Analysis of the investment and disinvestment behavior

Investment and disinvestment, in the sense of long-term acquisition and abandonment of assets, usually represent fundamental decisions, which often involve uncertainty regarding future returns and tradeoffs between current and future realization of the investment or disinvestment for both decision makers in developed and developing countries (Hill 2010b;

Sandri et al. 2010). The classical investment theory that is based on the net present value (NPV) criterion implies that a decision maker undertakes an investment if its expected present value exceeds the expected costs and if its NPV is positive (Jorgenson 1963; Tobin 1969). However, the weakness of the NPV criterion is that it often is not suitable for analyzing agro-economic investment and disinvestment decisions, which are regularly characterized by uncertainty, temporal flexibility, and irreversibility (Dixit and Pindyck 1994; Trigeorgis 1996). The real options approach (ROA), also referred to as the new investment theory, extends the classical NPV approach to explicitly account for uncertainty, flexibility, and irreversibility in investment decision making (Dixit and Pindyck 1994). Specifically, the ROA asserts that an investor may increase its profits by postponing an irreversible investment decision, even if the expected net present value of the returns exceeds the investment costs. Similarly, it may be optimal to postpone an irreversible disinvestment decision, even if the expected present value of the returns falls below the salvage value. According to the ROA, the value of an investment is referred to as ‘options value’ and consists of the intrinsic value, which is equal to the NPV, and the value of waiting (Trigeorgis 1996, p. 124). The idea of the ‘options value’ has been widely accepted in the investment literature since the seminal work of Dixit and Pindyck (1994).

That is, deferring the decision to invest and disinvest has a positive value because new information about the expected present value of the returns arrives in subsequent periods.

In contrast to the NPV criterion, the optimal investment trigger is shifted upwards and the optimal disinvestment trigger is shifted downwards in the case of the ROA. The reason is that the opportunity to postpone the investment and disinvestment decision causes opportunity costs that have to be covered by the expected returns. Hence, the ROA has been discussed as a possible alternative or an additional explanation for economic inertia (Abel and Eberly 1994; Dixit and Pindyck 1994). In this context, the ROA also has been examined with regard to the effect of policy interventions, in particular the effect of a price floor policy, which is often used to stimulate investment, on the investment behavior (Dixit and Pindyck 1994).

A rich literature exists on normative and econometric analyses of investment and disinvestment problems in an agricultural context using the ROA. Some normative applications include Purvis et al. (1995), Winter-Nelson and Amegbeto (1998), and Luong and Tauer (2006), but these applications merely indicate the explanatory potential of the ROA for observed economic inertia. Some studies provide empirical evidence for the

validity of the ROA using econometric approaches based on field data (e.g., Richards and Green 2003; Wossink and Gardebroek 2006; Hill 2010b). However, an empirical validation of real options models explaining investment and disinvestment behavior is difficult for several reasons. For example, predictions of the ROA usually refer to investment and disinvestment triggers, which are not directly observable (Odening et al.

2005). Furthermore, besides options effects, multiple investment options may coexist or financial constraints and risk aversion may affect the decision behavior (Huettel et al.

2010). In regard to these difficulties, it seems reasonable to use experimental methods for the validation of the ROA. The advantage of using experiments is that it allows observing individuals’ actual decision behavior in a controlled environment and the elicitation of otherwise unobservable variables, which improves the internal validity (Harrison and List 2004; Roe and Just 2009). The experimental investigation of the ROA is still in its early stages. There are few studies that use experimental methods in examining the ROA in the field of economics, which have been conducted with convenience samples of students or entrepreneurs in developed countries (Rauchs and Willinger 1996; Yavas and Sirmans 2005; Oprea et al. 2009; Sandri et al. 2010). However, there are only few experimental studies on the ROA in the field of agricultural economics, which have been conducted with agricultural entrepreneurs in a developed country (Maart-Noelck and Musshoff 2013;

Musshoff et al. 2013). These studies often come to different conclusions regarding the explanatory power of the ROA and thus, require further investigation. Furthermore, to the best of our knowledge, there are no experimental studies examining the ROA and the effect of policy measures, such as price floors on the investment behavior of decision makers in developing countries. A few attempts have been made to examine the impact of price support systems on investment in theoretical and empirical applications, but these studies provide conflicting results (Chavas 1994; Dixit and Pindyck 1994; Chavas and Kim 2004; Sckokai and Moro 2009; Patlolla et al. 2012). Thus, it is crucial to investigate if or under which conditions price support systems have an effect on the investment behavior.

In the light of the above, the first paper titled ‘Does Timing Matters? A Real Options Experiment to Farmers’ Investment and Disinvestment Behaviours’ and the second paper titled ‘Investment Behavior of Ugandan Smallholder Farmers: An Experimental Analysis’

of the dissertation seek to analyze the predictive potential of the ROA and the NPV approach to account for farmers’ investment and disinvestment behavior. In both papers, the experimental setting simulates a problem of optimal stopping, stylizing an option to

invest and disinvest in a project. The observed investment and disinvestment decisions during the incentive-compatible experiments are contrasted with normative benchmarks from the ROA and the NPV. The analysis of the two papers is similar, which may allow for a comparison of the studies. The two papers specifically differ in the framing of the experiment, the pool of subjects and sample size, the design and implementation of the experiment, as well as in the selected parameter values. For example, the first paper focuses on investment and disinvestment decisions in an agricultural context, whereas the second paper deals with investment decisions in a non-agricultural context with and without the presence of a price floor. Furthermore, in the first paper, the experiment was computer-based and conducted with a sample of German farmers, while in the second paper, the experiment was paper-based and conducted with a sample of Ugandan smallholder farmers.