Academic Program

Day 1 - Wednesday June 17, 2015 (Metropolitan Hotel, Athens)

8:00-8:40 Registration

8:40-8:55 President’s Welcome

9:00-10:15 Track II (Academic – Corfu Room)

R&D and Technology Investment
Chairperson: Luiz Brandão (PUC-Rio, Brazil)

 We model a multistage finite life investment problem subject to several sources of cost and price uncertainty, as typical of start up fims, complex industrial and construction initiatives and research and development projects for software, drugs and technology ventures. Additionally, the firm also has an option to expand the original project to take advantage of derivative investment opportunities once all the development stages are successfully completed, which is modeled as an American style option. An important characteristic of these initiatives is that as the firm incurs cost and invests, it learns both about the difficulty of developing and implementing the project and also about market conditions, and updates its prospects of timely completion and of expansion accordingly. This information can then be used to optimally decide whether further investments is warranted or not, given the expected future revenues of the whole venture.

  Objectives: How to best structure an IP licensing agreement taking account of embedded optionalities and other terms negotiated between licensor and licensee via a case study involving a prototypical options-based business model (biotech industry). Methodology: Binomial lattice simulation. Findings: It shows how IP management practices would change depending on who pays for the development costs, controls the continuation/development or abandonment option and thereby appropriates more of the embedded option’s value. It presents alternative (iso-value) menu licensing term choices (different combinations of royalty vs. fixed upfront fee or milestone payments) that are fair and optimal in properly accounting for optionality embedded in the R&D development and related licensing structures. Practical implications: Real options thinking leads to different perspectives on how patent licensing agreements should be structured properly accounting for which party controls the embedded optionality. Originality of the study: It proposes a comprehensive real options approach to: (a) appraise the IP asset capturing the value of optionality embedded in the underlying drug R&D program; (b) consider the licensor and licensee perspectives in negotiating the terms of the IP licensing agreement providing guidelines on how to determine its optimal remuneration structure reflecting a fair sharing of project value and embedded optionality among the parties; (c) offer a tool for IP portfolio management that helps a licensor prioritize internal R&D projects accounting for managerial flexibility and optimal licensing design under uncertainty.

   This paper investigates the valuation of an option to invest in an R&D project of uncertain cost on a finite time horizon. The common body of knowledge attributes a positive value to flexibility and the possibility to postpone an investment in order to wait for the arrival of new information. From this point of view a decision maker will assume that as time passes and the R&D projects terminal date approaches the value of the option to invest in the project will gradually vanish. Hence it appears logical that the willingness to invest in a project declines as time is running out. In my work I show that under certain conditions the opposite is the case i.e. as the deadline for completion approaches, decision makers increase their willingness to invest in the progress of the R&D project as a last effort to claim the reward and avoid failure. What appears as non-rational behavior of an individual who seeks to avoid sunk costs, is actually a fully rational investment strategy.

10:45-12:00 Track II (Academic – Corfu Room)

Sequential Investment, Venture Capital & Corporate Structure
Chairperson: Arkadiy Sakhartov (Wharton School, U of Pennsylvania, USA)

   The idea that corporate structure should be carefully selected to match corporate strategy has been acknowledged since Chandler (1962). Scholars highlighted the degree of centralization of resource allocation decisions and the type of incentives used to motivate business unit managers as two important features of corporate structure. The development of the theory about the effect those features have on value realized with corporate diversification has generated some critical controversies. In particular, whether firms should be structured as centralized or decentralized to realize greater economies of scope from resource redeployment remained unclear. Similarly, whether all diversified firms should use collaborative or parochial incentives was not resolved. Finally, how the incremental benefits of the highlighted features of corporate structure bear upon relatedness was speculated rather than rigorously derived. To overcome those limitations, the present study develops a simulation model explicating the interdependences of economies of scope and corporate structure. The study appears to be the first to rigorously derive these interdependences. The results of the present study offer several stimulating insights for corporate diversification research.

 This paper uses a real options approach to design a set of models to better understand entrepreneurial financing decisions, in a framework where a single shareholder and positive cash-flow generating firm are assessing its potential growth opportunities, for which it may require additional financial resources to be provided by a Venture Capitalist, provided that no debt financing will be available to fund such growth opportunities. In the base case, model outputs reveal that the envisaged profit growth should offset the ownership loss that the Entrepreneur will bear by allowing a Venture Capitalist to provide equity to fund the growth strategy. With the purpose of complementing this base case, a set of extensions was derived, including the case in which the Entrepreneur and the Venture Capitalist hold distinct profit growth prospects for the growth strategy, the case in which the Entrepreneur may hold a given minimum ownership requirement and the case in which, prior to the equity round, the Venture Capitalist is willing to acquire a ownership stake on the entrepreneurial firm. Provided that Entrepreneurs and Venture Capitalists find that the underlying profit flow of the Start-up Firm is modelled according to the same stochastic process, model prescriptions are valid for whichever stochastic process is chosen for the profit firm of the entrepreneurial firm.

 Investment in emerging technologies is often made in the light of uncertainty in both the arrival of new versions and the revenue that may be earned from their deployment. Further complicating such investment decisions is that the future development of emerging technologies depends crucially on government support, yet the absence of a clear policy framework increases uncertainty in revenue streams. We show how a firm can optimally take advantage of the flexibility over the investment timing and the technology adoption strategy facing price, technological, and policy uncertainty. More specifically, we analyse the impact of these features on the optimal investment decision, and, in particular, we illustrate the relative value of each type of discretion for a risk-averse decision maker, thereby capturing real-world attributes shaping decision making such as costs of financial distress and shareholder constraints over borrowing. Although the incentive to delay investment increases as both price uncertainty and the level of risk aversion increase, whether the sudden provision of a subsidy or the potential to replace equipment with more efficient ones mitigates the impact of price uncertainty and risk aversion remains an open question.

