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Real options and institutions

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Abstract

This article shows how growth options are affected by two types of external uncertainty: Transactional uncertainty that stems from institutional voids and increases transaction costs, and economic uncertainty that arises from the business environment. We theorize that these two types of uncertainty have opposing effects: A firm’s growth option value (proportional to firm value) is negatively associated with transactional uncertainty, but positively associated with economic uncertainty. In an empirical study, we directly compare firm-level growth option values across 34 countries and indeed find that economic uncertainty and various institutional measures for transactional uncertainty correlate in opposite directions with the value of growth opportunities. Interestingly, in countries with lower transactional uncertainty, the economic uncertainty in the business environment is more strongly related to proportional growth option value. The link between a country’s institutions and firms’ proportional growth options value is also moderated by firm size. The implication of our study is that institutions, such as property rights, business regulations, and contract enforcement are important preconditions for companies to appropriate growth option value under economic uncertainty. Our findings may help public policymakers in devising strategies for institutional development in their country, and corporate executives in assessing institutional factors when managing their company’s growth options.

Résumé

Cet article montre comment les options de croissance sont influencées par deux formes d’incertitude externe : l’incertitude transactionnelle qui provient des vides institutionnels et qui accroît les coûts de transaction, et l’incertitude économique qui est liée à l’environnement des affaires. Nous supposons que ces deux formes d’incertitude produisent des effets opposés : la valeur des options de croissance d’une entreprise (proportionnelle à la valeur d’entreprise) est négativement associée à l’incertitude transactionnelle, mais elle est positivement associée à l’incertitude économique. Sur la base d’une étude empirique, nous comparons directement les valeurs des options de croissance au niveau de la firme dans 34 pays et nous trouvons en effet que l’incertitude économique et des mesures institutionnelles variées concernant l’incertitude transactionnelle sont corrélées de manière opposée à la valeur des opportunités de croissance. Il paraît intéressant de noter que dans les pays avec une incertitude transactionnelle plus faible, l’incertitude économique dans l’environnement d’affaires est plus fortement liée à la valeur proportionnelle des options de croissance. Le lien entre les institutions d’un pays et la valeur proportionnelle des options de croissance d’une entreprise est aussi modéré par la taille de la firme. Notre étude a pour implication que les institutions, comme les droits de propriété, les réglementations du milieu d’affaires et l’exécution des contrats, constituent des conditions préalables importantes pour les entreprises s’approprient la valeur des options de croissance face à l’incertitude économique. Nos résultats peuvent aider les responsables des politiques publiques à élaborer des stratégies pour le développement institutionnel de leur pays, et les dirigeants d’entreprises à évaluer les facteurs institutionnels lorsqu’ils gèrent les options de croissance de leur entreprise.

Resumen

Este artículo muestra como las opciones de crecimiento son afectadas por dos tipos de incertidumbre externa: La incertidumbre transaccional que proviene de vacíos institucionales y aumenta los costos de transacción, y la incertidumbre económica que surge del entorno del negocio. Teorizamos que estos dos tipos de incertidumbre tienen efectos opuestos: El valor de la opción de crecimiento de una empresa (proporcional al valor de una empresa) es asociado de manera negativa con la incertidumbre transaccional, pero asociado positivamente con la incertidumbre económica. En un estudio empírico, comparamos directamente los valores de las opciones de crecimiento a nivel de la empresa en 34 países y de hecho encontramos que la incertidumbre económica y varias medidas institucionales para la incertidumbre transaccional se correlacionan en una dirección opuesta con el valor de las oportunidades de crecimiento. Curiosamente, en países con baja incertidumbre transaccional, la incertidumbre económica en los entornos empresariales es relacionada de una forma más fuerte al valor de opción de crecimiento proporcional. El vínculo entre las instituciones de un país y el valor de las opciones de crecimiento proporcional es también moderado por el tamaño de la empresa. La implicación de nuestro estudio es que las instituciones, como los derechos de propiedad, las regulaciones empresariales, y la ejecución de los contratos son precondiciones importantes para que las empresas se apropien el valor de la opción de crecimiento bajo incertidumbre económica. Nuestros hallazgos pueden ayudar a formuladores de políticas públicas en concebir estrategias para el desarrollo institucional en sus países, y a los ejecutivos corporativos en evaluar factores institucionales cuando gestionan las opciones de crecimiento de la empresa.

