Behavioral biases in capital budgeting: An experimental study of the effects on escalation of commitment given different capital budgeting methods

Abstract

This study examines if decision makers using less sophisticated capital budgeting methods, such as Net present value and Payback, display a higher level of escalation of commitment to a failing project, compared to decision makers using more sophisticated capital budgeting methods, such as Real options. Past studies advocates superiority in decision-making when incorporating more sophisticated models into a company’s capital budgeting. The findings coincide with previous studies; that decision makers explicitly using Real options display a lower escalation of commitment compared to decision makers using Net present value. However, no difference in escalation of commitment was recorded between decision makers using Payback and decision makers using Real options.