The Effects of Mental Accounting on Project Performance

34 Pages Posted: 4 Nov 2018 Last revised: 9 Aug 2019

See all articles by Manel Baucells

Manel Baucells

University of Virginia - Darden School of Business

Yael Grushka-Cockayne

University of Virginia - Darden School of Business; Harvard University - Business School (HBS)

Woonam Hwang

University of Utah - David Eccles School of Business

Date Written: October 13, 2018

Abstract

Problem Definition:
Project managers are responsible for setting and then revising projects' goals. As uncertainty related to project performance is resolved, a project manager is tasked with comparing ongoing costs, and potentially achieved scope, to a baseline plan. We question whether project managers can rationally anticipate and track this revision process.

Academic/Practical Relevance:
In practice, projects often fail to meet their goals and are subject to changes in scope, cost, and scheduled time. We consider the implications of behavioral tendencies and the revision strategy on decisions made and on overall project performance.

Methodology:
Our stylized model compares a rational project manager to a behavioral one. Specifically, we offer a framework for modeling mental accounting—which includes loss aversion and reference point updating—and narrow framing. We use the model to explore how project-level decisions are made.

Results:
We show that mental accounting results in insufficient adjustments of project scope and cost during revisions, and prevents abandoning projects even when doing so is optimal. Ultimately, mental accounting and narrow framing decrease projects' actual profits.

Managerial Implications:
We offer practical prescriptions for mitigating harmful effects of loss aversion, reference-point updating, and narrow framing. Beyond training, hiring less loss averse project managers, and practicing scenario planning, we show that reviewing a project using a cost milestone instead of a scope milestone helps maintain the reference cost equal to the budgeted cost, thereby inducing overall better decisions.

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

Suggested Citation

Baucells, Manel and Grushka-Cockayne, Yael and Hwang, Woonam, The Effects of Mental Accounting on Project Performance (October 13, 2018). HEC Paris Research Paper No. MOSI-2018-1317; Darden Business School Working Paper No. 3265724. Available at SSRN: https://ssrn.com/abstract=3265724 or http://dx.doi.org/10.2139/ssrn.3265724

Manel Baucells

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States

Yael Grushka-Cockayne

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States

Harvard University - Business School (HBS) ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

HOME PAGE: http://https://www.hbs.edu/faculty/Pages/profile.aspx?facId=263650

Woonam Hwang (Contact Author)

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

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