Exploring the Usefulness of Real Options Theory for Foreign Affiliate Divestments: Real Abandonment Options’ Applications

Abstract

Scholars propose that future research on real options theory should shift attention away from option buying during the first investment stage and toward option execution after investment. Researchers maintain that it would be interesting to explore the circumstances under which investors decide to withdraw their investments, thereby exercising the option to abandon their investments. The present research seeks to fill the gap in the literature and investigate the applicability of real options theory when an organization enhances sustainability policies while focusing on disciplined capital allocation through exit strategies. With case study data on Natura &Co’s divestment strategy for the Body Shop in November 2023, a real options analysis revealed the method’s practical advantages and disadvantages. This paper investigates real options theory in the context of the divestments of foreign affiliates, providing unique viewpoints and enhancing the theory beyond previous knowledge while also increasing our understanding of the divestiture phenomenon. This study concludes with a review of this paper’s theoretical contributions to real options theory, the managerial and practical/social implications of real options applications in general, and the valuation methods of abandonment options in particular, shedding light on the potential of future research.

1. Introduction

In a recent publication, Sakhartov et al. (2024) asked “Are real options useful for management research?” Sakhartov et al. argued that the question rightfully raised by Adner and Levinthal (2004) twenty years ago in the Academy Management Review “was a graceful invitation to clarify the real options theory and to enrich it with considerations typical to management research” (Sakhartov et al. 2024, p. 1).

Furthermore, Tong and Li (2011) proposed that future research should redirect our focus from option buying at the initial investment stage to option execution at the post-investment stage. For example, it would be intriguing to investigate the circumstances under which investors decide to leave their investments (Tong and Li 2011) by exercising the option to abandon. The current research addresses this gap caused by a lack of empirical evidence or data by investigating the circumstances and international settings under which multinational firms choose to leave their investments in foreign affiliates by exercising the option to abandon.

Scholars have urged that additional research should be conducted on the practical use of real-world options (Reuer and Tong 2007; Driouchi and Bennett 2012). Capturing case study data on the actual use of real options analysis can assist researchers in understanding the method’s practical strengths and drawbacks. Furthermore, Adner and Levinthal (2004) and Reuer and Tong (2007) advocated for additional research on topics such as abandonment options. Despite these prospective advantages for further research on the applicability of real options theory, none of the empirical studies have examined real-world options (Ipsmiller et al. 2019). The current study fills a gap in the body of empirical research by conducting a quantitative examination of the application of the real option of abandoning using the Black–Scholes option pricing model, the Binominal Option Pricing Model, and the option of abandoning with changing strike prices and its impact on the option’s premium when a multinational corporation decides to divest oversea affiliates.

Damaraju et al. (2015) argued that, even though real options theory keeps being employed in the study of a variety of investment decisions under scenarios involving uncertainty, little research has explored the impact of this reasoning on divestment decisions—for example, the decision to divest business units (abandon the option). In this vein, this study aimed to investigate the applicability of real options theory to international business research when investors decide to exit their investments by exercising so-called put options, i.e., the option to abandon.

Research finds evidence that previous studies on the prediction of real options theory found that, when a business unit’s environment is uncertain, corporations are cautious about selling subsidiaries and prefer to keep their divestment options open (Zingales 1995; Damaraju et al. 2015). However, the present investigation has empirically contributed to real options theory and demonstrated that MNEs gain value by abandoning an option that would have resulted in considerable losses if left open.

More recent research on foreign affiliate divestments has shown that real options considerations can delay exit choices, even when affiliates perform poorly and under unclear macroeconomic conditions (Belderbos and Zou 2009; Damaraju 2008; Damaraju et al. 2015). In contrast, the findings of this study reveal that total divestments may be better than deferring options when the business environment is highly uncertain. As a result, the findings of this study oppose the assumptions which suggest that gradually implemented divestment is preferable to complete divestment in uncertain conditions (e.g., Huchzermeier and Loch 2001; Trigeorgis 1997; Damaraju et al. 2015).

This study posed two research questions. First, in what circumstances and international contexts do international corporations decide to leave their investment in foreign affiliates by exercising the option to abandon? Second, how is the premium of the option to abandon valued when an international corporation decides to divest foreign affiliates?

In answering these research questions, this study on real abandonment options makes various contributions to the field. The first is the empirical nature of the research. This paper presents a case study of a real-world strategic project in which abandonment options were exercised and analyzed. The second contribution is the interdisciplinary approach. After investigating the usefulness of real options theory for foreign affiliate divestments, this study identified a rich tapestry of research prospects in the intersection of international business, strategic management, and financial management, and proposed several hypotheses for future quantitative research.

The third contribution is a proposal to advance the methodology. In terms of the research methodology, this study proposes a hybrid research model that combines standard option pricing methods such as the BSOPM with the BOPM and real abandonment options with changing strike prices as a sophisticated methodology to improve the research’s accuracy and efficiency. In fact, incorporating changing strike prices introduces additional complexity into the option valuation process. However, the proposed model is needed for the risk management of MNEs because the ability to adjust the strike price provides greater flexibility in managing the option, allowing MNEs to have more nuanced decision making.

