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Investments: The Sunk-Cost Effect

It is hard to disagree that investments are a challenging process that requires special attention, careful consideration, readiness to risk, and thorough analysis of the situation and its circumstances. When talking about projects, some people are certain of their future success and are ready to invest all their money into their implementation. Unfortunately, sometimes the results are negative, and one mistake that can lead to them is the investors’ irrational attention to sunk costs during their decision-making. Sunk-cost effects are observed by Dilip (2001) and Garland (1990) in their articles.

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To begin with, it is essential to notice that both researchers conduct experiments that involve undergraduate business students. To explore the functional relationship between the decision to continue investing in a research and development project and sunk costs, Garland (1990) divided students into three groups and provided them with the project scenario. Based on the previous investments, they have to decide whether to continue to invest the rest of the budget in the project. The first group revealed a significant and strong effect of sunk cost: as sunk cost increased, the students reported a higher likelihood of authorizing all remaining money into the project. The second group, in which the students decided to invest the next $1 million, also revealed a severe relationship with sunk cost. Finally, the last group did not show any dependence on sunk costs.

The author of the second article explores the effects of past investments of time and money. According to Dilip (2001), while the sunk-cost effect is not related to past investments of time, it appears when it comes to monetary investments. People account for time and money differently, which affects their choices and decision-making. Therefore, in order to make investors behave rationally when deciding on projects, it is essential to educate them about the economic value of time.

References

Dilip, S. (2001). The mental accounting of sunk time costs: Why time is not like money. Journal of Behavioral Decision Making, 14(3), 169-185.

Garland, H. (1990). Throwing good money after bad: The effect of sunk costs on the decision to escalate commitment to an ongoing project. Journal of Applied Psychology, 75(6), 728-731.

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