The Impact of Power Distance and Uncertainty Avoidance on Real Options Exercise: Potential for Suboptimal Time Delays and Value Destruction

ABSTRACT

Real options (RO) valuation has been promoted as a way to evaluate investment opportunities and make investment decisions that takes into account the value of managerial flexibility in the face of uncertainty. Although RO enjoys a substantial body of literature considering its application and suitability in different situations, the impact of national culture on the application of RO has received little attention. Values embedded in national culture affect the behavior of managers. In particular, these values play a role in how managers frame information, communicate, and make decisions, directly and indirectly affecting behavior through cultural layers such as organizational culture. National culture, therefore, can systematically affect the application of RO, potentially leading to suboptimal outcomes. In this article, we hypothesize how 2 particularly relevant dimensions of culture, power distance and uncertainty avoidance, affect RO exercise, and estimate the magnitude suboptimality of these effects using a model we develop for the case of a put option. Our estimates suggest RO may not always be a superior valuation approach to net present value for national cultures with certain characteristics.

KEYWORDS:

• National culture
• Real options
• Uncertainty avoidance
• Power distance

Acknowledgments

The authors would like to thank Paul Beamish, Haruo Horaguchi, Yuri Lawryshyn, Joshua Marineau, and Newell Wright.