Skip to main content
main-content
Top

Hint

Swipe to navigate through the articles of this issue

Published in: Business & Information Systems Engineering 5/2013

01-10-2013 | State of the Art

Valuation of IT Investments Using Real Options Theory

Author: Dipl.-Kfm. Christian Ullrich

Published in: Business & Information Systems Engineering | Issue 5/2013

Login to get access
share
SHARE

Abstract

Real Options Theory is often applied to the valuation of IT investments. The application of Real Options Theory is generally accompanied by a monetary valuation of real options through option pricing models which in turn are based on restrictive assumptions and thus subject to criticism. Therefore, this paper analyzes the application of option pricing models to the valuation of IT investments. A structured literature review reveals the types of IT investments which are valued with Real Options Theory in scientific literature. These types of IT investments are further investigated and their main characteristics are compared to the restrictive assumptions of traditional option pricing models. This analysis serves as a basis for further discussion on how the identified papers address these assumptions. The results show that a lot of papers do not account for critical assumptions, although it is known that the assumptions are not fulfilled. Moreover, the type of IT investment determines the criticality of the assumptions. Additionally, several extensions or adaptions of traditional option pricing models can be found which provide the possibility to relax critical assumptions. Researchers can profit from the results derived in this paper in two ways: First, it is demonstrated which assumptions can be critical for various types of IT investments. Second, extensions of option pricing models that relax critical assumptions are introduced.
Footnotes
1
Here, the assumptions of the BSM are listed although only assumption (A2) differs from the assumptions of the BM. But if the time intervals of the BM are scaled down, the binomial process of the BM can be converted to the continuous process of the BSM (Trigeorgis 1996, p. 83).
 
2
Assumption (A5) will not be further considered since it is not ROT-specific but rather necessary for several capital market models (as, e.g., the Capital Asset Pricing Model).
 
3
For the derivation of the formulas necessary for option valuation, see standard literature such as Franke and Hax (2003) or Perridon et al. (2009).
 
