Sunk Cost Fallacy

Introduction

In 2019, the world watched as WeWork, once hailed as a paradigm-shifting unicorn, spiraled into chaos. Adam Neumann, its charismatic CEO, had steered the company toward an IPO despite mounting evidence that the business model was fundamentally flawed. Billions of dollars had already been sunk into lavish office spaces, extravagant perks, and a marketing blitz that painted WeWork as a "tech company" rather than a real estate firm. Investors, captivated by the sunk costs and blinded by past investments, continued to pour funds into a venture hemorrhaging cash. When the IPO crumbled, and the company’s valuation plummeted from $47 billion to $8 billion almost overnight, the cost of clinging to those investments became painfully clear.

Why did experienced investors and executives ignore the red flags? The sunk cost fallacy—a psychological bias that convinces people to justify further investment based on what they’ve already spent—was at play. Leaders who fall prey to this bias risk more than financial losses; they jeopardize their credibility, organizational culture, and long-term strategy.

If sunk costs can mislead some of the world’s most seasoned leaders, how often might they quietly shape the decisions you make every day? Could your refusal to let go of a failing project or strategy be holding your business back?

What Is the Sunk Cost Fallacy?

The sunk cost fallacy is a cognitive bias that leads individuals to continue investing in a decision or project based on the time, money, or effort already spent, rather than on its current or future value. It reflects a flawed reasoning process where past investments—irretrievable and irrelevant—are used to justify further commitment, even when logic and evidence suggest cutting losses.

Nobel laureate Daniel Kahneman, a pioneer in behavioral economics, describes this phenomenon as "an escalation of commitment," where decision-makers fall into the trap of justifying prior expenditures instead of reevaluating the situation rationally. He notes, "The mind struggles to accept that sunk costs are gone and irrelevant to the future. Instead, it clings to them, leading to decisions that compound losses rather than reduce them."

Economist Richard Thaler, a leading authority on behavioral finance, highlights the role of emotions in perpetuating the sunk cost fallacy. According to Thaler, "People often feel compelled to see their investments through because abandoning them feels like admitting defeat—a psychological cost that can feel even greater than the financial one."

Professor Hal Arkes, who conducted foundational research on this bias, emphasizes how deeply ingrained it is in human decision-making. In his seminal study on the sunk cost fallacy, Arkes wrote, "The sunk cost effect is a powerful force because it preys on our desire to avoid waste and our tendency to honor commitments. Yet, it leads us astray by focusing on what we cannot change—what is already gone."

This bias is particularly damaging in leadership contexts, where decisions about resource allocation, strategy, and personnel often have far-reaching implications. The pressure to justify past choices and avoid the stigma of failure exacerbates the likelihood of succumbing to the sunk cost fallacy, particularly in high-stakes environments.

A practical example comes from organizational dynamics, where leaders might persist with failing projects to "save face" or avoid upsetting stakeholders. As Arkes notes, "Leaders are often incentivized to appear resolute, even if resoluteness perpetuates poor decisions."

Understanding this bias is critical for leaders aiming to make forward-looking, rational decisions. As Kahneman advises, "The ability to let go of sunk costs is a hallmark of good judgment. It’s about recognizing when persistence is a virtue and when it becomes a trap."

The Roots of the Sunk Cost Fallacy

The sunk cost fallacy is deeply embedded in human cognition, shaped by psychological, evolutionary, and social factors. It arises from our innate aversion to loss, our need to justify past actions, and our reluctance to admit failure. Several key experiments have illuminated the mechanisms driving this bias and its pervasive influence on decision-making.

The Theater Ticket Experiment: Aversion to Waste

One of the earliest and most influential studies on the sunk cost fallacy was conducted by Hal Arkes and Catherine Blumer in 1985. Participants were asked to imagine purchasing a non-refundable ticket to a theater performance. Later, they learned that the performance was likely to be unenjoyable. Despite this information, a significant number of participants indicated they would still attend the play, solely to avoid "wasting" the money already spent.

Arkes and Blumer concluded that the desire to avoid waste—a powerful psychological driver—overrides rational decision-making. They noted, "The tendency to continue a behavior because of prior investments highlights how emotional responses to perceived waste can distort logical judgment."

The Airline Study: Commitment Bias in High-Stakes Decisions

Another key experiment examined decision-making in a corporate context. Participants were presented with a fictional scenario involving a struggling airline company. The company had invested $10 million in a new airplane model but discovered mid-development that a competitor had released a superior product. Despite knowing that the new plane would not succeed in the market, most participants recommended continuing the project to avoid "losing" the initial investment.

