Kerry John Donohue Thesis (PDF 2MB)

A theoretical evaluation and empirical investigation into explanations for the escalation of commitment phenomenon in the particular organisational contexts of Expo 86 and Expo 88

Kerry John Donohue

A thesis submitted in the School of Management at the Queensland University of Technology in fulfilment of the requirements for the degree of Doctor of Philosophy

November, 2006 FORWARD

(i) Keywords ...... iii

(ii) Abstract ...... vi

(iii) Table of Contents ...... viii

(iv) List of Tables...... xiii

(v) List of Figures...... xiv

(vi) Glossary...... xv

(vii) Statement of Original Authorship...... xvi

(viii) Acknowledgement...... xvii

ii KEYWORDS

Management Science. Escalation of commitment. Evaluation Methodology. Utility Theory. Theoretical Modelling.

iii ABSTRACT

Escalation of commitment to failing investments is considered to be representative of biased forms of decision-making which may result in unproductive consequences. Decision makers adopt investment courses of action in initial conditions of uncertainty, which subsequently appear to lead to failure. When confronted with the prospect of their decisions producing losses, they commit decision errors thus escalating their commitment to their original courses of action. Several theories with rational and irrational antecedents have been developed in the literature to explain the escalation phenomenon. Fundamental theoretical differences are associated with the origin of the concept. Escalation of commitment was conceived in the decision theory context of the problem of resource allocation under uncertainty conditions. This thesis describes the resource allocation problem in order to identify and explain associated characteristics. Explanations of these characteristics reveal several problems: there are no decision rules available to handle uncertainty; decision makers consistently violate the requirements for rationality and rational economic decision making; individual utility maximization is divorced from the business objective of profit maximisation and also involves taking increased risks when there is an expectation that investment losses will be recovered; there are several criteria for and methods of investment evaluation which are computationally and analytically difficult to apply; and whether a decision error has been made is indeterminate with some investment projects whose success or failure cannot be determined until after project completion. These problems lead to the conclusion that the determination of the success or failure of an investment decision may depend on the valuation methodology selected. In this respect it is argued that investment decisions undertaken in public organisations should be evaluated using methodologies developed to measure social benefits and costs because calculations of private rates of return provide misleading assessments.

iv Research on the escalation phenomenon is dominated by a psychological perspective, which obtains its findings from extensive investigation of individuals in controlled experimental laboratory conditions. The experimental research has identified personal pre-dispositional, social and situational influences, which contribute to escalation and de-escalation of commitment. The major research focus has resulted in two theoretical explanations for escalation of commitment. These derive from descriptive cognitive motivational theories concerned with expectancy, that encourage rational decision making and dissonance, which in turn produce irrational self justification based decisions. An alternative research focus favours explanations from prospect theory. Research, critical of the psychological explanations favours rational explanations derived from the normative theory of expected utility, which encourages individual self-interested behaviour. This thesis is concerned with explaining escalation of commitment in organisations. This necessarily involves adopting an interdisciplinary perspective. This thesis examines two world expositions, Expo 86 and Expo 88. World expositions are unusual government events whose principal purpose is to celebrate human achievements. Expo 86 was held to celebrate Vancouver’s centenary. Expo 88 was held to celebrate Australia’s bicentennial. They were not designed for their potential profitability. To justify the expenditures involved other objectives are attached to the celebratory purpose. These usually are associated with urban renewal and economic development. They are unorthodox investment projects. They involve long lead times of capital expenditure followed by short operating periods of six months or less, after which time most of the capital improvements are either disposed of or demolished. Expo 86 incurred significant financial losses and was considered an escalation prototype. It became a case study used to develop a generalized theoretical model of escalation. The model specifies how initially formulated rational decisions are replaced progressively by decisions based on self- justification, which escalate commitment. Escalation is reinforced by psychological pre-dispositional, social and structural influences. The model is an extension of research findings from individual laboratory experiments.

v The thesis identifies several plausible alternative theoretical explanations for escalation in organisations. These involve emotional commitment, social influences to conform to group norms, the possibilities for deviating from rational decision making principles in the presence of uncertainly and the agency theory problem which involves individuals pursuing their own rational self interests which are contrary to the objectives of an organisation. Expo 86 was directly linked to urban renewal objectives. The economic project and urban planning studies of Expo 86 concluded that the event successfully achieved the urban development objectives using social cost benefit analysis as the criterion of evaluation. These objectives were rationally conceived and executed. As a result of the examination, the thesis explores the problems associated with investment projects having multiple objectives, looks at how rational explanations can be accommodated in the theoretical model and questions whether calculations of accounting negative rates of return should be the criteria for evaluation and the determinant of whether Expo 86 qualified as a prototypical example of escalation in organisations. The analysis of Expo 88 reinforced these concerns. A longitudinal dimension was adopted in the case study. This enabled the origins of the event to be explored, the objectives to be identified and the project to be evaluated using various private and public investment criteria. Expo 88 qualified as a failed private investment project on all but one of the financial investment criteria employed. The evaluation of Expo 88 as a public investment project produced social benefits and economic impacts in excess of social costs. Expo 88 was conceived by influential individuals who promoted the initiative for an exposition on the basis that its staging would be publicly and personally beneficial. The project was associated with multiple objectives other than its celebratory purpose that included tourism development and urban renewal from which the public was expected to benefit and which promoters believed justified the event. The principal decision makers were not directly influenced by profitability considerations because information had been provided during the planning phase, which indicated that the project would produce financial losses. Because of public pronouncements it became politically necessary to include the profitability of the project as an objective. Various costly and deceptive measures

vi were adopted in order to generate an impression of profitability. At the same time success was promoted publicly and successfully, not in terms of its profitability, but in terms of attendance figures. As a result of the analyses, the theoretical model was modified by incorporating rational motives into the original structure. Decision makers were driven by rational motives over the life of the projects. In the case of Expo 88 these rational motives derived from agency theory relationships and the pursuit of objectives concerned with economic development, celebration and political recognition. The thesis concludes with a discussion of the contributions and limitations of the research. The contributions involve modifications to the theoretical model to reflect the importance of rational motives in the decision making process, generalisation of the causes of escalation in organisations in various contingent circumstances and the impact that multiple project objectives and methodological problems concerned with evaluation criteria have on theory development. The major limitation relates to the selection of public organisations engaged in unorthodox investment projects as inappropriate representatives to examine the escalation phenomenon.

vii TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION...... 1

1.1. PURPOSE AND THEORETICAL CONTEXT ...... 1

1.2. DECISION THEORY CONCEPTS ...... 1

1.3. NATURE OF THE CONCEPTS ...... 2

1.4. CONCEPTUAL AND STRUCTURAL LIMITATIONS...... 3

1.5. ADDRESSING LIMITATIONS FROM THE THEORETICAL AND OPERATIONAL FOUNDATIONS .... 6

1.6. ACCOUNTING FOR THE ESCALATION PHENOMENON...... 8

1.7. THE RESEARCH ISSUES AND THEIR EXAMINATION ...... 16

1.8. RESEARCH METHODS AND RESULTS...... 17

1.9. CONTRIBUTION AND LIMITATIONS OF THE THESIS ...... 19

1.10. SUMMARY ...... 23

CHAPTER 2: FOUNDATIONS FOR THE EVALUATION OF RATIONAL AND EFFICIENT

BEHAVIOUR ...... 25 2 Introduction ...... 25 2.1 The Resource Allocation Problem ...... 28 2.1.1 Definition of the Concept...... 28 2.1.2 Critical Evaluation of the Resource Allocation Problem ...... 32 2.1.3 Summary ...... 34 2.2 The Normative Decision Rules under Risk Foundations: Bernoulli’s Expected Utility Theory...... 35 2.2.1 Explaining Bernoulli’s Concept...... 35 2.2.2 Evaluating Bernoulli’s Concept ...... 39 2.2.3 Summary ...... 41 2.3 Rationality...... 41 2.3.1 Explanation of the Concept...... 41 2.3.2 Behavioural Axioms...... 43 2.3.3 Utility Functions...... 46

viii 2.3.4 Summary ...... 48 2.4 Choice and Utility Maximisation...... 49 2.4.1 Derivation ...... 49 2.4.2 Summary ...... 51 2.5 Utility Max Under Risk Conditions: The Von Neumann and Morgenstern Expected Utility Theory ...... 52 2.5.1 Description of the Concept ...... 52 2.5.2 Critical Evaluation ...... 54 2.5.3 Summary ...... 55 2.6 Firm or Producer Efficiency ...... 55 2.6.1 Requirements...... 55 2.6.2 Summary ...... 58 2.7 Efficiency and Optimisation of Investment Decisions ...... 58 2.7.1 Motives...... 59 2.7.2 Evaluation...... 60 2.7.3 Models...... 66 2.7.4 Summary ...... 67 2.8 Social Efficiency: The Economic Evaluation of Public Welfare Projects...... 68 2.8.1 The Concept...... 68 2.8.2 Critical Evaluation ...... 70 2.8.3 Cost Benefit Analysis...... 73 2.8.4 Evaluation...... 75 2.9 Conclusion ...... 76

CHAPTER 3: REVIEW OF THE LITERATURE ON ESCALATION ...... 78 3 Introduction ...... 78 3.1 Conceptual Development...... 79 3.1.1 Origin of Concept...... 79 3.1.2 Defining Characteristics...... 80 3.1.3 The Sunk Cost Effect...... 82 3.1.4 Summary and Evaluation...... 84 3.2 Progression of the Concept...... 85

ix 3.2.1 Directions of Advancement ...... 85 3.2.2 Assessment...... 86 3.2.3 Psychological Predisposition Influences...... 88 3.2.4 Situational Influences and Contexts...... 89 3.2.5 Situational Inducements...... 91 3.2.6 Summary and Evaluation...... 92 3.3 De-escalation of Commitment ...... 94 3.3.1 De-escalation Prescriptions...... 95 3.3.2 Evaluation...... 96 3.3.3 Summary ...... 96 3.4 Theoretical Explanations for the Escalation Phenomenon...... 97 3.4.1 Dominant Explanations...... 97 3.4.2 Competing Explanations: Prospect Theory ...... 98 3.4.3 Competing Explanations: Agency Theory ...... 102 3.4.4 Competing Explanations: Organisational Commitment...... 106 3.4.5 Competing Organisational Explanations: Satisficing Behaviour ...... 108 3.4.6 Competing Organisational Explanations: Group Influences ...... 111 3.4.7 Competing Organisational Explanations: Coalitions of Rational Self Interested Individuals ...... 113 3.4.8 Sources of Theoretical Controversy ...... 115 3.5 The Dominant Theoretical Explanations ...... 119 3.5.1 Psychological Decision Theory...... 119 3.5.2 Expectancy Theory ...... 120 3.5.3 Dissonance Theory ...... 120 3.5.4 Methodological Issues Associated with Dissonance Theory ...... 123 3.5.5 Summary ...... 124 3.6 Research Issues...... 126 3.6.1 The Organisational Context ...... 127 3.6.2 Research Questions ...... 129 3.7 Conclusion ...... 130

CHAPTER 4: RESEARCH METHODS AND CASE STUDY RESULTS ...... 131

x 4. Introduction...... 130 4.1 The Methodological Approach Adopted ...... 131 4.1.1 The Research Question Approach ...... 131 4.1.2 Quantitative and Qualitative Methodologies ...... 132 4.1.3 Quantitative Methodology ...... 133 4.1.4 Quantitative Research Design...... 134 4.1.5 Qualitative Methodology ...... 136 4.1.6 Qualitative Research Design...... 138 4.2 Case Study One Results: World Expo 86 ...... 141 4.2.1 Introduction...... 141 4.2.2 The Process Model ...... 143 4.2.3 Re-examination of Expo 86 Decision Processes ...... 147 4.2.4 Matching the Nature of Expo 86 with Motives ...... 148 4.2.5 Summary...... 152 4.2.6 Conclusion...... 155 4.3 Case Study Two Results: World Expo 88...... 155 4.3.1 Introduction...... 155 4.3.2 Identification of Motives for Staging Expo 88 ...... 158 4.3.3 Classification of Motives...... 166 4.3.4 Modification and Realisation of Objectives ...... 169 4.3.5 Economic and Financial Outcomes of Expo 88...... 173 4.3.6 Summary...... 183 4.3.7 Conclusion...... 185

CHAPTER 5: DISCUSSION...... 187 5. Introduction...... 187 5.1 Theoretical Implication of Research Findings...... 187 5.2 Theoretical Development of Model ...... 193 5.3 Associated Theoretical Issues ...... 198 5.4 Theoretical Relationships...... 203 5.5 Theoretical Influences in Organisations...... 208 5.6 Contribution of the Thesis...... 211

xi 5.7 Limitations of the Thesis...... 215 5.8 Conclusion ...... 216

CHAPTER 6: CONCLUSION...... 218

APPENDIX

APPENDIX A: Defining Expected Value and Expected Utility ...... 226

APPENDIX B: Transformational Properties of Normative Utility Functions ...... 227

APPENDIX C: Specification of the Requirements for Optimising the Choice of Alternatives ...... 229

APPENDIX D: The Rationality Axioms of Von Newman and Morgenstern Expected Utility...... 231

APPENDIX E: An Alternative Formulation of Consumer Behaviour: Revealed Preference Theory...... 233

APPENDIX F: World Expositions...... 241

APPENDIX G: Summary of Financial Positions of BESBRA and SBC...... 254

APPENDIX H: Statistical Data on the Effects of Expo 88 on Tourism...... 271

BIBLIOGRAPHY...... 281

xii LIST OF TABLES

Table 1: Theoretical Explanations ...... 10 Table 2: The Decision Matrix under Risk...... 29 Table 3: Determinants of Escalation...... 146 Table 4: Expo 88: Summary of Principal Motives ...... 167 Table 5: Expo 88: Summary of Financial/Economic Outcomes ...... 174 Table 6: Theoretical Explanations of Escalating Commitment...... 188 Table 7: Theoretical Explanations for Escalation Type Behaviour in Organisations ..208

xiii LIST OF FIGURES

Figure 1: Ordering of Preferences ...... 45 Figure 2: The Concave Utility Function ...... 47 Figure 3: The Convex Utility Function...... 47 Figure 4: The General Utility Function ...... 48 Figure 5: Indifference Mapping of Utilities ...... 51 Figure 6: An Optimally Efficient Welfare Outcome ...... 72 Figure 7: A Three Phased Model of the Escalation Process ...... 145 Figure 8: A Modified Three Phased Theoretical Model of the Escalation Process....195

xiv GLOSSARY

Australian Bicentennial Authority...... ABA Australian Bureau Statistics ...... ABS Australian Exhibit Organisation ...... AEO Brisbane Exhibition and South Bank Redevelopment Authority...... BESBRA Bureau of International Expositions...... BIE Bureau of Tourism Research...... BTR Commonwealth Department of Finance ...... CDF Commonwealth Games Foundation ...... CGF Cost Benefit Analysis...... CBA South Bank Corporation ...... SBC South Bank Parklands ...... SBP Strong Axiom of Revealed Preference...... SARP Queensland State Archives ...... QSA Queensland Tourist and Travel Corporation ...... QTTC Resource Allocation Problem...... RAP Weak Axiom of Revealed Preference ...... WARP World Exposition Vancouver, 1986 ...... EXPO 86 World Exposition Brisbane, 1988...... EXPO 88

xv STATEMENT OF ORIGINAL AUTHORSHIP

The work contained in this thesis has not been previously submitted to meet requirements for an award at this or any other higher education institution. To the best of my knowledge and belief, the thesis contains no material previously published or written by another person except where due reference is made. Any contribution made to the research by others with whom I have worked is explicitly acknowledged in the thesis.

Kerry Donohue November, 2006

xvi ACKNOWLEDGEMENT

I am indebted to my supervisors Professor Neal Ryan and Professor Boris Kabanoff who encouraged me to undertake this project during the sunset of my academic career. Without their encouragement I am certain that I would not have commenced the project let alone completed it. There were far more attractive endeavours I would have preferred to have devoted my time to over the last three years. I wish to thank Dr Namrata Malhotra who kindly read the first chapter and provided helpful comments. I wish to thank Lee Macbeth who was responsible for the production of the final product. It is a regrettable characteristic of my age that I can still write faster than I can type. I wish to thank my wife Mary and my three children John, Kim and Catherine who tolerated my ill humour and lack of attention which became progressively worse as the thesis developed. Mary is correct in her comments that these unpleasantries would have been avoided if I had found the time, interest and motivation, as I should have, to complete a doctorate over thirty years ago.

xvii Chapter 1 INTRODUCTION

1.1 PURPOSE AND THEORETICAL CONTEXT The purpose of this thesis is to examine critically and empirically a theoretical controversy in decision theory. The controversy is concerned with determining what causes decision makers in organisational contexts to persist with a chosen course of action when confronted with information that the course of action appears to be failing. The controversy is examined empirically through the analysis of two public projects; Expo 86 and Expo 88. The research questions investigated are developed from the literature review and are contextualised in terms of the projects investigated. These are discussed in section 1.7. The controversy involves theoretical, empirical and evaluative dimensions. Considerable attention is devoted to the theoretical dimensions. This leads to a reinterpretation of the dominant psychological explanations and their reformulation in decision theory terms, the fundamental concepts of which are discussed in section 1.2.

1.2 DECISION THEORY CONCEPTS Decision theory distinguishes between problem solving, decision making, judgements and decisions (Bazerman, 2002; Goodwin and Wright, 1997). Research in problem solving emphasises the cognitive construction of new alternatives to resolve a problem. Research in decision making involves the selection of an alternative from a set of alternatives provided. The structuring of a problem is integral to the decision selection of an alternative but interest in decision making research focuses on the “process” of selection of an alternative. Decision making involves an interdependent exchange between a decision maker and an external environmental phenomenon or agent. Feedback from the external environment enables the decision maker to form a judgement about what decisive action is necessary to respond to, control, or change the external environment of interest. Judgement and decision making are closely related although they are differentiated in the research literature (Stevenson, Busemeyer and Naylor, 1990). A judgement is a cognitive assessment of a preference for an

1 alternative. It is transformed into a decision, that involves a “commitment to an action” when consequences contingent on the action are predicated to follow. A decision is an observable behavioural response to an inferred judgement. The theoretical controversy investigated in this thesis is grounded in descriptive decision making theory (Bell, Raiffa and Tversky, 1988; Edwards and Tversky, 1967; Edwards, 1961). It is concerned with the psychological behaviour and behavioural aetiology that are associated with the adverse consequences of a commitment to a decisive action. The decisive action, in turn, derives from and is dependent on judgements made on the basis of information about potential consequences of a previous contingent decision.

1.3 NATURE OF THE CONCEPTS Behaviour associated with persistence to a failing cause of action was given the name escalation of commitment by Staw (1976). The research literature on the phenomenon has been dominated by the experimental psychological perspective which had its origins in the pioneering studies conducted by Rubin and Brockner (1975) and Staw (1976). The decision making consequences of such behaviour have assumed the status of a decision making bias which is referred to as the escalation bias (Armstrong, 1996). Escalation of commitment has been associated with persistent forms of behaviour which are widely observed in individuals. In particular, escalation of commitment embodies decision makers taking actions in “uncertain” initial situations that subsequently appear to lead to failure or losses. When confronted with these apparent failures or losses, decision makers commit decision errors and escalate their commitment to the initially chosen course of action. The consequences are similar to a behavioural phenomenon associated with the so called “paradox of success”. In this situation, decision makers confronted with uncertain situations persist with failing courses of action, not because they are failing, but because they were successful on previous occasions. Escalating commitment is associated with beliefs that a losing course of action will succeed in the future or be psychologically successful. The paradox of success is associated with different but complementary belief structures that a

2 previously successful course of action will continue to be successful in the future (Audia, Locke and Smith, 2000). According to Audia, et al. (2000) decision makers in escalation situations assume that conditions in the future, which influence the performance consequences of the course of action, will be different from those in the past and result in an improvement in performance. In the paradox of success situations, decision makers assume that conditions in the future will be the same as those which produced successful courses of action in the past. Both phenomena are considered to be representative of unproductive forms of behaviour in uncertain circumstances which may have dysfunctional consequences. Both phenomena are not inconsistent with the initial use by individuals of satisficing (Forester, 1984; Simon, 1976) and intuitive (Agor, 1989; Behling and Eckel, 1991; Simon, 1987) models of decision making when confronted with decisions which are difficult, complex, unstructured and uncertain.

1.4 CONCEPTUAL AND STRUCTURAL LIMITATIONS The theoretical controversy centres on three interrelated issues (Brockner, 1992; Khan, Salter and Sharp, 2000; Staw, 1997). First, which of several possible explanations proposed in the literature are the most plausible? Second, do the explanations derive from rational, non rational, cognitively distorted rational explanations or some other plausible explanation? Third, is the non rational explanation obtained by inducing escalation of commitment in experimental situations as pronounced in real world organisational settings? That is, what is the external validity of the experimental psychological findings? (Brockner, 1992; Staw, 1997; Staw and Ross, 1987a). A brief introduction to these issues is provided in section 1.6. Escalation of commitment is complicated by a particular characteristic of the phenomenon. For an investment outcome to qualify as escalation of commitment, it is necessary for decision makers during the decision process to have committed a decision error or series of decision errors based on their interpretation of the negative feedback received about the prospects of their investment choice (Staw, 1982). The existence of a decision error eliminates the possibility that outcomes are associated with rational responses to the uncertain future. The consequences

3 of the decision error are that decision makers invest additional resources in the investment project. The initial decision to invest resources is made under conditions of uncertainty under which there are no rules to guide decision making. At the stage when negative feedback is received, the decision environment has become almost one of certainty, so that the decision to proceed with the commitment of additional resources is unequivocally erroneous. In psychological laboratory investigations of the phenomenon, the particular research strategies adopted have evolved so that it is possible to induce escalation of commitment under controlled experimental conditions which involve decision errors (e.g. Whyte, 1993). In these circumstances, attributing the phenomenon to a particular explanation which has been interpreted as a self justification form of rationalisation can be undertaken with a high degree of confidence (Brockner, 1992; Staw and Ross, 1987b). In natural organisational settings, determining whether the behaviour associated with persistence to a chosen course of action qualifies as escalation of commitment is more problematic. If the negative feedback about the prospects of investment decisions are uncertain or equivocal (Bowen, 1987), it is not possible to determine, unambiguously, whether decisions to invest additional resources in projects result from decision errors or from some other plausible explanation that may involve rational considerations (McNamara, Moon and Bromeley, 2002). The determination of causation in organisations is complicated further by the investment context in which the phenomenon has been investigated and the investment criteria involved in the assessment of the outcomes obtained. The central problem in economics is concerned with how scarce resources can be allocated among competing alternative uses (Galbraith, 1987). Theoretical solutions to the problem are complex. Integral to any solution to the problem is the economic theory of value which involves a number of normative pronouncements about how the principal actors in economic exchange should behave and what they should seek to accomplish (Arrow and Hahn, 1971). Individual actors are expected to behave rationally and maximise self interest (utility). Firms are expected to behave efficiently by maximising profits. Behavioural assumptions about the behaviour of individual actors derive from historical antecedents in the evolution of decision theory (Newman, 1988; Stigler,

4 1986). In modern neo-classical economics, normative theories of resource allocation have assumed positive theoretical dimensions. The rational maximising model not only specifies how individual actors should make choices but also it presumes to describe how individual actors actually choose (e.g. Thaler, 1980, 1986). In decision theory, the central problem of economics is captured in the resource allocation problem. This requires that decision makers allocate a limited resource between competing alternative choices in order to maximise some objective. The resource allocation problem is used to investigate decision making under conditions of risk and uncertainty. It is used also to explore, inter alia, the extent to which individual decision makers choose to make decisions according to the normative decision making models which have been developed in decision theory to explain decision making under risk conditions (Tversky and Kahneman, 1974, 1980, 1981, 1986, 1992). The model which dominates decision theory under risk is expected utility theory (Bernoulli, 1954). It remains the dominant model in these conditions even though it is known to be incorrect in describing individual choice behaviour once decision situations assume complexity and uncertainty attributes (Stevenson, Busemeyer and Naylor, 1990; Tversky and Kahneman, 1986). When decision situations assume these attributes, individuals are required to use decision processes which deviate from the requirements of the optimising decision models. Three generic alternative decision models have been identified which involve satisficing behaviour (Simon, 1976), intuition (Agor, 1989; Simon, 1987) and the implicit selection of a favourable alternative (Power and Aldag, 1985; Soelberg, 1967). The cognitive foundations for satisficing behaviour have been explored extensively in prospect theory (Kahneman, 1984; Kahneman, Solvic and Tversky, 1982). In experimental laboratory situations, the escalation of commitment phenomenon is investigated using research strategies which incorporate the resource allocation problem (Staw, 1976). The behaviour of individual decision makers is judged against the behavioural standards which should be obtained under the decision theory model of expected utility. The results of the investment decisions are evaluated in terms of the investment criteria which have been developed in economics from efficiency objective foundations to judge the value of

5 investment outcomes (see for example Bruce, McKern and Pollard, 1983 and Ross et al, 1994). The use of these economic evaluative frameworks involves considerable conceptual, theoretical and methodological problems. These problems impact upon the capacity to explain the behaviour associated with escalation once the context in which the escalation phenomenon occurs extends beyond the laboratory to encompass organisation. The problems relate to reasonableness, relevance and accuracy. Chapter 2 of this thesis is devoted exclusively to an examination of the theoretical and operational foundations against which behaviour and outcomes are evaluated in escalation situations. The examination is necessary not only to specify the requirements which are expected from individual decision makers but also to illustrate how difficult it is for individuals in complex and uncertain decision making situations to recognise the necessary requirements, let alone to comply with the formidable list of requirements.

1.5 ADDRESSING LIMITATIONS FROM THE THEORETICAL AND OPERATIONAL

FOUNDATIONS In Chapter 2, the nature of the resource allocation problem is defined under conditions of risk and uncertainty to indicate how difficult it is for decision makers to choose an appropriate alternative, irrespective of whether their behaviour is intendedly rational or not. It is not unusual for mistakes to occur. The mistakes do not have to derive from irrational sources. They can be due to ignorance and cognitive limitations (Kahneman, 1994; Kahneman and Tversky, 1979; Tversky and Kahneman, 1992). How decision makers should make a choice is then explored. This is accomplished by providing definitions of rationality and utility in decision theory and in economics. Only by giving precise expression to the meaning of these concepts is it possible to determine whether decision makers act rationally in the choice of alternatives in escalation situations. From these definitions the nature of the utility function in positive and negative commodity space is developed The nature of efficiency and the investment criteria available to evaluate projects under various contexts are then explored. The purpose of the analysis is

6 to reveal some disturbing features about the nature of investment in organisation contexts. The most significant feature to emerge from the analysis is the realisation that organisational efficiency is independent of the concept of individual utility. Unless the pursuit of efficiency coincides with the objective of enhancing individual utility, there is no reason to expect that individual decision makers will seek to maximise efficiency. In organisations in which managerial control and discretion are divorced from ownership it is conceivable that the decision to incur additional losses in an investment project can be a rational decision if individual utility is enhanced by the decision. The assumption that individual interests will coincide with organisational interests is a moral pronouncement (Perrow, 1986a). It is not a behavioural axiom of rational choice. Investment decisions are complex. Various decision rules have evolved to determine “ex ante” and to evaluate “ex post,” the value of an investment decision. The rules are discussed in chapter 2 with the aim of demonstrating the lack of agreement theoretically about the motives for investing, about which decision rule should be applied in which context, about the most appropriate way to account for risk, and about the absence of any meaningful decision criteria to assist decision makers when confronted with choice situations under uncertain conditions that require an immediate response. The purpose in chapter 2 is also to indicate that it is unreasonable, to expect individual decision makers to be able to conform to the requirements of the rational economic investment model irrespective of how the model is operationalised (Simon, 1978). It is mainly in this theoretically complex and unresolved world of investment that the escalation of commitment phenomenon has been investigated. The analysis indicates that the computational and information requirements necessary to apply any of the investment decision criteria are demanding and involve the exercise of independent judgement under conditions of risk and uncertainty. Consequently the determination of causation of escalation is complicated. As previously mentioned, the empirical side of this thesis is concerned with evaluating two public projects in terms of whether the outcomes are the result of the escalation of commitment phenomenon. As a result, the analysis of the evaluation of investment projects in chapter 2 is extended within the chapter to

7 encompass public investment projects. Public projects produce additional complications over private projects which make it difficult to judge whether decision outcomes are the result of behaviour associated with the escalation of commitment phenomenon. There are two additional complications. First, the analysis indicates that what is being evaluated is ultimately an unresolved ethical pronouncement about the value of individual welfare. This complicates the determination of public investment project outcomes. Second, the analysis indicates that the concepts of economic rationality and utility provide an incomplete and distorted description of social choice. This complication raises the possibility that it is inappropriate to evaluate the behaviour associated with investment in public projects against criteria developed exclusively from rational prescriptions. Both complications are exacerbated when public projects have several objectives which are not mutually exclusive.

1.6 ACCOUNTING FOR THE ESCALATION PHENOMENON The literature on the escalation of commitment phenomenon is reviewed in chapter 3. The review identifies the psychological predispositional, social and situational variables which have been identified in laboratory experiments as contributing to escalation of commitment. The factors which influence de- escalation also are indicated so as to critically evaluate the disputed role of information in reducing the incidence and duration of the phenomenon. Whether or not information acts to modify behaviour depends on why individuals persist with losing courses of actions (Simonson and Staw, 1992). In chapter 3, the theoretical explanations proposed for the existence of the phenomenon are reviewed. The laboratory experimental literature identifies four theoretical explanations which either promote rational or non rational antecedents. The evidence strongly supports a rationalisation process based on self justification as the principal cause of the phenomenon. In organisational contexts, the literature on escalation of commitment identifies three possible theoretical explanations, two of which are elaborations of the rational and non rational explanations encountered in the laboratory experimental literature. The third possible explanation is embedded in

8 organisational theory and has affective connotations which may derive from rational or non rational antecedents. A selective review of the organisational theory literature indicates that a particular organisational metaphor (Burrell and Morgan, 1979; Morgan, 1977) may provide the basis for two plausible associated or alternative explanations for the phenomenon. This literature provides support for a third alternative explanation grounded in conformity to social norms. The literature on economic project feasibility and evaluation provides descriptive and theoretical information which can be adapted to analyse the escalation of commitment phenomenon. This produces one further possible explanation for the existence of the phenomenon in organisations. The explanation is rational and ethically questionable. The extent to which the explanations derived from the organisational theory literature and the literature on economic projects are plausible, very much depends on the level of analysis selected, the degree of organisational transparency and the state of the external environment. The theoretical explanations are summarised in table 1. This is followed by brief explanations of the individual proposals. They are critically examined in chapter 3.

9 TABLE 1

THEORETICAL EXPLANATIONS

EXPLANATION REPRESENTATIVE SOURCE(S)

INDIVIDUAL

Normatively Rational: Expected Utility Theory Northcraft & Wolf (1984) Descriptively Rational: Expectancy Theory Levi (1982); Rubin & Brockner (1975); Staw (1976, 1980); Vroom (1964) Retrospective Rationalisation: Dissonance Brockner (1992); Festinger (1957); Theory Staw & Ross (1987) Deviations from Rationality: Prospect Theory Davis and Bobko (1986); Kahneman & Tversky (1984); Whyte (1986)

ORGANISATIONAL

Retrospective Rationalisation: Dissonance Ross & Staw (1986); Staw & Ross Theory (1987) Rational Self Interest: Agency Theory Dipanker (1997); Knight, Durham & Locke (2001) Affective Attachment: Organisational Bowen (1987) Commitment Bounded Rationality, Intuition and Retrospective March & Simon (1958); Cohen, March Rationality: Organisations as Decision Making & Olsen (1972); Simon (1987); Systems Starbuck (1983, 1985) Social Norms & Conformity: Group Think Janis (1982); Isenberg (1986) Coalitions of Rational Self Interest Accompanied Flyvbjerg (1996); Pickwell (1992); by Delusion Wachs (1989, 1990)

The first explanation involves the normative decision theory model of expected utility which underpins the economic decision model of rational choice. The utility function in positive commodity space is concave. In negative commodity space it is convex. The convex nature of individual utility in negative commodity space facilitates escalation in losing situations characterised by conditions of uncertainty. The convexity of the utility function in negative commodity space is potentially disturbing. Under conditions of uncertainty, utility

10 will be enhanced if beliefs are held that the investment of additional resources will produce a positive outcome. This means that a decision to invest additional resources in a losing investment project could just as likely be a rational response as a response based upon a need to justify a decision. Under conditions of uncertainty what constitutes rational or non rational behaviour is indeterminate. This is because there are no definitive decision rules available to assist decision makers to make choices (Arrow, 1992; Keynes, 1937). The second explanation derives from expectancy theory (Vroom, 1964). Expectancy theory is a cognitive motivational psychological theory which specifies the conventionally unspecified nature of utility in terms of the instrumental value of goal attainment. According to this theory, decision makers assess the probability that the goals will be achieved through the commitment of additional resources. According to Brockner (1992) and Staw (1980), this explanation operates mostly during the initial phase of the escalation process when project outcomes are uncertain. Expectancy theory based explanations have assumed a dominant position in the psychological literature together with the next explanation. The third explanation involves self justification and has been interpreted in terms of the “self justification paradigm” associated with Festinger’s (1957) motivational theory of cognitive dissonance. It is the dominant explanation that has emerged from the experimental laboratory research on the phenomenon. Cognitive dissonance theory predicts that when individuals experience cognitive dissonance, they will be motivated to reduce, eliminate or avoid the painful tension created and seek to recapture an equilibrium state of consonance. The escalation phenomenon is linked to one of several possibilities available to individuals to achieve an equilibrium state of consonance. The particular possibility associated with escalation involves ego defensive forms of rationalisation to justify the outcome chosen. The fourth explanation derives from particular findings in prospect theory concerned with framing, loss aversion and mental accounting. It has been proposed that prospect theory may account for the phenomenon either independently of other explanations (Kahneman and Tversky, 1984; Thaler, 1999; Whyte, 1986) or in conjunction with other explanations proposed (Davis and

11 Bobko, 1987; Khan, Salter and Sharp, 2000). Prospect theory was conceived by Kahneman and Tversky (1979) to explain risk taking behavioural deviations from rational decision making model prescriptions which individuals display when confronted with an uncertain future. Prospect theory (e.g. Tversky and Kahneman, 1992) describes how people actually behave when confronted with loss situations. The findings of this theory reinforce the normatively rational tendency under conditions of uncertainty for decision makers to invest additional resources in a project which is incurring losses. The attitude of individuals towards risks is asymmetrical. Prospect theory has demonstrated that in loss situations individuals are loss averse rather than risk averse. This means that individual decision makers become risk seekers and will seek to recover losses previously incurred. The joint effect of utility and prospect theory is for decision makers to persist with a losing investment project under uncertain conditions. Persistence is related to rational and distorted rational origins. Ross and Staw (1986) conducted the first systematic investigation of the escalation of commitment phenomenon in an organisational context. The case study chosen for investigation was Expo 86, a world exposition held in Vancouver, Canada. From the analysis conducted, Ross and Staw (1986) developed a theoretical model of the escalation process in natural organisational settings based on the situational, predispositional and de-escalation findings derived from the extant experimental literature. The model subsequently was refined in a theoretically inspired article (Staw and Ross, 1987a). They identified four classes of variables (project, psychological, social and institutional) which they proposed would be differentially important, depending on the stage reached in the escalation process. They argued that the dominant explanation for the persistence of escalation over the various phases of the model was justification, the same explanation which they found accounted for the phenomenon in individuals in experimental laboratory situations. The theoretical model is reproduced in chapter 4, section 4.2.2. Ross and Staw (1986) regarded Expo 86 as an escalation prototype and the project is now considered to be a classic example of the escalation phenomenon (Biyalagorsky, Boulding and Staelin, 2001). Despite the conclusions about

12 escalation reached by Ross and Staw (1986), a review of the literature indicates that, in complex organisational settings, alterative and/or associated explanations for justification inspired processes of rationalisation may be plausible. The first alternative organisation-based explanation derives from principal – agency theory and is the most recent proposed (Dipanker, 1997; Khan, Salter and Sharp, 2000; Knight, Durkham and Locke, 2001). The explanation involves the problem of adverse selection and derives from corporate ownership being divorced from managerial control and discretion (Berle, 1959; Berle and Means, 1932). Once this separation has occurred the consequences of individual utility being independent of organisational efficiency may be profound. The objectives of managers may be different from and detrimental to owners. The problem of independence has given rise to a theory of agency in the economics literature which presumes to describe how the rational behaviour of managers may deviate from the efficiency objectives sought by the owners of organisations. The problem of agency has become a major consideration in corporate governance (see for example Jensen and Meckling, 1976). The agency problem of adverse selection has been proposed as a plausible explanation for escalation of commitment in organisational contexts (Harrell and Harrison, 1994; Khan, Slater and Sharp, 2000). Agency explanations are rational in nature. They may also be morally reprehensible. The second alternative organisation-based explanation was introduced in the literature by Bowen (1987) in an article which criticised the dominant self- justification explanation for the phenomenon proposed by Staw and his associates (1978, 1980, 1981 and 1987b). This explanation proposes that, in organisational settings, particular organisational variables associated with commitment may provide an alternative explanation to individual self justification for the existence of the phenomenon. Organisational commitment was conceived as sets of behaviours and attitudes associated with alignment to a particular cause which either enhances or inhibits organisational performance (Porter, 1970). The particular explanation for escalating commitment is based on the well known adverse consequences (rigidity, inflexibility, persistence) of high levels of organisational commitment to particular courses of action (Kiesler, 1971; Salancik, 1977).

13 A third set of organisational theory based alternative explanations derives from the body of literature which directly either supports or criticises the conception of organisations, conceived by Simon (1947), as logical decision making systems. Because of internal limitations (knowledge, cognition, computation) and adverse external circumstances (complexity, unclear and inconsistent preferences and outcomes, uncertainty) decision makers operate within a framework of bounded rationally. This leads them to adopt satisficing models of decision making which limit rational choice possibilities to obvious alternative possibilities. Alternatively it leads them to adopt implicit favourite models of decision making, which are neither rational nor objective, because alternative choice possibilities are rejected in favour of subsequently seeking confirmation of the favourite initial choice. The conception of organisational decision making as a logical, analytical, bounded rational process has been criticised for ignoring its creative and intuitive elements. These elements may produce irrational decision making processes which have led to organisations being conceived as “garbage cans” (Cohen, March and Olsen, 1972), “organised anarchies” (March and Olsen, 1976; March, 1981) and “camping on seesaws” (Hedberg, Nystrom and Starbuck, 1976). More recent research has explored the intuitive model of decision making as complementary to rationality (e.g. Simon, 1987). The non rational dimension of organisation also has been explored in the context of organisations as cognitive structures (e.g. Nystrom and Starbuck (1981, 1984) which reveal that thought is imposed on action retrospectively (Starbuck; 1983, 1985; Weick, 1979, 1995). This research suggests that decisions often become rational only as decision makers use hindsight to explain and rationalise their decisions. This cognitive view of organisational decision making is consistent with the justification explanation proposed by Ross and Staw (1986) above. The fundamental difference is that this organisation theory set of models incorporates both rational and non rational decision making choice possibilities in complex organisations. The theory also complicates the decision making process by explicitly recognising that organisations are concerned with achieving several conflicting objectives simultaneously (Cyert and March, 1963). As a result, the

14 evaluation process may become problematic. The outcome being evaluated may not be the principal concern of the objective intent of the decision. The fourth alternative explanation derived from organisational theory literature involves the possibility that escalation of commitment is associated with two potential adverse influences on group decision making; groupthink and groupshift (Janis, 1972, 1982; Isenberg, 1986). Both influences have the potential to affect a group’s ability to evaluate alternative choice possibilities objectively. With groupthink, the pressure to conform produces a consensus of opinion within the group about the preference of alternatives. With group shift, group members exaggerate initial conservative or risky positions held about particular preferences for an alternative. The last possible alternative explanation derives from the economic project literature. This literature has produced a substantial body of evidence to demonstrate that when large public infrastructure projects are being considered it is not uncommon for an unhealthy formula for project approval to operate. The formula involves the underestimation of costs, the overestimation of revenues, the undervaluation of environmental impacts and the overvaluation of economic development effects (Flyvbjerg, Bruzelius and Rothengatter, 2003). The motives for producing deceptive forecasts of costs and benefits involve the rational self interests of the various promoters of individual projects who stand to derive a pecuniary or psychic benefit from their construction. The underlying theoretical explanation for the unfolding of what appears to be escalation of commitment to a failing public project as it proceeds from these deceptive forecasting foundations is agency theory. The case study of Expo 86 by Ross and Staw (1986) was the inspiration for the empirical research conducted in this thesis, and helped to identify the gaps in the literature which led to the formulation of the theoretically oriented research questions in section 1.7. The first study involves a re-examination of the data on Expo 86. As a result, the research questions are contextualised in terms of the two studies undertaken. The review of the literature on escalation and the decision making theoretical foundations has also identified significant gaps in the theoretical structure of the escalation of commitment construct, in the methodology used to

15 determine whether projects qualify as exhibiting the escalation phenomenon and in the interpretation of causation in natural organisational settings. Importantly, it is theoretically unsatisfactory to have nine potentially competing explanations for escalation in natural organisational settings. Nor is it self evident that self justification, the dominant explanation in the experimental psychological literature on the phenomenon, is the dominant explanation for decisions to persist with losing courses of action in natural organisational settings as Staw (1980, 1997) maintains. The research questions developed from the literature review are concerned centrally with examining the theoretical explanations in an attempt to reconcile the different perspectives. The combined influence of the theoretical analysis in chapters 2 and 3 and the empirical investigations conducted in chapter 4 led to the development of a theoretical model that supplements that proposed by Ross and Staw (1986) to explain the behaviour attributed to escalation of commitment in natural organisational settings. It is developed in chapter 4.

1.7 THE RESEARCH ISSUES AND THEIR EXAMINATION The examination of the theoretical explanations for the escalation phenomenon led to the development of three interdependent research questions. These are: (a) What causes the behaviour which has been interpreted as escalation of commitment in organisations?; (b) Is it possible that there are alternative explanations to those provided by Ross and Staw in their theoretical model of escalation to explain escalation type behaviour in organisations?; and (c) Is it possible that the escalation of commitment type behaviour exhibited in organisations is unrelated to the defining characteristics of the phenomenon? The research questions are examined empirically. The questions derive from a critical examination of the two principal explanations for the phenomenon proposed in the literature. The empirical examination involves an analysis of the

16 two public projects. Expo 86 has been called an escalation prototype (Ross and Staw, 1986) and is now considered to be a classic example of the phenomenon (Biyalagorsky, Boulding and Staelin, 2001). Expo 88 was considered to be an example of the escalation phenomenon when it was examined initially (Donohue, 1988, 1988a, 1988b). The re-examination of these two projects indicates that the explanations associated with the outcomes are more complicated than those originally proposed. The examination of the theoretical explanations led also to a reinterpretation of the theoretical antecedents which have been proposed as being responsible for the existence of the phenomenon. Because this thesis adopts a decision theory perspective, the dominant rational and non rational explanations for escalation have been recast in decision theory terms. As a result the dominant non rational explanation, which is concerned with self justification, assumes rational theoretical foundations.

1.8 RESEARCH METHODS AND RESULTS The research questions formulated in this thesis do not involve answers which derive from a strict application of the hypothesis based approach to scientific inquiry (Francis and Paap, 2001). Instead, the quantitative and qualitative methods of enquiry produce data which enable the escalation of commitment phenomenon to be investigated inductively. Financial outcomes are evaluated using different investment decision rules and the interpretation of theoretical causation is conducted in terms of an alternative literature to the orthodox psychological literature which is associated with the phenomenon. Quantitative and qualitative methodologies are synonymous with the logical positivist and idealist paradigms respectively and represent the objective and subjective extremes on a continuum of paradigmatic approaches (Denzin and Lincoln, 1998; Desphande, 1983). The combination of quantitative and qualitative methods provides a synergistic perspective of the evidence (Eisenhardt, 1989). This is appropriate to the holistic decision theory perspective adopted in the investigation of causation.

17 A combination of quantitative and qualitative approaches, as advocated by Reichardt and Cook (1979) provides a set of research methodologies which are appropriate for answering the research questions generated. Quantitative and qualitative approaches, when used jointly, are seen as complementary and reinforcing (Greene & Caracelli, 1979; Caracelli & Greene, 1997; Greene, Caracelli & Graham, 1989). Greene et al. (1989) highlight five major benefits of using a mixed methods approach, namely: (i) triangulation, tests the consistency of findings obtained through different methods; (ii) complementarity, clarifies and illustrates results from one method with the use of another method; (iii) development, results from one method shaping subsequent methods or steps in the research process; (iv) initiation, stimulates new research questions or challenges results obtained through one method; and (v) expansion, provides richness and details to the study exploring specific features of each method. The quantitative method used in this thesis involves an examination of all the financial transactions associated with the conduct of Expo 88 over the life of the project. The information is contained in the annual budget papers of the Queensland government and in the annual reports of the Expo 88 authority and the South Bank authority. The recording of these transactions in a consolidated form enables various investment criteria to be applied to the data. The results are that outcomes are either positive or negative depending upon which investment criteria are used. The social cost benefit analysis is not exhaustive. It is sufficiently complete to enable the positive or negative sign of the outcome to be determined unambiguously. The qualitative methodology involves a reinterpretation of the explanations provided in the literature for the escalation of commitment identified at Expo 86. A critical perspective is adopted. The qualitative methodology involved in the investigation of Expo 88 adopts a longitudinal analysis of the critical incidents which led to the decision by the Queensland government to host the exhibition. How the principal decision makers responded to negative feedback is also

18 explored. The method of enquiry principally involves an archival investigation of relevant documents held by Queensland State Archives, News Limited and the Commonwealth Department of Finance. The use of archival material is contentious. It is seen as a useful method of obtaining longitudinal data (Ginsberg, 1988; Huff, 1982). In contrast Singh (2001) is critical of retrospective studies in which the outcomes are known because of associated intrinsic bias. Shane and Veukataraman (2001) defend the use of retrospective archival studies citing studies which do not succumb to bias because of known outcomes. This study uses archival data to question the correctness of the known outcome and contends that the original analysis of causation may have been biased.

