Why is the adoption rate of real options valuation low among practitioners? : a multiple case study

Abstract

Real options valuation has been advocated as an appropriate valuation method for high-risk projects. Despite its popularity in literature, adoption among practitioners continues to be low. This paper researches why the adoption of real options analysis remains low by studying three topics; how companies value high-risk projects, to what extent managers incorporate real options thinking, and to what extent managers find real options analysis suitable for their businesses. The paper aims to develop new insights for the low adoption rate of real options analysis through an exploratory multiple case study. We have conducted interviews with top executives and managers that are involved in project valuations and have authority to make investment decisions. From these interviews, the study provides insight into how companies value and evaluate high-risk projects, how managers incorporate real options thinking in project assessments, and how practitioners perceive real option valuation. Generally, findings from our study support existing literature. None of our interviewed firms used real options analysis for project valuations, because managers lacked familiarity with the models. After interviewees were explained the basics of real options valuation, they argued against the method because it was perceived as costly to implement, they lacked the competence to perform the analysis, managers could not always exercise relevant real options, and confidence in employed methods reduced the need for additional sophisticated analysis. Nevertheless, all participants exhibited real option heuristics as they intuitively included the value of real options in investment evaluations. A potentially interesting finding from our study is that participating companies reported prioritizing non-financial investment criteria over valuations. As valuation was not the most important criterion for project assessments, the willingness to invest in sophisticated analysis diminished. Further studies on the prevalence and effects of this priority may increase the understanding of why real option adoption continues to be low.