Literature
go back to reference Angelou GN, Economides AA (2008) A decision analysis framework for prioritizing a portfolio of ICT infrastructure projects. IEEE Transactions on Engineering Management 55(3):479–495 CrossRef Angelou GN, Economides AA (2008) A decision analysis framework for prioritizing a portfolio of ICT infrastructure projects. IEEE Transactions on Engineering Management 55(3):479–495 CrossRef
go back to reference Balasubramanian P, Kulatilaka N, Storck J (2000) Managing information technology investments using a real-options approach. Journal of Strategic Information Systems 9(1):39–62 CrossRef Balasubramanian P, Kulatilaka N, Storck J (2000) Managing information technology investments using a real-options approach. Journal of Strategic Information Systems 9(1):39–62 CrossRef
go back to reference Banker R, Wattal S, Plehn-Dujowich JM (2010) Real options in information systems – a revised framework. In: Proc 31st international conference on information systems, St Louis Banker R, Wattal S, Plehn-Dujowich JM (2010) Real options in information systems – a revised framework. In: Proc 31st international conference on information systems, St Louis
go back to reference Bardhan I, Bagchi S, Sougstad R (2004) Prioritizing a portfolio of information technology investment projects. Journal of Management Information Systems 21(2):33–60 Bardhan I, Bagchi S, Sougstad R (2004) Prioritizing a portfolio of information technology investment projects. Journal of Management Information Systems 21(2):33–60
go back to reference Benaroch M (2002) Managing information technology investment risk: a real options perspective. Journal of Management Information Systems 19(2):43–84 Benaroch M (2002) Managing information technology investment risk: a real options perspective. Journal of Management Information Systems 19(2):43–84
go back to reference Benaroch M, Kauffman RJ (1999) A case for using real options pricing analysis to evaluate information technology project investments. Information Systems Research 10(1):70–86 CrossRef Benaroch M, Kauffman RJ (1999) A case for using real options pricing analysis to evaluate information technology project investments. Information Systems Research 10(1):70–86 CrossRef
go back to reference Benaroch M, Kauffman RJ (2000) Justifying electronic banking network expansion using real options analysis. MIS Quarterly 24(2):197–225 CrossRef Benaroch M, Kauffman RJ (2000) Justifying electronic banking network expansion using real options analysis. MIS Quarterly 24(2):197–225 CrossRef
go back to reference Benaroch M, Lichtenstein Y, Robinson K (2006) Real options in information technology risk management: an empirical validation of risk-option relationships. MIS Quarterly 30(4):827–864 Benaroch M, Lichtenstein Y, Robinson K (2006) Real options in information technology risk management: an empirical validation of risk-option relationships. MIS Quarterly 30(4):827–864
go back to reference Bernroider E, Koch S (2000) Entscheidungsfindung bei der Auswahl betrieblicher Standardsoftware – Ergebnisse einer empirischen Untersuchung in österreichischen Unternehmen. WIRTSCHAFTSINFORMATIK 42(4):329–338 CrossRef Bernroider E, Koch S (2000) Entscheidungsfindung bei der Auswahl betrieblicher Standardsoftware – Ergebnisse einer empirischen Untersuchung in österreichischen Unternehmen. WIRTSCHAFTSINFORMATIK 42(4):329–338 CrossRef
go back to reference Black F (1975) Fact and fantasy in the use of options. Financial Analysts Journal 31(4):36–41 CrossRef Black F (1975) Fact and fantasy in the use of options. Financial Analysts Journal 31(4):36–41 CrossRef
go back to reference Black F, Scholes M (1973) The pricing of options and corporate liabilities. Journal of Political Economy 81(3):637–654 CrossRef Black F, Scholes M (1973) The pricing of options and corporate liabilities. Journal of Political Economy 81(3):637–654 CrossRef
go back to reference Cao Q, Gu VC, Burns JR (2009) Applications of real option analysis to vendor selection process in IT outsourcing. International Journal of Information Systems and Change Management 4(2):143–155 CrossRef Cao Q, Gu VC, Burns JR (2009) Applications of real option analysis to vendor selection process in IT outsourcing. International Journal of Information Systems and Change Management 4(2):143–155 CrossRef
go back to reference Cox JC, Ross SA, Rubinstein M (1979) Option pricing: a simplified approach. Journal of Financial Economics 7(3):229–263 CrossRef Cox JC, Ross SA, Rubinstein M (1979) Option pricing: a simplified approach. Journal of Financial Economics 7(3):229–263 CrossRef
go back to reference Diepold D, Ullrich C, Wehrmann A, Zimmermann S (2009) A real options approach for valuating intertemporal interdependencies within a value-based IT portfolio management – a risk-return perspective. In: Proc 17th European conference on information systems, Verona Diepold D, Ullrich C, Wehrmann A, Zimmermann S (2009) A real options approach for valuating intertemporal interdependencies within a value-based IT portfolio management – a risk-return perspective. In: Proc 17th European conference on information systems, Verona
