Sunk costs and quasi-hyperbolic discounting: keeping profitable commitments by considering sunk costs

Brian Knox

Pacific Accounting Review, 2021, vol. 34, issue 1, 1-22

Abstract: Purpose - Managerial accounting education generally insists that managers should never consider sunk costs. This suggestion seems inconsistent with a common mode of thinking about future rewards: quasi-hyperbolic discounting. This paper aims to explore the conflict between sunk cost consideration and quasi-hyperbolic discounting and to illustrate when sunk cost consideration may be appropriate. Design/methodology/approach - The author conducted three numerical experiments, i.e. simulated experiments based on analytical models, to demonstrate how it can be beneficial to consider sunk costs in some circumstances. All three numerical experiments assume quasi-hyperbolic discounting. First, the author tested considering sunk costs with future rewards that are certain. Second, the author tested considering sunk costs with uncertain future rewards. Finally, the author tested two different educational interventions to change decision-makers’ thought patterns. Findings - The author found that considering sunk costs worsens decisions when there is bad news and improves them when there is good news. The author found that an educational intervention that partially dissuades managers from considering sunk costs improves decisions when bad news arrives and worsens them when good news arrives. The author also found that an educational intervention that reduces uncertainty improves decisions when bad news arrives and does not worsen these decisions when good news arrives. Originality/value - The author provided numerical examples of situations in which considering sunk costs is valuable. The findings on educational interventions provide information about the tradeoffs of teaching that sunk costs should never be considered.

Keywords: Commitment; Managerial accounting education; Numerical experiment; Quasi-hyperbolic discounting; Sunk cost; Sunk cost fallacy (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eme:parpps:par-09-2020-0129

DOI: 10.1108/PAR-09-2020-0129

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