Managerial Mental Accounting and Downstream Project Decisions

Abstract

Project leaders are responsible for planning, controlling, and revising projects. As a project unfolds, the leader evaluates the project’s progress by comparing ongoing costs and scope to a baseline plan and considers potential revisions. We offer a general model of managerial mental accounting, which includes loss aversion, reference point updating, and narrow framing, and examine how it impacts downstream decisions. Our model predicts insufficient adjustments of project scope and cost at revision, resulting in reduced financial profit. We show that the choice of measure to quantify the project progress—planned, actual, or earned—affects the updating of reference points, and hence the downstream decisions. Thus, progress measures could be wisely employed to mitigate insufficient adjustments. It turns out that measuring progress via planned scope is often advantageous, whereas utilizing earned value for cost is never advisable. This paper was accepted by David Simchi-Levi, behavioral economics and decision analysis. Supplemental Material: The online appendix is available at https://doi.org/10.1287/mnsc.2021.02929 .