1.9 CONTRIBUTION AND LIMITATIONS OF THE THESIS The contribution is both theoretical and empirical in nature. A major theoretical contribution derives from the reformulation of expectancy theory (Vroom, 1964) and cognitive dissonance theory (Festinger, 1957) in terms of expected utility theory; the normative standard against which decision making under risk conditions is judged. The theoretical arguments are discussed in chapter 5. The theoretical reformulation contributed to the development of an augmented model to explain escalation of commitment in organisational contexts. In both decision theory and neo classical economic theory, the motivational components of the utility function are not specified beyond the generalised statement that individuals are motivated by the self interested need to maximise satisfaction. Whether individuals achieve this position is an empirical issue which depends crucially on whether individuals behave rationally. There is no interest in identifying the motivational attributes of utility nor is there any need to do so from the theoretical perspective adopted (Cowen and Crampton, 2002). Vroom (1964) transformed the normative theory of expected utility into a functionally rational descriptive theory of cognitive motivation. In this thesis the expectancy theory of motivation is reformulated in terms of expected utility theory. In utility theory, the value of a preference for an outcome is its subjective expected utility. In expectancy theory, the values of a preference for an outcome

19 is the valence associated with its expected instrumentality. Utility is an unspecified motivational concept. Instrumentality is a motivational concept which specifies the descriptive nature of utility as being associated with the hypothetical construct of a needs hierarchy. It is the needs hierarchy which determines the value of a choice of an alternative. The value depends on the structure of the needs hierarchy in which higher order needs take precedence over lower order needs which, once satisfied, are no longer motivating (Maslow, 1954). Cognitive dissonance theory was formulated from the behavioural axiom that individuals are motivated to achieve consistency between what they know, believe and value and the behavioural actions in which they engage. The theory predicts that when individuals experience cognitive dissonance (inconsistency), they will be motivated to reduce, eliminate or avoid the painful tension created and seek to regain an equilibrium state of consonance (consistency) (Festinger, 1957). From an expectancy theory perspective, dissonance theory merely specifies that the contingent need which individuals are motivated to fulfil most urgently is the reduction in dissonance induced tension through restoration of consonance. Preferences are ordered in terms of the need to reduce or avoid cognitive dissonance. It is this need which is valued most highly. From a decision theory perspective, cognitive dissonance theory, conceptualised as a special case of expectancy theory, is merely a special form of expected utility theory. Individuals are motivated to order their preferences in terms of a utility function which maximises the need to maintain an equilibrium state of consonance. The value of a preference for an outcome is determined in terms of dissonance avoidance or redirection. From this utilitarian perspective, the irrational self justification explanation for the escalation of commitment can be conceptualised as a rationally determined ordered preference expression of consonance provided that the preferences are formed independently of any efficiency consequences. Two implications derive from this reformulation of expectancy theory and dissonance theory in terms of utility theory. First, the theoretical controversy assumes predominantly rational antecedents. Second, the potential for decision makers to persist with strategic investment decisions which do not contribute to

20 the performance of organisations is enhanced when the need to justify the decision choice is endowed with rational antecedents. The potential for escalation is exacerbated in those circumstances where managerial control and discretion are divorced from organisational ownership. Moreover, the rational antecedents for behavioural persistence which result in adverse organisational consequences are different from the rational motives which are associated with the agency problem of adverse selection. The rationally derived capacity for decision makers to persist with decisions which have adverse consequences because of the overwhelming need to reduce dissonance has not been recognised (Denis, 2001). Consequently, effective mechanisms to detect and reduce this form of behaviour have not been devised. Inadequate recognition of dysfunctional organisational decision making behaviour which derives either from rational antecedents as is the case with certain forms of escalation or from cognitive biases is not confined to the corporate governance literature. The deficiency is widespread in the strategic management literature. Parayre (1994:439) believes that escalation bias research largely is ignored. Mintzberg and Lampel (1999:22-24) highlight the importance of cognitive bias in strategy making and observe that strategic management research has involved minimal progress on these aspects of strategic decision making. The empirical contribution of this thesis involves theoretical, epistemological and methodological dimensions. The re-examination of Expo 86 involves a different interpretation of the events as they unfolded from those provided by Ross and Staw (1986). The different interpretation derives from introducing to the analysis, an alternative literature to that used by Ross and Staw and recognising that projects such as Expo 86 have multiple objectives. The alternative literature suggests that the decision to persist with the project, despite the accumulating financial losses, was a rational public policy choice (Gutstein, 1986; Olds, 1988). The capacity to provide very different explanations of the events associated with Expo 86 illustrates a potential limitation of research strategies which involve subjective interpretation. This form of research involves the possibility that explanations will be confined to those which favour the research interests of the investigators. Alternative perspectives may be overlooked or deliberately ignored. It is a problem of perception and cognitive bias.

21 The analysis of Expo 88 is conducted over the life of the project. Evidence is produced which suggests that the decision to proceed with the exhibition did involve rationalisation explanations but the principal explanations derived from rational antecedents which are not unrelated to those associated with Expo 86. The analysis of Expo 88 demonstrates that with public projects at least, there are methodological problems associated with determining whether the outcome(s) result(s) in a loss and therefore whether a characteristic of escalation of commitment is fulfilled. The financial analysis of Expo 88 indicates that the production of losses depends on which investment criteria are used, what objective is selected for evaluation and whether all costs which can be identified with the staging of the exhibition are recognised and brought to account. The financial analysis is conducted in Appendix G. The theoretical model developed by Ross and Staw (1986:294) has been modified to capture the explanations for project outcomes which derive from the analysis of the two case studies. In the modified model it is proposed that theoretical explanations acting either jointly or severally are responsible for decisions to invest additional resources in investment projects in the belief that expected outcomes will be realised. The objective situation confronting decision makers in organisational settings acts as a moderating influence over the theoretical explanations. In particular, the relevant objective situation for decision makers is the attitude and response to the risks associated with uncertain future project outcomes. The modified model is developed fully in chapter 5. The modified model is used to develop more generalised explanations for escalation of commitment in organisations and to indicate situations where escalation of commitment may be anticipated. These issues are discussed in chapter 5. The value of the contribution of the modified theoretical model is restricted by limitations of the thesis. Research on escalation of commitment is associated with conventional rational private investment projects with the single efficiency objective of profit maximisation. The studies selected for investigation in this thesis are public projects with peculiar investment characteristics. They involve long capital expenditure lead times for their preparation followed by short operating lives after which time most of the capital assets are disposed of or

22 demolished. They are associated with multiple objectives, most of which are unrelated to the pursuit of profit and display few of the attributes associated with rational private investment projects. In these respects the studies chosen are unconventional and do not conform to the investment requirements needed to investigate escalation of commitment in organisations. Never the less, the selection can be justified. The thesis builds on the seminal contribution of Ross and Staw (1986) who investigated Expo 86. Expo 86 is now regarded in the literature as a proto typical example of escalation of commitment in organisations, even though the impact of objectives associated with the project which are unrelated to profit are not investigated in the study. In this thesis, Expo 86 is re-examined. The collection of project objectives are identified and explored from several theoretical perspectives which leads to the conclusion that factors other than those identified by Ross and Staw contribute to escalation. The longitudinal case analysis of Expo 88, a similar organisation with similar objectives to Expo 86, represents an addition to the very few studies of escalation of commitment outside experimental laboratory situations. The longitudinal perspective adopted enables methodological issues associated with the performance measurement of investment projects to be addressed, It also enables motives and decisions associated with preparing and presenting the exposition to be identified and related directly to the development of a modified theoretical model of escalation in organisations. The model of escalation is sufficiently encompassing to enable it to be adapted to consider conventional investment decisions in private organisational settings.

1.10 SUMMARY This thesis is organised into six chapters. This introductory chapter introduces the nature of the research to be investigated, summarises the structure of the thesis and indicates its contribution to the literature. Chapter 2 is concerned with the theoretical decision making foundations and operational parameters which are involved in the analysis and evaluation of the escalation of commitment phenomenon. The quantitative methodologies used in the financial

23 analysis in Appendix G also are explored. Chapter 3 reviews the literature on escalation, identifies the research questions to be investigated empirically and contains a discussion of theoretical explanations associated with the cause of the escalation phenomenon. Chapter 4 sets out the qualitative methodologies to be used to investigate the research questions and introduces the major results associated with the analysis of Expo 86 and Expo 88, Chapter 5 contains a discussion of the findings in which the research implications are discussed. The concluding chapter summarises the research and emphasises that the thesis has been concerned predominantly with theoretical issues in decision making and escalation bias.

24 Chapter 2

FOUNDATIONS FOR THE EVALUATION OF RATIONAL AND EFFICIENT

BEHAVIOUR

INTRODUCTION This chapter is a prerequisite to the literature review in chapter 3 which is concerned directly with the research literature on the escalation of commitment phenomenon predominantly in the context of descriptive decision theory. The substance of this chapter is the counterpart to descriptive decision theory. It describes the normative decision theory context in which the escalation of commitment phenomenon is embedded and elaborates on the normative concepts which are associated with the resource allocation problem. The chapter also engages in a selected review of the normative economic literature on investment from which the methods used to evaluate escalation investments are derived. The purpose of the chapter is to explain the normative foundations involved in the construction and evaluation of the escalation of commitment phenomenon. An ancillary purpose is to demonstrate that project formation and evaluation under conditions of risk and uncertainty involve formidable computational effort by decision makers about problematic outcomes. Under these circumstances it is difficult to determine whether a decision error has been made and whether or not decisions are rational. In section 2.1, the resource allocation problem is defined and the peculiar decision theory attributes associated with the problem are identified and related to the assessment of escalation decisions. In section 2.2, the normative decision rules for individuals operating under conditions of risk and uncertainty are examined. This leads to the discussion in sections 2.3 to 2.5 of how the concept of individual utility is inextricably associated with the concept of individual rationality. In the first of these sections (section 2.3), the precise meaning of individual rationality is derived axiomatically and extended to encompass the concept of economic rationality against which escalation decisions in laboratory situations are evaluated. In section 2.4 the concept of rationality is considered in the context of utility maximisation under conditions of risk and uncertainty. In

25 section 2.5 an alternative theory of subjective expected utility is given formal expression. The main purpose of these sections is to explain exactly what is meant by the concepts of rationality and utility maximisation because they feature in the theoretical causation controversy in the escalation literature. The rationality conditions are formidable and raise the possibility, as Simon (1957) maintained, that decision makers are incapable of behaving in accordance with the requirements specified by the axioms. These possibilities for deviation are independent of the rationalisation explanations proposed for the escalation phenomenon (Staw, 1997). Also, it is important to explain precisely what rationality means and the contexts in which the axioms have been produced. This is because the axioms and the conditions for utility maximisation have been the subject of extensive and very different forms of investigation into the determination of whether individual behaviour approximates the axioms of rational choice. This distinctive form of psychological research is called prospect theory and explores inter alia how and why individual behaviour systematically and unsystematically violates the sufficient conditions of rationality (see for example Kahneman and Tversky, 1984; Tversky and Kahneman, 1992, Tversky, 1969, 1990). Prospect theory has been proposed as an alternative explanation to self justification for the behaviour associated with escalation of commitment in individual decision makers (Whyte, 1986, 1993) and in organisations (Khan, Salter and Sharp, 2000). Because the escalation of commitment literature seeks to extend the concept beyond the laboratory to explain apparently irrational investment decisions in corporate and public sector organisations, the concept of efficiency is explained in section 2.6 and linked to the concept of individual utility. This relationship is fundamental to understanding the decision rules that have been developed to evaluate investment decisions in private and public sector project and organisational contexts. It is these decision rules that provide the bases for evaluating the outcome of investment decisions which in turn determine whether investment choices are consistent with escalation of commitment. In experimental situations involving escalation of commitment, the behaviour of individuals is evaluated in terms of efficiency outcomes contingent

26 upon the behaviour of the individual being consistent with individual utility maximisation criteria. In organisational decision contexts, the escalation of commitment situation is very different. The outcomes evaluated derive from the combination of two sources which may not be inseparable. These sources involve the utility characteristics of the decision makers and the production and investment choice capabilities of the organisation. Together, these sources are responsible for the production of efficiency based financial outcomes. Only if the utility characteristics of the individual decision makers within the organisation coincide perfectly with the efficiency objectives of the organisation will the outcome evaluated be identical for both sources. In all other financial outcome situations, the utility obtained will deviate from the efficiency achieved. The values will not be coincidental. It is only recently that the literature on escalation has considered these possibilities and consequently alternative possible explanations for the behaviour exhibited in escalation situations (Buzkar, 1999; Shapira, 1997). The relationship between efficiency and investment decision making is explained in section 2.7. Under conditions of risk it is not absolutely clear which decision rule should be applied and the calculating requirements necessary to determine optimisation are formidable. As a result, the determination of explanation in escalation situations becomes more problematic. Under uncertain conditions the problem of determining causation is exacerbated by the absence of decision criteria. The rational response to uncertainty is to reduce the area of uncertainty (Arrow, 1992), a requirement which involves sophisticated quantitative analysis (Holloway, 1979). The evaluation of public projects requires that the investment criteria be extended to encompass welfare considerations. Section 2.8 develops and evaluates the theoretical principles and methodological requirements for determining the optimisation of social welfare. Social welfare considerations have been addressed in this chapter because they underpin the type of project investigated in this thesis. Coincidentally, the specification of the methodological requirements accomplishes a secondary purpose. This is related to the research requirement to specify the methodology involved in the conduct of the project. Together, section 2.7 and 2.8 derive the theoretical and empirical foundations for

27 conducting quantitative analyses of the value of private and public investment projects. Following these sections, the chapter ends with a brief conclusion in section 2.9. The conclusion summarises the major theoretical and evaluation issues discussed. These are associated with determining whether decision makers behave rationally when making choices about investment possibilities of an uncertain nature. The issues explored assist in understanding why it has been difficult to determine what causes escalation of commitment in organisational contexts. Matters of causation are explored in Chapter 3.

2.1 THE RESOURCE ALLOCATION PROBLEM

2.1.1 DEFINITION OF THE CONCEPT The concept of escalation of commitment to a failed course of action was conceived in the context of the resource allocation problem, in the particular decision theory circumstances of decision making under conditions of uncertainty (Staw, 1976). It is necessary to define and explain the terms mentioned in the previous sentence because they contribute to the confusion. The resource allocation problem requires that decision makers allocate a limited resource (budget, investment funds, energy, time, self identity) between competing alternative choices (projects, investment options, activities, employment options) in order to maximise some objective (profit, benefits, productivity, employment, job satisfaction, well being). In decision making theory, the problem is most frequently studied under conditions of risk. The resource allocation problem is a special case of decision making under risky or unknown circumstances. The general case of decision making under risk is depicted in table 2.

28 TABLE 2 THE DECISION MATRIX UNDER RISK

OUTCOME

O1 …. Oj …. On

A1 P1.1 . . . ALTERNATIVE

Ai Pij . . .

Am Pmn

In the general case, a decision maker is confronted with a choice between a number of known or provided alternatives where each alternative (Ai) is represented as a single row of the decision matrix composed of probability values.

Each alternative is associated with an outcome (Oj) which is represented as a single column of the decision matrix In decision making under conditions of certainty, the decision maker knows that if alternative Ai is chosen it will result in outcome Oj. The decision matrix comprises an array of unitary numbers which represent the situation that if alternative Ai is chosen, there is a hundred percent chance that outcome Oj will result. In decision making under conditions of risk, the decision maker knows or is provided with the information to know, that if alternative Ai is chosen, the likelihood that it will result in outcome Oj is given by the probability (Pij) that alternative Ai will produce outcome Oj. The probability can be derived objectively or subjectively. The decision matrix comprises probability co-efficients associated with each alternative and each outcome. Risk therefore involves the ability to

29 anticipate the likelihood, a probability co-efficient, that a particular outcome (Oj) will result from a particular chosen course of action (Ai). In decision making under conditions of uncertainty, the decision matrix is empty space. There are no probability co-efficients available to assist the decision maker. The decision maker is confronted with choice situations where it is impossible to determine the likelihood that a particular outcome (Oj) will result from a particular chosen course of action (Ai) before the chosen action is made.

This is because the probability that Ai will result in Oj is unknown or unknowable, the condition of uncertainty. The resource allocation problem comprises a subset of the decision matrix. Only under the condition of unlimited resource availability will the resource allocation decision matrix correspond with the general decision matrix. In all other situations where resources are limited, the choice set will be constrained. With unlimited resources the alternative choice set is A1 to Am i.e. Σ Ai. In the resource allocation problem, a limited amount of resources is available for use, which restricts the choice set to those alternatives which can be accommodated within the limitations of the resources available i.e. a subset of Σ Ai. The conventional resource allocation problem requires that the decision maker choose an alternative use from those limited by the nature and quantity of resources available and allocate the resources in such a way that the objective established is realised. Under conditions of risk, the decision maker knows that the likelihood that alternative Aj will produce the outcome Oj is given by the probability Pij. Each alternative involves the likelihood that a particular course of action will produce an outcome which more or less satisfies the objective required. Under conditions of uncertainty, the decision maker is ignorant of the extent to which a particular chosen course of action will produce an outcome which satisfies the objective specified. Although it is conventional to specify a single objective such as profit, each alternative is associated with a particular value to the outcome. This is because the outcomes are evaluated in terms of money; an unambiguous, unitary standard of ratio measurement. The study of the resource allocation problem in decision theory conventionally assumes that the decision maker has an initially fixed and limited amount of resources available for use, that all available alternatives from which to

30 choose from are known to the decision maker, that the decision maker is required to satisfy only one objective rather than several mutually exclusive or conflicting objectives and that the criterion for judging the value of the objective is that the outcome achieved be maximised in some way (Bazerman, 2002). These assumptions enable attention to be focused on the determination of maximising decision rules of allocation, to explore the normative requirements necessary to achieve maximising behaviour and to describe and explain the circumstances under which decision makers violate the normatively derived prescriptions provided to achieve maxima. It is under these assumed situational conditions that the experimental studies in the literature on escalating commitment were initially conducted (Bowen, 1987; Staw, 1976). During the conduct of the experiment, the decision maker was provided with information, of a non probabilistic explicit nature, that the initially chosen course of action (Aj) was failing in the sense that the specified objective (Oj) may not be realised let alone be maximised (Staw, 1976). If the decision maker chooses to commit additional resources to the failed or failing course of action, the act of allocating the additional resources is considered to constitute escalation of commitment behaviour. This is because the behaviour violates the maximising behaviour associated with rational decision making and violates the rationally derived normatively prescriptive decision rules required to maximise a single objective function in commodity space through the choice of all known available alternatives. It is these rationally determined forms of behaviour and decision making which establish the standards against which actions and outcomes are evaluated. If the experimental outcome of the decision to commit additional resources to a failing course of action is significantly at variance from that which could be expected rationally, the escalation literature considers the decision to commit additional resources to involve behaviour which is consistent with the escalation of commitment phenomenon. The consideration is determined from ex post affirmations (Bowen, 1987; Staw and Ross, 1987a).

31 2.1.2 CRITICAL EVALUATION OF THE RESOURCE ALLOCATION PROBLEM The methodology used in laboratory escalation of commitment experiments contains some unusual evaluation features. The research is grounded firmly in the theoretically descriptive decision making psychology tradition (Bell, Raiffa and Tversky, 1988; Shapira, 1997). Yet, the behaviour observed under conditions of uncertainty is evaluated in terms of decision rules under conditions of risk derived exclusively from the theoretically normative decision making tradition. What the decision maker actually does is assessed against philosophical and value determined prescriptions about what the decision maker should do in risky situations. The normative decision making tradition has little to say prescriptively or constructively about how a decision maker should make a decision under conditions of uncertainty. The only possible exceptions derive from the axiomatic development of the Von Neumann and Morgenstern expected utility theory on risky decision making into the uncertain neoclassical economic world of Game Theory (Von Neumann and Morgenstern, 1947). In game theory, the nature of uncertainty is different from the unknown or unknowable relationships between alternatives (Ai) and outcomes (Oj). In game theory, uncertainty is conceptualised in terms of the uncertain intentions of others (Von Neumann and Morgenstern, 1944). This ingenious conceptualisation of the nature of uncertainty leads to the situation that in the prisoner’s dilemma type game theoretic situations, the only possible outcome of a game played between two rationally behaving individuals will be sub optional. The outcome contradicts the possibility that the maximisation of an objective is achievable, as assumed in the traditional normative decision making tradition. This form of utility and uncertainty does not feature in the escalation of commitment literature even though modern organisation theory, which derives its origins from the seminal contributions of Herbert Simon, is founded on the decision theory conceptualisation of uncertainty in game theory. Simon (1947), an institutional economist, initially responded to the uncertainty implications of game theory by proposing a descriptive theory of organisational behaviour in which the

32 maximisation principle was replaced with a satisficing principle comprising satisfactory and unsatisfactory values. The foundation platform for the descriptive organisational behaviour theory was completed a decade later. Simon (1957) proposed that the economically rational principle of individual behaviour in organisational contexts be replaced by a bounded rational principle in which the behaviour of individuals is intendly rational. The bounded rational principle was derived from an awareness of the serious limitations associated with the Von Neumann and Morgenstern expected utility theory. The theory was constructed to handle risk situations in which decisions about outcomes from available alternatives are made only once, rather than on several or numerous occasions. The theorem is about maximising behaviour and states that if the preferences of an individual conform to certain axioms, then it is possible to represent the ordering of preferences during a game by an ordered index of expected utilities (Von Neumann and Morgenstern, 1944). In other words, the optimum outcome achieved, albeit less than the maximum possible, is one in which an individual maximises utility and this will occur if the behaviour of the individual is consistent with the behavioural axioms. The limitations of the theorem are two fold (see for example Savage, 1954; Kahneman and Tversky, 1979; Kahneman, Solvic and Tversky, 1982; Tversky, 1969; Tversky and Kahneman, 1981). Firstly, there is the problem that it is not always possible to state explicitly, the probabilities associated with each outcome as required by the theorem. Secondly, some of the axioms constructed to represent the requirements for rational maximising behaviour in proposed game theoretic situations are violated consistently by individual decision makers. The axioms which are violated consistently involve the independence related “sure- thing” principle, the independence between alternatives principle, the transitivity principle and the final outcomes principle which reveals the problem of framing (Tversky and Kahneman, 1981). A discussion of these axioms is undertaken in section 2.5.1 and appendix D. The escalation of commitment literature does not consider the possibility that escalation of commitment type behaviour observed in organisations could be associated with explanations which derive their origins from both the profound

33 insights and the serious limitations contained in the pioneering game theory contributions of Von Neumann and Morgenstern. The explanations are expressed exclusively in terms of the reasons derived from laboratory experiments on escalation of commitment. The omission is understandable in the journal literature. It is of dubious character that, as a result of the omission, modern texts in strategic management for example, treat escalation of commitment as a decision error and ascribe the explanations for the error to those derived from the study of escalation in laboratory situations (see for example, Davidson and Griffin, 2000; de Wit and Meyer, 1998; Hubbard, 2000; Robins, Bergman and Stagg, 1997). In experimental laboratory situations, it is possible to control for the situational conditions to determine the relationship between the dependent and independent variables selected for investigation. In organisational contexts, this level of control over strategic or non programmable decisions cannot be obtained. The resources available for use frequently are contestable and variable in amount, rather than rigidly fixed. The range of possible alternatives available to choose from may be incomplete, excluded from consideration or not completely known. There may be a requirement to achieve more than one objective where the objectives may either be independent, complementary, conflicting or competing. There may be little incentive or capability to produce outcomes which maximise the objective set. And, the decision makers may be ignorant of or uncertain about the relationship between alternatives and outcomes. In organisational contexts, the resource allocation problem therefore, may involve substantially more and different decisions of an uncertain nature than that encompassed only by the unknown relationships between outcomes and alternatives.

2.1.3 SUMMARY The differences in purpose and in the nature and scope of the uncertainty conditions confronting individual decision makers in organisational contexts and experimental laboratory situations are not trivial and are essential to comprehend. The differences are central to the debate about whether not only is the study of organisational behaviour and decision making different from individual decision

34 making research but also whether the findings from individual decision making research assist in understanding organisational decision making (Shapira, 1997). It is from this debatable context that Staw and his associates argue that their findings on escalation of commitment in experimental laboratory research situations may provide the reasons to explain why decision makers in organisations persist with failing courses of action (Ross and Staw, 1986; Ross and Staw, 1993; Staw and Hoang, 1995).

2.2. THE NORMATIVE DECISION RULES UNDER RISK FOUNDATIONS:

BERNOULLI’S EXPECTED UTILITY THEORY

2.2.1. EXPLAINING BERNOULLI’S CONCEPT The resources allocation problem is the basis upon which the orthodox theoretical structures in the discipline of economics are constructed. Neoclassical economics, the dominant economics perspective, has been defined as the efficient allocation of scarce resources amongst competing human wants (Samuelson and Nordhaus, 1985). From this definition, which involves the belief that resources should be allocated exclusively according to the governing principle of efficiency, has emerged questions about two principal concerns. What determines the prices of the goods and services produced? How should these goods and services be distributed amongst the various economic factors such as land, labour and capital responsible for their production? The answers provided comprise the substance for the theory of value and the theory of distribution (Galbraith, 1987). These two theories in combination, provide the basis for the consideration of several subsidiary concerns. First, how equitable or inequitable is the distribution of income, the necessary basis to purchase the goods and services produced? Second, under what efficiency conditions will the distribution be equitable? Third, what is involved in producing better or worse economic performances, when better or worse is defined in terms of efficiency? And fourth, under what economic conditions will the best economic performances, meaning the most efficient, be realised?

35 The resolution of the resource allocation problem in economics requires that elements from both the theory of value and the theory of distribution be utilised. Both theories in turn have their conceptual and mathematical origins in the evolution of the study of decision making under conditions of risk. The central concept in decision making on risk is utility and the concept and its objective equivalent in production; efficiency, underpin the economic laws of demand and supply. Together, these laws determine the prices at which goods and services exchange in markets. Under ideal conditions, market prices represent values. In 1731, Daniel Bernoulli presented a paper to the Imperial Academy of Science in St. Petersburg which was subsequently published in the papers of the Academy in 1738 (Bernoulli, 1954). The paper revolutionised the way that risk was conceptualised because, for the first time in history, Bernoulli applied measurement to something which cannot be counted objectively. The theorem that Bernoulli developed called Bernoulli’s expected utility theory, remains the normative standard, in modern decision theory against which to judge the behaviour of individuals in decision making situations under conditions of risk (Stevenson, Busemeyer and Naylor, 1990). The Von Neumann and Morgenstern expected utility theory is a distantly related case of the Bernoulli theorem. Bernoulli introduced his paper by questioning the prevailing view that the value of a choice could be determined from the objective probabilities attached to the consequences (see for example Hacking, 1975 or Stigler, 1986 for an historical overview of decision making under risk).

“Ever since mathematicians first began to study the measurement of risk, there has been general agreement on the following proposition: Expected values are computed by multiplying each possible gain by the number of ways in which it can occur, and then dividing the sum of these products by the total number of cases” Bernoulli, (1738), translated from the Latin by Sommer (1954).

According to Bernoulli (1954), “the value of an item must not be based on its price but rather on the utility it yields.” The argument is based on the proposition that any decision relating to risk involves two distinct but inseparable

36 elements: the objective facts and the subjective view about the desirability of what is to be gained or lost by the decision. Price and objective probability are not enough to determine what something is worth when an individual is required to make a risky decision about the uncertain future. This is because the facts ignore the consequences of a probable outcome. Bernoulli introduced the intuitively experienced concept of utility as the subjective element. Utility is a hypothetical construct and conveys a sense of usefulness, satisfaction or desirability. In the psychological literature the equivalent of utility involves the relationships between the concepts of need and motivation (Alderfer, 1972a, 1972b; Maslow, 1954). The utility experienced is different for each individual, and depends on different individual circumstances. This leads to the conclusion that the value of the outcome of a risky decision is determined uniquely by the different utility based risks which each individual associates with the selection of an alternative choice. Consequently, in decision situations involving risk about the uncertain future, decision makers will value the outcome of a decision in terms of their individual utility rather than the expected value. In these circumstances, the value of a particular outcome can be as varied as the number of individual decision makers involved. The calculation of utility based value for an individual decision maker involves the same method of calculation used to determine expected value except that utility is used as a weighting factor. The expressions are derived in appendix A. Bernoulli argued that the value individuals attach to risky decisions was not entirely variable between individuals, but could be determined. He argued that individuals will behave rationally and maximise their utility. Additionally, he postulated the novel idea that the “utility resulting from any small increase in wealth will be inversely proportionate to the quantity of the goods previously possessed” (Bernoulli, 1954). When this principle was independently discovered it provided the basis for analysing economic matters in marginal terms rather than total terms (Jevons, 1911; Marshall, 1920). The principle is the basis for the familiar concepts of “diminishing marginal utility” and diminishing marginal productivity” encountered in economics. The principle is the structural basis for determining objectively how much more over

37 how much less an individual wants. This particular conceptualisation of the nature of utility has set a basic standard for defining human rationality not only in mathematics and economics but also in other disciplines. For instance, most psychologists and moral philosophers would consider people who experience increasing utility of income and wealth as their income increases and their wealth accumulates as either abnormal (neurotic) or immoral (greedy). There is a logical extension to Bernoulli’s conceptualisation of the nature of utility about assuming risks. If the utility to be derived from each successive marginal increase in wealth is less than the utility derived from the previous marginal increase in wealth, then the “disutility” caused by a loss in wealth will always exceed the positive utility provided by a gain in wealth of equal size. This logical extension reveals the asymmetrical nature of rational risk taking. How people respond to this asymmetry is the focus of attention in the escalation of commitment literature even though this is not explicitly stated. Risk seeking will decline in successful outcome situations as the successive gains diminish in value. On the other hand, risk avoidance, will increase, if the successive gains realised are progressively lost. This will always be the case provided that individual decision makers do not seek to recapture that which has been lost which may involve the concept of sunk costs in investment decision situations. If for some reason decision makers believe that in uncertain situations what has been lost can be regained or if human behaviour is characterised by loss avoidance rather than risk avoidance, then the resulting behaviour may be considered to be irrational. Escalating of commitment involves the apparent violation of the utility principles underlying the asymmetrical nature of risk taking. Bernoulli’s concept of utility was a revolutionary innovation, but the initial treatment was limited in several ways. Firstly, the concept of rationality was ill defined. Secondly, individual utility is not determined absolutely and independently by a rationally calculating individual. It is determined in a comparative social context which, because others have more for example may lead individuals to want more even though the individual has enough according to any objective standard of measurement. It is a relative concept rather than an absolute concept. It is on the basis of this relativity that certain explanations for escalation of commitment type behaviour are predicated. Thirdly, Bernoulli

38 derived his postulates from a winning game, the structure of which produced the St. Petersburg paradox. The notion that games may involve losses did not enter the picture. Once losses are admitted, utility theory assumes the normative paradigm of choice in determining the extent of risk which individuals will assume in the expectation of achieving some psychologically desirable but uncertain gainful outcome. Finally, utility initially was afforded cardinal treatment in which numerical values of utility are attached. Such a treatment is restrictive. The restriction is removed when utility is treated as an ordered preference state. It makes little sense to talk about the value of an outcome as being a number of utils. It does make sense to say that “I like this outcome better than or worse than some other outcome.”

2.2.2. EVALUATING BERNOULLI’S CONCEPT The concept of utility was rediscovered in 1789 by the political economist Jeremy Bentham (1948). During the nineteenth century and the early twentieth century, economists and mathematicians progressively were successful in removing the limitations associated with the original formulation. The advances undertaken in utility theory provided the setting for the rigorous development of the concept of rationality. In economics, the definition of rationality differs from the conventional definition of rationality which is encountered most frequently in functional theories in the behavioural and social sciences. This notion of rationality approximates philosophical rationality with its signification of being “endowed with reason, agreeable to reasoning, sensible, sane, and moderate [intelligent], not foolish or absurd or extreme [or fanciful]; of or based on reasoning or reason…” (Fowler, 1965). In economics (and normative decision theory) the definition explicitly incorporates the principal that individuals maximise their utility (Intriligator, 1971). It is against this theoretical form of maximising rationality that the behaviour observed in escalation of commitment situations is evaluated. The definition of economic rationality is developed axiomatically in modern neoclassical economics (Herstein and Milnor, 1953). Theoretically, if individuals comply with the axioms they are considered to have behaved in a rational manner.

39 Rational behaviour is the normative basis for the expression of consumer preferences which determine the quantity of goods and services demanded. The normative counterpart for the maximisation of utility on the supply side of the economy, is that the producers of the goods and services demanded, maximise profits. Profits are a measurement of performance which represents a standardised approximation of producer efficiency. If individuals maximise their utility in the expression of their demand preferences under rational conditions and suppliers maximise their profits under various efficiency conditions, then the price at which the goods exchange in the market will be an equilibrium position. Moreover, the price at which the goods and services are exchanged under these conditions will be an accurate representation of their value. For an individual decision maker, the cognitive and emotional requirements necessary to fulfil the normative decision criteria are considerable, even if the criteria for evaluation are accepted as being universally valid (Bernstein, 1996). Furthermore, in organisational decision making contexts, the concept of utility nowhere precludes the possibility that individual decision makers, responsible for organisational outcomes, may seek to maximise their own utility. Individual utility may be significantly different from or involve more objectives than the single but variably valued efficiency outcome assumed to be associated with organisations in the escalation of commitment literature. The existence of this possibility is the foundation upon which principal – agency theory governance relationships have been developed (see for example Jenson and Meckling, 1976; Jenson, 1983). The situation becomes even more complex, demanding and indeterminate in organisational contexts if the possibility is admitted that organisations may pursue more than one independent objective simultaneously. In experimental situations involving escalation of commitment, the behaviour of individuals is evaluated in terms of efficiency outcomes contingent upon the behaviour of the individual being consistent with individual utility maximisation criteria. In organisational decision contexts, the escalation of commitment situation is very different. The outcomes evaluated derive from the combination of two sources which may not be inseparable. These sources involve the utility characteristics of the decision makers and the production and

40 investment choice capabilities of the organisation. Together, these sources are responsible for the production of efficiency based financial outcomes. Only if the utility characteristics of the individual decision makers within the organisation coincide perfectly with the efficiency objectives of the organisation will the outcome evaluated be identical for both sources (Debreu, 1959). In all other financial outcome situations, the utility achieved will deviate from the efficiency achieved. The values will not be coincidental. It is only recently that the literature on escalation has considered these possibilities and consequently alternative possible explanations for the behaviour exhibited in escalation situations (Buzkar, 1999; Shapira, 1997).

2.2.3. SUMMARY In the previous section, it was revealed that organisational decision making situations may involve more uncertainty dimensions than the particular dimension captured in escalation of commitment experiments. The uncertainty dimension captured in escalation of commitment experiments is only concerned with the initial impossibility of knowing the probability that a particular outcome will be associated with a particular chosen alternative course of action. As well, organisational decision making may involve uncertainty of a different nature in addition to that associated with the absence of probabilities. This includes the particular from of uncertainty associated with the uncertain intensions of others. In this section, the normative foundations for a utility based theory of choice under conditions of risk have been described. This theory forms the basis for the development of the economic theories of value and distribution from which have been developed performance criteria to evaluate the outcome of choice decisions under conditions of risk.

2.3 RATIONALITY

2.3.1 EXPLANATION OF THE CONCEPT In economics and finance, projects are evaluated in terms of criteria developed from assumptions about the behaviour of individuals and the behaviour of individual producing firms. As already indicated, the assumptions involve the

41 concepts of economic rationality and economic efficiency. From this perspective, project outcomes are evaluated in terms of “ex ante” antecedents (Samuelson, 1947). Alternatively, projects can be evaluated in terms of “ex post” consequences. This alternative system involves the evaluation of project outcomes in terms of market variables. The results obtained can, in turn, be evaluated in terms of whether they are consistent with rational behaviour and firm efficiency behaviour. This alternative system of project evaluation enables the concepts of utility and efficiency with their associated difficulties, to be removed from the analysis (Samuelson, 1948). It also removes the central sources of criticism directed at the neoclassical economic theories of pure competition. A brief explanation of this alternative system of economic project evaluation, in the context of individual consumer behaviour, is contained in appendix E. In normative decision theory and economics, rationality has a precise meaning and the concept is defined rigorously. Rational behaviour requires, as previously stated, that individuals comply with the axioms which define the concept of rationality (see for example Arrow and Hahn, 1971). The following derivation of rationality is drawn from Debreu, 1959 and Malinvaud, 1972). The value of an alternative outcome for an individual is the utility derived. The utility derived is expressed in the form of a “continuous” utility function:

u = f (x1, x2,… xj,… xn) In economics, it is conventional to endow the utility function with certain properties, which together permit the utility function to be subjected to mathematical expression and numerical calculation. There are four properties necessary to permit these transformations. These are outlined in appendix B. These four properties, which have been designed specifically for the purpose of numerical expression and calculation, have produced an unfortunate and unintended consequence. By assuming that the outcome or commodity set exhausts the choice possibilities, it is implicitly assumed that an individual decision maker or consumer has perfect knowledge of the available choices and perfect knowledge of the future alternatives available from which to choose from. In introductory expositions of economic theory, it is conventional to retain the assumption that the commodity set exhausts choice possibilities. In more

42 advanced treatments, the assumption can be relaxed without causing any consequent loss in mathematical rigour. The result is that the popular myth that economic rationality strictly involves the behavioural assumption of perfect knowledge can be dismissed. The assumption of perfect knowledge derives from particular properties assigned to the mathematical formulation of the continuous utility function. It does not derive from the behavioural axioms which define the concept of economic rationality although the ultimate effect may be the same.

2.3.2 BEHAVIOURAL AXIOMS There are three behavioural axioms which are necessary and sufficient to define the concept of rationality. There are an additional three axioms necessary and sufficient to define the concept of economic rationality which differs from strict rationality in the important respect that individuals are assumed to maximise their utility. Axioms are behavioural assumptions. They are statements, which are accepted as being true without proof, for the purpose of theory formulation and development. They are accepted as being plausible foundations to explain the behaviour observed in individuals in the context of decision making and commodity selection. The axiomatic development of rationality involves three possible preference states. These are: (a) x0 is not preferred to xi : (xo ≤ xi); (b) x0 is indifferent to xi : (xo ≤ xi and x1 ≤ xo) (c) xi is preferred to xo : (xo ≤ xi and not x1 ≤ xo) The preferences (a) and (c) are referred to as “strong preference orderings”. Preference (b) is referred to as a “weak ordering of preferences”. It is possible to construct a utility function from a weak ordering of preferences which represents the commonly experienced situation, that two or more combinations may be equally desirable or undesirable to an individual decision maker or consumer. The axioms of rationality involve: (1) The axiom of comparability or completeness. For any pair of combinations xo and xi in the combination set X, the individual is able to

43 choose xo ≤ xi and xi ≤ xo. The axiom excludes the condition that an individual is unable to make comparisons between alternative combinations. It is necessary that at least one of the axiomatic statements holds. It is entirely possible that both statements hold simultaneously, although this dual preference state is not required. The axiom is a behavioural statement about the intellectual or reasoning capabilities of individuals to make choices between alternative combinations of outcomes. (2) The axiom of transitivity. If the combination xo is not preferred to the combination xi and x1 is not preferred to combination x2, then xo is not preferred to x2 : that is if xo ≤ xi and x1 ≤ x2 then this implies that xo ≤ x2. The axiom assumes that individuals do not make contradictory preferences. In effect, the preferences or choice alternatives of individuals are “consistent”. This consistency axiom applies strictly to the preferences between alternatives in a given choice occasion. The consistency axiom can be extended to encompass the preference of alternative combinations on different choice occasions. Consistency is the central and ultimately the only sufficient behavioural axiom necessary to behave rationally. Axioms 1 and 2 together provide a “pre ordering” or weak ordering of preferences in the utility function. It is a binary relationship which is reflexive and transitive. In contrast, a strong preference ordering would imply that xo is equal to x1 as xo Rx1 and x1 Rxo. A strong preference ordering rules out indifferent preference orderings. While axioms one and two provide an ordering which is complete, they do not guarantee that the utility function represented possesses any real value. Consider the following situation which, in the absence of a condition to produce maximising behaviour, considers an individual with an addiction to analgesics. It two combinations of alternatives each contain aspirin, the individual, because of her addition, will always prefer the combination which contains more aspirin. Assume initially there are two combinations xo and x1, each

containing different amounts of two commodities: aspirin (xi) and fish 44 o 1 o 1 (x2). If there is more aspirin in x than in x (i.e. if x1 > x1 ) then the individual will prefer the combination, xo to x1. Assume there is a third 2 2 o 2 o combination, x such that x1 = x1 . The individual will prefer x to x if 2 o and only if x2 > x2 which is the situation in which there is more fish in x2 than in xo. The situation is represented in the figure 1.

FIGURE 1 ORDERING OF PREFERENCES

X2 Fish

1 2 X X

X0

(0,0) X1 Aspirin

In this situation, xo is preferred to xi, which contains less aspirin and x2, which contains the same amount of aspirin but more fish, is preferred to xo. The combination xo will be preferred to any combination in the shaded area and any combination on the line between xo and the horizontal axis. Any combination on the dotted line will be preferred to xo. This type of ordering is called a lexicographic ordering. As there are no points indifferent to xo, it is impossible to determine a continuous curve separating xo from the combinations which separate xo from the combinations that are preferred to xo and the combinations to which xo is preferred. It is possible for x1 and x2 to be as close as it is possible to be to xo without expressing indifference. The third axiom precludes orderings such as a lexicographic orderings and ensures that preferences are ordered in terms of real values.

45 (3) The axiom of continuity is expressed as the set of combinations not preferred to xo and the set of combinations to which xo is not preferred are both closed in X, for any xo. This axiom says it is possible to let x1, a combination not preferred to xo, come as close to xo so that xo will no longer be preferred to x1. That is, the individual will be indifferent to combinations xo and x1 under these conditions. This was impossible in the situation illustrated. The set of points not preferred to xo was not preferred. Lack of closure means that xo did not contain its boundaries. Debreu (1959:60-63) has demonstrated that these three rationality axioms provide sufficient conditions to specify the existence of a real valued utility function, which is a continuous function of the outcomes chosen or of the quanties consumed in the various combinations, such that u (xo ≤ u (x1) ≤ u (x)2 when xo ≤ x1 ≤ x2. Debreu’s proof does not imply the uniqueness of a utility function, merely that a utility function exists under rationality conditions. Economic rationality and normative decision theory require that individuals maximise their utility. The continuous utility function defined in terms of the three axioms does not produce an optional choice or combination. Three additional axioms are required to produce a utility function which is endowed with the maximisation property. These are concerned with monotonicity, convexity and the capacity to differentiate utility functions. The properties are derived in appendix C.

2.3.3 UTILITY FUNCTIONS The utility function associated with a particular outcome or commodity in commodity space can now be represented. It assumes the general form depicted in figure 2. The utility derived from the outcome or good purchased increases at a decreasing rate or declines at an increasing rate.

46

FIGURE 2 THE CONCAVE UTILITY FUNCTION

ui

ui = f (xi)

(0,0)

xi

An equivalent utility function can be derived axiomatically for negative outcomes, or the loss of utility experienced from the absence of or loss or of a good purchased and consumed (see for example Arrow, 1963 or Arrow and Hahn, 1971). Unlike the concave utility function depicted in the above diagram, the utility function in negative commodity space, is convex as represented in figure 3. In negative commodity space utility increases at an increasing rate, or declines at a diminishing rate.

FIGURE 3 THE CONVEX UTILITY FUNCTION

- xi ui xi (0,0)

ui = f (xi)

- ui

Figure 4 is representative of the general shape of the utility function in positive and negative commodity space with the point of inflection being at (0,0).

47 FIGURE 4 THE GENERAL UTILITY FUNCTION

uj

uj = f (xj)

(0,0) xj

The general shape of the rationally derived continuous utility function in both positive and negative commodity space has provided an alternative explanation for the escalation phenomenon from those provided in the escalation of commitment literature (Northcraft and Wolf, 1984). From this alternative explanation perspective, the generalised form of the utility function is important to understand.

2.3.4 SUMMARY The axiomatic development of the utility function precisely determines the meaning of economic rationality which is equivalent to the concept of rationality in decision theory. It also determines the “knowledge” based mathematical properties which are necessary and sufficient to give the utility function computing expression. It should now be apparent that the only essential requirements for economic rationality involve the capacity of an individual to be “consistent” in her ordering of preferences or alternatives and that the preference ordering is maximised in terms of individual utility.

48 2.4 CHOICE AND UTILITY MAXIMISATION

2.4.1 DERIVATION The resource allocation problem as previously indicated, is a special case of the general choice problem under conditions of certainty, in which an individual is assumed to maximise her utility function, consisting of all available commodities or alternatives, subject to the limited resource constraint that she has a limited budget, a linear constraint, which restricts her ability to satisfy all the preferences she desires. Formally, an individual is assumed to maximise an individual utility function, u = f (x1, x2 .. xi … xn), subject to the constraint that the total amount of income (y) available to spend is exercised in choosing to secure a combination of individual commodities (xi) which are individually associated with a particular price

(pi). The expenditure constraint is given by the expression, ∑ pi xi = y. This is a constrained maximisation problem in calculus. A general exposition of the conditions for a solution to the problem is given by Intriligator (1971) and Lancaster (1968). Briefly, an individual attempts to “allocate” a fixed expenditure amongst “n” commodities or alternatives which have a given price. In the calculus, the solution to the problem is provided by forming a Lagrangian function of the general form, L = u – l (∑ (pi xi – y) where “l” is a lagrangian multiplier in which “L” is differentiated with respect to Xi and l to obtain:

dl = du = Lpi , and – dL = ∑ pi xi – y

dxi dxi dl

By putting the value of the derivatives equal to zero, the mathematical equivalent of a position of maximisation or minimisation, the first order conditions are derived as:

du = Lpi , subject to ∑ pi xi – y

dxi

49 These are demand functions which describe the actual choice behaviour of the individual in the exercise of her preferences for alternative commodities or outcomes. Diagrammatically, the functions for well behaved utility preferences are the familiar downward sloping convex demand curves encountered in elementary economics texts. The global conditions for utility maximisation are given by the expression:

du/dxj = Pi

du dxi Pj

The expression du/dxi is interpreted as the “marginal utility” associated with xi and the ratio on the left hand side of the above expression is interpreted as the “marginal rate of substitution”. The expression can be rearranged to provide the general principle that equilibrium entails that all marginal utilities divided by the corresponding prices are equal.

Diagrammatically, the ratio of marginal utilities of xi and xj embody three assumptions derived from the axioms. They purport to capture the psychological behaviour of an individual decision maker in the process of choosing between alternative commodities or outcomes. These are:

(1) The individual is not oversupplied with either commodity; xi and xj. This is a nonsatiation assumption; (2) The individual’s consumer preferences possess a conceptually simple form of consistency. This is the axiom of transitivity; and

(3) If an individual has a relatively small amount of xi and a relatively

large amount of xj, then the individual will be willing to give up only a

relatively small amount of xi in exchange for a larger amount of xj.

The marginal utility of xi will be greater than for x1. This is the assumption of diminishing marginal rate of substitution. The assumption captures the reasonable condition that the scarcer a commodity is, or the less likelihood an alternative outcome is, the more valuable it will be regarded.

The diagrammatic representation of the preferred combinations of xi and xj to which the individual is indifferent, is indicated by indifference mapping. Figure

5 illustrates a hypothetical indifference mapping between xi and xj. 50

FIGURE 5 INDIFFERENCE MAPPING OF UTILITIES

xi J K Total Utility I u1 xi U

I K1 J1 I1 I1 0 xj xj

From the assumptions derived from the axioms, the indifference curve expressing indifferent combinations of xi and xj has several properties (Baumol, 1972): (1) An indifference curve which lies above and to the right of another represents preferred combinations of commodities. More is better than less; (2) Indifference curves, have negative slopes as a result of the first assumption. The slope of the curve is given by the marginal utility of

xi divided by the marginal utility of xj (du/dxi/du/dxj); (3) Indifference curves neither meet or intersect as a result of assumptions one and two; and (4) The absolute slope of an indifference curve diminishes to the right. This ensures that the indifference curve is “convex” to the origin to maintain consistency with assumption three and the axioms which ensure that utility in positive commodity space is concave.

