Real options, irreversible investment and firm uncertainty: Evidence from New Zealand

Abstract

This thesis investigates real options behavior in capital budgeting decisions using a firm-level panel data of companies listed in New Zealand Stock Exchange (NZX) from 2001 to 2012. In line with the real options literature, which emphasize the impact of irreversibility and valuable options on investment, this study finds that increases in total uncertainty of New Zealand firms negatively affect their incremental capital investment. Using simplified tax-adjusted capital asset pricing model developed by Cliffe and Marsden (1992), Lally (2000), Lally and Van Ziji (2003), Lally and Marsden (2004), total firm uncertainty can be separated into its market and firm-specific components for New Zealand specific dividend imputation system. Given that the irreversibility of capital is derived from asset-specificity at the individual firm level, increased firm-specific uncertainty displays a pronounced negative effect on firm investment that is consistent with real options behavior. Robust tests have been done within different subsamples that are classified by level of irreversibility, firm size, competition faced by firms, and level of leverage. Similar results for the investment-uncertainty relationship have been found among all the subsamples. Specifically, my empirical results indicate more profound negative investment-uncertainty relationship for firms (i) with more irreversible investment; (ii) with large size; (iii) facing more competition; (iv) with high leverage.