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Interrogating the Sunk Cost Fallacy

photograph of cruise ship sinking

It’s Saturday afternoon. You are lazing on the couch, thinking about your evening. You had planned to attend a concert, but you’re feeling tired. You realize that you would, on the whole, have a much better evening if you stayed home. So, you decide to skip the concert.

I think we can all agree that this would be reasonable. But let’s add a detail. You already purchased a concert ticket for $400, which you can’t recoup. Should you go to the concert, after all?

Regardless of what you should do, many of us would go to the concert, in full knowledge that staying in would be time better spent, because we have already paid for the ticket.

This is an example of what’s often called the ‘sunk cost fallacy.’

Here’s another example. Your family has booked an expensive vacation to Yosemite with the intention of having a fun, relaxing vacation. Unfortunately, though, Yosemite is on fire. You know that if you take the vacation as planned, you will be forced to stay indoors on account of the smoke and will experience virtually no fun or relaxation. Yet the money you spent on booking can’t be recouped. The only other option is a staycation, which would be low-grade fun and relaxing.

A family that decides to go on vacation simply because they have already invested resources into that vacation honors sunk costs.

Psychologists tell us that humans regularly honor sunk costs. That this tendency is irrational is often considered axiomatic and taught as such. For example, the textbook Psychology in Economics and Business proclaims:

Economic theory implies that historical costs are irrelevant for present decision making and only [present and future] costs and benefits should be taken into account. In everyday life, however, this implication of economic theory is frequently neglected thus forming another instance of irrational behavior.

The underlying idea is something like the following. The rational actor aims to promote the best possible outcome. This requires him to attend to the potential consequences of his actions. But sunk costs are by definition unrecoverable. So, the rational actor shouldn’t take them into account in deciding what to do. Someone who foregoes better outcomes simply because he has incurred costs that are irretrievably lost irrationally leaves goods on the table for nothing in return. He compounds, rather than recoups, his losses.

This seems reasonable enough. But things are not quite as simple as they seem.

First, the claim that “historical costs are irrelevant for present decision making” can easily be misunderstood.

Sometimes actors should attend to sunk costs because those costs constitute evidence bearing on the likelihood of future success.

A firm that has invested extensive resources into a fruitless project would be foolish to ignore those investments when deliberating about whether to continue dedicating resources to the project, since the sunk costs may constitute good evidence that future investments will also be fruitless.

Moreover, sometimes what looks from the outside like honoring sunk costs is really something else. Suppose you know that if you choose not to go to the concert, you will inevitably feel bad about wasting money. In this case, it might be perfectly rational for you to attend the concert in order to avoid this feeling. Or suppose you know that skipping the vacation will cause family conflict to bubble up down the line. Again, it might be all-things-considered best to go to Yosemite despite the smoke. True, the underlying dispositions may be irrational. But individuals can’t always control their emotions, and families can’t always control their dynamics. A rational actor must act within the constraints that apply to him. To those who are unaware of those constraints, a rational action can look irrational.

All this can perhaps be acknowledged by the defender of sunk cost orthodoxy. However, several philosophers have argued that this orthodoxy is mistaken.

One reason for being suspicious is that the tendency to honor sunk costs can be leveraged in useful ways. The philosopher Robert Nozick has argued that it can be utilized to counteract the tendency to act against one’s considered judgment about what one should do. Suppose that on Friday you think that you should go to the concert on Saturday because it will be educational, but you anticipate that once Saturday afternoon rolls around you will have trouble mustering the motivation to get off the couch. If you know that you have a tendency to honor sunk costs, then you can, on Friday, increase the likelihood that on Saturday you will do what you think you should do by purchasing the ticket in advance. Similarly, the tendency to honor sunk costs can be utilized to convince others that you will do something. You might be able to convince an incredulous friend that you will attend the concert by showing them that you have already purchased a ticket; if your friend knows that you tend to honor sunk costs, this will give them good reason to believe that you will attend the concert.

There’s more. The doctrine that present actions can’t touch past events, which is implicit in the sunk cost orthodoxy, is not entirely true.

While it’s true that present actions can’t have a causal impact on past events, present actions can change the meaning of past events in ways that matter to us. And as Thomas Kelly has argued, this can make it reasonable to attend to sunk costs.

Tolstoy’s Anna Karenina provides an illustrative example. Anna leaves her husband and beloved child to start a new life with her sybaritic lover, Vronsky. The new relationship fails terribly. In a famous discussion, British philosopher Bernard Williams points out that this failure seems to retroactively tarnish Anna’s decision by showing it to have been unjustified. In contrast, had her relationship flourished, this would have vindicated the cost she incurred. The intuition that success or failure can retroactively vindicate or tarnish a costly choice is not uncommon in human life. It’s not hard to imagine that Anna would have preferred that the cost she paid to start her new life with Vronsky not turn out to have been fruitless. And if she were to have such a preference, this would give her reason to take the fact that she paid this cost into consideration when deliberating about, say, whether to try to salvage her relationship with Vronsky. Thus, sometimes it seems to make rational sense to honor sunk costs.

Then there is the issue of moral sunk costs. Suppose you are a general in charge of deciding whether to authorize a mission to rescue two hostages. You know that the rescue mission will very probably succeed but also cost the life of one soldier. Let’s assume that you are morally justified in sacrificing up to one life to save the two hostages. You authorize the mission. Unluckily, the mission is unsuccessful, and a soldier dies. Then another opportunity arises. You can authorize a second rescue mission, which you know is guaranteed to succeed but will cost the life of another soldier. The question is this:

Is it morally acceptable to authorize this second mission, given that one soldier has already died and we stipulated that you are only justified in sacrificing up to one life to save the hostages?

In other words, should we honor moral sunk costs?

Ethicists disagree on this issue. Some think that assessments of moral costs and benefits should be prospective, ignoring sunk costs. On this view, you should authorize the second mission. Others argue that there’s an overall limit to the moral costs that can be justifiably incurred to achieve a worthwhile objective, meaning that moral sunk costs should be taken into account. On this view, you shouldn’t authorize the mission. Still others adopt an intermediate approach. The point, for our purposes, is that the answer to this question is non-trivial. To treat one answer as axiomatic is a mistake.

All this is to say that authoritative pronouncements decrying the tendency to honor sunk costs as clearly irrational are misleading at best. It’s not at all obvious that “[a] rational decision maker is interested only in the future consequences of current investments,” as the esteemed economist Daniel Kahneman put it. There are cases, like the original concert example, perhaps, where this is true. And it may always be irrational to choose an outcome merely because one has incurred sunk costs. But in many cases, it seems to make perfect sense to account for sunk costs in deliberation. We just need to be reflective about how and why we do so.