Abandonment Options and Information System Design

Abandonment Options and Information System Design We study a principal-agent model of moral hazard in which the principal has an abandonment option. The option to abandon a project midstream limits a firm's downside risk. From a consumption (production) perspective, the option is clearly beneficial. However, from an incentive perspective, the option can be costly. Removing the lower tail of the project's underlying cash flow distribution also eliminates the information it contains about an agent's (unobservable) productive input. In addition, there is also the issue that the option holder cannot always (ex ante) commit to the precise circumstances under which the option will be exercised. These concerns introduce an interaction in the valuation of the abandonment option and information system. In particular, the manner in which information is coarsened and the direction of the flow of information are critical design parameters that affect option value. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting Studies Springer Journals

Abandonment Options and Information System Design

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Publisher
Kluwer Academic Publishers
Copyright
Copyright © 2003 by Kluwer Academic Publishers
Subject
Business and Management; Accounting/Auditing; Corporate Finance; Public Finance
ISSN
1380-6653
eISSN
1573-7136
D.O.I.
10.1023/A:1022695705845
Publisher site
See Article on Publisher Site

Abstract

We study a principal-agent model of moral hazard in which the principal has an abandonment option. The option to abandon a project midstream limits a firm's downside risk. From a consumption (production) perspective, the option is clearly beneficial. However, from an incentive perspective, the option can be costly. Removing the lower tail of the project's underlying cash flow distribution also eliminates the information it contains about an agent's (unobservable) productive input. In addition, there is also the issue that the option holder cannot always (ex ante) commit to the precise circumstances under which the option will be exercised. These concerns introduce an interaction in the valuation of the abandonment option and information system. In particular, the manner in which information is coarsened and the direction of the flow of information are critical design parameters that affect option value.

Journal

Review of Accounting StudiesSpringer Journals

Published: Oct 2, 2004

References

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