The rest of the current paper is organized as follows. This paper initially outlines real options theory and its application in investment decisions. Next, this paper explores the limited research on real options abandonment, including measurement methods, benefits, and drawbacks. Two theoretical propositions summarize a key literature review outcome. Next, this paper explores a case study on Natura &Co’s divestment strategy for the Body Shop in November 2023. Having applied the Black–Scholes option pricing model (BSOPM) and Binominal Option Pricing Method (BOPM) with changing strike prices, the value of this abandonment option has been measured. The key conclusions of this empirical research justify the theoretical propositions and are congruent with the theory of real options. A higher uncertainty in a foreign affiliate strategic setting may lead to a complete divestment (sell-off) strategy.

In other words, the paper’s empirical findings imply that, having exercised the real option to abandon that may have been incorporated in the strategic choice due to a highly uncertain context, an international corporation can add more value than by exercising deferral options. In conclusion, the paper discusses its theoretical contributions to real options theory, practical managerial implications for real options applications and abandonment option valuation, and potential avenues for future research.

2. Key Literature Review

2.1. Real Options Investment: Definition, Types, and Reasoning

Real options investments are defined as sequential, definitive investments carried out in uncertain circumstances (Dixit and Pindyck 1994). According to the concept, obtaining a real option on a strategically important opportunity allows enterprises to postpone investment until a significant percentage of the uncertainty surrounding the opportunity is resolved. After making an initial investment, management should shift its focus to other concerns and wait for a signal indicating whether it is time to begin harvesting or grow the initial investment (Adner and Levinthal 2004).

In numerous strategic settings, a comprehensive valuation of M&A deals is an essential strategic responsibility; practitioners often accomplish this with high accuracy using a thorough discounted free cash flow (DFCF) valuation and scenario-based analysis. However, in settings where significant uncertainty and managerial adaptability are involved, such as flexibility to change paths, move forward, or abandon, the value of such flexibility must be explicitly considered (Chevalier-Roignant and Trigeorgis 2011). This flexibility may allow for capitalizing on positive market developments or reducing the impact of negative changes in the marketplace, and thus affects strategic choices (Chevalier-Roignant and Trigeorgis 2011, p. 198).

Tong and Li (2011) stated that initial investments provide investors with the option to grow, delay, or abandon. The ability to abandon a “bad” investment is critical to the flexibility advantage, as seen in a sequential strategic acquisition of a target company, because downside risk can be contained by exercising the option to defer, or resources can be redirected to other, more promising projects by exercising the option to abandon (Tong and Li 2011; Sahlman 1990).

However, Adner and Levinthal (2004) argued that the problem of abandonment is exacerbated by the fact that most abandoned options for strategic opportunities lack a specific, extrinsic expiration time. Indeed, the problems of discontinuing a venture may be greater than those of initiating it (Adner and Levinthal 2004). How much longer can a corporation keep the abandonment option open?

2.2. Options for Abandoning: Argumentation

Conventionally, most expansion options are akin to long calls, whereas abandonment options and several switching options may be technically viewed as long puts (Mun 2002, p. 100; Damodaran 2005). Unlike most other real options, an abandonment option is a long-put option whose value on a large scale depends on the irreversibility of the real assets—as sunk costs increase, the exit option’s value decreases (Rivoli and Salorio 1996).

An abandonment option is sometimes regarded as a switching option, and, in such a way, management strives to look good, by keeping, often futilely, the project going despite its obvious deficiencies (Mun 2002, p. 245). Alternate names or sub-types of an option to abandon include the exit option (Schwartz and Trigeorgis 2004) and the disinvestment option (Mauboussin 1999). Therefore, the abandonment option provides the possibility to terminate a loss-bearing or criteria-failing undertaking (Mauboussin 1999).

Damaraju et al. (2015) argued that most real options scholars appear to have adopted the premise that divestment decisions—the exercise of so-called put options—can be analyzed using the same real options logic as investment decisions (Damaraju et al. 2015; Dixit and Pindyck 1994). However, according to Damaraju et al. (2015), while there is growing literature on the impact of real options logic on strategic investments, there is limited research on its implications for the option to abandon.

As doubt about future cash flows is clarified, investors may choose to abandon a corporation for its liquidation value. Berger et al. (1996) clarified that an abandonment option is the same as an American put option and is analogous to buying an insurance policy that pays out if the company performs below expectations.

Options are flexible not because they replace a stream of installments with a larger lump sum payment, but because the payment process can be canceled in the event of a poor outcome (Adner and Levinthal 2004). Abandonment is vital for lowering downside risk, which is a key component of real options investments.

However, Adner and Levinthal (2004) argued that flexibility in the pursuit of growth options can erode the flexibility related to abandonment options. Moreover, Adner and Levinthal (2004) ultimately maintained that any strategic investment in which precise abandonment circumstances cannot be established ex ante should not be considered a real option (McGrath et al. 2004).

