An investment bubble is a period of excessive, and predictably unpro…table, investment(DeMarzo, Kaniel and Kremer, 2007, p.737). Such bubbles most often accompany the arrival of some new technology, such as the tech stock boom and bust of the late 1990s and early 2000s. We provide a rational explanation for investment bubbles based on the dynamics of learning in highly uncertain environments. Objec-tive information about the earnings potential of a new technology gives rise to a set of priors, or a belief function. A generalised form of BayesRule is used to update this set of priors using earnings data from the new economy. In each period, agents who are heterogeneous in their tolerance for ambiguity make optimal occupa-tional choices, with wages in the new economy set to clear the labour market. A preponderance of bad news about the new technology may nevertheless give rise to increasing rm formation around this technology, at least initially. To a frequentist outside observer, the pattern of adoption appears as an investment bubble.

with specified probabilities. A typical riskless decision concerns the acceptability of a transaction in which a good or a service is exchanged for money or labor. In the first part of this article we present an analysis of the cognitive and psychophysical factors that determine the value of risky prospects

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Gresham’s law has one precondition: If there is a fixed rate of exchange between bad and good money, then bad money could drive out good. We argue that when (1) there is no fixed exchange rate between bad and good money, and (2) when the government encourages free coinage, then there is a

The functional relationship between sunk costs and the decision to continue investment in a research and development (R&D) project was examined in an experiment with 407 undergraduate business students. Ss read an R&D scenario in which 10%, 30%, 50%, 70%, or 90% of a $10 million budget had been invested. One group of Ss indicated the likelihood of their allocating all remaining funds to finish the project. A second group indicated the likelihood of their allocating the next $1 million to continue the project. A third group indicated the likelihood that the project would be profitable. Strong, linear sunk-cost effects were observed in the fust 1 groups, with no indication that incremental costs played any role in decision making. Nonsignificant results in the 3rd group suggest that the eifects observed in the 1st group were not a function of higher outcome expectations among Ss with higher sunk costs. Sunk-cost effects have been observed in both business and personal decisions In two recent experiments, Garland and Newport (in press) examined sunk-cost effects from an information-processing perspective. In these experiments, absolute sunk costs (i.e, dollars expended) and relative sunk costs (i.e., dollars expended as a proportion of some overall project budget) were manipulated orthogonally. Consistent with derivations from prospect theory four different escalation situations and two different subject populations. Despite existing evidence for sunk-cost effects, numerous questions remain about the relation between sunk costs and decisions to escalate investments in ongoing projects. The research presented in this article was designed to address three such questions. First, previous research has generally involved a simple dichotomous manipulation of sunk costs (e.g., committing funds to begin a new project vs. committing funds to a project that has already involved a substantial investment). However, sunk costs, whether measured as a budget percentage or in raw dollars, form a naturally continuous scale. Thus, there is a need for experimental studies in which sunk costs are manipulated parametrically. This would allow for the examination of the functional relationship between sunk costs and willingness to incur additional costs to persist with a project. In the present research, sunk costs were manipulated at five levels, with 10% to 90% of a project budget previously expended. Second, although Garland and Newport (in press) found strong evidence for sunk-cost effects, their dependent measure asked subjects to indicate the likelihood of their committing all remaining funds in the budget to the project under consideration. With this measure, the proportion of a budget expended is perfectly and inversely correlated with, incremental costs (e.g., when $9 out of $10 million has been spent, there is a $1 million incremental cost associated with project completion; when only $1 out of $10 million has been spent, the incremental cost for completing the same project is $9 million). Thus, the strong effects observed by Garland and Newport may have been due to a normatively rational, prospective consideration of incremental costs rather than sunk costs. In the present research, subjects in one condition were asked 728

This study focuses on the political and institutional influences that lead organizational decision makers to avoid terminating unsuccessful investments, even when there is competition and they have the experience and incentives to maximize profits. I examine multilevel influences on sequential investment decisions in the U.S. venture capital industry through a qualitative study of the investment process and a quantitative examination of venture capital investments between 1989 and 2004. Results show that venture capital firms become less likely to terminate investments as they participate in more rounds of financing, despite evidence that expected returns are declining over rounds. Intraorganizational politics, as well as coercive and normative pressures from co-investors and limited partners, may influence the decisions to continue or terminate investments, regardless of the expected returns. The findings suggest that organizational safeguards designed to mitigate individual biases may give rise to political and institutional influences, which may in turn undermine the effectiveness of the decision process. • Bounds on individual rationality shape and constrain the efficacy of organizational decisions (e.g., March and Simon, 1958; Cyert and March, 1963). From a normative perspective, organizations should be able to avoid individual decision errors for several reasons. First, organizations have at their disposal several safeguards, such as monitoring or incentives that

We construct an agency model in which the planner (agent) makes project starting and termination decisions on behalf of the state (principal) to reflect the practice of socialist economies. The model shows that asymmetric information between the state and the planner regarding the quality of projects started leads to the persistence of unprofitable projects in most cases. Since in the model it is assumed that the state's objective is to maximize economic profit and the state has full power to dictate and enforce the optimal contract, the finding of the model has the implication that hardening budget constraints in socialist economies is difficult even under an "ideal " setting when these economies are free of social considerations and political frictions.

* We would like to thank Gary Gorton, Raphael de la Porta and an anonymous referee for useful comments. Kroszner would like to thank the Lynde and Harry Bradley Foundation for research

Recent currency and bond trading losses at Barings and Daiwa banks illustrate the willingness of managers to over-commit resources to a course of action in which sunk costs have been incurred and which by any rational standards should have been long discontinued. An international study of the determinants of managerial risk-taking is important because it sheds light on the extent to which aggressive decision-making reported in north American literature is prevalent elsewhere, and whether there are systematic differences between behaviours in different countries. The study has important implications for the practice of management. For example, by knowing cross-cultural differences in willingness to take risk, and to act in one’s individual rather than the general interest, managers in transnational corporations would be better able to predict risk-taking behaviours and adjust internal risk management systems accordingly. One of the more difficult management decisions is to decide whether to continue to commit resources to a risky and highly uncertain project (to escalate it), or to abandon it, after a great deal of corporate investment, and possibly personal commitment and reputation, have already been used up. Recent unauthorized speculation by financial traders in Barings and Daiwa banks are spectacular examples of the escalation of decisions which could and should have been terminated much sooner than they actually were. An understanding of the factors which lead to and exacerbated this escalation behaviour, and how they vary between national cultures, is therefore important to managers of multinational organizations if the risk of similar

Abstract We study an economy where all goods entering preferences or production processes are indivisible. Fiat money is added as an additional perfectly divisible parameter which may, but which does not have to be used in order to facilitate exchange. Unlike the standard Arrow-Debreu model