go back to reference Diepold D, Ullrich C, Wehrmann A, Zimmermann S (2011) Bewertung intertemporaler Abhängigkeiten zwischen IT-Projekten – Anwendung eines realoptionsbasierten Ansatzes unter Berücksichtigung projektspezifischer Risiken. Zeitschrift für Betriebswirtschaft 81(7):805–831 CrossRef Diepold D, Ullrich C, Wehrmann A, Zimmermann S (2011) Bewertung intertemporaler Abhängigkeiten zwischen IT-Projekten – Anwendung eines realoptionsbasierten Ansatzes unter Berücksichtigung projektspezifischer Risiken. Zeitschrift für Betriebswirtschaft 81(7):805–831 CrossRef
go back to reference Dolci PC, Macada ACG, Becker JL (2010) IT investment management using the real options and portfolio management approaches. In: Proc 16th American conference on information systems, Lima Dolci PC, Macada ACG, Becker JL (2010) IT investment management using the real options and portfolio management approaches. In: Proc 16th American conference on information systems, Lima
go back to reference Dos Santos BL (1991) Justifying investments in new information technologies. Journal of Management Information Systems 7(4):71–90 Dos Santos BL (1991) Justifying investments in new information technologies. Journal of Management Information Systems 7(4):71–90
go back to reference Ekström MA, Björnsson HC (2005) Valuing flexibility in architecture, engineering, and construction information technology investments. Journal of Construction Engineering and Management 131(4):431–438 CrossRef Ekström MA, Björnsson HC (2005) Valuing flexibility in architecture, engineering, and construction information technology investments. Journal of Construction Engineering and Management 131(4):431–438 CrossRef
go back to reference Fettke P (2006) State-of-the-Art des State-of-the-Art – Eine Untersuchung der Forschungsmethode “Review” innerhalb der Wirtschaftsinformatik. WIRTSCHAFTSINFORMATIK 48(4):257–266 CrossRef Fettke P (2006) State-of-the-Art des State-of-the-Art – Eine Untersuchung der Forschungsmethode “Review” innerhalb der Wirtschaftsinformatik. WIRTSCHAFTSINFORMATIK 48(4):257–266 CrossRef
go back to reference Fichman RG (2004) Real options and IT platform adoption: implications for theory and practice. Information Systems Research 15(2):132–154 CrossRef Fichman RG (2004) Real options and IT platform adoption: implications for theory and practice. Information Systems Research 15(2):132–154 CrossRef
go back to reference Fichman RG, Keil M, Tiwana A (2005) Beyond valuation: “option thinking” in IT project management. California Management Review 47(2):74–96 CrossRef Fichman RG, Keil M, Tiwana A (2005) Beyond valuation: “option thinking” in IT project management. California Management Review 47(2):74–96 CrossRef
go back to reference Franke G, Hax H (2003) Finanzwirtschaft des Unternehmens und Kapitalmarkt, 5th edn. Springer, Heidelberg Franke G, Hax H (2003) Finanzwirtschaft des Unternehmens und Kapitalmarkt, 5th edn. Springer, Heidelberg
go back to reference Gull D (2011) Valuation of discount options in software license agreements. Business & Information Systems Engineering 3(4):221–230 CrossRef Gull D (2011) Valuation of discount options in software license agreements. Business & Information Systems Engineering 3(4):221–230 CrossRef
go back to reference Harmantzis FC, Tanguturi VP (2007) Investment decisions in the wireless industry applying real options. Telecommunications Policy 31(2):107–123 CrossRef Harmantzis FC, Tanguturi VP (2007) Investment decisions in the wireless industry applying real options. Telecommunications Policy 31(2):107–123 CrossRef
go back to reference Henrich A (2002) Management von Softwareprojekten. Oldenbourg, München Henrich A (2002) Management von Softwareprojekten. Oldenbourg, München
go back to reference Heinrich B, Huber A, Zimmermann S (2011) Make-and-sell or buy of web services – a real option approach. In: Proc 19th European conference on information systems, Helsinki Heinrich B, Huber A, Zimmermann S (2011) Make-and-sell or buy of web services – a real option approach. In: Proc 19th European conference on information systems, Helsinki
go back to reference Herath HSB, Herath TC (2008) Investments in information security: a real options perspective with Bayesian postaudit. Journal of Management Information Systems 25(3):337–375 CrossRef Herath HSB, Herath TC (2008) Investments in information security: a real options perspective with Bayesian postaudit. Journal of Management Information Systems 25(3):337–375 CrossRef
go back to reference Hilhorst C, van Heck E, Ribbers P, Smits M (2006) Combining real options and multiattribute decision analysis to define the favourable IT infrastructure implementation strategy: a case study. In: Proc 14th European conference on information systems, Göteborg Hilhorst C, van Heck E, Ribbers P, Smits M (2006) Combining real options and multiattribute decision analysis to define the favourable IT infrastructure implementation strategy: a case study. In: Proc 14th European conference on information systems, Göteborg
go back to reference Hilhorst C, Ribbers P, van Heck E, Smits M (2008) Risk management and valuation of real options in IT projects: an exploratory experiment. In: Proc 16th European conference on information systems, Galway Hilhorst C, Ribbers P, van Heck E, Smits M (2008) Risk management and valuation of real options in IT projects: an exploratory experiment. In: Proc 16th European conference on information systems, Galway
