Investment, Valuation, and Growth Options

Andrew B. Abel () and Janice Eberly
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Andrew B. Abel: The Wharton School of the University of Pennsylvania and National Bureau of Economic Research, USA

Quarterly Journal of Finance (QJF), 2012, vol. 02, issue 01, 1-32

Abstract: We develop a model in which the opportunity for a firm to upgrade its technology to the frontier (at a cost) leads to growth options in the firm's value; that is, a firm's value is the sum of value generated by its current technology plus the value of the option to upgrade. Variation in the technological frontier leads to variation in firm value that is unrelated to current cash flow and investment, though variation in firm value anticipates future upgrades and investment. We simulate this model and show that, consistent with the empirical literature, in situations in which growth options are important, regressions of investment on Tobin'sQand cash flow yield small positive coefficients onQand larger coefficients on cash flow. We also show that growth options increase the volatility of firm value relative to the volatility of cash flow.

Keywords: Growth options; Tobin'sQ; investment; technology upgrades (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (8)

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DOI: 10.1142/S2010139212500012

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