The Best Armoury for an Uncertain Future

Should you continue to invest time, money and effort into a project even when its future success looks doubtful? In a bid to recover the loss, do you ignore the evidence in front of you and follow through with that endeavour? Many companies and public bodies face this predicament regularly, particularly in these uncertain Covid times.

The sunk cost bias refers to the behavioural tendency of continuing an endeavour, even if the outcome might not be advantageous. This could relate to ongoing investment in business, for example, or an emotional investment made in a relationship. Based on evidence from hypothetical scenarios, the sunk cost bias has come to be widely accepted in psychological research. In common parlance, it is also referred to as, ‘throwing good money after bad’.

Three researchers from the Department of Microeconomics & Public Economics at Maastricht University set out to investigate the sunk cost bias. But, in their experiments, the scenarios weren’t hypothetical, they were real. Marcello Negrini, Arno Riedl and Matthias Wibral, created a series of experiments, where participants were given real money to invest and potentially benefit from the fruits of their investments. The group created a two-stage investment task in which participants used the money to make an initial investment to start a project. In this first stage, the size of the investment and the responsibility of the investor varied. In the second investment stage, participants had to decide whether they would terminate the project or make an additional investment to finish the project.

The results were not what they were expecting. Negrini says, “After an initial project phase, people had to decide on a  follow-up and thus decide whether to make new investments. If the sunk cost bias plays a role, one would expect that people who have invested a lot in the first phase would be more inclined to continue and not abort a project, because their costs are higher. But, exactly the opposite happened. People who had invested a lot became more careful. That was an unexpected result.”   In fact, the team found a reverse of the sunk cost bias to be true. The larger the initial investment, the lower the likelihood of continuing to invest in the project.

To test whether the difference in outcomes depends on whether the scenario is real or hypothetical, the team also conducted a questionnaire with purely hypothetical scenarios with the same test subjects.  Negrini confirms, “then they do exactly what the sunk cost bias predicts: because of the sunk cost bias they make the predicted irrational choices. It seems that the sunk cost bias disappears when you get closer to reality with real incentives, such as money.”

So, it would seem that once you put real money on the table, the situation changes. Negrini adds, “we experimental economists like to pinpoint biases and boundedly rational behaviour. But, reality may be more positive than we thought. ”

Being aware of the sunk cost bias is important in decision-making.  But, perhaps we are more rational than previous research has given us credit for. Accepting the reality of ‘sunk costs’ and making rational decisions based on what we see in front of us and not on what we have already lost, could be our best armoury for an uncertain future.