go back to reference Ji Y (2010) Incorporating knowledge building in real options analyses of technology project investment. In: Proc 31st international conference on information systems, St Louis Ji Y (2010) Incorporating knowledge building in real options analyses of technology project investment. In: Proc 31st international conference on information systems, St Louis
go back to reference Kauffman RJ, Kumar A (2008) Network effects and embedded options: decision-making under uncertainty for network technology investments. Information Technology Management 9(3):149–168 CrossRef Kauffman RJ, Kumar A (2008) Network effects and embedded options: decision-making under uncertainty for network technology investments. Information Technology Management 9(3):149–168 CrossRef
go back to reference Kauffman RJ, Li X (2005) Technology competition and optimal investment timing: a real options perspective. IEEE Transactions on Engineering Management 52(1):15–29 CrossRef Kauffman RJ, Li X (2005) Technology competition and optimal investment timing: a real options perspective. IEEE Transactions on Engineering Management 52(1):15–29 CrossRef
go back to reference Kim HJ (2008) Real options: strategic technology migration options in wireless industry. In: Proc 14th American conference on information systems, Toronto Kim HJ (2008) Real options: strategic technology migration options in wireless industry. In: Proc 14th American conference on information systems, Toronto
go back to reference Kruschwitz L (2011) Investitionsrechnung, 13rd edn. Oldenbourg, München Kruschwitz L (2011) Investitionsrechnung, 13rd edn. Oldenbourg, München
go back to reference Kumar RL (1996) A note on project risk and option values of investments in information technologies. Journal of Management Information Systems 13(1):187–193 Kumar RL (1996) A note on project risk and option values of investments in information technologies. Journal of Management Information Systems 13(1):187–193
go back to reference Kumar RL (2002) Managing risks in IT projects: an options perspective. Information & Management 40(1):63–74 CrossRef Kumar RL (2002) Managing risks in IT projects: an options perspective. Information & Management 40(1):63–74 CrossRef
go back to reference Lankton N, Luft J (2008) Uncertainty and industry structure effects on managerial intuition about information technology options. Journal of Management Information Systems 25(2):203–240 CrossRef Lankton N, Luft J (2008) Uncertainty and industry structure effects on managerial intuition about information technology options. Journal of Management Information Systems 25(2):203–240 CrossRef
go back to reference Lee KJ, Shyu DS, Dai ML (2009) The valuation of information technology investments by real options analysis. Review of Pacific Basin Financial Markets and Policies 12(4):611–628 CrossRef Lee KJ, Shyu DS, Dai ML (2009) The valuation of information technology investments by real options analysis. Review of Pacific Basin Financial Markets and Policies 12(4):611–628 CrossRef
go back to reference Li X (2009) Preemptive learning, competency traps, and information technology adoption: a real options analysis. IEEE Transactions on Engineering Management 56(4):650–662 CrossRef Li X (2009) Preemptive learning, competency traps, and information technology adoption: a real options analysis. IEEE Transactions on Engineering Management 56(4):650–662 CrossRef
go back to reference Maklan S, Knox S, Ryals L (2005) Using real options to help build the business case for CRM investment. Long Range Planning 38(4):393–410 CrossRef Maklan S, Knox S, Ryals L (2005) Using real options to help build the business case for CRM investment. Long Range Planning 38(4):393–410 CrossRef
go back to reference Margrabe W (1978) The value of an option to exchange one asset for another. Journal of Finance 36(1):177–186 CrossRef Margrabe W (1978) The value of an option to exchange one asset for another. Journal of Finance 36(1):177–186 CrossRef
go back to reference Mertens P, Bodendorf F, König W, Picot A, Schumann M, Hess T (2010) Grundzüge der Wirtschaftsinformatik, 10th edn. Springer, Heidelberg CrossRef Mertens P, Bodendorf F, König W, Picot A, Schumann M, Hess T (2010) Grundzüge der Wirtschaftsinformatik, 10th edn. Springer, Heidelberg CrossRef
go back to reference Merton RC (1973) Theory of rational option pricing. The Bell Journal of Economics and Management Science 4(1):141–183 CrossRef Merton RC (1973) Theory of rational option pricing. The Bell Journal of Economics and Management Science 4(1):141–183 CrossRef
go back to reference Merton RC (1976) Option pricing when underlying stock returns are discontinuous. Journal of Financial Economics 3(1–2):125–144 CrossRef Merton RC (1976) Option pricing when underlying stock returns are discontinuous. Journal of Financial Economics 3(1–2):125–144 CrossRef
go back to reference Miller L, Choi SH, Park CS (2004) Using an options approach to evaluate Korean information technology infrastructure. The Engineering Economist 49(3):199–219 CrossRef Miller L, Choi SH, Park CS (2004) Using an options approach to evaluate Korean information technology infrastructure. The Engineering Economist 49(3):199–219 CrossRef