This study demonstrated how the sunk cost fallacy influences decisions at both individual and organizational levels. The researchers highlighted that "the escalation of commitment is particularly pronounced when the stakes are high, as the need to justify prior decisions becomes intertwined with concerns about reputation and accountability."

The Lottery Ticket Experiment: Personal Ownership and Emotional Attachment

A study by Richard Thaler explored how ownership intensifies the sunk cost fallacy. Participants were asked to choose between buying a lottery ticket for $2 or receiving $2 in cash. Once the tickets were purchased, participants were unwilling to sell them back for the same price—even though the objective value remained unchanged. Thaler attributed this behavior to the "endowment effect," where people ascribe greater value to things they own, compounding the sunk cost fallacy.

Thaler remarked, "The sunk cost fallacy becomes more entrenched when emotional attachment to the investment is involved. Ownership amplifies the psychological cost of abandoning a choice."

The Evolutionary Perspective: Risk Aversion and Survival

From an evolutionary standpoint, the sunk cost fallacy may be rooted in ancient survival mechanisms. In resource-scarce environments, abandoning an effort prematurely could mean the difference between survival and death. The inclination to "double down" on investments may have been advantageous in contexts where persistence often yielded rewards. However, in modern business settings, this primal instinct can lead to suboptimal outcomes.

As behavioral scientist Rory Sutherland explains, "The sunk cost fallacy may be an evolutionary hangover—a cognitive shortcut designed for a world of immediate payoffs, but ill-suited for the complexity of today’s decisions."

Neurological Insights: The Role of the Brain's Reward System

Recent neuroimaging studies have also shed light on the sunk cost fallacy. Researchers found that activity in the brain's ventromedial prefrontal cortex (vmPFC)—a region associated with value assessment—increases when individuals consider prior investments. This heightened activity suggests that the brain conflates past costs with potential future benefits, reinforcing the urge to persist with failing endeavors.

Neuroscientist Tali Sharot notes, "The brain is wired to seek rewards and avoid losses. When confronted with sunk costs, this neural circuitry can distort our perception of risk and reward, compelling us to chase losses rather than accept them."

The Business Impact of the Sunk Cost Fallacy

The sunk cost fallacy exerts a profound influence on leadership decisions, often steering organizations away from rational, forward-looking strategies. When leaders succumb to this bias, the consequences can ripple across various aspects of business, including financial management, strategic planning, and organizational culture. Below, we examine the impact of the sunk cost fallacy in these critical areas, supported by real-world examples.

Strategic Stagnation: When Persistence Becomes a Liability

In the corporate world, one of the most visible impacts of the sunk cost fallacy is strategic stagnation—when companies continue to pursue failing projects or initiatives simply because they have already invested heavily in them. This dynamic was evident in the case of Kodak. Despite its pioneering role in digital photography, Kodak clung to its film-based business model, pouring resources into preserving its legacy technology. The justification was clear: decades of investment in film production and processing infrastructure made pivoting to digital seem like abandoning a treasure trove of sunk costs. Ultimately, this persistence led to Kodak’s bankruptcy in 2012, as more agile competitors like Canon and Sony embraced the digital revolution.

Financial Drain: Throwing Good Money After Bad

The sunk cost fallacy can also manifest as financial mismanagement, where organizations allocate additional resources to projects that are unlikely to yield returns. Boeing’s development of the 737 Max serves as a cautionary tale. After initial investment in the aircraft, safety issues and crashes led to mounting regulatory and public scrutiny. However, instead of reevaluating the project’s viability, Boeing continued to funnel billions into redesigns and marketing campaigns to "salvage" its investment. The financial fallout, including lawsuits and production delays, cost the company over $20 billion and severely damaged its reputation.

Decision Paralysis: Fear of Change

Leaders under the sway of the sunk cost fallacy often experience decision paralysis, where the fear of admitting failure prevents them from taking corrective action. This dynamic was evident during Yahoo’s decline. The company persisted with unprofitable ventures like Yahoo Screen, a streaming platform that failed to compete with Netflix and YouTube. Despite dwindling user engagement, Yahoo executives were reluctant to shut down the platform, citing previous investments in content licensing and infrastructure. This inability to pivot quickly contributed to Yahoo’s gradual loss of relevance in the tech industry.