12:00 – 2:00 Luncheon

2:00-3:00 Track II (Academic – Corfu Room)

Mergers & Acquisitions
Chairperson: Artur Rodriues (U of Minho, Portugal)

  This paper develops a dynamic model for the timing and terms of mergers and acquisitions. Differently from previous models, we show that the firms agree about the timing, independently from how the merger surplus is shared. Firms always agree on the timing and discuss the sharing rule of the merger surplus according to their bargaining power or some other exogenous factor. We also show that, under asymmetry of information, the combination of surprises regarding merger timing and merger terms, can produce either negative or positive abnormal returns for the merging firms.

 In this paper, we develop a theoretical model that allows evaluating leveraged buyouts (LBOs) from the perspective of the investor. We provide explicit form solutions for all payoffs from acquisition to exit, and therefore feature the determination of net present value (NPV) and internal rate of return (IRR). The model is based on a crossing boundary approach where the default of the target firm is represented as a lower piecewise linear barrier. Those default barriers either consist of debt repayment and interest expenses, or are contractually-fixed by covenants like debt-to-EBITDA. Our approach features the typical LBO debt repayment schedules: fixed and cash sweep. Furthermore, the model captures all drivers of performance and leverage identified by empirical studies: firm-specific ones like profitability, cash flow growth, volatility and liquidation value, as well as external ones like credit risk spreads and pricing discounts for debt overhang.

 We study the optimal strategic behaviour of the target of a business acquisition where the acquirer is afraid that the former may return to the market after the sale, and therefore she uses a non-competition covenant which protects her (new) business against the future competition from the target. Yet, as the target can return to the market any time after the covenant expiry date, the value of the acquisition is comprised of both the intrinsic value of the acquired business and the value of a forward start option with a starting date that coincides with the expiry date of the covenant. Our findings suggest that the value of the forward start option of the target increases with the uncertainty of the profit flow associated with her return to the market and decreases with the time-to-maturity of the covenant. We also characterize the market conditions where the target should optimally re-enter the market as a follower, and provide closed (or quasi-closed) form solutions for her re-entry thresholds.

3:45-5:00 Track II (Academic – Corfu Room)

Financing & Investment Choices
Chairperson: Gordon Sick (U of Calgary, Canada)

 We examine firm valuation with optimal liquidity (retained earnings) and dividend choice under revenue uncertainty that incorporates debt financing and bankruptcy costs. We revisit the conditions for dividend policy irrelevancy and the role of retained earnings and dividends. Retained earnings have a net positive impact on firm value in the presence of growth options, high external financing costs and low default risk. High levels of retained earnings enhance debt capacity but have a negative effect on equity value. Opposite directional effects of retained earnings on equity and debt values lead to a U-shaped relation with firm value. Agency conflicts over dividend policy among equity and debt holders are more prevalent for firms with higher profitability, low volatility and high level of growth options.

   This paper endogenizes the cost of external funds and explores the implications on irreversible investments. The investment strategy incorporates equilibrium feedback that result from a bargaining process between the firm and a lender. Contrary to debt issuance, tax benefits and distress costs cannot be internalized by the firm. "Bad news" are less costly for the firm that has incentives to accelerate investment whereas creditors intend to delay it; underinvestment or overinvestment is determined by each party relative bargaining power and the size of bankruptcy costs. Default and credit market imperfections raise the cost of capital, which dampens the value of waiting. The impact of assets already in place, bankruptcy costs and leverage level are also examined.

6:00 – 7:30 Networking Reception at U Athens (Bus from Metropolitan Hotel at 5:15 pm and 5:50 pm)
Sponsored by University of Athens and ROG

Day 2 - Thursday, June 18, 2015 (Metropolitan Hotel, Athens)

9:00-10:15 Track I (Joint – Crete Room)

Empirical Evidence I
Chairperson: Diderik Lund (U of Oslo, Norway)

Offshore Wind Park Investment with Feed-in Tariffs: The German Renewable Energy Case
Valeria Jana Schwanitz (Potsdam-Institut of Climate Impact Research, Germany)

   The German Renewable Energy Sources Act of 2009 (and its latest revisions in 2014) set an ambitious goal of 30% for the share of renewables in total electricity consumption by 2020. A huge potential is seen for offshore wind energy amounting to a long-term goal of up to 25 GW of cumulative capacity for Germany by 2030.

A large amount of uncertainty is involved when planning, installing, and operating such a farm. This includes, foremost, technical cost uncertainty but also uncertainties related to the cost of input and/or output factors. Technical cost uncertainty exists due to the still limited experience with offshore wind technology. Therefore, a substantial amount of R&D costs need to be considered, e.g. for finding the optimal location, anchoring the foundation in the sea, establishing a grid connection, or maintaining the farm under sea weather conditions. Input cost or output cost uncertainties, on the other hand, can also be correlated with the economy (such as turbine costs fluctuating with changes in the world wide demand for steel and other metals).

