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Abstract:
The paper considers the problem of evaluating the probability of investing in a capital-investment project as a measure of the uncertainty-investment relationship in a real option model. By the use of the contingent claims analysis the opportunity to invest is modelled as an American call option with expiring time. We show that an increase in uncertainty of the project may actually have positive or negative effects on the probability of investing depending on which market parameters are called to restore the asset price equilibrium condition.

Investment, uncertainty, real options

Abstract:
This paper examines the effect of competition on the irreversible investment decisions under uncertainty as a generalization of the "real option" approach. We examine this issue with reference to an industry where each firm has only one investment opportunity which is completely irreversible and the product market reveals an inverted U-shape relationship between firm profits and industry size. That is, there are positive externalities for low level of the market size and negative externalities at high level of the market size. In the latter case, which corresponds to the traditional competitive industries, firms invest sequentially as market profitability develops. In the former case, which corresponds to industries in which investments are mutually beneficial, firms invest simultaneously after profitability of the market has developed sufficiently to capture all network benefits and to recover the option value of waiting. Put together, these extensions of the "real option" analysis, with strategic interactions, may help to explain both the cases of rapid and sudden developments such as the recent internet investments and the cases of prolonged start-up problems while waiting for the market to develop as the story of fax machines shows.

Competition, Network Effect, Real Options

Abstract:
A new instrument for hedging weather risks has made its appearance in the financial arena. Trade in 'weather derivatives' has taken off in the US, and interest is growing elsewhere. Whilst such contracts may be simply interpreted as a new tool for solving a historical problem, the question addressed in this paper is if, besides other factors, the appearance of weather derivatives is somehow related to anthropogenic climate change. Our tentative answer is positive. Since 'global warming' does not simply mean an increase in averaged temperatures, but increased climate variability, and increased frequency and magnitude of weather extremes, derivative contracts may potentially become a useful tool for hedging some weather risks, insofar as they may provide coverage at a lower cost than standard insurance schemes.

Global warming, climate variability, insurance coverage, weather derivatives

Abstract:
Our interest here concerns liquidity supply as a distinctive feature of the bank-firm relationship. Any agent facing an opportunity or a commitment may find him/herself unexpectedly illiquid, and hence he/she may find it profitable to borrow "on call" if this costs less than missing the opportunity or defaulting on the commitment, or it costs less than using non-money assets as means of payment. We first examine the relation between firm value and access to liquidity supply, and then we investigate the efficiency properties of bank refinancing contracts in a continuous time stochastic model of a repeated firm-bank relationship, where the key problem is the credibility of the mutual commitment between the two parties. Our main finding is that cost-minimizing and renegotiation-proof contracts emerge in the absence of perfect commitment and enforceability of payments as the borrower and the bank can exert mutual threat of termination.

Liquidity, firm value, bank relationships

Abstract:
Firms grant to their employees non-tradable stock options as an incentive device. Is the opportunity cost of issuing these options equal to the amount the company would receive if it sold the same options to outside investors? No, it is not, since the options granted to employees are non tradable, due to the incentive scheme to which they are related, and their value, i.e. the opportunity cost, may be lower or larger than the value of the corresponding tradable option.

Employees stock options, opportunity cost, nontradable options

Abstract:
The purpose of the present paper is to describe the role of uncertainty and technical change in an environmental context. Which impact does ecological uncertainty have on physical and R&D investments' decisions? How are pollution trajectories modified when uncertainty is taken into account? To reply to these questions we modify the ETC-RICE model described in Buonanno et al. (2000) by embedding in it the "hazard rate function" approach as in Bosello and Moretto (1999). With such a model we are also able to study some consequences of the implementation of the Kyoto agreement under different policy options - i.e. with or without different degrees of introduction of one of the so-called "flexibility mechanisms" (specifically, the Emissions Trading) - in order to assess its impact on agents' behaviour in terms of domestic abatement, consumption, physical and environmental investment, trading of emissions rights (quantity and price). The results show that uncertainty strongly influences agents' behaviour; in particular, agents calm down the increase of temperature via lower emissions. In addition, R&D expenditures are a mean exploited in order to trigger the "engine of growth" only when environmental endogenous technical change is allowed. However, even if uncertainty may stimulate technical change, long-run growth is negatively affected by its presence as predicted by the theory (e.g. Clarke and Reed 1994; Tsur and Zemel 1996; and Bosello and Moretto 1999).

