Information systems project escalation: a reinterpretation based on options theory

Abstract

Escalation of commitment is a well-known phenomenon whereby individuals and organizations continue to invest in what appear to be losing courses of action. Traditional theories of escalation implicitly assume the phenomenon is dysfunctional and results from flawed, or irrational, decision-making. Some have argued, however, that the phenomenon results from equivocal information concerning a particular course of action and does not necessarily represent a flawed or irrational decision process. To shed light on this distinction, we examine prior theories of escalation and introduce a reinterpretation of the phenomenon based on options theory.

To provide a context for our discussion, we examine information systems (IS) project escalation. While escalation is a general phenomenon, IS investments represent a particularly appealing context of study for several reasons. First, investments in information technology represent a significant and growing fraction of total capital expenditures for most organizations. Second, IS projects exhibit certain characteristics which create ambiguity and may cause them to be especially susceptible to escalation.

Our analysis suggests that traditional theories of escalation behavior give an incomplete picture because they do not provide a mechanism for distinguishing warranted from unwarranted escalation. Thus, traditional theories provide little explanation for those situations in which escalation behavior is economically prudent. Failure to consider the value of real options means that the perceived benefits of a project are lower than the actual benefits, meaning that managers are apt to reject or prematurely cancel projects that would in fact be economically beneficial to pursue.

This paper applies options theory to show that some projects that might otherwise be viewed as cases of unwarranted escalation, actually involve situations in which escalation is warranted. The options theory perspective offers new theoretical insights that challenge the traditional assumptions and yet complement existing theories regarding escalation behavior.