some nonlinear tax effects on asset values and investment decisions under uncertainty abstract tax system nonlinearities are often ignored but with uncertainty may have important implications for the magnitude and direction of tax effects this paper studies a particular nonlinear tax rule the policy subsidizes asset values but may discourage some investments and encourage earlier shutdown of some projects the marginal effective tax rate varies with project risk furthermore a corporate cash flow tax can encourage investment due to interactions with the nonlinear policy the paper also presents a general statement of the stochastic equilibrium valuation method which can be used to analyze other nonlinear taxes numerical examples demonstrate computational feasibility

s based taxation under default risk abstract this article studies the characteristics of a s based tax system under default risk in particular we show that its neutrality properties depend on whether debt is protected or unprotected in the former case this system is neutral in the latter case where default timing is optimally chosen by shareholders the s based system is neutral with respect to real decisions only if the firm s and the lender s tax rate are equal however the shareholders decision to default is always distorted

the nature of option interactions and the valuation of investments with multiple real options this paper deals with the nature of option interactions and the valuation of capital budgeting projects possessing flexibility in the form of multiple real options it identifies situations where option interactions can be small or large negative or positive interactions generally depend on the type separation degree of being in the money and the order ofthe options involved the paper illustrates through a generic example the importance of properly accounting for interactions among the options to defer abandon contract or expand in vestment and switch use it is shown that the incremental value of an additional option in the presence of other options is generally less than its value in isolation and declines as more options are present therefore valuation errors from ignoring a particular option may be small however configurations of real options exhibiting precisely the opposite behavior are identified comparative statics results confirm that the value of flexibility despite interactions manifests familiar option properties

venture capital staged financing and optimal funding policies under uncertainty abstract our paper presents a dynamic model of entrepreneurial venture financing under uncertainty based on option exercise games between an entrepreneur and a venture capitalist vc in particular we analyze the impact of multi staged financing and both economic and technological uncertainty on optimal contracting in the context of vc financing our novel approach combines compound option pricing with sequential non cooperative contracting allowing us to determine whether renegotiation will improve the probability of coming to an agreement and proceed with the venture it is shown that both sources of uncertainty positively impact the vc investor s optimal equity share specifically higher uncertainty leads to a larger stake in the venture and renegotiation may result in a dramatic shift of control rights in the venture preventing the venture from failure moreover given ventures with low volatility situations might occur where the vc investor loses his first mover advantage based on a comparative static analysis new testable hypotheses for further empirical studies are derived from the model

real investment options with multiple sources of rare events abstract we value real investment options when the underlying asset follows a mixed jump diffusion process involving various types sources of rare events jumps these jumps are assumed independent of each other with each type having a log normally distributed jump size and a random poisson distributed arrival time they may represent uncertainties about the arrival and impact on the underlying investment of new information concerning technological innovation competition political risk regulatory effects and other sources an analytic solution is presented for european claims call or put options with multiple sources of jumps a discrete time markov chain methodology implemented within a finite difference scheme is proposed for the valuation of american as well as european options the approach is also applicable to financial options with multiple types of rare events the approach is illustrated through valuing complex real options with compound features involving interactions between optimal investment and subsequent operating decisions specifically we value a growth option and an extension option

the valuation of multiple claim insurance contracts this paper provides a closed form solution for the value of a multiple claim insurance contract that is subject to a deductible amount and or an upper limit on claims the solution is a time integral of european option prices the model provides three important insights first systematic risk in insurance policies is altered in the presence of deductibles and maximum indemnity levels second idiosyncratic risk affects policy valuation and the required rates of return on underwriting portfolios finally contrary to traditional actuarial intuition changes in the risk free interest rate may either increase or reduce policy values

multi stage product development with exploration value enhancing preemptive and innovation options abstract we provide a real options framework for the analysis of product development that incorporates research and exploration actions product attribute value enhancing actions with uncertain outcome as well as preemption and innovation options we derive two stage analytic formulas and propose a general multi period solution using a numerical lattice approach our analysis reveals that exploration actions are more important when the project is out or at the money near zero npv and less important for high project values in a multi stage setting exploration actions are important even for in the money projects when follow on actions exist that can enhance the expected value of the project with path dependency early actions are more valuable since they enhance the impact or reduce the cost of subsequent actions preemptive controls affecting rare event jump frequency and innovations that introduce positive jumps are more valuable for firms with higher frequency of competitive threats involving low volatility

