In Too Deep: The Effect of Sunk Costs on Corporate Investment

ABSTRACT Sunk costs are unrecoverable costs that should not affect decision making. I provide evidence that firms systematically fail to ignore sunk costs and that this leads to significant investment distortions. In fixed‐exchange‐ratio stock mergers, aggregate market fluctuations after parties enter into a binding merger agreement induce plausibly exogenous variation in the final acquisition cost. These quasi‐random cost shocks strongly predict firms' commitment to an acquired business following deal completion, with an interquartile cost increase reducing subsequent divestiture rates by 8% to 9%. Consistent with an intrapersonal sunk cost channel, distortions are concentrated in firm‐years in which the acquiring CEO is still in office.

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Publication Details

Journal
The Journal of Finance
Published
2025-03-04
DOI
https://doi.org/10.1111/jofi.13430
Citations
4
Primary Topic
Corporate Finance and Governance
Type
article
Field-Weighted Citation Impact
15.64
Controls
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article

In Too Deep: The Effect of Sunk Costs on Corporate Investment

Marius Guenzel
4 citations
The Journal of Finance
Corporate Finance and Governance
15.64
article

In Too Deep: The Effect of Sunk Costs on Corporate Investment

Marius Guenzel
article en
4 citations

Abstract

ABSTRACT Sunk costs are unrecoverable costs that should not affect decision making. I provide evidence that firms systematically fail to ignore sunk costs and that this leads to significant investment distortions. In fixed‐exchange‐ratio stock mergers, aggregate market fluctuations after parties enter into a binding merger agreement induce plausibly exogenous variation in the final acquisition cost. These quasi‐random cost shocks strongly predict firms' commitment to an acquired business following deal completion, with an interquartile cost increase reducing subsequent divestiture rates by 8% to 9%. Consistent with an intrapersonal sunk cost channel, distortions are concentrated in firm‐years in which the acquiring CEO is still in office.

The Journal of FinanceVol. 80(3)
University of Pennsylvania (US)
Openalex Percentile: Top 2%
Corporate Finance and Governance
15.64
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