A real options model for analysis of industrial R&D expenditures

Abstract

The objective of this paper is to develop the model that can be used to explain the amount of research and development (R&D) expenditures of large and mature companies. The research methodology is based on real options approach. We model companies’ R&D expenditures as payments for the real option, which is the right of a company to invest in real assets in the future, and therefore to ensure business development. The main result is a valuation model, which includes several relevant factors. While existing research papers apply real options approach mostly to the R&D projects of particular companies or within particular industries and situations, the current paper applies the corresponding methodology in general and aggregated setting. We hope that it will contribute to understanding of R&D intensity in large innovative companies.