Corporate growth opportunities and capital structure of emerging firms: Theory and empirical evidence

If firms are viewed as portfolios of real investment opportunities, then the most successful are those with access to the most lucrative projects. However, real growth options are not endowed on companies but are instead acquired through competitive investments. Rather than assuming an exogenously specified distribution of positive net present value projects across firms, this dissertation examines the process of allocation of investment opportunities across firms by modeling basic R&D investment. In my model, a firm gains access to productive technology by successfully completing basic R&D projects before its competitors, thereby procuring patent protection to guarantee indefinite flows of monopoly rents. The valuation of growth opportunities that a firm acquires by being first in making a breakthrough innovation and introducing a new product into the market is modeled as a compound real option. In my model, the firm uses its level of basic R&D investment strategically to impact the speed of innovation.; In order for the firm to generate expected benefits by the time of discovery, it must exercise the real option by paying the manufacturing costs, the strike price of the option, which are unknown a priori. Both project value and the exercise price are considered stochastic. The existence of competition lowers the expected time of discovery.; The model determines that growth opportunities are a function of R&D outlays of the firm and its rivals; the expected manufacturing capital and the cost of hedging its volatility; the risk-free rate of interest; the expected monopoly rents and its volatility; the conditional probability of innovation; the correlation between capital expenditures and R&D project value; and advertising spending.; I apply the "excess market value" approach in estimating growth opportunities. The empirical study analyzes a sample of 208 publicly traded U.S. companies of which 107 are emerging and 101 are well established firms, over the period 1987 to 1993. A company is defined as emerging if it has never issued any cash dividends.; Emerging firms are found to be more reliant on internal capital markets, in high R&D industries, less concentrated, more volatile with less free cash flow and greater growth opportunities. R&D has positive and significant impact on growth opportunities. However, when controlled for other variables, R&D of mature firms are found to be significantly negative. I suggest this may reflect investors' preference for mature firms to purchase ready technology rather than engage in risky basic R&D investments during the sample period. I find that emerging firms have lower debt ratio, but this difference is not significant. There is evidence that surprises in capital expenditures have a negative impact on growth opportunities for emerging firms but not for mature firms.