A microfoundational model of real options reasoning: The roles of individual search propensity and perceived uncertainty

• Date: 01 March 2021
• DOI: http://doi.org/10.1002/sej.1355
• Published date: 01 March 2021

RESEARCH ARTICLE

A microfoundational model of real options

reasoning: The roles of individual search

propensity and perceived uncertainty

Stephen X. Zhang

1

| Renfei Gao

2

| Nicolás Odeh

3

|

Michael Leatherbee

3

1

Entrepreneurship, Commercialisation and

Innovation Centre (ECIC), University of

Adelaide, Adelaide, Australia

2

Alliance Manchester Business School, The

University of Manchester, Manchester, UK

3

Department of Industrial and Systems

Engineering, Pontificia Universidad Católica

de Chile, Santiago, Chile

Correspondence

Stephen X. Zhang, Entrepreneurship,

Commercialisation and Innovation Centre

(ECIC), University of Adelaide, 9-28, Nexus10

Tower, 10 Pulteney St, Adelaide, SA 5000,

Australia.

Email: stephen.x.zhang@gmail.com

Funding information

ANID (The Chilean Agency for Research and

Development), Grant/Award Number:

11170537

Abstract

Research Summary: To explain heterogeneity in real

options reasoning (ROR) across entrepreneurial ventures,

we propose a microfoundational model to explore the rela-

tionships between a firm leader's search propensity, per-

ceived uncertainty and the firm-level ROR-based behaviors.

Using a panel survey of 134 founder-CEOs of new ven-

tures, we find that founder-CEOs' search propensity is posi-

tively related to ROR-based behaviors in their ventures.

Moreover, we find that founder-CEOs' perceived effect

uncertainty is positively related to the ROR-based behav-

iors, but perceived response uncertainty is negatively

related to the ROR-based behaviors, revealing the impor-

tance of considering distinct types of uncertainty in entre-

preneurs' ROR. Our microfoundational model advances the

ROR literature by delineating how individual-level factors

may drive ROR in firms that face uncertainty.

Managerial Summary: Flexibility is key to startup success.

However, entrepreneurs craft and embed flexibility to differ-

ent degrees and under different situations. In orderto explain

this heterogeneity, we study the roles of entrepreneurs' indi-

vidual characteristics. Particularly, we study search propen-

sity and perceived uncertainty (distinguishing among

different types) in relation to flexibility, formally known as

real options reasoning (ROR). Analysis of 134 founder-CEOs

Received: 28 May 2018 Revised: 20 April 2020 Accepted: 23 April 2020 Published on: 3 August 2020

DOI: 10.1002/sej.1355

© 2020 Strategic Management Society

98 Strategic Entrepreneurship Journal. 2021;15:98–120.wileyonlinelibrary.com/journal/sej

of new ventures in Start-Up Chile showed that founder-

CEOs' search propensity is positively related to ROR in their

ventures. Moreover, founder-CEOs' perceived uncertainty is

related to ROR in ways that depend on the type of uncer-

tainty the entrepreneurs perceive; thus, not all types of

uncertainties relate positively to ROR. Such findings carry

managerial implications to those who want to understand

why certain startupsare more flexible.

KEYWORDS

new venture, perceived uncertainty, real options reasoning,

search propensity, strategic decision-making under uncertainty

1|INTRODUCTION

The ability to change (i.e., flexibility) is crucial for the adaptation and survival of businesses, especially under uncer-

tainty (Eisenhardt, Furr, & Bingham, 2010; Tang, Nadkarni, Wei & Zhang, 2020). To facilitate future changes under

uncertainty, real options theory proposes that firms can embed flexibility, that is, develop a series of real options

(Dixit & Pindyck, 1994; Myers, 1977; Trigeorgis, 1996) in strategic decision-making (Bowman & Moskowitz, 2001;

Kogut & Kulatilaka, 2001) and entrepreneurial initiatives (Li & Chi, 2013; O'Brien, Folta, & Johnson, 2003; Tong &

Li, 2011). Real options, similar to financial options, embed flexibility ex ante, conferring the right, but not the obliga-

tion, to undertake future actions contingent on how uncertainties turn out in the future (Bowman & Hurry, 1993;

Trigeorgis, 1996). Unlike financial options, which focus on explicit valuation of financial assets, the focus of manage-

ment scholars is decision-making heuristic known as real options reasoning (ROR) (McGrath, 1997; Trigeorgis &

Reuer, 2017).

Despite its intuitive appeal, ROR is used heterogeneously across firms (e.g., Krychowski & Quélin, 2010;

O'Brien & Folta, 2009). For instance, a survey by Graham and Harvey (2001) reveals that only 27% of their sampled

392 firms in North America used ROR. Accordingly, a burgeoning stream of research has examined the antecedents

of ROR-based behaviors, such as the scope of opportunity and market competition (McGrath & Nerkar, 2004; Tong&

Li, 2011). These studies, although profound and insightful, tend to explain ROR-based behaviors almost exclusively

on organizational or environmental factors, overlooking individual-level factors (Driouchi & Bennett, 2011; Raffiee &

Feng, 2014).

Nonetheless, microindividual factors may be key to enhance our understanding of ROR, given that ROR lies at

the “intersection between economic forces and psychological ones”(McGrath, 1999, p. 27). ROR-based behaviors,

like other firm-level strategic behaviors, are shaped by managers. Several perspectives have consistently highlighted

that microlevel individual differences matter in studying the strategic behaviors of firms, such as the perspectives of

strategic choice (Child, 1972) and upper echelons (Hambrick & Mason, 1984). Thus, it is important to explore

whether the heterogeneity of ROR-based behaviors can be explained by microlevel factors (Abell, Felin, &

Foss, 2008; Raffiee & Coff, 2015). Furthermore, management literature views ROR as a heuristic, implicitly recogniz-

ing that ROR is subject to individuals' traits and perceptions (Trigeorgis & Reuer, 2017). In fact, scholars have called

for a microfoundation of ROR to reveal the strategic roles of decision-makers in explaining the heterogeneity of

ROR-based behaviors in firms (e.g., Raffiee & Feng, 2014; Trigeorgis & Reuer, 2017). Our study aims to develop a

microfoundational model of ROR. To explain firm-level ROR-based behaviors, we identify two critical individual-level

factors: search propensity and perceived uncertainty, which correspond to two fundamental distinctions of real

ZHANG ET AL.99