Real Options Signaling Games with Applications to Corporate Finance

Review of Financial Studies, Vol. 24, No. 12, pp. 3993-4036

Rock Center for Corporate Governance at Stanford University Working Paper No. 57

83 Pages Posted: 23 Mar 2009 Last revised: 4 Feb 2013

See all articles by Steven R. Grenadier

Steven R. Grenadier

Stanford Graduate School of Business

Andrey Malenko

University of Michigan, Stephen M. Ross School of Business; Centre for Economic Policy Research (CEPR)

Date Written: June 29, 2011

Abstract

We study games in which the decision to exercise an option is a signal of private information to outsiders, whose beliefs affect the utility of the decision maker. Signaling incentives distort the timing of exercise, and the direction of distortion depends on whether the decision-maker's utility increases or decreases in outsiders' belief about the payoff from exercise. In the former case, signaling incentives erode the value of the option to wait and speed up option exercise, while in the latter case option exercise is delayed. We demonstrate the model's implications through four corporate finance settings: investment under managerial myopia, venture capital grandstanding, investment under cash flow diversion, and product market competition.

Keywords: irreversible investment, real options, signaling, asymmetric information, agency conflicts, venture capital, cash flow diversion, competition

JEL Classification: D81, D82, G13, G31

Suggested Citation

Grenadier, Steven R. and Malenko, Andrey, Real Options Signaling Games with Applications to Corporate Finance (June 29, 2011). Review of Financial Studies, Vol. 24, No. 12, pp. 3993-4036, Rock Center for Corporate Governance at Stanford University Working Paper No. 57, Available at SSRN: https://ssrn.com/abstract=1364839

Steven R. Grenadier

Stanford Graduate School of Business ( email )

Graduate School of Business
Stanford, CA 94305-5015
United States
650-725-0706 (Phone)
650-725-6152 (Fax)

Andrey Malenko (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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