Fumbling Sunk Costs

A core concept in economics is marginal analysisdecisions should depend on incremental costs and benefits. Costs already incurred that cannot be recoveredsunk costsare irrelevant. Surprisingly, businesses often wrongly consider sunk costs, a practice sometimes called the Concorde Fallacy after the most notorious case. Long after the Supersonic Transport Aircraft proved a commercial disaster, the British and French governments continued funding it because no senior official wanted to concede the project had been folly. When considering project renewal, managers have an ethical duty to focus on net present value and avoid letting emotional factors or concerns about their own reputations distort investment decisions.

Professional sports offer the best-known example of the Concorde Fallacya team signs a marquee player to an expensive long-term contract, then sticks with him no matter what. Consider the case of Robert Griffin III (RGIII), the 2011 Heisman Trophy-winning quarterback drafted second by the National Football League (NFL) Washington Redskins. Griffin cost the Redskins plentya four-year guaranteed contract worth $21.1 million as well as numerous draft picks traded to obtain the second overall pick in the draft. The deal also gave the Redskins an option to keep RGIII around a fifth year for a hefty sum; here sunk costs entered the equation.

In the first year of the contract, the investment paid off handsomelyGriffin was named Offensive Rookie of the Year, and the Redskins won their division for the first time in 13 years. But late that season, RGIII suffered the first of many injuries that kept him from regaining rookie form. Just before the 2015 season (the fourth and final year of the initial contract) the Redskins took advantage of their right to sign Griffin for 2016, promising a cool $16.2 million. At the time, the move was called the biggest blunder in NFL history because of the injury risk. The Redskins tried to hedge by not guaranteeing the salarymeaning the full amount would be owed only if RGIII stayed healthy the entire 2016 season. But under the terms of the initial contract, the team was on the hook if a 2015 injury prevented him from playing in 2016. Sure enough, in the 2015 preseason, Griffin suffered a concussionforcing the Redskins to bench him to prevent further injury that could carry over and cost $16.2 million. The team owned up to the mistake by releasing a now-healthy RGIII after the 2015 season.

Recent research suggests NFL teams routinely fail to ignore sunk costs. One study looked at factors influencing the number of games started by defensive players. The empirical model included performance measures like solo tackles for linebackers as well as contract size to test for the Concorde Fallacy. Other things being equal, performance rather than compensation should determine which players should start more games contracts are sunk because a player is paid the same dollars whether he begins the game on the field or the bench. Contracts turned out to have a large impacta 15% increase in a defensive players compensation boosted the number of starts as much as nine extra solo tackles would. In other words, more expensive players were more likely to start even if they did not perform better than players on the bench. From an economic perspective, choosing starters based on sunk costs deserves a flag for illegal procedure.

In 2-3 paragraphs only please answer the following; Recommitting to a losing project for emotional or reputational reasons can destroy shareholder wealth. What safeguards could a firm use to remove such bias from recommitment decisions? Please one website that you used to help in APA format.