Considering real options in short-term decision making

Nils Crasselt () and Christian Lohmann
Additional contact information
Nils Crasselt: Schumpeter School of Business and Economics, University of Wuppertal
Christian Lohmann: Schumpeter School of Business and Economics, University of Wuppertal

Journal of Management Control: Zeitschrift für Planung und Unternehmenssteuerung, 2016, vol. 27, issue 4, No 4, 369 pages

Abstract: Abstract Option-like situations in non-financial markets, often referred to as real options, are usually discussed and analyzed in the context of investment decisions. In spite of the real options literature’s focus on investment decisions, option-like situations are also frequently encountered in operating decisions. For instance, decisions on the operating mode of a flexible machine in the presence of switching costs can be characterized as complex real options problems with multiple compound options. For an optimal long-term solution, short-term decision rules must consider the value of these options. In this paper we first show how a fully rational decision rule that takes the long-term consequences of short-term decisions into account can be derived within the real options framework. We contrast the outcomes of decisions according to this benchmark rule with the outcomes of decisions according to the traditional decision rule based on current contribution margin and illustrate our findings with a simulation analysis providing for a rich set of environments characterized by different levels of uncertainty and different switching costs. A major drawback of the options-based rule is the necessity to estimate option values at every decision point drawing on information from all future periods. We therefore analyze how a simplified options-based decision rule that looks ahead only one period performs against the benchmark rule. In an extension of the simulation analysis we find that the simplified decision rule serves as a good heuristic and improves decision-making similar to the benchmark rule while at the same time being much more likely to be implemented in practice.

Keywords: Cost accounting; Real options; Short-term decision making; Simulation analysis (search for similar items in EconPapers)
JEL-codes: C63 D81 M41 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://link.springer.com/10.1007/s00187-016-0234-5 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:spr:jmgtco:v:27:y:2016:i:4:d:10.1007_s00187-016-0234-5

Ordering information: This journal article can be ordered from
http://www.springer.com/economics/journal/187

DOI: 10.1007/s00187-016-0234-5

Access Statistics for this article

Journal of Management Control: Zeitschrift für Planung und Unternehmenssteuerung is currently edited by Thomas Günther

More articles in Journal of Management Control: Zeitschrift für Planung und Unternehmenssteuerung from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().