Growth options and risk : an empirical analysis of the relation between growth options and unlevered beta

Abstract

Estimating risk is an important part of capital budgeting and valuation because risk affects the cost of capital. Firms and projects consist of both assets-in-place and growth options and it is typically assumed that growth options are riskier. This thesis examines the relation between growth options and risk. We base our research on the framework proposed by Bernardo, Chowdhry and Goyal (2007), who show that firms with high proportions of growth options relative to assets-in-place have higher unlevered betas. We apply a cross-sectional regression model for examining the effect growth options have on the unlevered beta in the time period 1990-2013 and the subsamples, 1995-2004 and 2005-2013. Our results show that accounting for growth options in determining the unlevered beta is not necessarily important for all industries and all time periods. Such findings have important practical implications for firms that base their investment decisions and valuation on the method of comparables. Our contradicting results shed new light on previous research, indicating an inconsistent relation between growth options and the unlevered beta across industries and time periods