
Mason, S. P., & Merton, R. C. (1985). The role of contingent claims analysis in corporate finance.
McDonald, R., & Siegel, D. (1986). The value of waiting to invest. The quarterly journal of economics, 101(4), 707-727.
Mclntyre, A. D., & Coulthurst, N. J. (1985). Theory and practice in capital budgeting with particular reference to medium-sized UK companies’. The British Accounting Review, 17(2).
Mintzberg, H., Raisinghani, D., & Theoret, A. (1976). The structure of” unstructured” decision processes. Administrative science quarterly, 246-275.
Morris, P. A., Teisberg, E. O., & Kolbe, A. L. (1991). When choosing R&D projects, go with long shots. Research-Technology Management, 34(1), 35-40.
Myers, S. C. (1984). Finance theory and financial strategy. Interfaces, 14(1), 126-137.
Paddock, J. L., Siegel, D. R., & Smith, J. L. (1988). Option valuation of claims on real assets: The case of offshore petroleum leases. The Quarterly Journal of Economics, 103(3), 479-508.
Pivoriene, A. (2017). Real options and discounted cash flow analysis to assess strategic investment projects. Economics and Business,
Ragozzino, R., Reuer, J. J., & Trigeorgis, L. (2016). Real options in strategy and finance: Current gaps and future linkages. Academy of Management Perspectives, 30(4), 428-440.
Rigby, D. (2001). Management tools and techniques: A survey. California management review, 43(2), 139-160.
Ross, M. (1986). Capital budgeting practices of twelve large manufacturers. Financial Management, 15-22.
Ryan, P. A., & Ryan, G. P. (2002). Capital budgeting practices of the Fortune 1000: how have things changed. Journal of business and management, 8(4), 355-364.
Rychłowska-Musiał, E. (2019). Real options bargaining games. Quantitative Finance and Economics, 3(4), 624.
Slagmulder, R., Bruggeman, W., & Van Wassenhove, L. (1995). An empirical study of capital budgeting practices for strategic investments in CIM technologies. International journal of production economics, 40(2-3), 121-152.
Triantis, A., & Borison, A. (2001). Real options: state of the practice. Journal of Applied Corporate Finance, 14(2), 8-24.
Trigeorgis, L. (1988). A conceptual options framework for capital budgeting. Advances in Futures and Options Research, 3(3), 145-167.
Trigeorgis, L. (1993). Real options and interactions with financial flexibility. Financial management, 202-224.
Trigeorgis, L. (1996). Real options: Managerial flexibility and strategy in resource allocation. MIT press.
Trigeorgis, L. (Ed.). (1995). Real options in capital investment: Models, strategies, and applications. Greenwood Publishing Group.
Van Putten, A. B., & MacMillan, I. C. (2004). Making real options really work. Harvard business review, 82(12), 134-142.
Vintila, N. (2007). Real options in capital budgeting. Pricing the option to delay and the option to abandon a project. Theoretical and applied economics, 7(512), 47-58.
XIA, H., & ZENG, Y. (2005). A Study on Firms Optimal Investment Strategies and Diffusion of New Technology under Multiple Generations of Future Innovations: A Real Option Approach. Journal of Industrial Engineering and Engineering Management, 19(3), 21-27.
Published
2020-01-15