Option to Invest

Abstract

This chapter develops a simple framework that lets managers analyze strategic investment and quantify flexibility in a competitive setting in relatively simple terms. It examines the monopolist’s deferral option to identify the main factors influencing the investment policy of a firm. It shows the importance of deriving the trigger strategies as part of the firm’s investment policy under uncertainty. Each firm should select a trigger level for the stochastic demand factor and decide to invest when the actual value of the process exceeds this investment trigger. Due to the existence of strategic interactions in the market, firms cannot simply set a trigger as a monopolist

they have to anticipate whether and when the rival will exercise its investment option in future states. The optimal investment option value reflects firms’ optimal future behavior in interaction with rivals and the resulting equilibrium industry structures.