Organisational change and performance in long-lived small firms: a real options approach

Abstract

This paper supports two key principles of real options reasoning: (a) the value of waiting and (b) the value of staging. It tests whether real options logic applies to small firms implementing significant changes (e.g. in technology) in a model of small firm performance, estimated on data collected by interviews with entrepreneurs. We found that to achieve a higher value by waiting, a delicate balance of precipitators of change against time until exercise is necessary (e.g. if there were just one or two precipitators, then waiting would certainly raise the value). Similarly, to achieve a higher value by staging, the entrepreneur needs to balance embedding against investment time. Thus, provided that investment time is less than 1¼ years, we found that embedding will raise the value. Overall, this implies that strategic flexibility in investment decisions is necessary for good long-run performance of small firms.

Keywords:

• real options
• strategic flexibility
• value of waiting performance
• small firms

JEL Classification:

• C21
• C42
• D21
• G31
• L25
• M13
• M21

Notes

Formally, Errais and Sadowsky (2008) modelled their multi-stage investment process as a perpetual N-stage Bermudan option. The determination of optimal exercise time uses dynamic programming approximation techniques, for a market with both market and technical uncertainties. An option of their form can be exercised at a fixed specified date in the future, with no expiration date, see Boyarchenko and Levendorskii (2002).

Specifically, Cronbach's (1951) alpha was 0.78, exceeding the level recommended by Nunnally (1978) of 0.7 and the data fitted yardstick measurement models (cf. Sandberg and Hofer 1987; Chrisman, Bauerschmidt, and Hofer 1998) well (; prob. ).

Though we dropped the influence of the risk-free rate of return (r) as its influence has been found to be weak, see Dixit and Pindyck (1994) and Ingersoll and Ross (1992). Note the value S includes future growth options, as the option is compound in nature.

This procedure was adopted because the chart of residuals against predicted values from a preliminary regression suggested an increasing relationship. A linear proportional relationship of the reciprocal of Sales to the absolute value of the residuals was found to be significant using Glesjer's test for heteroskedasticity, see Davidson and MacKinnon (1993, chap. 11).