However, imposing a strict time frame for exercising or abandoning the strategy increases the danger of quitting the project prematurely if the expected event occurs after the imposed date, or not exercising the option if the positive event comes “too early” (i.e., before the imposed date) (Zardkoohi 2004).

Zardkoohi (2004) argued that the primary rationale for investing in options is to enhance flexibility. Forecasting a certain date for exercising or abandoning an option diminishes the original flexibility for which the option was obtained. Adner and Levinthal’s (2004) assertion that real options without explicit dates for abandoning should not be called options is challenging to argue empirically.

Most business organizations possess rules and procedures, performance evaluation criteria, and other methods to prevent the systematic pursuit of failing strategies (Zardkoohi 2004). Some previous empirical studies have begun to investigate the implications of real options theory for divestment decisions.

For example, Alibeiki and Lotfaliei (2022) considered and applied a real abandonment option for Ford Motor Company and battery storage investments for electricity distribution networks. Borges et al. (2018) have shown that an application to calculate the real abandonment option for petroleum-producing fields can easily be used for project valuation under uncertainty. Fleten et al. (2017) have examined empirically the decisions to abandon existing production using information from 1,121 individual electric power generators located in the U.S. for the period 2001–2009.

Compernolle et al. (2014) demonstrated when the option to abandon innovative technology is considered regarding the adoption of an innovative groundwater remediation strategy. These findings align with the predictions of real options theory for divestments. In this vein, real options theory can provide valuable insights for international business (IB) research to understand the implications of international holding corporations’ decisions about whether to divest foreign affiliates in uncertain strategic settings.

Proposition 1. 

Real abandonment options can be applied in IB studies to provide a fair estimation of market value added when an international corporation divests foreign affiliates in the context of complex strategic settings.

2.3. Valuation of Options to Abandon: Simple Version and with Changing Strike Prices

The option to abandon is a put option, which has value if the underlying asset value (current market value) falls below the strike price (selling price) and earns value as the strike price rises. In contrast, a call option has no value if the asset value is less than the strike price, and its value increases as the strike price falls. According to Hull (2012), the Black–Scholes formula for the price of the put option at date T = 0 before maturity is given in Equation (1) as follows:

$$p=K e^{{-r}_{f}T} N\left(-d_2\right)-So N(-d_1)$$

(1)

where p is the price of the put option, and N(d) is the cumulative probability distribution for a variable that has a standard normal distribution with a mean of zero and a standard deviation of 1. The area under the standard normal density function from $-\mathrm{\infty }$ to d is the likelihood that a random draw from the standard normal distribution would have a value less than or equal to d. Therefore, an analyst gets that 0 ≤ N(d) ≤1 with N $(-\infty$) = 0, N(0) = ${\displaystyle \frac{1}{2}}$ and N$(+\infty$) = 1. The term $r_f$ is the continuously compounded risk-free rate of interest, and $d_1$ and $d_2$ satisfy Equations (2) and (3).

$$d_1={\displaystyle \frac{\mathrm{l}\mathrm{n}\left(\frac{So}{K}\right)+(r_f+\frac{{\sigma }^2}{2})T}{\sigma \surd T}}$$

(2)

$$d_2={\displaystyle \frac{\ln \left(\frac{So}{K}\right)+\left(r_f-\frac{{\sigma }^2}{2}\right)T}{\sigma \surd T}}$$

(3)

Here, σ is the volatility of the underlying asset, So is the price of the underlying assets at time zero, and e is a mathematical constant approximately equal to 2.71828, the base of the natural logarithm. A European put option with a strike price of K at maturity date T gives the right to sell underlying assets So at the strike price of K (Hull 2012, pp. 313–14). The Black–Scholes calculations are difficult because they rely on the geometric Brownian motion assumption for the underlying asset price. In this vein, the Black–Scholes option-pricing model is more accurate, but less intuitive for valuing real options than the binominal model (Čirjevskis 2021).

Virtually every investment has the option to be abandoned. This strategy is especially valuable where the net present value (NPV) is marginal but there is a large possibility of losses (Kodukula and Papudesu 2006). In this way, losses can be reduced by selling the affiliate’s business. A multinational corporation may have the option of abandoning an affiliate if the performance results do not meet the expectations of the headquarters. If abandoning the affiliate permits the headquarters to avoid more losses, the abandonment option may provide more value than the deferral option.

To put it simply, the contingent decision in this option is to forsake the affiliate if the projected reward (the underlying asset value) is less than the affiliate’s liquidation value or strike price. This option possesses the features of a put option. But how should a multinational corporation value the abandonment option? The current paper follows Kodukula and Papudesu’s (2006) methodological recommendations.

To value a put option, construct a binomial tree with one-step time intervals for one year and calculate asset values over the put option. The binominal option pricing lattice begins with So at the first node on the left and multiplies it by the up and down factors to obtain Sou and Sod, respectively, for the first step. Moving to the right, the binominal lattice follows an identical sequence for each node in the binomial tree until the final time-step. Each node’s top value represents its asset value as shown in Figure 1.

