Valuing the flexibility of investing in security process innovations

In this paper, we develop a decision model of a firm’s optimal strategy for investment in security process innovations (SPIs) when confronted with a sequence of malicious attacks. The model incorporates real options as a methodology to capture the flexibility embed ded in such investment decisions. SPIs, when seamlessly integrated with the organization’s overall business dynamics, induce organiza tional learning and provide the flexibility of switching to more suitable technologies as the environment of malicious attacks changes. The theoretical contribution of this paper is a mathematical model of the invest to learn and switching options generated upon early invest ment in flexible SPIs. The practical significance of the paper is the application of a binomial lattice model to approximate the continuous time model, resulting in an easy to use decision aid for managers. 2007 Elsevier B.V. All rights reserved.