Escalation and De-escalation of Commitment in Response to Sunk Costs: The Role of Budgeting in Mental Accounting

Research has traditionally assumed that people increase investment (or "escalate commitment") in response to previous investments (sunk costs). This paper presents several demonstrations which show that people will incorrectly de-escalate investment in response to sunk costs. I propose that people set mental budgets to control their resource expenditures: they set a budget for a class of expenses and track their investments against their budget. A lab study with real monetary incentives shows support for de-escalation and supports a specific rule for how people set budgets - based on the breakeven of total costs and total benefits. The budgeting process suggests that people are only likely to escalate commitment when they fail to set a budget or when expenses are difficult to track. The later part of the paper organizes the previous literature on escalation around these processes and provides additional experiments to illustrate each point. For example, I argue that previous demonstrations that have shown errors of escalation exclusively involve "incidental" investments that are difficult to track. A study in the current paper shows that people are more willing to invest time than money to salvage a monetary sunk cost and more willing to invest money than time to salvage a sunk cost of time, even when the time and money investments are of equal value. The paper concludes by discussing the rationality of escalation and de-escalation.