  An important application in the real options literature has been to investments in the oil sector. Two commonly applied “stylized facts” in such applications are tested here. One is that the correlation of the returns on oil and the stock market is positive, the other that it is invariant to changes in oil price volatility. Both are rejected in data for 1993–2008 for crude oil and the S&P 500 stock market index. Based on real options theory, consequences are pointed out. Higher volatility need not imply increased value and postponed investment.

  This paper provides evidence for the relationship between various forms of real options in infrastructure projects and the types and levels of government supports to the infrastructure investments. It analyzes the common real options and real options-based strategic investments and aligns them with the common types of public-private partnership (PPP) infrastructure projects. It then develops a model to show that the real options incorporated into the different types of PPP infrastructure projects directly affect the viabilities of such projects. The paper however shows that the relationship between the embedded real options and viabilities of infrastructure projects can be influenced by such factors as contract period and percentage of private sector contributions.

9:00-10:15 Track II (Joint – Corfu Room)

Renewable Energy & Policy
Chairperson: Stavros Thomadakis (U of Athens, Greece)

Wind uncertainties often lead wind power generators overestimate energy contracts with the distributors. Thus, international insurers are seeing the possibility of a new market: the wind insurance. The option of wind insurance in Brazil is new and the difficulties of establishing the right amount of wind to be provided is a challenge for both parties. In this sense, this work aims to develop a methodology to estimate all possible combinations of wind that lead to positive results for the generator and the insurer. For this purpose, we use the technique of real options of zero-cost collars type. In this case, there are a wind pair of exercise, called (bottom wind, upper wind). At each quarter, in the period of one year, if the average wind is below the bottom wind, the insurer bears the loss. Otherwise, if the wind is above the wind upper, the wind overload is the insurer. Partial results show a negative linear relationship between the expected value of the insurer and the certainty equivalent of the power wind generator. Also, the wind pairs follow a similar relationship.

 The new 2030 energy and climate framework, currently proposed by the European Commission, sets more ambitious targets compared to the EU 2020 strategy, including the increase of renewable sources by 27% in 2030. To achieve this indicative target, as well as the binding target for 2020, most Member States have provided generous support schemes to renewable producers, while offering to them priority to the dispatch schedule for producing electricity. Our study investigates the impact of the RES priority rule on the conventional power producers and particularly in their operation, profitability and their prospects in the overall EU electricity markets.

  Worldwide, renewable electricity projects are granted production support to ensure competitiveness. Depending on the design of these support schemes, the cash inflows to investment projects will be more or less exposed to fluctuations in electricity and/or subsidy prices. Furthermore, as renewable electricity technologies mature, there is a possibility that the current support scheme will be terminated or revised in ways that make it less generous or more in line with market mechanism. Using a real options approach, we examine how investors in power projects respond to such market and policy risks. We show that: (1) due to price diversification, the differences in market risk between support schemes like tradeable green certificates, feed-in premiums and feed-in tariffs are less than commonly believed; (2) the prospects of termination will slow down investments if it is retroactively applied, but speed up investments if it is not; and, (3) this policy uncertainty may add a substantial risk to investments, especially in the first case where investors expect future curtailment of subsidies to affect new and old installations alike. We conclude the paper by discussing the division of risk between investor and government.

10:45-12:00 Track I (Joint – Crete Room)

Empirical Evidence II
Chairperson: Peter Pope (London School of Economics, UK)

   Over the past two decades, a significant amount of academic knowledge has been created on how to apply real options analysis to business investments. Despite the many apparent advantages of using real options to value projects, the approach has not found favor with managers in practice. Some critics claim that the method is untrustworthy and might encourage too much risk taking. This dissertation provides an exploration of risk biases, viewed through the lens of prospect theory, as a potential cause for the mistrust toward real options. Using evidence from a survey of 67 business school students, the results showed that participants generally evaluated options with prospect theory’s S-shaped utility function rather than with the straight, risk-neutral function that is often assumed by normative pricing models. Pricing differences were found to be dependent on the framing of the scenario as either a gain or a loss and whether or not there were small probabilities involved. These findings bring into question the appropriateness of models based on the risk-neutral assumption.

  A stylized empirical fact is the rather substantial portion of SMEs who although in need of bank credit, do not apply for a loan, due to fear of possible rejection. Non-applying in-need borrowers are known as 'discouraged borrowers'. We propose a new perspective for modelling discouraged potential bank borrowers, based on a Real Options explanation. A loan application decision is clearly not a 'now-or-never' decision, since the decision can be delayed. Hence the firm may be considered as holding a Real Option. Employing firm-level survey data that allow us to identify discouraged firms, as well as, constructing Real Options proxies we test whether discouragement is explained by Real Option factors. Our approach takes into account the selectivity, subject to which the discouragement phenomenon is observed, by modelling discouragement using a Bivariate Probit with selection setup. Our results, provide empirical support for the presence of Real Options effects in the discouragement process.

  A real options-based firm valuation model suggests that momentum and long-term reversal effects in stock returns arise through an excess capacity channel linked to expected returns. The model predicts that momentum losers have mild excess capacity, but fully utilize their capacity, resulting in expected returns that are lower than for momentum winners. In contrast, long-term losers have higher excess capacity and a less than full capacity utilization, resulting in expected returns that are higher than for long-term winners. Cross-sectional and time-series tests show that a fundamentals-based proxy for excess capacity strongly conditions the momentum and long-term reversal effects in ways consistent with the model's testable implications.

