The Relationship between the Magnitude of Growth Opportunities and the Duration of Equity

Posted: 8 Dec 1999

See all articles by Padma Kadiyala

Padma Kadiyala

Pace University - Lubin School of Business

Abstract

Conventional wisdom holds that since cash flows from growth opportunities occur later in time relative to cash flows from existing projects, firms that can be characterized as growth firms, have a higher duration. In this paper, we adopt the real options approach to the valuation of growth opportunities and show that under certain circumstances, the opposite can be true; equity duration can be lower for growth firms. Further, we show that the relation between equity duration and the magnitude of growth opportunities depends on (i) the magnitude of the duration of assets in place, (ii) the market share of the firm in its industry, (iii) the magnitude of R&D expenditures, and (iv) the volatility of future cash flows generated by the investment project underlying the growth opportunity. We find empirical support for our predictions for firms in the utility and banking industries.

JEL Classification: G31, G32

Suggested Citation

Kadiyala, Padma, The Relationship between the Magnitude of Growth Opportunities and the Duration of Equity. Available at SSRN: https://ssrn.com/abstract=187432

Padma Kadiyala (Contact Author)

Pace University - Lubin School of Business ( email )

1 Pace Plaza
New York, NY 10038-1502
United States
914-773-3620 (Phone)

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