Escalation Effects

In organizations, escalation effects can be minimized by removing the individuals who made the initial investment from the decision making later on. Fortunately, individual investors can also learn to use various de-escalation strategies designed to make them more responsive to available evidence and keep them from throwing good money after bad. In one study, for example, Richard Larrick and others (1990) found that people often violate the sunk cost principle of economics, which states that only future costs and benefits, not past commitments, or “sunk costs,” should be considered in making a decision.

To appreciate the practical implications, imagine that you’ve bought a $75 ticket to a baseball game weeks in advance. Now, on the day of the game, you don’t feel well, it’s snowing, and your favorite player is injured. Do you still go to the game to make sure you use the ticket? Not wanting to “waste” the money, many of us would go even though the money is already sunk and even though we would have to bear the added costs of getting sick, driving in bad weather, and sitting through a boring game. To see if there is a more rational economic choice, ask yourself this question, Would you go to the game if someone called on game day and offered you a free ticket? If you said that you would go if you’d paid for the ticket but not if it were free, then—like investors who don’t know when to cut their losses—you fell into the sunk cost trap and should have stayed home.

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