The option values must then be calculated at each node in the tree using backward induction. This calculation displays the option values (bottom italicized numbers) at each node of the binomial tree using backward induction. Each node shows the maximum value of abandonment versus continuation. At each node, an analyst can choose to either abandon the project for a liquidation value or keep the option open until it expires. In the final node Sou3, the expected asset value should be compared to the liquidation value of the foreign affiliate.

Because a multinational corporation wishes to maximize its return, an analyst would continue rather than exit the affiliate if the underlying value of assets exceeds the liquidation price or exercise the option if the opposite is true. It should then go to the intermediate nodes, which are one step further from the previous time-step. Starting at the top, calculate the asset value of node Sou2 to keep the option open, applying Formula (4) of the intermediate value that was recommended by Mun (2002, p. 157), as follows:

$$IV=\left[\left(p\right)up+\left(1-p\right)down\right]e^{-r_f∆T}$$

(4)

where IV is the intermediate value, p is risk-neutral probability, up is the value if the price goes up, down is the value if the price goes down, e is the base of the natural logarithm, $r_f$ is continuously compounded risk-free rate of interest, and $∆T$ is time increment (years).

This is the discounted (at the risk-free rate) weighted average of hypothetical future option prices with risk-neutral probability weights. As a result, the risk-neutral probability should be used to calculate the starting node’s value at time zero. The difference between the underlined asset value and the real option to abandon in the first node So is the market value added (put option premium) that the corporation achieves by exercising this option.

According to Kodukula and Papudesu (2006), valuing an abandonment option has major limitations. First, the liquidation value cannot be determined with absolute accuracy because it is the result of negotiations with a buyer. Second, the strike price (affiliate liquidation value) may fluctuate during the option’s life cycle. Changing strike prices is an important issue in a setting where affiliates might lose significant value over time owing to severe competition, outdated technology, a loss of demand, and other variables.

As a result, if there is any question about the liquidation value, an analyst can use sensitivity analysis with option Greeks (delta, vega, gamma, rho, and theta) that quantify the sensitivity of option prices to changes in underlying price, volatility, interest rate, and time to expiration, as demonstrated in the case study below. These Greeks collectively offer useful insights for risk management.

Furthermore, if the strike price changes over the life of the option, the changes can be easily integrated into the real option valuation during the backward induction process, as will be seen in the Body Shop’s Natura &Co disinvestment strategy case study. Despite the limitations of using the Binomial Option Pricing Model to value an option to abandon, this technique improves communication with practitioners by making calculations apparent and tactically flexible.

Thus, Proposition 2 is as follows:

Proposition 2. 

Real abandonment options exercised by international corporations by divesting foreign affiliates strategizing in complex settings are a strategic decision-making tool, being both an appropriate valuation technique of market value added by exercising a simple put option and a strategic “roadmap” observation by exercising a put option with changing strike prices.

To test the internal and external validity of the propositions, as well as to contribute to real options theory on an option to abandon, the following case study on the Natura &Co divestment strategy for the Body Shop in 2023 was analyzed and interpreted. This case study should help readers better understand the phenomenon of divestment decisions (Damaraju et al. 2015) in terms of the antecedents and consequences of divestments for firm performance.

3. Case Study of Natura &Co: Divestment of the Body Shop in November 2023

Natura &Co Holding SA sold the Body Shop to Aurelius, a global private equity organization, in November 2023 for £207 million ($254.32 million) (Araujo et al. 2023a). The deal was part of Natura’s consolidation plan following the $2.5 billion sale of Aesop to L’Oréal earlier in 2022 (Douglass 2023). What was driving this uncommon strategic restructuring deal?

Natura was founded in 1969 in Sao Paulo, Brazil, and has a strong product portfolio that includes soaps and moisturizers. It is known not only for cosmetics but also for its overall natural and sustainability theme, which has a high resonance in Brazil due to Natura’s constant striving for excellence and enhancing of sustainability practices (Choudhary 2023). The company expanded beyond Brazil and Latin America, sequentially acquiring the brand name of Aesop in 2012 and 2016 (Čirjevskis 2023) and carrying out the full acquisition of the Body Shop in 2017 and Avon in 2019 (Čirjevskis 2020).

The Body Shop (TBS) was started in Brighton in 1976, growing rapidly through a franchise model because of its ethical stances, which include refusing to offer animal-tested goods and obtaining natural components that are ethically handled. The company was sold to the French cosmetics corporation L’Oréal for £652 million in 2006. This transaction did not provide L’Oréal with any synergies (Čirjevskis 2020). When the Body Shop’s sales and earnings declined, L’Oréal sold it to Brazil’s Natura, which already owned Australian natural cosmetics brand Aesop (Butler and Davies 2024).

