ORIGINAL RESEARCH
The real option approach to adoption or discontinuation
of a management accounting innovation: the case
of activity-based costing
Shu Feng
1
•
Chun-Yu Ho
2
Published online: 30 May 2015
Ó Springer Science+Business Media New York 2015
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 dif-
ference 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 incon-
clusive 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.
Keywords Activity-based costing Á Management accounting innovations Á Real option
theory Á Investment under uncertainty
JEL Classification D81 Á G13 Á G32 Á M41
& Shu Feng
sfeng@clarku.edu
Chun-Yu Ho
chunyu.ho@sjtu.edu.cn
1
Finance, Graduate School of Management, Clark University, 950 Main Street, Worcester,
MA 01610, USA
2
Economics, Shanghai Jiao Tong University, Antai College of Economics and Management,
Shanghai 20052, People’s Republic of China
123
Rev Quant Finan Acc (2016) 47:835–856
DOI 10.1007/s11156-015-0522-4