The Effects of Mental Accounting on Project Performance

32 Pages Posted: 4 Nov 2018 Last revised: 24 Mar 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 Business School

Woonam Hwang

HEC Paris

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. Typically, projects cost more than budgeted, take longer than planned, and are subject to scope changes. We consider the implications of behavioral tendencies, both at launch and at the revision points, 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. In addition, narrow framing discourages launching projects. Ultimately, mental accounting and narrow framing decrease projects' net benefits.

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 using a "cost-based revision" approach helps maintain the reference points constant and equal to the budgeted cost and initial scope, and induces 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. 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 Business School ( 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)

HEC Paris ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France

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