Which Types of Investments Benefit from Retaining the Flexibility to Terminate?

Abstract

Firms can choose to make investments while retaining the option to terminate them prior to completion. This flexibility can mitigate uncertainty about the investment that is present at the time of its initial funding. However, this flexibility can also detrimentally alter actions within the firm that are necessary for the investment’s success, such as whether scarce firm resources are allocated to the investment. This paper develops a set of hypotheses which predicts flexibility may not improve investment performance when the investment generates limited early-stage learning and requires certain types of resources. These hypotheses are empirically tested in a data set of new U.S. television programs, comparing programs that receive commitment in the form of a straight-to-series order with programs that are flexibly developed through a piloting process. This paper contributes to the literatures on innovation, entrepreneurship, and real options by identifying which investment types will benefit most from flexibility.

Keywords: commitment, experimentation, new product development, television industry

JEL Classification: D24, D81, L23, L26, L82, M11, O31, O32