We demonstrate how an auction model can be used in a traditional capital budgeting context to assign a value to the strategic advantage of long‐term forward contracts. Research in the field of industrial organization has pointed to the danger of ex post opportunistic bargaining as a motivation for the use of forward contracts in natural resources and manufactured products, but no operational procedure exists for estimating the value secured by these contracts. Arbitrage methods for valuing forward contracts assume a competitive market in which the factors creating the bargaining problem and motivating the use of long‐term contracts are not present. Use of the model is illustrated in the case of take‐or‐pay contracts for natural gas.

Over the last decade much attention has been focused upon strategic factors influencing corporate financing decisions, especially those relating to informational problems.The results of this research have primarily been suggestive--proposing possible explanations of phenomena, but not providing specific methods for incorporating the strategic factors into quantitative valuation techniques and models.Quantitative models of financial variables have primarily been developed for cases of perfect competition or similar special cases in which the strategic factors are not central.In this paper we provide a model in which the estimation of the value of strategic factors is the objective and for a relationship between prices across time which is at the center of finance theory.This paper develops the use of an auction model to value long-term forward contracts for the purchase of commodities.Recent theoretical and empirical research has emphasized the danger of ex-post opportunistic bargaining as a primary motivation for the use of long-term forward contracts in preference to a dependence upon spot markets.However, this literature has not developed an operational procedure for assessing the value to the firm of using a forward contract to eliminate this ex-post bargaining problem.Traditional arbitrage methods for valuing forward contracts sold on the organized exchanges ignore the bargaining problem, that is.they assume a competitive market in which the strategic factors creating the bargaining problem and motivating the use of long-term contracts are not present.We demonstrate how auction models can be used to assign a value to the strategic advantage of long-term contracts.This value is shown to depend primarily upon the number of potential buyers in the relevant market and the relation between the lower end of the range of reservation prices of these buyers and the fixed costs of installing the capacity to supply the commodity.Problems with assigning a value to the strategic advantage of long-term contracts are discussed and other important strategic features of long-term contracts which need to be valued are identified.RECEJVED1 .