Financial Budgets and Escalation Effects

Abstract

Escalation effects are instances in which a decision maker continues to commit resources to a losing course of action, solely because prior resource allocations have been made. The research described in this article examined the potential influence of financial budgets on such escalation effects. Determining such influences is important for a variety of reasons, including the prevalence of budgets in almost all real-world organizations where escalation effects would, in principle, significantly compromise the organizations' welfare. The results of five studies employing undergraduates and part-time master's degree students with working experience demonstrated the following: (a) the mere existence of financial budgets does not in and of itself affect the incidence of escalation effects; (b) escalation effects occur among experienced participants even when explicit future costs and benefits are provided; (c) the prospect that making additional investments to escalate commitment to a project would overspend a budget tends to reduce significantly decision makers' tendencies to exhibit escalation effects; (d) even when investment expenditures would not exceed overall budget limits, the prospect of overspending the budget for a substage of a multistage investment project has the same suppressive influence on escalation effects as the prospect of overspending an entire budget; and (e) a side effect of the use of budgets is that they can induce decision makers to eschew investment opportunities that generate net benefits. There is also evidence that the prospect of exceeding a budget introduces two mechanisms into participants' decision-making processes—more marginal cost-benefit reasoning and greater sensitivity to proscriptive consequences of exceeding a budget. Implications are discussed.