Incorporating Knowledge Building in Real Options Analysis of Technology Project Investment

Real options theory has provided a useful framework for technology investment decision making. Researchers in this area have emphasized the importance of considering the option-like characteristics of IT investment projects. However, unlike financial options, investment in IT projects is typically irreversible: such investment cannot be recovered for other purposes without very costly rework. The objective of our work is to study the effects of knowledge building on the valuation of real options by using a continuous-time stochastic model. To our knowledge, this is the first model that formally builds a linkage between proactive learning and investment cost and examines the consequences of this linkage on the management of real options. Our main finding is that knowledge building can expedite the adoption of new technology and significantly enhance the value of technology options.