High Sunk Costs Research Articles

Firms’ innovation and export survival in a Crisis

ABSTRACT Firms pay sunk costs to enter the export market. However, some firms fail to continue exporting despite paying the high sunk costs. The existing literature has not broadly explored such export market survival for firms, considering their level of innovation. Thus, this study investigates the effects of innovation on firms’ export market survival, using a panel dataset of South Korean manufacturing firms from 2006 to 2019. Adopting a discrete-time hazard model, this study uses patents for measuring innovation and considers the financial crisis period. The study finds that firms with higher innovation levels have lower hazard rates in the export market, implying a higher survival rate. Furthermore, a nonlinear relationship between innovation and export market survival demonstrates diminishing returns to innovation. Innovation is critical to firms’ export market survival, especially during the global financial crisis. Particularly, innovation during the global financial crisis helps high–medium technology firms survive in the export market. These empirical findings suggest that innovation is likely to increase the competitiveness of firms’ products and support their survival in the export market, even during the crisis period.

Currency Fluctuations and Foreign Direct Investment in Kenya

Purpose: This study investigates the relationship between currency fluctuations and Foreign Direct Investment (FDI) in Kenya over the period from 2013 to 2022.
 Methodology: Employing a causal explanatory research design and time-series secondary data, the study identifies the trends and determinants of currency fluctuation and its relationship with FDI. Secondary data is collected from the CEIC website while PICOT is utilized to select the relevant studies for analysis. The correlation analysis is conducted using SPSS to determine the relationship between currency fluctuation and FDI.
 Findings: The analysis reveals mixed uptrend and downtrend in both variables, showcasing a substantial reduction in FDI in recent years. The correlation analysis establishes a statistically significant negative relationship between exchange rates and FDI, in alignment with the theory of hysteresis and option values. This underscores the impact of currency fluctuations on inducing uncertainty, resulting in reduced FDI due to high sunk costs and delayed investment decisions.
 Unique Contribution to Theory, Practice and Policy: The study fills a crucial gap in the existing literature by offering insights on the relationship between currency fluctuation and FDI in the Kenyan context. Policy implications stress on the importance of stabilizing the Kenyan Shilling, mitigating real shocks, and fostering economic diversification to enhance the attractiveness of Kenya to foreign investments. This study provides valuable guidance for policymakers, the Kenyan government, and stakeholders seeking to formulate strategies that promote a conducive environment for sustained FDI and economic growth in Kenya.

Decision-making in terrorism sting operations: is entrapment driven by the sunk-cost effect and intergroup biases?

ABSTRACT Previous research has found that entrapment – inducing suspects to commit crimes they were not already predisposed to commit – is widespread in US terrorism sting operations, particularly those involving Muslims and racial minorities. To test whether the sunk cost effect and/or intergroup biases could explain decisions to authorise these operations, we conducted an experiment in which college student and MTurk participants (n = 1009) from the US and India decided whether to approve an operation featuring apparent entrapment. Sunk costs and suspect characteristics were manipulated across experimental conditions. Results for US participants (n = 792) show that high sunk costs increased approval of the operation only for relatively young participants, and only in scenarios with non-Muslim suspects. Scenarios with Muslim suspects yielded higher approval rates for participants who were confident in their decision. Indian participants (n = 217) were more likely than US participants to approve the operation and were unaffected by suspect religion and sunk costs. Results suggest that the sunk cost bias may play some role in entrapment, although other factors, such as outgroup bias, may also contribute to these decisions. The observed cross-cultural differences could result from international variations in susceptibility to the sunk cost effect, among other factors.

Why do some firms stop exporting?

During economic turbulence, such as those caused by the US-China conflict and COVID-19, sunk cost effect has garnered attention in IB literature. As it becomes increasingly difficult to predict export profits, relying on sunk costs for strategic positioning in export markets appears to be a rational decision. However, few studies quantitatively examined sunk cost effect variations, especially in export-exit decision-making. In our study, we quantified sunk cost effect with respect to export performance and export portfolio, specifically in terms of export-exit probability. Our findings indicate that the export-exit rate due to sunk cost effect is less than 50% only if export volume surpasses a certain threshold. Consequently, we have provided an explanation for why export exits still occur in the presence of high sunk costs. Additionally, we have identified that geographic diversification, up to four destinations, has more synergy with sunk cost effect than product diversification, particularly in volatile environments.