However, the true issue for Natura was the acquisition of Avon. In 2019, Natura paid $2 billion in shares for Avon. It was a relatively weak takeover (Choudhary 2023). The transaction was poorly timed, leaving Natura “with a hefty debt pile as the COVID-19 pandemic hit and then interest rates began to rise around the world” (Butler and Davies 2024, p. 1). Natura lost money for four quarters in a row over the year 2022. It lost $169.7 million in the fourth quarter of 2022, owing to lower revenues across all its business areas.

Natura’s top management stated that 2022 began on a rough note, with the company navigating a difficult macroeconomic situation that became worse with the Ukraine war along with “uncertainty surrounding the performance of a few business units after a post-pandemic change in consumer behavior” (Choudhary 2023, p. 1). In this vein, Natura opted to focus on its core Latin American market and pay off its debts by selling Aesop and the Body Shop, and Aurelius was one of the few bidders that came close to the asking price.

Natura &Co was now focused on disciplined capital allocation and deleveraging after agreeing to sell the Aesop brand to L’Oréal and the Body Shop to Aurelius (Araujo et al. 2023b). Thus, Natura &Co has exercised two viable exit strategies by selling Aesop and the Body Shop. As a result, the answer to the first research question—“In what circumstances and international contexts do international corporations choose to exit their investment in foreign affiliates by exercising the option to abandon?”—became evident.

The following section of the paper examines the application of a simple real option to abandon and a real option with changing strike prices in the context of the Body Shop’s disinvestment to answer the second research question—how to value the premium of the option to abandon when an international corporation decides to divest foreign affiliates—and to justify the theoretical propositions.

3.1. Measuring Real Options to Abandon with the Application of the BSOPM and BOPM

The Body Shop could be valuable to the buyer due to its brand awareness, global retail network, and established client base. Natura &Co could either continue doing business with the Body Shop affiliate or sell it to a strategic buyer for $254.32M (the liquidation value). The yearly volatility of the logarithmic returns of future cash flows is calculated to be 45.0%, with a continuous annual riskless interest rate of 11.61% for the next ten years. What is the value of the abandonment option?

Table 1. Inputs to put option valuation model: the Body Shop in November 2023.

Model Input	Estimated as	In General…	For the Body Shop	Source of Data
S	Market value of affiliate at the moment of liquidation	Discounted cash flow for the project	The Body Shop’s valuation in November 2023 was $258.83M	CBINSIGHTS (2024)
K	Liquidation price (selling price)	Capital expenditure of the project	Brazil’s Natura sold the Body Shop to Aurelius in a $254.32M deal	Araujo et al. (2023a)
σ	The volatility of the stock of headquarters within one week after the announcement of the deal.	Risk for assets of the project	Natura &Co GARCH volatility from 14–21 November 2023 was 45.0 percent	Dunis and Klein (2005), V-Lab (2023)
$r_f$	Risk-free rate of the country of the headquarters	Time value of the money	Brazil’s 10 y bond yield was 11.61 percent on 14 November 2023	Trade Economics (2024)
T	One year	Measures an annual value for flexibility	T = 1	Dunis and Klein (2005)

Source: Adopted from Damodaran (2012) and Vintila (2007) and extended by the author.

below summarizes the input data for valuing a put option using the BOPM and BSOPM.

First, a binomial lattice was created using Microsoft Office 2010 Excel tables, as illustrated in Figure 1, with two-month time intervals (ΔT is 0.17 of a year) for the following year, which establishes the market value and potential changes in the Body Shop’s value during the option’s life. The underlying lattice depicts the evolution of the underlying asset (S) over the life of the real option. However, before the underlying lattice can be produced, it must be determined how many discrete periods will be built—the number of time-steps. The number of time-steps is determined randomly based on the situation at hand. Mun (2002, pp. 153–54) observed that the binomial lattice approach unavoidably loses some precision in determining ROV; hence, with a small number of steps, the fundamental shortcoming of the binomial lattice approach becomes clear.

However, a shorter stepping time results in a lattice with greater granularity (more nodes). Lattices with increased granularity will produce more precise results, bringing them closer to the outcomes of a closed-form model, if appropriate (Kodukula and Papudesu 2006, p. 74). While Kodukula and Papudesu (2006, p. 96) state that, in ROV, four to six time-steps are typically sufficient for good approximations, the current study included six phases, each of which lasted about two months.

To address “a valuation” in the research question, the real options parameters were calculated, and the results are detailed in

Table 2. Real options binomial option pricing model parameters: Natura &Co divestiture of the Body Shop.

Parameters of the Binominal Tree	Numbers
Time increment (years) ΔT	0.17
$\mathrm{Up} \mathrm{factor} (u)=e^{\sigma \sqrt{∆T}}$	1.202
$\mathrm{Down} \mathrm{factor} (d)=d={\displaystyle \frac{1}{u}}$	0.832
Risk-neutral probability $(p)=p={\displaystyle \frac{e^{r_f∆T}-d}{u-d}}$	0.507

Source: Developed by the author, where e is the base of the natural logarithm, rf is continuously compounded risk-free rate of interest, and ∆T is time increment (years).

.

