Managerial Mental Accounting and Downstream Project Decisions

Abstract

Project leaders are responsible for planning, controlling, and revising projects. As a project unfolds, the leader evaluates the project’s progress by comparing ongoing costs and scope to a baseline plan, and considers potential revisions. We offer a general model of managerial mental accounting, which includes loss aversion, reference point updating, and narrow framing; and examine how it impacts downstream decisions. Our model predicts insufficient adjustments of project scope and cost at revisions, resulting in reduced financial profit. Loss aversion is harmful but only up to a point; and reference point updating may lessen or worsen insufficient adjustments. We show that the choice of measure to quantify the project progress—planned, actual, or earned—affects the updating of the reference point, and hence the downstream decisions. Thus, progress measures could be wisely employed to mitigate insufficient adjustments. It turns out that planned scope is often advantageous, whereas earned value for cost is never advisable.

Keywords: project management, behavioral operations, mental accounting, earned value analysis