How much are you willing to pay for a dollar?

Imagine an auction for a dollar and the person with the highest bid gets the dollar. However, not only the person with the highest bid must pay the price, also the person with the second highest bid must make a payment. The auction starts at one cent and you will see the price increasing up to ninety-nine cents, because until that point you will make a profit getting one dollar for less than a dollar. But the person with the second highest bid may now bid one dollar, because he does not want to pay money for nothing and it makes sense for him to pay one dollar for one dollar. And again, the person with the now second highest bid is willing to pay one dollar and one cent for the dollar, because it is reasonable for him to pay more for the reason stated above. This leads to the paradoxon that a person is willing to pay more for a dollar than its face value.

This is a very simple example for a behavioral phenomenon called Escalation of commitment. It describes the effect through which a person or a group of persons stay committed to a path of action they initially chose rather than change their course of action. Of course, you will now interject that you would have never taken part in the auction mentioned above, because it was all foreseeable. But simultaneously you can imagine further situations where people stick to their decisions although it seems irrational. Just think about an investment which turns out to be bad. Notwithstanding the bad investment, with the money you already spent and an optimistic view that you can turn things around, you might even invest additional money. Or an example which you might already have experienced: have you ever waited a long time at a restaurant without seeing your table getting ready? Probably you should have gone to another restaurant in the meantime but you already waited a long time, thus you are not very willing to change your mind. This specific example is commonly referred to as the ‘sunk cost fallacy’ or ‘Concorde Effect’ (Arkes and Ayton 1999).

According to Staw and Ross (1987) and Brockner (1992) there are three different criteria for a situation of escalating commitment. First, a big amount of resources (e.g. time or money) has already been committed. Second, the first steps of the project (or the investment) were not successful. And finally, there is now the choice to invest more resources or to end the project altogether. People are very likely in these situations to continue their activity and renew their commitment, which seems very irrational to us.

However, research has uncovered various reasons for this behavior. There might be reasons in the project itself. Maybe you have some financial burdens to end the project and are not willing to pay additional money to end it; you rather tend to continue it. It could also be that there are psychological reasons for you to continue. The biggest one according to Staw is self-justification. You keep on making further investments to justify your prior decision to yourself or your business environment. Even though you are likely to stop your investments at some point you might stay committed to them not to embarrass yourself in front of your social environment. No one should think of you as someone who makes bad decisions or investments. Also, there might be some structural reasons for the ongoing investment of resources. Maybe the process of stopping has a high bureaucratic burden or it will harm the reputation of your business. There are plenty of reasons for someone to stick to ‘irrational behavior’ and more often than not, multiple reasons appear together. Therefore, it is very important to always analyze the situation carefully and keep looking for the bundle of reasons why somebody is committing significant parts of his or her resources to an apparently ‘lost cause’.

It is very important for a lawyer to be aware of this behavioral pattern. Not only to detect if you are working on a case that is not worth continuing anymore and hence should be setteled. But also to be able to give the best advice to your client, when spotting such behavior on his part. Although your client might not be happy about you making him aware of his irrational behavior regarding for example an investment, this is what makes you a good lawyer: to help your client to get to the right decisions for his business and private life. Do not make your client pay more than a dollar for a dollar.


Links and Sources:

Arkes, Hal R., and Peter Ayton. “The Sunk Cost and Concorde Effects: Are Humans Less Rational than Lower Animals?” Psychological Bulletin 125.5 (1999): 591-600. Print.