For the first step, the underlying lattice begins with node “A” at the first node on the left and multiplies it by the up and down factors to obtain node “B” ($258.83M × 1.202 = $311.03M) and node “C” ($258.83M × 0.832 = $215.39M). Moving to the right, repeat for each node in the binomial tree until the final time-step. Figure 2 depicts the top value at each node as the market value of TBS at that node.

Then, Figure 2 illustrates the option values (bottom italicized numbers) at each node of the binomial tree by using backward induction with the risk-neutral probability. Each node represents the value maximization of the abandonment versus continuation of TBS’s business. At every node, the lattice has the option to either abandon TBS’s business for a selling price of $254.32M or continue keeping the option open until it expires.

Beginning with the terminal nodes representing the last time-step, the binomial tree uses backward induction with the risk-neutral probability. TBS’s estimated asset value at node “V” is $779.34M, whereas its liquidation value is $254.32M. Natura would rather continue (green node) than abandon TBS (red node) since Natura seeks to maximize its value. Thus, the option value at this node is 779.34M (green). At node “Z”, the expected asset value of TBS is $179.34M, compared to the liquidation value of $254.32M; thus, it makes sense to sell off TBS and exercise the abandonment option (red), resulting in an option value of $254.32M at this node. Using the strike price as a liquidation price ($254.32M throughout the whole binomial tree), the option value for the Body Shop disinvestments is $31.43M.

The market capitalization of TBS is $258.83M, but the liquidation (selling) price is $254.32M, giving a relatively small loss of $4.51M. Real options analysis, however, shows a TBS value of $290.26, yielding an additional $31.43M ($290.26M minus $258.83M) due to the abandonment option. In other words, real options analysis shows that this strategic deal of selling TBS resulted in an expanded net present value (eNPV) of approximately $26.91M, namely, $31.42M plus a loss of $4.51M using Mun’s formula (Mun 2002, p. 168), where eNVP equals static (passive) NPV plus option value of managerial flexibility.

Second, the same option value was produced by using the Black–Scholes equation for this put option, which was calculated with DerivaGem 2.0 (Hull 2012), as shown in Figure 3. The abandonment option increased Natura &Co’s market value by $26.92 million.

As a result, the first theoretical proposition was justified by demonstrating that real abandonment options can be applied in IB studies when an international corporation divests foreign affiliates in the context of complex strategic settings. This also provides an answer to the second research question.

3.2. Measuring the Value of an Option to Abandon with a Changing Strike Price

As previously stated, adjusting strike prices is an essential concern in situations where affiliates may lose significant value over time, as occurred with the Body Shop when it was sold to Aurelius in November 2023. On 15 February 2024, Aurelius placed the Body Shop’s UK division in administration, a procedure under the insolvency laws of several common law jurisdictions, like bankruptcy in the United States, and hired a business advisory firm as administrators to help the company through the procedure (Butler and Davies 2024).

On 16 February 2024, only one day after the UK division declared bankruptcy, the Body Shop Germany entered administration and stated that all 60 stores would be closed within the next few months. That same day, the Body Shop appointed administrators for its Belgium, Ireland, Austria, Luxembourg, and France subsidiaries, all of which were scheduled to be placed under administration as early as the next week (Butler 2024).

Moreover, on 1 March 2024, Body Shop Canada filed for creditor protection and stated that it would halt online operations and close 33 of its 105 locations. On the same day, Body Shop USA closed all its locations and stopped operating online. On March 10, Body Shop USA filed a petition for bankruptcy under Chapter 7 liquidation. Thus, how does one value a put option (an option to abandon) when the strike price (affiliate liquidation value) varies throughout the option’s life cycle?

After analyzing the dropping revenues generated by the Body Shop worldwide from 2020 to 2022 (Statista 2024b) and the decreasing EBITDA of the Body Shop from 2019 to 2023 (Statista 2024a), it was assumed for the showcase that the market value would be reduced by 33% at every step of the options life cycle. In terms of the options life cycle, L’Oréal sold TBS to Brazilian beauty giant Natura for €1 billion in September 2017 (Butler 2017), then Natura sold it to Aurelius six years later in November 2023. In the same vein, the option life cycle was set at six years in this case.

Table 3. Option to abandon with varying strike prices. Input parameters: Natura &Co divestiture of the Body Shop.

Parameters of the Binominal Tree with a Changing Strike Price	Numbers
Time increment (years) ΔT	1.00
$\mathrm{Up} \mathrm{factor} (u)=e^{\sigma \sqrt{∆T}}$	1.568
$\mathrm{Down} \mathrm{factor} (d)=d={\displaystyle \frac{1}{u}}$	0.638
Risk-neutral probability $(p)=p={\displaystyle \frac{e^{r_f∆T}-d}{u-d}}$	0.522
So	$258.83M
T	Six years
K	$254.32M
K${∆T}_1$	$173.39M
K${∆T}_2$	$114.16M
K${∆T}_3$	$76.49M
K${∆T}_4$	$51.25M
K${∆T}_5$	$34.34M
K${∆T}_6$	$23.01M

Source: Developed by the author, where So is the price of the underlying assets at time zero, K is a strike price at maturity date T, and KΔT_n is a varying strike price, e is the base of the natural logarithm, rf is continuously compounded risk-free rate of interest, and ∆T is time increment (years).

summarizes the input parameters, as well as the u, d, and p values for this problem.

