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Financial Slack, Risky Decision Making and Escalation of Commitment

Author: HeChao
Tutor: TangYang
School: Tianjin University of Commerce
Course: Accounting
Keywords: Financial Slack Risk Propensity Risk Perception Escalation ofCommitment Sitkin&Pablo risk behavior model
CLC: F275
Type: Master's thesis
Year: 2012
Downloads: 122
Quote: 0
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Abstract


After reviewing the extant research on escalation of commitment carefully, we findthat all were based on an important assumption, that is, enough low cost resource isavailable to satisfy enterprise’s investment demand at any time. The former researchesjust focus on human being’s psychological bias as well as incentives to explain whydecision makers would usually prefer to persist with the failing course of action. So,whether the enterprise have enough low cost resource slack to meet the need ofinvestment, especially financial resource slack, has never been conducted effectively,of which is one of two essential conditions due to escalating behavior argued by MengMeng(2007). Also, in the areas of strategic management, recourse slack is deemed asan important f to promote organization growth and drive new product innovation. So,in this paper, we want to examine the affection of financial slack on decision maker’strend to continue investing, and simultaneously inspecting the psychology activitythrough two variables, namely, risk propensity and risk perception.We employ our college’s students to conduct a laboratory experiment and find thefollowing results:(1) Financial slack is negatively related to risk perception.(2)Financial slack is positively related to escalation of commitment.(3) Risk perceptionis fully mediated the effects of financial slack on escalation of commitment. Inaddition, we also try to further prove the Sitkin&Pablo risk behavior model inperspective of escalation of commitment, which Wong(2005) argue has conceptualoverlap with risk behavior. Results show that:(1) Risk propensity is negatively relatedto risk perception.(2)Risk propensity is positively related to escalation ofcommitment.(3) Risk perception is negatively related to escalation of commitment.(4)Risk perception is fully mediated the effects of risk propensity on escalation ofcommitment.One contribution of the present study is its empirical demonstration of the missingrole of financial slack in escalation of commitment by existing literature. And usingSitkin&Pablo risk behavior model, we first systemically examine psychologicalmechanism under escalation scenarios. There are also four important practical implications of the present study. First, we should take high alert of enterprise whichhas enough financial slack, because its manager would have low risk perception andtrend to continue to increase investment to a failing project. Second, risk propensity’positive relationship with escalating tendency inspire us to select appropriatemanagers according to special feature of the project, while risk perception’s negativeaffection told us that de-escalation through adjusting manager’s risk perception is aneasy and effective method. Finally, we can monitor and forecast the occurrence ofescalation of commitment through assessing manager’s risk propensity as well as riskperception.

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CLC: > Economic > Economic planning and management > Enterprise economy > Corporate Financial Management
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