The divestment-reinvestment sequence in foreign countries: The role of relational vs. transactional ownership

In this paper, we claim that ownership is a key determinant of the firms' divestment-reinvestment sequence in a foreign country. Building on the notion of ‘relational vs. transactional ownership’, we distinguish between relational-type firms (namely, family-owned and state-owned firms), and transactional-type firms (privately non-family-owned firms). We argue that relational-type firms are less likely to both divest from, and reinvest in, a given foreign country. In fact, relational owners set a lower performance threshold of intervention than transactional ones; additionally, in order to turn the tide, the former often increase resource injection when subsidiary performance falls below the threshold. Such an escalation of commitment increases sunk costs and further decreases the likelihood of divesting the subsidiary. Moreover, when a divestment occurs, the memory of high sunk costs incurred reduces the propensity to reinvest in the same host country. We test our conceptual framework on a large sample of investments, divestments and subsequent re-entries undertaken in the period 2000–2015 by 602 Italian firms. Our econometric findings corroborate our hypotheses, thus contributing to the literature on the interdependencies between divestment and reinvestment choices, and their relationships with corporate ownership.

Can the ladder of investment approach make on-track competition sustainable in the railway market? A study of asymmetric infrastructure access charges

The gradual liberalisation of the EU railway market, which began in the early 2000s, has entered its final phase with the formal opening of national markets for commercial passenger transport. However, the level of competition established in some countries is still not sufficient to increase passenger welfare. Based on the previous experience, this phenomenon stems from high barriers to entry for new operators, such as high sunk costs, relatively high infrastructure train access charges (TAC) for commercial passenger traffic, and competition between asymmetric participants, where the incumbent still dominates the market. One of the solutions to improve the conditions for entry is asymmetric market regulation, used in the telecommunications sector. The asymmetric access regulation is based on lower TAC for entrants than for incumbent for a limited period, which is part of the ladder of investment (LOI) approach. In principle, the current EU regulatory framework requires equal and non-discriminatory TAC for all railway operators which provide similar services in a similar market segment with similar infrastructure quality. Any deviation from this principle must be justified. In practice, infrastructure managers (IM) often charge much higher TAC than the marginal cost of using the infrastructure for long-distance passenger traffic because that market can absorb this higher cost. This does not leave much possibility for entry or survival of potential entrants in the passenger market segment. Therefore, this paper will present a duopoly competition model between asymmetric on-track competitors within the commercial passenger transport market segment. We will explain the pros and cons of the introduction of asymmetric access regulation as an essential package of market entry strategy to establish sustainable competition for commercial passenger railway transport services.

Global Value Chains and the Slowing Down of Globalisation

Global value chains (GVCs) have been a major feature of the phase of economic globalisation that began after the 1980s. After the global financial crisis of 2007-08, however, this phase has come to an end, being replaced by one characterized by a significant slowdown in the degree of international economic openness, due to not only economic but also geopolitical reasons.. GVCs have also shown a slowing growth trend after then.
 The future scenarios for GVCs, however, suggest the possibility that they may be more resilient than expected.
 A first theoretical explanation provided in the literature argues that the reshoring of foreign intermediate production would be prevented by the high sunk costs that would have to be incurred.
 However, an additional possible reason for GVCs resilience - this is the main theoretical contribution of this article - is due to the option of friendshoring or nearshoring, rather than reshoring. Moving the production to more suitable foreign destinations, characterized by a political or geographical proximity with the domestic one, would avoid the newly perceived strategic and geopolitical costs, while retaining the economic benefits of offshoring, thereby making GVCs resilient.

Effects of COVID-19 restrictions on mechanization service providers and mechanization equipment retailers: Insights from phone surveys in Myanmar.

Agrifood sector mechanization service providers (MSP) and mechanization equipment retailers (MER) have increasingly become the providers of mechanical technologies for smallholders in developing countries, including Myanmar. Evidence remains scarce on the effects of COVID‐19 on these MSPs and MERs. This study provides insights into the effects of COVID‐19 restrictions on MSPs and MERs in Myanmar, using unbalanced panel data from five rounds of phone surveys. Direct responses to COVID‐19 involving movement restrictions, market disruptions, and growing financial challenges had significant negative effects on revenue prospects, service delivery, and sales of machines and equipment. Negative revenue prospects during a particular period can further hurt revenue prospects in subsequent periods. This is consistent with the hypotheses that MSPs who had incurred high sunk costs in machines can engage in more desperate and, thus, potentially suboptimal business practices to recover the sunk cost. Overall, policies to minimize movement restrictions and various financial struggles and mitigate any pessimism at the beginning of the production season are all important to make sure MSPs and MERs continue to function effectively under COVID‐19.

