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Corporate investment decisions with switch flexibility, constraints, and path-dependency

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Abstract

We model sequential, corporate investment decisions with time-to-build delays, operating scale mode switching, operating constraints, and path dependencies. We also account for stochastic salvage (abandonment) values that are utilization (path) dependent. Our results highlight a key link between economic depreciation, stochastic salvage values and operational flexibility with asymmetric switching costs. We further identify conditions uncovering a non-conventional impact of resulting path-dependencies on the investment-uncertainty relationship: higher uncertainty and lower asset return shortfall (“dividend yield”) may expedite, rather than delay, corporate investment. High switching costs, operating constraints, and economic depreciation may reduce or eliminate these non-conventional effects.

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Notes

  1. Standard assumptions include continuous-time capital asset pricing (Merton 1973b; Breeden 1979), absence of market imperfections (taxes etc.), market completeness (spanning), and an all-equity firm facing proprietary investments.

  2. Using ten time steps instead of five between decisions improves investment option value accuracy insignificantly only. In general, denser grids are relatively more important for out-of-the-money options.

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Authors and Affiliations

  1. Department of Accounting and Finance, University of Cyprus, P.O. Box 20537, CY 1678, Nicosia, Cyprus

    Spiros H. Martzoukos

  2. Ministry of Economics, Nicosia, Cyprus

    Nayia Pospori

  3. Durham University Business School, Durham, UK

    Lenos Trigeorgis

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  1. Spiros H. Martzoukos
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  2. Nayia Pospori
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  3. Lenos Trigeorgis
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Correspondence to Spiros H. Martzoukos.

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Martzoukos, S.H., Pospori, N. & Trigeorgis, L. Corporate investment decisions with switch flexibility, constraints, and path-dependency. Rev Quant Finan Acc 62, 1223–1250 (2024). https://doi.org/10.1007/s11156-023-01234-4

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