Climate change, endogenous technical change, uncertainty

Abstract:
The government of common agricultural and forestry land is a topic that is currently enjoying a revival of interest. Many local communities have shown the ability to pursue sustainable use of natural resources thanks to their self-governed authorities. In this context the relationship between public and private interest which is established in use of the resource is a fairly controversial. The paper proposes a dynamic model to analyse the behaviour of a user of a common property resource in a "real option" framework, where the value of the right to use the resource is affected by: 1) uncertainty on the future amount of the resource; 2) entry and exit costs and 3) the number of users competitors.

Common property resources, option value, uncertainty

Abstract:
This paper tries to explain why most migration flows show some observable jumps in their processes, a phenomenon that seems to be sympathetic with the characteristic of irreversibility of migration. We present a real option model where the choice to migrate depends on both the differential wage between the host country and the country of origin, and on the probability of being fully integrated into the host country. The theoretical results show that the optimal migration decision of a single individual consists of waiting before migrating in a (coordinate) mass of individuals. The dimension of the migration flow depends on the behavioural characteristics of the ethnic groups: the more "sociable" they are, the larger the size of the wave and the lower the differential wage required. A second part of the paper is devoted to calibrating the model and simulating some migration flows to Italy in the last decade. The calibration is able to replicate the observable migration jumps in the short term. In particular, the calibrated model is able to conjecture the induced labour demand elasticity level of the host country and the behavioural rationale of the migrants.

Migration, Real Option, Labour Market, Network Effect

Abstract:
In this article, we analyse the optimal investment decision in a new health care technology of a representative hospital that maximises its surplus in an uncertain environment. The new technology allows the hospital to increase the quality level of the care provided, but the investment is irreversible. The article uses the framework of the real option literature to show how the purchasing rules might influence the level of investment. We show that the investment in new technology is best incentivate within a long term contract where the number of treatments reimbursed depends on the level of investment made in the period when the technology is new. In this way, asymmetry of information does not affect the outcome of the contract. In our model in fact the purchaser can verify the level of the investment only at the end of each period but the purchasing rule has an anticipating effect on the decision to invest.

Health care technologies, Medical quality, Irreversible investments, Real option

Abstract:
In this article we analyse the effects of different regulatory schemes (price cap and profit sharing) on a firm's investment of endogenous size. Using a real option approach in continuous time, we show that profit sharing does not affect a firm's
start-up decision relative to a pure price cap scheme. Unless the threshold after which profit sharing intervenes is very high, however, introducing a profit sharing element delays further investments: this decreases the present value of total investment. We also evaluate the reduction in the firm's value due to profit sharing, linking this reduction to the option value of future investments.

regulation, investment, profit sharing, real options, RPI-x

Abstract:
Ecolabel award schemes have become increasingly popular. Their rationale is to enable (concerned) consumers to identify "green" products. By so doing, ecolabelling should stimulate environmental innovation, and induce firms to reduce the supply of conventional (polluting) products. Our analysis however points out that the two phenomena are not necessarily correlated. Through a dynamic model of investment decisions, the paper outlines the situations under which ecolabelling could induce perverse effects (increased invesrment in conventional technologies), and examines whether setting quantitative restrictions on the issuing of labels could constitute an antidote.

Abstract:
We analyze the optimal investment strategy of a monopolist which has subscribed a concession contract to provide a public utility, i.e. water service. We present a strategic model in which a monopolist chooses both the timing of the investment and the capacity. We focus not only on the value of the immediate investment, but rather on the value of the investment opportunity. We then extend the model to two interdependent projects, where investing in the first project provides the opportunity to acquire the benefits of the new investment by making a new outlay. We show that flexibility to defer an investment may generate, ceteris paribus, additional profits which may induce positive effects in terms of policy and consumers surplus.

