Joint Ventures and the Option to Expand and Acquire Bruce Kogut (1991) Management Science, 37(1):...
-
Upload
shanon-conley -
Category
Documents
-
view
215 -
download
0
Transcript of Joint Ventures and the Option to Expand and Acquire Bruce Kogut (1991) Management Science, 37(1):...
Joint Ventures and the Option to Ex-pand and Acquire
Bruce Kogut (1991)Management Science, 37(1): 19-33.
Jae Kyun Yoo
Foundations of Strategy Research (Fall 2013)
• Undergrad: U.C. Berkeley (Political Sci-ence)
• Masters: Columbia University (Interna-tional Affairs)
• Ph.D.: M.I.T. Sloan• Assistant, Associate, Chaired Professor at
Wharton• Currently Chaired Professor at Columbia
University
Introduction
• The task of building a market position and competitive capabili-ties requires lumpy and non-trivial investments.
Bruce Kogut (1991)Joint Ventures and the Option to Expand and AcquireManagement Science, 37(1): 19-33.
• It is beyond the resources of a single firm to buy the right to expand in all potential market opportunities.
• A partner, especially one which brings the requisite skills, may be sought to share the costs of placing the bet that the oppor-tunity will be realized.
Joint Ventures• Due to its benefits of sharing risk and of reducing overall in-
vestment costs, joint ventures serve as an attractive mecha-nism to invest in an option to expand in risky markets.
Focus - The exploration of the link in the timing of the ac-quisition of joint ventures and of the exercise of the option
to expand.
• To exercise the option to expand requires further commitment of capital, thus requiring renegotiation among the partners.
• One possible outcome is that the party placing a higher value on this new capital commitment buys out the other.
Real Option Perspective
• Firms engage in cooperative ventures as buffers against uncertainty (Pfeffer & Nowak, 1976) and that managerial discretion is severely limited by environmental volatility (Hannan & Freeman, 1977; McKelvey & Aldrich, 1983).
• Joint ventures are designed as mechanisms to exploit, as well as buffer, uncertainty.
• Joint ventures are investments providing firms with the dis-cretion to expand in favorable environments, but avoid some of the losses from downside risk.
Real Options Theory
Bruce Kogut (1991)Joint Ventures and the Option to Expand and AcquireManagement Science, 37(1): 19-33.
Real Options
• Joint ventures are real options… in terms of the economic op-portunities to expand and grow in the future.
Bruce Kogut (1991)Joint Ventures and the Option to Expand and AcquireManagement Science, 37(1): 19-33.
• An alternative or choice that becomes available with a busi-ness investment opportunity. Real options can include oppor-tunities to expand and cease projects if certain conditions arise, amongst other options. They are referred to as “real” because they usually pertain to tangible assets such as capital equipment, rather than financial instruments. Taking into ac-count real options can greatly affect the valuation of potential investments. Oftentimes, however, valuation methods, such as NPV, do not include the benefits that real options provide. - In-vestopedia
Real Options (cont.)
Bruce Kogut (1991)Joint Ventures and the Option to Expand and AcquireManagement Science, 37(1): 19-33.
• The value of any investment can be broken into the cash flows stemming from assets as currently in place and those stem-ming from their redeployment or future expansion (Myers, 1977).
𝑉 𝐽=𝐹 𝑗 ( 𝐾 ,𝜋 )+𝑂 𝑗 ( 𝐾 ,𝜋 )
Value of the venture as estimated by the jth
firm
Value of the assets
in their current use
Valuation of the future growth op-portunities
Pindyck (1988)K: investment
: current value of an uncertain state variable
Joint Ventures as Real Options
Two options why joint ventures can be viewed as analogues.
Waiting to invest – It pays to wait before committing resources.
• Joint ventures resolves partly the tradeoff between buying flexibility now and waiting to invest and focus later (Werner-felt & Karnani, 1987).
Expanding production – Investment commitment is necessary in or-der to have the right to expand in the future.
Bruce Kogut (1991)Joint Ventures and the Option to Expand and AcquireManagement Science, 37(1): 19-33.
• When the market for the technology or new product is proven, the option to acquire is likely to be exercised.
Timing of Exercise
Bruce Kogut (1991)Joint Ventures and the Option to Expand and AcquireManagement Science, 37(1): 19-33.
• The acquisition is justified only when the perceived value to the buyer is greater than the exercise price.
Value of the op-tion to acquire
Value of the jth firm of purchasing
the remaining shares in the ven-
ture
Price of pur-chasing the remaining
shares
and <1 and is the current share owned by firm j
¿
Timing of Exercise (cont.)
Bruce Kogut (1991)Joint Ventures and the Option to Expand and AcquireManagement Science, 37(1): 19-33.
• The timing of the exercise of the option to terminate the ven-ture by acquisition is influenced by two considerations: the ini-tial base rate forecast underlying the valuation of the business and the value of the venture to each party as realized over time.
The venture will be acquired when its valuation exceeds the base rate forecast.
Selection Cues and Market Valuation
Two time-varying specifications of the market cues relevant to the acquisition decision is considered.
Short-term annual growth rate
Annual residual error from a long-term trend
These two variables are proxies for changes in the unobserved state variable that determines the value of the joint venture.
• The likelihood of an acquisition should increase with positive movements of the proxy variable.
Bruce Kogut (1991)Joint Ventures and the Option to Expand and AcquireManagement Science, 37(1): 19-33.
¿
¿
Statistical Results
Bruce Kogut (1991)Joint Ventures and the Option to Expand and AcquireManagement Science, 37(1): 19-33.
Managers are sensitive to a long-term intra-industry base rate which serves as a standard by which to eval-uate annual changes.
Termination by Dissolution
Bruce Kogut (1991)Joint Ventures and the Option to Expand and AcquireManagement Science, 37(1): 19-33.
If joint ventures are designed as options, then as long as the investment is sunk and the operating costs are moderate, downward movements should not lead to dissolution.
Conclusion
Joint ventures are designed as options.
Bruce Kogut (1991)Joint Ventures and the Option to Expand and AcquireManagement Science, 37(1): 19-33.
Factors that increase the likelihood of an acquisition.• Unexpected increases in the value of the venture.• The degree of concentration in the industry.
Firms may profit from uncertainty.• A more flexible production process or organizational design (Pi-
ore & Sabel, 1984).• Investments in joint ventures which serve as platforms for pos-
sible future development.