10:45-12:00 Track II (Joint – Corfu Room)

Public Policy Investment Appraisal
Chairperson: Panayiotis Alexakis (U. of Athens, Greece)

 Acquirers often buy other companies and subsequently sell some of their assets. We assume that the acquirer has the option to sell activities outside its core business to an outside firm, which can make more efficient use of these resources. Thus, the takeover makes it possible to exploit synergy gains and it also incorporates the embedded option represented by the potential divestment gains. We examine whether the acquisition premium is affected by this option. All merger and acquisition announcements, and divestitures of acquired assets carried out subsequently, during the period from January 1999 to December 2009 for US based firms are considered. We estimate a model using the bid premium as the dependent variable and several factors identified in the literature as determinants of the premium as independent variables. Our results indicate that the premium is positively related to the runup on the target’s stock and the percentage of the value of the first divestiture. On the contrary, the premium is negatively related to the size of the target and the market-to-book ratio of the target. Finally, we find evidence that the premium is positively related to the value of the divestitures and negatively related to the time interval between the acquisitions and the subsequent divestitures.

 Massive capital investment is required into both existing and new urban infrastructures in order to address the historically unprecedented challenges faced by many cities around the world. However, traditional methods of appraisal and evaluation are widely regarded as inadequate since they do not correctly take into account the various sources of uncertainty nor the multiple interdependencies among investment projects. In this paper we develop a new portfolio-based appraisal framework that combines a real options approach to investment under uncertainty with a mathematical modelling approach of infrastructure interdependencies. In particular, we apply the least square Monte Carlo approach to option valuation and model interdependencies among infrastructure investments to be physical, cyber, geographical, or logical. The application of the framework is illustrated through the appraisal and evaluation of a hypothetical investment into a portfolio consisting of a number of physical and digital urban infrastructure investments. We show that such an approach has enormous potential to enhance investment decisions, particularly with regard to timing, scale, and project selection, thus potentially creating significant value for investors. Future work will comprehensively evaluate the comparative performance of the conventional and new approach under a wide range of real-world case studies.

   Under the Kyoto Protocol, CDM (Clean Development Mechanism) projects are GHG-friendly projects hosted by developing countries that earn carbon credits to overcome financial and economic barriers. In this paper, we model the dynamics of investments in a unilateral, one revenue stream CDM project with the real options method, taking into account the irreversibility and ongoing uncertainty pertaining to the process. The model proposed is a modified version of the Majd and Pindyck (1987) model that allows for a finite horizon of the operating period. We assume that the risks pertaining to the registration period while construction may start expose the project to a catastrophic failure of its carbon revenues. For the solution, a numerical method is implemented with calibrated parameter values. The analyses show that the main threat to the CDM market is the volatility of carbon prices.

12:00 – 12:45 Keynote Address (Corfu Room)
Bart Lambrecht (University of Cambridge)
Real Options and Agency Dynamics in Corporate Finance

Professor Lambrecht is Professor of Finance at Cambridge Judge Business School and Director of the Cambridge Endowment for Research in Finance (CERF). Previously he taught at Lancaster University and he has held visiting positions at the University of Calgary, UCLA and the MIT Sloan School of Management. He received an MPhil in Finance and a PhD in economics from the University of Cambridge. Dr. Lambrecht is a fellow of the CEPR and an associate of the Real Options Group. He is an associate editor of the Journal of Banking and Finance, the Journal of Business Finance and Accounting, Financial Management, and the Review of Finance. He is the founder of the annual Cambridge Corporate Finance Theory symposium.

Professor Lambrecht has published papers on a variety of topics in corporate finance. His earliest work studies the role of strategic behaviour and competition for the valuation and exercise of real options. Related work examines the role of product market competition and human capital for corporate capital structure. A number of his papers use real options methods to study the timing and dynamics of corporate restructurings (such as takeovers, mergers, outsourcing decisions, and corporate bankruptcies), and explore how these restructurings are influenced by agency or strategic considerations. Professor Lambrecht also developed two theories that generate the celebrated Lintner (1956) dividend model. One theory argues that Lintner-style payout smoothing results from managerial risk aversion and habit formation, and the other shows that this type of payout and income smoothing can also result from asymmetric information and learning between inside and outside shareholders. His most recent work focuses on the dynamics of payout, debt and investment policy.

12:45 – 2:00 Luncheon

2:00 – 3:00 Panel Discussion (Metropolitan Hotel, Corfu Room)
Growth-Linked Loans, (Un)Balanced Budgets, Infrastructure Investment and Growth in Europe
Moderator: Panayiotis Alexakis (U of Athens, Greece)

Panelists Include:
Gikas Hardouvelis (ex Minister of Finance, Greece)
Dean Paxson (U. of Manchester, UK)
Peter Pope (London School of Economics, UK)
Gordon Sick (U. of Calgary, Canada)
Lenos Trigeorgis (U. of Cyprus & King’s College London)
Yanis Varoufakis (Minister of Finance, Greece)

3:30 Buses Leave from Metropolitan Hotel for Monemvasia (320 km)

Day 3 - Friday June 19 (Academic-Monemvasia)

9:00-10.:15 Track I (Aghios Nikolaos Church)

Sequential Investment & Expansion
Chairperson: Yuri Lawryshyn (U of Toronto, Canada)

  We provide a general model for comparing stepwise and lumpy investments, considering stage specific volatilities, drifts and possibility of project failure. Stepwise investments allow for interim project value realizations, instead of considering only a final project value as in sequential investments. We conceive of an environment in which stepwise investment costs exceed lumpy investments, even if the total combined project value of the stages equals the lumpy project value. We find there are tight conditions on the parameter values required in order to compare the two strategies. Also that increased uncertainty does not necessarily reduce the relative value of stepwise investments. We evaluate the trade-offs between the proportion of project value in each stage, and the relative investment costs. Our model could be extended to allow for inhibited or enhanced second stage project values, or even reduced investment costs, due to a learning effect, in arriving at those optimal trade-offs.

