Resources, Real Options and Corporate Strategy

A ̄rm's resources are di±cult to identify and imitate. Firms learn about their resources by undertaking real investments and observing the outcomes. The types of real investments a ̄rm will make depends on what the ̄rm is expected to learn from the outcomes of these investments and the real options that are available for it to exploit in the future. We predict that ̄rms will follow a life-cycle in which they specialize when young, diversify after some time and then either expand into a large diversi ̄ed ̄rm or focus and specialize. We explain why similar investment opportunities are valued di®erently by ̄rms, o®er a possible explanation for the well-documented diversi ̄cation discount, and characterize the heterogeneity in corporate investment behavior and in the market price reaction of ̄rms' traded securities to signals of ̄rm performance. ¤Address all correspondence to either author at The Anderson School at UCLA, 110 Westwood Plaza, Los Angeles, CA 90095-1481; phone: (310) 825-2198 (Tony) or (310) 825-5883 (Bhagwan); fax: (310) 206-5455; e-mail: [email protected] or [email protected]. We thank Michael Brennan, Matthias Kahl, Steve Lippman, Steve Postrel, Richard Rumelt, Eduardo Schwartz, Avanidhar Subrahmanyam, Lenos Trigeorgis, David Wessels, and seminar participants at the Real Options Conference at Northwestern University, the AFA meetings in New York, the Texas Finance Conference, University of Arizona and University of Michigan for many useful comments.