Prospect Theory Predictions When Escalation Is Not the Only Chance to Recover Sunk Costs

Abstract

Two experiments tested the effect of risk of alternative investment opportunities on decision behavior in an escalation context. In the first experiment (n = 170), the risk of the reinvestment option, which had been unsuccessful and incurred a sunk cost, was held equal to that of an alternative investment project. Responsibility for the previous decision was manipulated between these subjects. Subjects were required to choose between the reinvestment option and the alternative. Responsible subjects demonstrated classic reinvestment (escalation) tendencies, and nonresponsible subjects exhibited a significant tendency to avoid reinvestment. Subjects in the second experiment (n = 195) completed the same decision task and were also assigned to high and low responsibility conditions. In this experiment the risk of investing further in a previously chosen project, relative to the risk of the alternative project, was manipulated. Those subjects who were responsible for the first decision (a) demonstrated no preference for or against continued pursuit of the initial project (i.e., there was no escalation tendency) and (b) preferred the less risky of the second investments, regardless of whether it was or was not the initially chosen project. Nonresponsible subjects showed no risk preference or proclivity for reinvestment. The results of these experiments suggest that salient information concerning relative risk dominates the effect of prior performance information when alternative investments are considered. We discuss the implications of these findings for decision theory and for methodology in commitment escalation research.