 The optimization of a modular expansion strategy, while extremely relevant in the industrial setting, requires sophisticated numerical modeling for the valuation of even simple scenarios. In this work, we develop both a numerical model and a model based on Monte Carlo simulation utilizing real options, to provide a methodology for optimizing a plant expansion strategy. Our case study is associated with a wastewater treatment plant expansion; however, the methodologies developed here can be extended to many industrial settings, including mining, oil and gas, and manufacturing. The value of the Monte Carlo simulation is that it is much more easily understood by practitioners and more versatile in that it can be used to model non-standard processes. The results of both of our models match consistently, essentially validating the Monte Carlo technique.

  We develop a general model for generation investments under uncertainty that considers replacing an incumbent product with a new generation product. We allow for partial (retentions) or complete replacement, but also for the possibility that the existence of an incumbent product may enhance the value of the new product, or reduce the investment required to develop and promote that new product, as is characteristic of movie and book sequels, and other new product developments. We provide quasi-analytical solutions for the thresholds that justify new product introduction and the real option value of the investment opportunity, considering both incumbent and new product value uncertainty, and possible correlation. The new product thresholds are more or less a linear function of the value of the incumbent product sacrificed, even with partial retention, but not linear with regard to any enhancement of the new product due to the incumbent, or a investment cost reduction. The real option value sensitivity to changes in these factors is far from linear.

9:00-10.:15 Track II (Malvasia Hotel)

Product(ion) Switching Options
Chairperson: Nikolaos Milonas (U of Athens, Greece)

  In determining an investment viability and the need for comparison of alternatives to the capital allocation, it is necessary to rely on tools that allow a decision more assertive. In a context of uncertainty, the methodologies used in practice, such as NPV, IRR and Discounted Payback, does not adequately address variations that may occur in determining factors of revenue and cost. In the study conducted by Ozorio et al (2011), using a Monte Carlo Simulation, the authors sustain the existence of product exchange value in integrated steel plants, based on the premise that the iron ore price changes occurs in a manner equivalent to that of steel. This study aims to extend our understanding of product exchange value, specifically modeling determinants of revenue and cost and what are the impacts of these, considering different stochastic movements.

  This paper examines the implications of the production transformation asymmetry on prices of the commodity relative to the prices of its derivative products. When the production transformation process of a harvested good is irreversible, the price linkage between the harvested good and its derivatives breaks. This happens in the case where the supply of the good declines significantly and when independent demand for the good exists. Because the price of the good can rise above the combined value of its derivatives, it is associated with a valuable option not to process. The equilibrium processing margins are derived within a three period model. We show that the option not to process is valuable and can only be exercised by those who carry the commodity. Furthermore, it is shown that a partial hedging strategy is sufficient to reduce all price risk and it is superior to a strategy of no hedging. Preliminary results from the soybean complex support our predictions.

  We study infinite–horizon, optimal switching problems under a general class of stochastic volatility models that exhibit "fast" mean–reversion by using techniques from homogenisation theory. This leads to perturbation theory, providing closed–form approximations to the full switching problem which is often intractable, both analytically and numerically. We apply our general results to certain, well–known switching problems and volatility models, providing qualitative information on the effect of multi–scale stochastic volatility on optimal switching decisions and hysteresis. Our results indicate that multi–scale stochastic volatility strongly affects the frequency and the optimal timing of switching between modes. The proposed methodology is of interest to a number of applied problems involving switching flexibility, for example optimal production management of natural resources or foreign direct investment in the face of fluctuating exchange rates.

10:45-12:00 Track I (Aghios Nikolaos Church)

Flexible Capacity Decisions
Chairperson: Gordon Sick (U of Calgary, Canada)

Do Plants Freeze Employment upon Uncertainty Shocks?
Matthias Meier (University of Bonn, Germany)
Ariel Mecikovsky (University of Bonn, Germany)

Winner of the Best Student Paper Award for 2015

  Following the real option literature, whether or not uncertainty shocks drive business cycles depends on adjustment frictions. If plants freeze and remain inactive in response to increased uncertainty, real economic activity contracts. We show that a standard plant model with factor adjustment frictions identifies the importance of labor adjustment costs through the response of layoffs, quits and hiring on uncertainty shocks. Layoffs decline in response to a positive uncertainty shock when employment adjustment is sufficiently frictional, while layoffs increase otherwise. Empirically, we show that higher uncertainty reduces hiring and quits, while it raises layoffs. This finding suggests that plants do not freeze employment adjustments upon uncertainty shocks. Different from investments, this renders employment responsive to policy changes. The model also suggests that economies with more flexible labor markets should experience more layoffs upon uncertainty shocks. Using labor flow data from France, Germany and UK, we obtain empirical evidence that supports this hypothesis.

