Have you ever watched a bad decision get worse? Perhaps a project that is late and over budget, with little plan or confidence to reach a successful conclusion? But one where the project is allowed to continue and funding continues to flow in its support? How about holding onto stock investments past the prudent time to divest, when all signs point to selling? Maybe we purchase even more shares. We may refer to this nature of behavior as throwing good money after bad. A more studied and reported term for the behavior is the Escalation of Commitment.
In 1976 Barry Staw, then an associate professor at Northwestern University, described Escalation of Commitment as the human trait to continue with a failing course of action even when new information suggests changing course. He went on to add that there are three reasons we are motivated to stay the present course. First, we fear the heavy emotional pang of regret we will have if we admit our failure. Second, we hold to the belief that we’re so close to completion, or success, that continued investment appears wise. Lastly, the hit to our ego is too heavy a load to face.
Another tendency is for decision makers to apply a “confirmation bias” to their assessment. This occurs when self-belief conflicts with objective proof that our current course of action is no longer reasonable. How many of us invested in the equity market and held onto certain stocks beyond objective reason? We convinced ourselves that the stock had “hit bottom” and was positioned to rebound, only to learn the expensive lesson that it was time to cut our losses.
Gaining an external perspective from a knowledgeable and informed source can serve us well. I recall a major investment I authorized for a Fortune 500 company. While I was confident with our choice, I engaged a well-regarded outside firm to assess the quality of our decision, our approach and implementation plan. While this does not abdicate my accountability to the success of the initiative, it did lend an objective lens to the soundness of our decision and the probability of success down the road. I also brought them back at critical milestones to reassess our progress and to report risks to management.
I am reminded by an old Wall Street saying, “No tree grows to the sky.” We need to be cognizant of the performance of our investments. We need to be ready to make bold decisions when events warrant, and when facts support a shift in investment strategy. Though not widely popular on the surface, these decisions will prove to be prudent and incisive.