Escalation and premature termination in MIS projects: the role of real options

The purpose of this paper is to examine how the real option theory is applicable to evaluation of cases of escalation and premature termination of Management Information Systems (MIS) projects.

The paper compares the implications of psychological and economic escalation theories with lessons from the real option theory as applied to MIS projects. Then, it examines published case studies, and discuss when project continuation enhances and reduces value for the manager and the firm.

Escalation of commitment is continuation of an investment project after receiving negative signals. Escalation was identified as a significant problem in MIS projects often explained by the desire of the manager to avoid recognizing mistakes and to protect reputation. The opposite problem of premature termination of certain investment projects was also identified. This study argues that accurate application of real option theory is critical to distinguish between escalation and premature termination. Under the real option theory, an investment project is analogous to a financial option, in that there is an opportunity to continue the project, but no obligation. Continuation has value when there is uncertainty and new information about the project may be revealed. Failure to account for the real options in a project is value‐reducing as it may lead to mistakes in premature termination of projects when projects with real option value are labeled as cases of irrational escalation.

The paper details the implications of real option theory to evaluating project continuation in the MIS setting.

This paper applies insights from real option theory to studies of escalation in MIS. Continuing a project may be seen as escalation when it actually has value for the firm, as new information received by continuing the project reduces uncertainty.