Abstract
Though widely accepted in psychology, the Sunk Cost Effect (SCE) finds little support from recent evidence in economics. The SCE is when individuals continue along an unprofitable course because of resources expended. The present study employs an abstract laboratory setting with a simple optimal decision rule and repeated decisions to estimate the SCE. The unique design, modeled after penny auctions, allows subjects to endogenously accumulate sunk costs, which psychologists claim is an important component. I find evidence that sunk costs increase one’s willingness to continue along an unprofitable course of action by 21.9%. Subjects do not learn to ignore sunk costs. Reference-based theories provide an alternative mechanism for SCE behavior. Though I find evidence against Realization Utility, reference points explain observed behavior better than sunk costs do. This draws into question whether there is a need for a separate SCE or if the Effect is only a special case of Prospect Theory. Proposed potential mediators are responsibility for sunk costs, gain/loss domain of the choice, profitability of the action, and time between sinking costs and taking action.
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