Strategic Real Options∗

I introduce a strategic seller to a standard model of real options. A privately informed seller, such as a startup, tries to court a forward-looking buyer, such as a venture capitalist. The buyer learns gradually about the seller’s quality, high or low, through exogenous news and can “adopt” the seller at any time. The seller pays a flow cost but can exit or privately upgrade its quality at any time. I discover two novel kinds of reputational dynamics in equilibrium: a resetting barrier, where low types upgrade at low states inducing discrete upward jumps in reputation, and skew Brownian motion, where low types exit continuously at intermediate states, creating a permeable barrier for reputation. Contrary to the classic lemons result, the seller prefers this private information environment to one with symmetric information. The rich strategic interaction between the buyer and seller implies, somewhat surprisingly, that players may benefit from increases in their own cost parameters. Other applications of the model include political lobbying, dating, job search and higher education.