Investor valuation of the abandonment option

Philip G. Berger, Eli Ofek, Itzhak Swary

Research output: Contribution to journalArticlepeer-review

Abstract

We investigate whether investors price the option to abandon a firm at its exit value. Theory prices this real option as an American put with both a stochastic strike price (exit value) and a stochastic value of the underlying security (the value of cash flows). The empirical implications are that firm value increases in exit value, after controlling for expected going-concern cash flows, and that more generalizable assets produce more abandonment option value. Using discounted earnings forecasts to proxy for expected cash flows and prior literature to categorize asset generalizability, we find strong support for the predictions of abandonment option theory.

Original languageEnglish
Pages (from-to)259-287
Number of pages29
JournalJournal of Financial Economics
Volume42
Issue number2
DOIs
StatePublished - Oct 1996

Keywords

  • Abandonment option
  • Asset structure
  • Earnings forecasts
  • Exit
  • Valuation

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