Real options, sequential bargaining game and investment decisions with network effects

This thesis addresses a common problem in the capital budgeting, the optimal time and size of capital investment, using techniques of real options in a cooperative game setting. In addition, it reflects a combination of real option theory to invest, coupled with competitive game between a first mover and a second mover in the development of a common-use asset and cooperative game theory between a first mover and a second mover to capture a network effect.Thus, the first mover has to decide when to build, what capacity to build and what the optimal economic rent is for using the facility. The second mover has to decide whether to use the first mover's facility or build its own facility, and if it decides to build its owns, what the optimal time and size are.In the model, two firms in the same industry have similar and interacting capital investment opportunities, such as to build or purchase a production facility. There is a real option for both firms to delay the investment until they have suitable price and production conditions. There are advantages to a first mover who can build a facility to its own specifications and locational or functional preference. This first mover advantage encourages early investment. There is also a cooperative bargaining game to be played between these two firms because the launch of one firm's investment influences the payoffs and therefore the launch of the other firm's investment. Also, there is a beneficial network effect from operating synergy if the first mover successfully encourages the second mover to start production immediately by sharing the production facility.