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

Abstract

PurposeThe 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.Design/methodology/approachThe 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.FindingsEscalation 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.Practical implicationsThe paper details the implications of real option theory to evaluating project continuation in the MIS setting.Originality/valueThis 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.

Beyond Option Based Investment Decision: A Project Management Approach to System Valuation

“…As mentioned above, current studies that measured the value of risky projects and used NPV or ROA stopped at the initial decision and neglected to investigate the impact of the way the project is managed on its business value. A project includes one or more real option opportunities when managers have the option, but not the obligation to adjust the future direction of the project in response to information about the project's performance [7,24]. Managers should not only recognize opportunities using these options but also manage projects to maximize its expected value.…”

Information Systems Impact on Nurse Call Response – Role of Velocity and Uncertainty

“…For example, real options perspective is used to evaluate the costs and benefits of different approaches, and select future IT investments (Chulkov andDesai 2008, Tiwana et al 2006). Under high velocity or equivocal situations, information gathered may have multiple interpretations -e.g., positive or negative, biased or unbiased (Bowen 1987).…”

Unraveling equivocality in evaluation of information systems projects

“…Several studies pointed the causes to the drawbacks of traditional capital budgeting techniques (Chulkov and Desai 2008;Keil and Flatto 1999;Taudes et al 2000;Tiwana et al 2006;Tiwana et al 2007). Keil and Robey (1999) indicated that escalations may be the result of equivocal situations formed by a lack of clarity about projects' success and failure criteria.…”

“…Unraveling Equivocality in Evaluations of Information Systems Projects (Chulkov and Desai 2008). In certain cases, escalating a project is needed and considered to be rational based on this view (Tiwana et al 2006).…”

“…In these studies, equivocality was a given independent variable and was manipulated in the experiments; thus, the causes of equivocal situations still remain a question mark. Furthermore, most studies concerning equivocality in IS/IT project mainly focused on the common use of capital budgeting techniques (Chulkov and Desai 2008;Keil and Flatto 1999;Taudes et al 2000;Tiwana et al 2006;Tiwana et al 2007). Evaluations using these techniques are argued of having a tendency to systematically underestimate the true value of the projects (Keil and Flatto 1999).…”