A Little is Not Enough: How Flexibility Affects Resource Allocation and Outcomes

Abstract

This paper examines investment flexibility from a commitment perspective. Firms can choose to make investments while retaining the option to terminate them prior to completion. This flexibility can mitigate uncertainty about the investment present at the time of its initial funding. However, this flexibility can also detrimentally alter actions within the firm that are necessary for the investment’s success, such as whether scarce firm resources are allocated to the investment. This paper uses a simple model to hypothesize that in some cases flexibility can worsen investment outcomes relative to commitment by changing the level of allocated resources, despite the potential benefits of flexibility. This hypothesis is empirically tested in a dataset of new US television programs, comparing programs which receive commitment in the form of a straight to series orders with programs which are flexibility developed through a piloting process. This paper thus contributes to the growing literature exploring when firms should flexibly invest.