The cost effectiveness of new reservoir hydroelectricity: British Columbia’s Site C project

Large-scale, reservoir hydroelectric facilities can play an important role in decarbonizing the electricity sector. However, new hydroelectric facilities are costly, and several recent projects in Canada have been subject to cost over-runs. In this paper, we develop a methodology for evaluating the cost-effectiveness of new reservoir hydroelectric projects. We apply this methodology to a case study of the Site C hydroelectric project currently under construction in British Columbia, Canada. Our approach makes use of a purpose-built linear programming capacity expansion and dispatch model, resolved at an hourly frequency and incorporating detailed treatment of balancing area requirements, available wind and solar resources, watershed constraints on hydroelectric potential, and endogenous electricity trade. Our simulations reveal that the value of the Site C project is unlikely to exceed its total cost, and only exceeds the avoidable cost of project cancellation in scenarios where BC and Alberta build additional inter-provincial transmission capacity and aim for 100% decarbonization of their electricity systems. Site C provides a cautionary tale for policymakers and planners pursuing large hydro-electric projects. Potential cost over-runs can render large hydroelectric projects uneconomic relative to alternatives. The decision to complete the Site C project is only justified by its high sunk costs.

Decision tools for adaptation to climate change: Portfolio analysis of tea plantation investments in Rwanda

Climate change produces new challenges to the development strategies of the most vulnerable countries, where there is urgent need of effective adaptation policies. However, the uncertainty about the expected costs of climate change and about the benefits of adaptation hampers the design and the implementation of adequate measures. Alternative decision-support tools and decision strategies can be adopted by policy makers and the private investors. In this paper, we assess the effectiveness of Portfolio Analysis (PA) as a decision-support tool for adaptation strategies under different climate change scenarios. PA effectiveness is explored in the context of tea plantation investments in Rwanda. Tea is a key commodity for the Rwandan economy, and the agriculture sector is one of the most negatively affected by climatic changes, especially in developing countries. It is a perennial crop, for which investments have high sunk costs and economic returns are highly sensitive to changes in the average temperature and in rainfall distributions. Thus, returns on investments in new tea plants are affected by high climate-induced uncertainty. PA aggregates different investment options into portfolios, instead of considering a single option, and allows identification of an efficiency frontier of best portfolios in terms of trade-off between economic efficiency (expected net present value) and risk (variance of the economic performance). In spite of its advantages, PA remains rarely used in climate change adaptation analysis. In this paper we show how PA can be performed in practice when evaluating adaptation investments against different climate change scenarios. The results show that, using PA, new possible allocations of resources emerge, identifying alternative investment solutions with a better trade-off between economic return and risk. PA here emerges as an effective tool in designing long-term investments in the agriculture sector, robust to the complex and uncertain effects of climate change. A Sensitivity analysis of the results to different social discount rates and different climate change scenarios suggests how these two factors can be relevant for the choice of investment portfolios.

Knowledge generation and market orientation during global crises in supply chains

PurposeSupply chains (SCs) depend on interorganizational relationships (IORs) to function optimally, yet crises may lessen the knowledge flows therein. This paper aims to address this issue by proposing a mediation effect between knowledge generation and market orientation by crisis perception in SC.Design/methodology/approachPartial least square structural equation modeling was used to test the hypotheses. Data collection comprised 279 full answers of business-to-business organizations in global SCs.FindingsThe data provide evidence that, contrary to the extant literature, knowledge generation during a crisis in a SC does not mitigate crisis perception. In addition, findings suggest there are no significant differences between manufacturing and service SCs in sensemaking during crises and that during crises, SC links diminish cooperation in terms of knowledge generation and sharing and focus on individual performance.Originality/valueThe authors have found a conflicting theoretical issue – while extant literature posits setting IORs lead to high sunk cost, making IOR channels costly and reliable for information flows during crises, the behavioral perspective posits that when crises hit, exogenous shocks induce inwards focus diminishing information flows. The results provide insights on this seemingly inconsistent scenario and point to future avenues of research.

A qualitative assessment tool for innovative waste logistics scenarios: a case study for Flanders

With new, innovative logistics tools and frameworks coming to the market rather quickly, developing a decision support framework to assess its value before carrying out extensive, quantitative economic assessment studies and large-scale implementation is necessary. This paper focuses on developing a qualitative decision support framework—aiding the deployment of successful tools in the logistics landscape and avoiding high sunk costs without added value. Resulting in a qualitative tool based on a literature review and industry expert interviews. The derived parameter impact model assesses the importance of different parameters, allowing to find opportunities without the need for extensive information and/or investments. Therefore, the parameter impact model was applied to three different cases of waste logistics located in Flanders: (1) the use of telemetry (i.e., the use of sensors to identify the filling rate of waste collection points remotely), (2) small waste compactors on the business side, and (3) inland waterways to transport waste to treatment centers. The qualitative results can vary depending on the specific case, establishing the fundament for future innovations.

