Abstract

Financing Real Options in an Environment of Asymmetric Information

A model based on asymmetric information between the management of a corporation and external investors discusses the incentives that emanate from financing and influence decision-making on whether to exercise a real option, i.e. to make use of an opportunity for investment. It is taken into account that a financing relationship may come into existence at the time of investment in a real option and the time of the possible exercise of the option. Such financing relations may be associated with countervailing incentives on the corporate management’s investment behaviour. It turns out that an appropriately shaped financing scheme would allow the real option to be exercised precisely if it is efficient. This shows that welfare losses do not occur in spite of asymmetric information. The model analysis is followed by a discussion of the question to what extent this result is robust in a scenario of possible expansions.