Real Options In Practice: An Exploratory Survey Of How Finance Officers Deal With Flexibility In Capital Appraisal

Dissatisfaction with discounted cash flow techniques has lead to a growing literature focusing on the value of managerial flexibility in handling real asset investments, a subject are known as real options. This paper describes an exploratory survey of senior financial officers in industrial firms, examining the significance that real options assumed in their investment decisions, whether their firms had established procedures for assessing real options, and whether their intuitions were consistent with what theory prescribes. We found that, while real options commonly occurred and were generally significant in determining how decision makers regard an investment, there was wide variation between individual decision makers in their perception of real options. Most respondents could recall an example of a real option with which they had dealt, and in about half the cases the option had been necessary for the associated investment to be sanctioned. Few firms have procedures to assess options in advance. Real options may not always be desirable since, in the eyes of at least some respondents, they can reduce organisational commitment to a project. Very few decision makers seems to be aware of real option research, but, mostly, their intuitions agreed with the qualitative prescriptions of such work.