The role of competitive amplification in explaining sustained performance heterogeneity

AbstractResearch SummaryThis article introduces a formal model of long‐term resource dynamics under uncertainty. The model demonstrates the importance of competitive amplification for the emergence of sustained performance heterogeneity. In some markets, small differences in resource positions tend to amplify over time into large performance differences. The model predicts that this amplification and the resulting performance heterogeneity are largest in markets where firms compete for critical resources that are highly scalable, carry high sunk cost, depreciate rapidly and exhibit strong time‐compression diseconomies. Amplification emerges because in these markets an advantaged firm tends to have a stronger incentive to invest than a follower. Prior theories had paid little attention to the critical role of such competitive interactions in shaping long‐term resource dynamics.Managerial SummaryIn some markets, performance differences between competitors are much larger than in others. For instance, in high‐tech markets just one or a few firms tend to generate a large share of profits, while in utilities many different firms can exhibit similar performance levels. The mathematical model in this article suggests that the characteristics of the critical resources in a market play an important role in whether firms in that market will have similar versus very different performance levels. For instance, competition for resources that are not capacity‐constrained and depreciate rapidly—such as innovative technologies—tend to induce advantaged firms to extend their leads, which over time causes any small differences in resource positions to amplify into large performance differences. Conversely, capacity‐constrained and long‐lived resources—such as industrial plants—tend to induce attenuation of performance differences.

Farmers' Exit from Land Operation in Rural China: Does the Price of Agricultural Mechanization Services Matter?

AbstractThis study uses data covering 3,914 farm households, collected from Henan province in China, to investigate the links between the price of agricultural mechanization services and farmers' exit from land operation. The results indicate that the increasing price of agricultural mechanization services leads to farmers leaving land operation, especially when the high sunk costs and the long‐term breakeven period of self‐owned machinery are considered. This effect is intensified by the rapid rural–urban migration in China. Further analysis reveals that the surge in service prices reduced land renting‐in and encouraged non‐grain production. Our analysis suggests that the agricultural mechanization service market in China tends to work against the survival of smallholder farmers. However, the price of agricultural mechanization services is conducive to eliminating less‐productive farmers and cultivating new agricultural operators.

The third route: Using extreme decentralization to create resilient urban water systems

For much of the world's urban population, centralized treatment plants and pipe networks built in the nineteenth and twentieth centuries provide homes with water and a means of disposing of the resulting wastewater. Due to the real or perceived inability of existing systems to deliver safe and palatable water, many users apply additional treatment prior to consumption. Where piped water supply is lacking, drinking water is obtained through water vendors at considerable cost. Despite economic inefficiencies and public health risks inherent in these two water supply systems, the high sunk costs of existing water infrastructure along with low returns on investment and the inflexible nature of the institutions involved in water provision have slowed down the diffusion of alternative approaches that may prove to be less expensive, more adaptable and safer than the current system. We advocate a third, complementary route: household-based personalized water systems. Initially, relatively affluent people expecting more functionality and sustainability from water systems will invest in personalized water systems that allow them to tailor their water to their personal preferences. This approach will tap into the tremendous creativity-base of individual users and entrepreneurs, facilitating the type of co-creation that accelerated the rapid development of consumer electronics. Competition among manufacturers and economies of scale that accrue as these systems become more popular will lead to rapid innovation that drives down costs, improves performance and expands access. These solutions complement emerging approaches for sanitation and resource recovery that do not rely upon sewers for the management of human waste.

Reshaping Global Trade: the Immediate and Long-Run Effects of Bank Failures

I study the first modern global banking crisis that began in London in 1866 and provide causal evidence that financial sector disruptions can reshape international trade patterns for decades. Using newly collected archival loan records that link banks to their operations abroad, I estimate that countries exposed to banks whose headquarters in London failed exported 17% less on average to each destination until 1905. Exporters trading with destinations for the first time, facing more competition in goods markets, and with little access to alternative forms of credit experienced more persistent losses, consistent with hysteresis arising from high sunk costs of entry into exporting.

