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Demand lotteries, abandonment options and the decision to start R&D and process innovation

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  • Dobbelaere, Sabien
  • Luttens, Roland Iwan
  • Peters, Bettina

Abstract

We study different determinants of real-life R&D decisions within a net present value framework. Besides entry threat, Bertrand competition and multi-stage R&D with an abandonment option, our model includes demand uncertainty, modelled as a lottery. A lottery becomes more divergent when the difference between the outcomes of the lottery increases. We derive under which lottery probabilities more divergent demand lotteries positively or negatively affect the decision to start R&D. Using CIS IV data for about 2600 German firms, we find that for firms facing lotteries where the good state is more likely to prevail a 10% increase in the degree of divergence of the demand lottery increases the likelihood of undertaking R&D by 1.2 percentage points. For firms facing a demand lottery where the bad state is most likely to prevail, a 10% increase in the degree of divergence of the demand lottery decreases the likelihood of undertaking R&D by 4.6 percentage points. Having the option to abandon R&D projects significantly increases the likelihood of undertaking R&D.

Suggested Citation

  • Dobbelaere, Sabien & Luttens, Roland Iwan & Peters, Bettina, 2015. "Demand lotteries, abandonment options and the decision to start R&D and process innovation," management revue. Socio-economic Studies, Rainer Hampp Verlag, vol. 26(1), pages 25-51.
    • Handle: RePEc:rai:mamere:mrev-2015-01-dobbelaere
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    Cited by:

    1. Rammer, Christian, 2022. "Measuring process innovation output: Results from firm-level panel data," ZEW Discussion Papers 22-002, ZEW - Leibniz Centre for European Economic Research.
    2. Brandão, Luiz E. & Fernandes, Gláucia & Dyer, James S., 2018. "Valuing multistage investment projects in the pharmaceutical industry," European Journal of Operational Research, Elsevier, vol. 271(2), pages 720-732.

    More about this item

    Keywords

    multi-stage R&D; demand uncertainty; entry threat; abandonment option;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives

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