2.4.2 SUMMARY This completes the axiomatic and mathematical foundations involved in the selection of alternative choices under conditions of certainty. Choices are selected on the basis that individuals behave rationally in the sense that not only are they

51 “capable” of making preference decisions between known alternatives but also they are “consistent” in their selection of preferred alternatives. Economic rationality provides the criterion about which alternatives actually are chosen by individuals. The alternatives chosen are those that maximise individual utility or satisfaction. As previously indicated, the economic literature has, for the most part, dispensed with utility analysis in most of the theory of consumer behaviour and more generally in the analysis of economic decision making. In contrast, the concept of utility and its structure remain central in decision theory.

2.5 UTILITY MAXIMISATION UNDER RISK CONDITIONS: THE VON NEUMANN AND

MORGENSTERN EXPECTED UTILITY THEORY.

2.5.1 DESCRIPTION OF THE CONCEPT The theoretical foundations of game theory derive from the rational axioms contained in the Von Neumann and Morgenstern expected utility theory. The theory has been expressed verbally in section 2.1.2. It is now expressed in its usual form as follows:

EU (Ai) = Pu Oi + (1-P) U Q2 On first inspection, the formulation is identical to the expression of Bernoulli’s expected utility theory for evaluating decisions under risk. This is misleading. The difference between the two expressions is the different conceptualisations of utility and in the determination of the individual’s evaluation (u) of the outcomes. A numerical value, called utility, is derived for each possible outcome. This concept of utility is unrelated to the intuitively experienced concept of utility or satisfaction discussed in the previous sections on utility and rationality. It is an operational instrument which, in the absence of the players in a game, enables the investigator to determine or predict which of several risky alternative propositions, an individual player will prefer. In strategic games between individual players, an investigator must be able to predict how a player will rank risky decisions in order to evaluate the outcomes obtained. This operational concept of utility retains one characteristic associated with the traditional conception. Numerical values of

52 marginal utility can be calculated which are the numerical equivalent of the traditionally derived measures of marginal rates of substitution. The numerical values of utility in a game are constructed from a hypothetical game in which the outcomes usually are conceived in terms of extremes. Arbitrary values, which are numerically different, are assigned to the extreme outcome which is extremely desirable and to the extreme outcome which is extremely undesirable. The value of a particular outcome (Oj) associated with an actual game is the value of the particular probability U(P), derived from the hypothetical extreme probabilities, where the individual is indifferent between U(P) and Oj (Von Neumann and Morgenstern, 1947, Chapter 1 and Appendix). This conceptualisation of utility assumes that individuals will behave rationally. If individual behaviour is consistent with five necessary and sufficient axioms of rational behaviour, an individual will always make decisions in accordance with the predictions of the Von Neumann and Morgenstern expected utility theorem. (Herstein and Milnor, 1953; Luce, 1959; Luce and Raiffa, 1957; and Marshak, 1950). The five sufficient behavioural axioms are concerned with transitivity, continuity, independence, choice of preferences and compound probabilities. They are described in appendix D.

53 2.5.2 CRITICAL EVALUATION As with the rationality axioms which underpin traditional utility theory, these axioms have attracted considerable criticism in the economic literature and in the descriptive decision theory literature (Samuelson, 1952 and Tversky and Kahnemann, 1980, 1981). These are discussed at length in chapter 3. At this point, it is sufficient to note certain obvious short comings. It is clear that very few, if any individual will perform the complicated calculations required to comply with the compound probabilities axiom. This is irrelevant theoretically but it is relevant in practice. Firstly, very few individuals are capable of performing the calculations even if they wanted to (Simon, 1957). Secondly, it is not at all clear that any individual would want to perform the complicated calculations. It is even questionable whether it is in one’s self interest that one “should” do so (Luce and Raiffa, 1957, Chapter 2). The independence axiom has an obvious objection (Samuelson, 1952). Most individuals will not pay an entry price of, say $800 to play a game of chance, say the toss of a coin, in which there is a fifty-fifty chance of winning either $1000 or nothing. The actuarial value of the game is $500. An individual may be willing to pay $100 or alternatively accept as little as $100 but no less, not to play the game. The amount of $100 represents the expected value of the game to the individual. The individual is indifferent between receiving a $100 certain and the alternative of playing the game. For the individual, receiving a $100 not only represents “a sure thing” or a belief that paying $100 will return $1000 but also the risk averse profile of the individual. Now consider a change in context. There are two games of chance which differ only in that in the first, the potential pay off is as in the first example and in the second the pay off is $100. According to the independence axiom, the individual should be indifferent between playing the two games. This is rarely the case. Individuals frequently prefer the first game because securing the $100 now involves playing a game which may be perceived as involving risk. Situations which involve this type of example indicate that preference orderings may be changed when an outcome no longer represents a sure thing. The example also

54 illustrates that the relative expected values between the initial game and the $100 certain is variable in the sense that the values are “not independent” of the context in which the situation occurs. This is a problem of framing which is discussed in the next chapter (Tversky and Kahnemann, 1981).

2.5.3 SUMMARY The Van Neumann and Morgenstern expected utility theory was constructed to enable observers to determine whether participants in a game were behaving rationally. The axioms have been generalised and subjected to experimental investigation of their veracity. In complicated choice situations decision makers make choices which consistently deviate from the requirements of the first three axioms. These findings provide the bases for the proposals that prospect theory explanations account for escalation bias (e.g. Sharp and Salter, 1997).

2.6 FIRM OR PRODUCER EFFICIENCY

2.6.1 REQUIREMENTS Producer efficiency in most treatments in economics is derived independently of individual consumption preferences based on the maximisation of the individual’s utility function. Some treatments recognise that the relationships between demand and supply may be interdependent. A case in point is the supplier induced demand associated with the provision of medical services and diagnostic equipment (Arrow, 1963b; Culyer, 1971; and Richardson, 1980). Utility maximisation is assumed to be the basis upon which decision makers exercise their preferences for consumption. The equivalent behavioural assumption for the operation of firms is that they maximise profits. Profits derive from the surplus value obtained in converting resource inputs into outputs of final goods and services for consumption. The relationship that converts inputs into outputs is the production function. The production function specifies the technologically maximum amount of output that can be obtained from combining given amounts of input in the most efficiency way. In this sense the inputs are technologically interdependent. The chosen combination of inputs represents the state of existing knowledge about the technological and managerial information

55 required to select the production process which is the best alternative available (Rumelt, 1991). To determine the actual amount of output which can be produced for any given level of expenditure; a linear resource constraint; the production function is transformed into a quasi cost function in which the price of each input is provided. These are production costs. The particular amount of output of economic interest is that level in which is specified the conditions for maximum efficiency of the conversion process. The condition involves the use, subject to the expenditure constraint, of the least cost combination of inputs. The mathematical solution involves providing the production function with several properties based on reasonable assumptions about diminishing returns in the form of diminishing marginal productivity and the existence of increasing, constant and decreasing returns to scale as all inputs are increased simultaneously. A complete explanation is provided for example in Cohen and Cyert, (1975). With the assumptions specified, the analysis involves the mathematical equivalent of that involved in the determination of utility maximisation. The problem, once again, is a resource allocation problem in which the objective is to maximise the value of a production function subject to an expenditure constraint. The mathematical derivation is described briefly as follows. A firm has a production function of the general order:

Q = f(X1 X2 … Xn)

Where X1 is the amount of an input Xi (say human capital) used by the firm. At any given output level say O1, the firm will attempt to produce O1 as cheaply as possible which means that the firm is also attempting to minimise its expenditure where total expenditure available for production is given by:

E = P1 X1 + P2 X2 + … Pn Xn The Langrangian function is formed as: 1 El = P1 X1 + P2 X2 + … Pn Xn + l [f(X1, X2, …, Xn) – O ]

56 Differentiating and setting the first order conditions as zero, the following expressions are obtained:

dEl = P1 + l df = O,

dx1 dxi

dEl = Pz + l df = O,

dx2 dx2

dEl = Pn + l df = O, and

dxn dXn 1 dEl = F(X1, X2, Xn) - Q = O,

dl

Rearranging,

P1 = - l d f , P2 = - l d f , Pn = - l d f

dX1 dX2 dXn By dividing one equation by the other, the condition for efficiency maximisation is given as

P1 = df/dX1 = Marginal Product X1

P2 df/dX2 Marginal Product X2 When the ratio of the price of inputs equals the ratio of their marginal products, efficiency maximisation is realised. The conditions for profit maximisation are obtaining by extending the analysis to include: • The possibility of producing two or more products or services from the same expenditure restricted quantity of resource inputs; and • Adding a function about the amount of revenue which a firm can expect to obtain from the sale of various combinations of the goods and services produced. Given this additional information, the analysis proceeds in a mathematically equivalent way to the processes used in the derivation of the condition for production efficiency. It is a constrained optimisation problem. For a complete explanation of the analysis see for example, Cohen and Cyert, (1975:111-138). The fundamental condition for profit maximisation is obtained when;

57 “The rate of product transformation between every pair of outputs, holding all other outputs and inputs constant is numerically equal to the inverse ratio of their prices”. (Cohen and Cyert, 1975:129). The condition is captured in the following expression:

Profit maximisation = dqxj = Marginal rate of transformation xj =

Pi

dqxi Marginal rate of transformation xi

Pj

2.6.2 SUMMARY It is no accident that the condition for profit maximisation shares a common identity with the condition for utility maximisation derived in section 2.4. Both are constructed under the assumption that it is socially desirable to maximise efficiency in the satisfaction of human wants. The equilibrium position involving the demand for and supply of a particular good or service is obtained theoretically when consumers maximise their utility and producers maximise efficiency by maximising profits. An understanding of the conditions for producer efficiency is necessary to understand the logic involved in evaluating private sector and public sector projects. Producer efficiency provides the foundations for the development of the theory of the firm (see for example, Silverberg, 1978). The foundations for an economic theory of value are obtained by combining the theory of the firm and individual utility theory. The result is a theory of markets which contains little about the behaviour which takes place within firms. Only one form of behaviour is recognised. Firms are assumed to maximise profits (efficiency). This implies that decision makers guiding the activities of firms behave rationally and adopt the efficiency objectives of the firm as being consistent with their individual self interests.

2.7 EFFICIENCY AND OPTIMISATION OF INVESTMENT DECISIONS Projects involve the investment of scarce resources in the expectation that the benefit to be derived from an investment will exceed the cost of the

58 investment. Investment decisions are complex and various decision rules have evolved to determine ex ante, and to evaluate ex post, the value or worth of an investment (Ross et. al., 1994). Investment decisions in practice, if not always theoretically, are resource allocation problems.

2.7.1 MOTIVES The literature on investment reveals that a number of reasonable motives have been used and continue to be used to make investment decisions. One involves maintaining the total amount of capital employed proportional to the total amount of output produced. The motive produces the acceleration principle (Hicks, 1946). Another involves making investments in areas unrelated to production in order to maintain rated capacity (Chandler, 1990). A third involves, not capital widening as in the first motive, but capital deepening; the intensification of capital in response to technological progress or an adverse change in the cost of other production inputs. A fourth involves a direct relationship between sales, a measure of growth, and investment (Baumol, 1972). A fifth involves diversification into related or unrelated businesses or investments in order to produce an acceptable compromise between risk and return (Markowitz, 1952). A sixth motive can be mentioned. This involves the managers of capital making investment decisions which enhance their own interests (Williamson, 1970, 1975, 1979, 1983; Jenson, 1983, 1993). With the possible exception of the last motive, the other motives all have one characteristic in common. The underlying reason for the motive expressed is profit related. Business survival depends on profits being obtained. Wealth creation requires that income be earned or profits generated. Consequently, the decision rules developed to evaluate the value of an investment all employ the notion of a profitable return on investment. There are three standard criteria of which two involve optimising the value of an investment decision. These two are efficiency determined. The first criterion is the frequently employed but defective payback period. This simply involves making judgements about whether the time taken or expected to be taken to earn the income necessary to recover the cost of the

59 investment is acceptable. Under risky conditions, the payback period is transformed into the finite horizon criterion. According to this criterion, risky investments which extend beyond a designated terminal date simply are excluded from consideration. The second criterion is known as the marginal efficiency of investment or the internal rate of return. The marginal efficiency of an investment project is that rate of interest which ensures that the discounted present value of the expected future marginal returns exactly equals the investment cost of the project. The rule informs the potential investor that it is efficient to continue to invest or select alternative investment projects in which to invest, up to the point where the marginal efficiency of investment; the return, is greater than or equal to the marginal cost of capital; the interest rate. This criterion frequently is the basis for evaluating public investment projects using a social cost benefit methodology. There are some obvious limitations associated with its use. The discount rate has be determined by a process of iteration. Where the number of alternative investment projects is limited, it provides little guidance for assigning priorities between the limited but potentially competing investment alternatives. The third criterion is closely related to the second and under certain conditions, the outcomes are identical. This criterion avoids the obvious limitations of the second criteria but introduces a new set of limitations. The most important involve the assumption of independence, how to account for negative cash flows and how should the use of positive cash flows generated during the life of the investment project be treated. The criterion states that for a firm to maximise its profits from an independent investment project, it is necessary that the present value of the net after tax cash flows associated with the investment project, discounted at the market rate of interest, the opportunity cost of capital, be positive.

2.7.2 EVALUATION Under conditions of risk, the discount formulas used to calculate the desirability of investment projects need to be modified. How the modifications are

60 effected depends, in part on which technique is preferred or known. The most common practice involves assigning an additional weight to the discount rate for independent projects to account for the associated risk. Alternatively, the discount rate can be modified according to representative gains or losses (Shackel, 1952). The formulas can be modified according to standard probability theory (Markowitz, 1952). This requires that probability statements be attached to indices of expected return and risk, where risk is defined in terms of the statistical variance of the expected returns. The computational requirements necessary to produce the probability weighted indices are rarely, if ever, performed in practice. The concept of definite relationships between risk and return is fully appreciated in financial markets and simple models, which require considerable judgement, substitute for the sophisticated theoretical requirements of the original Markowitz construction. The model most frequently employed in financial and investment markets is the familiar capital asset pricing model, despite its inherent limitations (Sharpe, 1990). This model assumes that investors will have no difficulty estimating the inputs in the model from past experience. As Keynes (1921) has noted the use of data from the past is dangerous as a guide to the future because it requires degrees of belief which are not measurable. The model also assumes that individual behaviour is sufficiently rational and informed to follow the presumptions advanced by Markowitz (1952) and Sharpe (1990). Equally seriously, the beta co-efficient in the model is the market variance measure of relative risk. It overlooks the tendency for individual investments, even entire markets to regress to the mean (Savage, 1954) or display covariance features (Baumol, 1996) and be associated with risks and consequences not captured or associated with the two measured variables of return and variance. As Jeffrey (1984:35) has commented “volatility perse, be it related to weather, portfolio returns, or the timing of one’s morning news paper delivery, is simply a benign statistical probability factor that tells us nothing about risk until coupled with a consequence”. Finally, an acceptable common practice which is consistent with a risk- return type of modification, involves subjecting an investment project or a number of alternative investment projects to sensitivity analysis. This involves modifying

61 the assumptions upon which the original analysis was performed and inspecting how these changes effect the final outcome. Usually the outcome associated with the best possible and worst possible expected or possible situations are calculated. Needless to say, this requires judgement and frequently, heuristics substitute for reasoned analysis of possibilities. It is conceivable that modified formulas could be constructed using the expected utility indices developed to evaluate the outcomes of strategic games (Von Neumann and Morgenstern, 1947). This has not been attempted in investment practice because the requirements are even more demanding than those necessary to apply Markowitz type solutions. It is beyond the scope of this project to provide elaborate explanations of the various acceptable decision criteria available for use. Nor is it necessary. Any standard text in financial management contains relatively complete explanations and derivations of the standard decision criteria mentioned in this section (see for example Ross et. al., 1994). What is not generally covered in the standard textbook presentations is information which leads to the realisation that investment decisions involve complications which cannot be handled by applying the standard decision criteria. These complications are germane to the escalation of commitment literature. There are four complications which are particularly relevant: • The first involves the problem of capital rationing or the limited availability of funds. With limited resources to invest, the issue is no longer concerned with the selection of an ideal collection of investments. It is concerned with determining the best course of action to follow with the resources available. There is no obvious solution to this dilemma; • The second complication involves the problem that investment projects, by their very nature are usually indivisible, all or nothing selections. The result is that there may be over or under investment in a project or the choice is restricted to a proceed or abandon alternative; • The third complication is that many investment decisions involve alternatives which are mutually exclusive so that if one alternative is selected, the other alternative, irrespective of its value, is automatically rejected; and

62 • The fourth complication involves investment decisions where an initial investment cannot be undertaken unless an interdependent investment is also undertaken. Each investment decision depends on the completion of other investment decisions; a common situation in green site developments or new mine developments. There is an unrelated and unresolvable complication (Solow, 1963). This involves the tautological valuation of capital. The value of capital is the rate of return derived from its use and the rate of return derived is, in turn, derived from the value of capital. Theoretically then, the value of capital is determined subjectively and, by extension, from its utility value to an individual or collection of individuals. As we have seen, utility is an individualistic concept which varies between individuals and only assumes an efficiency maximisation dimension if it can be assumed that individuals behave rationally, maximise utility and optimise their self interest when efficiency maximisation obtains. There are no obvious or readily available solutions for these four types of investment complications. The general solution to the collection of complications involves the use of integer programming (Weingartner, 1963). Relatively few people are familiar with the mathematics involved in this form of programming so that it is not unexpected that when individuals are confronted with an investment complication, the sensible decision may involve, for example, resorting to past experiences or using intuition or some simple heuristic or involving their individual risk profiles. Nevertheless, the standard economics and finance literature prescribe what a rational decision maker should do when confronted with investment choices which involve risky decisions. A rational decision maker is supposed to ignore sunk costs whose opportunity costs are zero, because they are irrelevant in the choice of future alternatives, identify all possible investment alternative courses of action, calculate the benefits and costs associated with each alternative to determine the consequences, and then choose the investment which is expected to produce the highest value as reflected in the investment returns. It is assumed that the values of the investment returns coincide with the preference orderings of the individual decision maker. It is assumed also that the individual decision maker somehow possesses the criteria which will permit her to rank the set of

63 investment return consequences according to her utility derived preferences. The decision making process involves problem diagnosis, the identification of all possible alternative courses of action and the analysis of each alternative to determine the consequences. Only after engaging in this complicated, time consuming and expensive decision making process is the decision maker expected to actually make a decision about the set of investment choices available. It may be possible, but improbable, that an individual will engage in this form of prescribed behaviour in investment circumstances involving risk. Calculations may be undertaken over a limited but non exhaustive range of alternatives, but normally intuitive devices substitutes for complete calculation. In the common investment circumstances involving uncertainty, it is simply impossible for an individual decision maker to adopt the behaviour recommended. The question of whether it is probable or improbable does not arise. Investment decisions under uncertain conditions are particularly hazardous. Not only do individuals in these circumstances develop an ambiguity aversion and violate expected utility preference orderings by attempting to avoid uncertain alternatives (Curley, Yates and Abrams, 1986; Ellsberg, 1961 and Yates, 1990) but also, individuals vary their expected utility preference orderings when provided with feedback about available alternatives even after they have been trained in the preferred choice of alternatives (Myers, Suydom and Gambino, 1965). As a result of these violations of fundamental rational principles, Lee (1971) has concluded that it is not possible to use expected utility theories to describe the exercise of individual choice for an investment alternative. In the same tradition, Bernstein (1996) has commented, as follows, in the context of risky decisions: “Perhaps people are not nonrational, but the traditional model of rationality may specify a pattern of behaviour that captures only in part the way that rational human beings make their decisions. If that is the case, the problem is with the model of rationality rather than with us human beings. If the choices people make are both logical and predictable, even with varying rather than constant preferences, or with preferences that do not suit the strict prescriptions of rationality, behaviour can still be modelled by

64 mathematical techniques. Logic can follow a variety of paths in addition to the paths specified in the traditional model” (Bernstein, 1996:265)

That Lee (1971) can derive the conclusion outlined above is in no way surprising. Under conditions of uncertainty, individuals have no definitive decision rules to assist in the selection of an appropriate alternative. In effect, the decision maker is forced into a situation of clutching at straw or searching for the proverbial needle in a haystack. The study of investment decisions under uncertain conditions has not progressed in any meaningful way since the concept was introduced into the economics literature by Knight (1921), assumed central stage under Keynes (1936) and provided Arrow (1951) with the incentive to conceptualise the existence of complete insurance markets to handle uncertainly. If eminent scholars such as Keynes and Arrow are correct, no progress can be anticipated. Keynes (1937) in responding to criticism of “The General Theory” asserted: “By “uncertain” knowledge… I do not mean merely to distinguish what is known for certain from what is only probable… The sense in which I am using the terms is that in which the prospect of a European war is uncertain, or … the rate of interest twenty years hence, or the obsolescence of a new invention… About these matters, there is no scientific basis on which to form any calculable probability whatever. We simply do not know!” (Keynes, 1937:210)

Arrow (1951) in a similar vein, maintains that people are reluctant to accept uncertainty, over estimate the amount of information that is available to make uncertain decisions and the probability estimates which are calculated do not “reflect the tentative, creative nature of the human mind in the face of the unknown” (Arrow, 1951). Elsewhere, Arrow has confessed: “To me our knowledge of the ways things work, in society or in nature, come trailing clouds of vagueness… When developing policy

65 with wide effects for an individual or society, caution is needed because we cannot predict the consequences. … The essence of risk management lies in maximising the areas where we have some control over the outcome while minimising the areas where we have absolutely no control over the outcome and the linkage between effect and cause is hidden from us.” (Arrow, 1992:46)

Needless to say there have been attempts in the economics literature to formulate decision rules for choosing investment alternatives under conditions of uncertainty with, not surprisingly, little apparent success. Decision theories of expected utility have been proposed (Cohen and Cyert, 1975) and continue in use because there are no effective substitutes for them, even though the theories “are known to be wrong” (Stevenson, Busemeyer and Naylor, 1991:350). The optimistic, pessimistic and ambivalent attitudes which different individuals hold have produced surprisingly, the maximin criterion, the maxi-max criterion and the Hurwicz criterion. These are discussed extensively by Modigliani, (1948). In addition a mini-max regret criterion has been proposed which owes its origins to the consequences associated with decision regret (Bell, 1983). A Bayesian criterion is available based on the formation of inferences in decision theory. The problem with this criterion in investment situations is that it is not usually possible or desirable to establish in advance what unknown probabilities are to be considered equally probable (Baumol, 1972). The most promising advances have involved the development of quantitative techniques which are designed to reduce the area of uncertainty confronted by decision makers (see for example Holloway, 1979). The computational and analytical requirement are formidable.

2.7.3 MODELS In the psychological literature learning models have been developed in experimental conditions to help explain how serial investment decisions of a similar nature, should be made. Outside the laboratory, the learning principles

66 have restricted applications because investment decisions frequently are made only once. The learning principles are analogous to a hill climbing exercise. A hill climbing learning model involves making changes in future investment decisions on the basis of whether or not the previous investment produced an acceptable return or not. If it does, the next investment will be of a similar nature. If it doesn’t, a change in direction is warranted. The model is supported by empirical research (Busemeyer and Myung, 1987). The logic is different from that encountered in learning models of reinforcement. Reinforcement models in investment contexts produce the characteristics of the paradox of success because rewards are predicted to strengthen the previously successful investment decision and therefore inhibit a change in direction (Bandura, 1977a, 1977b; Luthans and Kreitner, 1985). The hill climbing model produces unexpected consequences (Busemeyer and Myung, 1987; Busemeyer, Swenson and Lazarte, 1986). According to Busemeyer et al (1986, 1987) the learning, and by extension, the consequences, will be influenced by the existence or non existence of local investment maximums. If a decision maker encounters an investment which produces a local maximum before encountering the existence of a global maximum, then the decision maker will become trapped at the local maximum and never discover the global maximum. This finding is relevant to the entrapment phenomenon which is aligned to the escalation of commitment phenomenon (Brockner and Rubin, 1985).

2.7.4 SUMMARY This brief overview of the efficiency of investment decision making reveals a rather depressing picture. The different motives for investing produce different consequences which may only be distantly related to profitability. The rational decision rules which have been designed to evaluate investment proposals and consequences are complicated and require considerable computation. If the nature of the proposed investment is complicated, the standard decision rules cannot be applied without extensive and mathematically difficult modification. Once an investment decision involves risk, the standard practice involves making

67 simplifying assumptions which produce imprecise outcomes which may be of limited value. When the investment decisions are made under conditions of uncertainty there are no acceptable decision rules available to evaluate the potential value of an investment. The decision maker operates under Arrow’s “clouds of vagueness”. The rational prescriptions advanced to guide the decision maker cannot be invoked in these uncertain circumstances. Besides being impossible, to attempt to do so would be irrational. Finally, there is the problem that the theoretical foundations for rational decision making under risk conditions “are known to be wrong”. It is in this murky world of investment that the escalation of commitment phenomenon was conceived. It is perhaps ironic that the title of the article which launched the concept contained the words “knee deep in the big muddy” (Staw, 1976).

2.8 SOCIAL EFFICIENCY: THE ECONOMIC EVALUATION OF PUBLIC WELFARE

PROJECTS

2.8.1 THE CONCEPT Neoclassical economists are obsessed with measurement. It therefore comes as no surprise that the economics discipline has developed measurement techniques to determine the value of phenomena in the public domain (Harberger and Jenkins, 2002). Phenomena which non economists, perhaps, would accept automatically and unquestionably as valuable. The economics interest derives from the need to know the actual value in circumstances of constrained choice and to determine the social value of natural and human made features in the event that they should or could cease to exist or in the event that such features are changed and or developed. Central to the evaluation of such features is the concept of opportunity cost which involves the most efficient use of scarce resources in their best alternative use. It is a measure of the value of an opportunity foregone. The economic evaluation of public assets and projects is derived from theoretical welfare economics. This branch of economics endeavours to formulate propositions which enable alternative economic situations open to society to be

68 ranked in order of importance (Mishan, 1968, 1969). Economic public project evaluation is the applied derivative which transcends project ranking to capture the individual numerical value of a project. The acceptability of an individual project is judged against a value standard; the social discount rate which shares a close relationship with the private investment concept of the opportunity cost of capital. The calculating methodology is closely related to the optimisation decision criteria used to evaluate investment opportunities. The difference is in terms of the composition of the data which is evaluated. The rationale for the development of welfare economics and its public project evaluation derivative rests entirely on two assumptions; one an ethical judgement, the other a behavioural proposition (Londero, 2003; Mishan, 1968). Individuals are considered to be the best judge of their own welfare and individuals are expected to behave in an economically rational manner. Given these two requirements, the entire edifice can be constructed. Without the ethical judgement it is not possible to judge welfare. It is only possible to describe how an individual acts. In traditional welfare economic models, it is usual, at least initially, to make a number of simplifying assumptions and ignore the existence of certain limitations in order to develop a pure and uncomplicated theory of welfare optimisation. The structural limitations in particular, undermine the robustness and validity of this economic theory of value (Graaff, 1948, 1957). The development of the conditions for the maximisation of social welfare are developed fully by, for example Arrow and Hahn (1971), Little (1957), Sen (1970, 1977), and Tinbergen (1966). Recent textbook treatments generally are less rigorous. Mathematical exactitude has been sacrificed in favour of providing greater access and understanding through verbal and diagrammatic treatments (Harberger and Jenkins, 2002). In the following overview, the limitations and assumptions are revealed explicitly. The most complete and rigorous treatment of these matters is contained in Arrow and Hahn (1971), Debreu (1957) and Malinvaud (1972).

69 2.8.2 CRITICAL EVALUATION On the positive economics side the limitations potentially include: the lack of sufficient conditions to determine the existence of a solution which is stable and unique; the inability to provide a solution in the case where oligopolistic behaviour is present; and the fact that it is implicitly biased institutionally in favour of market economies and liberal democratic institutional arrangements. On the welfare or normative side, the potential limitations include: the presence of externalities, lump sum taxes and monopolies; the existence of public goods which ensure that the opportunity cost of consumption is zero; the presence of indivisibilities which means that actual decisions do not conform with the assumption of marginal changes; and the rational maximising assumptions of convexity in consumption and concavity in production. It is difficult and frequently impossible to remove from or capture these limitations in the analysis. In contrast, most of the simplifying assumptions, other than rationality can be relaxed without loss of rigour. Conventional neoclassical welfare economics usually makes the following simplifying assumptions: (i) The existence of perfect competition in both product and factor markets which permits the existence of market equilibrium defined as:

du/dxj = Pi dqxj

du/dxi Pj dqxi (ii) The absence of market failure which implies that markets efficiently allocate resources; (iii) The existence of rationality by both consumers and producers to provide predictability; (iv) The numeriare does not reflect complexities in the actual world. That is, the value of money remains constant and is not effected by inflation or deflation; (v) The absence of joint and common inputs and outputs to ensure that the production function remains uncomplicated;

70 (vi) The absence of government intervention to ensure that resource allocation is not distorted; (vii) The absence of externalities in both production and consumption markets to ensure that benefits or costs are not derived or incurred by agents not directly involved in market transactions; (viii) The market supplies all economic goods and services. This assumption ensures that preference orderings and production possibilities are complete; (ix) These economic goods and services exhaust the possibilities for welfare; and (x) The existence of an equitable distribution of income. An efficient outcome depends, “inter alia” on the ability of individuals to express their preferences in markets. Preferences cannot be exercised efficiently unless income is distributed equitably. If these assumptions hold, then the three necessary conditions for overall efficiency in commodity space can be described. These are: (i) The subjective rate of substitution common to all consumers must be equal to the rate of transformation in production common to all firms, for any pair of goods in the system; (ii) The common subjective rate at which suppliers substitute between any pair of inputs must be equal to the common rate of substitution in production; and (iii) The subjective rate of substitution must be equal to the common rate of transformation of any pair consisting of one commodity and one input. The market condition which produces the equality is the common ratio of prices. If two other assumptions are invoked then the sufficient conditions for overall efficiency can be described. These assumptions are: (i) The existence of a unique and stable competitive equilibrium; and (ii) That consumer indifference curves are convex to the origin and the production function isoquants are concave to the origin in the case of the production transformation curve.

71 Given that these necessary and sufficient conditions are obtained, then the competitive equilibrium is necessarily optimum in the Pareto efficiency sense. That is, there is no other allocation of resources that will make any one person better off without making at least one other person worse off (Pigou, 1932). This position is an optimally efficient welfare outcome. Diagrammatically, the competitive equilibrium corresponds to some point on the efficiency frontier. The precise point depends on the initial distribution of income which in turn depends on the initial distribution of the ownership of resources. Unless it can be assumed that the initial distribution of income is equitable or can be made equitable by a suitable tax transfer of purchasing power, the Pareto efficient competitive equilibrium will not correspond, except incidentally, with a welfare optimum which is determined by the point of tangency between the efficiency frontier and the social welfare function as outlined in figure 6.

FIGURE 6 AN OPTIMALLY EFFICIENT WELFARE OUTCOME

Project/Product x SUBJECTIVE WELFARE SPACE

dPx Xi dPy

OBJECTIVE OUTPUT Social Welfare Function SPACE Efficiency Frontier (0, 0) Yj Project/Product y

The logic developed in the construction of the conditions for a social welfare optimum is an extension of the forms of analysis presented in sections 2.3 to 2.6.

72 2.8.3 COST BENEFIT ANALYSIS The applied branch of theoretical welfare economics concerned with the evaluation of public economic projects is cost benefits analysis (Dasgupta, 1972; Londero, 2003). In the final analysis, the reduced form treatment of costs and returns differs from that involved in applying the optimisation decision rules developed to evaluate investment decisions in only two respects. First, public benefits and costs are included in the calculations as well as the private costs and benefits typically associated with private investment projects. Second, the analysis considers the impacts which extend beyond the immediate project being evaluated. In this respect, a partial or general equilibrium stance is adopted which is more suitable in evaluating the formulation and execution of economic policies, providing their principal objective is efficiency related. Whether or not government policies and projects should be evaluated in terms of an efficiency criterion, is of course a debatable proposition. The information required to perform a rigorous cost benefit analysis is demanding, qualitatively and quantitatively extensive and extremely time consuming. It is therefore an expensive exercise. For these reasons, less rigorous expositions have been developed which employ an identical logic and derive from a common theoretical origin. In Australia, local government councils require developers to conduct environmental and economic impact studies of their development proposals if they are sensitive or exceed a certain scale and scope. In the United States, the local authority assumes responsibility for the conduct of these studies. The Australian federal and state governments have adopted program management and program budgeting arrangements and conduct project feasibility studies. These arrangements not only encourage the outcomes of policies to be assessed in terms of economic criteria but also shift the locus of control from the management of processes to the management of outcomes and from the measurement of inputs to the measurement of outputs. There are a number of theoretical issues which make it difficult, even questionable, to apply standard cost benefit forms of analysis to evaluate public projects and policy proposals. One set of theoretical issues concerns the ethical

73 criterion. The second concerns the essential requirement that individuals behave rationally. The Pareto principle for judging welfare is the simplest, most ethically persuasive and most commonly used criteria. Yet its use, theoretically, is limited to policy proposals in which everyone benefits and no one is harmed. It is a criterion which avoids the problem of making interpersonal comparisons in situations where some people benefit from a proposal and others are harmed. The Hicks (1939) criterion and the Kaldor (1940) criterion attempt to overcome the Pareto limitation by introducing the potential for compensating, in money terms, those harmed but, in the process, introduce a different limitation in that it may now be impossible to judge whether the welfare changes resulting from a proposal are better or worse than the initial position. The Scitovsky (1941) criterion addresses this limitation by employing a stricter test of welfare. The Kaldor criterion is applied twice; initially to determine the changes in welfare from the initially position to the changed position and subsequently from the changed state back to the initial position. The problem with the modified Pareto criteria is that monetary compensation equal to the opportunity cost of the welfare losses is, from an individual utility perspective, an inaccurate measure of value. Ultimately, there are no unambiguous means available to capture directly, interpersonal differences in the value of welfare. The Bergson (1954) criterion addresses this problem of value in-determination by proposing that the social welfare function be constructed from a set of “explicit” value judgements which enable the evaluation of projects to proceed. Unfortunately, this criterion does not resolve the ethical dilemma. It merely shifts the problem from an inability to determine unambiguously the value of individual welfare losses and gains, to one which involves questions about who should determine the explicit values embodied in the social welfare function and what should be these explicit values.

74 2.8.4 EVALUATION Satisfactory and acceptable solutions to these two questions remain unanswered. On the first question, even involving democratic political choice processes does not provide an unambiguous solution. As Arrow (1951) has demonstrated with his “impossibility theorem”, a democracy, defined in terms of four reasonable choice axioms, cannot guarantee that social decisions will reflect individual preferences. Any answer to the first question involves a casuistic moral philosophic resolution. In principle, there is no unambiguous right or wrong answer and what appeals to one society may not appeal to another society or even the same society at different periods in its history. The moral philosophy which has been most influential in providing a value criterion for the justification of social welfare programs in western societies during the last two decades is the liberal utopian Rawlsian theory of justice (Donohue, 1976). It involves invoking a minimax criterion of value in which the welfare of the most disadvantaged members of society are satisfied before the welfare of the most advantaged members are addressed (Rawls, 1971). The second theoretical issue involves the problem of rationality with its economic and psychological origins in the concept of utility. Much of this chapter has been concerned to develop the concepts of utility and rationality and firstly to indicate that utility provides an incomplete representation of individual economic behaviour and secondly to draw attention to the fact that individuals consistently, systematically and unsystematically violate the crucial axiom of transitivity in traditional decision models. Recently, Arrow (1990, 1996) has expressed his reservations about the difficulties involved in conducting and interpreting standardised forms of cost benefit analysis. Arrow’s reservations are concerned mainly with; the behavioural representativeness and operational efficacy of utility theory, the problems of determining and assigning probabilities and thirdly the violations of the axioms of rationality as revealed through “prospect theory”. Of particular concern is the framing issue and the violation of the transitivity axiom through the reversal of preference orderings (Tversky and Kahnemann, 1981, 1986, 1992).

75 2.9 CONCLUSION In the escalation of commitment literature, investment decisions made in uncertain circumstances are evaluated. The evaluation is conducted in terms of whether the subsequent investment decision, informed by feedback about the negative consequences of the initial decision, are consistent with or deviate from rational expectations and the standards of efficiency which have been developed, in different situations, to value investment decision outcomes. This chapter has provided the armoury to critically examine, in the next chapter, the literature on the escalation phenomenon as the focus of investigation shifts from individuals in experimental laboratory situations to strategic investment decisions undertaken in organisational contexts. A comprehensive and uncomplicated, albeit brief, analysis of the concept of utility has been undertaken. The analysis commenced with its origins in the rationality inspired enlightenment period and with the observation that utility theory remains the dominant paradigm in decision theories of risk. The analysis progressed to a consideration of how economic rationality has been incorporated in the concept to provide the theoretical basis for the analysis of individual economic behaviour. The analysis culminated in the realisation that economists have devised ways to engage in positive analysis without recourse to the concept because it not only poses operational difficulties but also fails to provide an adequate basis to explain the complexity of individual economic behaviour to enable predictions to be made with confidence. The concepts and procedures examined in this chapter indicated that the concept of efficiency was pervasive. The economic and financial decision rules which have been developed to evaluate investment decisions are predicated on the assumption that efficiency prevails. Individuals are assumed to behave rationally and individual interests are presumed to coincide with producer interests. As well, the analysis indicated that the computational and information requirements necessary to apply the investment decision criteria are demanding and involve the exercise of independent judgement when conditions do not involve certainty. The evaluation of public projects contained two additional

76 complications. First, what is being evaluated is ultimately an unresolved ethical pronouncement about the value of individual welfare. Second, the concept of utility inspired rationality provides an incomplete and distorted description of social choice. The most revealing outcome of the examination was the realisation that no decision rules of any substance or veracity have been developed to assist decision makers with investment decisions under uncertain conditions. The most that can be expected is that the area of uncertainty is reduced. Importantly, there is no theoretical basis to determine whether individuals behave rationally or should behave rationally when they fail to follow the rational prescriptions advanced to deal with investment decisions of an uncertain nature. Their behaviour is not prescribed when, as Keynes (1937) said, “We simply do not know”.

77 Chapter 3

REVIEW OF THE LITERATURE ON ESCALATION

INTRODUCTION This chapter reviews the literature on the escalation of commitment phenomenon and develops the research issues associated with the research project. The literature is embedded in decision theory and project evaluation, the foundations of which were explored in the previous chapter. Section 3.1 looks at the development of the escalation concept from several perspectives. Subsection 3.1.1 examines its origins. Subsection 3.1.2 specifies the defining characteristics of the concept. Subsection 3.1.3 examines the problem of escalation of commitment in the particular ambiguous situation of the sunk cost effect. A short summary of the developmental perspectives is provided in subsection 3.1.4. The various subsections in section 3.2 examine how the empirical literature has advanced. Subsection 3.2.2 indicates that the orthodox psychological literature on escalation has evolved to the point where the primary objective of on going research is to identify addition situational and predisposition influences which exacerbate escalation in experimental condition which favour a self justification explanation for the existence of the phenomenon. Subsection 3.2.3 examines the literature on psychological predisposition. Subsections 3.2.4 and 3.2.5 examine the phenomenon in various situational contexts and identify the situational influences which enhance or induce escalation. Conditions in which decision makers associate the decisions to commit additional resources with personal responsibility feature prominently in this research. This literature is evaluated briefly in subsection 3.2.6. The two subsections in section 3.3 are concerned specifically with identifying and evaluating respectively the various factors which reduce the incidence of escalation. This literature is examined critically because particular de- escalation strategies are rejected as they are inconsistent with the prescriptions which derive from the dominant self justification theoretical explanation for escalation.

78 Section 3.4 examines the literature which is concerned with trying to explain why escalation of commitment occurs. A critical perspective is adopted. The dominant explanations are examined in subsection 3.4.1. The following subsections examine theoretical explanations which are derived from prospect theory (3.4.2), agency theory (3.4.3), organisational commitment (3.4.4), satisficing behaviour (3.4.5), group influences (3.4.6) and coalitions of self interest (3.4.7). Section 3.4 concludes with a brief subsection which identifies the various sources which contribute to the theoretical controversy. Section 3.5 examines the rational expectancy theory derived explanation and the non rational dissonance theory derived explanation for escalation. Explanations derived from these two theories dominate the psychological literature on escalation. The theories are described in subsections 3.5.2 and 3.5.3. Methodological issues associated with dissonance theory are discussed in subsection 3.5.4. The literature review is summarised in subsection 3.5.5. Section 3.6 identifies the particular organisational setting that the research in this project is associated with. This enables the theoretically oriented research questions that are derived directly from the literature and specifically related to the particular organisational setting to be specified.

3.1 CONCEPTUAL DEVELOPMENT

3.1.1 ORIGIN OF CONCEPT The decision making concept of escalation of commitment to an ineffective course of action was conceived in the first of a series of published psychological experiments conducted by Staw and his associates (Staw, 1976). The nomenclature used to identify the phenomenon was attention getting. It quickly assumed recognition as the acceptable phrase to describe a form of behaviour which is manifested in decision making circumstances which involve uncertainty. There was nothing new about the behaviour which was observed in the early experiments. It is only the name which presumes to describe the behaviour which was novel. Reviews of the phenomenon have been conducted by Brockner and Rubin (1985), Brockner (1992), Staw (1997), Staw and Ross (1987a) and Teger (1980).

79 The willingness of individuals and organisations to persist with a losing course of action which results in adverse consequences has been widely observed (Biyalagorsky, Boulding and Staelin, 2001). It was investigated initially in the experimental psychological literature by Rubin and Brockner (1975). Rubin and Brockner (1975) coined the term “entrapment” to describe the incrementally induced behaviour they investigated. Entrapment research typically has involved experimental subjects incurring small continuous losses either as a function of the passage of time or as the result of active decisions to reinvest resources. Under a variety of experimental conditions, subjects eventually become entrapped within the losing cause of action beyond the point where benefits exceed costs. In later articles, Brockner and Rubin and their associates identify entrapment with the escalation phenomenon (Brockner, Houser, Birnbaum, Lloyd, Deitcher, Nathanson and Rubin, 1986; Brockner, Nathanson, Friend, Harbeck, Samulson, Houser, Bazerman and Rubin, 1984; Brockner and Rubin, 1985; Brockner, Rubin, Fine, Hamilton, Thomas and Tversky, 1982; Brockner, Rubin and Lang, 1981; Brockner, Shaw and Rubin, 1979). In 1986, Brockner and his associates defined entrapment as referring “to the process by which organisation decision makers escalate their commitment to an ineffective course of action in order to justify the allocation of previous resources” (Brockner, et al 1986). Two other phrases have been used extensively to describe the behavioural process associated with the concept. Teger (1980) attributed the process to an attempt to avoid the ultimate anticipated adverse consequences when “too much has been invested to quit.” Northcraft and Wolf (1984) described the Teger process in the general circumstances of the “sunk cost effect” which Staw referred to in an earlier article (Staw, 1980; Staw and Ross, 1978). Kahneman and Tversky (1984) have referred to the effect as the “dead loss effect.”

3.1.2 DEFINING CHARACTERISTICS The defining characteristics of escalation of commitment situations have been described by Brockner (1992), Brockner and Rubin (1985), Bowen (1987), Staw (1981, 1982, 1997) and Staw and Ross (1987a). Escalation situations possess three common features:

80 (a) decision makers allocate substantial resources to an uncertain course of action in the hope of achieving some goal or goals; (b) decision makers receive feedback that the ongoing chosen course of action is not achieving their goals; and (c) decision makers have the opportunity to choose whether to persist with or withdraw from the previously chosen course of action. To withdraw involves costs and constitutes an expense. To persist involves a belief that the investment benefits are achievable. Decision makers are confronted with the situation of simultaneously believing that additional investment may enhance the prospect of goal attainment and as an irretrievable expense. Escalation of commitment involves the decision to commit additional resources to a failing course of action in those circumstances where the choice to do so involves a decision error. As Staw (1981, 1982) maintains escalation involves a syndrome of decision errors. For a decision error to occur, the negative feedback about the prospects of the chosen course of action must not be of an uncertain or equivocal nature. For the choice to qualify as a decision error, the negative feedback must be unequivocal. At the very least this means that the nature of the negative feedback about the prospects of goal achievement is objectively improbable. The commitment of additional resources therefore involves extremely high objective risk which contrasts with the more probable subjective expectations held by the decision maker. The criteria are more rigorous than initially proposed by Brockner, Shaw and Rubin (1979). They proposed that the perceived probability of goal attainment merely be less than one. Bowen (1987) criticised the early experimental literature on escalation on the basis that the negative feedback was equivocal. As a result, the decision maker was confronted with a decision dilemma in which the outcome remained uncertain. In these circumstances the decision to commit additional resources may be due not to a decision error, but to several plausible alternative explanations including a rational economic response (Bowen, 1987). According to Bowen (1987) for a decision error to occur the negative feedback must be unequivocal. That is, “…the feedback must predictably indicate that future performance will… not meet the outcome standards in the future” Bowen

81 1987:56). The decision error criterion ensures that the probable cause of the phenomenon in laboratory manipulated situations is more likely to be self justification rather than any alterative explanation. Although Brockner (1992) cites research to indicate that decision makers experienced unequivocal negative feedback in some of the earlier experimental studies, more recent experimental studies on escalation have attended to Bowen’s criticism by ensuring that the negative feedback is sufficiently unequivocal to produce a decision error when additional resources are committed (Whyte, 1993). Bowen’s criticism of the earlier research designs is not unrelated to the conceptual problems associated with the sunk cost effect.

