Discussion Paper Details

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Title: The Economic Value of Flexibility When There is Disagreement

Author(s): Arnoud W A Boot and Anjan Thakor

Publication Date: January 2003

Keyword(s): corporate finance and Managerial decision-making

Programme Area(s): Financial Economics

Abstract: We develop an economic theory of ?flexibility?, which we interpret as the discretion or ability to make a decision that others disagree with. We show that flexibility is essentially an option for the decision-maker, and can be valued as such. The value of the flexibility option is decreasing in the extent to which the decision-maker?s future decision-relevant opinion is correlated with the opinions of others who may be able to impede the decision. We argue that flexibility drives economic decisions in a significant way. The applications we consider are: the entrepreneur?s choice of flexibility in the initial mix of financing raised; the use of flexibility to understand differences in security design and the firm?s security-issuance decision; the impact of flexibility on the use of collateral in lending; the role of flexibility in capital budgeting decisions; the effect of flexibility considerations in the design of contracts in a principal-agent setting; the interpretation of ?power? and conformity in organizations in the context of flexibility; and the choice between private and public ownership in the context of flexibility.

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Bibliographic Reference

Boot, A and Thakor, A. 2003. 'The Economic Value of Flexibility When There is Disagreement'. London, Centre for Economic Policy Research.