Real Options Meet Organizational Theory: Coping with Path Dependencies, Agency Costs, and Organizational Form

Abstract

Scholars have begun to recognize the importance of integrating organizational issues into real options theory. In doing so, some argue that options are inappropriate for evaluating critical strategic investments. In a more in-depth analysis, we argue that the organizational form that an option takes has a profound effect on exercise decisions. When options are initially integrated, organizational elements such as routines and culture become increasingly intertwined over time, raising the cost of abandoning the option – in effect, pushing firms to exercise options. In contrast, initially isolated options become idiosyncratic and more costly to integrate over time – pushing firms to kill them. There are also reputational and social capital effects that may bias exercise decisions beyond the mere consideration of costs, leading to escalation or missed opportunities.

Accordingly, firms must first be able to manage the associated organizational costs and minimize systematic bias in exercise decisions. Real options theory is moving away from the limitations of the financial options analogy and is increasingly integrated with strategy and organization theory. This shift requires that researchers consider issues such as intermediate organizational forms, external monitoring of exercise decisions, portfolios of competing options, and group process interventions.

Citation

Coff, R.W. and Laverty, K.J. (2007), "Real Options Meet Organizational Theory: Coping with Path Dependencies, Agency Costs, and Organizational Form", Reuer, J.J. and Tong, T.W. (Ed.) Real Options Theory (Advances in Strategic Management, Vol. 24), Emerald Group Publishing Limited, Leeds, pp. 333-361. https://doi.org/10.1016/S0742-3322(07)24012-4