go back to reference Myers SC (1974) Interactions of corporate finance and investment decisions – implications for capital budgeting. Journal of Finance 29(1):1–25 CrossRef Myers SC (1974) Interactions of corporate finance and investment decisions – implications for capital budgeting. Journal of Finance 29(1):1–25 CrossRef
go back to reference Panayi S, Trigeorgis L (1998) Multi-stage real options: the cases of information technology infrastructure and international bank expansion. The Quarterly Review of Economics and Finance 38(3):675–692 CrossRef Panayi S, Trigeorgis L (1998) Multi-stage real options: the cases of information technology infrastructure and international bank expansion. The Quarterly Review of Economics and Finance 38(3):675–692 CrossRef
go back to reference Perridon L, Steiner M, Rathgeber AW (2009) Finanzwirtschaft der Unternehmung, 15th edn. Vahlen, München Perridon L, Steiner M, Rathgeber AW (2009) Finanzwirtschaft der Unternehmung, 15th edn. Vahlen, München
go back to reference Schwartz ES, Zozaya-Gorostiza C (2003) Investment under uncertainty in information technology: acquisition and development projects. Management Science 49(1):57–70 CrossRef Schwartz ES, Zozaya-Gorostiza C (2003) Investment under uncertainty in information technology: acquisition and development projects. Management Science 49(1):57–70 CrossRef
go back to reference Singh C, Shelor R, Jiang J, Klein G (2004) Rental software valuation in IT investment decisions. Decision Support Systems 38(1):115–130 CrossRef Singh C, Shelor R, Jiang J, Klein G (2004) Rental software valuation in IT investment decisions. Decision Support Systems 38(1):115–130 CrossRef
go back to reference Tao C, Jinlong Z, Benhai Y, Shan L (2007) A fuzzy group decision approach to real option valuation. Rough sets, fuzzy sets, data mining and granular computing. In: Lecture notes in computer science, vol 4482. Springer, Heidelberg, pp 103–110 Tao C, Jinlong Z, Benhai Y, Shan L (2007) A fuzzy group decision approach to real option valuation. Rough sets, fuzzy sets, data mining and granular computing. In: Lecture notes in computer science, vol 4482. Springer, Heidelberg, pp 103–110
go back to reference Taudes A (1998) Software growth options. Journal of Management Information Systems 15(1):165–185 Taudes A (1998) Software growth options. Journal of Management Information Systems 15(1):165–185
go back to reference Taudes A, Feurstein M, Mild A (2000) Options analysis of software platform decisions: a case study. MIS Quarterly 24(2):227–243 CrossRef Taudes A, Feurstein M, Mild A (2000) Options analysis of software platform decisions: a case study. MIS Quarterly 24(2):227–243 CrossRef
go back to reference Tiwana A, Keil M, Fichman RG (2006) Information systems project continuation in escalation situations: a real options model. Decision Sciences 37(3):357–391 CrossRef Tiwana A, Keil M, Fichman RG (2006) Information systems project continuation in escalation situations: a real options model. Decision Sciences 37(3):357–391 CrossRef
go back to reference Trigeorgis L (1996) Real options: management flexibility and strategy in resource allocation. MIT Press, Cambridge Trigeorgis L (1996) Real options: management flexibility and strategy in resource allocation. MIT Press, Cambridge
go back to reference Webster J, Watson RT (2002) Analyzing the past to prepare for the future: writing a literature review. MIS Quarterly 26(2):xiii–xxiii Webster J, Watson RT (2002) Analyzing the past to prepare for the future: writing a literature review. MIS Quarterly 26(2):xiii–xxiii
go back to reference Wu F, Li HZ, Chu LK, Sculli D, Gao K (2009) An approach to the valuation and decision of ERP investment projects based on real options. Annals of Operations Research 168(1):181–203 CrossRef Wu F, Li HZ, Chu LK, Sculli D, Gao K (2009) An approach to the valuation and decision of ERP investment projects based on real options. Annals of Operations Research 168(1):181–203 CrossRef
go back to reference Zandi F, Tavana M (2011) A fuzzy goal programming model for strategic information technology investment assessment. Benchmarking: An International Journal 18(2):172–196 CrossRef Zandi F, Tavana M (2011) A fuzzy goal programming model for strategic information technology investment assessment. Benchmarking: An International Journal 18(2):172–196 CrossRef
go back to reference Zhu K (1999) Evaluating information technology investment: cash flows or growth options. In: Workshop on information systems and economics (WISE), Charlotte Zhu K (1999) Evaluating information technology investment: cash flows or growth options. In: Workshop on information systems and economics (WISE), Charlotte
Metadata
Title
Valuation of IT Investments Using Real Options Theory
Author
Dipl.-Kfm. Christian Ullrich
Publication date
01-10-2013
Publisher
Springer Fachmedien Wiesbaden
Published in
Business & Information Systems Engineering / Issue 5/2013
Print ISSN: 2363-7005
Electronic ISSN: 1867-0202
DOI
https://doi.org/10.1007/s12599-013-0286-0

Other articles of this Issue 5/2013

Business & Information Systems Engineering 5/2013 Go to the issue

Imprint

Imprint

Catchword

Makers

Editorial

Green IS

Premium Partner