Options, the value of capital, and investment

Andrew B. Abel, Avinash K. Dixit, Janice C. Eberly, Robert S. Pindyck

Research output: Contribution to journalArticlepeer-review

220 Scopus citations

Abstract

Capital investment decisions must recognize the limitations on the firm's ability to later sell or expand capacity. This paper shows how opportunities for future expansion or contraction can be valued as options, how their valuation relates to the q theory of investment, and their effect on the incentive to invest. Generally, the option to expand reduces the incentive to invest, while the option to disinvest raises it. We show how these options determine the effect of uncertainty on investment, how they are changed by shifts of the distribution of future profitability, and how the q-theory and option pricing approaches are related.

Original languageEnglish (US)
Pages (from-to)753-777
Number of pages25
JournalQuarterly Journal of Economics
Volume111
Issue number3
DOIs
StatePublished - Aug 1996

ASJC Scopus subject areas

  • Economics and Econometrics

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