To solve this problem, first, a binomial tree representing the asset values was constructed as shown in Figure 4. The top values at each node of the tree depicted in Figure 4 represent asset values. However, instead of applying the same strike price of $254.32M to each node of the binomial lattice to determine the contingent decision, the strike price of $23.01M is applied for Year 6 at the end nodes, $34.34M is applied at the nodes for Year 5, $51.25M is applied at the nodes for Year 4, and so on.

For example, at node “AB”, the estimated asset value is $17.39M, compared to a liquidation value of $23.01M in Year 6. Because the liquidation value is higher, the choice will be made to abandon the business (red color). At node “U” for Year 5 (K${∆T}_5)$, the liquidation value is $34.34M (red color), which is compared to the projected asset value of TBS for keeping the option open, considering the downstream optimal decisions using Formula 4 as follows: [0.522 ($42.78M) + (1–0.522)($17.39M)] * exp(−0.1161)(1) = $27.28M. Because the liquidation value is higher, the node “U” is abandoning the project. Using different strike prices (liquidation prices) across the whole binomial tree, the option value for the Body Shop disinvestments is calculated to be $2.28M. Thus, real options analysis shows a TBS value of $261.11M, yielding an additional $2.28M ($261.11M–$258.83M) due to the abandonment option.

DerivaGem has provided the put option value with an unchanged strike of $48.53M. Therefore, if the strike price were $254.32M across the entire lattice, the option would be overvalued by $46M. Comparably even with an average strike price of $103.42M over the option’s entire period, the option would also be overvalued by $2.16M according to the BSOPM result. Thus, the BOPM approach not only allows for the incorporation of changing strike prices into the option solution but also makes it transparent for practitioners, unlike the other methods. As a result, the solution to the second research question has been presented, and the second theoretical proposition is justified.

4. Findings and Discussion

Despite the growing literature on the implications of real options logic for strategic investments, research on its implications for divestments is still in its early stages (Damaraju et al. 2015). Divestments can be understood as the exercise of put options (Dixit and Pindyck 1994). Previous empirical research has begun to investigate some of the implications of real options theory for divestment decisions. This research investigated the implications of real options theory for company divestiture decisions, strategizing in complex settings and empirically justified theoretical propositions that real options theory can be fruitfully explored in the context of divestment of affiliated companies abroad.

This research has contributed to real options theory as follows: Previous research on the predictions of real options theory stated that, when a business unit’s environment is uncertain, firms are hesitant to divest it and instead prefer to leave their divestiture options open (Zingales 1995; Damaraju et al. 2015). However, the current paper has evidenced that Natura has added value by abandoning the option and that significant losses would result if it were kept open.

More recent research on foreign affiliate divestments has indicated that real options considerations will lead to delayed exit decisions, even when affiliates perform poorly if macroeconomic conditions are unpredictable (Belderbos and Zou 2009; Damaraju 2008; Damaraju et al. 2015). In contrast, the findings of this study show that complete divestments may be preferable to defer options when the business environment is highly uncertain. As a result, the findings of this study also contrast with the predictions of real options theory, which states that incremental divestment will be preferred over complete divestment under uncertain circumstances (e.g., Huchzermeier and Loch 2001; Trigeorgis 1997; Damaraju et al. 2015).

5. Conclusions, Research Gaps Addressed, Limitations, and Future Work

Exploring real options theory in the context of divestments of foreign subsidiaries can lead to new perspectives and advance the theory beyond what is already known. In this vein, the research presented here makes important theoretical improvements as well as managerial and practical implications for furthering real options theory and extending our understanding of the phenomenon of divestments.

The current paper has shifted the research focus from initial investment to the post-investment stage and addressed several research gaps. The importance of this shift in the research focus is fourfold. First, previous research primarily focused on the initial investment stage of real options theory, neglecting the execution phase, particularly the option to abandon investments. This paper shifts the focus to the post-investment stage, specifically investigating the circumstances under which investors decide to withdraw their investments by exercising the option to abandon.

Second, there is a scarcity of empirical studies examining the practical application of real options theory in the context of divestments. This paper provides empirical evidence by analyzing Natura &Co’s divestment strategy for the Body Shop, demonstrating the practical advantages and disadvantages of real options analysis in real-world scenarios.

Third, having contributed to the limited research on the valuation methods for abandonment options, particularly with changing strike prices, this study advanced the methodology by proposing a hybrid model that combines the Black–Scholes Option Pricing Model (BSOPM) and the Binomial Option Pricing Model (BOPM) with changing strike prices, enhancing the accuracy and efficiency of abandonment option valuation.

