Essays on Emerging Applied Methodologies for the Valuation of Technology

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Essays on Emerging Applied Methodologies for the
Valuation of Technology

• PhD Summer Project
• Suvankar Ghosh

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3 Essays

• An Adoption Decision Model for Emerging Capital
  Budgeting Methodologies
• A Real Options Approach to Enterprise Integration
  Investments
• A Nested Options Model for Cellular Manufacturing
• Todays Talk is Mainly About Paper 1

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Status of the Essays
Essay Status Future Work
An Adoption Decision Model for Emerging Capital Budgeting Methodologies Appeared in 2006 Annual Decision Sciences Institute Conference Being continuously improved to make it journal ready
A Real Options Approach to Enterprise Integration Investments Practitioner version of this article exists Substantial work remains to make it suitable for an academic journal
A Nested Options Model for Cellular Manufacturing Accepted for publication in 2007 Proceedings of the Annual DSI Conference Substantial additional research needs to be done. So far only a conceptual model
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Overview of Adoption Model Paper

• Build a theoretical model for the acceptance by
  industry of new capital budgeting methodologies
  such as Real Options Analysis (RO) and Economic
  Value Added (EVA)
• Key model constructs
• Perception of theoretical soundness
• Perception of practical applicability
• Methodology Adoption Model is analogous to TAM
• Formulate measures of the sentiment of academic
  and practitioner communities. Sentiments are
  computed by scoring academic and practitioner
  articles
• Propositions of Methodology Acceptance Model
  (MADM) and empirical sentiment data to conclude
  if EVA or RO is more likely to be embraced

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Motivation

• Businesses are unhappy with the tools they have
  to measure their investments in IT or
  manufacturing technology
• Historical methodologies for appraising capital
  investments have major shortcomings
• Net Present Value (NPV)
• Internal Rate of Return (IRR
• Return on Investment (ROI)
• Payback Period
• Companies are turning to new approaches such as
  EVA and RO

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Two New Methodologies

• EVA Economic Value Added
• Originated in the industry
• Popularized by Stern-Stewart
• Real Options Analysis (RO)
• Originated in the Black-Scholes theory of pricing
  of financial options
• Applied to the pricing of real assets
• Both EVA and RO have been around since the 1990s
• Applied to appraising capital investments in many
  industries
• biotech, oil and gas, telecommunications

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EVA Basic Definitions

• EVA NOPAT COC
• NOPAT is Net Operating Profit After Tax
• COC is the Cost of all Capital

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Real Options

• Based on the application of the classic
  Black-Scholes options pricing model to real
  assets
• An investment opportunity is an option on an
  underlying asset

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Methodology Acceptance Decision Model (MADM)

Theoretical Soundness of Methodology
Attitude to Methodology
Likelihood of Acceptance
Practical Applicability of Methodology
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Key Lemma on Relative Acceptance Likelihood

• Methodology A has greater likelihood of adoption
  than methodology B if A is superior to B in one
  of the two dimensions of theoretical soundness
  and practical applicability and at least as good
  as B in the other dimension.

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Operationalizing the Model

• Define proxy variables for the constructs of
  Theoretical Soundness and Practical Applicability
• Sentiment of the academic community as expressed
  in publications in academic literature is the
  proxy for theoretical soundness
• Sentiment of the practitioner community as
  expressed in practitioner literature is proxy for
  practical applicability
• Score the academic and practitioner article
  depending on whether they are favorable or
  unfavorable to the methodology
• 3 Very Favorable, 2 Favorable, 1 Partly
  Favorable, 0 Neutral, -1 Partly Unfavorable, -2
  Unfavorable, -3 Very Unfavorable

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Sample

• Sample academic and practitioner articles on EVA
  and ReOA from 1992 to 2005
• 25 sample of the 56 quarters in 1992-2005
• Sample drawn from EBSCO electronic databases --
  a major vendor of information services
• Business Source Premier 1,100 peer-reviewed
  business journals
• Academic Search Premier 3,600 peer-reviewed
  journals
• Total of 87 articles on EVA and ReOA which were
  content-analyzed and scored

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Data Analysis

• A two-element vector of sentiment based on
  article scores for each methodology
• 14 instances of the sentiment vector for ReOA and
  EVA
• Perform MANOVA analysis to test various
  hypotheses about the interest levels in ReOA and
  EVA

Academic Sentiment Practitioner Sentiment
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Results

• Manova Omnibus test
• H1 There is no difference between ReOA and EVA
  in the overall sentiment considering both
  academic and practitioner sentiment
• Result Hypothesis was easily rejected at a0.05
  Wilks Lamda was 18.62 with p-value of less than
  0.0001
• Univariate Protected F tests
• H2 There is no difference in the academic
  sentiment between EVA and ReOA
• Result We cannot reject this hypothesis at
  a0.05. F-value is 1.59 with p-value of 0.218

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Results (cont.)

• H3 There is no difference in the practitioner
  sentiment between EVA and ReOA
• Result Hypothesis is rejected at a0.05, F-value
  is 32.11 with p-value of less than 0.0001
• Overall Findings from Analysis of Sentiment
• There is a difference in the overall sentiment
  between EVA and ReOA, and the practitioner
  community is the driver of this difference

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Conclusions

• EVA appears to have a better likelihood of
  adoption compared to RO. Also it appears as
  practitioner interest in EVA increases, that is
  fostering an acceleration of academic interest in
  EVA
• Firms should first adopt EVA and then RO
• Migrating to EVA-based financial system however
  is not easy
• Implementation challenges can be formidable
• Could lead to losing sight of other critical
  elements to survival like cash flow
• Critical success factors include management
  commitment, effective corporate governance
  system, and comprehensive training
• EVA training programs are not cheap and can cost
  anywhere from 250,000 to 1M depending on size
  of company
• RO bears watching. Efforts underway to simplify
  RO for practitioners such as making it more
  NPV-like in how its is operationalized (Feinstein
  and Lander, 2002)