Spatial Temporal Analysis of Freight Flow through Indian Major Seaport System

This paper analyzed the space time interactions among the freight flows through major Indian ports. Freight flow data at regular intervals in the form of spatial time series were collected for the twelve major ports located along the east and west coast of India. The system of freight flows was modeled through interactions both in time and space dimensions as a multivariate stochastic process. Effect of the neighbor port freight on a subject port was analyzed to understand the degree of dependency among the competing/non-competing ports. Demand elasticity analysis suggested that ports are more sensitive to changes in their own demand over time than the corresponding spatial changes indicating bulk of the demand dependency on hinterland economic activity. Interestingly, only two ports are found to be competing with each other as they share common hinterland. In general, it can be inferred that the inter-port relationship within Indian major port system is complimentary or co-operative. Proposed models can be used for assessing the impact of freight flow changes from one port to the nearest neighboring port. Study findings will help port authorities and policy makers for holistic development of port system by making right investments in required locations to promote balanced development. It has also implications towards formulating policies on port development considering Government of India's preferred mode of choice for infrastructure development is PPP, and policy formulation for this mode of development is required to address competition concerns considering the high sunk cost associated with ports development.

The asymmetric response of farmers to an expected change in the price of rubber: The roles of sunk costs and path dependency

This study examines the impacts of sunk costs and path dependency of rubber farming on farmers’ production responses to expected changes in the price of rubber based on a simple choice experiment implemented in the upper Mekong region in March, 2013. The results show that nearly 73% of farmers choose to adjust their production behaviors when the price of rubber is hypothesized to increase by 50%, while only approximately 55% choose to adjust their behaviors when the price of rubber is hypothesized to decrease by 50%. The responses of farmers to these two hypothetical changes in the price of rubber are significantly asymmetric. The estimation results of empirical models consistently indicate that higher sunk costs and a longer path dependency of rubber farming significantly hinder the probability that smallholders will adjust their production behaviors in response to the two hypothetical changes in the price of rubber. The significant difference in the impacts of sunk costs and path dependency on the choice of response behaviors under the two hypothetical situations may, to some extent, help explain the observed asymmetric responses. Additionally, the impacts of sunk costs and path dependency on the specific adjustments to production behaviors are heterogeneous. The findings provide essential empirical evidences for the roles of sunk costs and path dependency in farmers' production behaviors in the context of the price volatility of agricultural products.

Monopoly Rents and Foreign Direct Investment in Fixed Assets

In the past two decades, much of foreign direct investment in the primary sector has flowed to unconventional, politically risky destinations. This presents a puzzle for theories that emphasize the ex post immobility of --- and hence high potential expropriation risk for --- fixed asset investment. Existing theories overlook one critical aspect of fixed assets: large capital requirements and high sunk costs act as entry barriers, resulting in market concentration and strong firm incentive for monopoly rent extraction. Personalist dictatorships, we posit, provide an attractive institutional environment for fixed asset investors because the lack of institutional constraints and leaders' families' control of key economic sectors facilitate rent-seeking activities. We find that personalist dictatorships have significantly more foreign investment in the primary sector, and fixed-asset intensive industries in general, than other regimes. This study highlights the importance of accounting for heterogeneity among investors and political regimes to understand the politics of FDI.

Policy analysis of perennial energy crop cultivation at the farm level: Short rotation coppice (SRC) in Germany

Perennial energy crop production methods such as short rotation coppice (SRC) have gained interest among farmers and policy makers. SRC is characterised by rapid biomass production, low inputs, and high managerial flexibility. SRC plantations also provide environmental advantages relative to annual crop production and contribute to the transition towards renewable energy. Yet, the combination of high sunk costs and high uncertainty hampers SRC adoption among farmers. Policy instruments currently implemented to foster SRC adoption exhibit limited success. In this paper we assess the performance of different policy measures intended to stimulate SRC adoption in terms of efficiency and farm-level effects, taking into account related uncertainty. We use a combination of stochastic programming and the real options approach in our model featuring SRC poplar cultivation in Germany. We analyse four policy measures intended to foster SRC adoption: an establishment subsidy, a price floor, a guaranteed price, and increasing the “Ecological Focus Area” (EFA) value for SRC systems within the European Union Common Agricultural Policy. Our results indicate that a guaranteed price can stimulate immediate SRC adoption; however, it is inferior to the other instruments in other dimensions. An establishment subsidy as recently implemented in the study area might incentivise farmers to adopt SRC by contributing substantially to farm income, but should be modified because it may encourage postponement of SRC adoption. Increasing the EFA coefficient and a price floor are more efficient measures in terms of governmental expenditures, while having limited positive effects on bioenergy produced.