Cultural Consequences: Normalizing Escalation of Commitment

The sunk cost fallacy doesn’t just affect leaders; it can permeate organizational culture. When leaders consistently justify poor decisions based on past investments, it sets a precedent for employees to follow suit. This dynamic fosters a culture of risk aversion and defensiveness, stifling innovation and discouraging open dialogue about failure. In such environments, team members may hesitate to voice concerns about ongoing projects, fearing repercussions for challenging leadership’s sunk-cost-driven decisions.

A notable example is the Challenger Space Shuttle disaster. NASA’s decision to proceed with the launch, despite warnings from engineers about potential O-ring failure, was influenced by the agency’s commitment to the shuttle program and the significant resources already spent. The tragedy underscored how a culture that prioritizes justification over safety can have catastrophic consequences.

Opportunity Costs: The Price of Holding On

Perhaps the most overlooked consequence of the sunk cost fallacy is the opportunity cost—the missed chances to pursue more promising ventures. Resources tied up in failing projects could be redirected toward innovation, market expansion, or talent development. For example, Blockbuster’s refusal to embrace digital streaming, despite Netflix’s growing dominance, exemplifies how sunk costs in physical stores and DVD rental systems can prevent companies from seizing transformative opportunities.

How to Mitigate the Sunk Cost Fallacy

Mitigating the sunk cost fallacy requires deliberate effort to challenge ingrained thought patterns and foster a decision-making environment that values rationality over emotional attachment. Below are strategies to help leaders and teams overcome this bias, with each approach grounded in actionable insights.

Focus on Future Value, Not Past Investments

The most effective way to combat the sunk cost fallacy is to reframe decisions around future value. Instead of asking, “How much have we already invested?” ask, “What are the expected outcomes if we continue versus if we stop?” This forward-looking mindset shifts attention away from irretrievable costs and toward potential returns.

As Nobel laureate Daniel Kahneman advises, "Good decision-making is about considering the future consequences of actions, not the cost of actions already taken." Incorporating this principle into leadership discussions can help avoid the trap of justifying poor decisions based on past commitments.

Implement Decision Review Frameworks

Introducing structured frameworks for reviewing decisions can create a more objective evaluation process. One such approach is the “pre-mortem analysis,” where teams imagine a decision failing and work backward to identify what could lead to its failure. This exercise reduces emotional attachment by encouraging a critical assessment of the project’s viability.

For example, during the development of Amazon Web Services, Jeff Bezos frequently challenged his teams to consider scenarios where AWS could fail. By focusing on potential pitfalls, Bezos ensured that decisions were driven by data and market needs, not sunk costs.

Encourage a Culture of Admitting Mistakes

Leaders who normalize the practice of admitting mistakes create an environment where the sunk cost fallacy is less likely to thrive. When employees and executives alike feel safe acknowledging missteps, they are more willing to course-correct without fear of blame or retribution.

Satya Nadella, CEO of Microsoft, famously emphasized the importance of a "learn-it-all" culture over a "know-it-all" one. By valuing learning over ego, Nadella has transformed Microsoft’s decision-making ethos, enabling the company to pivot away from unproductive investments without hesitation.

Set Predefined Exit Criteria

To avoid falling victim to escalating commitment, establish clear exit criteria for projects at the outset. These criteria should include measurable benchmarks that signal when it’s time to stop, regardless of previous investments. For instance, if a new product fails to achieve a specified market share within a defined timeline, the team discontinues development.

Google’s discontinuation of products like Google Wave demonstrates the effectiveness of this approach. Despite significant investment in the platform, Google shut it down when it failed to gain traction, redirecting resources to more promising ventures.

Seek Diverse Perspectives

Decision-making groups that include diverse perspectives are less prone to the sunk cost fallacy. External advisors, cross-functional teams, and even dissenting voices within an organization can challenge entrenched thinking and encourage rational reevaluation of decisions.

Research from Wharton Professor Adam Grant shows that teams with psychological safety—where members feel free to voice disagreements—are more likely to avoid groupthink and biases like the sunk cost fallacy. Encouraging diversity of thought ensures that decisions are scrutinized from multiple angles, reducing the influence of past investments.

Quantify Opportunity Costs

Explicitly calculating opportunity costs can help counteract the sunk cost fallacy by highlighting what could be gained by redirecting resources. When leaders see the potential benefits of alternative investments, they are more likely to abandon unproductive projects.

For instance, when Netflix decided to transition from DVD rentals to streaming, it was driven by a clear understanding of the opportunity cost. The company recognized that clinging to its DVD business would limit its ability to capitalize on the rapidly growing streaming market.

