Optimal Exercise of Jointly Held Real Options: A Nash Bargaining Approach with Value Diversion

European Journal of Operational Research, Vol. 239, No. 2, pp. 565–578, 2014

40 Pages Posted: 18 Mar 2011 Last revised: 29 Aug 2014

See all articles by Shantanu Banerjee

Shantanu Banerjee

Lancaster University - Management School

Ufuk Güçbilmez

University of Glasgow - Adam Smith Business School

Grzegorz Pawlina

Lancaster University - Department of Accounting and Finance

Date Written: June 6, 2014

Abstract

This paper provides a two-stage decision framework in which two or more parties exercise a jointly held real option. We show that a single party’s timing decision is always socially efficient if it precedes bargaining on the terms of sharing. However, if the sharing rule is agreed before the exercise timing decision is made, then socially optimal timing is attained only if there is a cash payment element in the division of surplus. If the party that chooses the exercise timing can divert value from the project, then the first-best outcome may not be possible at all and the second-best outcome may be implemented using a contract that is generally not optimal in the former cases. Our framework contributes to the understanding of a range of empirical regularities in corporate and entrepreneurial finance.

Keywords: decision analysis, investment timing, real options, Nash bargaining solution, agency problem

JEL Classification: G31, G32

Suggested Citation

Banerjee, Shantanu and Güçbilmez, Ufuk and Pawlina, Grzegorz, Optimal Exercise of Jointly Held Real Options: A Nash Bargaining Approach with Value Diversion (June 6, 2014). European Journal of Operational Research, Vol. 239, No. 2, pp. 565–578, 2014, Available at SSRN: https://ssrn.com/abstract=1786615 or http://dx.doi.org/10.2139/ssrn.1786615

Shantanu Banerjee

Lancaster University - Management School ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

Ufuk Güçbilmez

University of Glasgow - Adam Smith Business School ( email )

Glasgow, Scotland
United Kingdom

Grzegorz Pawlina (Contact Author)

Lancaster University - Department of Accounting and Finance ( email )

The Management School
Lancaster LA1 4YX
United Kingdom
+ 44 1524 592834 (Phone)
+ 44 1524 847321 (Fax)

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