Why Are Bad Products So Hard to Kill?

Abstract

It is puzzling that firms often continue to invest in product development projects when they should know that demand will be low. We argue that bad products are hard to kill because firms face an inherent conflict when designing managers' incentives. Rewarding success encourages managers to forge ahead even when demand is low. To avoid investing in low-demand products, the firm must also reward decisions to kill products. However, rewarding managers for killing products effectively undermines the rewards for success. The inability to resolve this tension forces the firm to choose between paying an even larger bonus for success and accepting continued investment in low-demand products. We explore the boundaries of this argument by analyzing how the timing of demand information affects product investment decisions.product development, managerial incentives, moral hazard, adverse selection, information acquisition

Deadlines in Product Development

“…Reasons include project managers' excessive optimism (March and Shapira 1987), escalating commitment to chosen paths (Boulding, Morgan and Staelin 1997), and ignorance of negative information (Biyalagorsky, Boulding and Staelin 2006). Simester and Zhang (2010) find that bad products are hard to kill because managers have better knowledge about project quality. Rewarding managers for killing bad products weakens their incentive to work -they can always shirk effort, claim that the project is bad, and be rewarded.…”

“…Rewarding managers for killing bad products weakens their incentive to work -they can always shirk effort, claim that the project is bad, and be rewarded. We share Simester and Zhang (2010)'s view that firms' tradeoff between project returns and payroll costs affects their project termination decisions. Our paper complements this literature by asking when firms would find it optimal to terminate a project that is still worth continuing.…”

“…(Section 5.1 shows that the firm cannot improve profits by committing to a long-term contract.) The agent enjoys an outside utility of zero, and holds limited liability to the firm (Simester and Zhang 2010). Therefore, in period t the firm will optimally pay the agent a wage normalized to zero if success is not achieved.…”

On the sunk-cost effect in economic decision-making: a meta-analytic review

“…Some researchers argue that the sunk-cost effect has often been confounded and confused with other effects, such as the project completion effect (Garland and Newport 1991;Conlon and Garland 1993;Garland and Conlon 1998;Boehne and Paese 2000;Jensen et al 2011). In addition to the reasoning with behavioral mechanisms, some researchers argue that such biases are due to informational asymmetries or inefficiencies (Shin 2008;Simester and Zhang 2010).…”

Harbingers of Failure

“…The new product development literature has identified escalated commitment (Boulding, Morgan and Staelin 1997;Brockner and Rubin 1985;Brockner 1992,), an inability to integrate information (Biyalagorsky, Boulding and Staelin 2006) and distortions in management incentives (Simester and Zhang 2010) as possible explanations. Our identification of this class of Harbingers provides an alternative explanation.…”