TAILIEUCHUNG - Real Options in practice Chapter 8

CHAPTER 8 Managing Relationships with Real Options. As much as the real option framework requires an organizational mindset and culture to flourish, equally it also drives and changes managerial and organizational behavior. In its most simple form, contracts and agreements with embedded real options may be designed to spur certain behaviors while penalizing others. | Managing Relationships with Real Options As much as the real option framework requires an organizational mindset and culture to flourish equally it also drives and changes managerial and organizational behavior. In its most simple form contracts and agreements with embedded real options may be designed to spur certain behaviors while penalizing others. A point in case is the bidding auction for the Antamina The Peruvian government had set up an auction whereby participants were asked to submit bids for the right to explore the mine as well as for the planned expenditures to develop the mine following a two-year exploration period. Figure provides a cursory outline. The auction design incorporated embedded real options namely the option to defer the decision to commit mine exploration until after a two-year 30 penalty FIGURE The strategic options in the Antamina mine auction 263 264 REAL OPTIONS IN PRACTICE exploration period nodes 2 3 a novelty in the mining industry. Traditionally mining auctions imply a bidding process for the upfront fee that entitles the winner to the right but not the obligation to explore the mine a scenario that led to one of the first real option The rules proposed by the Peruvian government instead asked bidders to bid for both the option premium that is acquisition of the right to explore node 1 as well as the exercise price that would lead to acquisition of the best-case scenario node 5 . This auction structure produced very specific incentives designed to induce certain behavior among the bidders. First of all it created a strong motivation for bidders to propose high investments for the actual mine development the exercise price of the second stage of the compound option. Thereby however the layout of the bidding process also increased the probability that the option will move out of the money in the second stage and that the project will be abandoned by the successful bidder at node 4. However the .

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