DP3061 Strategic Advantage and the Optimal Exercise of Entry Options

Author(s): Enrico C Perotti, Silvia Rossetto
Publication Date: November 2001
Keyword(s): entry, growth opportunities, real options, strategic investment, technological innovation
JEL(s): G12, G31, L11, L13
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3061

We investigate the timing and the valuation of strategic investment aimed at enhancing entry opportunities in related market segments. As demand is uncertain, entry options should be exercised at the optimal time, trading off the market share gain against the option to wait until more information is revealed, while anticipating competitors' entry behaviour. When the strategic investment grants a strong competitive advantage, the innovator can optimally choose the timing of entry; in case of weaker advantage, the investing firm enters just before its competitor would. In a context of increased uncertainty, the value of waiting to invest rises, but the value of a strategic investment increases even more. In some cases, strategic investment can act as a threat to discourage cross-entry, making parallel monopoly sustainable.