Real options theory in strategic management
| Published date | 01 January 2017 |
| Author | Jeffrey J. Reuer,Lenos Trigeorgis |
| Date | 01 January 2017 |
| DOI | http://doi.org/10.1002/smj.2593 |
Strategic Management Journal
Strat. Mgmt. J.,38: 42–63 (2017)
Published online EarlyView 15 November2016 in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/smj.2593
Received 30 April 2014;Final revision received14 March 2016
REAL OPTIONS THEORY IN STRATEGIC
MANAGEMENT
LENOS TRIGEORGIS1and JEFFREY J. REUER2*
1Department of Accounting and Finance, School of Management and Business,
King’s College London, University of Cyprus, Nicosia, Cyprus
2Leeds School of Business, University of Colorado, Boulder, Colorado, U.S.A.
Research summary: This article provides a review of real options theory (ROT) in strategic
management research. We review the fundamentals of ROT and provide a taxonomy of this
research. By synthesizing and critiquing research on real options, we identify a number of
important challenges as well as opportunities for ROT if it is to enhance its impact on strategic
management and potentially develop into a theoretical pillar in the eld. We examine how
ROT can inform the key tensions that managers face between commitment versus exibility as
well as between competition versus cooperation, and we show how it can uniquely address the
fundamental issues in strategy. We conclude with suggestions on future research directions that
could enhance and unify the thus-far distinct main approaches to real options research.
Managerial summary: Real options theory (ROT) applies the heuristics and valuation models
originally designed for nancial securities to the domain of corporate investment decisions
(e.g., joint ventures [JVs], foreign direct investment, research and development [R&D], etc.)
and strategic decision making under uncertainty. This article provides a synthesis of this body
of research in strategic management and related disciplines. We suggest how ROT can address
fundamental issues of strategy,including the dilemmas managers face between commitment versus
exibility as well as between competition versus cooperation. We discuss how three distinct
approaches to realoptions analysis can complement each other, and we identify some of the main
challenges and opportunities for ROTto become a theoretical pillar in strategy. Copyright © 2016
John Wiley & Sons, Ltd.
INTRODUCTION
This article provides a critical review and synthe-
sis of real options theory (ROT) in strategic man-
agement research. ROT has produced important
insights and empirical evidence on various topics
in different streams of research in strategic man-
agement, such as market entry timing, modes of
entry, and organizational forms (e.g., joint ventures
Keywords: real options; fundamental issues in strategy;
strategic decision making; uncertainty; theory of the rm
*Correspondence to: Jeffrey J. Reuer, Leeds School of Busi-
ness, University of Colorado, Boulder, CO, U.S.A. E-mail:
jeffrey.reuer@colorado.edu
Copyright © 2016 John Wiley & Sons, Ltd.
[JVs], acquisitions, etc.), foreign direct investment
and MNC performance, cooperation versus compe-
tition trade-offs and so on, yet challenges remain
in our understanding and application of ROT in
the domain of strategic management. Taking stock
of this literature and providing a synthesis is also
important in light of three distinct approaches to
real options research that have emerged over the
years, each having its own strengths and limitations,
but not as yet building on each other. For read-
ers new to this theory, we cover the fundamentals
of ROT by clarifying when real options exist and
by highlighting some of their distinctive features
and drivers. We also offer a taxonomy of research
on real options, highlighting key areas in which
Real Options Theory in Strategic Management 43
signicant progress has been made as well as iden-
tifying areas in which advances have been limited
and deserve further attention. Our categorization
and synthesis of the relevant strategic management
literature on real options also aims to present unify-
ing interpretations and critical assessments to help
identify some of the primary challenges and promis-
ing future opportunities for this literature.
Another important objective of our review is
to consider the potential for extending ROT to
engage with and address the fundamental issues
of strategy that have occupied the eld’s atten-
tion since its inception. In particular, we submit
that ROT can offer new insights into the drivers
of rm heterogeneity and competitive advantage
(e.g., Peteraf, 1993), organizational form and asso-
ciated build-borrow-buydecisions (e.g., Capron and
Mitchell, 2012), cooperation versus competition
trade-offs arising in many market and technology
contexts (e.g., Smit and Trigeorgis, 2004), and the
role of headquarters in multinational rms (e.g.,
Rumelt, Schendel, and Teece, 1994). In our review,
we articulate ROT’s connections to these funda-
mental strategy issues by noting two trade-offs
that often underpin strategic choices: between com-
mitment and exibility (e.g., Ghemawat, 1991;
Smit and Trigeorgis, 2004) and between compe-
tition and cooperation (e.g., Teece, 1992). The
commitment-exibility trade-off reects the impor-
tance of “staging” choices as one of the core
elements of strategy (Hambrick and Fredrickson,
2001) as well as the classic advantages of a rst
mover such as preemption. The competition versus
cooperation trade-off lies at the heart of compet-
itive strategies and rms’ interactions with others
(e.g., Chen and Miller, 2015), and relates to strate-
gic choices concerning corporate boundaries as well
as technology development and commercialization
activities (e.g., Gans and Stern, 2003). Uncertainty,
a key driver in ROT, critically informs these ten-
sions, and because it also features centrally in other
theories in strategic management, often in different
ways, it provides a basis for comparisons as well as
potential integration.
We further suggest that novel research oppor-
tunities exist to realize ROT’s potential through
better integration of the three main approaches
to conducting real options research, namely, real
options reasoning, real options modeling, and
behavioral perspectives on real options. These three
approaches have largely developed independently
and are sometimes presented as rival versions
of ROT in strategic management. We identify
a number of opportunities that the eld might
pursue by marshalling them in combination, and
we provide some guidance on what such a research
agenda might entail. We also bring up a number of
frontier areas for research that hold promise and
pathways for strategic management research.
FUNDAMENTALS OF REAL OPTIONS
THEORY
We begin by dening real options, which amounts
to describing what makes them “options,” and then
what makes them “real.” The term option—as
opposed to alternative or possibility— is of impor-
tance in understanding the theory’s origins and
boundaries and in developing and testing relevant
hypotheses. An option is a right, but not an obli-
gation, to take some future specied action at a
specied cost. At its core is a fundamental decision
asymmetry to take a future decision (e.g., invest)
only if it’s benecial to the decision maker, but not
otherwise. In some organizational contexts, certain
rights might be established through contracts (e.g.,
patents, JVs) or preferential access to investment
opportunities (e.g., in an equity investment); alter-
natively,they might be established through idiosyn-
cratic knowledge that a rm possesses (e.g., through
learning by doing or research and development
[R&D])1. The fundamental decision asymmetry of
options involving the right but not the obligation to
act also gives rise to an asymmetry in rm outcomes
in the presence of uncertainty. For example, in the
case of a call option to invest, the holder is able
to access upside opportunities (through exercising
the call by investing or expanding) while limiting
downside losses (by not exercising it in the event of
adverse developments).
Myers (1977) coined the term real options and
envisioned bringing the theory of nancial options
to the realm of strategic decision making. Real
1This denition of options as rights, or claims on future oppor-
tunities, is different from the informal usage of the term options,
such as when a rm is said to take an “options approach” by under-
taking a number of small and disparate activities, which may not
confer clear rights. Moreover,just as a right must exist, it is equally
important that the decision maker is not obligated to act in the
future for an option to exist. In some contexts, however,rms may
be compelled to undertake certain investments due to regulation,
competitor actions, prior contractual commitments, or governance
inseparabilities (e.g., Argyres and Liebeskind, 1999).
Copyright © 2016 John Wiley & Sons, Ltd. Strat. Mgmt. J.,38: 42–63 (2017)
DOI: 10.1002/smj
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