Irreversible investment, Flexibility to defer, Capacity expansion choice

Abstract:
When economic agents decide their optimal environmental behavior, they have to take into account non continuos evolutionary trends and irreversible changes characterising environmental phenomena. Given the still non perfect biophysical and economic knowledge, decisions have to be taken in an uncertain framework. The paper analyses in the specific how agents' optimal choices are affected by the presence of a future possible, but uncertain catastrophic occurrence provoked by a climate collapse due to global warming.

Abstract:
To avoid the extremely high profit levels found in the recent experience of public utilities' regulation, some regulators have introduced a profit-sharing (PS) rule that revises prices to the benefit of consumers. However, in order to be successful, a PS rule should satisfy appropriate incentive conditions.

In this paper, we study the incentive properties of a second best PS mechanism designed by the regulator to induce a regulated monopolist to divert its "excessive" profits to the customers. In a real option model where a regulated monopolist manages a long-term franchise contract and the regulator has the option to revoke the contract if there is serious welfare loss, we first endogenously derive the welfare maximising PS rule under the verifiability of profits. We then explore the dynamic efficiency of this PS rule under the non-verifiability of profits and study the firm's incentive to comply with it in an infinite-horizon game. Finally, we derive the price adjustment path which follows the adoption of a PS rule in a price cap regulation.

We show that the riskiness of the distribution of the firm's future profits and the regulator's cost in revoking the franchise contract are key factors in determining the equilibrium properties of a dynamic PS rule.

Price-cap regulation, Profit-sharing, Real options

Abstract:
The main issue is the organization of firms when different degrees of labor participation are taken into account. We start reviewing the literature on the LM firm. We then consider a less radical labor participation, i.e., the Aoki firm. We survey extensions of the Aoki's firm to the case of market uncertainty, where also the question of the optimal allocation of the shut down decision is tackled, when shareholders are not able to maximize the total payoff accruing to both workers and owners. By and large, it appears that the degree of labor participation in decisions and rent sharing in a firm is not a settled question, even though it seems to depend on the respective degree of firm specificities of production factors.

Abstract:
The paper studies the effect of scale economies on the optimal capacity adjustment of a multiplant firm. It is shown that with increasing economies of scale plants are ranked in decreasing order, after which the optimal choice is to scrap the largest one. On the contrary, if there are decreasing economies of scale the optimal policy would be to wait before abandoning intermediate plants. That is, decreasing economies of scale amplify the effect of uncertainty on disinvestment and tend to increase the plant's life.

Abstract:
The main issue is the organization of firms when different degrees of labour participation are taken into account. We start reviewing the literature on the LM firm. We then consider a less radical labour participation, i.e., the Aoki firm. We survey extensions of the Aoki's firm to the case of market uncertainty, where also the question of the optimal allocation of the shut down decision is tackled, when shareholders are not able to maximise the total payoff accruing to both workers and owners. By and large, it appears that the degree of labour participation in decisions and rent sharing in a firm is not a settled question, even though is seems to depend on the respective degree of firm specificities of production factors.

Abstract:
When assigning a concession contract, the regulator faces the issue of setting the concession length. Another key issue is whether or not the concessionare should be allowed to set the timing of new investments. In this paper we investigate the impact of concession length and investment timing flexibility on the "concession value." It is generally argued that long-term contracts are privately valuable as they enable a concessionaire to increase her overall discounted returns. Moreover, the real option theory suggests that investment flexibility has an intrinsic value, as it allows concessionaires to avoid costly errors. By combining these two conventional wisdoms, one may argue that long-term contracts, which allow for investment timing flexibility, should always result in higher concession values. Our result suggests that this is not always the case. Firstly, investment flexibility does not always increase the concession value. Secondly, long-term contracts do not necessarily increase the concession value.