capabilities as real options strategy research consists of a balance between positive and normative theory normative theories suggest particular heuristics or cognitive representations to find appropriate solutions heuristics permit faster solutions to real time problems they also suffer from the potential of negative transfer to inappropriate applications the theory of real options provides the appropriate heuristic framing of competencies and exploratory search a real options approach marries the theory of financial options to foundational ideas in strategy organizational theory and complex systems we join these approaches to identify three pairs of concepts scarce factor and the underlying asset in option theory inertia and irreversibility and the ruggedness of landscape and option values strategic theories of resources largely define a core competence as unique and nonimmutable in doing so this definition has wrongly forgotten barney s initial insight into scarce factor markets as determining the valuation of a competitive asset financial theory of real options derives its heuristics of investing in exploratory search by inferring future value of today s investments from market prices we apply the three conceptual pairs to the evaluation of capabilities as real options through a formal descriptive model the valuation of core capabilities is derived from observing the price dynamics of correlated strategic factors in the market because of inertia managers cannot easily adjust the wrong set of organizational capabilities to the emergence of market opportunities however firms that have made investments in capabilities appropriate to these opportunities are able to respond from this description we define core competence as the choice of capabilities that permits the firm to make the best response to market opportunities the heuristic framing of capabilities as real options guides the normative evaluation of the balance between exploitation and exploration

how big is the tax advantage to debt this paper uses an option valuation model of the firm to answer the question what magnitude tax advantage to debt is consistent with the range of observed corporate debt ratios we incorporate into the model differential personal tax rates on capital gains and ordinary income we conclude that variations in the magnitude of bankruptcy costs across firms can not by itself account for the simultaneous existence of levered and unlevered firms when it is possible for the value of the underlying assets to jump discretely to zero differences across firms in the probability of this jump can account for the simultaneous existence of levered and unlevered firms moreover if the tax advantage to debt is small the annual rate of return advantage offered by optimal leverage may be so small as to make the firm indifferent about debt policy over a wide range of debt to firm value ratios the observed range of debt to firm value ratios in the u s economy is roughly speaking from zero to 60 percent traditional explanatory models of capital structure have focused on the tradeoff between the tax shield and bankruptcy costs arising from the use of debt finance 2 9 10 18 19 other

valuation of path dependent contingent claims with multiple exercise decisions over time the case of take or pay hull and white 1993 introduced a method to extend lattice based contingent claim val uation techniques to problems with path dependent payoffs this paper builds upon their method in the process of valuing two types of commodity purchase contracts that ex hibit a form of timing flexibility not previously analyzed in the literature the techniques demonstrated take advantage of characteristics of claims that simplify incorporation of path dependencies possible uses for the methods demonstrated include the valuation of port folios of mortgages capital projects where intensity of use affects productivity ofthe asset and capital projects with storage characteristics

revisiting corporate growth options in the presence of state dependent cashflow risk abstract given a non trivial market price of risk we study the impact of state dependent cashflow risk on the optimal investment policy and on the ensuing value of an unlevered firm that holds the option of scaling up cashflows from its assets in place upon incurring an irreversible cost the firm s investment decision and value are studied as a function of the market price of risk and of the degree of state dependence in cashflow risk

option pricing when the underlying asset earns a below equilibrium rate of return a note in their classic paper black and scholes 2 present two derivations of the european call option pricing formula the first which we will refer to as the replication derivation relies on the fact that the returns from the option can be replicated by holding a continuously revised position in the underlying asset and bonds this implies that if an option is not priced according to the blackscholes formula there is a sure profit to be made by some combination of either short or long sales of the option and underlying asset this argument is seemingly independent of considerations relating to capital market equilibrium the second derivation which we will call the equilibrium derivation evolves from the requirement that the option earn an expected rate of return commensurate with the risk involved in holding the option as an asset this note considers the pricing of a call option on an asset which earns an expected rate of return lower than that necessary to induce investors to hold it we show in this case that even if the replication strategy is feasible it is inefficient a consequence of this is that the correct option pricing formula is different than the black scholes formula unlike the black scholes formula our formula requires as an input the difference between the expected rate of return on the underlying asset and that expected rate of return which would be required to induce holding of the asset other papers have made a similar point constantinides 3 and cox et al 4 have argued that in equilibrium the prices of traded contingent claims must satisfy a partial differential equation which is identical to the black scholes partial differential equation only when the underlying asset pays no dividends and earns a rate of return sufficient to induce holding of the asset more recently ingersoll 5 has noted that commodities often pay a nonpecuniary service yield the value of which must be taken into account in deriving the option price none of these authors however explain why the black scholes formula is sometimes inappropriate the purpose of this note is to demonstrate why the black scholes formula needs modification even if replication is feasible we provide an intuitive derivation of the correct formula and discuss why divergences of the equilibrium price from the black scholes formula do not result in arbitrage opportunities

