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Real‐option valuation of research and development investments

Author

Listed:
  • Hemantha S.B. Herath
  • Wayne G. Bremser

Abstract

Purpose - Aims to promote an integrated performance measurement system. Design/methodology/approach - The literature on R&D performance measurement identifies the need for an integrated performance measurement system for strategy implementation. Develops a theoretical framework for R&D performance measures, incorporating real options to define strategic net present value, which values the plan to make R&D investments. Findings - Real options techniques can be used to value managers' options to shelter investments from adverse effects and exploit upside potential. The shift in valuation paradigms from a naïve net present value model to active risk management implicit in real options requires performance measures that reflect real option value and defines strategic value created (SVC), which is based on residual income concepts. Since residual income is known to be superior to ROI in motivating goal congruence, infers that SVC has similar advantages. Originality/value - Illustrates how SVC would be used as a performance measure for a new drug in the commercialization stage, considers several relevant questions and discusses how SVC could be used in a firm's balanced scorecard.

Suggested Citation

  • Hemantha S.B. Herath & Wayne G. Bremser, 2005. "Real‐option valuation of research and development investments," Managerial Auditing Journal, Emerald Group Publishing Limited, vol. 20(1), pages 55-72, January.
    • Handle: RePEc:eme:majpps:02686900510570704
    DOI: 10.1108/02686900510570704
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