Real options as a component of the market value of stocks:: evidence from the Spanish Stock Market

This paper aims to examine how investors' expectations about the value of a firm's real options are reflected in the price of its stocks. If the real-option approach is correct, then the efficient-market hypothesis predicts that stock prices will reflect the available information relative to the real options held by firms and their ability to identify, acquire, maintain and exercise them. The role of investment irreversibility, operating and financial flexibility, business and geographical diversification, and size are examined as indicators of a firm's real option strategy. The empirical analysis of a panel of 101 companies listed on the Spanish Stock Exchange during the period 1991 - 1997 provides evidence consistent with predictions. The market value of the real option portfolio is significantly and positively related to business diversification, asset irreversibility and operating leverage, and negatively related to size. In addition,financial leverage and geographical diversification are not significantly related to our proxies for the market value of real options. These results are robust even after controlling for industry, and alternative measures of investment flexibility and business diversification.