Practice Detached Decision-Making

Finally, leaders can cultivate the ability to make detached decisions by creating distance between themselves and the outcomes. One way to achieve this is by imagining they are advising a peer or considering the decision from an outsider’s perspective. This mental exercise reduces emotional bias and fosters more rational analysis.

As Hal Arkes, one of the leading researchers on the sunk cost fallacy, observes, “Detachment allows decision-makers to focus on the logic of the situation, not the emotions tied to past investments.”

Prominent Research on the Sunk Cost Fallacy

The sunk cost fallacy has been a cornerstone of behavioral economics and decision-making research, revealing how deeply ingrained this bias is in human cognition. Below, we explore key studies that provide unique insights into its effects, each with intriguing implications for leadership and business strategy.

"Would You Swim Across the River?": Exploring the Illusion of Progress

In a study by Daniel Kahneman and Amos Tversky, participants were asked to imagine swimming halfway across a river only to discover it was infested with dangerous creatures. Despite the new information, a majority indicated they would continue swimming forward rather than turning back, citing the distance already covered as justification. This experiment highlights how the illusion of progress can amplify the sunk cost fallacy.

For leaders, this is a powerful metaphor: the perception of "being close to success" often overrides rational assessments of risk and feasibility. Recognizing the fallacy requires stepping back and asking, "Would this decision make sense if we were starting fresh?"

"The High Cost of Free Perks": When Investments Go Beyond Money

Behavioral economist Dan Ariely conducted a study showing how the sunk cost fallacy extends beyond financial commitments to include time and effort. In one experiment, participants were offered free cinema tickets but had to wait in long lines to claim them. Those who spent more time waiting were more likely to attend the movie, even when reviews indicated it was terrible. Ariely concluded, "The time invested created an emotional cost that people felt compelled to justify."

This finding resonates in corporate settings, where leaders often feel obligated to see through initiatives that have consumed significant employee time and energy. It underscores the importance of viewing both time and effort as sunk costs, not factors in decision-making.

"Chasing Losses in the Casino of Business": Escalation of Commitment in Competitive Environments

A landmark study by Barry Staw investigated how competition exacerbates the sunk cost fallacy. Participants were placed in simulated business environments where they competed against others. Those facing fierce competition were more likely to double down on failing strategies to "save face" or appear resilient. Staw described this as “competitive escalation,” noting, "In high-pressure environments, the fear of appearing weak can overshadow rational analysis."

This dynamic is especially prevalent in industries where reputation and perceived strength are critical. Leaders must balance the drive to compete with the discipline to reevaluate their strategies objectively.

"When Nostalgia Becomes a Trap": The Role of Emotional Attachment

A recent study by Francesca Gino explored how nostalgia influences decision-making. Participants were asked to reflect on projects or initiatives they felt emotionally invested in. They were then given evidence suggesting these initiatives were no longer viable. Despite the data, participants who expressed strong nostalgia for the projects were significantly more likely to continue them.

For leaders, this study is a cautionary tale about the dangers of romanticizing past efforts. Gino suggests that creating a forward-looking narrative can help mitigate the influence of nostalgia, encouraging leaders to focus on future opportunities rather than clinging to the past.

"The Cost of Public Promises": Accountability and Sunk Costs

A study by Linda Babcock and George Loewenstein examined the interplay between public accountability and the sunk cost fallacy. Participants were asked to commit to a project publicly and then presented with evidence suggesting it was doomed to fail. Those who made public declarations were twice as likely to continue the project compared to those who had committed privately. The researchers concluded, "The fear of reputational damage intensifies commitment to failing initiatives."

This finding highlights the importance of creating environments where leaders can reverse decisions without fear of losing credibility. Building a culture of transparency and adaptive thinking can help reduce the pressures of public accountability.

Conclusion

The sunk cost fallacy is a silent yet powerful force that can derail even the most seasoned leaders. By anchoring decisions to past investments rather than future potential, this bias traps organizations in cycles of inefficiency, missed opportunities, and escalating losses. Recognizing its presence in yourself and your team is the first step toward overcoming it.

As a leader, your ability to let go of unproductive ventures and focus on what truly drives value is critical. By fostering a culture of rationality, implementing structured decision frameworks, and encouraging adaptability, you can ensure that your organization thrives, unburdened by the weight of sunk costs. The question remains: Are you ready to lead with clarity, or will you allow the past to dictate your future?