Real Option Financing Under Asymmetric Information
33 Pages Posted: 19 Mar 2010
Date Written: March 12, 2010
I study the impact of capital market imperfections on the exercise of a real option. An entrepreneur has private information about a venture for which she seeks outside funding. An initial investment gives access to a continuous ﬂow of information about the project. The duration of that experimentation phase is used to signal quality and investment may be delayed relative to the ﬁrst best. Investors use milestone contracts, and the entrepreneur is granted stock options with a vesting period or receives a compensation in case of failure. The pay-performance sensitivity of her compensation is correlated with risk taking. The initial mix of inside and outside ﬁnancing effects the timing of future investment, in line with empirical evidence.
Keywords: Real Options, Innovation, Financial Contracts
JEL Classification: G32, D82, D83
Suggested Citation: Suggested Citation