Concession contracts, Real option theory, Investment timing flexibility, Water utilities

Abstract:
From 1997 to 2001 we observe in the USA a faster growth in the number of Nonemployer firms (NF) vis-a-vis Employer firms (EF). The diverse speed of net entry may be due to particular internal organisation of the two types of firms and the effect that this has on the reactions to market uncertainty. However, the set of internal organizations of firms is larger than that made up simply by EFs and NFs, in particular among newborn firms, since we observe corporate start-ups with employees, firms owned and managed by their founders who are simultaneously the employees and, finally, non corporate enterprises. The second class of firms mostly belongs to the category of NFs, according to US nomenclature, while non corporate firms may belong to either category. Our curiosity is attracted by different entry patterns of NFs and EFs and our aim is to interpret them. According to recent literature, firms carry out an irreversible investment, such as entry, only if market prices are strictly larger than average total costs (Marshallian point). However, the trigger price that makes firms become active is affected by institutional rules, the existence of profit sharing, efficiency wages, exit options - i.e. partial reversibility, financial constraints. Then, the internal organization of a newborn firm may make the difference. In a continuous time stochastic environment, where firms bear a sunk cost, we model entry as a growth option. On the trace of distinct objective functions we show that NFs and EFs have specific entry patterns in terms of output price and/or size. Why? Simply because they react in diverse fashions to market price volatility. In this sense we are able to show that, in most cases, the NF is locally less risky. This makes the NF better suited to enter under conditions of higher volatility. This exactly corresponds to what happened during the years between 1997-2001.

Entry strategies, Uncertainty, Nonemployer, Employer firms

Abstract:
The main aim of the paper is to highlight the relation between flexibility and vertical integration. To this purpose, we go through the selection of the optimal degree of vertical disintegration of a flexible firm which operates in a dynamic uncertain environment. The enterprise we model enjoys flexibility since it can switch from a certain amount of disintegration to vertical integration and viceversa. This means that the firm never loses vertical control, i.e., the ability to produce all inputs even when it buys them in the market. This sort of flexibility makes for results which are somehow contrary to the Industrial Organization recent literature and closer to the Operations Research results. In this sense we provide a bridge between the two approaches and rescue Industrial Organization from counterintuitive conclusions.

Vertical Integration, Outsourcing, Entry, Flexibility

Abstract:
In this article, we analyse the interactions between financial and start-up decisions in an oligopolistic framework, where firms compete to enter a new market. We show that preemption can substantially reduce the negative effects of credit rationing on start-up investment decisions.

capital structure, irreversibility, preemption, real options

Abstract:
The paper analyses the timing of spontaneous environmental innovation when second-mover advantages, arising from the expectation of declining investment costs, increase the option value of waiting created by investment irreversibility and uncertainty about private payoffs. We then focus on the design of public subsidies aimed at bridging the gap between the spontaneous time of technological change and the socially desirable one. Under network externalities and incomplete information about firms' switching costs, auctioning investment grants appears to be a cost-effective way of accelerating pollution abatement, in that it allows targeting grants instead of subsidizing the entire industry indiscriminately.

Environmental innovation, Investment irreversibility, Network externalities, Investment grants, Second-price auction

Abstract:
This paper analyses the decision to invest in quality by a hospital in an environment where doctors are devoted workers, i.e. they care for specific aspects of the output they produce. We assume that quality is the result of both an investment in new technology and the effort of the medical staff. Hospital services are paid on the basis of their marginal cost of production while the number of patients treated depends on a purchasing rule which discriminates for the level and timing of the investment. We show that the presence of devoted doctors affects the trade-off between investment and the purchasing rule so that for the hospital it is not always optimal to anticipate the investment decision.

Hospital technology, Devoted worker, Quality, Irreversible investment, Real options

Abstract:
Recent European legislation on immigration has revealed a particular paradox on migration policies. On the one hand, the trend of recent legislation points to the increasing closure of frontiers (OECD 1999, 2001,2004), trying to limit the immigrants’ stock. On the other hand, there is an increase in regularization, i.e., European policies are becoming less tight. Our aim here is to develop a theoretical model that tries to explain if it is better for the government to tighten or relax limits for immigrants in order to control migration inflows better. To this end, we use a real option approach to migration choice that assumes that the decision to migrate can be described as an irreversible investment decision. In our model the government has in mind a specific upper bound on immigrants, and the policies adopted (admission requirements or regularizations) are signals for each potential migrant that reveal information about this limit. Our results show that promoting uncertainty over this migration upper bound may improve the government’s control on migration inflows (quotas). This could explain that the paradox of counterbalancing policies is not an odd evidence. In particular, we show that if the government controls the information related to the immigration stock it could delay the mass entry of immigrants, maintaining the required stock in the long run and controlling the flows in the short-run.

