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The Impact of Time-to-Build on Strategic Investment Under Uncertainty

This study explores how time-to-build influences strategic investment decisions under uncertainty. It investigates various equilibrium states, such as delay and incremental Cournot equilibria, demonstrating that the magnitude of uncertainty shapes investment behavior. Notably, the presence of time-to-build alters the trade-off between commitment and flexibility, affecting firms' responses to uncertainty. The findings highlight that a longer time-to-build leads to a decrease in social welfare and changes in the price premium dynamics. This research links investment timing models to product price evolution and reveals novel equilibrium outcomes.

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The Impact of Time-to-Build on Strategic Investment Under Uncertainty

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  1. Pacheco de Almeida, Goncalo and Peter Zemsky (2003). The effect of time-to-build on strategic investment under uncertainty. Rand Journal of Economics, 34 (1): 167-183. Presented by Jiyoon Chung

  2. Overview • Research question: Does time-to-build matter for the theory of strategic investment under uncertainty? • Model • Equilibrium analysis • Comparative statics • Conclusion

  3. Model A firm maximizes a weighted average of its expected period-II and –III revenues less the expected cost of investment.

  4. Equilibrium Analysis • Equilibrium Typology • Delay equilibrium: Both firms wait to invest. • Incremental Cournot equilibrium: Both firms make the same incremental investment. • Commit-delay equilibrium: One of the firms commits while the other delays investment. • Commit-incremental equilibrium: One of the firms commits, while the other makes an incremental investment.

  5. Equilibrium Analysis • The magnitude of uncertainty determines which equilibrium exists. Without time-to-build, • If uncertainty great  Delay • If uncertainty low  Commit-delay • With time-to-build, an initial price premium exists • The tradeoff between commitment and flexibility is altered • If short time-to-build and low uncertainty  Commit-incremental • If long time-to-build and low uncertainty  Incremental Cournot

  6. Comparative Statics • If time-to-build increases, • Social welfare decreases • The extent to which firms exploit the option to wait decreases • The price premium decreases

  7. Conclusion • For a sufficiently long time-to-build or sufficiently small uncertainty, Incremental Cournot is the unique equilibrium • Introducing time-to-build • Shifts (non-monotonically) the classic tradeoff between commitment and exploiting the option to wait • Gives rise to novel types of equilibria where firms make incremental investments • Links models of investment timing to the evolution of product prices

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