«Information Systems Project Continuation in Escalation Situations: A Real Options Model Amrit Tiwana Iowa State University, College of Business, 2340 ...»
Decision Sciences C 2006, The Author
Volume 37 Number 3 Journal compilation 2006, Decision Sciences Institute
Information Systems Project Continuation
in Escalation Situations: A Real
Iowa State University, College of Business, 2340 Gerdin Business Building, Ames, IA, 50011,
Department of Computer Information Systems, J. Mack Robinson College of Business, Georgia State University, 35 Broad Street, Room 919, Atlanta, GA 30303, e-mail: firstname.lastname@example.org Robert G. Fichman Department of Information Systems, Boston College, Carroll School of Management, 452B Fulton Hall, Chestnut Hill, MA 02467-3808, email: ﬁchman@bc.edu
Subject Areas: Decision Making, Escalation, Information Integration, Information Systems, Innovation Management, Investment Decisions, Project Continuation, Project Management, and Real Options.
† Corresponding author.
IS Project Continuation in Escalation Situations
INTRODUCTIONAn escalation situation exists when there is “decision making in the face of negative feedback about prior resource allocations, uncertainty surrounding the likelihood of goal attainment, and choice about whether to continue” (Brockner, 1992, p. 122).
The bulk of prior work on escalation has sought to understand apparently irrational instances of escalation where actors persist in courses of action that they could (or should) have known were destined to fail (Staw, Sandelands, & Dutton, 1981;
Brockner, 1992). The main goal has been to isolate nonrational factors (i.e., those leaving the project payoff structure unaffected) that reinforce escalation tendencies.
For example, managers are more likely to escalate when they have a greater need for self-justiﬁcation, when sunk costs are higher, and when they hold asymmetric information about project status (Keil, 1995).
Despite the primary focus on nonrational factors, escalation researchers have acknowledged the possibility of other rational factors that promote escalation in the presence of negative feedback. An early literature review by Staw (1981) included two rational factors—probability of future outcomes and value of future outcomes—as determinants of continuation tendencies. Bowen (1987) argued that instances of escalation often involve equivocal information about project status and future prospects and that in such cases the common understanding of escalation as an irrational process of throwing good money after bad would not necessarily hold.
In fact, there can be numerous subtleties not readily apparent to external observers that could promote project continuation in spite of negative feedback about project status. In the context of information technology (IT) investment projects, Keil and Flatto (1999) suggested that one of these subtleties is the presence of real options in a given project. In particular, they argued that, in instances that appear to be unwarranted (i.e., irrational), escalation may actually be warranted (i.e., rational) escalation were the value of real options taken into account. In this research, we examine whether real options actually do increase the propensity to engage in what we call warranted continuation in escalation situation, that is, a normatively rational continuation of a troubled IT project that has continued uncertainty about goal attainment.
Opportunities to embed real options are pervasive in IT projects (Benaroch, 2002). A project embeds real options when managers have the opportunity (but not the obligation) to adjust the future direction of the project in response to external or internal events. These adjustments can take the form of deferring the project, switching the project to serve a different purpose, changing the scale of the project, implementing it in stages, abandoning the project, or using the project as a platform for future growth opportunities. Yet, real options, which can represent a substantial portion of a project’s value (Taudes, Feurstein, & Mild, 2000), rarely enter into a project’s formal justiﬁcation process in practice. Instead, quantitative project valuations are typically based on traditional discounted cash ﬂow techniques such as net present value (NPV) that ignore option value (Busby & Pitts, 1997). Naturally, formal post-mortems are likely to focus on how actual experience comported with expectations on this same NPV basis.
Even though real options are rarely considered explicitly, some studies beyond the IT context indicate that operational managers often implicitly recognize Tiwana, Keil, and Fichman 359 the value of real options (Busby & Pitts, 1997; Kogut & Kulatilaka, 2004). Therefore, there may be instances in which projects that appear to external reviewers employing an NPV logic to have undergone an irrational escalation actually underwent a warranted continuation owing to implicit recognition by operational managers of real options external to the original justiﬁcation decision. However, this would only be a pervasive phenomenon if it were true that operational IT managers were likely to place a signiﬁcant value on real options and were more prone to continue troubled projects when they do.
