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The real option approach to adoption or discontinuation of a management accounting innovation: the case of activity-based costing

Author

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  • Shu Feng

    (Clark University)

  • Chun-Yu Ho

    (Shanghai Jiao Tong University, Antai College of Economics and Management)

Abstract

This paper employs the real option approach (ROA) to study the investment decision of a management accounting innovation—the case of activity-based costing (ABC)—adoption or discontinuation under uncertainty. We argue that investing in ABC is analogous to having the option rights in a financial (American) call option. We propose a model taking the firm’s total annual production as primary decision variable and using the added annual net profits after establishing ABC to identify the optimal threshold for adoption or discontinuation. We find that the optimal adoption (resp., discontinuation) threshold is higher (resp., lower) when obtained by the ROA than by the net present value (NPV) method; thus, the ROA is more conservative than the NPV approach. Their difference stems mainly from the ROA’s option value of delay before implementing the adoption/discontinuation decision. Further, recent empirical researches based on survey found inconclusive results about the adoption of ABC. For instance, there are studies found that manufacturing sector having a higher adoption rate of ABC than non-manufacturing sector, but the other studies find the opposite. Our theoretical model explains the inconclusive results from the empirical researches can be driven by the variations in mean and volatility of sectoral output growth, which are omitted in those studies.

Suggested Citation

  • Shu Feng & Chun-Yu Ho, 2016. "The real option approach to adoption or discontinuation of a management accounting innovation: the case of activity-based costing," Review of Quantitative Finance and Accounting, Springer, vol. 47(3), pages 835-856, October.
    • Handle: RePEc:kap:rqfnac:v:47:y:2016:i:3:d:10.1007_s11156-015-0522-4
    DOI: 10.1007/s11156-015-0522-4
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    More about this item

    Keywords

    Activity-based costing; Management accounting innovations; Real option theory; Investment under uncertainty;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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