3.1.3 THE SUNK COST EFFECT The sunk cost effect is a theoretical economically irrational process of investing additional resources in a project when the initial investment is presumed subsequently to be a sunk cost by the decision maker. A sunk cost is an investment which is independent of the consequences of any subsequent additional investment of resources. Sunk costs generate negative cash flows in anticipation that sufficient future positive cash flows will be generated to provide an adequate return which compensates for the cost of the investment. Technically, sunk costs do not exist if there are no revenue and cost flows or flows of psychic costs and benefits over a period or if all costs and benefits associated with an investment occur during the same time period or as a result of a single decision (Laughhunn and Payne, 1984). Staw (1980) believes that the sunk cost effect is responsible for the widespread observation of the escalation of commitment phenomenon in community affairs. Garland and his associates (Garland, 1990; Garland and Adkinson, 1989; Garland and Newport, 1991; and Garland, Sandefur and Rogers, 1990) have investigated the effect in organisational situations. Their research provides support for Staw’s belief. Yet, the existence of sunk costs in an investment project can be equivocal to the decision maker in the absence of sufficient information about future revenue and cost flows. While the costs may be known or predictable, future benefit flows involve uncertainty and cannot be anticipated ex ante with

82 confidence (Conlon and Garland, 1993; Conlon and Wolf, 1980). From an accounting perspective, no such problems of identification arise. Sunk costs are determined from an ex post evaluation of the revenue and costs of the project when it is well advanced or has been either completed or abandoned. The difficulties associated with the identification of sunk costs by the decision maker lead Northcraft and Wolf (1984) to make four valid observations about the effects of negative feedback on the prospects of an investment decision. Firstly, they correctly demonstrated that it is only possible, unambiguously, to identify an investment decision as a sunk cost when the investment is considered over its effective life. In effect, sunk costs usually can only be determined definitely by the accounting decision criterion under decision conditions of certainty or risk. Secondly, they illustrated that the existence of sunk costs is contingent. It depends on the context. An investment project may constitute a sunk cost to a particular private investment decision maker. An identical investment project may not constitute a sunk cost either to another private investment decision maker faced with different environmental circumstances or if it takes place in a public governmental setting for example. Thirdly, they drew attention to an obvious economically logical solution to the decision dilemma posed by negative feedback. A decision maker, confronted with negative feedback about an investment, may decide rationally to minimise losses rather than maximise gains by invoking the “recovery in use” principle which distinguishes between fixed and variable costs at the margin. As Northcraft and Wolf stated: “Faced with negative feedback (i.e., certain losses through cost overrun or revenue short fall), the manager may wish to continue a project to its natural (albeit costly) conclusion, whereby recovery through use would be maximised and loss through sunk costs minimised. Intuitively, this strategy is rather attractive and may underlie the manager’s feeling that the accountant is not capturing the whole picture in the prescriptions to ignore sunk costs in making investment decisions” (Northcraft and Wolf, 1984:227)

Fourthly, they pointed out that psychologists have: 83 “tended to leave negative feedback’ ill-defined in their experimental examinations of sunk costs situations… This reflects the psychologist’s claim that the “correctness” of further resource allocation is not an issue. The psychologist is interested only in whether the existence of sunk costs influences psychological commitment… in the face of negative financial feedback.” (Northcraft and Wolf, 1984:227)

As previously noted psychological research on escalation effectively has responded to the fourth observation. As the experimental laboratory investigations on escalation have progressed, the ill-defined nature of the negative feedback about the prospects of a successful outcome has assumed the condition of an improbable risk (e.g., Whyte, Saks and Hook, 1997). No longer are subsequent resource allocation decisions generally examined under the possibility that the eventual outcome may be uncertain. The possibility that negative feedback provided to experimental subjects will provoke a behavioural response other than one based on rationalisation effectively has been precluded. The prospects of evoking a justification response has been enhanced.

3.1.4 SUMMARY AND EVALUATION In the experimental psychology literature, escalation of commitment has assumed the status of a cognitive bias which is induced by a decision error under experimental conditions which minimise the prospects of eliciting a rational response. Effectively, cognitive choice of alternative behavioural options has been curtailed. In responding to criticism of the ill defined nature of negative feedback, the simulated experimental environment has adopted conditions which have become increasingly removed from the murky world of actual investment decision making. Northcraft and Wolf (1984) not only argued that explicit information would reduce escalation tendencies but also that persistence with a losing course of action may be a rational response. Until recently, the provision of sufficient

84 information has not been found to reduce escalation tendencies in experimental subjects in experimental conditions (Simonson and Staw, 1992). However, there has been no substantive defence mounted against the rationality criticism. Simonson and Staw (1992) have justified the omission by noting in a footnote “that the major purpose of escalation research has been to isolate noneconomic motives relevant to investment situations – to show how economic data must compete with psychological and social forces in determining investment behaviour”.

3.2 PROGRESSION OF THE CONCEPT

3.2.1 DIRECTIONS OF ADVANCEMENT The orthodox literature on the escalation of commitment phenomenon has advanced in two main directions. Firstly, there is the literature which adopts the experimental psychology tradition. This literature is concerned to identify the individual psychological dimensions and situational contexts which encourage individuals to become susceptible to the phenomenon and rationalise their behaviour predominantly from a justification perspective. Increasingly the investigations are explored in the context of the sunk cost effect in which the extreme unlikelihood of successful outcomes are expressed in terms of probability statements (e.g. Whyte, Saks and Hook, 1997). Uncertainty has been expunged, problem situations have become more artificial. Fundamentally, the focus of attention has shifted from the study of escalation in circumstances of decision uncertainty to the exploration of psychological dimensions and situational contexts which induce escalation in resource allocation conditions of extremely high risk. The inducement of commitment has assumed the leading item on the investigation agenda. In these circumstances, as previously stated, escalation assumes the status of a decision error and, implicitly or explicitly, the theoretical explanation for the phenomenon is accepted as involving self justification. The theoretical explanation of the phenomenon is discussed in section 3.4. This research is not concerned with this particular body of literature. The view adopted is that it is rather futile and unnecessary. From the motivational

85 perspective which is explored in section 3.4, rationalisation is one of four choices available to individuals when they experience dissonance. If three of the four choices effectively are removed from consideration it becomes inevitable, it seems, that a rationalisation response will most likely be chosen by the experimental subjects. The clinical psychology literature on defence mechanisms provides plausible explanations for why individuals choose to rationalise their decisions (Corsini, 1984). There seems little point in seeking to rediscover these explanations in artificially induced business investment contexts. Secondly, there is a growing escalation literature which examines decision making behaviour and performance outcomes in organisational contexts (see for example Drummond, 1996; Ross and Staw, 1993; Ross and Staw, 1986; Staw and Hoang, 1995; Staw, Koput and Barsade, 1997). Ineffective performance outcomes have been attributed to the escalation phenomenon. Moreover, the theoretical explanations for the existence of escalation in these organisational contexts have been dominated by the need to rationalise the decision in terms of self justification. It is this organisational literature on escalation which is the principal focus of attention in this research. This literature is discussed in section 3.4.

3.2.2 ASSESSMENT In the escalation literature, the critical observations made by Northcraft and Wolf (1984) have been largely ignored or dismissed as irrelevant (e.g. Arkes and Blumer, 1985; Simonson and Staw, 1992). This lack of recognition is understandable. Alternative theoretical explanations for the behaviour in uncertain conditions undermines the elaborate rationalisation explanations and research strategies which have been constructed to explain the phenomenon. Conceivably, too much has been invested to admit the possibility of plausible alternative theoretical explanations or to concede that behaviour in organisational contexts which lead to ineffective resource allocation outcomes is more complex than can be explained simply in rationalisation terms. This is not to deny the existence of rationalisation inspired escalation of commitment behaviour to ineffective resource allocation outcomes in

86 organisational contexts. On the contrary, it is simply to make the point that in conditions of uncertainty whether or not a decision is erroneous may be problematic and once this is admitted, utility theory provides an alternative theoretical explanation which possess greater predictive power, albeit in the absence of being able to identify the powerful motivational forces such as self justification which influence susceptibility to decision error.

87 3.2.3 PSYCHOLOGICAL PREDISPOSITION INFLUENCES Until recently, the experimental psychology literature on the identification of individual differences which encourage escalation have not produced encouraging results. This is somewhat surprising for two reasons. Firstly, present computing capacity enables data to be subjected to a variety of sophisticated statistical forms of analysis. The forms of analysis increase the potential to produce counter hedonic findings which support the hypotheses being investigated about individual difference variables associated with justification. Secondly, Staw (1980) provided potential pathways for the future investigation of individual difference variables which appear to have remained largely ignored. In the context of developing a theory of escalation, Staw implied that individual beliefs about competency levels would influence susceptibility to dissonance as would situations which threaten the equilibrium of the self concept. Despite these propositions, Staw and Ross (1978) found no escalation effects associated with self-esteem, tolerance for ambiguity or dogmatism. Teger (1980) did not find any effects on escalation of commitment associated with tolerance to ambiguity, losses of control, Machiavellianism, or risk taking. Levi (1981) did not find any relationship between escalation of commitment, locus of control and the bi-polar mood swings of mania and depression. On the other hand, Knight and Nadel (1986) found, as could be expected from a theoretical justification perspective, a positive relationship between escalation and self-esteem. Sanderlands, Brockner and Glynn (1988) investigated persistence in insolvable games and found that individuals with high self-esteem attempted fewer problems than those with low self-esteem. Houser (1982) found empirical support for the implied theoretical connection between self competence and escalation. Individuals with generalised feelings of competence were more likely to escalate their commitment. Rao and Monk (1999) investigated the relationship between motivation and escalation. They found, as could be anticipated from cognitive motivation theory, that commitment was negatively correlated with the need to maintain an internal image of competence. Schaubroeck and Williams (1993) found that Type A individuals were more prone

88 to escalate their commitment to a failing course of action than Type B individuals. Recently, Whyte, Saks and Hook (1997) found a strong relationship between self percept of high/low efficacy and the tendency to exacerbate/diminish susceptibility to the escalation bias. The finding is consistent with the extensive research on self efficacy conducted by Bandura and his associates (eg. Bandura, 1977; Bandura, 1982, Bandura, 1986; Bandura and Cervone, 1983; Bandura and Schunk, 1981; Bandura and Wood, 1989; Cervone and Peak, 1986; Eden and Aviram, 1993; Gecas, 1989; Gist and Mitchell, 1992; Wood, Bandura and Bailey, 1990). In two recent studies (Simons, Shadur and Waldersee, 1999; Simons, Waldersee, Kienzle and Court, 2000) escalation was found to be associated with personal disposition factors. Cognitive differentiation and risk taking for individuals with high self efficacy influenced the length to which individuals were prone to be committed. Escalation of commitment also was strongly associated with managerial mood and impulsiveness. These studies on individual predisposition to escalation of commitment provide support for the theoretical rationalisation explanation for the phenomenon. Individuals justify their behaviour in escalation situations. The more capable and self confident individuals believe themselves to be, the more likely they are to escalate their commitment to ineffective courses of action. From this line of empirical research, escalation appears to be an affliction to which the more successful are more vulnerable.

3.2.4 SITUATIONAL INFLUENCES AND CONTEXTS In contrast to the paucity of research on individual predisposition to escalation, research on situational variables has been extensive. The phenomenon, as conceived by Staw (1976) has been investigated in many situations and replicated on many occasions. Kirby and Davis (1998) discussed the many settings in which the phenomenon has been demonstrated. These include impression management, job search, group decision making, performance appraisal, job evaluation systems and individual decision making. The resources committed in these settings may involve money, time, reputation and self-identify (Brockner, 1992).

89 Historical events that have involved escalation have been identified. Judging from the literature the effect appears widespread. Arkes and Blumer (1985) provide examples of public projects for example, which have been completed even though the initial investments were considered to be sunk costs. The more prominent historical events which have been identified in the escalation literature as involving escalation of commitment include: recent world expositions (Ross and Staw, 1986); the development of an electronic share settlement process at the London Stock Exchange (Drummond, 1996); and the Vietnam War (Staw, 1976; Teger, 1986). Bowen (1987) considered that Staw’s interpretation of the Vietnam War was incorrect. He argued that the Vietnam War did not involve escalation because of the impossibility of determining whether the events, as they unfolded, involved a decision error. Project variables either have been proposed (Staw and Ross, 1987) or investigated (Drummond, 1996; Ross and Staw, 1986; Ross and Staw. 1993; Staw and Hoang, 1995). These studies are unusual because the investigation involved organisations and occurred outside the standard experimental or simulated experimental laboratory situations which characterise most research on the escalation phenomenon. Perceived responsibility has been investigated under a variety of situations, with the results generally supportive of Staw’s proposition. Whyte (1993) investigated the situation where the individual decision maker is solely responsible for the initial decision. This research built on the incidental results associated with the moderating influence of personal responsibility in Brockner et al’s (1986) investigation of the phenomenon in group verses individual decision making contexts. Staw (1976) indicated that the tendency to escalate commitment would be enhanced if the responsibility was substantial and if the consequences of the initial decision were negative. Whyte (1993) investigated the situation where the individual received support and encouragement from the group for the initial decision. In these circumstances commitment escalated. Kirby and Davis (1998) adopted an agency perspective in their investigation which indicated that individuals would escalate their commitment when the initial decisions were not monitored by others. In an earlier article, Davis and Bobko (1986) adopted a prospect theory perspective in their investigation of responsibility and escalation. The results, “prima facie” appeared to contradict the generally positive relationship

90 found to exist between the extent of personal responsibility and the extent of escalation; a relationship which was proposed initially by Staw (1980). Brockner (1992) has evaluated the Davis and Bobko results to show that no contradiction exists. When the feedback was framed negatively and individuals were personally responsible, commitment was greater. Negative framing led individuals to interpret the feedback as negative. Commitment was reduced if the feedback was framed positively.

3.2.5 SITUATIONAL INDUCEMENTS The orthodox psychological literature on escalation of commitment has investigated various situationally induced determinants of escalation. This research has sought to determine: • the situational conditions which are most likely to induce decision makers to become susceptible to escalation and entrapment behaviour; • how escalation can be reduced; and • why the conditions encourage escalating behaviour. Early research adopted a social psychological perspective which suggested that interpersonal variables could affect the decision to escalation or withdraw from an adverse course of action. This research has identified four main sets of variables which appear to influence the decision. The first involve the nature of competition. Brockner et al, (1986) revealed that decision makers, particularly males, become more committed competing against another individual than they do when competing against non social stimuli or situations involving chance. The second involve the presence or absence of social interaction. Bazerman, Beekun and Schoorman (1982) showed that decisions made by individuals in group decision making situations in which there was low personal responsibility were less susceptible to escalation than individuals with high or low personal responsibility in groups with high personal reasonability. The results are consistent with those obtained by Staw and his associates. The third involve the presence or absence of an evaluative audience. Fox and Staw (1979) suggested that administrators would most likely escalate their commitment if they believed there was considerable resistance to the adopted course of action by others in an organisation.

91 The fourth involves the presence or absence of an entrapment model which induces the escalation behaviour of individual decision makers. Brockner, Bazerman, Rubin and their associates (1984) conducted four experiments which indicated that individuals, irrespective of gender, who observed an entrapped model, escalated their own commitment to a course of action significantly more than those who did not witness an entrapment model. The condition was reversed if the individual expressed regret, rather than pleasure, about the behaviour. It was moderated if the entrapped model was perceived to be an inappropriate person to model their behaviour. Specifically, the model in the experiment was unlikable and lacking in intelligence. They also found that after negative feedback, particular decision alternatives elicited escalation among low responsibility decision makers. The alternatives were different from those that elicited the escalation behaviour amongst high responsibility decision makers. The interaction between responsibility and escalation was moderated in terms of the framing of the problem situations. Interestingly, they found that when feedback was negatively framed, the escalation results become consistent with previous research on the relationship between responsibility and escalation.

3.2.6 SUMMARY AND EVALUATION More recent research, having generally accepted the moderating influence of interpersonal situational variables, has tended to focus on exploring the situations which involve personal responsibility. The situations examined are associated with either the perception of personal responsibility held by the individual decision maker or as perceived by the individual decision maker as being associated with significant others. Much of this more recent research appears to have been inspired by Staw’s remarkable synthesising essay on rationality and justification (Staw, 1980). In this essay, Staw specified the conditions which he maintained would enable research on dissonance to be distinguished from research on the self concept. He subsequently concluded that the principal factor which exacerbated the incidence and duration of escalation of commitment was ego-defensiveness; which is

92 consistent with the need to justify one’s behaviour when exposed to or responsible for actions which are perceived by others as irrational. Responsibility has assumed the position of an instrumental variable in the manipulation of the underlying concept of ego-defensiveness. The experimental laboratory psychological literature on the escalation phenomenon, which either supports or criticises self justification explanations as the principal source of causation, has derived two main sets of variables which enhance the prospect that individual decision makers will be induced to escalate their commitment to a failing course of action. The first set relates to psychological predisposition. The dominant predisposition explanation involves the construct of the self concept in the particular context of perceptions held about one’s competency and self confidence. The more successful individuals are, or perceive themselves to be, the greater the likelihood that they will be induced into becoming susceptible to the prospect of escalating their commitment to a failing course of action. The second set relates to situational variables in which the dominant explanation to emerge involves personal responsibility. High levels of personal responsibility for the initial decision induce susceptibility to escalation. Persistence is exacerbated in situations where the behaviour is not monitored and where personal responsibility for the investment action is either supported by or criticised by others who are present at or are aware of the decision taken. The dominant explanations derived from the two sets of variables investigated under the rationalisation paradigm are not unrelated. The need to avoid dissonance and maintain consistency in escalation situations can be evoked either by threatening the internal perceptions of competency and responsibility or by the existence of external interpersonal relationships which impact on internal perceptions of competency stimulated by the threat of being personally responsible.

93 3.3 DE-ESCALATION OF COMMITMENT

3.3.1 DE-ESCALATION PRESCRIPTIONS The question of how escalation of commitment can be reduced has not attracted substantial interest in the research literature. There is an obvious reason for the omission. The psychological predisposition variables and the various situational contexts which have been found to be associated with the phenomenon suggest, counter intuitively, the various means which can be employed to reduce the incidence and duration of escalation behaviour amongst decision makers. De-escalation prescriptions generally have been a by product of the identification seeking research. Limit setting has been proposed as a method of reducing escalation (Brockner, Shaw and Rubin, 1979; Teger, 1980). Nathanson et al (1982) indicated that information supplied to decision makers in experimental situations about the problem of entrapment, deterred individuals from engaging in the escalation inducing situation. In contrast, the learning models developed to explore decision making under uncertainty found no improvement in performance despite extensive training. Ross and Staw (1979) explored some general means of escalation reduction in their exploratory paper on the possible theoretical determinants on escalation. McCain (1986) demonstrated that escalation was reduced when the investment losses were repeated and transparent. In other words when the results obtained assumed the probabilistic situation of objective or subjective certainty. The results then are not unexpected. In a recent experimentally derived article, Simonson and Staw (1992) directly addressed the issue of how to reduce escalation. Several techniques were explored and three were found to be effective. The first involved setting minimum target levels that would lead to a change in policy if the initial policy was not achieved. This technique corresponds with the limit setting proposals suggested in the earlier research literature. The second involved making negative outcomes less threatening. This would act to minimise the prospects of evoking self justification forms of rationalisation. The third involved evaluating decision makers, not in terms of decision outcomes, but on the basis of the decision

94 processes employed. They suggested that the individual’s vigilance and skills be developed to deal with the ambiguity inherent in escalation situations. Incidental to the primary purpose of the study, Simonson and Staw (1992) found that the results supported the orthodox escalation theoretical paradigm which maintains that justification is an important explanation of the escalation condition. Being accountable for a decision outcome produced the greatest commitment in individual decision makers. They found that the self diagnostic condition which may increase defensiveness as well as increased vigilance did not reduce escalation of commitment significantly nor did the threat reduction condition. Simonson and Staw (1992) did not promote the provision of additional information as an effective de-escalation strategy. This is consistent with the previously noted failure of information to change the behaviour of decision making in laboratory experimental situations which induce rationalisation explanations for the escalation of commitment manifested. They conceded that individual decision makers will withdraw their commitment when “the economic facts become sufficiently negative and clear cut” (1992:420). To support this concession they cited Brockner and Rubin’s (1985) study which showed that investment depends on the value of the objective as well as the costs involved in achieving the objective. They also cited Northcraft and Neal’s (1986) study which indicated that when the opportunity cost of a decision is presented explicitly, the tendency to withdraw from an escalating situation is enhanced. On the other hand, they qualified their concession in a footnote by referring to case research on Expo 86 (Ross and Staw, 1986) in which they observed that “once an escalation situation has become sufficiently imbedded with other (e.g., social and organisational) forces, negative data may need to be overwhelming in magnitude to stimulate withdrawal.”

3.3.2 EVALUATION The argument that the provision of information which is less than definitive is ineffective was based on the proposition that, because real investment decisions are ambiguous (uncertain), the provision of the type of information necessary to

95 persuade decision makers to withdraw their commitment “begs the question of escalation; such procedures give decision makers the very information they must themselves estimate in a naturalistic situation” (Simonson and Staw, 1992). The argument is perplexing because the existence of escalation is predicated on a decision error having been made by the decision maker. Yet, in uncertain investment situations whether or not a decision error has been made is problematic and cannot usually be determined other than from an “ex post” position. To reinforce their argument, they referred to evidence to support the effectiveness of attending to the decision making process rather than the provision of non definitive additional information. The later is ineffective, it further is argued, because decision makers do not evaluate the information available before making a decision (e.g. Nisbett and Ross, 1980) and use various heuristics and shortcuts to simplify decision tasks, save time and conserve effort (e.g. Kahneman and Tversky, 1979; Payne, Bettman and Johnson, 1988). The argument is spurious and appears to be an elaborate attempt to defend rationalisation explanations for escalation of commitment in organisational contexts and to preclude the existence of alternative causal explanations. The argument also is dangerous to the rationalisation explanation which Staw and his associates propose. To admit that information is ineffective for the reasons they use to support their thesis must also mean that problems associated with lack of information evaluation, the use of heuristics and shortcuts are operating undetected in the psychological experimental laboratory experiments which induce rationalisation responses. As a result, these cognitive deficiencies introduce the possibility that explanations other than rationalisation, could be responsible for escalation of commitment in the laboratory experimental situation.

3.3.3 SUMMARY In contrast to the information ineffectiveness position held by Simonson and Staw, research in economics for example (e.g. Arrow, 1971; Gneezy and Potters, 1997) indicates that additional information about consequences should reduce the “area” of uncertainty and improve the prospect of a correct decision being made.

96 In the escalation literature, recent research has identified three control procedures which can be adopted to reduce escalation (Dipankar, 1997). These are: • the provision of unambiguous feedback regarding previous expenditure; • the preparation of progress reports on the investment project; and • the provision of information about future benefits of additional expenditure. All three control mechanisms involve the provision of information to reduce feedback ambiguity. The effectiveness of the measures clearly depends on which theoretical explanation is responsible for the escalation phenomenon. If the dominant cause derives from self justification, then their effectiveness will be muted. If, on the other hand, the dominant cause derives from some rationally derived alternative explanation, then their effectiveness will be enhanced. Kirby and Davis (1998) and Staw, Koput and Barsade (1997) favour a rational explanation which leads them to advance more powerful de-escalation processes. They advocated that the behaviour of top management be subjected to increased monitoring and that more frequent turnover of top management will lead to de-escalation in the aggregate.

3.4 THEORETICAL EXPLANATIONS FOR THE ESCALATION PHENOMENON

3.4.1 DOMINANT EXPLANATIONS The psychological laboratory experimental literature has produced two predominant explanations to account for the escalation phenomenon. It has been suggested that the first derives from prospectively rational antecedents (Levi, 1982; Rubin and Brockner, 1975; Staw, 1976, 1980), which have been interpreted in terms of Vroom’s (1964) expectancy theory. According to this interpretation, decision makers regard goal attainment as instrumentally valuable. They assess the probability that the attainment of the goals will be achievable though the commitment of additional resources. Vroom’s (1964) prospectively rational expectancy theory of motivation is a psychological elaboration of expected utility

97 theory. The unspecified nature of utility is given expression (see chapter 5, section 5.4). The second prominent explanation is derived from retrospective rationalisation antecedents. This explanation has been interpreted in terms of Festinger’s (1957) theory of cognitive dissonance. It is this self justification inspired explanation which has come to dominate the orthodox psychological literature. It is the dominant explanation promoted by Staw and his associates (see for example Staw and Ross, 1987a) and by Brockner and his associates (see Brockner, 1992) in both experimental and natural organisational settings. It is also the explanation which is now provided in standard management texts for the existence of escalation bias in managerial decision making (eg. Davidson and Griffin, 2000; Hubbard, 2000). It is only recently that self justification has been seriously challenged as the dominant explanation to explain escalation type outcomes in organisational settings (see for example, McNamara, Moon and Bromley, 2002). The two dominant explanations are discussed at greater length in section 3.5. This is done in terms of the theoretical explanations derived from expectancy theory (Vroom, 1964) and dissonance theory (Festinger, 1957). The two explanations are evaluated in chapters 5, section 5.4.

3.4.2 COMPETING EXPLANATIONS: PROSPECT THEORY Whyte (1986, 1993) suggested that prospect theory may explain the willingness of decision makers to persist with a losing course of action. Prospect theory was conceived by Kahneman and Tversky (1979) to explain risk taking behavioural deviations from rational decision making model prescriptions which individuals display under conditions of uncertainty. According to Tversky and Kahneman (1992) rational decision making requires exceptional cognitive capabilities and considerable emotional self control. As Kahneman (1994) has pointed out “The failure of the rational model is not in its logic but in the human brain it requires. Who could design a brain that could perform the way this model mandates? Every single one of us would have to know and understand every thing, completely and at once.”

98 Kahneman and Tversky (1992) attribute the non rational behavioural patterns that they have discovered to the emotional loss of control and the cognitive difficulties which individuals experience in making risky decisions about the uncertain future. Accordingly, individuals resort to heuristics, cognitive shortcuts and more subjective forms of measurement when making decisions. Prospect theory has systematised the collection of cognitive biases which have been independently discovered (see for example, Bell, Raiffa and Tversky 1988; Schwenk, 1984, 1988) and which lead to erroneous perceptions. Perceptions which in turn, are exhibited as behavioural patterns which systematically and non systematically deviate from rational decision making prescriptions. In general, the findings from prospect theory (see Kahneman and Tversky, 1992) demonstrate that: • decision makers display risk aversion when offered a choice in situations envolving potential gain and then turn into risk seekers when offered the same choice in a different situation. In loss situations decision makers become loss averse (Kahneman and Tversky, 1979, 1984); • decision makers tend to ignore the common components of a problem and concentrate on the component parts in isolation. It is quite common not to be able to see the wood for the trees (McKean, 1985); • decision makers have difficulty recognising how much information is enough and how much is too much (Tversky and Koehler, 1994); • decision makers pay excessive attention to low probability events which are novel and overlook events that happen routinely (Fox and Tversky, 1995); • decision makers treat costs and uncompensated losses differently, even though their impact on income and wealth is identical. Decision makers appear to have different mental accounts for different activities. The balance in these accounts together with an aversion to ambiguity influences the nature of the decision when costs or losses are incurred. As Thaler (1999) explains “The accounting system provides the inputs to be both “ex ante” and “ex post” cost benefit analysis”. Maintaining separate mental accounts explains why decision makers pay attention to sunk costs (Kahneman, 1994; Thaler, 1999); and

99 • decision makers may commence with purely rational decisions about how to manage risks and then extrapolate prospects based on good or bad luck. As a result, decision makers ignore such phenomena as regression to the mean and fail to withdraw from a situation when they rationally should (Kahneman and Tversky, 1979). Two of the most striking findings in prospect theory are relevant to the escalation of commitment phenomenon. The first is the consistent violation of the axiom of transitivity or invariance discussed in chapter 2. Kahneman and Tversky (1984) and Tversky and Kahneman (1981, 1982, 1986) use the expression to describe the inconsistent choices associated with the same problem which appears under different frames. As Kahneman and Tversky (1984) comment “The moral of these results is disturbing. Invariance is normatively essential [what we should do], intuitively compelling, and psychologically unfeasible.” The second is the asymmetry between the way individuals consistently respond to decisions making gains and decisions involving losses. Kahneman and Tversky (1979) found that when choices involve additional gains, decision makers become risk averse. When the choice involves losses, decision makers become risk seekers. This asymmetrical finding has been replicated extensively in experimental conditions (see McKean, 1985). Kahneman and Tversky (1992) interpret the experimentally produced evidence as demonstrating not only that individuals are loss averse rather than risk averse but also, as Tversky (1990) maintains, preferences can be manipulated by changes in the reference points. Prospect theory consistently demonstrates that individuals become risk seekers when confronted with potential losses. In Chapter 2, the axioms of rationality were used to derive the general nature of the utility function in the dual situations of positive and negative commodity space. In positive commodity space the utility function is concave to the origin. In negative commodity space the utility function is convex. The nature of the utility function is independent of the distorted preferences for risk revealed in prospect theory. Because of the convex shape of the utility function in negative commodity space, in uncertain situations which involve potential losses, the commitment of additional resources involves a marginal additional loss of individual utility if the

100 choice results in additional losses. In contrast, if the commitment of additional resources leads to a partial or total recovery of the losses incurred, the amount of increase in individual utility is substantial. In choice situations involving uncertainty, the rational choice, guided by potential gains or losses in utility, is to commit additional resources to a course of action. Prospect theory adds an additional dimension to conventional utility theory with the experimental evidence consistently demonstrating that the behavioural patterns towards risk are asymmetrical. When confronted with potential losses in uncertain conditions, individuals become risk seekers (Gomez-Mejia and Wiseman, 1997). The tendency to assume risk seeking behaviour so as to avoid losses, reinforces the rationally derived utilitarian preference to seek to recapture losses (Sharpe, 1990). It is the problem of asymmetrical risk preferences in conjunction with the problem of framing which Whyte (1993) promoted unsuccessfully as an alternative explanation for the escalation of commitment phenomenon. Brockner (1992:50- 52) mounted a vigorous defence in favour of self justification which had the effect of refuting Whyte’s suggestion. While Brockner (1992) has admitted that explanations other than self justification may contribute to the escalation phenomenon, he maintains, as does Staw (1997) that self justification is the dominant explanation in organisational contexts and that prospect theory explanations cannot replace self justification. Brockner’s (1992) defence of self justification was mounted through emphasing the experimental findings obtained by Davis and Bobko (1986). When feedback was negatively framed, escalation was more pronounced when personal responsibility was high. When the feedback was positively framed there was no effect of personal responsibility on continuation of commitment. The findings, according to Brockner (1992) are more supportive of self justification than prospect theory. There is, of course, a problem associated with Brockner’s defence of self justification. The findings provide ambiguous interpretations. Self justification can be the only interpretation if the positively framed feedback is in positive commodity space where the utility function is concave. Although the feedback in the Davis and Bobko (1986) experiment was positively framed, the intrinsic nature of the feedback was negative. This ensures that the relevant underlying utility

101 function is in negative commodity space and consequently convex. With convexity the most plausible explanations for the commitment of additional resources are either rational or prospect theory augmented rational responses to a losing course of action. In laboratory situations where the decision to commit additional resources derives from a decision error, self justification is the most plausible explanation for the existence of the phenomenon. In situations where the nature of the negative feedback about goal achievement remains uncertain, alternative explanations may dominate and self justification may merely act to complement alternative explanations and reinforce the consequences of escalation. There is another possibility. The various explanations may jointly reinforce the tendency to escalate commitment to a course of action. For instance, the behaviour of individuals operating in uncertain financial security markets generally is at odds with the prescriptions advocated by the rational utilitarian decision making model (French and Poterba, 1991; Shefrin and Statman, 1984; Thaler, 1986, 1992, 1993). It has always been considered a good (rational) idea to realise profits because you can “never get poor by taking a profit”. It follows that cutting your losses is also a good (rational) idea (Bernstein, 1996). Yet individuals hate to take losses, not only because they are loss averse but also because to accept a loss is an acknowledgement that an error has been committed. In other words, the combination of the loss averse behaviour revealed by prospect theory and the ego defensive behaviour (promoted as self justification) involved in denial of an error leads individuals to cling to their mistakes in the belief that the market will recover and vindicate their judgement.

3.4.3 COMPETING ORGANISATIONAL EXPLANATIONS: AGENCY THEORY The difficulties that have confronted corporate entities during the recent past have inspired a search for explanations of the escalation of commitment phenomenon in organisational contexts which either replace or supplement the dominant explanations advanced in the literature. The explanations which have emerged recently draw on, but are different from the competing explanations discussed in the previous sections (see McNamara, Moon and Bromley, 2002).

102 The first of the possible alternative explanations is agency theory. Agency theory is an economic theory of rational behaviour which seeks to explain why firms may not achieve their objectives when principal decision makers subjugate organisational interests in pursuit of their individual interests. Rationality is contextualised and the problem sources are different from the rational explanations proposed by Northcraft and Wolf (1984). These explanations were discussed previously in section 3.1.3. Problems associated with agency relationships have been suggested as contributing to escalation bias. Khan, Salter and Sharp (2000) cite research which suggests “the presence of adverse selection (agency theory) and the framing of information (framing theory)” together may explain the escalation of commitment bias. As Harrell and Harrison (1993) previously noted, Khan et al (2000) proposed that both the incentive to shirk and asymmetrical information must be present for the escalation bias to be explained in terms of agency theory. Knight, Durham and Locke (2001) extend the agency and prospect theory explanations for risk taking behaviour by incorporating the potential of goals to motivate risk taking behaviour. They concluded (Knight et. al, 2001:335) that “difficult goals consistently motivated teams to choose strategies with higher levels of risk.” And, Sharp and Salter (1997) have found that agency theory has strong explanatory powers for project escalation decisions. As Dipanker (1997) has noted, once agency theory explanations are introduced, escalation of commitment may be due to either irrational behaviour in response to a cognitive bias or a rational action. Attributing escalation to the agency problem of adverse selection involves rational behaviour. Adverse selection is a deliberate action to knowingly communicate favourable information about the initial investment choice. The possibility that corporate outcomes which appear to be the result of the escalation of commitment phenomenon can be attributed to the agency problem of adverse selection is not surprising (Berle and Means, 1932). What is surprising is not only how long it has taken for agency theory explanations to emerge in the escalation literature but also that the explanation is confined to the problem of adverse selection.

103 Once corporate ownership (principal) is divorced from managerial control (agent), the possibility that escalation type outcomes will occur becomes pronounced and extends way beyond the limits of adverse selection (Berle, 1959). Moreover, it is conceivable that the behaviour which leads to the negative outcomes is perfectly rational, irrespective of whether an agency or a self justification aetiology is invoked (Flyvbjerg, Bruzelius and Rothengatter, 2003). In the previous chapter the conceptualisation of utility and its rational derivation was developed. The conditions for efficiency were also developed but independently of the conditions for utility maximisation. This is standard practice and methodologically appropriate. Nowhere in the analysis was it demonstrated or suggested that utility maximisation involved the pursuit of efficiency. It can be inferred that a preference state which is motivated by a desire for more rather than less may involve efficiency dimensions, but equally, it may not. The definition of economics implicitly contains the belief that individuals are wasteful rather than efficient in their economic pursuits. In contrast, constrained individual investment decision analysis is predicated on the assumption that individual preferences will coincide with efficiently valued investment choices. Self interest is assumed to be maximised when the choice involves the highest valued investment alternative. This is a moral or ethical pronouncement (Phelps, 1975). It is derived from liberal philosophical antecedents which promote the opportunity for individuals to pursue their self interest on the basis that relationships between individuals fundamentally are moral in nature (Wilber, 1998). It is not an axiom of rational choice although it was presumed to be in the orthodox neoclassical economics literature and continues to be so, as an implied assumption on investment in modern orthodox economics texts (Irwin and Vines, 2001; Lewis, 1999). The presumed relationship was challenged initially in the market circumstances where the parties involved in the potential transaction possessed unequal information about the object of the transaction (Alchien and Demitz, 1972). In the original papers by Spence and Zeckhauser (1971) and Ross (1973), the challenge was conceived in terms of agency problems. The challenge was given full expression when the existence of asymmetrical information was leveraged into the initial formulation of principal-agency theory (Jensen and Meckling, 1976). The

104 acceptance of the need for the theory as the guiding influence in corporate governance is indicative of a change, not in the nature of rationality, but in fundamental moral relationships. The relationship also is problematic in that it rests on the assumption of the ascendancy of money as the motivating force of human behaviour in the exercise of preferences for economic goods and services. It is not difficult to discern how money has become confused with motivation and assumed the status of a principal motivating force. Money, in its legally sanctioned roles as units of currency and account, has no intrinsic value unless it is exchanged for the goods and services which individuals need and want and are motivated to fulfil. In the previous chapter (sections 2.4 and 2.8) it was demonstrated that under, and only under, perfectly competitive market conditions, the values of individual utility and individual welfare are maximised when the ratio of marginal utilities are equal to the ratio of the respective prices of the goods and services over which interest is held. As prices are specified in money terms, where money adopts its role as a unit of value, it is understandable, but erroneous, to assume that the money values that are obtained are utilitarian values. The money values revealed are ratio units of measurement with money assuming the role of a unit of account. The money values are representative of the underlying utilitarian value. The money values are not, and theoretically never have been, utility. The problem of associating money with welfare was encountered in section 2.8. There it was acknowledged that the Kaldor criterion did not necessarily capture the utilitarian value of welfare losses through the payment of monetary compensation. The problem has not been resolved in agency theory. Indeed, its existence appears to have produced a biased perspective on the necessary incentives required to reward senior executives. Agency theory is predicated on the assumption that actors behave rationally in the pursuit of the maximisation of their self interests. The underlying structure is expressed in terms of a continuous utility function whose motivational attributes are unspecified. Consequently the objective functions, which presume to model the motivational induced behaviour of chief executives, acting as agents of the principal owners in response to various incentives, is unspecified. What is specified is the monetary value of the outcome which presumes to assign a value to the unknown motivational composition of the

105 underlying construct of utility. The ultimate result is not surprising. The incentives advanced and promoted as instruments designed to align the interests of agents with the interests of principals, are expressed predominantly in terms of monetary rewards. The proposition that individual self interest is maximised when the value of an organisation investment choice is maximised is not exceptional. Nor is it confined to economics and finance. Functionally rational theories of organisation and management are littered with theories which are predicated on the implicit assumption that managerial objectives correspond with the metaphorically conceived rational purposeful goal seeking objectives of organisations (e.g. Burrell and Morgan, 1979; Morgan, 1986). Incongruously, these orthodox theories, with rare exception (e.g. Veblen, 1933, 1934), do not subscribe to the same proposition for non managerial organisational employees whose behaviour needs to be monitored and controlled (Perrow, 1986b). The adverse consequences associated with adherence to the proposition about managerial self interest has been revealed over the recent past. The proposition has been tested and found to be lacking in substance in the corporate world of business. Until recently, management and organisational theorists chose to ignore the profound insight expressed by F. Scott Fitzgerald (1968) in The Great Gatsby. “The rich are different from you and me” “Yes, they have more money” These fundamental philosophical antecedents have not yet been addressed in the escalation literature.

3.4.4 COMPETING ORGANISATIONAL EXPLANATIONS: ORGANISATIONAL

COMMITMENT Bowen (1987) has proposed several alternative explanations including ones derived from rational derivatives. Additionally, in organisational contexts where the nature of the negative feedback is ambiguous, Bowen (1987) has proposed that organisational commitment may provide a plausible alternative explanation. Escalation of commitment was conceived as an individual behavioural response to the negative consequences of a decision. Commitment in this context

106 is associated semantically with the meaning of the word commitment as ordering into action, being exposed to risk, or being obliged to adhere to a course of action (Fowler, 1965). It is a response to a cognitive assessment influenced by motivational antecedents. Organisational commitment was conceived as sets of behaviours and attitudes which enhance or inhibit organisational performance depending on the levels of commitment expressed (Porter, 1970). In this context, commitment is associated semantically, with the meaning of commitment as the act or state of pledging, binding or aligning oneself to a particular cause (Fowler, 1965). It is an affective alignment or attachment with moral dedication dimensions. The two forms of commitment conceptually are different which creates the potential for confusion. This is unfortunate and the source of the potential confusion can be easily identified and reconciled. The use of the word commitment in the specific context of escalation of commitment refers to the act of adhering to an adverse course of action. It is associated with consequences. In contrast, the alternative use of the term commitment is associated with the antecedents of the escalation phenomenon. It is this form of commitment which has been proposed by Bowen (1987) as an alternative explanation. The potential adverse consequences of high levels of organisational commitment to courses of action are well known (Kiesler, 1971; Salancik, 1977). When strategic changes require flexible responses, high level of organisational commitment to the previous structure produces inflexibility. According to the assumption that organisational commitment is “built by actions in which one is responsible for large consequences” (Staw, 1982:103), Staw argued that four factors contribute to organisational commitment; the salience of the action, the consequences of the action, responsibility for the action, and responsibility for the consequences of the action. These four factors independently or in combination bind organisational members to particular behaviours which may involve escalation. The potential for organisational commitment to provide an alternative explanation in organisational contexts reveals a theoretical weakness with the dominant self justification theoretical explanation which does not appear to have been recognised in the literature.

107 The weakness concerns the asymmetrical nature of the self justification explanation. Self justification derived escalation of commitment is a reaction to the consequences of a decision rather than a response to possible antecedents which are not considered. Organisational commitment is one such antecedent condition.

3.4.5 COMPETING ORGANISATIONAL EXPLANATIONS: SATISFICING BEHAVIOUR This alternative organisation based theoretical explanation for the escalation of commitment phenomenon derives from the management theory literature which, according to Morgan (1996) conceptualises organisations in terms of the image of the human brain. The foundation elements of this organisation theory were presented in chapter 2, section 2.1.2. The theory had its origins at the then Carnegie Institute of Technology (now Carnegie-Mellon University) in the pioneering research conducted by Herbert Simon (1947, 1965) and developed subsequently by Simon and his associates, the more prominent being Richard Cyert (1963), James March (1958, 1962, 1981) and William Starbuck (1965, 1985). It is a structural theory of organisational behaviour, unlike the theories of the human relations school that conceptualise organisational behaviour in terms of important dimensions of individual behaviour such as leadership, job satisfaction and motivation (Perrow, 1986b). Structure is achieved by reducing the behaviour of individuals to actions motivated by, at best, bounded rationality. A fundamental premise of the theory is that decision making is synonymous with managing (Welch and Cyert, 1970). A second fundamental premise is that decision makers in organisations, confronted with non programmable problems, are unable to comply with the utilitarian axioms of rational choice. This is because their ability to make decisions is constrained by cognitive limitations and insufficient knowledge about the uncertain future. While decision makers may be intendedly rational, the extent to which decisions are rational are necessarily “bounded” by these limitations. In these organisational circumstances decision makers will choose either intendedly rational satisficing choices that limit choice possibilities to obvious alternative choice possibilities or non rational choice

108 strategies such as the adoption of implicit favourite models of decision making (Soelberg, 1967; Power and Aldag, 1985). As Simon (1965) noted, with non programmed type decisions, the techniques used to make decision may involve judgement, intuition, creativity, the use of rules of thumb and heuristic problem solving models. Simon’s basic organisational theory provided the conceptual framework for analysing management decision making in different contexts. Important works include the “muddling through” model of public administration (Lindbloom, 1959, 1968; Forester, 1984), the “garbage can” models of organisation (Cohen, March and Olsen, 1972; March and Olsen, 1976) and the development of a behavioural theory of the firm as an alternative explanation to standard economic treatments in micro economics (Cyert and March, 1963). The latter work recognised that, at any given time, organisations have multiple conflicting objectives that require irreconcilable management decision making, in contrast to the single profit maximisation objective assumption used in standard microeconomic theory (Malinvaud, 1972). As the conceptual framework evolved, the role of intuition and creativity in decision making that was previously ignored in the early development of the theory, assumed greater prominence. Evidence emerged to indicate that intuition and creatively were not necessarily irrational. Rather, the unconscious processes distilled from experience complemented rationality (Agor, 1989; Behling and Eckel, 1991; Simon, 1987). Evidence to support the proposition that decision makers in organisations sought intendedly rational satisficing outcomes, rather than outcomes that were aimed at maximising an objective function such as efficiency (profitability) or utility derived from the growing literature on evolving industry structures and the growth and development of organisations. Starbuck (1965) reviewed the then literature on organisation growth and development and identified ten motives for the growth of US firms that were not necessarily mutually exclusive. At that time US industry was expanding internationally predominantly via competitive trade advantages derived from an overvalued exchange rate, high levels of productivity and knowledge about the effective use of transport and communications. Only four of the motives identified were associated with organisational efficiency, purpose and effectiveness. These were the desire for higher profit, greater revenue, lower

109 costs and monopolistic power, the attainment of which enables an organisation to survive and grow relatively inefficiently. Three of the motives were associated with problems of managing an organisation. These were the desire for a stable environment, organisational survival and organisational self realisation. The other three motives were associated with the self interests of organisational decision makers. These were the desire for higher executive salaries, the desire for prestige, power and job security and the desire to engage in risk and adventure. The organisational implications of the last three motives were not explored at that time to any extent under the umbrella of the decision making theory of organisation. The potential adverse consequences of self interested motives were given expression in the economics literature in the form of principal agency relationships (see section 3.4.3). These essentially utilitarian based rational forms of behaviour by the agent have become increasingly important in the governance of organisations as systems of trade restriction progressively have been relaxed and replaced by a monetarist philosophy of markets. This systemic shift to market forces as the principal means of economic adjustment has forced organisations in all industries and structures to devote greater attention to the need to become more efficient. The cognitive limitations that Simon (1947) recognised as forming a foundation for the development of a decision making theory of organisation were explored subsequently by Kahneman and Tversky (1979). Their research was concerned with explaining risk taking behavioural deviations from normatively rational decision making prescriptions. Kahneman and Tversky called the nature of the research they were conducting Prospect Theory. The importance of this theory in the escalation of commitment context has been discussed above in section 3.4.2. The non rational dimensions of managerial decision making have been explored under the cognitive structure conceptual framework. Brunsson (1982, 1986), Nystrom and Starbuck (1981, 1984), have demonstrated that decision makers in organisations justify irrational decisions retrospectively. Irrational decisions are subjected to ‘ex post’ forms of rationalisation. Morgan’s (1997:393) comments on this research are revealing; “Decisions, it seems, often become rational as we used hindsight to rationalise and explain them.” These research

110 findings are consistent with the rationalisation explanation advanced by Staw and his associates (1976) to account for the escalation phenomenon. The importance of the decision making theory of organisations as a possible alternative explanation of the escalation of commitment phenomenon involves the possibility that persistence with a losing course of action in uncertain circumstances may involve decisions that are rational, intendedly rational, irrational or rationalisations derived from ex post justification. The theory recognises that decision makers in organisations frequently do not comply with the prescriptions of the normatively rational decision making model because of cognitive limitations and the need to make strategic choices in uncertain circumstances. Under these conditions and circumstances decision makers engage in the use of alternative choice models. Providing an explanation for a non programmed type decision is complicated further by the complex nature of organisational objectives. This structural theory recognises that organisations are engaged in the pursuit of multiple irreconcilable objectives simultaneously. Whether the nature of a decision can be explained as being rational or not, will be associated with the explicit and implicit preference ordering assigned to the associated objectives by decision makers. Evaluation of the outcome of an organisational decision requires recognition that the outcome being evaluated may be associated with several competing objectives involving decisions of varying levels of the principal decision makers.

