The Sunk Cost Fallacy and Endowment Effect in Nonprofits

The sunk cost fallacy is present when organizations invest resources in a failing endeavor simply because they have already incurred costs (1,2). The organization may attempt to justify past expenditures rather than make rational decisions based on future benefits.

Nonprofits can engage in this fallacy when they persist with programs ineffective programs simply because they have already invested heavily in them. For example, a nonprofit may continue a financial literacy workshop that has shown no improvement in community economics simply because they spent years developing the curriculum.

The endowment effect is present when an organization overvalues something simply because it possess the object (3,4). This is closely related to the sunk cost fallacy. The endowment effect differs from the sunk cost fallacy in that it is the “owning” of the object, rather than the developmental expenditure, that creates the endowment effect. There may have been no costs to obtaining the object. In essence, people and organizations so dislike giving up something they own that they may place a higher than reasonable value on the item.

Nonprofits can engage in this bias when they hold onto outdated programs, branding, or strategies because they feel a strong attachment. For example, a nonprofit might decline a partnership with another organization because they fear changes to their established programming. This could occur despite the partnership being beneficial to both organizations and the community.

These emotional attachments can prevent organizations from decisions that would best serve their stakeholders. To avoid these biases:

1. Nonprofits should directly assess at planning meetings whether these biases may be operating.

2. Nonprofits should adopt a forward-looking, evidence-based approach to decision-making through regularly scheduled evaluations of program impact.

3. Nonprofits should celebrate strategic shifts that align with their mission rather than mourn “failed” investments.

References:

1. Arkes H. & Blumer C. The psychology of sunk cost. Organizational Behavior and Human Decision Processes, 1985; 35:124-140.

2. Thaler R. Mental accounting matters. Journal of Behavioral Decision Making, 1999; 12:183-206.

3. Thaler R. (1980). Toward a positive theory of consumer choice. Journal of Economic Behavior & Organization, 1980; 1:39-60.

4. Kahneman D. Knetsch J. & Thaler R. (1990). Experimental tests of the endowment effect and the Coase theorem. Journal of Political Economy, 1990; 98:1325-1348.

Disclaimer for Educational Content

The information provided on this website, through our blog, courses, webinars, or any other form of communication, is for educational purposes only and is not intended to be a substitute for professional advice. While we strive to provide accurate and up-to-date information, we make no guarantees regarding the accuracy, completeness, or effectiveness of the content.

No Financial, Legal, or Investment Advice
The content is not intended to provide financial, legal, or investment advice. Any strategies or information shared are meant for general education only and may not be suitable for your specific financial or business situation. Always consult with a licensed professional before making any decisions based on the information provided.

Not Responsible for Outcomes
The creators of this content are not responsible for any decisions or actions taken based on the information presented. By using this content, you acknowledge that any financial or business decisions are made at your own risk. We do not guarantee any specific results, including but not limited to financial success, business growth, or improved financial literacy.

Accuracy of Information
While we make every effort to ensure the information shared is accurate and reliable, we cannot guarantee that all content is free of errors. We recommend verifying any information through multiple sources or consulting with an expert before relying on it.

Third-Party Links and Resources
We may provide links to third-party websites or resources for your convenience. However, we do not endorse, control, or guarantee the accuracy of any third-party content. Accessing such resources is done at your own discretion and risk.

Limitation of Liability
In no event will the creators, owners, or affiliates of this website be held liable for any direct, indirect, incidental, special, or consequential damages arising from the use or inability to use the content provided, even if we have been advised of the possibility of such damages.

Changes to Content
We reserve the right to update or modify the content at any time without notice. Please check back periodically for updates.