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Capital Structure, Product Market Dynamics, and the Boundaries of the Firm

Dirk Hackbarth, Richmond Mathews () and David Robinson ()
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Richmond Mathews: University of Maryland, College Park, Maryland 20742
David Robinson: Duke University, Durham, North Carolina 27708

Management Science, 2014, vol. 60, issue 12, 2971-2993

Abstract: We model a new product market opportunity as an option and ask whether it is best exploited by a large incumbent firm (integration) or by a small separate firm (nonintegration). Starting from a standard framework, in which value-maximizing investment and financing decisions are jointly determined, we show that integration protects assets in place value, whereas nonintegration protects option value and maximizes financial flexibility. We show that increases in standard measures of cash flow risk predict exploitation of new opportunities by specialized firms, whereas increases in product market competition (e.g., the risk of competitive preemption) predict exploitation by incumbents. We also show that alliances organized as licensing agreements or revenue-sharing contracts sometimes better balance the sources of value and thus may dominate more traditional forms of organization. These organizational equilibria arise from the dynamic interaction of the new opportunity’s option-like features with realistic competitive forces. This paper was accepted by Brad Barber, finance.

Keywords: capital structure; corporate investment; organizational design; real options (search for similar items in EconPapers)
Date: 2014
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