3.4.6 COMPETING ORGANISATIONAL EXPLANATIONS: GROUP INFLUENCES A fourth organisational based theoretical explanation for the escalation of commitment phenomenon derives from the influence that membership of groups has on individual and organisational decision making. During the 1950s significant social psychological research was conducted into group influences in either reinforcing or changing existing beliefs, attitudes, opinions, values and actions. Of particular interest in this research agenda was the attempts made to identify individual motives, abilities and attributes that contributed to susceptibility to group influences. As well, this research investigated particular circumstances and

111 contexts in which group influences became pronounced (Asch, 1952, 1955; Hovland, 1954; Hovland, Janis and Kelley, 1953; Janis and King, 1954). The pioneering research on double loop learning complements the research on group influences. Argyris and Schon (1974, 1978) showed that when people felt threatened or vulnerable, they often engaged in defensive routines designed to protect themselves and their group. Argyris and Schon (1978) suggested that the use of defensive routines was systemic and universal. Building on the background of the group influence research, Janis (1972) coined the term “groupthink” to characterise situations where people in groups are influenced by collective illusions and perceptions that have reinforcing qualities. The governing force behind “groupthink” decision making is adherence to the norm for consensus which discourages group members from appraising alternatives objectively or critically evaluating unpopular or minority alternatives. Favoured ways of thinking are encouraged which subsequently trap groups within socially constructed realities and prevent the emergence of alternative realities. “Groupthink”, under the dominant influence of the norm for conformity, may encourage the manifestation of groupshift. Groupshift is characterised by an exaggerated adherence either to initial choice positions, which are usually conservative or, more often than not, by shifts towards choice positions of greater risk and uncertainty. Situations that are described as being the outcome of “groupthink” embody a number of common symptoms. These involve a strong sense of assumed consensus which reinforces the illusion of unanimity and encourages dissenting members to maintain their silence about deviations from group consensus; the use of social pressure on members who express doubts about shared views or the veracity of strong rationalisation tendencies mobilised to support shared opinions, overcome resistance to assumptions despite evidence to the contrary and maintain chosen positions (Isenberg, 1986; Moorhead and Montanari, 1986). Situations that are described as being the result of “groupthink” in the literature (Janis, 1974, 1982; Morgan, 1997) such as the Challenger disaster and the Bay of Pigs invasion of Cuba during the Kennedy administration could be described alternatively as classic examples of the escalation of commitment phenomenon. The dominant explanations for the occurrence of these events

112 however, are different. The dominant explanation for escalation of commitment to failure is a self justification process of retrospective rationalisation, derived from experimental psychological research on individuals (Ross and Staw, 1993). With “groupthink” several theoretical explanations operate in combination (Janis, 1974, 1982; Isenberg, 1986). The overarching norm for consensus induces a social construction of reality which is maintained by defensive routines reinforced by rationalisation tendencies throughout the decision process.

3.4.7 COMPETING ORGANISATIONAL EXPLANATIONS: COALITIONS OF RATIONAL

SELF INTERESTED INDIVIDUALS The last possible organisational based theoretical explanation for the escalation of commitment phenomenon derives from the literature on economic feasibility and evaluation of public sector infrastructure projects (Margolis, 1970; Morris and Hough, 1987; World Bank, 1994a, 1994b). This literature indicates that public sector project approval repeatedly involves: • Underestimation of project costs; • Overestimation of project benefits; • Undervaluation of environmental impacts; and • Overvaluation of economic development effects. (Flyvbjerg, Bruzelius and Rotherngatter, 2003:1)

Public sector projects are susceptible to serial overestimation of social benefits and underestimation of social costs (World Bank, 1994a). Public sector projects have long lead times between approval and completion increasing the risk that forecasts will be inaccurate. They are not subject to the discipline of the market. Ownership is diffused. The risks to individuals in promoting projects is negligible. Accountability is low and easily abused particularly because the political proponents of public sector projects may have long departed from political office by the time the project is completed which has long been forgotten by the public. It is not unusual for public sector projects to be associated with several objectives which may or may not be mutually exclusive. Nor is it unusual for political objectives to override economic consequences even though the project is

113 evaluated exclusively in economic terms. These public project characteristics, in combination, provide an ideal climate of vulnerability for the emergence of opportunistic behaviour (Williamson, 1975; Williamson and Winter, 1991). In some jurisdictions there are positive incentives to distort the estimation of project benefits and costs. For example, in the United States cities compete for limited discretionary Federal grants. As Wachs (1990) comments, given the competition for funding, it is in the political and economic self interest of grant applicants to inflate benefits and deflate costs. Flyvbjerg, et al (2003) point out the motives behind the production of deceptive forecasts of project costs and benefits are associated with the rational economic self interests of the promoters of public sector projects. “Politicians, may have a monument complex, ingenuous like to build things and local officials sometimes have the mentality of empire-builder. In addition, when a project goes forward, it creates work for engineers and construction firms, and many stakeholders make money. If these stakeholders are involved in, or indirectly influence, the forecasting process, then this may influence outcomes in ways that make it more likely that a project would be built. Underestimating is economically rational for such stakeholders because it would increase the likelihood of (private) revenues and profits.” (Flyvbjerg, et al, 2003:47)

Even though the promoters of public sector projects may face legal, economic and ethical consequences if it is discovered that the social costs and benefits have been deliberately and deceptively fabricated, the characteristics associated with public sector projects minimises the risk of discovery. In research conducted by Pickrell (1990, 1992) on urban rail transit projects, he suggest that promoters do not disclose that the estimates have been fabricated deliberately, Wachs (1989, 1990) goes further. He provides evidence that promoters lie about the forecasts and further suggests that fabrication of deceptive social costs and benefits is a practice which is nearly universal.

114 If promoters are concerned to justify their deceptive and deceitful forecasts, they do so by rationalising their actions. It is common for project promoters and forecasters to believe their projects will benefit society or achieve specific political objectives and therefore they are justified in fabricating costs and benefits to get projects built (Flyvbjerg, et al, 2003). The characteristics associated with public sector projects particularly those relating to the low level of accountability, uncertainty of outcomes, negligible risk to promoters and the presence of multiple objectives, facilitates the selection of projects which maximise the economic self interests of some stakeholders and enables the favourite projects of other stakeholders to be selected. The costs to society involve the erosion of democratic accountability, the waste of public resources and the loss of economic efficiency (Flyvbjerg, et al, 2003). The fabrication of deceptive forecasts of social costs and benefits, either promotes the selection of projects that would not have been otherwise selected because they are not economically viable, or the rejection of alternative projects which produce superior cost/benefit ratios. The literature on the decision making processes involved in the selection of public sector projects indicates that several theoretical explanations are associated with the choice of projects that do not maximise social benefits or minimise social costs. Agency theory (section 3.4.3) accounts for the capacity of stakeholders to exercise their rational economic self interests. The decision making model (section 3.4.5) together with prospect theory (section 3.4.2) fits the intendedly rational or non rational (selection of favourites) behaviour of other stakeholders. The capacity to justify decisions is derived from retrospective rationalisation antecedents. This is the dominant theory for escalation promoted by the experimental literature (section 3.4.1) and also features prominently in the decision making model (section 3.4.5).

3.4.8 SOURCES OF THEORETICAL CONTROVERSY Why decision makers in resource allocation situations choose to commit additional resources after receiving discouraging information about the prospects of achieving an investment objective, has not been resolved. Sections 3.4.1 to 3.4.8 indicated that several plausible explanations exist at the individual and

115 organisational level of analysis, based on underlying theoretical propositions about rational decision making, distorted rational decision making, irrational decision making and social influences in organisations. The status of the research literature therefore remains controversial (Brockner, 1992; Brockner and Rubin, 1985; Staw, 1997; and Staw and Ross, 1987a). Both Staw and his associates (see Staw and Ross, 1987a) and Brockner and his associates (see Brockner, 1992) identify several causes operating in particular organisational contexts but remain convinced that escalation to commitment is due predominantly to self justification which they would maintain produces an irrational series of behavioural responses driven by rationalisation processes. More recent literature favours predominantly rational explanations in organisational contexts based on the agency problem of adverse selection (Dipanker, 1997; Knight, Durham and Locke, 2001; Sharp and Salter, 1997). The decision making model (section 3.4.5) accommodates both rational and non rational explanations. The empirical literature derived from psychological laboratory experiments overwhelmingly favours self justification as the principal explanation for the phenomenon. As previously noted (sections 3.2.3 to 3.2.5) this result is not unexpected, given the research designs adopted which induce escalation under conditions where the subjects are influenced by personal responsibility. A detailed examination and interpretative analysis of the literature indicates that most of the controversy about causation in organisational contexts derives from the treatment and conceptualisation of several interrelated issues. These involve: (a) whether the decision to commit additional resources occurred under conditions of risk or uncertainty and whether or not the additional commitment involved a decision error as required. Bowen (1987) and Northcraft and Wolf (1984) criticised the early experimental literature on the basis that the negative feedback received about outcome prospects was equivocal or ambiguous. To the extent that the negative feedback in organisational contexts remains uncertain, or the prospective outcome remains uncertain, it is not possible to determine whether a decision error has been made. Nor is it possible to

116 objectively derive criteria to determine whether decision makers, confronted with uncertainty about the outcome, subsequently behave rationally or not. This is the source of considerable confusion in the literature. It is a fundamental reason for the attention given to uncertainty in chapter 2 where it was indicated that there are no decision criteria to determine the appropriateness of an uncertain investment decision. Consequently, there are no objective criteria to determine whether a decision maker is behaving rationally in these uncertain situations. At best the situation enables decision makers to be intendedly rational (section 3.4.5); (b) whether the investment constituted a sunk cost. Section 3.1.3 indicated that it is frequently difficult to determine during the life of a project whether an investment is a sunk cost. Consequently it is difficult to attribute the commitment of additional resources under ‘ceteris paribus’ conditions to non rational causes. Rational or intendedly rational explanations may be just as probable; (c) whether the objective associated with the investment of additional organisational resources coincided with the self interests of the decision maker. Section 3.4.4 indicated that where there was a lack of coincidence, rationally derived explanations may be just as plausible as self justification explanations, which in turn may be perfectly rational (see section 3.5.5); (d) whether the principal explanations derived from expectancy theory and cognitive dissonance theory are theoretically independent. This issue is examined in section 3.5. The analysis concludes that the theories are not independent. Rather, it is argued that they are different manifestations of the same underlying theoretical structure. If the analysis and conclusion are plausible then the implications for strategic decision making in organisations where ownership is divorced from managerial control is profound. It also means that in particular organisational circumstances, self justification becomes a rational response;

117 (e) whether, in organisational settings, the nature of risk and uncertainty, which is relevant to the investment decision, can be confined to the presence or absence of probable outcomes associated with the choice of available alternatives. This issue was discussed in chapter 2. It is not trivial or easily dismissed. For example, investment decisions which do not involve replacement of obsolete or exhausted plant and equipment usually involve discretionary strategic dimensions. Strategic discretion involves uncertainty characteristics over and above that associated with the probabilistic or non probabilistic choice of alternatives associated with an investment objective. Strategic discretion involves a different order of choice. The coexistence of the choice of an investment and the strategic requirement to choose directionality, implies a different order of uncertainty associated with the relationship between the investment and the strategic performance of the organisation. The nature of uncertainty is compounded. The experimental literature does not consider this compounded form of uncertainty which exists in organisations. Therefore the experimental laboratory findings on escalation may not be generalisable beyond the laboratory. It follows that the assignment of probable cause to the phenomenon in organisational setting, based on the experimental evidence, may well be incomplete; and (f) whether the evaluation criteria used to determine the success or failure of a decision and therefore whether the decision qualifies as escalation of commitment are valid. For private investment decisions, it is universally accepted that decision outcomes should be evaluated in terms of accepted financial economic investment criteria (chapter 2, section 2.7). This applies to projects characterised by uncertainty of outcomes and those that involve sunk costs even though it is difficult to evaluate project performance in these latter situations until after projects have been completed (section 3.1.3). In the absence of sufficient information to make a normatively rational investment decision, decision makers resort to alternative decision making processes which may range from the intendedly rational to the non

118 rational and may subsequently involve rationalisation to justify the decision (sections 3.4.2 and 3.4.5). Public sector projects involve two fundamentally different evaluation methodology issues. Firstly, it has been argued (chapter 2, section 2.8) that the appropriate evaluation criterion to use is social cost benefit analysis because the methodology provides for the calculation of both private and public costs and benefits. To adopt private investment criteria as the method or evaluation is misleading and inaccurate. Secondly, public sector projects frequently have several objectives which may involve both economic and political purposes. They also frequently possess characteristics which makes them vulnerable to opportunistic behaviour. The presence of multiple objectives makes it difficult to formulate a constrained maximisation objective function or to determine what objective function decision makers intend to maximise or satisfy or to determine the motives behind their selection.

3.5 THE DOMINANT THEORETICAL EXPLANATIONS

3.5.1 PSYCHOLOGICAL DECISION THEORY Although Nicholas Bernoulli is credited with conducting the first psychological experiment (Kagel and Roth, 1995), the modern experimental psychological interest in decision theory originated with Edwards (1954) who introduced psychologists to the gambling paradigm and the economics literature on expected utility which he referred to as subjective probability; the coincidental amalgamation of objective probability and subjective motivation. Several lines of psychological thought in decision theory have evolved and been elaborated upon (e.g., Steiner, 1972). Brunswick (1956) introduced ideas about prediction in probabilistic environments. Tanner and Swets (1954) applied decision theory concepts to signal detection and categorisation (Swets, 1961). Thurstone (1959) initiated research on the application of ideas in psychophysics and measurement theory to individual preferences. And, Estes (1959) and Luce (1959) applied theories of learning to the choice of individual preference alternatives in environmental conditions of uncertainty.

119 The development of cognitive expectancy theories of motivation have their origins in the early investigations of Lewin (1938) and Tolman (1932). Their evolution has been influenced considerably by the expectancy theory of Edwards (1954) which is derived from the decision theory concept of expected utility. Vroom (1964) introduced an instrumental theory of cognitive motivation which has become the benchmark theory against which extensions and refinements have been formulated (e.g. Campbell, Dunnette, Lawler and Weick, 1970; Porter and Lawless, 1968).

3.5.2 EXPECTANCY THEORY Vroom postulated that individuals anticipate satisfaction or reward, not through the habit strengthening general excitation associated with stimulus- response connections, but through the selective functioning of actions which lead to their achievement (Atkinson, 1964). The process which produces a desired outcome produces a learned connection in the form of a behaviour – outcome expectancy. For Vroom (1964), the motivational force is the instrumental value of an outcome. This value derives from the joint effect of “expectancy” or subjective probability; a belief concerning the probability that a behavioural action will be followed by a particular outcome and, the “valence” or the expected value of an outcome where valence is the strength of an individual’s preference for a particular outcome. The numerical expression of this strength ranges between plus and minus one as does the value of expectancy. As previously noted (section 3.4.1), expectancy theory has been postulated as a major theoretical explanation for the existence of the escalation of commitment phenomenon (Levi, 1981; Rubin and Brockner, 1975).

3.5.3 DISSONANCE THEORY As previously noted (section 3.4.1), an alternative and equally dominant explanation for the behaviour exhibited in escalation of commitment situations is a self justification form of rationalisation. The perspective invoked to explain this form of rationalisation is an elaboration of cognitive dissonance theory (Festinger, 1957).

120 Cognitive dissonance theory was formulated from the behavioural axiom that individuals are motivated to achieve consistency between what they know, believe and value and what behavioural actions they engage in. Festinger replaced the terms consistency and inconsistency with the words consonance and dissonance which he claimed were more neutral and less associated with connotations of logicality (Festinger, 1957). Cognitive dissonance theory predicts that, when individuals experience cognitive dissonance or the potential for cognitive dissonance, they will be motivated to reduce, eliminate or avoid the painful tension created and seek to recapture an equilibrium state of consonance. In decision theory the condition manifests itself as risk avoidance. There are several possibilities available to enable individuals to accomplish this equilibrium state. Firstly, they can change the behavioural outcomes. Secondly, they can change their values and beliefs. Thirdly, they can search for new knowledge which can serve to either reaffirm or reject the choice between the first two possibilities. Fourthly, they can engage in ego defensive forms of rationalisation to justify the outcome chosen. At this general motivationally conceived level of explanation, cognitive dissonance theory virtually is indistinguishable from other models of cognitive consistency such as those proposed by Heider (1958), Osgood (1960) and Rosenberg (1960). The major sources of differentiation occur at more specific explanatory levels where, “inter alia”, the “insufficient justification paradigm” is introduced (Abelson, Aronson, McGuire, Newcombe, Rosenberg and Tannenbaum, 1968). Functionally rational self interested, goal seeking decision makers are reactive and proactive in their behaviour (Staw, 1980). They are motivated by a competency drive to predict and control their environments. They may either adapt to environmental contingencies reactively, or proactively attempt to change or control environmental contingencies. According to Staw (1980), the behaviour exhibited in these environmental adjustment processes may assume two forms of rational behaviour. The first is the traditional “prospective” form of rationality associated with judgement and decision making theory, rational economic decision making and expectancy theory. The second is a “retrospective” form of subjective rationality associated with the Freudian clinical psychological concept of

121 rationalisation. Decision makers re-evaluate outcomes to make them appear as if they have behaved rationally, competently and reasonably. They justify the outcomes of their choice of alternatives. In dissonance theory, the insufficient justification hypothesis is concerned with the consequences of behaving in a manner which is inconsistent with fundamental values, beliefs and attitudes in the absence of environmental justification. Staw explains the phenomenon in the following terms. “According to the theory [of cognitive dissonance], dissonance should be aroused by inconsistency between one’s attitude towards an activity and knowledge of its enactment. However, as external pressure (e.g., promised reward or threatened punishment) on the individual to perform the activity is decreased, the dissonance aroused by its enactment is increased. The crucial point is that the level of dissonance should be at its maximum if the extrinsic reward or punishment is just barely enough to elicit the behaviour; any incentive greater than this minimal amount (being consistent with the behaviour) should, theoretically, produce less cognitive dissonance” (Staw, 1980:55-56)

Aronson (1968) clarified the connection between cognitive dissonance and self justification processes. As Staw (1980) states, Aronson proposed “that positive self-concept is an important boundary condition for dissonance theory effects.” Aronson (1968) observed that it is the inconsistency between the concept of one’s self and the behaviour or attitude expressed that is dissonance inducing. If a decision maker believes she is incompetent and the decision she makes about an outcome is a mistake, no distress or pain is induced and so there is no motivation to reduce dissonance. On the other hand if she is self confident and believes she is competent, a decision error will produce a painful experience and she will be motivated to reduce dissonance.

122 3.5.4 METHODOLOGICAL ISSUES ASSOCIATED WITH DISSONANCE THEORY There is a methodological problem associated with psychological studies of dissonance. As Staw (1980) observed, most experimental psychological studies have been concerned with self justification rather than cognitive consonance and dissonance. The studies indicate that decision makers justify their behaviour to protect their self concepts. If they believe they are competent, they re-evaluate alternatives to ensure that the outcomes are correct (e.g., Knox and Inkster, 1968) or re-evaluate their attitudes towards activities to ensure they did not make a mistake in committing themselves to unsatisfactory outcomes (e.g., Linder, Copper and Jones, 1967; Pallak, Sogin and Van Zante, 1974). A dissonance framework has been used in these early studies not to study cognitive dissonance, but to investigate consequences which threaten or elaborate the self concept. Dissonance theory is concerned with the consequences of cognitively experienced inconsistencies. Dissonance effects which can be explained in terms of the insufficient justification hypothesis in experimental conditions involve alternative choice situations. In these situations, the decision maker acting independently of any external inducement, makes a choice of an alternative. The chosen alternative results in significant negative consequences for the decision maker and the outcomes of which, the decision maker was in a position to anticipate in advance. Crucially, the alternative chosen results in an outcome which is judged rationally to be a decision error. Research indicates that under these experimental conditions, self justification for the dissonance created is enhanced if the decision maker is personally responsible for the decision (e.g., Cooper, 1971; Staw, 1976). As Staw (1980) maintains the decision maker has made “a clear-cut mistake in deciding to undertake a negative task without extenuating circumstances or the promise of other rewards. …In short, the subject, despite his general need for competence, is typically induced into behaving irrationally in most dissonance experiments. Therefore we would interpret most dissonance effects as products of ego-defensiveness”. The above quotations from Staw have been inserted deliberately. The dissonance reducing need to justify ones actions is instrumental in producing a

123 theoretical rationalisation explanation for the apparently irrational behaviour observed in the escalation of commitment phenomenon. The theoretical explanation rests on one and only one crucial assumption. This is that the decision maker independently has made, and knows she has made, a decision error in the choice of available alternatives. The progressive elaboration in the literature of ego-defensive explanations for the existence of escalation of commitment phenomenon are predicated on the assumption that decision makers unambiguously, have made a decision error in their choice of preferences. As the literature has advanced, the experimental conditions have been modified progressively to ensure that information about the prospects and outcome of the initial decision are unambiguously errors of judgement.

3.5.5 SUMMARY The literature review has indicated that several distinct theoretical explanations have been proposed to account for the phenomenon of escalating commitment to a failing course of action. In laboratory experimental situations which induce escalation under decision error conditions, the dominant explanation has involved a self justification form of rationalisation derived from dissonance theory. The other dominant theoretical explanation derived from laboratory experimental situations has involved expectancy theory. This descriptively rational explanation has prevailed during the initial phase of the phenomenon where the decision circumstances involve uncertainty. The normative theory of expected utility, the equivalent of expectancy theory, has been proposed under decision conditions of uncertainty and in those situations involving sunk costs. Prospect theory has also been proposed as an alterative explanation for escalation of commitment in individual decision making. Prospect theory has investigated the cognitive inability of decision makers to comply with the requirements of the normative model of rational choice. How individuals behave when confronted with loss situations however, is consistent with expectations derived from the characteristics of the normative utility function in negative utility space. In natural organisational settings five additional explanations for the escalation of commitment phenomenon have been identified. These involve either

124 extensions of the explanations derived from the experimental literature or explanations derived from agency theory, organisational commitment, the conforming influence of group membership and the consequences of bounded rationality. The agency explanation is extended to encompass the effects of coalitions of self interest engaged in the promotion of public sector projects which are vulnerable to opportunistic behaviour. The theoretical explanations involve rational, intendedly rational, non rational group pressure and affective forms of behaviour. The last two may involve rational or non rational antecedents. From a utility perspective, rational behaviour only assumes the non-productive forms of behaviour associated with the escalation of commitment phenomenon when the concept of utility embodies the pursuit of efficiency. Theoretically, this will occur only when the maximisation of self interest coincides with the objective of maximising the value of an investment opportunity. Utility was conceived in the decision making context of a winning gamble. The St. Petersberg paradox involves A tossing a coin and continuing to toss a coin until it comes up heads. In the original game A pays B one ducut, the current equivalent of approximately A$100 (Baumol and Baumol, 1994), if a head is tossed on the first throw, two ducuts if the head comes up on the second throw, four ducuts on the third toss eight on the fourth and so forth. Bernoulli (1738) asked how much C would have to pay B for the privilege of taking B’s place in this winning game. Mathematically, the expected value of the gamble is infinity, but Bernoulli (1738) concluded that B would sell her opportunity to C “with great pleasure for twenty ducuts”. The twenty ducuts represents the utility value of the gamble to B. In the gambling paradigm, it is unquestionable that the winning game possesses utilitarian value which is significantly different from the expected or actuarial value of the outcome of the game. Moreover, it is unquestionably in B’s rational self interest to be involved in the winning game at the outset. In the study of the resource allocation problem in the escalation context of laboratory experimental situations, the existence of coincidence between utility and efficiency may be a reasonable assumption to make. This is provided the individual decision maker perceives the problem as a resource allocation problem in which the decision maker’s self interest is maximised if the solution selected is

125 an efficient outcome. In organisational contexts the assumption of coincidence is problematic.

3.6 RESEARCH ISSUES

3.6.1 THE ORGANISATIONAL CONTEXT Ross and Staw (1986) conducted a study of Expo 86 in Vancouver and concluded that it represented an escalation prototype. As previously noted (subsection 3.2.4) projects such as Expo 86 are now considered to be classic examples of the escalation phenomenon. From a review of the then current literature, Ross and Staw (1986) proposed that four general classes of variables affected escalation behaviour. Their analysis of Expo 86 confirmed the importance of these four classes of variables. More generally, Staw and Ross (1987a) have provided an extensive elaboration of the four categories of factors which influence escalation and have suggested that these factors are differentially important over the stages of the escalation process and over the life of the project. Importantly, self justification remains the dominant explanation but other factors, including other psychological factors supplement and reinforce escalation tendencies. They do not replace self justification. Escalation in Expo 86 was due to an inter action of micro (e.g. social and psychological) and macro (structural, economic) effects. The four sets of variables involve project determinants, psychological determinants, social determinants and structural determinants (Ross and Staw, 1986). Project variables which involve consideration and assessment of such matters as the size, duration, value, and the costs and benefits associated with the commencement and completion of a project, are likely to be the most important determinants of escalation during the initial stages of a project. It is during this stage of the life of a project that issues of feasibility are being considered. Brockner (1992), Staw (1997) and Staw and Ross (1987a) consider that expectancy theory explanations, at these early stages of the life or a project, are most influential in determining the initial process of escalation; the decision to persist with a project with uncertain consequences.

126 Psychological and social determinants, it is maintained become increasingly important at the decision error stage of the escalation process; the stage where negative feedback is received. Ross and Staw (1986) emphasised self justification but considered that other mechanisms may also be relevant. They mentioned the self inference behaviour associated with organisational commitment (Salancik, 1977), the tendency to process information to ensure the perseverance of beliefs (Nisbett and Ross, 1980) and three social determinants which have been investigated; modelling, social norms and the unwillingness to expose errors to others (Fox and Staw, 1979). Brockner (1992) considered that the psychological and social influences which may augment self justification include prospect theory, decision dilemma theory and those social variables previously investigated by Brockner and Rubin (1985). The various situational and psychological predisposition factors which influence escalation were reviewed in subsection 3.2.3 to 3.2.5. Ross and Staw (1986:277) suggested that structural determinants “arise and increase in prominence as a project unfolds over time.” They further suggested (Staw and Ross, 1987:60) that “structural determinants perpetuate continued involvement in escalation situations”. What makes these structural determinants so influential in inducing perservence, they maintain, is that many of the structural variables possess the properties of side bets. Side bets involving economic, technical, political and organisational values, not only became attached to projects as they develop but also become locked into a project. Ross and Staw (1986) illustrated the locking in effect of side bets with Lockheed’s attempt to enter the commercial aviation market. The reluctance to abandon the loss making venture was less related to a desire to curtail further financial losses then it was about their reluctance to abandon the commercial aviation market. This in turn would signal the failure of their corporate strategy.

3.6.2 RESEARCH QUESTIONS In this research project, the Ross and Staw (1986) study of Expo 86 is re- examined. The analysis is then extended by examining a similar project; Expo 88 over the life of that project as recommended in the literature (Northcraft and Wolf,

127 1984). Expo 88 exhibited similar characteristics to those reported by Ross and Staw in their investigation of Expo 86 (Donohue, 1988a). The purpose of conducting this particular examination is related to the interrelated research questions. Section 3.4 indicated that the explanation for escalation of commitment remains theoretically controversial with several different determinants having been promoted as the principal cause. This controversy leads to the specification of the first research question:

What causes the behaviour which has been interpreted as escalation of commitment in organisations?

The second research question derives from subsection 3.4.2 in which it was argued that in certain circumstances it may be perfectly rational for decision makers to persist with project loss situations. It is also derived from subsection 3.5.5 in which it was argued that self justification can be a rational response rather than a form of rationalisation. The arguments expressed in these sections lead to the specification of the second question:

Is it possible that there are alterative explanations to those provided by Ross and Staw in their theoretical model of escalation to explain escalation of commitment type behaviour in organistions?

The third research issue is an extension of the second and is specified as follows:

Is it possible that the escalation of commitment type behaviour exhibited in organisations is unrelated to the defining characteristics of the phenomenon?

The defining characteristics are discussed in subsection 3.1.2

128 3.7 CONCLUSION This review began with an overview of the conceptual origins and development of the escalation of commitment phenomenon. The defining characteristics of the phenomenon and the peculiar contextual settings in which the research into the phenomenon are embedded are identified. The overview builds on and depends on the foundations presented in chapter 2. The review traces the progress of research in escalation and identifies the various psychological predispositional and situational variables which contribute to escalation of commitment. The factors which reduce the incidence of escalation and contribute to the decision to withdraw from a project are discussed. The theoretical explanations which have been proposed for the existence of the phenomenon are discussed. The rational and non rational theoretical antecedents to the explanations are identified and compared. The review of the theoretical literature on the phenomenon provided the platform for the reconstruction of the dominant theoretical explanations in terms of expected utility theory which are considered in chapter 2. The chapter concludes with the formulation of three research questions which derive from the theoretical controversy about the nature of causation that was revealed from the literature review. The research questions are examined in chapter 4.

129 Chapter 4

RESEARCH METHODS AND CASE STUDY RESULTS

INTRODUCTION This chapter explains and justifies the quantitative and qualitative methodologies used to examine the decision making processes and outcomes associated with two studies concerned with public sector investment activities with finite project lives. Following the methodological “raison de etre” in section 4.1, the results of the examination of the two case studies are reported. The first case study involves an examination of Expo 86. It is undertaken in section 4.2. The examination involves first, a reproduction of the model formulated and the results obtained by Ross and Staw in their investigation of Expo 86 (Ross and Staw, 1986). Second, a reinterpretation of the events is undertaken using a literature which provides a very different perspective on why the events reported occurred. The investigation indicates that processes associated with decisions to proceed with the staging of Expo 86 were associated with rational anticendents. From this alternative interpretation of events, rationalisation explanations are present but do not assume the prominence accorded to them by Ross and Staw (1986, 1987). The second case study involves an examination of Expo 88 and is undertaken in section 4.3. It is concerned with identifying why decisions were taken to host Expo 88 when studies commissioned by or available to the Queensland government produced forecasts indicating that the financial outcome would be negative. The examination of Expo 88 considers data over the entire life of the project as suggested by Northcraft and Wolf (1984). The longitudinal analysis indicates that the motives to persist with Expo 88 were associated mainly with rational anticendents linked to traditional utility theory and agency theory. Rational motives persisted through the project and were supported by rationalisation processes. Expo 88 satisfied ambitions of principal decisions makers and was associated with beliefs that Expo 88 would be an effective instrument for promoting economic development and achieving urban renewal objectives.

130 The second case study also looks at the evaluation of Expo 88. This examination indicates that a positive or negative outcome can be generated. The sign of the outcome depends upon which investment criteria and system of accounting is used. The study illustrates that whether a project qualifies as meeting the financial loss requirements for escalation of commitment, depends crucially on the system of evaluation used to assess project outcomes and the stage of the project during which the evaluation is undertaken. The chapter concludes with a summary.

4.1 THE METHODOLOGICAL APPROACH ADOPTED

4.1.1 THE RESEARCH QUESTION APPROACH The research questions formulated in this thesis do not involve answers which derive from a strict application of the hypotheses based approach to scientific inquiry. Instead, the methods of inquiry produce data which enable explanations of the escalation of commitment phenomenon to be investigated and the project outcomes to be evaluated according to different criteria. The research problems are instrumental in determining the research methodologies selected (Cook and Campbell, 1979; Denzin and Lincoln, 1998; Eisenhardt, 1989; Glasser and Strauss, 1967; Keppel, 1982; Strauss and Corbin, 1990; Yin, 1989). The research questions are formed in terms of seeking answers to questions involving “what” and the possibility that alternative sources of causation exist and can be identified. This approach avoids the restrictive nature of hypothesies testing which requires a definitive positive or negative response to a closed question (Francis and Paap, 2001). Instead, the open nature of the research questions is the most appropriate form of construction when the purpose of the research is exploratory and explanatory seeking rather than the confirmation or elimination of specific hypotheses. From this perspective, the thrust of the research predominantly is inductive. The principal aim of the empirical research is to gain a greater understanding of why decision makers in organisational settings persist with investment projects which appear to be failing financially. A hypothetical deductive based investigative approach would be restrictive and may well limit the

131 elucidation of understanding. This is because the outcome of hypothesis formulated research depends on the nature of statistical probabilities in a world which is assumed to be characterised by stochastic determinism (Wallace, 1963). In contrast, this research approach seeks to explain why certain forms of behaviour occur, whether the explanations proposed depend on individual perceptions and frames of reference and whether the labels attached to the behavioural patterns depend on the evaluative criteria used to assess outcomes.

4.1.2 QUANTITATIVE AND QUALITATIVE METHODOLOGIES The empirical research in this thesis is accomplished through combining elements from the quantitative and qualitative research traditions. Quantitative and qualitative methodologies are synonymous with the logical positivist and idealist paradigms respectively and represent the objective and subjective extremes on a continuum of paradigmatic approaches (Burrell and Morgan, 1979; Desphande, 1983; Guba and Lincoln, 1994; Layder, 1993). At the extreme the quantitative approach coincides most closely with positivist views which emphasise postulation followed by verification through experimental proof. More generally the approach is concerned with numbers. At the other extreme the qualitative approach in contrast, involves an interpretive, subjective approach of idealism which is not grounded in an objective view of reality (Wallace, 1967). More generally the approach is concerned with words. The combination of quantitative and qualitative methods provides a synergistic perspective of the evidence (Eisenhardt, 1989). This is appropriate to the normative and descriptive decision making perspectives adopted in this investigation of the explanations for escalating commitment. A combination of quantitative and qualitative approaches, as advocated by Reichardt and Cook (1979), provides a set of research methodologies which are appropriate for answering the research questions generated. Quantitative and qualitative approaches, when used jointly and appropriately, are seen as complementary and reinforcing rather than competitive and mutually exclusive (Greene & Caracelli, 1979; Caracelli & Greene, 1997; Greene, Caracelli & Graham,

132 1989). Greene et al. (1989) highlight five major benefits of using a mixed methods approach. The benefits involve: (vi) triangulation, which tests the consistency of findings obtained through different methods; (vii) complementarity, which clarifies and illustrates results from one method with the use of another method; (viii) development, which results from one method shaping subsequent methods or steps in the research process; (ix) initiation, which stimulates new research questions or challenges results obtained through one method; and (x) expansion, which provides richness and details to the study exploring specific features of each method. The appropriate use of a combination of methodological approaches is a pragmatic approach to the issues being investigated. It acknowledges that one method does not have absolute superiority other the other method. It recognises that different methods are required to answer the research questions formulated. And, it acknowledges that the dichotomisation of research approaches as either quantitative or qualitative tends to over simplify a variety of assumptions about the nature of knowledge which underlie the different approaches to research (Morgan and Smircich, 1980). Instead, the nature of this research could not be advanced unless a combination of quantitative and qualitative research methodologies were invoked in the investigation. The combined use of quantitative and qualitative methodologies reinforces their individual advantages. It overcomes some of the limitations inherent in each of these methodological forms used alone. The relative merits of each approach are discussed in the following sections.

4.1.3 QUANTITATIVE METHODOLOGY Quantitative research methods typically are based on the positivist approach to scientific inquiry. The approach underlies the hypothetic – deductive model of the confirmation of hypotheses (Brody, 1970). It is the most appropriate approach in “mature sciences” where the principal aim is to try to match the

133 underlying assumptions of the science to what is observed in nature (Kuhn, 1970). Numeric data are used to answer research questions. The methods derive from the physical sciences and assume a concrete view of the social world in which elements can be abstracted from their social context, defined and then measured in an objective way (Morgan and Smircich, 1980; Rosner, 1990; Winer, 1971). Quantitative methodologies are endowed with several strengths. They are the most suitable for use in experimental research which involve samples of underlying populations and where variables can be manipulated independently with the objective of establishing causal relationships. They are the most useful for condensing and manipulating large amounts of numerical data into analysable formats from which conclusions can be derived from the mathematical calculations performed. Quantitative methods favour research designs that can be derived from the manipulation of data. The questions are concerned with issues which involve length, breadth, and height, how much and how many and to what extent the information is generalisable to populations. The strengths determine the limitations of quantitative forms of analysis. They are not designed to reveal much about individual persons, phenomenon, events and consequently have limited value in non experimental situations characterised by complexity, uniqueness, change and the absence of control. These are characteristics associated with historical methods of comparative analysis and case study modes of inquiry which are explanatory in nature and may be concerned with theory construction (Morgan and Smircich, 1980; Richardson, 1996).

4.1.4 QUANTITATIVE RESEARCH DESIGN In this research, quantitative methods are not used to accomplish their traditional scientific objectives of either making inferences about the characteristic of populations or providing information in numerically appropriate forms which enable the hypotheses being tested to be confirmed or rejected. Nevertheless, the objective of this quantitative research remains evaluative. However, the form of evaluation and the quantitative techniques used to perform the evaluation

134 exercise are different from those traditionally associated with quantitative research (Aaker and Day, 1990; Bailey, 1987). The second case study involves a quantitative and qualitative examination of Expo 88. The quantitative examination consists of an economic and financial evaluation of the outcomes of Expo 88. The evaluation process adopted is associated with the quantitative project evaluation pedagogy (see for example, Bussery, 1973; Harberger and Jenkins, 2002; Little and Murlees, 1969, 1974). The methodologies are discussed in chapter 2, section 2.8. The evaluation process commences with applying the standard financial accounting model to classify, summarise and calculate accounting outcomes for the financial transactions associated with Expo 88 (Longergen, 1998; Roth, 1997; Rowe and Morrow, 1999). The transactions are recorded in money terms where money is used jointly as the unit of account and as a measure of value (Australian Financial Review, 1999; Carew, 1998). The data used in producing the standard financial accounting statements derive from the annual reports of the Brisbane Exhibition and South Bank Development Authority (BESBRA) and the South Bank Corporation (SBC). The financial information contained in these financial statements is treated as the standard or benchmark against which financial and economic evaluative extensions are compared. The first extension involves the identification and incorporation of expenditure items incurred by other government agencies. These expenditures are directly associated with the staging of the exhibition but do not appear in the standard financial accounts. These expenditures represent subsidies. The data derive from the annual budget statements of the Queensland and Australian Governments. The operations of Expo 88 extended over several years during which high levels of inflation were recorded. As a result, there is a case for evaluating the financial outcomes of the Expo 88 authority in current accounting terms as well as the conventional historical cost basis of financial recording. Current accounting systems involve discounting, that explicitly recognise the time value of money (Ross et al., 1994). The time value of money is an opportunity cost that is measured conventionally as the interest foregone. An evaluation of Expo 88 in current accounting terms is incorporated in the research design.

135 Expo 88 was a public sector project initiated by the Queensland government and managed by a statutory authority established by the Queensland government. Public projects produce externalities which have both positive and negative effects. An externality is an economic benefit created for, or cost incurred by, third parties who are not involved directly in economic exchange between two transacting parties (Arrow, 1996). The evaluation of public projects involves an assessment of the externalities that are generated over the life of the projects. The system of evaluation which explicitly recognises the externalities and incorporates their value in the discounting process is social cost benefit analysis (Baumol and Wilson, 2001). Cost benefit analysis is the applied branch of theoretical welfare economics. The principles and limitations associated with this system of evaluation were discussed in chapter 2, section 2.8. The research design incorporates a partial cost benefit analysis. The analysis is not exhaustive in the identification and valuation of externalities. However, it is sufficient to produce a definitive economic welfare outcome. Although the research strategy adopted conforms to a mixed method research approach (Creswell and Plano Clark, 2007), the quantitative research undertaken is very much subordinate to the dominant qualitative methodologies adopted. The use of quantitative techniques primarily serves two important purposes. It enables publicly available financial and economic data generated from Expo 88 over nearly two decades to be uniformly valued, standardised, consolidated and summarised consistently. The other purpose is to use numerical data to determine whether a decision error has been made, a fundamental requirement of the concept of escalation of commitment. The quantitative analysis therefore involves an exhaustive application of the methods used to evaluate the value of investment projects.

4.1.5 QUALITATIVE METHODOLOGY In the final analysis, the philosophy of qualitative methods of research involves the interpretation of words irrespective of how the data are manipulated. The analysis involves data reduction, data display, data interpretation and the

136 derivation of conclusions (Denzin and Lincoln, 1998; Miles and Huberman, 1984; Parke, 1993; Richardson, 1996; Strauss and Corbin, 1990, 1998). The epistemological mode of inquiry is subjective and interpretative (Slade, Gordon and Schmitt, 1986). The methods of investigation are more closely related to the anthropological research tradition than to physical science traditions (Denzin and Lincoln, 1998; Deshpande, 1983). Qualitative methods usually are associated with inductive modes of inquiry which are more likely than deductive experimental modes of inquiry to lead to serendipitous findings and new theoretical integrations that extend beyond initial preconceptions and frameworks (Eisenhardt, 1989; Miles and Huberman, 1984; Strauss and Corbin, 1990). The intension frequently is to achieve observations of real, complex and changing situations in the settings in which they occur. These situations and the phenomena of interest do not usually favour quantification. Qualitative research is valued as a source for well grounded rich descriptions and explanations of processes (Miles and Huberman, 1984; Richardson, 1996; Strauss and Corbin, 1990). These are precisely the requirements needed to answer the interpretative attributes associated with the research questions formulated in this thesis. It is the acceptable approach used in the development of new theory and the development of alternative theory which are testable in terms of measurable constructs linked to real data (Denzin and Lincoln, 1998; Eisenhardt, 1989). The major limitations associated with qualitative research methods are well documented (see for example Eisenhardt, 1989; Miles and Huberman, 1984; Yin, 1989, 1993). The methods of data analysis are not always well formulated and may lack systematisation. The data once obtained, are usually voluminous, rich in information and complex. This may result in problems of data summation and interpretation, in difficulties in choosing the appropriate method of analysis and may result in problems in building parsimonious theory. There is also the potential for specificity of result which implies a lack of desired generalisability. Awareness of the limitations should assist in the selection of the appropriate methods and cases which are consistent with the aim of answering the research questions formulated.

137 4.1.6 QUALITATIVE RESEARCH DESIGN Qualitative research typically involves the selection of cases in which the process of interest is transparently observable. The analyses typically focus on understanding the dynamics of the present (Eisenhardt, 1989; Parke, 1993). In this respect the use of case studies is no different from the use of surveys and experiments. The focus of analysis is contemporary events. In contrast, with archival and historical studies, the focus of attention becomes the analysis of past events (Yin, 1989). On the other hand, historical analyses, being predominantly qualitative on nature, share common features with case study analysis. As a result these methods are suitable for answering questions which require “how and why” type responses without the requirement to control events (Yin, 1989). The ability to control events is the distinctive feature of research designs involving experiments (Kuhn, 1970; Wallace, 1963). Archival research augments historical research by answering questions concerned with “who”, “what”, “where”, “how much” and “how many” (Yin, 1989). The qualitative empirical research in this thesis focuses on the analysis of two cases; Expo 86 and Expo 88. The perspective adopted is not contemporary. It is historical and longitudinal. The method of data collection is archival. The qualitative research design and the cases selected for analysis are not without their problems. Ross and Staw (1986) commented that their analysis of Expo 86 raised issues of researcher objectivity, accuracy and replicability. Their concerns emanated from the existence of voluminous information about the event and the need to select material from this data which concentrated primarily on the ongoing decision to host the exposition, the focus of their analysis. To ensure accuracy and replicability, Ross and Staw (1986) constrained their analysis to ensure that all the information used was available in the public domain. They were reassured about researcher objectivity because they maintained “the essential facts are not in dispute” (Ross and Staw, 1986:280). The first study involves a re-examination of the research conducted by Ross and Staw (1986) on Expo 86. Their results are reproduced in the context of the model Ross and Staw (1986) constructed to explain the escalation of commitment phenomenon in organisational settings (see section 4.2.2). Their explanations for

138 what occurred are based on their selection of the available data which they maintained were confined to material concerned with decisions to host the exposition. The re-examination adopts a critical perspective. It is based on data obtained from sources which were not considered by Ross and Staw (1986). These data are the literature on world expositions and their social value (see for example Anderson and Wachtel, 1986; Fainstein and Fainstein 1983; Peters, 1982; Rydell, 1984; Zimmerman, 1974). The perspective adopted in the re-examination results in a different interpretation for why the exposition took place in the face of financial losses. It also incorporates events which occurred after January 1985. Ross and Staw (1986) based their analysis on data collected in the years before and during January, 1985. It did not incorporate data from events which occurred between February, 1985 and October, 1986 when the exposition ended. The qualitative analysis of Expo 88 is faced with the same issues that confronted Ross and Staw in their analysis of Expo 86. As a result, the material used in the analysis is confined predominately to what is available in the public domain. The only exception is the material collected from interviews conducted during 1988 with several individuals directly associated with the initiative for Expo 88. The material is reported in Carroll (1989) and Donohue (1988a). The sources include, Queensland State Archives, Queensland Government Parliamentary Library, Queensland State Library, News Ltd and the Commonwealth Department of Finance. Data obtained from interviews have not been used directly even though such sources provide, as Ross and Staw (1986) commented, “greater candour and perhaps fewer attempts at impression management.” The use of this material has been confined to confirmation of material in the public domain. As with Expo 86, the outcome has been reported extensively so these “facts” are known. The use of archival material in research is contentious. On the positive side, it is seen as a useful method of obtaining longitudinal data (Ginsberg, 1988; Huff, 1982). Obtaining longitudinal data is a prerequisite in the analysis of Expo 88 because the objective of the analysis is to understand why the Queensland government decided to persist with the hosting of the exposition when information had been provided which forecast that the financial outcome would be negative.

139 In contrast, Singh and Lumsden (1990) are critical of retrospective studies in which the outcomes are known because of the associated intrinsic bias. Scott and Veukafaraman (2001) defend the use of retrospective archival studies citing studies which do not succumb to bias because of known outcomes. The research in this thesis supports both perspectives. The analysis indicates that the interpretations of events in the original studies are capable of different interpretations. The defining nature of the research questions implies that theoretical explanations for escalation of commitment be examined and evaluated in terms of the information derived from the analysis of the selected studies. To this end the qualitative methodology is extended to encompass research protocols associated with inductive theory building from cases (Creswell, 1994; Creswell and Plano Clark, 2007; Denzin and Lincoln, 2003; Eisenhardt, 1989; Eisenhardt and Graebner, 2007; Glaser and Strauss, 1967; Langley, 1999). The extended methodology is consistent with the inductive methodological protocols used by Ross and Staw (1986) to develop a theoretical model of escalation of commitment in natural organisations from the analysis of a single case study. This is a methodology that does not meet the usual quantitative positivist requirement to derive theoretical conclusions statistically from a randomly selected representative sample of an underlying population. The case study that Ross and Staw (1986) selected for investigation is neither representative nor randomly chosen. It was chosen precisely because of the particular insights to be gained from the special characteristics associated with the organisation. The methodological protocols used, particularly the close relationship forged between the theoretical literature and the data driven analysis of information in the public domain contributes powerfully to the reliability of the analysis, the capacity of the study to be replicated and the persuasiveness of the study (Siggelkow, 2007) The re-examination of Expo 86 involves the collection and analysis of data in the public domain beyond the time frame considered by Ross and Staw (1996) in their study. The extended time frame enables revealed discrepancies in the additional data from that collected by Ross and Staw (1986) to be examined from several theoretical perspectives.

140 The analysis of Expo 88 replicates the methodological protocols used by Ross and Staw (1986). The fundamental difference is the time frame of the analysis. The analysis is longitudinal and extends over two decades. The extended time frame enables data to be collected to examine theoretical explanations of escalation concerned with utility in the context of the sunk cost effect. The information collected about Expo 88 is voluminous but the analysis of this information is selective and directly relates to the research questions, to the theoretical literature and the evaluation of investment projects. The methodology adopted enables the study to be replicated.

