DP3013 Irreversible Investment with Strategic Interactions

Author(s): Robin Mason, Helen Weeds
Publication Date: October 2001
Keyword(s): network effects, pre-emption, real options
JEL(s): C73, D81, L13, O31
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=3013

This Paper examines irreversible investment in a project with uncertain returns, when there is an advantage to being the first to invest, and externalities to investing when others also do so. Pre-emption decreases and may even eliminate the option values created by irreversibility and uncertainty. Externalities introduce inefficiencies in investment decisions. Pre-emption and externalities combined can actually hasten, rather than delay, investment, contrary to the usual outcome. These facts demonstrate the importance of extending ‘real options’ analysis to include strategic interactions.