immigration, real option

Abstract:
Tools for recreational resources management are topics of great theoretical and practical interest. The most commonly used tool undoubtedly is the licence or permit. The implementation of a system of licences to regulate the use of a natural resource is far from simple as it presupposes the answer to a number of questions. This paper focuses on the point of view of the purchaser and, in particular, models his behaviour when considering the purchase of a licence that authorises him to benefit from a natural resource in accordance with certain rules and procedures. The model assumes that the behaviour can be compared to that of an investor faced with a Call option, i.e. the right (but not the obligation) to make an investment at any time in a given financial unit at a pre-established price. The model was used to study the effect on purchase timing and licence duration of certain factors such as the uncertainty of the benefits and the irreversibility of the purchase. The results show that under uncertainty the consumer tends to delay the purchasing time and, then, to purchase a licence of longer duration than the one that would be purchased considering only the present value deriving from the expected flow of benefits.

Option value, irreversibility, natural resources, licences

Abstract:
Recent European Legislation on immigration has revealed a particular paradox on migration policies. On the one hand, the trend of recent legislation points to the increasing closure of frontiers (OECD 1999, 2001, 2004), also by using immigration quotas. On the other hand, there is an increase of regularization, i.e., European policies are becoming less tight. Our aim here is to study these counterbalanced and opposite policies in European immigration legislation in a unified framework . To do this, we have used a real option approach to migration choice that assumes that the decision to migrate can be described as an irreversible investment decision where quotas represent an upper bound limit. Our results show that the paradox of counterbalancing immigration policies is not odd but it could be in line with an optimal policy to control migration inflow. In particular, we show that if the government controls the information related to the immigration quota system it could delay the mass entry of immigrants maintaining, in the long run, the required immigration stock and controlling the flows in the short-run.

Immigration, Real Option, Quota System

Abstract:
Recent European Legislation on immigration has revealed a particular paradox on migration policies. On the one hand, the trend of recent legislation points to the increasing closure of frontiers (OECD 1999, 2001,2004), also by using immigration quotas. On the other hand, there is an increase of regularization, i.e., European policies are becoming less tight. Our aim here is to study these counterbalanced and opposite policies in European immigration legislation in a unified framework . To do this, we have used a real option approach to migration choice that assumes that the decision to migrate can be described as an irreversible investment decision where quotas represent an upper bound limit. Our results show that the paradox of counterbalancing immigration policies is not odd but it could be in line with an optimal policy to control migration inflow. In particular, we show that if the government controls the information related to the immigration quota system it could delay the mass entry of immigrants maintaining, in the long run, the required immigration stock and controlling the flows in the short-run.

Immigration, Real Option, Quota System

Abstract:
We study the competition to operate an infrastructure service by developing a model where firms report a two-dimensional sealed bid: the price to consumers and the concession fee paid to the government. Two alternative bidding rules are considered in this paper. One rule consists of awarding the exclusive right of exercise to the firm that reports the lowest price. The other consists of granting the franchise to the bidder offering the highest fee. We compare the outcome of these rules with reference to two alternative concession arrangements. The former imposes the obligation to immediately undertake the investment required to roll-out the service. The latter allows the winning bidder to optimally decide the investment time. The focus is on the effect of bidding rules and managerial flexibility on expected social welfare. We find that the two bidding rules provide the same outcome only when the contract restricts the autonomy of the franchisee, and we identify the conditions under which time flexibility can provide a higher social value.

Concessions, Auctions, Bidding Rules, Managerial Flexibility

Abstract:
This paper provides a general framework to determine the optimal penalty fee to induce a contractor to respect the contracted delivery date in public procurement contracts (PPCs). We did this by i) developing a real option model to evaluate the investment timing flexibility that the inclusion of a penalty clause in the contract gives the contractor; ii) investigating the probability of enforcing the penalty rule which is here assumed to be negatively affected by the quality of the judicial system and by the discretionality of the court in voiding the penalty rule itself. Our model shows that the optimal penalty fee increases as the uncertainty over the contracts investment costs increases and the probability of the penalty enforcement decreases Using parameters which mimic the Italian context, we then calibrate the model to evaluate the range of penalties set by the Italian legislation on PPCs. According to our calibrations, the optimal penalty fees result highly sensitive to the quality of the judicial system and to the discretional power of courts of law: in particular, the optimal penalty for delay in PPCs should be of different level in the different Italian macro-regions and, in some cases, much higher than that set according to the present Italian law.

