Does Contract Complexity Limit Opportunities? Vertical Organization and Flexibility

The vertical organization of production entails a range of make-or-buy decisions of intermediate goods that are influenced by the difficulty of writing contracts with a potential supplier. When contracting causes high transaction costs, a firm can decide to vertically integrate the production of the intermediate product. Contract complexity can be measured by decomposing the range of inputs into inputs that are traded on an exchange (low contract complexity), inputs for which reference prices exist (low to medium contract complexity) and other, often relationship-specific inputs (medium to high contract complexity). This inaugural lecture addresses the impact of contract complexity on the growth opportunities of a firm. The present value of growth opportunities are embedded in the market value of a firm, which is a multiple of the firm’ stock price. Examining the relation between the growth opportunities as part of the market value and contract complexity, we find that contract complexity has a negative impact on the growth opportunities of a firm if vertical integration is difficult. Whereas, on average, growth opportunities account for 56% of the market value of a firm, this percentage ranges between 50% and 53% for firms in sectors where contracts are complex and vertical integration is difficult. The difference represents a current market value between € 12 bn. and € 24 bn. only taking into account Dutch listed firms.real options;vertical organization;outsourcing;contract theory;flexibility;firm value

Domestic Plant Productivity and Incremental Spillovers from Foreign Direct Investment

We develop a simple test to assess whether horizontal spillover effects from multinational to domestic firms are endogenous to the market structure generated by the incremental entry of the same multinationals. In particular, we analyze the performance of a panel of 10,650 firms operating in Romania in the period 1995-2001. Controlling for the simultaneity bias in productivity estimates through semi-parametric techniques, we find that changes in domestic firms’ TFP are positively related to the first foreign investment in a specific industry and region, but get significantly weaker and become negative as the number of multinationals that enter in the considered industry/region crosses a specific threshold. These changing marginal effects can explain the lack of horizontal spillovers arising in traditional model designs. We also find these effects to vary between manufacturing and service, suggesting as a possible explanation a strategic change in technology transfer decisions by multinational firms as the market structure evolves.transition economies;multinational firms;productivity

Does Contract Complexity Limit Opportunities? Vertical Organization and Flexibility

The vertical organization of production entails a range of make-or-buy decisions of intermediate goods that are influenced by the difficulty of writing contracts with a potential supplier. When contracting causes high transaction costs, a firm can decide to vertically integrate the production of the intermediate product. Contract complexity can be measured by decomposing the range of inputs into inputs that are traded on an exchange (low contract complexity), inputs for which reference prices exist (low to medium contract complexity) and other, often relationship-specific inputs (medium to high contract complexity). This inaugural lecture addresses the impact of contract complexity on the growth opportunities of a firm. The present value of growth opportunities are embedded in the market value of a firm, which is a multiple of the firm’ stock price. Examining the relation between the growth opportunities as part of the market value and contract complexity, we find that contract complexity has a negative impact on

Imitation, patent protection and welfare

Once a new technology has been invented it is shown that the innovator has an incentive to postpone technology adoption when the cost of imitation is high and patent protection is strong. With the possibility of licensing it is shown that licensing oftechnology instead of delaying technology adoption is optimal when imitation costs are relatively low and patent protection is relatively strong. Therefore, from a welfare perspective, licensing should be encouraged

The recently chosen digital video standard : playing the game within the game

In the recent process leading to the agreement on the digital versatile disc two product standards have been developed: one by Philips and Sony, and the other by Toshiba and Time Warner. Three actions in the process of standardization have startled business analysts. First, Matsushita's choice to support the Toshiba-Time Warner standard. Second, Sony's statement to unconditionally market the standard developed with Philips. Third, the unexpected agreement between parties on a uniform standard. We show that these moves in the game concerning the digital video standard should be viewed as a game within a larger game. The larger game encompasses the players' interest beyond the digital technology. We develop and apply a straightforward managerial framework for product standardization games that supports managers looking beyond the small game

A Real Options Perspective On R&D Portfolio Diversification

This paper shows that the conditionality of investment decisions in R&D has a critical impact on portfolio risk, and implies that traditional diversification strategies should be reevaluated when a portfolio is constructed. Real option theory argues that research projects have conditional or option-like risk and return properties, and are different from unconditional projects. Although the risk of a portfolio always depends on the correlation between projects, a portfolio of conditional R&D projects with real option characteristics has a fundamentally different risk than a portfolio of unconditional projects. When conditional R&D projects are negatively correlated, diversification only slightly reduces portfolio risk. When projects are positively correlated, however, diversification proves more effective than conventional tools predict.real options;portfolio analysis;research & development

A Model for Evaluating Pharmaceutical R&D Investment Projects under Technical and Economic Uncertainties

This study sets up a compound option approach for evaluating pharmaceutical R&D investment projects in the presence of technical and economic uncertainties. Technical uncertainty is modeled as a Poisson jump that allows for failure and thus abandonment of the drug development. Economic uncertainty is modeled as a standard di¤usion process which incorporates both up-and downward shocks. Practical application of this method is emphasized through a case analysis. We show that both uncertainties have a positive impact on the R&D option value. Moreover, from the sensitivity analysis, we nd that the sensitivity of the option with respect to economic uncertainty and market introduction cost decreases when technical uncertainty increases

Defensive Disclosure under Antitrust Enforcement

We formulate a simple model of optimal defensive disclosure by a monopolist facing uncertain antitrust enforcement and test its implications using unique data on defensive disclosures and patents by IBM during 1955-1989. Our results indicate that stronger antitrust enforcement leads to more defensive disclosure, that quality inventions are disclosed defensively, and that defensive disclosure served as an alternative but less successful mechanism to patenting at IBM in appropriating returns from R&D

The Option Value of Advanced R&D

Existing tools for making R&D investment decisions cannot properly capture the option value in R&D. Since many new products are identified as failures during the R&D stages, the possibility of refraining from market introduction may add a significant value to the NPV of the R&D project. This paper presents new theoretical insight by developing a stochastic jump amplitude model in a real setting. The option value of the proposed model depends on the expected number of jumps and the expected size of the jumps in a particular business. The model is verified with empirical knowledge of current research in the field of multimedia at Philips Corporate Research. This way, the gap between real option theory and the practice of decision making with respect to investments in R&D is diminished

Unionization Structure, Licensing and Innovation

Taking technological differences between firms as given, we show that the technologically advanced firm has a stronger incentive for technology licensing under a decentralized unionization structure than with centralized wage setting. Furthermore, We show that, in presence of licensing, the incentive for innovation may also be stronger under decentralized unions. Unions have a clear preference for centralization only if productivity improvements are relatively small