Investor Valuation of the Abandonment Option: Empirical Evidence from UK Divestitures 1985-1991
27 Pages Posted: 26 Jun 2015
Date Written: 2010
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: Suggested Citation