Abstract:
In a continuous-time framework we study the technology and investment choice problem of a continuous co-digestion biogas plant dealing with randomly fluctuating relative convenience of input factor costs. Input factors enter into the productive process together mixed according to a given initial rule. Being inputs relative convenience stochastically evolving, a successive revision of the initial rule may be desirable. Hence, when the venture starts the manager may or may not install a flexible technology allowing for such option. Investment is irreversible and flexibility is costly. The problem is solved determining in the light of future prospects the optimal revision and then playing backward fixing the investment timing rule.

factor proportions, technological choice, flexibility, real options, alternative energy source

Abstract:
One of the main reasons why workers' enterprises (WE) still represent a relevant chunk of the economy may lie in some affinities with conventional profit maximizing firms. To prove this, we compare the entry policies of WEs and conventional firms when they can decide size at entry while having to stick to it afterwards. Even though short run differences remain, a long run coincidence appears besides that under certainty. Endogenizing size and time of entry in an uncertain dynamic environment we see that WEs enter at the same trigger and size of conventional firms. Both of them wait less and choose a dimension larger than the minimum efficient scale. This may be another way to explain why WE are still an important share of the economy (Hesse and Cihàk, 2007) despite the ongoing mantra of their imminent demise.

Workers' Enterprises, Entry, Uncertainty, Rigidity

Abstract:
We study the competition to acquire the exclusive right to operate an infrastructure service, by comparing two different specifications for the financial proposals - 'lowest price to consumers' vs 'highest concession fee', and two alternative contractual arrangements: a contract which imposes the obligation to immediately undertake the investment required to operate the concessioned service and a contract which simply assigns to the winning bidder the right to supply the market at a date of her choosing. By comparing the returns of these alternative award criteria and concessioning conditions, we show that concessioning without imposing rollout time limits may or may not provide a higher expected social value, depending on the bidding rule used to allocate the contract. In turn, the relative advantages of each award criterion are affected by the concessioning conditions.

concessions, auctions, award criteria, service rollout time limits

Abstract:
We provide a general framework in which to determine the optimal penalty fee inducing the contractor to respect the contracted delivery date in public procurement contracts (PPCs). We do this by developing a real option model that enables us to investigate the contractor’s value of investment timing flexibility which the penalty rule - de facto - introduces. We then apply this setting in order to evaluate the range of penalty fees in the Italian legislation on PPCs. According to our calibration analysis, there is no evidence that the substantial delays recorded in the execution times of Italian PPCs are due to incorrectly set penalty fees. This result opens the way for other explanations of delays in Italian PPCs: specifically, we extend our model to investigate the probability of enforcing a penalty which we assume negatively affected by the "quality" of the judicial system and the discretionality of the court in voiding the rule. Our simulations show that the penalty fee is highly sensitive to the "quality" of the judicial system. Specifically referring to the Italian case, we show that the optimal penalty should be higher than those set according to the present Italian law.

Public Procurement Contracts, Penalty Fee, Investment Timing Flexibility, Contract

Abstract:
One of the reasons why workers' enterprises (WE) still represent a relevant chunk of the economy may lay in some affinities with conventional profit-maximizing firms. To provide a solid basis to this presumption, we compare the entry policies of WEs and conventional firms when size is set at entry and kept fixed afterwards. Even though short-run differences remain between WEs and conventional firms, a long-run coincidence appears in an uncertain dynamic environment. Endogenizing size and time of entry we see that the two kinds of firms enter at the same trigger market price and size. Both of them enter earlier and choose a dimension larger than the minimum efficient scale. This generalized coincidence may be another way to explain why WEs still make for an important share of the economy despite the ongoing mantra of their imminent demise.