  This paper analyzes the optimal capital investment scale and timing in the context of real options, cooperative bargaining and network effects. Firms in the same industry often have related and interacting investment opportunities, such as the construction of a shared production facility. Each firm has a real option to delay investment, driven by price and quantity uncertainty. Accelerating investment is a first mover advantage arising from the ability of the first mover to customize the common facility to its own specification. Mitigating the desire to move first is the desire to capture network effects arising from the ability to spread the industry's public costs over a larger user base. The first mover (the leader) has to decide on the scale and timing of construction, as well as the optimal economic rent to charge the second mover for use of the common facility. The second mover (the follower) has to decide whether to use the first mover's facility or build its own facility, and if it decides to build its own, the optimal scale and timing of construction. The analysis demonstrate that (i) the leader can improve its enterprise value by being cooperative, i.e., building excess production capacity and allowing joint usage. (ii) there is a non-monotonic concave relationship between each firm's reservation lease rate and the commodity price. This provides testable implications for understanding a firm's investment behavior under competition.

 Transmission system operators (TSOs) build transmission lines to take generation capacity into account. However, their decision is confounded by policies that promote renewable energy technologies. Thus, what should be the size of the transmission line to accommodate subsequent generation expansion? Taking the perspective of a TSO, we use a real options approach not only to determine the optimal timing and sizing of the transmission line but also to explore its effects on generation expansion.

10:45-12:00 Track II (Malvasia Hotel)

Switching Issues & Applications
Chairperson: Nicola Seomandi (Carnegie Mellon U, USA)

  Investments in the area of technological innovations are particularly risky, since, apart from price uncertainty, firms must take into account not only uncertainty in the arrival of innovations but also the presence of potential rivals. Therefore, we develop an analytical framework for sequential investment in order to determine how duopolistic competition impacts a firm’s technology adoption strategy. We assume that firms either adopt a compulsive strategy and invest sequentially in each technology that becomes available or a leapfrog/laggard strategy, whereby they first wait for a new technology to arrive and then decide whether to invest in a newer or an older version, respectively. Thus, we determine both the optimal technology adoption strategy, and, within each strategy, the optimal investment rule. Results indicate that the relative loss in the value of a leader due to the presence of a rival decreases as the first–mover advantage and the rate of innovation increase, yet increases with greater price uncertainty. Intriguingly, while technological uncertainty has a non–monotonic impact on the optimal investment threshold of a follower, it does not impact a leader’s investment decision. Finally, we compare the investment strategies and illustrate how, unlike in the case of monopoly, the compulsive strategy always dominates the leapfrog/laggard strategy.

  Irreversible investment, with its notion of option value, has been well discussed. Complete reversibility has been less studied. We examine a simple lumpy stopping problem for the full range, from completely irreversible to completely reversible investment, but with a focus on the latter. The optimal stopping rule under complete reversibility is to invest when the project generates enough net cash flow to cover Jorgenson’s opportunity cost of investment, and to disinvest when it does not. Given the static nature of this rule, net present value as a timing rule under reversibility is not pertinent, despite suggestions to the contrary. We find that investments that are even slightly irreversible have much in common with completely irreversible investments but nothing in common with completely reversible investments. The case of reversible investment provides a foil for understanding that the distinguishing feature of investment compared with other inputs is that it entails some irreversibility.

  The operations of merchant energy trading in wholesale markets across different locations and current and future dates can be represented as a network where storage and transport trades compete for the capacity of storage and transport assets. We study the tradeoff between storage and transport trading for a network with a single storage asset and multiple transport assets, a realistic situation that we model as a Markov decision problem (MDP). Due to the intractability of computing an optimal policy of this MDP, we leverage our structural analysis of this model to modify a least squares Monte Carlo method to obtain a heuristic policy, also computing both lower and upper bounds on the market value of an optimal policy. On a realistic natural gas application, we document a substantial tradeoff between storage and transport trading. This tradeoff is difficult to manage, as sequential storage and transport trading is considerably suboptimal, especially when prioritizing transport over storage. In contrast, our joint policy is near optimal. A practice-based method based on sequentially reoptimizing a deterministic model is also near optimal, but, even after simplification, is computationally more intensive than our approach. Moreover, we highlight the operational differences between managing storage jointly with transport assets versus as a single asset. Beyond natural gas, our research has relevance for managing the merchant trading operations of other energy sources, natural resources, and other storable commodities.

12:00 – 2:00 Luncheon

2:00-3:15 Track I (Aghios Nikolaos Church)

Strategic Investment & Preemption
Chairperson: Bruno Versaevel (EMLYON, France)

  We study the combined effects of uncertainty and competition on the timing optimization of investments in complementarity inputs for non-preemption duopoly (leader-follower) markets with either a weak-patent system where spillover-knowledge is allowed or a strong-patent system where proprietary-knowledge holds. We find that, for some input-sequencing investment scenarios, ex-ante and (expected) ex-post market shares play an important role on firms’ behaviour, and when uncertainty about the inputs cost and revenue are considered together with competition, the conventional wisdom which says that “when a production process requires two extremely complementary inputs firms should upgrade (or replace) them simultaneously”, does not necessarily hold particularly for the follower. Some of the illustrated results show nonlinear and complex investment criteria for both firms.

 We study entry in a growing market by ex-ante symmetric duopolists when sunk costs differ for the innovating and imitating firm Strategic competition takes the form either of a preemption race or of a war of attrition, the latter being likelier when demand uncertainty is high. Industry value is maximized when firms seek neither to race nor to delay investment. Free imitation is socially costly, and if the consumer surplus resulting from imitation is not too large the socially optimal imitation cost, as may be induced by patent protection, involves preemption. Finally, we discuss endogenous entry barriers and contractual alternatives that increase the likelihood of preemption regimes, with differing implications for imitator entry. When the cost of imitation is low for instance, innovators are shown to rely more heavily on trade secrecy and patents. Welfare-enhancing takeovers and licensing are also shown to occur.