4.2 CASE STUDY ONE RESULTS: WORLD EXPO 86

4.2.1 INTRODUCTION In 1986, Ross and Staw published an article on Expo 86 that was held in the Canadian city of Vancouver between 2 May and 13 October, 1986. Appendix F provides a brief explanation of the origin and nature of World Expositions. Their analysis of the exposition was based on data collected between 1978 and January, 1985. According to the authors, the study represented a substantial advancement in research on the escalation of commitment phenomenon. Previously, research on the phenomenon had been concerned with exploring various perspectives from the confines of laboratory situations in which each perspective accounted for some of the variance in controlled experiments. As Ross and Staw stated in their introduction: “…escalation research has not only become increasingly complex, but it has also become more and more detached from its object of study – that is, how commitment builds up over time in naturally occurring decision situations. Therefore, this paper will attempt to serve several closely related purposes. First, we will review briefly the rather disparate literature on escalation, providing a simple classification scheme that should be useful for future reviews and empirical summaries. Second, we will provide a detailed case study with which we attempt to ground or illustrate extant theory in a naturally occurring setting. Finally, using the case study as a prototypical example of escalation, we pose a new model

141 of escalation that integrates several determinants of escalation behaviour as they may evolve over time.” (Ross and Staw, 1986:275)

For Ross and Staw (1986:274), Expo 86 was “a visible and prototypical example of the escalation of commitment” phenomenon. It was: “a clear – cut case of escalation of commitment. (because) During a sequence of decisions made between 1978 and 1985, a $78 million project with a ‘worst case’ deficit of $6 million became a $1.5 billion project with a projected provincial deficit of $311 million.” From their analysis of Expo 86, Ross and Staw (1986) derived several conclusions. These were: (a) the study provided field grounding for previous laboratory based research on psychological and social determinants of escalation of commitment. The study revealed that several perspectives could be identified that operated in different circumstances; (b) the study indicated that different forces, including macro institutional variables (Pfeffer and Salancik, 1978) not captured in laboratory experiments, operated differentially at different times and with different intensity over various phases or stages of the escalation of commitment process; and (c) the development of a theoretical model of escalation in which escalation of commitment was characterised as a process which involved four phases (Staw and Ross, 1987). Each phase of the process was associated with a different set of determinants. The determinants evolved sequentially and comprised economic project determinants, psychological determinants, social determinants, and structural determinants. Theoretically, the rational explanations associated with economic project determinants at the beginning of the escalation process are subsumed by psychological explanations associated with self justification during the next phase of the escalation process. These self justification explanations become reinforced by psychological and social determinants including

142 organisational commitment and the conforming influence of groups in the third phase of the process. During the fourth phase, the process becomes embedded through the emergence of structural institutional determinants.

4.2.2 THE PROCESS MODEL In their analysis of Expo 86, Ross and Staw (1986) developed a three phase model in which two phases; those associated with psychological and social determinants respectively, are combined. As Ross and Staw (1986, footnote 3:295) explained, the reason for combining these two phases was because; “…it is extremely difficult with Expo to distinguish between psychological and social determinants. When the primary decision makers are public officials…, sorting out social political motives from psychological determinants of behaviour is not only difficult but probably unnecessary.” The three phase model is reproduced in figure 7. The determinants associated with each phase, as reported by Ross and Staw (1986), are summarised in table 3 in the relevant column below the illustrated model. The determinants summarised in table 3 are associated with several of the theoretical explanations discussed in chapter 3, section 3.4. The way the model is constructed, psychological expectancy theory explanations dominate the project determinants in phase one of the events. The initial uncertainty also facilitates intendedly rational behavioural explanations as determinants in this phase. The psychological determinants in phase two are dominated by explanations associated with rationalisation derived from the dissonance theory need for self justification. Organisational commitment and group influences feature prominently as psychological and social determinants of the phenomenon in the model. At the level of analysis of theory construction these determinants assume a reinforcing influence underpinned by rationalisation processes rather than as plausible alternative theoretical explanations. The commitment to persist with a project which is expected to fail in conventional private investment evaluation terms

143 (phase three) is explained in terms of an elaboration of the findings on embeddedness reviewed in chapter 3, section 3.2.5. No theoretical explanation derived from rational self interested behaviour (agency theory) appears as a determinant in the model. Either no evidence was found for this type of behaviour at the level of analysis conducted or the existence of this form of behaviour was not in the public domain.

144 Figure 7 A THREE PHASED THEORETICAL MODEL OF THE ESCALATION PROCESS AS DEVELOPED BY ROSS AND STAW, (1986:294)

145 Table 3 DETERMINANTS OF ESCALATION PROJECT PSYCHOLOGICAL AND SOCIAL STRUCTURAL Determinants Identified (Phase 1) Determinants Identified (Phase 2) Determinants Identified (Phase 3) (i) Initially “perceived” as (a) Psychological (i) Structural embeddedness objectivity beneficial project (i) Perception that information increased via increase in size - increase in tourism implied. processing errors supported of project which over time (ii) Benefit/cost projections perseverance of beliefs. involved increased initially uncertain - increasing financial deficit commitment by government - no feasibility study projections addressed to the project and other - then projections not mainly by increasing constituents associated with accepted universally attendance figures from the project. This included the - projections not objectively 12.5 million to between 20 population who were verifiable. and 28 million. favourably disposed towards Therefore, explanation for (ii) Personal responsibility of the the exposition. persistence conceived as rational Provincial Premier with the (ii) Development of symbolic from both utility and expectancy explanation indeterminate attachments theory perspectives between self justification and - reputation (iii) By 1984, financial loss organisational commitment. - competence outcome in excess of $300 (b) Social Determinants - competitiveness million anticipated with (i) Increasing need for external (iii) Structural factors concerned confidence (certainty) justification in the face of with reputational damage and (iv) Conclusion. Project variables political vulnerability. the possibilities for legal insufficient to explain (ii) High level of inconsistency redress. repeated affirmation to demonstrated by Premier if (iv) Conclusion. Institutional persist with project with fully Expo 86 cancelled because he forces produce side bets anticipated financial losses had consistently promoted its (externalities) which which had risen from $6 value. exacerbate the escalation of million initially to more than (iii) Behavioural models did not, commitment tendency as it $300 million. as previous research would progresses beyond the initial have anticipated, promote phases. The phenomenon withdrawal (cancellation). becomes embedded. Proposed that lack of influence due to ability of decision makers to psychologically differentiate their situations from analogous situations. No comparison possible between expositions on the basis that comparing expositions like comparing apples to oranges. (iv) Conclusion. The decisions to persist with projects beyond the point where costs exceed benefits predominantly influenced by self justification forms of rationalisation exacerbated by social determinants.

146 4.2.3 RE-EXAMINATION OF EXPO 86 DECISION PROCESSES The theoretical interpretation by Ross and Staw (1986) of the critical decision events which took place during the first and second phases of the Vancouver exhibition are consistent with the expectancy theory based and dissonance theory based explanations which dominate the psychological literature (Brockner, 1992; Staw, 1997). The social and institutional determinants moderate escalation tendencies either through promoting tendencies to persist with or withdraw from a situation. Staw and his associates appear to maintain their adherence to the self justification hypothesis as the explanation which accounts for most of the variance (Simonson and Staw, 1992). More recently Staw (1997) has expressed criticism of rational explanations for the escalation phenomenon. In this re-examination of the decision processes involved in Expo 86, the lens through which data are examined is widened and refocused. Additionally, attention is given to the evaluation of Expo 86. How the project is evaluated ultimately determines whether it qualifies as exhibiting escalation of commitment. The re-examination of the decision processes produces interpretations of events which differ from those provided by Ross and Staw (1986). In the opening page of their article, they posed the following question: “Are there factors that naturally lead people to become committed to behaviour in escalation situations, or are we simply attaching post-hoc behavioural explanations to situations where reasonable decisions simply did not work out as planned?” (Ross and Staw, 1986:274) This re-examination does not contribute to or promote the “ex post” behavioural proposition. It does suggest however, that frames of reference strongly influence perceptions which in turn influence the selection of the data subset and consequently the subjective interpretation of the critical decisions at Expo 86.

147 4.2.4 MATCHING THE NATURE OF EXPO 86 WITH MOTIVES The planning literature on World Fairs has commented on how their nature and purpose has changed since the first international exposition was held in London in 1851 (see for example, Olds, 1988; Rydall, 1984; Anderson and Wachtel, 1986; Zimmerman, 1974). Four periods have been identified during which particular themes have dominated (Olds, 1988; Zimmerman, 1974). The first period, from 1850 to 1889, was concerned principally with celebrating the achievements of the industrial revolution and the prominent role occupied by individual nations in these achievements. It was a period of supreme confidence in Europe when society lauded the advances in science (see for example, Benedict, 1983). The exhibitions during this period were held in prominent cities most closely associated with national aspirations. The cities involved and the number of times held were London (2) Paris (3), Munich (1), New York (1) and Philadelphia (1). The second period, between 1890 and 1930, was concerned principally with individual cities in the United Sates expressing pride in their development and promoting the concept of the beautiful city (Olds, 1988). In the first period, world expositions where inspired by national aspirations and achievements. In the second period, world expositions became provincial instruments for promoting individual city ambitions. It was recognised that cities competed against each other for economic development and a key economic growth factor was the availability of sufficient labour from rural areas and from overseas (Chandler, 1962, 1992; Commons, 1934; Veblin, 1933, 1934). World expositions became instruments to attract investment and labour. The third period, between 1931 and 1961, was concerned with promoting the efficiency dimensions of individual cities in the United States. Few world expositions were held during this period characterised by depression, war and reconstruction. Those that were, in New York and Chicago, were concerned with attracting corporations on the basis that their city could best meet envolving corporate needs because they were the most efficient (see for example, Anderson and Wachtel, 1986).

148 The fourth period, which began in 1962 and continues to the present, has been concerned predominantly with using World expositions as the political and economic instrument to promote “the city of renewal.” The belief that regional economic development can be stimulated through the renewal of areas of urban decay are dominant motives associated with the staging of World expositions since the 1960s including Expo 86 and Expo 88. The belief is not unfounded. There is sufficient evidence to indicate that, if the urban renewal process is managed effectively, the economic development advantages obtained through agglomeration economics can be substantial in differentiated modern market dominated economies (see for example Collis and Montgomery, 1997; Grant, 2002). The decision makers associated with these projects anticipated the theoretical evolution of the resource based view of strategy (Barney, 1991; Prahalad and Hamel, 1990). This economic development motive was not addressed by Ross and Staw in their analysis of Expo 86. As a result, they did not develop an appreciation of the extent to which the political and business leaders of Vancouver would go to achieve economic development and growth objectives (Gottdeiner, 1987). They focused on the private rate of return on investment in the event and derived their conclusions from an analysis of this particular focus. Ross and Staw (1986:281) observed that “The financial history of world expositions is not a happy one. Since the onset of world fairs in 1851, only 20 have broken even or made a profit.” This loss making outcome should perhaps have alerted them to the possibility that the objectives and outcomes were not associated with conventional financial investment outcomes. It did not, even though they stated (Ross and Staw, 1986:288) that “Expo (86) was never intended to be a money-making endeavour”. Their observations continued. “The Canadian experience with hosting world events is even less fortunate. Both the 1967 Montreal Exposition and the 1976 Olympic Games proved to be financial debacles. In 1963 the projected loss for Expo 67 was $47 million. The actual deficit was six times that amount - $285 million.” While the 1976 Olympic Games was a financial debacle, the outcome of Expo 67 was not. Expo 67 achieved the economic objectives established even though Ross and Staw imply that Expo 67

149 was an example of the escalation phenomenon because escalating financial loss projections were known and ignored. In contrast to the expressions of failure made by Ross and Staw (1986), the planning literature regards the 1967 Montreal Exposition as one of the most successful. According to Peters (1982:17), Expo 67 was used as “an excuse to pyramid dozens of public projects including a new subway system (the Metro), highway expansion (finished 10 years ahead of schedule), and 745 acres of new parklands in the middle of the St. Lawrence River.” Expo 67 was the culmination of substantial Expo non related urban restructuring which was aimed at “encouraging private investment and tourism.” The 1968 San Antonio World Fair explicitly was connected with an inner city renewal program in which the exposition authority used federal and local government urban renewal funds to acquire 147 acres of substandard housing (Peters, 1982). The close relationship between economic development and world expositions was noted by Montgomery (1968:85). “The two things fit beautifully: the urban renewal process provided the vehicle that made possible the land assembly and clearance necessary to get the fair up on time; at the same time the fair provided impetus that picked up the pace of public development action. Now, with the fair going and a slug of new public facilities up and operating, private investment on a massive scale has started in downtown San Antonio.” The relationships between expositions and economic development were explained clearly by King Cole, President of Expo 74, held in Spokane, Washington State. “If it seems a complicated route to urban renewal, it was necessary. This city had a sort of resentment of its downtown area… Three times in the past, the city voters had turned out city councils that ran for office on a platform of downtown renewal… But when we started pushing the idea of a World Fair, which would bring about downtown renewal incidentally, citizens bought the idea.” (Cited in Olds, 1988:40)

150 According to Yake (1974:55), the 1974 Expo in Spokane was simply the means used to “squeeze a revitalisation program that ordinarily would have taken 20 years into a intensive five-year effort.” The principal motive associated with the 1982 International Energy Exposition held in Knoxville, Tennessee was no different from that associated with Expo 74. Expo 82 was seen as the catalyst to enable downtown redevelopment to make ‘a great leap forward’ (Knack, 1982:8). It was an attempt to alter existing patterns of uneven development and as a mechanism for the establishment of a tourist and business convention centre (McDonald and Wheeler, 1983:163). The 1962 Seattle World Fair was conceived similarity; as primarily an instrument to redevelop a “blighted area” (Lynes, 1962:21). The initiative for the 1984 New Orleans Expo in Louisiana was explicitly associated with economic development through urban renewal. In the 1970s the New Orleans economy was suffering from economic stagnation (Smith and Keller, 1983). The staging of a hallmark event such as a World Fair was proposed as the means to revitalise business interest and redevelop the inner city (Douglas, 1984). According to Olds (1988:50), the fair was a failure in relation to attendance and finance, as expected, but it was a success in terms of inner city redevelopment and caused minimal direct residential displacement effects because the exposition was held in a decaying riverside warehouse district. The exposition stimulated substantial reconstruction and rehabilitation efforts. This included hotel and retail mall developments, the completion of the New Orleans Convention Centre, riverfront clearance and development and road construction and repair (Douglas, 1984). The dominant motives associated with Expo 86 in Vancouver were no different from those associated with the five World expositions held in North America that preceded it. Expo 86 was held on 70 hectares of inner city waterfront land on the north bank of False Creek and on three hectares of land to the north of the Central Business District. The area had been marked for redevelopment since the early 1960s but no redevelopment commenced until the land was compulsorily acquired by B.C. Place. BC Place was the Provincial Crown Corporation responsible for providing a serviced site for Expo 86 and for managing the design and urban development of the north shore of False Creek (Olds,

151 1988:69). BC Place was established on 12 February, 1981. The dual roles for which BC Place had responsibility indicated explicitly that economic development objectives were linked inexterably to the hosting of Expo 86. As early as 1974, the hosting of a World Exposition was seen as the instrument to overcome opposition and enable the redevelopment of the north shore of False Creek to proceed. As Premier Bennett explained: “The trigger for this development will be Transpo’ 86 (Expo 86)… We see in this exposition an opportunity to host a major World Fair and to proceed with developments that suit our present and future needs… we see in Transpo’ 86 the chance for a celebration that will leave a lasting legacy.” (Cited in Olds, 1988:68) These sentiments were echoed by Jimmy Pattison, Chairman of Expo 86 in 1985 when he stated that Expo 86 would be “the biggest urban development project in North America. It will change the face of Vancouver forever.” (Cited in Anderson and Wachtel, 1986:7). Gutstein (1986:65), after conducting an impact assessment of Expo 86, reached a similar conclusion; “Expo is really a gigantic urban redevelopment project, an expenditure of more than one billion dollars to spur public and private development.”

4.2.5 SUMMARY Ross and Staw (1986:281) based their analysis of Expo 86 on the two motives that they identified as being responsible for the government of British Columbia filing an application through Quebec with the International Bureau of Exhibitions (IBE) in 1979 to host an exhibition in 1986. According to Ross and Staw (1986) Expo 86 would “highlight Vancouver’s centennial celebration” and would “be good for business.” Their evaluation of Expo 86 in terms of conventional financial outcomes is based on the business motive. They did not seem to recognise that the exhibition may have been stimulated by more complicated motives even though they included a footnote (1986:287) of an impact study that appears in the Anderson and Wachtel publication. This

152 publication explores “inter alia” the development and planning dimensions associated with the project. The analysis undertaken in the previous section suggests that World Expositions have become instruments of economic development wielded by state/provincial governments. Their principal purpose has become the means which enables urban redevelopment projects to proceed by overcoming the resistance towards such projects held by the political constituency. To the extent that these motives dominate, the most appropriate criteria of evaluation of outcomes is cost benefits analysis or cost effectiveness analysis. Was Expo 86 a success or a failure? Any answer depends very much on the perspective adopted, on the dynamic relationships between means and ends and on the assignment of the benefits and costs associated with the exposition. From the narrow financial accounting perspective it was, as Ross and Staw (1986) reported, a failure. From the outset, the principal decision makers knew that financial losses would be far in excess of the initial projected financial loss of $6 million. The small projected financial loss of $6 million was released publicly in 1980. It was represented as a worst case basis with the aim of obtaining public approval for the project. The financial projections were never intended to be a realistic representation of the possible financial outcome (Olds, 1988). There was concern expressed about how the public would react to the projected growth of the financial losses that were released over time. The two cases identified by Ross and Staw, (1986:282-286) principally are concerned about how the public would react to the projected financial losses. It is the need to “justify” these losses and how this was accomplished that Ross and Staw (1986) focus on. The ultimate solution offered by the Premier to the growing financial loss projections was to establish a lottery to recover the deficit. From an economic development perspective, the exposition has been judged a success, albeit achieved at considerable cost (Ley and Olds, 1988). Long term economic benefits have resulted from the urban renewal programs and the costs are regarded simply as unavoidable sunk costs necessary to initiate change. The principal direct costs of the exposition involved the financial accounting deficit in excess of $300 million and the displacement of the long term residents who occupied housing on the site before the exposition was held.

153 From a strictly individual utilitarian perspective, Expo 86 was a resounding success. The people who attended, predominantly the local population, were given precisely what they wanted and the public costs associated with their private enjoyment were ignored. In a letter to the editor of the “Globe and Mail” on 12 August, 1987, The Australian High Commissioner to Canada, Mr A. S. Laurie captured this perspective in the following statement: “Ask former B.C. Premier Bill Bennett and Expo 86 Chairman Jimmy Pattison about negative images projected as a result of union problems, lack of money, protests over the site clearing and housing of former tenants, construction behind schedule, all now forgotten in the afterglow of a successful venture.” Whether decisions taken in the early 1980s to persist with the hosting of Expo 86 were based on rational or irrational anticendents very much depends upon which of these three perspectives is adopted as the basis for evaluating the outcome of Expo 86. It is only by adopting the narrow financial accounting perspective and focusing on the data that placates public concerns about projected financial losses is it possible to conclude that Expo 86 exhibited escalation of commitment characteristics associated with the need to justify actions through rationalisation. Alternatively, if the objective of economic development through the process of urban renewal is accepted as the dominant motive, then the decisions to persist with the project derived predominantly from rational anticendents. With the exception of Expo 82 held in Knoxville, the other five world expositions held in North America between 1962 and 1984 achieved their economic development objectives. Knowledge of these successes meant that decisions to persist with the Vancouver project were not made under conditions of uncertainty and did not involve a series of decision errors. The worsening current ratio of costs to benefits were known and deemed to be acceptable in the pursuit of long term economic development objectives (Anderson and Wachtel, 1986:41). Reasonable decisions simply did not work out as planned. Unanticipated additional operating costs were involved and avoidable investment costs were incurred to satisfy public expectations.

154 4.2.6 CONCLUSION Two possible sets of theoretical explanations can be used to describe the decision making processes involved in Expo 86. Which set best describes these processes depends on which objectives and which investment criterion is used to evaluate project outcomes. The model constructed by Ross and Staw (1986) captures the decision making processes and identifies the dominant theoretical explanations for enduring commitment to the project when the profitability of the event becomes the analytical focus and evaluation is conducted using conventional accounting outcomes as the criterion of investment performance. If the economic development and urban renewal programs are selected as the objectives for analytical attention, then the dominant theoretical explanation of the decision making processes is the persistence of rationality throughout the life of the project. Rationalisation, becomes a moderating influence evoked to justify the private investment losses. Evaluation of the project in terms of social cost benefits produced social benefits in excess of the social costs which included the financial accounting losses.

4.3 CASE STUDY TWO RESULTS: WORLD EXPO 88

4.3.1 INTRODUCTION “A World Exposition, commonly referred to as an Expo or a World’s Fair is a unique gathering of nations brought together to review and exhibit man’s achievements in a specific field of endeavour – the theme at a specific point in time. It offers an unsurpassable opportunity to participate in a technological and cultural exchange of world ideas” (Minnikin, 1987:1).

“Its purpose is to compare, to show with pride, to emulate the achievement of others. The world gathers to show what has been done, to view a world balance sheet of the evolution of its people at a given moment in time (World Expo 88, 1984:1).

“Ladies and Gentlemen they wanted a party, not just a January 26 party…. They wanted action, surprise, worldliness but most importantly they wanted fun.

155 Fun in large measure. They wanted Channels 10, 9 and 7 but not the ABC” (Currie, 1988:1).

“Together we gave the world pleasure, education, celebration and fun” (Edwards, 1989).

“The World’s fair is a tired institution…. It is a long time since it startled the world with its products or offered stimulating or controversial themes. No longer an instrument of genuine intellectual exchange, it has been reduced to an expenditure shot in the arm and an instrument of national propaganda” (Ada Louise Huxtable quoted in Anderson and Wachtel, 1986:40).

The quotations that introduce this investigation of Expo 88 enable the reality of the project to be distinguished from the rhetoric which was packaged for public consumption. Expo 88 was conceived and executed for the purpose of achieving several objectives. Other than symbolically, none of the objectives were associated with the formal purpose of world expositions as articulated in the two opening quotations. The most comprehensive analysis of the origins of Expo 88 was undertaken by Carroll (1989, 1990). In these papers that described the policy process, most of the motives for undertaking the exhibition were identified. Carroll and Donohue (1989a) mentioned a number of additional motives to those identified by Carroll (1989). Craik (1988a) explored the political dimensions surrounding the exhibition and Hall (1988) examined Expo 88 from a planning dimension and lamented the failure to consider the returns from the investment. Donohue (1988a and 1988b), using preliminary data, evaluated Expo 88 from a financial and economic perspective and concluded “inter alia” that escalation of commitment tendencies were present in the efforts to justify the success of the project. Donohue (1988a) adopted a general equilibrium economic paradigm to produce preliminary estimates of the impact of Expo 88 on the Queensland economy. A final report was not produced because access to the information required to produce such a report, and held by the Brisbane Exhibition and South Brank Redevelopment Authority (BESBRA), was withheld after the preliminary

156 report was presented to BESBRA. This was because it revealed the off balance sheet financial contributions by government and identified unanticipated leakages from the Queensland economy through the repatriation of income overseas by international participants and interstate by corporate participants. The report also estimated that the expected continuous positive tourism impact of the exhibition would not be realised. This estimate was revealed subsequently to be correct (Queensland Tourist and Travel Corporation, 1989). The Queensland Tourist and Travel Corporation (QTTC) produced an impact study in 1989 that focused on the effects of Expo 88 on tourism in Queensland. The accounting firm KPMG Peak Marwick was commissioned to produce an economic impact study of Expo 88 on the Queensland economy in 1988. The study adopted a partial equilibrium framework. The study concluded that Expo 88 had generated significant employment and contributed more than $1 billion towards the Queensland economy predominantly through the multiplier effects of additional building construction, employment and expenditure on accommodation facilities (see Queensland State Archives: Expo 88). Pannel Kerr Foster was commissioned to produce an economic impact study in 1984. The study titled “Expo 88 Economic Impact Study” predicted a similar impact (see Queensland State Archives: Expo 88). The study estimated that the direct and indirect income effects could be as high as $1 billion. Direct and indirect employment effects were estimated at nearly 16, 000 man years. In this research the restrictions that inhibited the completion of the original study were absent. Sufficient information was available from the sources referred to in section 4.1.4 to enable a comprehensive analysis of the motives and outcomes of World Expo 88 to be performed. Importantly, the analysis has been conducted from the perspective of the research questions formulated and the financial data used cover the period from 1984 to 2002. The period is more than sufficient to address longitudinal requirements and concerns about sunk costs effects (Northcraft and Wolf, 1984). Appendix H contains a brief history of Expo 88. The accompanying tables list the international and national participants (table 1), the corporate participants (table 2), the retail operators (table 3), the sponsors and officials suppliers (table 4) and significant events associated with the South Bank Corporation (SBC) that replaced BESBRA (table 5). Appendix G consists of

157 10 tables that summarise financial and economic outcomes of BESBRA and SBC. The financial positions are expressed in current prices, constant prices and discounted value terms. Appendix H contains a number of tables extracted from published BTR reports and from published results of surveys on tourism conducted by QTTC. The tables capture the financial tourism effects of Expo 88.

4.3.2 IDENTIFICATION OF MOTIVES FROM STAGING EXPO 88 Parts of this section draw on Carroll (1989, 1990), Carroll and Donohue (1989 and 1989b), Donohue (1988b) and personal conversations between Peter Carroll and the author. As Carroll (1989:51) concluded, the road to “Expo 88 was long, tortuous and uncertain.” Carroll (1989) and Carroll and Donohue (1989a, 1989b, 1989c) identified that the initiative for a World Exposition in Australia derived from several influential individuals. Because of their positions or experiences, these individuals were committed to the value of expositions for different reasons and subsequently benefited from or reasonably expected to benefit from the staging of a World Exposition. In 1974, Patrick Reid, the then Canadian government delegate to the Bureau of International Expositions (BIE) encouraged William Worth, the then Australian government delegate to BIE and the then head of the Commonwealth government special unit responsible for expositions, the Australian Exhibit Organisation (AEO) to influence the Australian government in staging a universal exhibition as part of the celebration in 1988 of the bicentennial of European settlement. Worth, together with his eventual successor at AEO, Eric Wigley, were successful in influencing the Commonwealth government, then headed by Gough Whitlam, to notify BIE in May, 1975 of its intention to register for a universal exposition in 1988. It was the Whitlam headed government in opposition that had persuaded the Australian government in 1972 to renew its membership of BIE after it had been withdrawn in 1945 (see appendix F). Reid’s interest in having a universal exposition in Australia in 1988 was associated with his attempt to influence the Canadian government in mounting a World Exposition in Vancouver in 1986 to celebrate its centennial and to secure the time slot in advance by preventing the French government mounting a

158 competitive bid to BIE. As Carroll (1989) explained, he expected that the French government would seek to hold a universal exposition in 1989 to celebrate the bicentennial of the French Revolution. Early registration of intension with BIE by the Australian and Canadian governments would minimise the competitive threat from France. This was because universal expositions can only be held at intervals of not less than ten years under BIE rules (see appendix F). Reid’s motives were associated with the celebratory value of world expositions and with their value as instruments of economic advancement. The economic results of which he had observed in connection with recent specialised expositions in the United States as Canadian delegate to BIE. In late 1982 the Vancouver press reported that Reid expected that Expo 86 would inject $970 million into the regional economy and create 15,000 man years of employment (cited in Ross and Staw, 1986:283). By that time Patrick Reid had been appointment Commissar General of Expo 86 by the Canadian government in recognition of his role with BIE in World Expositions. In the Australian context, William Worth continued to exert considerable influence in advancing proposals for an exposition in Australia in 1988 in his capacity first as head of AEO and then after he retired from the Commonwealth public service when he was appointed a consultant to the Australian Bicentennial Authority (ABA). In this role his advice was sought by the Queensland government. Also he became a member of the Commonwealth and state governments’ joint task forces, along with Erica Wigley who had assumed the position of head of AEO. The task forces had been established in 1978 to investigate the proposals for a universal exposition to celebrate the bicentennial in either Sydney or Melbourne. In January, 1976 the University of Queensland architect, Frank Maccormick approached Worth at AEO for advice about the possibility of holding a specialised exposition in Brisbane in 1988. It is from this initiative that the Queensland government become aware of the possibilities associated with World Expositions. As an architect, Maccormick had been associated with the design of Australian pavilions at previous World Expositions in the United States. He was “enthused by the success of the Spokane Expo in sparking the redevelopment of a decaying

159 riverside site and saw similar opportunities for the near city-centre Kangaroo Point site” (Carroll, 1989:43). Maccormick was successful in gaining the support of the Brisbane Chamber of Commerce under the then President, Tom Burrell and the Queensland branch of the Royal Australian Institute of Architects. Despite intense lobbying by Burrell and Maccormick the proposal generated little interest in the Queensland government until late 1978 when a proposal was forthcoming. The Queensland government had been occupied with mounting a bid for the Commonwealth Games in Brisbane in 1982; the first time it had attempted such an initiative. The bid was successful and the Commonwealth Games that eventuated was judged to be a resounding success, thus demonstrating to the southern states that Queensland could manage such hallmark events. The Queensland proposal for a specialised exhibition was not welcomed at AEO because it threatened to undermine alternative proposals being mooted at the time, particularly the proposal for a universal exposition in either Melbourne or Sydney. Under BIE rules an interval of five years must elapse between the staging of a universal and a specialised exposition in the same country (see appendix F). At a meeting on 2 November, 1978 of Commonwealth and state government representatives convened to consider proposals for the Bicentennial, the Queensland proposal for a specialised exposition was unsuccessful. The Queensland proposal undermined proposals for a universal exposition and was flawed. A detailed feasibility study had not been undertaken and the Chamber of Commerce had indicated that it was unwilling to raise financial contributions to match the Queensland government promise of a grant of equal magnitude. The Australian Bicentennial Authority (ABA) was given the role of processing proposals for the Bicentennial and devising a program of activities for 1988. John Reid of James Hardie Industries had been appointed Chairman of ABA in 1979 and was convinced of the need for an universal exposition as the centre piece of the Bicentennial year (Carroll, 1989). To that end he had recruited Worth as a consultant and worked in close co-operation with Wigley at AEO. In April, 1980 the joint task force submitted its feasibility study “A possible Exposition Australia 1988 Sydney” to the Commonwealth and state governments where it received a negative response from the Commonwealth Department of

160 Finance (Podger, 1989) and the New South Wales government (Carroll, 1989). The joint task force recommended a universal exposition at Darling Harbour in Sydney. Although the Commonwealth government indicated that it would be prepared to offer the New South Wales government a matching grant of some $200 million towards the cost of the exposition the proposal for an exposition ultimately was rejected. On 4 January, 1981, the Commonwealth and New South Wales governments jointly announced that it would be impractical to proceed with an exposition because the capital outlay of some $1 billion would interfere with commitments for basic infrastructure (Commonwealth Record, 1981). As Carroll (1989:45) stated Reid, Wigley and Worth “were both dismayed and surprised when they realised in December, 1980 that the proposal was likely to be rejected.” Despite the rejection of the proposal, Reid continued in his effects to stage an exposition as the centre piece of the Bicentenary. He approached the states and eventually managed to gain the support of the Queensland government for a specialised exposition. The Queensland Premier Joh Bjelke-Petersen had indicated his support for an exposition on 5 January, 1981. As well, Reid had gained the support of Ian Russell, the then President of the Queensland Confederation of Industry and the Chairman of the Queensland Council of ABA and senior staff at AEO including Wigley. In Queensland a co-ordinating group was established to investigate the possibilities. The group included Worth of ABA, the Deputy Premier and Treasurer, Llew Edwards and the Coordinator General, Sydney Shubert. Shubert, the most senior public servant in Queensland whose department was responsible for economic development through “inter alia” the provision of infrastructure development, had long been interested in the redevelopment of the decaying South Brisbane and Kangaroo Point sites. Interest by Shubert and his counter part, the then Secretary of the Treasury, may also have been motivated by their having to look at the decaying South Brisbane site from their offices across the river in George Street as a Treasury official of the time informed the author (Kneebone, 1996). In September, 1981 the Queensland Cabinet authorised the conduct of a feasibility study even though it was known at the time that the Commonwealth government under the prime ministership of Malcolm Fraser would not provide a

161 matching grant and would not provide matching capital grants for the cost of an exposition. Cameron McNamara produced a study titled “International Exposition Feasibility Study, Brisbane Area” in October, 1981 (see Queensland State Archives: Expo 88). The study estimated capital costs of $255 million, operating costs of $11 million and recommended the South Brisbane site even though it would be the most expensive to develop because of the associated costs of land resumption. Queensland cabinet approved the study on 5 November, 1981 with the qualification that it would proceed further only if the Commonwealth government entered into cost sharing arrangements. The Queensland government proposal was not favourably received by the Commonwealth. The Commonwealth Cabinet on 9 November, 1981 directed that officers from several Commonwealth and Queensland state departments prepare a financial analysis of the Queensland proposal. The results were not favourable (Carroll, 1989). The analysis estimated that the gross commitment of the Commonwealth in 1988 prices would be $449 million with the Queensland government commitment being $485 million. Capital costs to the Commonwealth were estimated at $245.8 million in current 1981 price terms. The estimated costs were persuasive. The second proposal by the Queensland government was not accepted by the Fraser government. As a result no request for an exposition was made to BIE, an essential requirement as only national governments are able to deal with BIE (see appendix F). Despite this second rejection by the Commonwealth, the Queensland government initiated a third proposal for a specialised exposition in 1982 that eventually was successful. The initiative for the third proposal built on previous initiates but was due mainly to the efforts of Frank Moore, the then Chairman of the Queensland Tourist and Travel Corporation (QTTC) and to some extent, Sir Llew Edwards. Moore sought to convince the Premier that a specialised exposition could proceed on a private enterprise basis. Moore gained the support of Edwards and together they worked to obtain the necessary business and political support including that from the then Deputy Prime Minister, Doug Anthony. Moore gathered together a group of supportive local business entities and commissioned David Graham of David Graham Pty. Ltd. to investigate the private enterprise concept. Graham reported that the private enterprise concept appeared feasible.

162 Armed with this support and information Moore was able to convince Bjelke-Petersen of the value and feasibility of a specialised exposition based on private enterprise principles. In January, 1982 Bjelke-Petersen sought the advice of Reid and Worth at ABA as to the feasibility of staging a private enterprise exposition. He was reassured that this was the normal approach adopted in the United States (Carroll, 1989). The funding concept appealed to the Premier’s fundamental economic development philosophy and contained the added benefit of apparently solving the problem of funding the exposition. As Hall (1988) stated “the Expo was to be the crowning achievement of his private enterprise ethos, with the event not costing Queenslander’s a cent.” Bjelke-Petersen was sufficiently convinced of the funding outcome to state publicly in June, 1983 “the exposition will not cost Brisbane a cent and in fact we expect to make a profit at the end when the land and buildings are sold” (The Courier Mail, 26 July, 1989). It is the financial claim in this pronouncement that the Queensland government and the Expo Authority sought to justify as events unfolded (Donohue, 1988a and b). In this they were successful. As Carroll (1989) stated Moore’s motives in persisting with efforts to stage an exposition were several. He was irritated by the negative feelings expressed in the southern states towards Queensland having the centrepiece of the Bicentennial. He saw the exposition from the stand point of long standing interstate rivalry that involved the southern states regarding Queensland as a peripheral state. For Moore, it was an opportunity for Queensland to demonstrate that it could undertake a significant project using private enterprise principles that the “socialist” southern states were unable to do. In his position as Chairman of QTTC he saw the exposition in terms of the positive impact on tourism development. At that time Queensland had been successful in attracting a disproportionate share of the domestic tourism market through marketing its natural attractions and through innovative supplier induced demand policies (Donohue and McGovern, 1991). International tourism was seen as the next stage in the evolution of tourism development. The QTTC was convinced, from overseas experience, that staging hallmark events would provide an effective means of generating demand through international promotion. For Moore, a specialised exposition would provide marketing and advertising exposure in

163 emerging international markets such as the United States that was beyond the capacity of QTTC to fund. It is possible also that Moore anticipated that he could benefit personally from the exposition. The Queensland government had always intended to dispose of the Expo 88 site after the exposition and Moore emerged as the Chairman of the Consortium in 1988 that expected to acquire the land in instalments for redevelopment (see appendix G, footnote 1 to table 7). Edwards benefited from the support he engendered. After resigning from the Queensland parliament he was appointed Chairman of the Brisbane Exposition and South Bank Redevelopment Authority (BESBRA). BESBRA was established by the Queensland government to manage the exposition and then dispose of the land for redevelopment. In his capacity as Chairman he was responsible for the selection of contractors and exclusive suppliers (see appendix F, table 4). Following Expo 88 he secured directorships and positions with prominent contractors and suppliers including a directorship with Westpac Banking Corporation that had been awarded the only retail banking facilities on the Expo site during the six months of the exposition (Carroll, 1989). John Reid also was rewarded. Following his resignation from ABA he was appointed to the board of BESBRA. Maccormick, who initially proposed an exhibition in 1976 was appointed to design the site for Expo 88 (The Courier Mail, 2003). In February, 1982 Bjelke-Petersen wrote to Malcolm Fraser requesting the Commonwealth to ask BIE to secure a place for a specialised exposition in Brisbane in 1988. Fraser agreed to the request on 23 March, 1982 but indicated that the Commonwealth would not accept any financial commitment (see Carroll, 1989). Within a month the decision was reversed. On 18 April, 1982 Bjelke- Petersen informed the Prime Minister that Queensland would not be proceeding with a proposal for an exposition. The reasons for withdrawing were many. A number of state Ministers remained unconvinced that the project was feasible. There was opposition from senior public servants particularly in Treasury. Little support in the form of financial contributions was forthcoming from the private sector. Australia had entered a period of public sector financial austerity and the project initially would entail substantial borrowings that would involve scrutiny of the financial implications by Loan Council, the body responsible for the borrowing requirements of Australian states and territories.

164 Despite this withdrawal and the potential embarrassment resurrecting a proposal would cause, Edwards and Moore in particular were able to persuade Bjelke-Petersen to revisit the proposal after the Commonwealth Games at which Queensland demonstrated convincingly to the other states that it could organise and stage a hallmark event of that magnitude. Moore was also able to persuade the Premier to retain the services of Dan Whitehead, manager of the Commonwealth Games Foundation and his senior management team as the base for an Expo Study Secretariat (see Carroll, 1989). On 29 November, 1982 the Queensland cabinet approved the allocation of $250,000 for a feasibility study to examine and extend the Moore proposal and $250,000 to retain the services of the Commonwealth Games management team. A request was sent to Doug Anthony, the Acting Prime Minister to instruct Wigley at AEO to submit a renewed bid for a specialised exposition at the meeting of BIE on 8 December, 1982. Carroll (1989) reported that the pressure by the Queensland government for the urgency of the submission to BIE by the Commonwealth was associated with the absence of Prime Minister Fraser who may not have approved the Queensland proposal had he been present. On 2 December, 1982 Commonwealth public servants from the Departments of Prime Minister and Cabinet and Home Affairs met with Queensland officials and with Worth of ABA. According to Carroll (1989) Worth reported that the meeting was dominated by David Graham. At the meeting Graham proposed the Leisure-Technology theme, estimated that 20-30 international participants would be required and provided cost estimates of $105 million for land acquisition and development of which $90 million would be recoverable from the resale of the site. The Graham study did not include debt servicing charges. When these were included in the calculations, costs increased to $150 million producing a deficit in current prices of $60 million. The submission to BIE went forward to the meeting on 8 December, 1982. After a visit by BIE to Brisbane in 1983, approval was given by BIE on 5 December, 1983 for Queensland to stage a specialised exhibition on the South Bank site in 1988 (see appendix F). BESBRA was established on 18 February, 1984. The name of the authority explicitly recognised that the exposition was inextricably linked to the redevelopment of an area experiencing urban decay (Park and Feros, 1985).

165

4.3.3 CLASSIFICATION OF MOTIVES The account in the previous section indicates that when BIE gave approval in 1983 for the staging of a specialised exposition, the successful proposal had been linked to the pursuit of many and varied objectives associated with the aspirations of several influential individuals. It involved the symbolic value of a World Exposition as the most suitable event to act as the centrepiece of celebrations for the Bicentennial. It was used as a competitive weapon against the French government to secure an advantage for Canada in the pursuit of BIE approval for an exposition in Vancouver in 1986. It assumed the centrepiece of the Bicentennial and in this role it was used by the Queensland government as an instrument to secure an advantage over the southern states in the continuous contest of interstate rivalry. Based upon the success of the Commonwealth Games, the Queensland government expected to be able to demonstrate to the southern states that Queensland had the resource capacity and the knowledge and skills capabilities to mount an event of the magnitude and complexity of a World Exposition. This would demonstrate that the private enterprise philosophy espoused in Queensland as the source of economic advancement was superior to the “socialist” development policies pursued by the states of New South Wales and Victoria. Moreover, the Premier of Queensland had been persuaded that the Queensland government expected to generate a profit from staging the exposition. The proposal was linked directly to economic development objectives associated with the effects of urban renewal programs in inner city areas of urban decay. This development objective was associated also with tourism promotion in the domestic and international markets. QTTC was dominated by a marketing philosophy. Under this philosophy there was a general belief that promotional activities were at least as important as fundamental economic variables of price and income in generating and sustaining market demand. Additionally, the successful proposal was associated with personal motives of principal players. They were committed to the value of World Expositions for one or more of the reasons identified above and also expected to benefit personally. For most of the

166 principal actors they did secure personal benefits. These were either in the form of direct financial gain from positions held or secured subsequently or in the form of the derivative effects of recognition and reputation obtained from being associated with the exposition.

TABLE 4

EXPO 88: SUMMARY OF PRINCIPAL MOTIVES

MOTIVE SITUATION Provide symbolic value: achievement, Symbolic value as a celebration of Australia’s Bicentennial recognition Competitive Weapon: advantage Australian registration of interest with BIE provided Canada with a competitive advantage over France to secure a world exposition in Vancouver in 1986 Central Focus: attention, recognition Acted as the centrepiece for Australia’s Bicentennial celebration over a six month period. Resolving insecurities: self image, reputation Exposition enabled Queensland, in the context of interstate rivalry, to demonstrate to NSW and Victoria that the state had the managerial and organisational capabilities to handle large scale complex events. Produce opportunities for urban and economic Demonstrate to the Southern States that the private development: advantage, power enterprise philosophy of development was superior to their socialist development philosophies Economic advancement via tourism Become a vehicle to promote international tourism and development: achievement, advantage, obtain international recognition with resources unavailable recognition to QTTC Personal advancement: recognition, Principal promoters for staging exhibitions derived personal achievement benefits from their involvement Profitability expectation: efficient achievement Motive used to influence then Premier of Queensland to agree to hold the exposition

From a decision theory perspective, the motives identified derive predominantly from rational anticendents associated with conventional utility and agency theory. Cost implications of the decision to proceed were very much secondary considerations to several of the principal actors although they had been paramount for Primer Minister Fraser and the New South Wales Premier in the joint decision in 1981 not to proceed with a universal exposition at Darling Harbour. The principal players involved in the third Queensland proposal were pursuing very different agendas. They were committed to World Expositions either because of their intrinsic celebratory value or because of the economic, reputational and personal benefits that they anticipated would be derived from staging an exposition. None of the principal players were ignorant of the general positive economic and negative financial outcomes of previous expositions in North

167 America. This information was available to them either though the positions they held or through studies available to them. (See for example Queensland State Archives, Expo 88 Master Files, 5-1-1, 2, 3, 6). Nor were they unaware of the negative financial outcomes projected in the cost studies prepared to assist decision making associated with earlier proposals. This is important from the perspective of escalating of commitment and decision theory because it indicates that the principal players, with the possible exception of the Queensland Premier, did not engage in the final decision process under conditions of financial uncertainty. The accumulated evidence indicated that there was a high probability that a negative financial outcome would be obtained from staging the specialised exposition in Brisbane. Rationalisation anticedents also were present. The decision to proceed was based on the ability of individuals to convince the Queensland Premier that a profitable private enterprise mounted exposition could be achieved. This was a matter of faith for there was no evidence available to support the realisation of a profitable outcome. The final decision to proceed relied upon a simple cost study of projected expenditures and cost recoveries produced by David Graham. The study indicates that a deficit of between $15 million and $60 million could be expected. Why this cost study was accepted is not known. In terms of projected financial outcomes, it was the most optimistic of several cost studies that had been conducted before the final decision to proceed was made. The decision was made without a detailed feasibility study having been conducted. An economic feasibility study would have investigated “inter alia”, the revenue implications through exploring demand possibilities. A possible source of justification was Queensland’s public financial position. Financially, Queensland was in the best position of all the states to withstand any adverse cost implications. This was because of the long standing practice of producing annual surplus budgets and the practice followed by Treasury of secreting surplus funds in hollow logs (Robinson, 1994).

168 4.3.4 MODIFICATION AND REALISATION OF OBJECTIVES Following the decision to proceed, the Queensland government commissioned David Graham to produce a feasibility study. The study titled “Expo 88 Financial Study” was presented to the government in May, 1983. For the government the most disquietening feature of the report was the estimate of the number of visits of only 7.8 million that could be expected (Donohue, 1988b). This estimate provoked a strong reaction because it disclosed that the profitability objective would not be realised. Given the history of the proposal the government was committed to the project. To have withdrawn would have destroyed the reputation of the Queensland government with the Commonwealth and other states governments. It also would have reinforced the negative perception of Queensland’s managerial abilities held be the southern states that the government was anxious to demonstrate were unfounded. Most disturbing was the potential response from the Queensland public should the adverse information have become public knowledge. The exposition had been promoted as a private enterprise concept and shortly after the report was presented, the Queensland Premier publicly pronounced that the exposition would be a profitable venture that would not cost the public a cent. It is to the credit of the management of the enterprise that they were able to overcome this potentially disastrous setback at least from the perspective of promoting and thereby engendering the public perception that the project was a success. This was accomplished in various ways and the fear of financial failure explains why the Queensland government and the Chairman of Expo 88 persisted in writing to the Commonwealth requesting financial assistance including matching capital grants based on what the Commonwealth had offered the New South Wales government in 1980 (see Carroll, 1989). The requests were unsuccessful even though it had been customary for national governments to provide substantial financial assistance at previous World Expositions. The Commonwealth restricted financial contributions largely to those matters that it was obliged to as a member of BIE (see appendix F and appendix G, table 6).

