Equity Stakes and Exit: An Experimental Approach to Decomposing Exit Delay

47 Pages Posted: 9 Mar 2014 Last revised: 9 Mar 2015

See all articles by Daniel W. Elfenbein

Daniel W. Elfenbein

Washington University in St. Louis - John M. Olin Business School

Anne Marie Knott

Washington University in St. Louis - John M. Olin Business School

Rachel T. A. Croson

Michigan State University

Date Written: January 2015

Abstract

Despite evidence that delayed exit is a pervasive and consequential problem, relatively little is known about its causes. Moreover, the study of exit delay is confounded by the fact that behavioral theories arising in the literature on escalation of commitment and economic theories that incorporate option value both yield predictions that delay increases in sunk costs and uncertainty. We construct a laboratory experiment that enables us to compare the timing of participants’ exit decisions with optimal choices that incorporate option value in the absence of sunk costs. We show that receiving equity stakes – the actual cash flows of the enterprise and control rights over continuation – generates delay beyond the optimal exit point for participants allocated to unprofitable firms. While participants with equity stakes make decisions that are nearly optimal given their beliefs, their beliefs are significantly distorted relative to a control group that does not receive equity stakes. The pattern of distortion is consistent with confirmatory bias and motivated reasoning. More generally, we show that incentives affect decision making not only by affecting the payoffs of different outcomes but also by distorting information processing, which in turn affects how decision-makers see the relative likelihood of different outcomes. This suggests that models of behavior that assume incentives affect behavior alone may be incomplete.

Keywords: exit, real options, behavioral bias, behavioral strategy, escalation of commitment

JEL Classification: L20, D21, D81, C91, M13

Suggested Citation

Elfenbein, Daniel W. and Knott, Anne Marie and Croson, Rachel T. A., Equity Stakes and Exit: An Experimental Approach to Decomposing Exit Delay (January 2015). Available at SSRN: https://ssrn.com/abstract=2406138 or http://dx.doi.org/10.2139/ssrn.2406138

Daniel W. Elfenbein (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1156
St. Louis, MO 63130-4899
United States

HOME PAGE: http://www.elfenbein.net

Anne Marie Knott

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1156
St. Louis, MO 63130-4899
United States

Rachel T. A. Croson

Michigan State University ( email )

East Lansing, MI 48824
United States

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