   This paper examines the investment behavior of a managerial firm facing competition by developing an investment timing model within real option exercise game framework. Product market competition is modeled in a full preemption fashion. The delegation of investment decision to a manager creates an agency conflict since the true quality of the underlying project is observed privately by the manager, which gives her the scope for diverting part of the cash flows for private benefits. Thus, an optimal contract has to be designed which induces the manager to truthfully his private information and to invest at a strategically optimal level. The particular research question of concern is whether competition serves as an incentive mechanism for the agency problem. Our results indicate that while competition tends to induce (over-) early-investment for both types of the project, the agency problem calls for delaying the investment for the low quality project, with the overall effect being dependent on the relative importance of preemption threat to the agency conflict. Accordingly, the existence of preemption threat can mitigate the (social) inefficiency stemming from agency conflict for the low quality project. Furthermore, competition provides additional incentives to the manager for truth-telling and as a result allows the owner to provide less (informational) rents to the manager. Finally, allowing for positive correlation between the competing firms' underlying project values supplies (also) additional incentives to the manager for truth-telling and it suppresses the distortion in the low quality project's exercising trigger that originally stems from the agency problem.

2:00-3:15 Track II (Malvasia Hotel)

Early Exercise & Computation Approaches
Chairperson: Mark Shackleton (Lancaster U, UK)

  LSM (Least Squares Monte Carlo) is an algorithm proposed by Longstaff & Schartz (2001) for pricing options that, as the name implies, uses the Monte Carlo method, and values the early exercice of america type options. The object of this paper is to study the LSM for applications, targeting in particular the pricing of real options. For this, relevant characteristics of the algorithm - such as convergence, optimal exercise boundary and applicability to real options - will be assessed. Concomitantly, the results of the algorithm will be compared to results obtained by other models, such as the Bjerksund-Stensland model and the binomial model of Cox, Ross and Rubinstein, in the case where the uncertainty is modeled with a Geometric Browning Motion. One of the significant advantages of the LSM algorithm is the possibility of use of virtually any stochastic model for the underlying uncertainty. Therefore the article will also access the convergence of the LSM method or algorithm for stochastic models such as mean reversion, two factor processes such as Schwartz & Smith (2000) and also processes combined with Poison jumps.

  In a symposium held at Georgetown University in 2003, a panel of academics and practitioners identified a set of requirements known as the Georgetown Challenge that real-options analyses must meet in order to get more traction and wider acceptance amongst practitioners in the industry. In a bid to meet some of these challenges, this article proposes a non-parametric approach for the evaluation of real-options featuring early exercise possibilities. It cross-fertilizes techniques used in the finance industry, in statistics, and in actuarial sciences to yield a methodology articulated around the use of a bootstrapping technique to both use as much market data as possible and to resample the risk-neutral evolution of the underlying business venture, a non-parametric Esscher transform to perform risk neutralization of the evolution of the business venture value, and finally, regression-based techniques to both value real-options with early-exercise possibilities and to determine optimal investment timing.

 The paper applies a real options framework to a value a firm with flexibility to switch between different operational modes. Developing conditions that are equivalent to smooth pasting, it uses discount factors to capture the value and beta of each options that is present. When betas and investment thresholds are known, it shows how to solve for option values and investment costs. For multiple modes and thresholds, the paper proposes a matrix based solution that significantly improves computations and intuition.

3:45-5:00 Track I (Aghios Nikolaos Church)

Strategic Investment & Capacity Choice Games
Chairperson: Dean Paxson (Manchester Business School, UK)

 Applying the real options framework, this article investigates firms’ strategic decisions regarding capacity investment in a market with uncertain demand. We formulate a duopoly model where firms become active on the market by making an irreversible investment and henceforth hold an option to exit this market if the demand level falls too low. The combination of three decision components, capacity choice, entry and exit timing, results into multiple trigger strategies for the second investor. In particular, in the presence of a large player in the market it can either choose to coexist with its rival in a duopoly or monopolize the market by installing a sufficiently large capacity. In the endogenous game there exist a preemptive equilibrium where the first investor takes the risk of being forced out of the market upon entry of the second investor. Whether this happens or not depends on the future realizations of the stochastic process.

This paper considers an incumbent-entrant framework, where the incumbent has the option to extend his current capacity and where the entrant has the option to enter the market by a capacity investment. Our model explicitly considers both optimal timing of the investment and setting the capacity level at the moment of investment. Where in the literature entry deterrence is done by overinvestment, we find instead that entry deterrence takes place by timing: the presence of a potential entrant gives the incumbent the incentive to invest first. The incumbent only invests a small amount, which is, however, large enough to delay a larger investment by the entrant. We also consider the situation where the investment decision involves only timing, i.e. the capacity decision is given. In such a case we find that the investment order changes, i.e. now the entrant invests before the incumbent does. Innovation is considered as an alternative framework where asymmetric firms have the option to make an investment in an innovative product. Both players have the option to leave the old market for the new market.