valuation and management of fishing resources under price uncertainty the traditional expected net present value methods cannot properly capture the management flexibility and strategic value aspects of a fishery and may understate its value instead this paper develops a real options model to conceptualize and evaluate fishery exploitation flexibility specifically general models to value the opportunity to either exploit or invest in a fishery are presented they suffice to determine not only these values but also the optimal policy for opening closing delaying and setting its harvest rate the sustainable case in which the harvest rate equals the natural net growth function is also considered concerning the exploitation decision it is found that as could be expected the higher the resource price the higher the value of this opportunity in both models general and sustainable however the resource stock affects both models differently as to the investment opportunity its value is always lower than the exploitation opportunity because of investment costs finally numerical simulations are run in order to illustrate the nature of the solution sensitivity analysis concerning the influence of the tax rate convenience yield risk free interest rate and price volatility on the value of the fishery is also reported

the learning curve and optimal production under uncertainty this article examines the implications of the learning curve in a world of uncertainty we consider a competitive firm whose costs decline with cumulative output because the price of the firm s output evolves stochastically future production and cumulative output are unknown and are contingent on future prices and costs we derive an optimal decision rule that maximizes the firm s market value produce when the price exceeds a critical level which is a declining function of cumulative output we show how the shadow value of cumulative production the total value of the firm and the decision to produce depend on the volatility of the price and other parameters uncertainty increases the critical price required for the firm to produce but also increases the value of thefirm thus during periods of high volatility firms facing a learning curve ought to be producing less but are worth more

enemies or allies henry george and francis amasa walker one century later an evaluation and commemoration of two pioneering american economists one century after their deaths in 1897 biographical sketches are followed by expositions and assessments of their contributions to economics areas covered include distribution theory the explanation of poverty george s single tax proposal the business cycle and money and statistics a novel interpretation of george s treatment of rent is provided also covered are the parallels and antagonisms between george and walker and the uneasy relationship between george and the academic economists of the era an appendix provides a brief guide to the literature

the impact of assets in place on corporate financing and investment decisions abstract in a dynamic setting with asymmetric information we consider firms debt equity choice and investment timing we extend recent research by adding an abandonment option and assets in place and we show that these extensions make debt more attractive this implies e g that mature firms with larger assets in place mainly use debt financing whereas young high growth firms without assets in place frequently use equity financing and signal their type by early investment simulation analyses confirm this and our model is thus able to explain empirical patterns which contradict the static pecking order theory

the odd notion of reversible investment abstract irreversible investment and the attendant concept of real option value have been well discussed complete reversibility has been frequently invoked but less studied especially for the case of lumpy investment typically considered in capital budgeting we examine a simple lumpy investment problem for the full range from complete irreversibility to completely reversibility with a focus on the latter the optimal stopping rules under complete reversibility are 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 these rules net present value as a timing criterion under reversibility is not pertinent investments that are partially reversible 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 as treated in corporate finance is that it entails at least some irreversibility

quotas as options valuation and equilibrium implications abstract this paper presents formulae for the values of quota licenses in stochastic environments that are based on observable parameters and examines the impact of parameter changes on domestic equilibrium we show that the option pricing methodology currently used widely in the finance literature may be applied to the valuation of licenses in a potentially wide range of market environments

petroleum taxation under uncertainty contingent claims analysis with an application to norway abstract contingent claims analysis provides a useful tool for analysing the value of tax claims and of companies after tax values under uncertainty the method is presented and applied to the analysis of how norwegian petroleum taxes affect company behaviour few results can be derived analytically a numerical approach is suggested with a stylized description of production possibilities the norwegian taxes are found to have strong distortionary effects the relation to other methods and problems connected with the application are discussed

the equilibrium valuation of risky discrete cash flows in continuous time this paper values a contingent claim to discrete stochastic cash flows generated by a poisson arrival process with a randomly varying intensity parameter in the most general case both the size and the arrival intensity of cash flows may correlate wih state variables in a continuous time economy assuming the conditions of an intertemporal capital aset pricing model solutions for the value of the contingent claim can be found using various techniques the paper suggests immediate applications to the valuation of insurance contracts the decision to build a firm with unknown future investment opportunities and the pricing of mortgage backed securities

