Real options and the theory of foreign direct investment

• Published in: International business review Vol. 16; no. 6; pp. 687 - 712
• Main Authors: Li, Jing, Rugman, Alan M.
• Format: Journal Article
• Language: English
• Published: Elsevier Ltd 01-12-2007; Elsevier
• Series: International Business Review
• Subjects: Economic models; FDI theory; FDI theory Market entry mode Option modeling Real options theory Regional location; Foreign direct investment; Internationalization; Location of enterprises; Market entry; Market entry mode; Multinational enterprises; Option modeling; Options on stocks; Real options theory; Regional location; Uncertainty; FDI theory; Real options theory; Market entry mode; Regional location; Option modeling
• ISSN: 0969-5931; 1873-6149
• DOI: 10.1016/j.ibusrev.2007.08.004

We extend applications of real options theory to foreign direct investment (FDI) research regarding choice of location and choice of market entry mode under uncertainty. Our study is motivated by the regional configuration of multinational enterprises (MNEs), as well as observed deviations from the stages model in internationalization theory. We shed light on these issues using real option modeling and computer simulations. The results suggest that from the standpoint of pursuing business opportunities and generating real options, building a subsidiary in a nonhome region could be more beneficial than in a home region. However, high option exercise cost may reduce the option value of a nonhome-region location. Our models also imply that choice of entry mode depends on the
magnitude (high vs. low) and the
type (exogenous vs. endogenous) of uncertainty. When uncertainty is high and endogenous, MNEs may prefer high-commitment entry modes because they contribute to the reduction of uncertainty and provide valuable growth options.