Resumo

Este artigo mostra como as opções de crescimento são afetadas por dois tipos de incerteza externa: incerteza transacional que decorre de vazios institucionais e aumenta custos de transação e incerteza econômica que surge do ambiente de negócios. Nós teorizamos que esses dois tipos de incerteza têm efeitos opostos: o valor da opção de crescimento de uma empresa (proporcional ao valor da empresa) está negativamente associado com a incerteza transacional, mas positivamente associado à incerteza econômica. Em um estudo empírico, comparamos diretamente os valores de opções de crescimento no nível de empresa em 34 países, e constatamos que a incerteza econômica e várias medidas institucionais para incerteza transacional se correlacionam em direções opostas com o valor das oportunidades de crescimento. Curiosamente, em países com menor incerteza transacional, a incerteza econômica no ambiente de negócios está mais fortemente relacionada com o valor da opção de crescimento proporcional. A ligação entre as instituições de um país e o valor das opções de crescimento proporcional das empresas também é moderada pelo tamanho da empresa. A implicação do nosso estudo é que as instituições, tais como direitos de propriedade, regulações de negócios e observância de contratos, são pré-condições importantes para que as empresas se apropriem do valor da opção de crescimento sob incerteza econômica. Nossos resultados podem ajudar formuladores de políticas públicas na elaboração de estratégias para o desenvolvimento institucional em seu país e executivos de empresas na avaliação de fatores institucionais ao gerenciar as opções de crescimento de suas empresas.

概要

本文介绍了增长期权是如何受到两种类型的外部不确定性影响的:由制度空隙产生的并增加交易成本的交易不确定性,和源于商业环境而产生的经济不确定性。我们推论,这两种类型的不确定性有相反的作用:一个公司的增长期权价值(与公司价值成比例)与交易不确定性负相关,但与经济不确定性正相关。在一项实证研究中,我们直接比较在34个国家企业层面的增长期权价值并的确发现,经济不确定性及交易不确定性的各种制度措施与增长机会的价值反相关。有趣的是,在交易不确定性较低的国家,商业环境经济不确定性与比例增长期权价值更密切相关。一个国家的制度和公司的比例增长期权价值之间的联系受企业规模影响。我们研究的启示是: 制度,如产权、商业规则、合同的执行是公司在经济不确定性下获得增长期权价值的重要先决条件。我们的发现可能有助于公共政策制定者为其国家的制度发展,和为企业高管在管理其公司增长期权时评估体制因素制定战略。

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Acknowledgements

We thank the Editor, Mona Makhija, and three anonymous referees for their careful and detailed comments. Any remaining our errors are of course our own. The sequence of authors was randomly determined. Part of the research was done while van Bekkum was at The Conference Board in New York City.

Author information

Authors and Affiliations

  1. Finance Group, Erasmus School of Economics, Erasmus University and Erasmus Institute of Management, PO Box 1738, 3000 DR, Rotterdam, The Netherlands

    Han Smit

  2. Department of Applied Economics, Erasmus School of Economics, Erasmus University, Tinbergen Institute, and Erasmus Institute of Management, PO Box 1738, 3000 DR, Rotterdam, The Netherlands

    Enrico Pennings

  3. Finance Group, Erasmus School of Economics, Erasmus University, Tinbergen Institute, and Erasmus Institute of Management, PO Box 1738, 3000 DR, Rotterdam, The Netherlands

    Sjoerd van Bekkum

Authors
  1. Han Smit
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  2. Enrico Pennings
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  3. Sjoerd van Bekkum
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Corresponding author

Correspondence to Han Smit.

Additional information

Accepted by Mona Makhija, Area Editor, on 7 November 2016. This article has been with the authors for six revisions.

Appendix: The Total Marginal Effects of Institutions

Appendix: The Total Marginal Effects of Institutions

This table presents the total marginal effect of a one standard deviation change in institutional quality on PVGO. Coefficients on Contract enforcement are multiplied times −1 to facilitate easy interpretation. We define transactional uncertainty due to institutional voids as the negative of all institutional dimensions in the table. The first data column presents the 25th, 50th, and 75th percentiles of Size and Economic uncertainty. Each of the other columns presents the total marginal effect (“dydx”) of the different measures for institutions on PVGO, i.e., All institutions (AI), Business regulations (BUS), Property rights (PROPR), and Contract enforcement (CONTR.ENF) at different levels of Size and Economic uncertainty (Econ. Unc.) as predicted by the model in Table 6. All coefficients are scaled by the standard deviation of the respective institutional variable.

 

Size

dydx (AI)

dydx (BUS)

dydx (PROPR)

dydx (Contr.Enf)

25th percentile

3.9

0.556***

0.265***

0.346***

0.253***

  

(4.575)

(5.475)

(3.680)

(4.202)

50th percentile

5.3

0.290**

0.171***

0.202**

0.172***

  

(2.591)

(3.635)

(2.422)

(4.152)

75th percentile

6.7

0.005

0.069

0.049

0.086

  

(0.041)

(1.261)

(0.585)

(1.462)

 

Econ. Unc.

dydx (AI)

dydx (BUS)

dydx (PROPR)

dydx (Contr.Enf)

25th percentile

31%

0.180*

0.1000

0.096

0.114**

  

(1.755)

(1.622)

(1.321)

(2.192)

50th percentile

42%

0.253**

0.126**

0.153*

0.161***

  

(2.312)

(2.107)

(2.018)

(3.350)

75th percentile

57%

0.350***

0.161**

0.230***

0.224***

  

(2.918)

(2.637)

(2.817)

(4.277)

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Smit, H., Pennings, E. & van Bekkum, S. Real options and institutions. J Int Bus Stud 48, 620–644 (2017). https://doi.org/10.1057/s41267-016-0055-7

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