debt policy and the rate of return premium to leverage equilibrium in the market for real assets requires that the price of those assets be bid up to reflect the tax shields they can offer to levered firms thus there must be an equality between the market values of real assets and the values of optimally levered firms the standard measure of the advantage to leverage compares the values of levered and unlevered assets and can be misleading and difficult to interpret we show that a meaningful measure of the advantage to debt is the extra rate of return net of a market premium for bankruptcy risk earned by a levered firm relative to an otherwise identical unlevered firm we construct an option valuation model to calculate such a measure and present extensive simulation results we use this model to compute optimal debt maturities show how this approach can be used for capital budgeting and discuss its implications for the comparison of bankruptcy costs versus tax shields

the neoclassical production function as a relic of anti george politics implications for ecological economics abstract widespread support for henry george s land tax proposal prompted a backlash from wealthy landowners who focused their political efforts on tax policy the backlash corresponded chronologically with the development of neoclassical economics and land barons became active in the establishment of academic economics institutions in the united states whereas the classical economists frequently referred to the factors of production as land labor and capital neoclassical textbooks appearing in the 20th century increasingly ignored land and provided a production function y f k l in which capital and labor were the only factors explicitly identified neoclassical authors had several possible reasons for using a two factor production function but the political influence on neoclassical economics during its formative stages was conducive to avoiding reference to land when discussing factors of production an emphasis on land would have invited scrutiny of land rents for tax purposes ecological economics has evolved as a response to the shortcomings of neoclassical economics in dealing with the environmental perils of economic growth one of those shortcomings is the capital labor production function which hides the importance of land and natural resources ecological economists have developed production functions that are more ecologically oriented and one of them is explained herein

investment decisions in hog finishing an application of the real options approach in this paper option pricing theory is applied to an investment problem in hog production a stochastic simulation model capable of pricing american type options is developed this is achieved by recursive calculation of the exercise frontier the model is used to determine the investment trigger and the disinvestment trigger for a pig fattening barn under german market conditions it turns out that the investment trigger taking into account the value of waiting in an uncertain environment can be considerably higher compared to classical investment criteria such as the net present value this offers an explanation as to why farmers are indeed reluctant to invest in hog production another finding is the sensitivity of the option prices with respect to the stochastic process that is assumed for revenues and variable costs of the production activity

schooling costs and child labour in rural pakistan a conventional argument in the child labour debate is that improvements in access to schools are an effective way to reduce the labour force participation of children it is argued that schooling competes with economic activity in the use of children s time and enhanced access to schools interpretable as reduction in schooling costs may raise school attendance at the expense of child labour in this article we draw a distinction between child labour within the household intra household and child work in the labour market extra household and examine the separate effects of schooling costs upon these two types of child labour in rural pakistan consistent at least in part with our theoretical framework we find that extra household child labour and schooling costs are positively related whereas intra household child labour is insensitive to changes in the costs of schooling our results suggest that reduction in schooling costs will have limited success in the abatement of child labour in rural p

the relation between forward prices and futures prices abstract this paper consolidates the results of some recent work on the relation between forward prices and futures prices it develops a number of propositions characterizing the two prices these propositions contain several testable implications about the difference between forward and futures prices many of the propositions show that equilibrium forward and futures prices are equal to the values of particular assets even though they are not in themselves asset prices the paper then illustrates these results in the context of two valuation models and discusses the effects of taxes and other institutional factors

the neoclassical advent american economics at the dawn of the 20th century for the u s economy the last quarter of the 19th century brought the closing of the western frontier agricultural hardship in the south the rise of large corporations and trusts and the emergence of a serious labor movement the fledgling american economics profession struggled to document and prescribe for the confounding mix of industrialization urbanization and rural crisis in 1900 the relatively small community of serious economic researchers focused on applied issues in public policy and industrial organization the prominent institutionalist school strongly influenced by the almost millennial theories of the social gospel movement emphasized the inequities of the emerging economy and looked forward to a new more cooperative system of production on the eve of the 20th century john bates clark published in 1899 the distribution of wealth a theory of wages interest and profit with this volume neoclassicism matured into a major intellectual force within american economic thought with clark as its defining figure clark s analytical approach and his normative purposes hardly went unchallenged moreover the great majority of economists in the united states continued to work in the institutionalist vein up to world war ii nevertheless by viewing the american neoclassical advent in the context of its own time we can gain a deeper understanding of both american economics at the turn of the 20th century and the early character of the school that came to dominate our discipline