Revenue-Enhancing Pre-Investment Activities Under Uncertainty

44 Pages Posted: 26 Jun 2018

See all articles by Tord Olsen

Tord Olsen

Norwegian University of Science and Technology (NTNU) - Department of Industrial Economics and Technology

Verena Hagspiel

Norwegian University of Science and Technology (NTNU) - Department of Industrial Economics and Technology

Date Written: June 11, 2018

Abstract

Models of investment under uncertainty mostly concern the firm's stochastic environment as exogenously given and subject to constant characteristics. We consider a firm that can sequentially invest to alter the growth rate of a project through a revenue-enhancing pre-investment activity prior to entering a new market, both when the change is fixed and when the magnitude of the change can be optimally chosen by the firm. We find that this incentivises the firm to invest early in revenue-enhancing activities, and then wait to invest to enter the market. There is both an option value of waiting that delays investment in revenue-enhancing activities, as well as an accelerating effect from the change in growth rate. The overall effect on the investment thresholds from increased uncertainty is ambiguous. Which effect dominates is dependent on both the cost parameters and the magnitude of the change in the rate of growth. When the firm can optimally choose the amount of the revenue-enhancing activity, we find that the firm invests more in these activities when uncertainty is higher, but the effect of uncertainty can still be ambiguous. When the marginal cost of the activity increases, the firm both delays the investment and undertakes less revenue-enhancement, but the overall amount spent increases. We conclude that increasing the drift through revenue-enhancing pre-investments is very attractive for the firm, and that this affects the firm's optimal investment.

Note: This submission has been put back to 'Not Submitted' status because it is a requirement to provide BOTH the English and Polish versions of your title and abstract. Please provide the English versions of your title and abstract. Please go to your My Papers page, select the 'Edit' button next to the paper name in the 'In Process Papers' section, make any requested changes, and click 'Submit to SSRN'. If you have questions on how to do this, email support@ssrn.com, or call 1-877-SSRNHELP (877-777-6435 toll free) or 1-585-442-8170 outside the US.

Keywords: Sequential Investment, Real Options, Endogenous Uncertainty, Optimal Control

JEL Classification: G00, G10, G11

Suggested Citation

Olsen, Tord and Hagspiel, Verena, Revenue-Enhancing Pre-Investment Activities Under Uncertainty (June 11, 2018). Available at SSRN: https://ssrn.com/abstract=3194617 or http://dx.doi.org/10.2139/ssrn.3194617

Tord Olsen (Contact Author)

Norwegian University of Science and Technology (NTNU) - Department of Industrial Economics and Technology ( email )

NO-7491 Trondheim
Norway

Verena Hagspiel

Norwegian University of Science and Technology (NTNU) - Department of Industrial Economics and Technology ( email )

NO-7491 Trondheim
Norway

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
42
Abstract Views
419
PlumX Metrics