Valuation and Return Dynamics of New Ventures

54 Pages Posted: 12 Jan 1999 Last revised: 7 May 2000

See all articles by Richard C. Green

Richard C. Green

Carnegie Mellon University - David A. Tepper School of Business

Jonathan Berk

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Vasant Naik

Lehman Brothers International, Europe

Date Written: October 1998

Abstract

We develop and analyze a model of a multi-stage investment project that captures many features of R&D ventures and start-up companies. An important feature these problems share is that the firm learns about the potential profitability of the project throughout its life, but that research and development effort itself is only resolved through additional investment by the firm. In addition, the risks associated with the ultimate cash flows the firm realizes on completion of the project have a systematic component, while the purely technical risks are idiosyncratic. Our model captures these different sources of risk, and allows us to study their interaction in determining the risk premia earned by the venture during development. Our results show that the systematic risk, and the required risk premium, of the venture are highest early in its life, and decrease as it approaches completion, despite the idiosyncratic nature of the technical risk.

Suggested Citation

Green, Richard C. and Berk, Jonathan B. and Naik, Vasant, Valuation and Return Dynamics of New Ventures (October 1998). NBER Working Paper No. w6745, Available at SSRN: https://ssrn.com/abstract=133653

Richard C. Green (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

315B Schenley Park
Pittsburgh, PA 15213-3890
United States
412-268-2302 (Phone)
412-268-7064 (Fax)

Jonathan B. Berk

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Vasant Naik

Lehman Brothers International, Europe ( email )

25 Bank Street
30th Floor
London E14 5LE
England

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