169 Two of the measures adopted by BESBRA involved stimulating demand for visits. The first involved adopting marketing strategies that would provide the public with what they wanted; a party bursting with fun and pleasure (see section 4.3.1, second and third opening quotations). The marketing strategy was successful albeit, at the cost of substantially increasing the entertainment budget (see appendix G, tables 1 and 2). To ensure that visitors were satisfied with the number of participants, sufficient representation was achieved through offering inducements to participants. Inducements included direct financial assistance and indirect financial assistance mainly in the form of making the volunteer workforce available to assist in manning pavilions (see appendix F and Queensland State Archives, Expo 88 Master File 1.3.27, Financial Assistance to Underdeveloped Countries). The second measure involved the adoption of a ticket pricing policy that would ensure the responsiveness of the public and guarantee the generation of revenue through increased attendances (see Queensland State Archives, Expo 88 Master Files on Ticketing Policy, 2.5 P, and Ticket Pricing Research, 7.1.02). Essentially, the policy incorporated an appreciation of the concept of economic elasticity of demand. A ticket price discounting policy was introduced to which there was an overwhelming positive public response. If anything the policy was too successful. Revenue was forgone because the price discounts offered proved in hindsight to be excessive. Over 400,000 season tickets and 800,000 three day tickets were issued before the end of the second and final discount period on 31 January, 1988. The total number of season and three day tickets issued was 526, 500 and 2.1 million respectively. Approximately 85 percent of season ticket passes were issued to Queensland residents. Season ticket holders accounted for approximately 50 percent of total visits by the general public to Expo 88 (Donohue, 1988b). Data collected by QTTC indicated that 90 percent of visits to Expo 88 were domestic visitors. Of these 27 percent were from the Brisbane region, 26 percent were from New South Wales and 13 percent were from Victoria with the balance drawn predominately from regional Queensland, (QTTC, Expo 88 Impact Study). A third measure involved public deception. The expenditure outlays on Expo 88 incurred by the Commonwealth, the Queensland government and the

170 Brisbane City Council were not recorded in the financial accounts of BESBRA nor was there any acknowledgement by BESBRA that these expenditures had been incurred. The amount of these expenditure outlays exceeded $108 million (see appendix G, tables 5 and 6). This amount does not include expenditures incurred by the other Australian states and territories from participating in the exposition. Rental charges collected from the states and one territory contributed to the revenue collections of BESBRA. The Northern Territory did not pay rent on the premises occupied. A fourth measure involved redefining the nature of success of Expo 88 that avoided any mention of profitability or investment returns. During the six months that Expo 88 operated the nature of success was promoted in terms of attendance figures (see for examples The Courier Mail during this period) which were guaranteed as a result of the ticketing policy and the revised marketing strategy. By the time Expo 88 closed on 30 October, 1988 the Chairman of BESBRA was able to claim that Expo 88 had been the most successful exposition ever held. This claim was justified in terms of the number of visitations per capita (see for example Closing Financial Report: World Expo 88, Brisbane). The official number of visits to Expo 88 was 18,560,477. This was inflated by including 2, 800,000 visitations by BESBRA staff, official visitors and the volunteer workforce (see appendix F). Nevertheless, the Graham estimate of 7.8 million visits that had been responsible for the strategic initiatives had been more than doubled largely through the marketing and ticket price discounting policies. The introduction of these measures had been motivated by the fear of project failure. The effect was to change the nature of Expo 88 from the founding basis of World Expositions as celebrations of scientific and technological accomplishment to a six months long party that was embraced by the public. During the party participants actively promoted their countries, their state or territory as tourist destinations and their products and services. Participants sold products and provided foods and beverages for sale to the public. All activities that were contrary to BIE philosophy (Carroll, 1989). Carroll and Donohue (1989c) commented on the party dimension of Expo 88 as follows:

171 “If it is judged as a party, then it may be judged a success, though the authors are uncertain as to what constitutes the criteria by which one judges the success or failure of a party. The number of visitors may provide an appropriate measure, and the bulk of Expo visitors, as measured by the large number of surveys undertaken for BESBRA, certainly expressed very favourable opinions of the event. However, had such visitors known of the full cost of the party they were invited to attend, perhaps their opinions would have been rather different.”

A rational criterion emerged in the form of the reaction of the Queensland public towards their government’s intended use of the expo site after the exposition. The utility that individuals gained from attending Expo 88 contributed to the inability of the Queensland government to realise their objective of selling the exposition site for redevelopment in order to recover capital outlays. The site became associated with the pleasure experienced and the public expressed the desire to maintain the site for recreational activities. The Queensland government acceded to public demand. As a result BESBRA was wound up and SBC was established to create and subsequently manage the South Bank Parklands (see appendix F, table 5). For the Queensland government, acceding to this public demand has entailed considerable cost. The government failed to recover over $200 million that would have been obtained had the entire exposition site been sold (see appendix G, table 7). Moreover the development and operation of South Bank Parklands has been expensive. Between 1989/90 and 2001/02 the SBC spent over $160 million on capital developments within the Parklands and the Queensland government has provided SBC with annual operating grants in excess of $2 per visitor to the Parklands (appendix G, table 9, footnote 5). By 2005, public and private sector contributions to improvements and operations of the Expo 88 site had reached $800 million. It is anticipated that an additional $300 million will be spent on the site by 2008 (The Australian Financial Review (2005). Total operating grants, valued in historical cost accounting terms, amounted to $112 million by the end of June, 2002 (appendix F, table 5 and appendix G, tables 9

172 and 10). The cost of maintaining and improving the Parklands has not been questioned by the public. In 1997 SBC reported that 33 percent of international visitors to Brisbane visited South Bank Parklands. In 1998 SBC reported that the Parklands were Brisbane’s number one event venue (see appendix F, table 5).

4.3.5 ECONOMIC AND FINANCIAL OUTCOMES OF EXPO 88 This case study illustrates the problem of determining whether the project was a financial success or not. It also illustrates the problem decision makers face in choosing an appropriate criterion to evaluate the financial outcome of complicated public projects with long lead times of capital expenditure followed by brief operating lives. For escalation of commitment to exist, it is necessary to demonstrate unambiguously that the project under investigation not only is a financial failure, but also that decision makers knew that it would be a failure. In financially complicated public projects such as Expo 88 with multiple objectives this is not an easy matter to determine. It very much depends on the perspective of the evaluator, the extent of knowledge of the project and the extent of familiarity with economic principles of private and public finance. It also depends on the time period over which the project is evaluated. Table 4 reveals the problem set. Table 4 summarises the financial and economic outcomes of Expo 88 using different evaluative criterion derived from the information contained in the tables in appendix G. The footnotes accompanying table 4 provide explanations of the evaluation criteria associated with each outcome. A cursory examination of the financial outcomes indicates that a positive investment rate of return was realised on only one of 12 criteria employed. In contrast, positive economic outcomes were obtained although the balance of payments effect was negative (appendix G, table 8).

173 TABLE 5

EXPO 88: SUMMARY OF FINANCIAL / ECONOMIC OUTCOMES OVER THE PERIOD 18 FEBRUARY, 1984 TO 7 MAY, 1989

TOTAL METHOD OF TOTAL TOTAL TOTAL LIABILITIES/ NET SURPLUS/ (NET RETURN ON ASSETS/ECONOMIC EVALUATION REVENUE EXPENDITURE ECONOMIC/COSTS DEFICIT) INVESTMENT BENEFITS $’000 $’000 $’000 $’000 $’000 $’000 Historical Cost 1 274,963 483,230 221,534 220880 654 0.001

Historical Cost 2 307,685 535,607 231,600 242748 (11,148) -2.09

Historical Cost 3 274,963 590,966 .. .. (76,168) -12.89

Historical Cost 4 307,685 639,343 (87,970) -13.76

Current Cost 1 300,763 602,571 221,534 .. (80,274) -13.32

Current Cost 2 313,311 627,531 231,600 .. (82,620) -13.16

Current Cost 3 300,763 724,737 221,534 (163,738) -22.59

Current Cost 4 313,311 754,878 231,600 (169,650) -22.47

Present Value 1 327,457 690,016 221,634 (94,559) -13.70

Present Value 2 351,556 741,434 231,600 (108,344) -14.61

Present Value 3 327,457 828,170 221,534 (232,713) -28.10

Present Value 4 351,556 888,733 231,600 (255,643) -28.76

Balance of Payments (102,000)

Economic Impacts POSITIVE

Cost Benefit Ratio POSITIVE Source: Appendix G, tables 1 to 8

174 Notes: 1. Historical cost 1 are financial outcomes of BESBRA for the period 15th February, 1984 to 31st December, 1988, the date when BESBRA was supposed to be wound up. 2. Historical cost 2 are financial outcomes of BESBRA from the period 15th February, 1984 to 7th May, 1989, the date when BESBRA was actually wound up. 3. Historical cost 3 are financial outcomes for the period 15th February, 1984 to 31st December, 1988. Off balance sheet contributions by government are incorporated (see appendix G, tables 5 and 6). 4. Historical cost 4 are financial outcomes for the period 15th February, 1984 to 7th May, 1989. Off balance sheet contribution by government are incorporated (see appendix G, tables 5 and 6). 5. The financial deficits in historical cost 3 and 4 outcomes exclude the contributions to capital (appendix G, table 5) which remain government assets. 6. Current cost outcomes 1 to 4 replicate the historical cost outcomes. Values are expressed in either December 1988 prices or June 1989 prices. The two outcomes recorded in June, 1989 prices marginally inflate the results as transactions for the Authority ended on 7th May, 1989. The inflationary effects are calculated annually. 7. Return on investment is calculated on the resources expended rather than the balance of assets, predominantly land. 8. Present value outcomes replicate the historical cost outcomes. Values are expressed in December, 1989 prices and June, 1989 prices. A real discount rate of 6.5% applies, based on the average real rate of interest over the period on the 10 year Commonwealth government bond. 9. The real value of an outcome is derived from the Fisher effect that shows the relationship between inflation, nominal returns and real returns. The relationship is: (1+R) = (1+r) x (1+i) Where R = real return r = nominal return i = inflation rate

175 10. Final value of consolidated assets at December, 1988 and June, 1989 have not been adjusted for inflation or the real time value of money i.e. the real bond rate.

If Expo 88 is represented as a private enterprise project, there are three accounting/financial criteria that can be applied to evaluate the project. These involve measuring the project in conventional historical cost terms, in current cost accounting terms and in terms of the discounted real value of the project. Each of these measures incorporates the notion of profitability. Appendix G tables 1, 2 and 3 summarise the audited consolidated accounts of BESBRA. These are expressed in conventional historical cost accounting terms and do not include direct contributions of the Commonwealth, the Queensland government and the Brisbane City Council. When BESBRA was wound up on 7 May, 1989, an audited loss of $11,148,000 had been reported. If BESBRA had been wound up on 31 December, 1988 as originally intended, an audited profit of $654,000 would have been recorded. Between 1 January, 1989 and 7 May, 1989 expenditures, mainly in the form of debt servicing charges, far exceeded the revenue received from debt recovery and the sale of improved assets such as the amusement park (The Courier Mail, editorial, 1 June, 1989). Neither the Queensland government nor BESBRA promoted the profitable outcome given that the Queensland public had by December, 1988 accepted that Expo 88 had been a success in terms of attendance figures. Nevertheless, it is only by adopting the extremely narrow historical cost based financial evaluation criteria is it possible to claim that Expo 88 produced a profitable outcome. When the final results are adjusted for inflation and expressed in current cost accounting terms the $11 million loss becomes a loss of $82,620,000. When the $11 million is expressed in terms of the discounted present value using a real social discount rate of 6.5 percent, the outcome becomes a loss of $108,344,000. It has become standard financial practice to evaluate private investment projects in terms of their discounted present value. From this perspective Expo 88 did not achieve the profitability objective and did cost the Queensland public substantially in terms of the opportunity cost of public services foregone.

176 Contributions by the private sector to Expo 88 were disappointing and for the most part economically disruptive in the short term. For example, two purpose built hotels were constructed near the exposition site. They were sold at substantial loss by the developers after Expo 88 closed because of lack of patronage. Taxi services were increased during the exposition by issuing additional licences. This had the effect of reducing the profitability of the industry in Brisbane after the exposition. The taxi services available exceeded demand resulting in reduction in the market value of tradeable taxi licences. Corporate sponsorship also was disappointing. Most of the corporations that did provide assistance were rewarded for the sacrifice with exclusive supplier arrangements with BESBRA (appendix F, table 4). To the extent that corporations who participated at Expo 88 were government instrumentalities (appendix F, table 2), the financial transactions represented intergovernmental transfers from a public finance perspective. The largest single source of private sector support was provided by the volunteer workforce. Volunteers not only contributed to the achievement of record attendances that were selected as the measure of success of the exposition but also the implicit value of their free labour was costed by BESBRA and formed a substantial component of the financial assistance provided to participants as inducements to attend the exposition. The implicit labour value of the contribution of the volunteer workforce exceeded $100 million. It is only possible to ignore the value of the volunteer workforce contribution by assuming that the marginal product of this labour was zero. If Expo 88 is evaluated as a public investment project using private investment evaluation criteria it is necessary to include the undisclosed government financial contributions to Expo 88. When these contributions are included financial outcomes deteriorate further. The calculations performed in Table 4 exclude those infrastructure contributions identified in appendix G, table 5 such as the improvements to rail services on the grounds that these contributions remain government assets; with their improvement merely having been advanced to accommodate the particular needs of Expo 88. These infrastructure contributions amounted to $31 million in historical cost accounting terms. As table 4 indicates, the inclusion of government contributions recorded in appendix G,

177 table 6 compounds the losses. The financial outcome, measured in historical cost terms, becomes a loss of $88 million. In current accounting terms the loss becomes $170 million and the net present value loss becomes $256 million. If the exposition is judged in terms of the objective of stimulating tourism demand, it was an expensive promotional exercise that produced little sustainable impact (Donohue, 1988a and 1988b). This was partly because of an unanticipated adverse external shock that undermined promotional influences on demand. In 1989 there was a Pilots’ dispute of several months duration that severely disrupted domestic air services and discouraged international visitations. It was also because the other states and territories had learned from the Queensland initiatives in attracting domestic tourists and became more competitive and professional in promoting their attractions as tourist destinations (see Donohue and McGovern, 1991). The principal effects on tourism in Queensland were associated with the scale and duration of the exposition. These were sufficient to distort and disrupt established patterns of tourism to and from Australia, within Australia and within Queensland. These were anticipated by Donohue (1988a) and confirmed by later reports published by the Bureau of Tourism Research (BTR) and QTTC (see for example the BTR Domestic and International Tourism Monitor series, the published surveys of QTTC on domestic and international visitors and QTTC’s Expo 88 Impact Study). Appendix H contains a number of tables extracted from forecasts of international tourism published by BTR and the results of surveys and information collected on tourism published by QTTC. Information contained in these tables illustrates the disruptive effects of Expo 88 on tourism patterns. Tourism effects were not generally associated with tourism growth except in the unwanted sense that it stimulated additional growth in overseas travel by Australian residents. Rather, they were associated with the redistribution of tourism flows both in terms of time and place of destination. Expo 88 acted as a tourism magnet during the six months of its operation. International visitations increased significantly during the exposition period, fell during the Pilots’ dispute and then resumed the established pattern (see appendix H). The only states that experienced an increase in tourism demand during the exposition period, as measured by Australian Bureau of Statistics series on accommodation occupancy

178 rates in hotels, motels and caravan parks was New South Wales and Queensland. Within Queensland the increased demand was confined to the Southeast Queensland statistical region. The other designated tourism regions in Queensland experienced a decline in occupancy rates during the exposition period compared with the corresponding period in the previous year. At the extreme, North Queensland tourism region did not recover pre Expo 88 levels of tourism demand until after 1990. Expo 88 had a profound effect on travel time preferences, particularly for recreational travel within Australia and within Queensland. The effect was to compress into a six month period the travel intentions of domestic travellers to and within Queensland. Intensions that would, in the absence of Expo 88, normally have been expressed over a period of between 12 and 18 months (see appendix H). In these respects the tourism effects of Expo 88 were less about the stimulation of tourism demand and more about the temporary disruption of the patterns of tourism demand. These disruptive effects were not anticipated by decision makers who encouraged the mounting of the exposition on the grounds that a hallmark event would be an effective means of tourism promotion. In chapter 2 it was argued that public investment projects should be evaluated according to social cost benefit analytical principles. The principles were explained in section 2.8. A social cost benefit study is different from an economic impact study, the type of study that consulting agencies were commissioned to provide by BESBRA (see section 4.3.1). An economic impact study determines the net income, expenditure and employment direct and indirect effects on final demand (output) of an economic activity after all injections and leakages have been identified (see Donohue and McGovern, 1991b; Jensen, Mandeville, and Karunaratne, 1979). The impact studies conducted for BESBRA concluded that Expo 88 had produced positive economic impacts. The same conclusion was reached by Donohue (1988a) although the extent of income generated towards final demand was reduced by a balance of payments leakage directly attributable to activities at Expo 88. Overseas participants repatriated income from profits derived from the expenditure of visitors who were predominantly Australian residents. The effect on the balance of payments was estimated at between a negative $85 million and

179 a negative $103 million in current 1988 prices (appendix G, table 8). The estimate did not include the effects of net capital imports such as the monorail that operated during Expo 88 and now conveys patrons to the casino on the Gold Coast. Nor did it include the full expenditure switching effects of visitors who substituted consumption of domestic produced goods and services for imported goods and services. These two effects were not calculated at the time and there is now insufficient information available to provide reasonable estimates of their additional impact on the balance of payments. As well, the net effects of the increased propensity for Australian residents to travel overseas as a result of being influenced by the exhibits of participating countries at Expo 88 were not calculated. At the time this was due to the unavailability of official statistics. It is now impossible to determine because any influence was corrupted by the subsequent Pilots’ dispute in 1989. Donohue (1988a) identified a number of social benefits and costs directly associated with Expo 88 but was unable to determine unambiguously whether the ratio of benefits to costs was positive or negative although the calculation performed suggested that a positive ratio would most likely result (Donohue, 1988b). This was partly because there was insufficient information made available and partly because insufficient time had elapsed to anticipate how events would ultimately unfold. Additionally, there was the problem that multiple objectives were associated with the project with the profit motive possibly being the least important initially other than as assurance employed by principal players to secure the project’s approval. The profit motive subsequently assumed importance for a time when it became necessary to justify the feasibility of the project to the public. This was because of the public pronouncement by the Queensland Premier about generating a profit without costing the public a cent. While it theoretically is possible to accommodate multiple objectives in a social cost benefit analysis it is extremely difficult to incorporate in practice. As a result an investigator normally is required to choose a single objective against which to evaluate a project. With Expo 88 the difficulties are pronounced because the objectives were interrelated; with the achievement of one objective contingent upon the achievement of other objectives. The social benefits Donohue (1988a) identified involved:

180 • A reduction in public hospital outpatient attendances in Brisbane beyond that which could have been anticipated from changes in Medicare in 1988 that encouraged patients to attend general practitioner clinics (Cairns, 1990). Expo 88 revealed that for many patients attending public hospital outpatient clinics with customary long delays before receiving treatment was a means of social interaction that was otherwise denied them. Visiting Expo 88 was an effective social substitute; • An increase in the demand for public transport that for the period of the exposition reversed the long term trend of declining patronage; • An upgrading of infrastructure services and facilities before they would otherwise have been undertaken; • Providing a socially effective and safe environment for the aged and the lonely that had been lacking in the suburbs before the exposition. Following Expo 88, these problems were addressed by the state and local government by encouraging fundamental changes in the nature of entertainment, recreation and retailing in Brisbane. Expo 88 was not responsible for legislative changes that permitted outside dining but the dining experiences provided at the exposition certainly contributed to the subsequent proliferation of restaurants and coffee houses with outside dining facilities; • The contributions to income, output and employment that were calculated in the economic impact section of the study. In the 1988 study these economic impacts were not valued highly in social cost benefits terms based on the logic that the resources used in generating economic impacts could have been employed elsewhere in the Queensland economy with more substantial and longer lasting effects. Most of the buildings constructed for the exposition were demolished after the exposition closed; and • Increases in the value of properties in the immediately surrounding suburbs of Highgate Hill, South Brisbane and West End at a faster rate than would otherwise have been the case. These suburbs had

181 been declining as preferred places to reside. The exposition stimulated the process of gentrification. The social costs identified involved: • The displacement of long term residents in rental accommodation in the immediately surrounding areas; • An increase in certain types of crime; • A decline in Police representation during the period of exposition in regions outside South East Brisbane; • An increase in total motor vehicle accidents. Road deaths increased by 95 in South East Queensland and Northern New South Wales during the exposition period against a long term declining trend in road deaths in these areas; • An increase in business hardship and business bankruptcy mainly in regions outside South East Queensland. This was because the volume of public expenditure at the exposition was sufficient to significantly reduce and distort normal domestic consumption patterns. Businesses that obtained substantial benefits from the exposition mainly involved large retailers in South East Queensland, domestic suppliers to Expo 88, transport companies such as coach operators, accommodation outlets and those businesses servicing accommodation outlet requirements in Northern New South Wales and between Noosa and the Gold Coast in Queensland. The incomplete 1988 study speculated that the urban renewal intensions of the Queensland government on the exposition site would produce mixed outcomes of uncertain economic benefit. In the study it was argued that intense commercial and residential development possibly would produce depressing effects on property prices and business activity in the central business district. These outcomes did not eventuate because of the previously mentioned public pressure exerted on the state government to retain the exposition site as public recreational space. The pleasure visitors obtained from the exposition was transformed into a lasting legacy that stimulated fundamental changes in Brisbane and contributed to improvement in visual amenity.

182 Expo 88 was the initiative that enabled Brisbane residents to rediscover a city centre that had long been in decline due to a preference for suburban shopping centres. It acted as the catalyst for the Brisbane City Council to extend the urban renewal process beside the river and amend by-laws permitting patrons to be served food and beverages externally. Together these initiatives encouraged the repopulation of the inner city areas that had either long been deserted or had fallen into disfavour. The exposition also provided the state government with the vision to extend the cultural precinct on the South Bank. From these perspectives Expo 88 achieved urban renewal objectives far beyond anything originally conceived. It is the process of urban renewal that primarily is responsible for the generation of positive social benefits. The ultimate effect has been the conversion of a large country town into a sophisticated liveable city (The Sunday Mail, 2005).

4.3.6 SUMMARY This case study of Expo 88 began with identifying the initiative for a World Exposition to be its value as a celebratory event for the Bicentennial. Individuals with sufficient political influence saw an exposition as an opportunity to achieve very different objectives predominantly related directly and indirectly to economic progress and development but also associated with the promotion of individual self interests. The analysis indicated that the exposition was successful in its celebratory role. It did enable Queensland to demonstrate to the other states that it was capable of organising a complex event from which the public derived substantial enjoyment. As well, positive economic impacts were experienced. On the other hand, the exposition did not achieve the somewhat spurious objective of making a profit. Nor did it achieve the politically more important tourism objectives but these were unexpectedly impeded by external shocks that followed the exposition. The nature of the urban renewal process and the positive flow on consequences of the process have been successful to the extent that the ratio of benefits to costs is estimated to be positive. The urban renewal program that was implemented

183 however, had never been intended by the state government. The program was a political reaction to the pressures of public demand. The length of this case study has been necessary in order to provide as complete an account as possible of the motives that were responsible for the staging of Expo 88. It has also been necessary in order to illustrate the difficulties involved in choosing an appropriate criterion of evaluation and in determining whether the project was successful either in a financial or an economic respect. If the analysis had not been extended beyond the period when the exposition closed, it would not have been possible to incorporate the consequences of the renewal program, consequences that ultimately made the project an economic success, albeit unintentionally. The theoretical explanations for the enduring commitment to the project are dominated by rational and rationalisation decision making processes. Expo 88 was driven by many of the underlying motives associated with public sector projects discussed in chapter 3, section 3.4.7. Influential individuals either acting alone or together were able to successfully promote the staging of the event motivated by their own rational self interests reinforced by beliefs that the expected adverse financial outcome could be justified because, “inter alia”, the public would benefit from the indirect economic development and urban renewal effects. The expected negative financial outcome was not disclosed publicly. Instead, because the Premier had publicly stated that Expo 88 would be profitable, the nature of the event was changed and promoted at considerable additional expense. Considerable income was foregone in order to boost attendances and the nature of success was redefined in terms of manipulating attendance figures in order to achieve record attendances. The major social benefits which ultimately derived from Expo 88 were not anticipated and were unintentional. They derived from community reaction to the proposed sale of the site to private interests to recover capital outlays. The Queensland government responded positively to the community reaction because it was politically vulnerable at the time. The exhibition was able to proceed because the major characteristics associated with public sector projects (see chapter 3, section 3.4.7) were present and because financial outcomes were less

184 important than the pursuit of other objectives including objectives associated with the rational self interests of the promoters.

4.3.7 CONCLUSION This chapter has described the quantitative and qualitative research methodologies used to examine two complex public sector case studies with unusual investment horizons that involved long lead times of capital expenditure followed by short operational periods. The substance of the research comprised an inductive analysis of the motives associated with initiatives to mount World Expositions in Vancouver in 1986 and in Brisbane in 1988. The “raison de etre” for selecting these particular cases was that the author had reservations about the legitimacy of the escalation of commitment attributes assigned to them by Ross and Staw (1986) and Donohue (1988a). Ross and Staw (1986) described Expo 86 as an escalation prototype. From their analysis of Expo 86 they developed a sequential theoretical model of escalation of commitment in organisations. The analysis conducted in this chapter has demonstrated that whether the motive associated with persistence to hold these expositions was held to involve “ex post” decision rationalisation was contingent. It depended on the data selected as the basis of investigation, the period over which the investigation was conducted and the investment criterion selected to evaluate projects. The analysis of Expo 86 discovered a planning literature that provided an alternative explanation of the outcome of the project to that provided by the escalation of commitment literature. The planning literature considered that the exposition was successful because economic development objectives had been achieved through a process of urban renewal albeit, at considerable cost. The analysis also revealed that the decision to hold the exposition was a rational process that enabled the urban renewal process to proceed. It was seen as the unavoidable means to achieve preferred ends. The investigation of Expo 88 involved the collection, analysis and synthesis of substantial data. This enabled the complex motives associated with initiatives to hold the exposition to be identified and classified into categories involved with

185 rationality and rationalisation. The analysis also identified the peculiar role assumed by the objective of achieving a profitable investment rate of return. The profit motive was used as the objective of influence during the decision process that secured the approval for the exposition by the then Premier of Queensland. After the decision to proceed was made there arose a need to justify the project in terms of profitability. Finally the need to achieve a profit on the project receded because the management of BESBRA was able to redefine the nature of success in terms of record attendances. This criterion of success was accepted by the public. People who attended obtained considerable enjoyment from the experience. In the next chapter the research findings reported in this chapter are analysed and used to modify the theoretical model of escalation of commitment in organisations constructed by Ross and Staw (1986).

186 Chapter 5 DICUSSION

INTRODUCTION In this chapter the theoretical implications of the research findings are discussed in section 5.1. This provides a framework for the theoretical developments undertaken in section 5.2. These developments form a central part of the thesis. They consist of modifications to and extensions of the theoretical model reproduced in section 4.2.2. The most important changes made to the original model involve strengthening the importance of rational influences in the decision process and the incorporation of agency theory influences in the form of the pursuit of individual self interests of decision makers. Associated theoretical influences are considered in section 5.3. These are concerned with selection criterion for evaluation of project outcomes, the problem of sunk costs and an exploratory discussion of whether projects with little or no direct financial value are unavoidable intermediate means required to achieve indirect economic development objectives. In section 5.4 arguments are developed to indicate correspondence in certain contexts between expected utility theory and cognitive motivational theories of expectancy and dissonance. Section 5.5 generalise the theoretical influences. The contributions of the thesis are discussed in section 5.6. This is followed by a discussion of limitations in section 5.7. The chapter ends with a brief conclusion.

5.1 THEORETICAL IMPLICATIONS OF RESEARCH FINDINGS The literature review conducted in chapter 3 identified several theories that have been proposed as explanations for the phenomenon of escalating commitment to failing investment projects in resource allocation situations. Four of the theoretical explanations had their origins in individual decision making laboratory experiments. In organisational contexts, these and other theoretical explanations concerned with satisficing behaviour, organisational commitment, group conformity and agency problems of adverse selection were identified in the

187 literature review. The theoretical explanations are summarised in the following table. Table 6

THEORETICAL EXPLANATIONS OF ESCALATING COMMITMENT ANTICEDENTS THEORY

Normatively Rational Expected Utility Theory Descriptively Rational Expectancy Theory Retrospective Rationalisation Dissonance Theory Affective Attachment Organisational Commitment Deviation from Rationality Prospect Theory Rational Self Interest Agency Theory Satisficing Behaviour Organisation Decision Theory Social Norms and Conformity Group Think

The sequential theoretical model constructed by Ross and Staw (1986) following their case analysis of Expo 86 utilised two of the theoretical explanations as the principal sources for the existence of the phenomenon in organisations. The theories utilised were expectancy theory and dissonance theory. Expectancy theory provided a rational basis for decision makers to proceed initially with investment projects. From this perspective decisions are predicated on positive information provided by economic project variables such as feasibility and expected rate of return. Dissonance theory provided an explanation for why decision makers in organisations irrationally persist with investment projects after information becomes available of sufficient veracity to indicate that projects will fail financially. Decision makers justify persistence in terms of rationalisation. According to the model, persistence with projects that are failing financially are exacerbated in organisations by social influences that reinforce the need for rationalisation and institutional constraints that make it difficult to withdraw from projects with failing financial prospects after there has been substantial project progress. Institutional constraints provided the possibility for additional penalties of both a financial and psychological nature to be incurred. The theoretical model was reproduced in section 4.2.2. 188 In chapter 4 Expo 86 and Expo 88 were revisited. The aetiology of the decisions to proceed with these two projects after principal decision makers were confronted with adverse information about their financial prospects were re- examined. With Expo 86 it was possible to extend the data already examined by Ross and Staw (1986) to encompass an urban planning literature that had formed a different perspective from that held by Ross and Staw about the purpose and outcomes of World Expositions in general and Expo 86 in particular. The research on Expo 88 has provided an opportunity that was denied the author when two incomplete studies were conducted previously (Donohue 1988a and 1988b). This analysis of Expo 88 produced data that enabled the origins of the exposition to be investigated at different levels of analysis for the motives associated with attempts to stage an exposition. It also allowed the investigation to be extended for a period far beyond the time when the exposition closed. The extended time frame of the analysis produced a more complete understanding of the origins and the outcomes generated by the exposition. This understanding would not have been obtained if the analysis had been terminated before or at the same time the exposition closed. Because the existence of the escalation of commitment phenomenon depends on the realisation of negative financial outcomes, it was a necessary requirement of the analysis to undertake a complete financial assessment of the accounts of BESBRA and SBC. This was extended to include off balance sheet expenditures. The financial assessment was widened to incorporate an incomplete economic analysis that nevertheless was sufficient to enable the conclusion to be reached that Expo 88 ultimately produced positive social benefits additional to the positive economic impacts identified. The nature of the social benefits were not anticipated by the principal decision workers given that the Queensland government intended to sell the site for alternative real estate uses that would have been commercially disruptive. The financial and economic assessments are undertaken in appendices F, G and H. Appendix F contains a brief history of the origin and nature of world expositions. This is followed by a brief history of Expo 88 in which non financial performance indicators such as level of attendance, degree of sponsorship and the extent of official participation representativeness are discussed. The first four

189 tables attached to this appendix list the international, national and corporate participants at Expo 88, the suppliers to the event and the entities that provided sponsorship. Table 5 of this appendix provides a list of significant events associated with the Expo 88 site between 1988 and 2002. Appendix G consists of ten tables concerned with the financial positions of BESBRA and SBC. The first four tables summarise the financial position of BESBRA at various periods between 1984 and 1989. Tables 5 and 6 identify and bring to account the sources and nature of off balance sheet financial support for Expo 88. Table 7 provides a present value analysis of the land compulsory acquired by BESBRA. Table 8 summarises the balance of payments effects of Expo 88 and Tables 9 and 10 provide a financial history of SBC between 1989 and 2002. Appendix H examines the impact of Expo 88 on tourism. This appendix contains nine tables which summarise the impacts on international tourism, domestic tourism and public transport. The results obtained from the analysis of Expo 86 in chapter 4 do not support Ross and Staw’s (1986) interpretation of the events as an escalation prototype. Three reasons dominated decisions to persist with the project even though knowledge was accumulating as planning for the event progressed that made it increasingly certain that substantial financial losses would be incurred. The first was the need to fulfil the promise to the public that Expo 86 would be a suitable event to celebrate the centenary of Vancouver. In this capacity there had never been an expectation by the organisers of the event that Expo 86 would produce a positive financial result. It was only the magnitude of the financial losses that would be incurred that were unknown to the organisers when the decision was made to stage an exposition. The decision error was the miscalculation of the extent of the financial losses. The problem is that the decision error is only distantly related to the principal objectives. The second reason was the opportunity afforded by the event to realise anticipated economic benefits and impacts from the urban renewal process. The staging of the exposition had been directly linked to the economic development objectives from the beginning. Both these reasons were motivated by rational antecedents.

190 The third reason involved institutional constraints. It is these constraints that may best explain why the organisers ultimately persisted with the project when alternatives to the event could have been found to satisfy the objectives contained in the first two reasons. The most important institutional constraint involved the political need to satisfy expectations held by the public about the event that were created by the political organisers. It is in this context that the decision to persist with the event displays both rational and rationalisation motives. It was a politically rational decision to satisfy the public expectations created. On the other hand there was a need to justify the event because of the mounting disquiet expressed by the public through the media about the financial costs accumulating. The Premier provided an acceptable solution to public concerns about increasing financial costs. The organisers of the exposition delivered an event that exceeded the politically promised expectations for the event held by the public. This was accomplished through the collective enjoyment obtained from the experience. The level of pleasure was sufficient to achieve the incidental effect of inducing the public to discount the considerable public costs responsible for the pleasure derived. The qualitative analysis of Expo 88 revealed a complex set of objectives associated with the initiative to stage an exposition that derived from rationally motivated intensions of principal decision makers which could be justified in terms of the political and social benefits anticipated. Rationalisation of the decision to proceed with the exposition was confined mainly to those activities surrounding the need to justify the event in terms of the ill conceived but necessary promise of achieving a profitable outcome. The organisers of Expo 88 were able to replicate a particular achievement of Expo 86. They delivered an exposition that produced experiences from which the public derived considerable pleasure which enabled them to consider Expo 88 a success. The organisers reinforced the public perception of success by redefining success in terms of the record number of people who attended the event. As well, the organisers employed various strategies at considerable cost to increase revenue in order to limit the extent of the projected financial losses. The final accounts of BESBRA tabled in the Queensland parliament in 1989 conveyed the impression that financial losses were

191 insignificant. The consolidated accounts for the period ending 31 December, 1988 even recorded a small audited profit of $654,000. This was achieved simply by not recording off balance sheet expenditures. As a result of the motives identified and the subsequent actions of the principal decision makers, it is not possible to conclude that the project was dominated by motives and decisions associated with the theoretical explanations for escalation of commitment to failure. On the other hand, the quantitative analysis of Expo 88 produced the negative financial results necessary for the project to quality as a potential case of escalation of commitment. Of the 12 financial criteria used in the financial evaluation, only one produced a positive outcome. Without a knowledge of the various objectives, other than profit, that were instrumental in the pursuit of project approval and of the positive social benefits and economic impacts that were produced, it would be possible to conclude from the financial results alone that Expo 88 was an example of escalation of commitment to failure. The qualitative analysis of Expo 88 was able to identify the extent to which principal decision makers were motivated by dual rational objectives related to public interests and individual self interest which were justified. They were motived by the value of World Expositions as instruments to achieve celebration, managerial recognition and economic development objectives. As well, there was an expectation that they would benefit personally from an exposition being held. In chapter 2 considerable discussion was devoted to demonstrating and reinforcing the theoretical independence of organisational efficiency and individual utility maximisation. There is no reason to expect, other than incidentally and ethically, that organisational objectives associated with the pursuit of profit maximisation coincide with individual objectives associated with the pursuit of utility maximisation. In corporations with diversified or public ownership divorced from management, the potential for individual and organisational interest to diverge can be considerable in the absence of sufficient control measures to ensure accountability. In the organisational economics literature the divergence of interests has been investigated from an agency theory perspective with the divergence of interests being represented as agency problems with adverse ethical

192 and economic consequences. The information collected on Expo 88 was sufficiently complete to enable the extent of the agency problem to be revealed.

5.2 THEORETICAL DEVELOPMENT OF MODEL The re-examination of Expo 86 and Expo 88 in this research has provided sufficient information to indicate that the theoretical model produced by Ross and Staw (1986) needs to be modified to accommodate the findings of the research, at least in the particular context of the projects investigated. In figure 8 the theoretical model presented and discussed in chapter 4 has been modified to accommodate the findings. The changes made to the original model are highlighted in bold type. The most significant changes made to the original model are the incorporation of rational motives in each of the three phases of the sequential decision making process. In the original model, explanations derived from rational motives do not contribute after the initial phase as to why decision makers in organisations persist with investment projects that produce indications of financial failure. The rational motives incorporated in the modified model can be expressed in terms of normative expected utility theory or expectancy theory, the descriptive theoretical equivalent. They can also be expressed in terms of the pursuit of individual self interest from the organisational perspective of agency theory. They emanate from the initial circumstances which encourage intendedly rational satisficing forms of behaviour to be expressed. In the modified model it is possible for the project performance related rationally determined motives to operate independently of, or in conjunction with, motives associated with the pursuit of individual self interest. It is also possible for the two sets of rationally determined motives to exist and operate independently of, or interdependently with, psychological motives and social influences associated with the need for justification through rationalisation. The research conducted on Expo 86 and Expo 88 indicated that a collection of objectives derived from rational and rationalisation motives become intertwined and may coexist over the life of a project with either rational or irrational motives dominating the decision process at any particular point in time. Both projects

193 were characterised by the existence of a multitude of motives that individually either reinforced, interacted with or operated independently of other motives. As well these relationships and the importance of each motive changed over the life of the projects.

194 Figure 8 A MODIFIED THREE PHASED THEORETICAL MODEL OF THE ESCALATION PROCESS PHASE 1 PHASE 2 PHASE 3 Objective Objective Objective Situation Situation Situation T1 T2 T3 (FU) (FU or FR) (FR or FC)

+ +/0 +/0 + + Perceived Project Rational Influences + • Perceived Project • Perceived Project Economics (Utility/Expectancy) Economics Economics • Response to FU • Response to FU/FR

+ Bounded + +/0 Rationality + + +/0

Rationalisation Decision to Begin a Decision to Decision to + Influences Course of Action Action Persist Action Persist T1 T2 T3 (Dissonance)

+ + +/0 + +/0 + Agency Influences + (Maximise Psychological + Psychological Individual and Social and Social Self Interest) influences Costs of reinforcing Withdrawal

persistence +

Institutional Embeddedness of Agency Project: Political Influences Support, Linkage to Ideology and

Coming Purpose +/0

Agency Influences Notes : + sign indicates positive contribution : 0 sign indicates no influences : +/0 indicates positive or no influence depending on project contingencies : T1, T2 and T3 represent different time periods (intervals) operating sequentially. : FU represents uncertain future : FR represents risky future : FC represents certain (known) future

195 The research on the two projects did not indicate that the decision making processes were dominated by uncertainty about expected outcomes. Uncertainty existed at the initial exploratory stage and in the limited sense that the explicit nature of the urban renewal process was unexpected. Also the extent of the financial losses that were ultimately incurred could not be anticipated. With Expo 86, from the data collected, there did not appear that any attempts beyond limiting the scale of the exposition were made to contain expenditures. This was because the solution provided to the mounting costs did not warrant containment. With Expo 88 the early projections of a non profitable outcome encouraged the management of BESBRA to implement measures, at considerable additional cost, to increase revenue flows, to redefine the nature of project success and to disguise the extent of the costs incurred. The evidence about the nature of uncertainly embedded in project outcomes precludes the possibility that decisions to proceed were associated with the rational utility maximising possibilities under uncertainty discussed in section 2.3. In this respect the projects conformed to experimental conditions that exclude the possibility that decisions to proceed are rational. Information provided to the decision maker makes it certain that the outcome will be a financial failure and the decision to persist will be an error. The problem was that with Expo 86 and Expo 88 financial gains or losses were not the criteria that decision makers and the public used to evaluate the success of the projects nor was the prospect of financial gains or losses directly associated with the initial celebratory reason why the projects proceeded. If uncertainty of outcomes had charactered either project during the second and third stages of the decision process it would have been difficult to distinguish the sources of the motives involved without the information collected on identifying objectives. In the absence of this information it is possible to interpret the decisions to persist with the projects as being involved with rational motives or irrational justification motives or both. The modified model recognises these possibilities by identifying the objective conditions under which decisions are made as important variables which influence the nature of the motives involved in each phase of the model. The conditions are denoted as uncertain, risky and certain.

196 The theoretical implications of these different conditions were discussed in chapter 2 and summarised in section 3.4.8. The analysis of Expo 88 indicated that justification motives were involved in the decision making process in both proactive and retrospective circumstances. The principal proponents justified their interests in staging the event in terms of the social benefits that would accrue. The final approval to stage the exposition was obtained by convincing the Queensland Premier that it would be profitable. There was a further need to justify the profit dimensions of the project after unfavourable information was received about the projected attendances. If realised, the low attendance figures would have ensured that the project would produce an unprofitable outcome and be publicly unacceptable. These events occurred five years before the exposition was held. They represent “ex ante” rationalisation expressions of justification. The psychological experimental literature on escalation of commitment has examined the role of justification as an “ex post” phenomenon. This form of justification was identified in analysis of Expo 88 in the way the financial accounts were presented and in the way the success of the exposition was defined and promoted. The possibility that justification related motives assume “ex ante” decision characteristics has theoretical implications. These are considered in the following section. In the modified model “ex ante” justification possibilities are represented in the box before phase one of the decision process. The level of analysis of Expo 88 conducted in this investigation precluded a focus on the social influences which the original model included as factors contributing to persistence. However, two of these social influences, organisational commitment and group think, were discussed in chapter 3, sections 3.4.4 and 3.4.6 and are explicitly included in the revised model as factors which contribute to persistence. These social influences in the model constructed act as reinforcing variables for the underlying rational and rationalisation motives. As well these psychological and social influences involve fundamental individual rationalisation decision making processes for their expression. A different level of analysis to that conducted could have ignored the ideographic determinants and provided explanations for persistence entirely in terms of the complex social psychological processes involved in the manifestation of social influences.

197

5.3 ASSOCIATED THEORETICAL ISSUES The modified theoretical model does not address problems of identifying objectives and determining the appropriate criteria to evaluate project outcomes. The modified model was developed from the analysis of two public sector projects characterised by complexity. Multiple objectives that derived from very different origins and motives were identified as contributing to decision making processes. This created difficulties in determining outcomes and selecting criteria to evaluate performance. The financial analysis of Expo 88 produced evidence to establish that conventional private investment evaluation criteria concerned with efficiency are insufficient to capture the range of social and economic results of complex public funded projects such as World Expositions. Research on escalation of commitment conducted in experimental conditions uses conventional financial investment criteria to evaluate projects from which the presence or absence of escalation of commitment is determined. The same method of assessment was used by Ross and Staw (1986) to evaluate Expo 86. Expo 86 produced substantial financial losses. Spurious assessment of project outcomes derive from evaluating such projects in conventional financial terms. Only by widening the nature of the evaluation did it become possible to incorporate the multiple objectives and gain a greater appreciation of the outcomes produced. These problems of evaluation and identification and specification of objectives involve theoretical and empirical dimensions additional to those addressed in the psychological literature on escalation of commitment. These dimensions and their consequences were discussed in chapter 2. From this discussion the conclusion was reached that public sector projects should be evaluated according to economic criteria that involve the calculation of social benefits and costs. Expo 88 produced ambiguous performance outcomes. Positive economic impacts and benefits were produced. On the other hand negative financial outcomes were produced that became increasingly negative as the process of evaluation used progressively more sophisticated measures of financial

198 performance. Research on escalation of commitment in organisations needs to appreciate that project outcomes may depend on the method of evaluation. If invalid methods are used to determine performance, conclusions reached about the presence of escalation of commitment may also be invalid. The analysis of Expo 88 shed light on the problem of sunk costs encountered in the literature on escalation of commitment. This problem was discussed in chapter 3, sections 3.1.3 and 3.4.5. The analysis provided support for the proposition that the entire life of a project needs to be considered before a judgement can be made about whether costs incurred are sunk or not. If sunk costs can only be determined from an “ex post” examination of results it is difficult to discern how the nature of motives involved in decisions to escalate expenditures on an investment project can be specified from an “ex ante” presumption about the sunk cost nature of the investment. The motives may be rational or irrational. Their nature becomes particularly difficult to identify if the objective conditions are characterised by uncertainty as the discussion in chapter 2, section 2.3.3 indicated. The analysis produced three insights into the sunk cost effect. First, it was not possible to determine the nature of the costs incurred before or after information was provided that indicated the project would most likely be a financial failure until after Expo 88 closed. The period over which the analysis was conducted needed to be over the effective life of the project. Second, the results were ambiguous with respect to sunk costs. In the absence of information about the multitude of objectives involved it is possible to infer that the financial results demonstrated escalation attempts to unsuccessfully recover sunk costs. On the other hand, the exposition was successful in its role as a celebration and produced positive economic benefits that vindicated non financial objectives associated with the project. Third, the analysis of motives of principal decision makers indicated generally that their principal concerns were not related directly to cost considerations except in the particular context of the need to satisfy public expectations. Decisions to proceed with the exposition after approval was granted by BIE were not based on how much had been invested or how much more it was projected to cost.