Fourth, there has been insufficient exploration of how real options reasoning influences divestment decisions, especially under uncertain conditions. This paper empirically demonstrates that MNEs can gain value by exercising abandonment options, even in highly uncertain environments, challenging previous assumptions that deferral options are preferable.

Therefore, the current paper enhances real options theory by providing a deeper understanding of its applicability in divestment decisions. In addition, the study proposes new theoretical propositions that real abandonment options can be applied in international business studies to estimate market value added during divestments. When it comes to methodological advancement, the paper introduces a sophisticated hybrid model for valuing abandonment options, incorporating changing strike prices to reflect real-world complexities. Thus, having demonstrated the practical application of this model through a detailed case study, the paper provides a clear roadmap for future research and practice.

5.1. Managerial Implications

When it comes to managerial considerations, there is not much doubt that real options analysis fosters more insightful discussions among senior executives. In this vein, the current study provides a practical model of real options analyses and contributes to facilitating and enhancing decision-making processes and strategizing in complex settings. It aids in the discovery of additional value that traditional NPV methodologies do not fully recognize and, more importantly, it fosters a systematic conversation about the sources of risk and how a company intends to respond to those risks (Chevalier-Roignant and Trigeorgis 2011).

While an ordinary investment business case just outlines potential risks, real options analyses place a far greater focus on these risks, as well as the managerial flexibility to respond. Senior managers who have had limited training in real option methods frequently revert to familiar ways, notwithstanding the limitations these methods entail when dealing with specific scenarios (Chevalier-Roignant and Trigeorgis 2011, p. 200). Therefore, the hybrid model of real options analyses, as presented in the paper, appears to be a valuable tool for strategic management and international business research and practice, particularly in the context of divestitures.

The paper’s empirical findings can be stated as follows: by exercising the real put option (option to abandon), which may have been included in the strategic decision due to a highly uncertain context, an international corporation can add more value than by exercising a deferral option. Moreover, the application of real options to abandon with changing strike prices is often more realistic in real-world scenarios, as market conditions and project circumstances may evolve. This makes the proposed model more applicable to practical situations.

5.2. Practical and Social Implications

Driouchi and Bennett (2012) stated that only a small number of large corporations have heard of or used this approach. As a result, future empirical research could focus on strengthening the practicality of real options reasoning and making it more accessible to businesses and managers when making uncertainty-based decisions. An examination of the application of a simple real option to abandon and a real option with changing strike prices in the context of Natura &Co’s divestment of the Aesop brand in 2022 could also be a future research direction.

Managers can take numerous practical actions to integrate real options analysis into the decision-making process. First, they can invest in training programs to familiarize the team with real options analysis and its applications. Second, they can implement software tools that support real options analysis, such as DerivaGem or other financial modeling tools. Third, management can start with pilot projects to apply the methodologies in real-world scenarios, gradually scaling up as the team gains confidence and expertise. Fourth, managers can involve academic institutions to stay abreast of the latest research and incorporate cutting-edge methodologies into practice. By applying these findings, practitioners can make more informed, flexible, and strategic decisions, ultimately enhancing their organization’s performance and resilience in the face of uncertainty.

Regarding the social implications of this study and, particularly, findings on the United Nations SDGs’ good practices, the case study and real options abandonment analyses revealed how Natura &Co is improving sustainability practices by focusing on disciplined capital allocation. In this sense, there are a few potential avenues for future groundbreaking innovations in real options theory. The concept of sustainable investments can connect real options theory with sustainability. Therefore, developing real options models that incorporate environmental, social, and governance (ESG) concerns could be a promising research area that could assist corporations in making more sustainable investment decisions.

5.3. Opportunities for Future Research

Furthermore, to enrich the future of scientific literature with fresh theoretical contributions and professional implications, the author developed numerous hypotheses that might be tested in future quantitative research as follows: Null Hypothesis (H0): There is no significant relationship between the level of competition in the foreign market and the likelihood of an international corporation exercising the option to abandon. Alternative Hypothesis (H1): Foreign affiliates operating in highly competitive markets are more likely to be abandoned by international corporations. Thus, the answer to the first question of the study can be definitively clarified by quantitative research.

Regarding the answer to the second research question, the following hypotheses can be tested: Hypothesis 1: Null Hypothesis (H0): There is no significant difference in the premium of the option to abandon between foreign affiliates with high profitability and those with low profitability. Alternative Hypothesis (H1): Foreign affiliates with high profitability have a significantly higher premium associated with the option to abandon compared to those with low profitability. Hypothesis 2: Null Hypothesis (H0): There is no significant relationship between the volatility of the foreign affiliate’s market value and the premium of the option to abandon. Alternative Hypothesis (H1): The premium of the option to abandon a foreign affiliate is positively correlated with the volatility of its market value.

These hypotheses could be further refined based on specific research objectives and the availability of relevant data. Quantitative research methods, such as regression analysis and/or option pricing models, could be employed to test these hypotheses and estimate the premium of the option to abandon. Therefore, future studies could contribute by carrying out a more systematic examination of the existing research on this issue as well as investigating how and why real options logic is (or is not) employed in IB practice.