Optimal Risk Adoption and Capacity Investment in Technological Innovations

Abstract

Technological innovations often formulate new market regimes and create incentives to abandon existing, less attractive ones. However, this decision depends not only on market forces, such as economic and technological uncertainty, but also on attitudes toward risk. Although greater risk aversion typically raises the incentive to postpone investment, the impact of risk aversion becomes more complex when a firm has discretion over both the timing and the size of a project. We develop a utility-based regime-switching framework in order to analyze how a firm with discretion over investment timing and project scale may choose to abandon an existing market regime to enter a new one. Results indicate that greater risk aversion hastens investment in an existing regime by decreasing the amount of installed capacity, but delays its abandonment, thereby hindering the transition to a new one. In contrast, greater demand uncertainty in the new market regime raises the value of the investment opportunity and, in turn, the incentive to abandon the existing regime. Furthermore, we find that uncertainty over the arrival of a technological innovation may accelerate investment in the existing regime and reduce the relative loss in project value in the absence of managerial discretion over project scale.

Timing and green decisions for competitive manufacturers under demand uncertainty and risk aversion

“…De Giovanni and Iakimova (2022) study the joint effects of uncertainty, competition, and risk preferences on the optimal timing and capacity of firms in a duopoly market. Sendstad et al (2022) analyze how technological and demand uncertainty interacts with firms' attitudes towards risk and influences firms' decisions to abandon the existing market regime in order to enter the new one.…”

Tripartite Evolutionary Game Analysis of Participants’ Behaviors in Technological Innovation of Mega Construction Projects under Risk Orientation

“…The risk perceived loss coefficient is 1 if all participants choose the simple cooperation strategy. The rest of the cases are described by setting discount coefficients of the risk perception loss [51]. Risk and benefit are inversely proportional, and the presence of risk will lead to the reduction of the participants' benefits [52].…”