In Too Deep: The Effect of Sunk Costs on Corporate Investment

ABSTRACT Sunk costs are unrecoverable costs that should not affect decision making. I provide evidence that firms systematically fail to ignore sunk costs and that this leads to significant investment distortions. In fixed‐exchange‐ratio stock mergers, aggregate market fluctuations after parties enter into a binding merger agreement induce plausibly exogenous variation in the final acquisition cost. These quasi‐random cost shocks strongly predict firms' commitment to an acquired business following deal completion, with an interquartile cost increase reducing subsequent divestiture rates by 8% to 9%. Consistent with an intrapersonal sunk cost channel, distortions are concentrated in firm‐years in which the acquiring CEO is still in office.