INVESTOR VALUATION OF THE ABANDONMENT OPTION

We investigate whether investors price the option to abandon a firm at its exit value. Theory prices this real option as an American put wit h both a stochastic strike price (exit value) and a stochastic value o f the underlying security (the value of cash flows). The empirical imp lications are that firm value increases in exit value, after controlli ng for expected going-concern cash flows, and that more generalizable assets produce more abandonment option value. Using discounted earning s forecasts to proxy for expected cash flows and prior literature to c ategorize asset generalizability, we find strong support for the predi ctions of abandonment option theory.