Investor Valuation of the Abandonment Option: Empirical Evidence from UK Divestitures 1985-1991

27 Pages Posted: 26 Jun 2015

See all articles by Ephraim Clark

Ephraim Clark

Middlesex University Business School

Magid Gadad

The Academy of Graduate Studies

Patrick Rousseau

Institut d'Administration des Entreprises d'Aix-en-Provence (IAE Aix)

Date Written: 2010

Abstract

This paper looks at divestitures by 144 UK firms listed on the London Stock Exchange from 1985 to 1991 and investigates whether and how accurately investors price the firm’s option to abandon assets in exchange for their exit value. Theory prices this real option as an American style put and the model we test includes the major features of the abandonment option literature: stochastic firm value, stochastic exit value, intermediate cash flows and uncertain project life. It also includes random events that can short circuit the optimal timing of the divestiture and trigger abandonment prematurely. The empirical implications are that investors do price the abandonment option but that they price it imperfectly because the exit price is private information. There is evidence that the effects of the timing factor are accurately priced and that the probability of forced premature abandonment figures in the option pricing.

Keywords: real options; abandonment; divestiture; premature abandonment; abnormal returns

JEL Classification: G13, G33, G35, M41

Suggested Citation

Clark, Ephraim and Gadad, Magid and Rousseau, Patrick, Investor Valuation of the Abandonment Option: Empirical Evidence from UK Divestitures 1985-1991 (2010). Multinational Finance Journal, Vol. 14, No. 3/4, p. 291-317, 2010, Available at SSRN: https://ssrn.com/abstract=2622946

Ephraim Clark (Contact Author)

Middlesex University Business School ( email )

The Burroughs
London, NW4 4BT
United Kingdom

Magid Gadad

The Academy of Graduate Studies

PO Box 72331
Tripoli
Libya

Patrick Rousseau

Institut d'Administration des Entreprises d'Aix-en-Provence (IAE Aix) ( email )

Clos Guiot Puyricard - CS 30063
Aix en Provence, Bouch du Rhone 13089
France
33-4-42-28-08-08 (Phone)

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