Return distributions of strategic growth options

In this study we develop implications for the return distribution of firms with embedded strategic growth options. In our model we integrate real option theory with a Cournot-Nash framework where two firms choose output levels endogenously and may have investment-timing differences. Simulations of the returns of the strategic growth option show that traditional option variables, such as the value of the project relative to the investment (i.e., moneyness of the growth option), the return interval relative to the period the project can be deferred (i.e., maturity), and uncertainty in demand for the product are significant determinants for the moments of the distribution of the option returns. In addition to these option variables, uncertain preemption may introduce discontinuities in the payoff of our model and consequently further enhance skewness and kurtosis. Investment-timing differences between competitors may even lead to bimodal return distributions, where the firm with a first-mover advantage has a high probability to generate high returns.