ARE SUNK COSTS IRRELEVANT? EVIDENCE FROM PLAYING TIME IN THE NATIONAL BASKETBALL ASSOCIATION†

I. INTRODUCTION "Sunk costs are irrelevant," is a common mantra of price theory, but our students seldom believe this claim--and for good reason. Political and corporate leaders alike appeal to sunk costs to justify future policies. The "escalation effect," which Borland, Lee, and Macdonald (2011) define as, "commitment to a previous decision despite the expected marginal benefit of that commitment being less than expected marginal cost," has become a key element of behavioral economics, dating back to seminal work by Thaler (1980) and Tversky and Kahneman (1981), and of economic experiments (e.g., Khan, Salter, and Sharp 2000). Most evidence regarding the relevance of sunk costs stems from anecdotes or artificial experiments. We provide a real-world test of the escalation effect by estimating the impact of draft position, particularly lottery and first round status, on playing time in the National Basketball Association (NBA). Whether a team maximizes wins or profits, it should give the most playing time to its most productive players regardless of how they were acquired. (1) However, sports commentators constantly report that teams are committed to specific players because they had used high draft choices or paid high prices to obtain them, a classic application of the escalation effect. The abundance of data on productivity and playing time allows us to test whether teams give first-round draft picks or lottery picks more playing time than other players after accounting for performance. We build on earlier studies of playing time in the NBA by Staw and Hoang (1995) and by Camerer and Weber (1999) (hereafter "CW") by employing data and techniques that have only recently been widely used. Our estimation builds on Staw and Hoang and on CW in three ways. First, our more recent data avoid possible problems of heterogeneity. Second, we have access to variables that better measure playing time and player productivity, its main determinant. Third, and most importantly, we focus more on the transition between discrete states--lottery versus nonlottery and first versus second round--than on the precise order of draft picks. This shift of focus leads us to use regression discontinuity (RD) analysis. RD enables us to avoid omitted variable bias and thus to discuss causality when evaluating how crossing such thresholds as the lottery or the first-round of the draft affects playing time. The next section of this article briefly reviews the literature on sunk costs, with particular attention to Staw and Hoang (1995) and CW. The third section shows that our data are consistent with those used by previous studies by applying CW's framework and variables to our data. Section IV explains the relevance of regression discontinuity and presents the empirical model. Section V addresses several potential threats to the validity of our RD estimates. The sixth section presents and discusses our results. The seventh section concludes. II. THE BEHAVIORAL ECONOMICS OF SUNK COSTS Standard neoclassical theory claims that sunk costs have no bearing on current choices because they affect neither marginal benefit nor marginal cost. However, Thaler (1980) and Tversky and Kahneman (1981) cite psychology studies dating back to the 1950s showing that subjects consider previous expenditures of money or effort when making decisions. Their findings thus contradict the core neoclassical assumption that agents behave rationally. Despite the controversy over sunk costs and their centrality to the neoclassical-behavioral debate, there is little rigorous empirical analysis of their role in decision-making. One of the few tests comes from Staw and Hoang (1995). Using data for players drafted in the first two rounds of the 1980-1986 NBA drafts, (2) they regress playing time per season on draft position, performance measures, and such control variables as race and nationality conditional on players' years of experience. …