In this research, we investigate the effects of real options on IT project continuation in escalation situations. Our approach is to use a conjoint study to examine how the presence of one or more different option types affect managers’ perceptions of project value and their expressed likelihood of continuing investment in troubled projects. In particular, we study escalation scenarios where there is negative feedback and considerable uncertainty about goal attainment and where managers should be indifferent toward continuation from a traditional NPV perspective (i.e., the NPV is set at zero). Making the base-case indifference toward continuing allows us to better isolate the effects of having one or more real options present.
The key question for us is not whether IT managers might place some positive value on real options. Prior research outside IT (Busby & Pitts, 1997) suggests that they often do, and we see no obvious reason why either the IT project context or the escalation context per se would prevent managers from recognizing option value. Rather, we see the key research issues as being: (i) how strongly option value translates into an increased propensity to continue a troubled project and (ii) what differences exist in how different types of real options (i.e., to switch use, change scale, stage investments, abandon, or strategically grow a project) are valued in escalation situations. The ﬁrst issue gives an indication of how pervasive the phenomenon of warranted continuation due to recognition of options might be in practice. The second issue can provide some initial insights into possible biases in how options are valued.
Our results show that the presence of real options does lead to a tendency toward continuing projects (i.e., warranted continuation), and this tendency increases with the number of real options that are present. Second, our results show that in escalation situations managers place a much higher value on options that spawn new investment opportunities (strategic options), as compared with options that allow them to reconﬁgure such elements as the timing, scale, and scope of an investment (operating options). Some options, such as the option to abandon, are given very little comparative value.
Negative feedback about project progress and uncertainty about goal attainment are very common occurrences on IT projects (Wallace, Keil, & Rai, 2004).
Decisions about whether to continue or to terminate these troubled IT projects are among the most difﬁcult that IT managers face. To come to a full understanding of these escalation situations and to advise managers appropriately, researchers must endeavor to sort out the rational forces from the nonrational. This study complements the large body of previous work examining nonrational factors that promote unwarranted escalation by considering a pervasive but subtle rational factor—the presence of real options—that could lead to warranted continuation.
IS Project Continuation in Escalation Situations The remainder of the article proceeds as follows. In the next few sections, we review the relevant literature on escalation, describe real options analysis (ROA), and use real options theory to develop our hypotheses. Then we describe the methodology and data collection and present our analyses and results. Finally, we discuss the theoretical and normative implications of these results, identify directions for future research, and conclude with a summary of the study’s key contributions.
ESCALATION AND REAL OPTIONSEscalation of Commitment The concept of escalating commitment refers to the human tendency to adhere to a course of action even in the face of negative information concerning the viability of that course of action (reviews of the escalation literature can be found in Staw & Ross, 1987a; Brockner, 1992). Much of the prior literature characterizes escalation as a phenomenon that arises from ﬂawed decision-making processes. The prevailing view is that these ﬂawed—often irrational—decision-making processes lead to ﬂawed decisions and dysfunctional organizational outcomes. As Brockner et al.
(1986, p. 122) observe: “The tendency for decision makers to continue allocating resources to an ineffective course of action can be extremely maladaptive, both for individuals and organizations.” A similar perspective is expressed by Staw and Ross (1987a), who tend to view escalation as a dysfunctional response.
In fact, all three dominant theoretical perspectives that have been invoked to explain the phenomenon—self-justiﬁcation theory, prospect theory, and agency theory—paint escalation behavior as irrational. Self-justiﬁcation theory describes escalation as an attempt by individuals to rationalize their previous behavior against a perceived error in judgment (Staw & Fox, 1977). Prospect theory describes escalation behavior as decision makers acting contrary to the invariance criterion of rational choice (Kahneman & Tversky, 1984). Similarly, agency theory views escalation behavior as the agent pursuing a course of action that is irrational from the principal’s perspective (Harrison & Harrell, 1993). Normative prescriptions in the literature suggest that an escalated project should be terminated because it is irrational to throw good money after bad (Boehm, 1981; Staw & Ross, 1987b).