 We consider firms with differing cost structures investing non-cooperatively in production capacity to subsequently compete in output under capacity constraints. Firms have operational flexibility to discontinue production or fully utilize their capacity in the presence of competition and stochastic demand. This paper extends the extant literature on strategic investment under uncertainty by considering competition among asymmetric firms with temporary shut-down and expansion options as well as optimal capacity investment decisions. We analyze the effect of various parameters such as initial demand, volatility and heterogeneity on firm values and concentration based on equilibrium characterizations for output choices, firm profits and values in Cournot oligopoly. We find that (ex ante) linear capacity investment cost asymmetry leads to (ex-post) heterogeneity with highly non-linear capacity distributions. A interesting strategic feature of the model is that, while constrained firms are marginalized for high demand, unconstrained firms exert greater market power by expanding production and capture a larger/disproportional share of the growing total market value. The initial capacity decision-marking must account both for the stand-alone value of an marginal capacity unit and for its strategic effect through creating larger “strategic” convexity at large demand levels.

3:45-5:00 Track II (Malvasia Hotel)

Ambiguity and Fuzzy Investment Options
Chairperson: Motoh Tsujimura (Doshisha U, Japan)

Pollutant Abatement Investment Policy under Ambiguity
Motoh Tsujimura (Doshisha University, Japan)

   This paper investigates a pollutant abatement investment under ambiguity in a two-period setting. We consider there are representative consumer and firm in an economy and formulate the social welfare maximization problem. Then we numerically derive the optimal level of abatement investment. Furthermore, we analyze the comparative static effects of the model's parameters and find an increase in the degree of ambiguity encourages pollutant abatement investment.

  In this paper we study a two-player investment game with a first mover advantage in continuous time with stochastic payoffs, driven by a geometric Brownian motion. One of the players is assumed to be ambiguous with maxmin preferences over a strongly rectangular set of priors. We develop a strategy and equilibrium concept allowing for ambiguity and show that equilibira can be preemptive (a player invests at a point where investment is Pareto dominated by waiting) or sequential (one player invests as if she were the exogenously appointed leader). Following the standard literature, the worst case prior for the ambiguous player if she is the second mover is obtained by setting the lowest possible trend in the set of priors. However, if the ambiguous player is the first mover, then the worst case prior can be given by either the lowest or the highest trend in the set of priors. This novel result shows that “worst case prior” in a setting with geometric Brownian motion and -ambiguity does not equate to “lowest trend”.

  We investigate the implications of technological innovation and non-diversifiable risk on entrepreneurial entry and optimal portfolio choice. In a real options model where two risk-averse individuals strategically decide on technology adoption, we show that the impact of non-diversifiable risk on the option timing decision is ambiguous and depends on the frequency of technological change. Compared to the complete market case, non-diversifiable risk may accelerate or delay the optimal investment decision. Moreover, strategic considerations regarding technology adoption play a central role for the entrepreneur’s optimal portfolio choice in the presence of non-diversifiable risk.

6:30-8:00 Local Reception (Square in front of Theofano Art Hotel)

Day 4 - Saturday June 20 (Academic-Monemvasia)

9:00-10:15 (Aghios Nikolaos Church)

Theoretical Models & Issues
Chairperson: Andrianos Tsekrekos (Athens U of Economics and Business, Greece)

   In this paper I examine optimal investment rules when interest rates are near the zero lower bound. Extant approaches produce an ambiguous relationship between investment and interest rates and are difficult to reconcile with prolonged periods of interest rates near the zero lower bound and low investment. I use the shadow-rate model of Black (1995) for modeling interest rate uncertainty and show that when interest rates are at the lower bound and the shadow rate is substantially below the bound, it is always optimal to defer investment and wait for resolution of uncertainly about interest rates. So long as the interest rate volatility is positive, the shadow interest rate approach is consistent with low investment and interest rates near the zero lower bound.

Entry and Exit Decisions under Output-Price Uncertainty: A Generalized Class of One-Dimensional Diffusions
José Carlos Dias (ISCTE-IUL Business School, Portugal)
Manuela Larguinho (ISCAC, Portugal)
Carlos Braumann (University of Évora, Portugal)

 We consider the optimal entry and exit policy of a firm in the presence of output price uncertainty and costly reversibility of investment under a generalized class of one-dimensional diffusions accommodating different drift and volatility specifications. This will allow us to analyze how output price uncertainty and costly reversibility affects the optimal entry and exit policy of a competitive price-taking firm, and how the hysteretic band is affected by the choice of the appropriate stochastic process.

  We look at the debate on the equivalence of the Dixit-Pindyck (DP) and Arrow-Fisher-Hanemann-Henry (AFHH) option values. Casting the problem into a financial framework allows to disentangle the discussion without unnecessarily introducing new definitions. Instead, the option values can be easily translated to meaningful terms of financial option pricing. We find that the DP option value can easily be described as time-value of an American plain-vanilla option, while the AFHH option value is an exotic chooser option. Although the option values can be numerically equal, they differ for interesting, i.e. non-trivial investment decisions and benefit-cost analyses. We find that for applied work, compared to the Dixit-Pindyck value, the AFHH concept has only limited use.

10:30-11:30) Panel Discussion: Current State, Challenges and Future Prospects

Panelists Include:
Luiz Brandão (PUC-Rio, Brazil)
Yuri Lawryshyn (U of Toronto, Canada)
Artur Rodrigues (U of Minho, Portugal)
Nicola Secomandi (Carnegie Mellon U., USA)
Mark Shackleton (Lancaster U, UK)
Bruno Versaevel (EMLYON, France)

11:30 Best Student Paper Award and Closing Remarks

11:30-12:15 Coffee Break 

Conference Concludes

1:00-6:00 pm Bus Tour in Monemvasia Region (Outside the Gate)

2:00 Bus Returns to Athens (320 km) (Outside the Gate)
Note that there are return buses to Athens on Saturday and on Sunday at 2:00 pm