Innovation through quasi-integration: An application of option theory to governance decisions in the biotechnology industry
Abstract
It has been argued that behavioral incentives for research and development are more efficiently governed within the administrative hierarchies of firms rather than the contractual mechanisms of markets. Yet, movement toward unified governance places resources at hazard. The main focus of this study is to examine where the costs of increased resource commitment offset the need for more control. It will establish how firms choose to govern investments in research and development. In particular, this study elaborates upon the motives for using partial equity investments in collaborative relationships versus outright acquisition of another firm. Two types of equity-based collaborations, minority direct investments and joint ventures, are characterized as call options providing the right, but not the obligation to acquire the partner at a later date. Like financial options, these "real" options increase in value during periods of uncertainty, precisely where transaction cost theory has had difficulty. As such, the principles of option theory are used to predict when these options take on value and are implemented. It is proposed that the choice between partial equity investments and acquisition is a function of transaction costs and option value. The combined transaction cost-option theory model is tested on a sample of 451 minority investments, joint ventures, and acquisitions in the biotechnology industry from 1984 to 1992. A multinomial logit model was specified to estimate the impact of the independent variables on the probability that each of the three governance structures would be selected. The results strongly support the combined transaction cost-option theory model. Option theory is shown to significantly improve the estimation of governance choice. Furthermore, variables which theoretically increase option value are found to be related to the preference for initiating minority investments and joint ventures over acquisitions. Curiously, transaction cost variables generally do not relate as expected. These results suggest that option theory is helpful in assessing when option value dominates the governance decision. This study extends the growing conceptual base of options analysis within strategic management by carefully specifying and empirically testing the complete option model. In doing this, it provides insight into the difficulty which transaction cost theory has had in explaining governance decisions in the domains of technological uncertainty.
Degree
Ph.D.
Advisors
Schendel, Purdue University.
Subject Area
Management
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