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Tony W. Tong, Yong Li Presenter: Wen ZHENG Tony W. Tong is an assistant professor of management of the Leeds School of Business at the University of Colorado. He received his Ph.D. from The Ohio State University. His current research applies real options theory to study firms’ corporate development activities such as alliances, acquisitions, and corporate venture capital. Yong Li is an assistant professor of the School of Management at the State University of New York at Buffalo. He received his Ph.D. from the University of Illinois at Urbana–Champaign. His current research applies real options theory to study investment under uncertainty and venture capital. Contents Introduction Theory and Hypothesis Empirical Discussion • The paper draws from real options Introduction theory to compare CVC and acquisition empirically Theory Empirical Discussion • The paper draws from real options Introduction theory to compare CVC and acquisition empirically Theory Empirical Investment modes that are important tools that firms can employ to further their Discussion external business development and corporate growth initiatives. • The paper draws from real options Introduction theory to compare CVC and acquisition empirically Theory Empirical CVC is the investment of corporate funds directly in external start-up companies. Discussion It involves an investing firm taking a minority equity stake in a private entrepreneurial company (Gompers and Lerner, 1998). Mode CVC Acquisition Introduction Option Theory One-time deal and few Flexible to make Expand sequential investment sequence investment possibility Empirical Flexible to liquidate Difficult to divest a Abandon its investment company Discussion Flexible to defer High commitment and Defer deciding to expand or little deferral option abandon Real options become more salient in CVC investments compared to acquisitions under conditions of uncertainty Hypothesis 1 (H1). The greater the level of Introduction uncertainty, the more CVC is preferred over time. Theory An increase in the exogenous uncertainty Empirical enhance the value of all types of real options. Discussion Option to expand and abandon adjust and reverse active reduce downside risk and capture upside should the environment develop favorably. Option to defer Limit exposure to market uncertainty Introduction Irreversibility Theory Positive relationship between uncertainty Empirical Growth Opportunity and preference for Discussion CVC over acquisition Competition Hypothesis 2 (H2). The greater the level of Introduction irreversibility, the stronger the positive Theory relationship between uncertainty and the Empirical preference for CVC over acquisition. Discussion Irreversible: resale value < cost Irreversible resale value sensitive to uncertainty Value of Option Acquisition is harder to reverse than CVC Hypothesis 3 (H3). The greater the level of Introduction growth opportunities, the weaker the Theory positive relationship between uncertainty and the preference for CVC over acquisition Empirical Discussion Growth opportunity Opportunity cost of waiting Indecision loss of profit streams in the present or future periods Downside loss can be less valuable when there is significant upside potential Hypothesis 4 (H4). The greater the level of Introduction competition, the weaker the positive relationship between uncertainty and the Theory preference for CVC over acquisition Empirical Extent that growth opportunities shared Discussion Strategic value of commitment Competitive investment Strategic value of commitment >flexibility value of deferring CVC provides flexibility to defer, while acquisitions signal commitment to potential rivals. • Sample: Public firms (Compustat) • Year: 2003-2005 Introduction – Coverage of private acquisitions would Theory become more accurate and extensive since 2003 Empirical • CVC: First-round CVC investments Discussion – Valuable real options – On a similar footing with acquisitions • Acquisition: Acquisition of private targets • Acquisition started as CVC – Exercise of the options that are embedded in the initial CVC investment Dependent Variable CVC vs. Acquisition Introduction 1 if investment is structured as CVC investment, 0 if structured as an acquisition. Theory Explanatory Variables Empirical Exogenous uncertainty Volatility of industry stock market indices Discussion Irreversibility Asset intangibility Growth Opportunities Market-to-book ratio Level of competition One-minus-industry concentration ratio Control Variables (Investment Firms) Size Introduction Nature log of the firm’s total assets in million dollars. Theory R&D intensity Empirical R&D expenditure as a percentage of sales. Profitability Discussion Return on sales: income before extraordinary items as a percentage to sales Firm’s experience in CVC versus acquisition Logged the ratio of one plus the number of CVC investments to one plus the number of CVC acquisition. Control Variables (Investee’s industry) Industry profitability Introduction Sum of the income before extraordinary items for all Theory of the firms in the industry in which the investee resides as a percentage of industry sales Empirical Industry R&D intensity information asymmetry Discussion The amount of R&D expenditures for all of the business in the industry as a percentage of industry sales IP regime Carnegie Mellon Survey of Research and Development Control Variables (Investor investee dynamic level) Inter-industry investment Introduction 1 when the investor and the investee operate in two different three-digit SIC industries, and 0 otherwise. Theory Different State geographic location Empirical 1 when the investor and the investee are located in two different state, 0 otherwise. Discussion Control Variables (Investee characteristics) Investee age Take log of subtract value between the founding year from the current year Investee size Take the log of the number of employees. Two Stage Probit model Introduction First Stage Sample selection model Distinguish firms that undertook CVC investments Theory or acquisitions from firms that undertook neither investment Empirical P( Undertake CVC or acquisition)= f ( size, profitability, R&D Discussion intensity, capital intensity , financial leverage) Second Stage The choice of CVC versus acquisition P(Undertake CVC)= f ( Uncertainty, Uncertainty* irreversibility, Uncertainty*Growth opportunities, Uncertainty* competition, Control Variable) Descriptive Statistics and Correlation Matrix Introduction Theory Empirical Discussion Heckman Regression Results Introduction Theory Empirical Discussion H1 Heckman Regression Results Introduction Theory Empirical Discussion H2 Heckman Regression Results Introduction Theory Empirical Discussion H3 Heckman Regression Results Introduction Theory Empirical Discussion H4 Heckman Regression Results Introduction Theory Empirical Discussion Heckman Regression Results Introduction Theory Empirical Discussion Heckman Regression Results Introduction Theory Empirical Discussion Heckman Regression Results Introduction Theory Empirical Discussion Heckman Regression Results Introduction Theory Empirical Discussion Heckman Regression Results Introduction Theory Empirical Discussion Results including investee age and investee size Introduction Theory Empirical Discussion Robustness check Another measure of uncertainty Introduction Regress industry sales over five years against time and then used the standard error of the regression coefficient Theory divided by the mean of industry sales to develop a standardized proxy of uncertainty for each industry and year. Empirical Another measure of irreversibility Industry inverse leverage Discussion Explore the sensitivity of the findings to alternative models Technological innovation Companies outside of the high-tech realm Minority acquisition • When an investment is surrounded by high levels of market uncertainty, maintaining Introduction flexibility becomes more important, and Theory firms attach greater value to the real options embed in initial CVC investments vis-à-vis Empirical acquisition. Discussion • The value of real options under uncertainty is contingent upon several factors that may either increase or decrease such value and therefore my shape firms’ choice between CVC and acquisition. (Irreversibility and Growth opportunity) • Focus on only two investment mode Other investment mode like alliance, joint Introduction ventures Theory • Take the investing firm’s perspective to Empirical examine investment mode choice From Discussion the perspective of both the investor and the investee • Focus on creation of option Option creation + option implementation
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