Technological Innovation, Product Life Cycle and Market Power: A Real Options Approach

Johnson T. S. Cheng (), I-Ming Jiang () and Yu-Hong Liu ()
Additional contact information
Johnson T. S. Cheng: Department of International Business, Soochow University, No. 56, Section 1, Guiyang Street, Taipei 10048, Taiwan, ROC
I-Ming Jiang: Faculty of Finance, College of Management, Yuan Ze University. No. 135, Yuan-Tung Road, Chung-Li, Taoyuan 32003, Taiwan, ROC
Yu-Hong Liu: Faculty of Department of Accountancy, Graduate Institute of Finance & Banking, National Cheng Kung University, Tainan City, 70101, Taiwan, ROC

International Journal of Information Technology & Decision Making (IJITDM), 2015, vol. 14, issue 01, 93-113

Abstract: This paper employs a real options approach to analyze optimal investment decisions. When investment projects have the characteristics of irreversibility, uncertainty and the option to wait or exit, the traditional net present value (NPV) method would underestimate the value of investment, since it neglects the values of timing and operational flexibility. The distinctive feature of this paper is that the effects of product life cycle (PLC) as well as market power are incorporated into the model. In addition, and different to the approach in Liaoet al.[Optimal investment decision and product life cycle: A real options approach,Sun Yat-Sen Management Review 11(3) (2003) 1–36], we introduce the concept of technological innovation into the model. It is shown that the optimal waiting time for the investment is longer than both those in the American call options model of McDonald and Siegel [The value of waiting to invest,Quarterly Journal of Economics 101(4) (1986) 707–727], which does not incorporate dividend yield, and Liaoet al.[Optimal investment decision and product life cycle: A real options approach,Sun Yat-Sen Management Review 11(3) (2003) 1–36], but is shorter than that in Dixit and Pindyck's [Investment under Uncertainty(Princeton University Press, Princeton, NJ, 1994)] model, which incorporates dividend yield. Finally, a comparative static is used to analyze the determinants of optimal investment decisions. Our results indicate that the investment-ratio threshold will be higher, and thus the optimal entry time for an investment will be delayed, when (1) the PLC is longer, (2) the uncertainty is greater, (3) the discounting rate is higher, (4) market power is larger, (5) jump size intensity is stronger and (6) the payoff out ratio (R&D/revenue) is larger.

Keywords: Technological innovation; market power; product life cycle (PLC); real options approach (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (4)

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DOI: 10.1142/S0219622014500874

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