Managers’ Incorporation of the Value of Real Options into Their Long-Term Investment Decisions: An Experimental Investigation

Posted: 29 May 2009

See all articles by Christine A. Denison

Christine A. Denison

Iowa State University

Anne M. Farrell

Miami University Farmer School of Business - Department of Accountancy

Kevin E. Jackson

University of Illinois at Urbana-Champaign - Department of Accountancy

Date Written: May 28, 2009

Abstract

While academic and practitioner literature has advocated the use of real options in firms’ long-term investment appraisal processes, few studies have examined the extent to which real options are incorporated into decisions when they are made available. We experimentally examine supervising managers’ decisions of how much funding to provide to subordinates’ long-term investment project proposals. We predict and find that supervising managers rely less on the value of real options than the value of a project’s planned implementation path when making these decisions, and that providing a financial summary aggregating the planned path and real options components of value rather than displaying them separately increases reliance on the real options component. We provide evidence that the financial summary affects decisions through perceptions of the relative accuracy of the planned path and real options components of value. Further, we explore how the proportion of total project value from real options affects managers’ reliance on non-cash-flow information.

Keywords: Long-term Investments, Real Options, Aggregation, Judgment and Decision-Making

JEL Classification: D89, G31, L29, M49

Suggested Citation

Denison, Christine A. and Farrell, Anne M. and Jackson, Kevin, Managers’ Incorporation of the Value of Real Options into Their Long-Term Investment Decisions: An Experimental Investigation (May 28, 2009). AAA 2010 Management Accounting Section (MAS) Meeting Paper, Available at SSRN: https://ssrn.com/abstract=1411359 or http://dx.doi.org/10.2139/ssrn.1411359

Christine A. Denison

Iowa State University ( email )

Ames, IA 50011-2063
United States

Anne M. Farrell (Contact Author)

Miami University Farmer School of Business - Department of Accountancy ( email )

800 East High Street
3094 Department of Accountancy / MSC 1002
Oxford, OH 45056
United States

Kevin Jackson

University of Illinois at Urbana-Champaign - Department of Accountancy ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

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