Capital Budgeting and Escalation of Commitment

ABSTRACT: This study uses experimental methods to explore whether incorporating real options into net present value analysis can reduce escalation of commitment, or the tendency of decision makers to continue to commit resources to a project after receiving negative feedback. This reduction in escalation behavior should occur because the incorporation of real options offers the user greater cognitive accessibility to the possibility of project abandonment. Findings indicate that users of real options exhibit less escalation of commitment than do users of net present value analysis alone. The main result demonstrates that the use of real options in capital budgeting can affect the behavior and decisions of the user even in an experimental setting that controls for the informational advantage of using real options.

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The Effects of Hurdle Rates on the Level of Escalation of Commitment in Capital Budgeting

Behavioral Research in Accounting ◽

10.2308/bria.2003.15.1.63 ◽

2003 ◽

Vol 15 (1) ◽

pp. 63-85 ◽

Cited By ~ 33

Author(s):

Mandy M. Cheng ◽

Axel K-D. Schulz ◽

Peter F. Luckett ◽

Peter Booth

Keyword(s):

Potential Problem ◽

Control Mechanism ◽

Capital Budgeting ◽

Effective Control ◽

Control System Design ◽

Escalation Of Commitment ◽

Use Of Self ◽

Investment Portfolio ◽

Average Return ◽

Hurdle Rates

This study proposes that organizations should consider project hurdle rates, as part of their control system design, to reduce escalation of commitment behavior in managers. In particular, we empirically examined the escalation of commitment tendencies in managers receiving organization-set, self-set, and no hurdle rates. Consistent with prior expectations, we found self-set hurdle rates to be an effective control mechanism resulting in significantly lower levels of escalation of commitment. Contrary to expectations, however, organization-set hurdle rates were not effective. Self-set hurdle rates also resulted in significantly higher cut-off rates compared to the average return of the investment portfolio held by the managers. As escalation of commitment has been recognized as a serious potential problem in organizations, the use of self-set hurdle rates is a step toward reducing the level of escalation tendencies in managers.

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Escalation of Commitment: Supporting Role from Accountants

SRIWIJAYA INTERNATIONAL JOURNAL OF DYNAMIC ECONOMICS AND BUSINESS ◽

10.29259/sijdeb.v4i2.87-94 ◽

2021 ◽

Vol 4 (2) ◽

pp. 87

Author(s):

Agil Novriansa ◽

Ahmad Subeki ◽

Aryanto Aryanto

Keyword(s):

Decision Making ◽

Undergraduate Students ◽

Investment Decision ◽

Investment Project ◽

Capital Budgeting ◽

Sunk Costs ◽

Financial Accounting ◽

Escalation Of Commitment ◽

Sunk Cost ◽

Investment Decision Making

Previous research has mostly examined the phenomenon of escalation of commitment in the context of decision making by managers in an investment project. However, in the capital budgeting process, before making investment decisions managers tend to consider information produced by accountants. This study examines the phenomenon of escalation of commitment using the perspective of supporting role of accountants as the party that provides information for investment decision making by managers, especially in the presence of sunk costs. This study uses a laboratory experimental method. The sample in this study are 156 undergraduate students majoring in Accounting who had passed Financial Accounting and Management Accounting courses. Based on the results of the independent sample t-test, it shows that accountants who experienced sunk cost conditions tend to provide reports that directed managers towards escalation of commitment behavior compared to accountants who do not experience sunk cost conditions. The presence of sunk cost makes accountants have better mind frame to get the possibility of profit compared with a definite loss so that the decisions they make tend to provide reports that lead to the escalation of commitment behavior.

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Effective use of capital budgeting tools

Business Horizons ◽

10.1016/s0007-6813(75)80008-5 ◽

1975 ◽

Vol 19 (5) ◽

pp. 57-65 ◽

Cited By ~ 7

Author(s):

G PETRY

Keyword(s):

Capital Budgeting ◽

Effective Use

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Process Accountability as a De-Escalation Technique

Journal of Personnel Psychology ◽

10.1027/1866-5888/a000245 ◽

2020 ◽

Vol 19 (2) ◽

pp. 63-74

Author(s):

Klaus Moser ◽

Hans-Georg Wolff ◽

Roman Soucek

Keyword(s):

Cognitive Processes ◽

Information Search ◽

Employment Relationship ◽

Escalation Of Commitment ◽

Tunnel Vision ◽

Course Of Action ◽

Performance Problems ◽

Over Time ◽

Biased Information

Abstract. Escalation of commitment occurs when a course of action is continued despite repeated drawbacks (e.g., maintaining an employment relationship despite severe performance problems). We analyze process accountability (PA) as a de-escalation technique that helps to discontinue a failing course of action and show how time moderates both the behavioral and cognitive processes involved: (1) Because sound decisions should be based on (hopefully unbiased) information search, which requires time to gather, the effect of PA on de-escalation increases over time. (2) Because continuing information search creates behavioral commitment, the debiasing effect of PA on information search diminishes over time. (3) Consistent with the tunnel vision notion, the effects of less biased information search on de-escalation decrease over time.

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