Effects of Monitoring Costs on Real Options Analysis
Abstract
This paper is the first to analyze importance of monitoring costs in real options analysis. Monitoring costs, in this context, are tied to the process of making key investment or management decisions. Monitoring costs differ from previously considered types of frictions, as they make it optimal to spread decisions (and not only actions) in time. In the first part of the paper, we present a qualitative introduction of monitoring costs in real options analysis and their effects on the optimal decisions during the life of the real option. In the second part, we implement numeric valuation of a real option in the presence of two types of frictions, monitoring costs and option maintenance costs. We illustrate our results using a number of three-dimensional surface plots. We analyze effects of the two frictions on the option value and the optimal decision timing and supplement our results by analyzing sensitivities to all major parameters of the model. The surface plots serve two purposes. First, they allow to quantify importance of the considered frictions. Second, they could be consulted as qualitative indicators in analyzing projects with similar characteristics.
Keywords:
real options, option to wait, monitoring costs, transaction costs
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Articles of the Russian Management Journal are open access distributed under the terms of the License Agreement with Saint Petersburg State University, which permits to the authors unrestricted distribution and self-archiving free of charge.