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Real Options and Escalation of Commitment: A Behavioral Analysis of Capital Investment Decisions
Christine A. Wilkinson,
Iowa State University
ABSTRACT. This study uses experimental methods to explore whether incorporating real options into net present value analysis can reduce escalation of commitment, or the tendency of decision makers to continue to commit resources to a project after receiving negative feedback. This reduction in escalation behavior should occur because the incorporation of real options offers the user greater cognitive accessibility to the possibility of project abandonment. Findings indicate that users of real options exhibit less escalation of commitment than do users of net present value analysis alone, but results do not support the proposed cognitive accessibility explanation. The main result demonstrates that the use of real options in capital budgeting can affect the behavior and decisions of the user even when the informational advantage of using real options is controlled for.
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