199 More generally, the expositions were not conventional investment projects in which projected rates of return are of paramount importance in decisions to proceed. Both projects involved large capital expenditures over long lead times. This was followed by operating periods of no more than six moths after which time much of the capital expended was disposed of or demolished. This unconventional investment status undermines the relevance of sunk costs and investment returns in any investigation of escalation of commitment. Neither the costs incurred nor the projected financial returns were determinate in decisions made either to hold or to proceed with the staging of the expositions. Expo 86 and Expo 86 were linked explicitly to urban renewal objectives. Research on Expo 86 produced information that suggested that it would not have been possible politically to embark on the process of urban renewal without the exposition providing intermediate assistance. The two quotations reported in section 4.2.3 that related to earlier expositions in North America suggested there were no alternatives to the courses of action adopted. It was claimed the urban renewal initiatives were contingent on the staging of the expositions. The research on Expo88 provided evidence that the contingent relationship between urban renewal initiatives and expositions was less tenuous. Expo 88 was associated with multiple objectives. The opportunity to engage in a program of urban renewal was not directly associated with the objectives that were responsible for initiatives to hold an exposition in Australia. Urban renewal was a subsidiary objective that gained importance as the convoluted decision making process evolved. The urban renewal program was conceived as a private sector responsibility that would enable the Queensland government to recover capital costs through the sale of the exposition site at an inflated price. The research conducted produced conflicting evidence on the relative importance of the staging of expositions as catalysts for economic development gained through urban renewal processes. The quality of the data sets may contribute to this conflict. The quality of the data available and the depth of analysis conducted on Expo 88 enabled the multitude of objectives involved in the staging of the exposition to be identified and their relative importance established. This was not possible with the analysis of Expo 86. If more data on the earlier exposition had been available a different perspective from that reported on the

200 contingent relationship may have emerged. Unidentified objectives may have been involved in the decision processes. Their achievement may have depended on the ability of decision makers to justify the need for the expositions in terms of the claimed relationship with urban renewal programs. It is not possible from the evidence provided by this research to substantiate the claims made about the North American expositions that they were unavoidable instruments used to progress urban renewal programs. If there were no alternatives solutions, the staging of the expositions suggest that the decision processes involved rational antecedents that knowingly or unknowingly involved substantial direct costs. The costs involved were considered to be necessary to achieve economic development objectives. If there were alternative solutions to progress urban renewal plans the staging of the expositions was an avoidable expense which involved a loss of economic efficiency and a waste of public resources. In these circumstances the decisions to proceed with the expositions can be attributed to several reasons. It is possible that the decision process was driven by rational or irrational motives derived from unidentified objectives. With Expo 88 the process was driven by objectives other than those associated with urban renewal. It is also possible that the decision processes were irrational. There is another possibility. This involves escalation of commitment by decision makers to the claimed contingent relationship. It is plausible that decision makers came to believe in the presumption of a contingent relationship. It is also plausible that the belief is reinforced progressively through a process of justification in defence of the claimed unavoidable relationship. There is a body of research literature that supports each of the possibilities proposed. The psychological literature on escalation of commitment provides support for the possibility that beliefs arise that subsequently need to be justified. The economic and sociological literature on mega projects such as World Expositions considers that such projects can be economically irrational investment projects that should not have been undertaken (see for example Beck, 1992; Flyvbjerg, Bruzelius and Rothengatter, 2003; and Giddens, 1990). Ill conceived projects proceed because of delusions about outcomes, lack of accountability, deceit, insufficient attention given to risk and rational self interest of key

201 stakeholders involved in such projects. As Flyvbjerg et al (2003:61) have observed “In reality the world of mega project preparation and implementation is a highly risky one where things happen only with a certain probability and rarely turn out as originally intended.” There is research conducted in the economics literature that maintains not only that decisions are imperfect because there is an incentive for agents to use some information imperfectly (see for example Heiner, 1988) but also that it is necessary to make irrational decisions initially in order to propel organisational change to rational action (see Brunsson, 1982, 1986; March and Olsen, 1976, 1989). As previously mentioned the nature of the research conducted does not permit the exploration of this issue beyond the level that has been discussed. The issue needs to be investigated further. Whether projects of considerable expense are unavoidable means to further courses of action have wider implications in democratic societies (Flyvbjerg et al, 2003). In the next section an attempt is made to examine relationships between theories that have featured prominently in the escalation of commitment literature as explanations of the phenomenon.

5.4 THEORETICAL RELATIONSHIPS The nature of the data sets used in the analysis of the two cases was not conducive to the identification of decisions that could be attributed to prospect theory influences. Whether such influences operated in decision making processes remains unanswered in this research, other than in the limited sense that project objectives were framed in terms of outcomes having little to do with conventional financial investment criteria. The data available provided sufficient information to identify a collection of motives involved in decision making processes that could be interpreted in terms of three of the theories identified in the escalation of commitment literature as dominant explanations for the escalation of commitment phenomenon. These theories were normative utility theory, descriptive expectancy theory and cognitive dissonance theory. Other theoretical explanations were present but these were interpreted as reinforcing influences that supported the dominant theoretical explanations. These theoretical explanations were associated with organisational commitment and group think.

202 Normative utility theory is based on the proposition that individuals seek to enhance the undescribed properties of utility through maximising their self interests. Utility theory is the standard rational model of choice in decision making conditions under risk conditions. The theory was discussed in chapter 2 sections 2.2 and 2.4. Utility theory underpins the rational economic decision making model discussed in section 2.7.2 in that chapter. It also provides the theoretical foundations upon which agency theory is built. Agency theory is predicated on the assumption that individual agents in organisations rationally pursue their individual self interests that may deviate from the best interests of the organisation. Agency problems derived from self interests of principal decision makers featured prominently in decision making processes associated with the staging of Expo 88. Agency theory was discussed in chapter 3, section 3.4.3. The two cognitive theories of motivation that dominate explanations of escalation of commitment in the psychological literature were introduced in chapter 3, section 3.4.1. They were discussed in section 3.5. Expectancy theory was developed by Vroom (1964). The theory owes much to the earlier expectancy theory of Edwards (1954) that derived its origins from expected utility theory. Dissonance theory was developed by Festinger (1957). The “insufficient justification paradigm” is a particular elaboration of dissonance theory. It is from this elaboration that behaviour exhibited in escalation of commitment situations is explained. Decision makers rationalise their erroneous choices through a process of “ex post” self justification. It is this explanation that Staw and Brockner and their associates mainly attribute to the irrational behaviour exhibited by decision makers in laboratory experiments when they escalate their commitment to a particular course of action. In this section, an attempt is made to express these two descriptive psychological theories of cognitive motivation in terms of traditional expected utility theory. A close inspection of the Vroom model reveals a very clever reformulation of traditional expected utility theory and the novel use of new words to replace utility associated concepts. Together, these modifications transform a normative decision theory into a functionally rational descriptive theory of motivation. A more powerful explanatory model of cognitive motivation is derived that, in the process, sacrifices the assumed predictive power of expected utility theory. The

203 theoretical generalisability and parsimony of utility theory has been removed. However, the much maligned and essential transitivity axiom of utility theory is retained implicitly. It now assumes a discontinuous transitive form based on a needs hierarchy. The implications of retaining the axiom of transitivity in a motivational context have not been explored in the literature. The possibility that the choice of preference states may be inconsistent, potentially produces a fundamental weakness in expectancy theories of motivation. There is also a theoretical problem associated with cognitive dissonance theory. As a theory of motivation it is not independent of expectancy theories of motivation. It is possible to reconstruct and reconceptualise dissonance theory at the general motivational level of explanation as a special form of expectancy theory. In expectancy theory, the value of a preference for a particular outcome, which an individual is motivated to fulfil, derives from the instrumentality associated with the achievement of an outcome. There are two classes of outcomes in expectancy theory. The objective outcome which may have no intrinsic value or may only assume value when it is associated with its instrumental role in securing second order outcomes. The nature of these second order outcomes traditionally have been conceptualised in terms of a needs hierarchy. These dual outcomes share an approximate equivalence to expected value and expected utility in decision theory. From an expectancy theory perspective, dissonance theory merely specifies that the contingent need which individuals are motivated to fulfil most urgently is the reduction in dissonance induced tension or pain through the restoration of consonance. It is this situational need which is valued most highly. Preferences are ordered in terms of the need either to reduce the level of intensity of cognitive dissonance or to avoid the possibility of its existence. If adverse consequences threaten a belief in one’s competency, dissonance can be reduced through a process of self justification. From a decision theory perspective, expectancy theories of motivation can be conceptualised as particular forms of expected utility theory in which new words substitute for concepts in utility theory without any significant change in meaning. In utility theory, the value of a preference for an outcome is its subjective expected utility. In expectancy theory the value of a preference for an

204 outcome is the valence associated with its expected instrumentality. Utility is an unspecified motivational concept which possesses the property of ordinal measurability. It serves merely as the underlying construct which enables behaviour based on the choice of alternatives to be predicted. Instrumentality is a motivational concept that specifies the descriptive nature of utility as being associated with the hypothetical construct of a need hierarchy. In effect, the concept of utility maximisation has not been abandoned. Rather, it has become diluted. It has been replaced and provided with specification with the proposition that preferences exist and are ordered in terms of their value in a needs hierarchy. A needs hierarchy is a hypothetical structure in which higher order needs take precedence over lower order needs, provided that lower order needs have been satisfied (Maslow, 1954). Once a need has been satisfied it is no longer motivating. The needs hierarchy determines the value of a choice of an alternative. The concept of utility has been endowed with a powerful motivational explanatory structure that, as previously stated, does not enhance the predictive power of utility theory. The predictive power of expectancy theories are compounded further by two additional complications. Firstly, the satisfaction of particular needs is associated with particular learned behavioural responses which become reinforced and routinised. The need to engage in further cognitive decision making activity is extinguished in these situations. Automatic behavioural activities are associated with learned responses to particular need induced stimuli. Secondly, individual behaviour is influenced by actions which are culturally prescribed as social norms and by imitating or modelling the behaviour of significant others. Again, patterns of learned behaviour that are determined by these forms of social forces do not involve or may not involve a direct motivation induced cognitive decision making response. The result is that there exists a range of behavioural patterns which are prescribed by reinforced habit induced responses, rather than through the exercise of reason. These habitual forms of behaviour are consistent with the essential transitivity axiom of individual rational behaviour. They merely represent abbreviated and functionally adaptive responses to the goal of utility maximisation. Their existence enhances the predictive power of positive economic models

205 designed to investigate basic economic consumer behaviour. On the other hand, the existence of automatic learned responses to an extensive range of basic economic needs complicates explanations of human behaviour derived exclusively from a motivational perspective. The existence of a discontinuous motivationally regulated needs hierarchy reduces the explanatory power of the postulated behaviour outcome expectancy learned connection. The complex motivational structure of utility however, does provide a theoretical perspective to understand why the essential rational axiom of consistency in the choice and ordering of preference states is systematically and unsystematically violated. This conceptualisation of utility also provides an alternative perspective to the cognitive and emotional reasons usually expressed to explain the inconsistent and heuristic behaviour patterns investigated in prospect theory. An essential component of any explanation is the proposition that individual self interest is defined in terms of a needs hierarchy. Value is manifested in terms of motives to fulfil needs organised according to a preference structure, which remains unsatisfied. Because satisfied needs are no longer motivating, they do not possess any utilitarian value. This is contrary to the usually expressed axioms in utility theory that human wants are unlimited which prohibits need satiation and ensures that more is preferred to less albeit, at a diminishing rate. From a decision theory perspective, cognitive dissonance theory, conceptualised as a special form of expectancy theory, now becomes a special case of expected utility theory. Individuals are motivated to order their preferences in terms of a utility function that maximises the need to maintain an equilibrium state of consonance. The value of a preference for an outcome is determined in terms of dissonance avoidance or reduction. From this utilitarian perspective, the rationalisation explanations for the escalation of commitment phenomenon can be conceptualised as rationally determined ordered preference expressions of consonance, provided that the preferences are formed independently of any efficiency dimensions. From the psychological perspective just presented, the two dominant theoretical explanations for the existence of the escalation of commitment phenomenon are not mutually exclusive. They are different manifestations of the

206 same underlying construct of cognitive motivation in which individual preferences are ordered according to the strength of different individual needs. Moreover, it has been argued that both dissonance theory and expectancy theory can be conceptualised as special forms of expected utility theory in decision theory in which the unspecified motivational attributes of utility have been given expression. In the analysis of Expo 88, the need to justify decisions was interpreted as both an “ex ante” and an “ex post” phenomenon. In “ex ante” circumstances, justification assumes rational derivatives in terms of the perspective presented above. To the extent that the arguments presented in this section are logically defensible it is conceivable that the irrationally prescribed self justification motive used to explain behaviour in escalation of commitment situations may assume rational antecedents in organisations. In the research literature, rationalisation is an “ex post” consequence of incorrectly choosing courses of action that escalate commitment to an investment decision. There are two possibilities for the self justification motive to assume rational antecedents. The first is where, as in the Expo 88 situation, the need to justify a particular course of action was incidental to the dominant objectives and occurred before and during the times when decisions were made to continue with the staging of the exposition. The second is where, as explained in chapter 2, section 2.7.2, the decision maker is confronted with uncertainty about the future prospects of a particular course of action and develops beliefs that justify persistence with the course of action adopted. This section has explored the possibility that utility theory, expectancy theory and dissonance theory are interdependent. Expectancy theory is the rationally descriptive derivative of normatively rational expected utility theory. Cognitive dissonance theory when conceptualised in terms of the status of consonance in the needs hierarchy assumes characteristics of expectancy theory. These characteristics may assume rational foundations. In the next section a synthesis of the theoretical influences that contribute to escalation of commitment type behaviour in organisations is undertaken.

207 5.5 THEORETICAL INFLUENCES IN ORGANISATIONS Table 6 encapsulates how, and under what circumstances, the various theoretical explanations identified in the thesis may contribute to escalation of commitment type behaviour in organisations. The table is concerned with capturing two crucial stages in the decision making process. The first is the initial stage when the decision to invest resources under conditions of uncertainty is made. The second is the stage when information is received by decision makers about the negative prospects of the original investment decision. It is at this stage that decision makers first choose either to increase or decrease their commitment to the expenditure of additional investment resources.

TABLE 7

THEORETICAL EXPLANATIONS FOR ESCALATION TYPE BEHAVIOUR IN ORGANISATIONS PROJECT FORMATION STAGE RECIPT OF INFORMATION STAGE DECISION ENVIRONMENT DECISION ENVIRONMENT AND DECISION POSSIBILITIES OF OUTCOMES • Uncertainty of outcome(s) (a) Uncertainty (negative feedback equivocal) • Project Objectives • High probability that decision influences o Unclear (Uncertain) remain/reinforced as per initial phase o Multiple possibilities depending on contingencies o Of public or private potential benefits • If decision processes rational increased o Feasibility studies equivocal likelihood of “sunk cost” situation with • Provides opportunities for pursuit of self evaluation of outcomes possible only interest possibilities retrospectively • Opportunities contingent on extent of (b) Prospect of loss outcomes unequivocal ownership / management congruence, • Influences as per Ross and Staw model with nature of corporate governance, reporting, escalation reinforced by identified research extent of decision making autonomy psychological, social and structure embeddedness factors • May be exacerbated by group contingencies and organisational defence mechanisms Or Contingent circumstances permit agency influences to be exercised (c) Prospect of loss outcomes probable but not certain Either High prospect of (a) influences continuing Or Maximise utility (convex in negative space) in belief that potential losses recoverable, reinforced by prospect theory loss aversion Or Agency prospects dominate decision processes

208 DECISION MAKING PROCESS POSSIBILITIES UNDER UNCERTAINTY/COMPLEXITY • Attempt to maximise utility/expectations which may or may not coincide with organisational objectives • Attempt to follow rational decision process model • Prospective satisfaction of unmet needs (e.g. dissonance) • Engage in satisficing rational /irrational decision processes such as o Use of heuristics o Past experience o Intuition o Implicit favourite models CONTINGENT INFLUENCES ON DECISION MAKING CONTINGENT INFLUENCES PROCESSES • Level of organisational commitment of • Ability to identify and rank objectives and principal decision maker(s) potential outcomes • Extent of group influences on decision • Extent to which objectives are scrutinised maker(s) • Nature of investment project • How project variables are framed (Prospect • Extent of internal and external monitoring of theory) decision processes • Extent of deceitfulness either deliberate or • Extent to which monitoring agencies are able to opportunistic with guile influence the decision process

The table indicates that various decision making processes may be involved in the initial stage when investment resources are committed to an investment project under conditions of uncertainty. The commitment decision may involve rational or intendedly rational or irrational process. These processes may, depending on the circumstances, be influenced by the affective attachment of decision makers to an organisation, by how the objectives and potential outcomes of the investment project are framed and by the pressure to conform to group expectations and influences. The decision environment may provide opportunities for decision makers to pursue their own self interests independently of organisational interests. Principal-Agency theory explanations for the commitment of resources at this stage of the decision process depend on project variables such as scale, complexity and project objective possibilities. They also depend on organisational governance variables. The potential for decision makers to engage in opportunistic behaviour is associated with the extent of decision making autonomy granted to the principal decision makers and the effectiveness of internal and external monitoring of organisations and personal performance.

209 At the stage when decision makers in organisations receive information about the prospective outcome(s) of the initial investment of resources, it is not immediately obvious what explanatory processes are involved in the decision to commit additional resources to investment projects. Explanations for why decision makers commit additional resources at this stage depends not only on the knowledge, capabilities and motives of the decision makers but also on the state of the information received and on a collection of contingencies which, if percent, contribute to escalation of commitment of resources. If the information received about investment outcomes remains uncertain or the project does not encompass multiple objectives, some of which are not directly associated with the pursuit of profitability, then there are no compelling reasons to suggest that the decision processes involve explanations which are any different from the possibilities listed in the table in the initial stage. The processes may be rational, intendedly rational or irrational. It is also possible that processes are consistent with the rational framework associated with the determination of sunk costs. If the negative information received about projects is unequivocal (extremely improbable that positive returns will be realised), the most likely explanation for escalation of commitment at this stage is retrospective rationalisation reinforced by the collection of psychological and social influences identified by Ross and Staw (1986) which were derived from the laboratory experiemental research. The only other likely explanation for the commitment of additional resources under the unequivocal condition involves decision makers pursuing their own self interests. Whether agency influences are likely depends on whether contingent circumstances provide opportunities for decision makers to further their own interests. The table summarises the possible theoretical explanations for escalation of commitment in the decision environment where the negative information received by decision makers is problematic (realisation of losses is probable but not certain). Depending on the nature of the investment project and the associated contingencies, explanations for decision makers to escalate their commitment of resources may be no different from those possible explanations identified in the initial stage. They may also be associated with rational behaviour derived either

210 from agency relationships or from attempts to maximise utility when the utility function assumes convexity. This analysis indicates that escalation of commitment type decision making behaviour in organisations will be enhanced, and may be anticipated, if they decision making environment is uncertain or equivocal, if the investment project is complex and associated with multiple objectives that are poorly articulated, if managerial control is divorced from ownership, if there is a high degree of executive autonomy, if performance monitoring is deficient, if the climate of the organisation is resistant to change, and if decision makers are susceptible to group influences, display high levels of organisational commitment and are vulnerable to ego defensiveness.

5.6 CONTRIBUTION OF THE THESIS The concept of escalation of commitment in two public section organisations with unusual investment characteristics was examined in this thesis. World Expo 86 in Vancouver and World Expo 88 in Brisbane required substantial capital expenditure during the long periods of site preparation. The events were attended predominantly by local residents. They lasted 164 days and 184 days respectively after which time most of the purpose built structures and improvements were demolished. Both expositions were initiated by influencial individuals who were committed to the idea of holding World Expositions for a multitude of reasons in the public interest that included their value as celebratory events and their instrumental role in progressing economic development objectives through urban renewal processes. World Expo 88 also acted as the means that enabled the Queensland government to demonstrate competence in managing projects. A prominent characteristic of World Expo 88 revealed from the analysis was the extent to which private interests were involved in the decision making process. This thesis has provided a theoretical and an empirical contribution to the research literature on escalation of commitment. The major theoretical contribution has been the extensions made to the theoretical model constructed by Ross and Staw (1986) to explain the escalation of commitment process in

211 organisations. The research conducted on Expo 86 revealed an alternative perspective on the nature of the motives involved in the decision making process from that advanced by Ross and Staw to explain why decisions were taken to persist with the event when information disclosed that the event would fail financially. The different perspective disclosed a collection of motives that dominated the decision making process throughout the life of the project. These involved the pursuit of rational economic project related objectives that were independent of the financial outcomes pursued in conventional investment projects. The theoretical model was modified to accommodate the influence of these rational motives. The inclusion of rational influences introduces the possibility of a different interpretation of why complicated events such as Expo 86 occur other than the irrationally driven escalation prototype interpretation proposed by Ross and Staw (1986). The research conducted on Expo 88 supported the research findings obtained from the analysis of Expo 86. Expo 88 was used as the ideal vehicle to achieve a collection of economic development and public policy objectives that were considered by principal decision makers to be largely independent of the actual financial outcome produced by the event itself. Decision makers knew that there was a high probability that the exposition would be a financial failure. This knowledge did not deter them from proceeding with plans for the exposition. Nor was the decision to proceed based on a decision error. There was concern expressed about an adverse public reaction to the expected unprofitable nature of the venture. This concern led to the adoption of various measures that ultimately induced the public perception that the exposition was successful. As previously mentioned the need to justify the outcome resulted in some of the measures adopted. The quality and nature of the available data analysed in the Expo 88 case study enabled a third set of motives to be identified in the decision making process and their importance established. The influence of these motives produced the most significant changes to explanations for why events occurred in the theoretical model. Particular interests of principal decision makers and the extent to which they were driven to satisfy these interests were instrumental in decisions adapted to stage the exposition throughout the life of the project. These

212 individual interests coincided with and deviated form the assumed public interests of the project. Self interests are captured in the modified theoretical model as agency theory related problems involving the divergence between individual interests of decision makers and the best interests of organisations. These agency problems, it is suggested may be influential in each phase of the decision making process. The identification of the pervasive role assumed by individual self interest in the investment decision making process represents a significant theoretical contribution and potentially the most disturbing. The finding suggests that when there is inadequate public accountability, inadequate monitoring of executive decisions, insufficient attention devoted to risk and uncertainty and the presence of ambiguity about appropriate criteria of evaluation, the opportunity for individual decision makers to pursue self interest is enhanced with the exercise of these interests becoming more probable in organisations with diversified or public ownership. In any of these circumstances, behaviour in organisations that produces escalation of commitment to courses of action that result in adverse financial consequences may be due to an irrational response to the need for self justification. Behaviour may also be explained in terms of rational antecedents that include the strong likelihood that decision makers are engaged in the pursuit of their own interests. The research on Expo 88 indicated that the latter is engaging and pronounced. The exercise that explored relationships between expected utility theory, cognitive expectancy theory and cognitive dissonance theory represents an additional theoretical contribution. The exercise indicated that it is possible to express expectancy theory and dissonance theory in terms of expected utility theory. If, as occurred in Expo 88, the need to justify particular expected outcomes assumes antecedent characteristics, then supposedly irrational decisions can be considered to be rational. Individual utility is enhanced though a reduction in cognitive dissonance. The managerial implications are disturbing. The need to use appropriate criteria to evaluate investment projects has been a recurring methodological theme throughout this thesis. It has been discussed at considerable length in earlier chapters. The financial consequence of using different investment criteria was demonstrated in the financial analysis of

213 Expo 88 in chapter 4 and appendices F and G. Unless the appropriate criterion is used to evaluate outcomes, there is the potential for investigators to judge projects as examples of escalation of commitment when a different criterion would indicate otherwise. The principal methodological contribution of this thesis is an extension of the need to use appropriate evaluation criteria. It involves the argument, supported by subsequent illustration of consequences, that public projects should be evaluated in terms of economic effects that involve impacts and social cost benefit considerations. The analysis of Expo 86 and Expo 88 independently demonstrated that courses of action adopted could be interpreted differently when the evaluation of outcomes was extended beyond the use of conventional financial investment criteria to encompass the use of economic impact and social cost benefit criteria. From the case study analysis of the two expositions it was possible to construct more generalised explanations, albeit incomplete and exploratory, for why escalation of commitment type behaviour occurs in organisations. The possibility that several theoretical explanations may be involved in the escalation of commitment process crucially depends not only on whether and for how long the decision environment is characterised by uncertainty but also on characteristics of investment projects such as size, scope, duration, complexity, ownership and the presence of one or more objectives and potential outcomes. Under the decision condition of uncertainty several theoretical explanations involving rational, intendedly rational and irrational decision processes are plausible. The nature of the project may provide contingent circumstances that promote irrational decision making and reveal opportunities that encourage self interested behaviour from decision makers. The research conducted in this thesis contributed to the embryonic research literature that indicates that it may be possible to identify prospectively, important, but variable influences that contribute to the likelihood that organisations will be vulnerable to escalation or commitment tendencies as investment projects are progressed.

214 5.7 LIMITATIONS OF THE THESIS The sequential theoretical model of escalation of commitment in organisations developed by Ross and Staw (1986) has been extended to accommodate the findings of this research. The extensions represent an achievement but they also represent a limitation. The extensions to the model derived from an analysis at a particular level of two studies that displayed few of the characteristics associated with conventional investment projects either in the public or the private sectors. Private investment projects and public infrastructure projects are associated with specific efficiency related objectives, the achievement of which can be evaluated with the use of standard measures of rate of return on investment. The two case studies analysed were associated with multiple objectives in the public interest and in the interest of individuals responsible for decisions made. Consequently, the generalisability of the extended model is questionable. It is possible that the usefulness of the extended model is restricted to public projects that are not directly related to infrastructure development. Even though the purpose of the research was exploratory, the two cases analysed represent a poor choice of selection from the perspective of theory development. A more representative selection of cases concerned with conventional investment projects could, it is suggested, produce results that refine the analysis concerned with generalised explanations of the escalation process. A further limitation related to the multitude of objectives identified. The nature of the analysis and the extent to which objectives appeared to be interrelated resulted in an inability to determine the relative importance of each of the objectives or indeed which of the many objectives was the most important. The analytical perspective adopted required considerable judgement. It is entirely possible that the particular perspective adopted was inappropriate. Fundamental differences between the conclusions reached in this research and those reached by Ross and Staw in their analysis of Expo 86 derive from the different perspectives adopted. Perspectives adopted influence the selection of data, the interpretation of data and the evaluation of data. Because of the inability to

215 determine the relative importance of each objective, whether the perspective adopted was appropriate remains unresolved in this research. The perspective adopted led to the use of economic welfare measures of evaluation of outcomes. Ross and Staw chose to evaluate Expo 86 as if it was a private investment project. Each method of evaluation produced different results which impacted on conclusions reached about the nature of the decision process involved. In this thesis a societal perspective was adopted for evaluation purposes. Ross and Staw chose to evaluate Expo 86 in terms of its efficiency which is defensible and appropriate from a different perspective to that selected in this research.

5.8 CONCLUSION This chapter summarised the theoretical explanations proposed in the literature for the development of escalation of commitment in organisations. The results reported in chapter 4 were related directly to the theoretical model developed by Ross and Staw (1986) from their investigation of Expo 86. As a result of additional findings and the theoretical interpretation of the findings, the theoretical model was modified to accommodate influences that were either not considered in the original model or were considered not to have any impact beyond the initial phase of the sequential process. Rational economic project variables had major impacts on the initial investment decision and continued to be influential over the effective life of the projects. Agency problems represented the inclusion of a new set of influences in the theoretical model. These derived from the personal interests of principal decision makers. These interests had a profound and continual impact on decisions made in relation to Expo 88. In the original model psychological variables associated with justification assumed a dominant influence during the second phase of the process. In the modified model it is recognised that these variables may assume influence during the early phase of the process. The early appearance of these psychological variables led to an examination of possible relationships between three of the theories proposed as explanations for the escalation phenomenon. In the examination it was argued that it was logically possible for the two cognitive theories of motivation to assume rational antecedents when conceptualised as

216 particular forms of expected utility theory. In a practical sense the dominant theoretical explanations coexisted and become intertwined. These and the other theoretical explanations identified, contributed to a greater understanding of the general conditions under which the various theories influence decisions. The problem of determining appropriate criteria to evaluate projects such as World Expositions was discussed briefly and followed the general discussion of principles of evaluation encountered in earlier chapters. The problem of sunk costs was discussed in the context of the two cases investigated. If was argued that expenditures incurred could not be classified as to their nature until after the projects had effectively ended. The problem of sunk costs led to a discussion about whether the projects investigated were necessary as intermediate instruments to achieve economic development objectives. The discussion was inconclusive. There was research evidence available to support their unavoidability. There was also considerable research available to suggest that they were avoidable, but because they proceeded, the consequences were a loss of economic efficiency and a waste of public resources. The contributions and limitations of the thesis were discussed in the final sections. The next chapter provides a conclusion to the thesis.

217 Chapter 6 CONCLUSION

Is it possible to explain decision making behaviour in organisations that produces escalation of commitment to investment courses of action that are failing? Is it a process of decision making in which decision makers behave rationally initially, then persist with failing courses of action by progressing to irrational behaviour because of the psychological need to justify their actions? Is this irrational inducement towards escalation of commitment reinforced differentially by social influences and institutional constraints that inhibit the possibility of withdrawal from an investment project as it is advanced? Is it possible that the escalation of commitment phenomenon encountered in organisations is predominantly a convoluted rationally motivated decision making process during which opportunities emerge for decision makers to engage in the pursuit of individual self interest that correspond with and diverge from project objectives? Is it possible that conventional investment measures of project evaluation provide misleading assessments of outcomes in public sector projects? Is it possible to be misled about the value of project outcomes when judgements about outcomes are based on conventional calculations of private rates of return on investment? Is it possible that contingent circumstances increase the likelihood that decision makers will engage in escalation of commitment type behaviour? This thesis did not provide answers characterised by generalisability to any of these questions. It did, however, contribute to greater understanding of these and related questions in the particular context of the examination of two World Expositions and in more generalised organisational contexts. World Expositions celebrate human scientific achievements. They are unusual publicly endorsed and predominantly public funded projects that display few of the characteristics associated with conventional investment projects. World Expositions are approved by BIE, an international organisation established in 1928 by a diplomatic convention. BIE deals only with national governments. Expositions require long lead times of site preparation that involve substantial capital expenditure. The two

218 expositions examined in this thesis lasted approximately six months only, after which time substantial capital improvements associated with site preparation were demolished or sold in order to prepare the sites for alternative planned uses. It is unusual for governments hosting these events to expect them to be profitable or cost neutral although some expositions held in the past have been profitable. The life cycle of these events makes the probability of a profitable outcome unlikely. On the other hand, their life cycle combined with their celebratory value makes these events attractive to host governments as instruments to pursue objectives predominantly of a political and an economic development nature. These objectives are not directly associated with the celebratory value of expositions and they are unrelated, except incidentally, to the profitability objective associated with conventional investment projects. The heterodox nature of the two investment projects examined in this thesis limited the applicability of the major theoretical contribution. The analysis of the two expositions provided sufficient information to conclude that escalation of commitment in organisations is more complex than is suggested in the literature. An exploratory attempt was made to capture this complexity by summarising how theoretical explanations concerned with rational, irrational and intendedly rational behaviour could independently or inter dependently be responsible for the escalation phenomenon. The possibility that one or more theoretical explanations is primarily responsible depends on the existence of uncertainty in the decision environment and a number of contingent possibilities associated with the investment project. This comprised modifications and extensions to the theoretical model introduced in chapter 4. This limitation was compensated for by access to rich data sources, particularly in the case of Expo 88, which enabled a multitude of objectives with diversified motivational origins to be identified. The heterodox nature of the expositions were ideal projects to demonstrate the inappropriateness of using conventional investment rate of return analysis to evaluate their outcomes. Expo 86 made substantial financial losses. Expo 88 also made substantial financial losses when all costs directly related to the project were accounted for. This adverse financial outcome deteriorated when the accounting revenue and cost flows were expressed in terms of discounted real present values.

219 Nevertheless, both projects were successful in achieving public objectives unrelated to the private calculus of profitability. Their celebratory value was vindicated through attendance figures (a record in the case of Expo 88) and the positive reaction expressed by most of the public at the pleasure experienced. The initiative for the events originated in proposals to stage World Expositions as centrepieces to celebrate the centenary of Vancouver and the Australian Bicentennial. Promoters expected costs involved in staging the celebratory events to exceed revenue collections. By the time BIE gave approval for the staging of the expositions the celebratory purpose was linked directly to the derivation of economic development initiatives expected to flow from the renewal of the decayed urban sites selected. The authorities established to manage the expositions recognised the redevelopment objectives in their charters. In the case of Expo 88, the redevelopment objective was incorporated in the name of the authority; Brisbane Exposition and South Bank Redevelopment Authority (BESBRA). The economic development objectives were achieved broadly as planned in Vancouver and contrary to the planned intensions of government in Brisbane. The plans that were implemented were an expression of public demands influenced by their experiences at the exposition. They produced more sustainable and spectacular effects in changing life styles in Brisbane than would have occurred had the state government’s plans been implemented. Expo 88 acted as the catalyst for changes in life styles and the urban environment that were largely unanticipated by the state government. The combined effects of those changes to the spacial and architectural characteristics of the urban environment, to public transport systems and to life styles that evolved from Expo 88 enhanced Brisbane directly and Queensland indirectly as tourist destinations. This increased attractiveness to tourists was not anticipated when the use of Expo 88 as a hallmark event to promote international tourism featured prominently as an objective in moves by the Queensland government to gain approval for an exposition. The tourist developments that were expected to flow from tourism promotional use of Expo 88 were never confirmed. International and domestic tourism in Australia was adversely affected in 1989 by a severe external shock in the form of a pilots’ dispute. The immediate effects of Expo 88 on tourism were not expected. These involved the spacial and

220 temporal redistribution of tourism flows in Australia. The magnitude and duration of the event made Brisbane the preferred tourism destination in 1988 to the detriment of tourist destinations outside southeast Queensland. Tourism numbers experienced in Queensland over a twelve to eighteen month period were condensed into the six months of the exposition. The existence of non profit related objectives complicated the theoretical development and empirical investigation of the escalation of commitment phenomenon in this research. Because of their unprofitable financial outcomes it would have been possible to conclude that these projects qualified as escalation of commitment prototypes. At a higher level of analysis than that undertaken, alternative explanations derived from organisational commitment and group think would have been possible. By adopting a perspective that focused attention on the reasons why they were unprofitable it would have been possible to produce evidence in support of the theoretical model of escalation of commitment developed by Ross and Staw from their analysis of Expo 86. The conclusion would have been erroneous. A research finding which supported the theoretical model would have been incomplete and misleading. The nature and depth of analysis conducted on Expo 88 in chapter 4 and appendices F, G and H provided support for arguments developed in chapter 2 about the ambiguity of the measures used to evaluate investment and the need to evaluate complex public funded projects such as the expositions investigated in this research in terms of their economic contribution. The analysis also provided support for the contestable argument expressed in chapter 3 about the identification of sunk costs. This research demonstrated that investment projects needed to be investigated over their effective life before the nature of costs involved could be determined unequivocally as sunk costs. Both expositions were successful in providing social economic benefits even though the precise nature of success was not anticipated by the promoters. From a conventional investment viewpoint, expenditures incurred in the development of the Expo 88 site would have been judged as sunk costs because decision makers knew that the exposition would most likely be unprofitable. By the time the event ended, a different judgement would have been formed. The social economic benefits generated, it could be argued, justified the costs incurred.

221 The most significant finding from the empirical research was not unexpected. Much of chapter 2 was concerned with the development of definitions of the resource allocation problem, rationality, individual utility and organisational efficiency. Considerable attention was devoted to the possibility that individual interests of decision makers could deviate from the efficiency requirements of organisations over which they had managerial control. This was because utility maximisation, derived from the pursuit of rational individual self interest, was theoretically independent of the maximisation of organisational efficiency. The investigation of the origins of Expo 88 in chapter 4 revealed that the initiative was due to the efforts of a number of influential individuals who were driven to achieve a variety of objectives of public and personal interest. Many of the objectives were based on ill defined beliefs and the possible consequences of these beliefs were inadequately considered but were subsequently justified. What was unexpected was the dominant role assumed by individually formulated rational objectives in the decision making process and the extent to which individuals were motivated to achieve objectives of assumed public interest and simultaneously satisfy objectives of individual self interest. The capacity of individuals involved in the decision making process to command such influence was associated with several circumstances. There was the problem, exaggerated in the public sector which lacks the discipline of the market, of ownership being divorced from managerial control. The possibilities to engage in opportunistic behaviour as a result of this divorce were enhanced by the lack of public accountability. Individual commitment to the event encouraged a willingness to proceed with the event and subsequently to enhance the attractiveness of the event without sufficient knowledge to make reasonable decisions. The climate surrounding the event encouraged the withholding of adverse information from the public. Event success was redefined in terms of attendance records and the extent to which the event was unprofitable was disguised through deceptive accounting practices which did not reveal off balance sheet expenditures. It was also associated with lack of experience of the risks and uncertainties involved in mega projects such as World Expositions which, because of their costs, encouraged the development of multiple objectives, other than their celebratory purpose, and produced multiple consequences many of which were unforseen.

222 These research findings were instrumental in the development of modifications to the theoretical model of escalation of commitment in organisations. The structure of the theoretical model was retained. The structure emphasised the sequential nature of the development of escalation of commitment through the differential influence of different motives and variables on the behaviour of decision makers. In the original model the rationally motivated economic project related explanations responsible for the initiation of investment project gradually were replaced by irrational psychological explanations derived from the need to justify additional resources being invested in financially failing projects. Decisions to escalate commitment to failing projects were reinforced by social and psychological influences derived mainly from the experimental research literature and institutional constraints that increased the financial and psychological costs of withdrawal. The development of the modified model represented the major theoretical contribution of the thesis. If differed from the original model by recognising that rational explanations could be responsible for decisions to persist with investment projects throughout their life even though external, but false, impressions indicated early in their project life that they would fail financially. The rational explanations derived from the utility expected from the achievement of economic objectives, from intendedly rational derivatives and from the agency problem of decision makers in organisations pursuing their individual self interests. Rational explanations occupied a prominent role in the modified model either because of uncertainty about project outcomes or because objectives that dominated the decision making process were not related directly to any requirement by decision makers to produce a profitable private return on investment. The explanation that irrational psychological motives associated with a need for justification were responsible for decisions to persist with investment projects with early indications of financial failure were strengthened in the modified model. This was done by recognising that this explanation was not confined to subsequent phases of the decision making process but could be also applicable at the beginning of the decision making process. The central feature of the modified theoretical model was the explicit acknowledgement that escalation of commitment to an investment project in

223 organisations could either be a rational process or an irrational process or a process in which rational and irrational explanations operated interdependently to produce a multitude of outcomes. Which process or combination of processes dominated decision making was contingent. It depended on the nature of the particular investment project and the presence or absence of uncertainty in the decision environment. The possibility that the need for justification could be an antecedent explanation for escalation of commitment inspired the analysis that sought to determine whether three of the most prominent theoretical explanations proposed for the existence of the phenomenon were related through the hypothetical construct of motivation. The three proposed explanations derived from normative expected utility theory, cognitive expectancy theory and cognitive dissonance theory. These were introduced in chapters 2 and 3. The analysis conceptualised the cognitive motivational theories as special forms of expected utility theory. The conclusion reached from the logical arguments developed was that expectancy theory was the descriptive equivalent of expected utility theory and that cognitive dissonance theory in certain circumstances could assume rational antecedents. This implied that the irrational justification explanation proposed for escalation of commitment could be a rational self interested response to the need for decision makers to achieve an equilibrium state of consonance. A characteristic of the Vancouver exposition was the suggestion that economic development objectives expected to be achieved from the renewal of a decayed urban area would not have been possible without the exposition. There is research to support and refute the claims made by organisers of the event that it was an unavoidable necessity to achieve desired ends. The different claims were not central to this investigation. The research reviewed was inconclusive. It is an important issue in need of further research because of the resource allocation issues involved, the lack of concern with efficiency maximisation and the apparent acceptance of satisficing behaviour as the basis of decision making. The research produced three practical implications of importance. The first and most important derived from the considerable capacity revealed by the research for decision makers to pursue individual self interests in organisations. There is a need for increased vigilance to ensure that decision makers are unable

224 to purse self interests that are not in the best interests of the organisation. The research indicated that the capacity for the promotion of self interests can be pronounced where decisions involve complicated large scale projects with considerable risk and uncertainty of outcomes. It can also be pronounced in organisations where there are inadequate measures of evaluation available to account for the courses of action adopted by managers. Public sector organisations and those corporations with extremely diversified ownership appear to be the most vulnerable as research on agency theory would confirm. The second involved the need to use the most effective measure to evaluate investment projects. This was a recurring theme throughout the thesis and its importance cannot be underestimated. Investment projects are undertaken for very different purposes, in different institutional contexts, produce intended and unintended consequences and the purpose may involve a multitude of objectives. The use of inappropriate measures of evaluation may provide misleading information about the nature of investment outcomes. This information may be used to form misleading judgements about the nature of the investment including whether it represents an example of escalation of commitment. The third involved the possibility that the potential for escalation of commitment type behaviour to occur in organisations could be partially anticipated. The potential to escalate commitment is enhanced when investment projects are complex with poorly defined objectives and unknown outcomes, when performance monitoring and intervention measures are inadequate and when principal decision makers are influenced by group processes, are affectively attached to their organisation and display high ego defensive patterns of behaviour.

225

APPENDIX A

DEFINING EXPECTED VALUE AND EXPECTED UTILITY

The calculation of the expected value of an alternative and the expected utility of an alternative is derived directly from the additive laws of probability theory (Savage, 1954).

The expected or actuarial value (EV) of an alternative (Ai) is defined as the sum of the probability (Pij) weighted outcomes (O1-n) associated with the alternative (Ai). It is calculated from the following expression:

EV (Ai) = Pi1 O1 + Pi2 O2 + … Pij Oj +… PiN ON

The expected utility (EU) value of an alternative (Ai) is defined as the sum of the joint probability weighted (Pij) and utility weighted (u) outcomes (O1-n) associated with the alternative (Ai) (Bernoulli, 1738). It is calculated from the following expression.

EU (Ai) = Pi1 u O1 + Pi2 u O2 + … Pij u Oj +… PiN u ON

226 APPENDIX B

TRANSFORMATIONAL PROPERTIES OF NORMATIVE UTILITY FUNCTIONS

There are four properties necessary to permit utility functions to be subjected to mathematical calculations (Arrow and Hahn, 1971). These are:

(1) There is a finite number of alternatives (Ai) attached to outcomes (Oj), say “n” so that each alternative outcome (x) can be characterised numerically in terms of a common “unit of measurement”. This property

allows any combination or assortment of alternative outcomes (X= Ai

Oj), to be expressed numerically as a vector with “n” components: (X1,

X2,… Xn) where each component always refers to the same alternative outcome. Each alternative outcome is considered usually as being linked with an axis in spacial dimension, “n”, of real numbers, Rn. It is conventional to limit the alternative outcomes set to an area of space which is substantially less than that covered by the entire space of real numbers, Rn. In economics, alternative outcomes are usually considered to be economic commodities, or goods or services in the context of the utility of individual consumers; (2) An alternative outcome (x), conventionally a commodity, does not contain any “negative components”. This property specifies that the

outcome vector, x=f (x1,x2,-xn) is characterised by the complete absence of negative numbers. The utility function occupies only positive commodity space, a subset of Rn; (3) The alternative outcome combinations possess the property of 0 o o o o “divisibility”. Let x = (x1 , x2 , xj , xn ) be a particular assortment or combination of outcomes available. Then any combination of the 0 o o o o general form, bx = (bx1 , bx2 , bxj , bxn ) where 0 ≤ b ≤ 1, can be

227 derived from this combination. This property permits the utility function to comply with the mathematical rules necessary to use calculus methods of analysis and expression; and (4) The outcome set is “unbounded from above.” This property means that the outcome set, not only contains the outcome combination of zero numerical outcomes, (0, 0,… 0,… 0), but also if the combination x1 2 2 1 belongs to the outcome set, then any combination, x , where xj ≥ xi , where i = 1, … n, belongs to the outcome set.

The symbol “u” is utility and is interpreted as the numerical representation of the value of the satisfaction or desirability which an individual derives from selecting an alternative outcome, or conventionally, alternative consumption combinations. It is a precise number which facilitates the ordering of outcome (commodity) combinations according to the preferences expressed by an individual decision maker or consumer. The utility function is a numerical representation of a preference ordering in the sense that “u” is a number associated with each 0 o o o o possible combination, such that, for example, combination x = (x1 , x2 , xj , xn ) is i i i i i preferred to another combination, say x = (x1 , x2 , xj , xn ). The number associated with x0 will be greater than the number associated with xi.

228 APPENDIX C

SPECIFICATION OF THE REQUIREMENTS FOR OPTIMISING THE CHOICE OF

ALTERNATIVES

There are three axioms concerned with the requirements that utility functions are endowed with the property of maximisation (Arrow and Hahn, 1971). These are derived below: (1) The axiom of dominance (Monotonicity). In the situation where there are two combinations xo and x1 in X such that xo dominates x1, then xo will be preferred to x1. o o o 1 1 1 o Assume that x = (x1 , x2 ) and x = (x1 , x2 ). Given these combinations, x 1 o 1 o 1 o 1 o 1 will dominate x if x1 ≥ x1 and if x 2 ≥ x2 or if x1 > x1 and x2 ≥ x2 . The axiom captures the belief that an individual would reasonably prefer the combination that contains more of one of the two goods and not less of the other good. The individual always prefers more to less, the condition of Monotonicity. The utility function, as a result of this axiom, becomes a “strictly increasing” function of the values of the outcomes or the quantities of the goods consumed or purchased; (2) The axiom of strict convexity. If two combinations xo and x1 are indifferently preferred, then a linear assortment of these combinations will be preferred to xo and x1. A set S, is said to be convex if a line segment between any two points

Q1 and Q2 in that set belongs to it entirely. If all the points,

Q = pQ1 + (1 – p) Q2 where O ≤ p ≤ 1 belongs to S, then S is convex. The mean weighted (p) linear combination defines all the points (Q) on a

straight line drawn between Q1 and Q2. If the conditions for convexity are applied to the convex consumption set X, then preferences will be convex if: p x1 + (1 – p) xo ≥ xo when x1 ≥ xo (O ≤ p ≤ 1), or if p x1 + (1 – p) xo > xo when x1 > xo (O < p < 1). The structure is illustrated in figure a.

229 FIGURE A CONVEX INDIFFERENT PREFERENCE ORDERING

xo

x1 (p x1 + (1 – p) xo)

x1

x1

The structure implies that the utility function is “strictly quasi-concave”. As u (x1) > u (xo) when x1 > xo, then u (p x1 + (1 – p) xo > u (x)o when X1 indiff. Xo; and (3) The axiom of differentiability. This axiom assumes that the strictly increasing (axiom 1) and quasi concave (axiom 2) continuous utility function can be differentiated twice. It is necessary, in applied settings, to be able to determine if the utility function has reached a maximum or a minimum position when a point of inflection or a turning point is encountered. Unless the utility function can be differentiated twice, it is usually not possible to determine whether the particular position encountered is a maxima or

minima. The first derivative, representing the “marginal utility” of xj as a

function of its quantity is given by the expression du/dxj. Second order derivatives (the derivative of the derivative) have the property according to Young’s Theorem that d 2 u = d 2 u

d xi d xj d xj d xi Marginal utilities (du/dx), according to axiom 1 are positive, so that the utility function does not cross the horizontal axis to produce negative utilities.

230 APPENDIX D

THE RATIONALITY AXIOMS OF VON NEUMANN AND MORGENSTERN EXPECTED

UTILITY

There are five rationality axioms (See Luce and Raiffa, 1957). These are described below. A more detailed expression can be found in Von Neumann and Morgenstern (1947).

(1) The axiom of transitivity. This axiom is identical to the transitivity axiom previously derived in the traditional utility theory context. It is an axiom about the consistency of preferences; (2) The axiom of continuity of preferences. This is a plausible behavioural axiom of indifferences between preferences. Unlike its counterpart in traditional utility theory, it is derived from probabilities and not from actual preferences.

Formally, it there are three outcomes, O1, Oj and On and O1 is preferred to Oj i and Oj is preferred to On, there exists a number, a probability P1 , such that O

< pj < 1 and Oj is indifferent to Pj: O1, On;

(3) The axiom of independence. For any four outcomes (e.g. prizes); O1, O2, O3,

and O4, if O1 is indifferent to O2 and O3 is indifferent to O4 then P: O1, O3 will

be indifferent to P: O2, O4 for any probability P. Broadly, this axiom states that if two prospects (investments) involve equal probabilities of attaining outcomes which are different but which are valued equally, then the two investments will be equally attractive; (4) The axiom of the desire for success (a sure thing principle). For any

alternatives A1 and A2, and any probability numbers P0 and P1, if A1 is

preferred to A2, then P0: A1, A2 is preferred to p1: A1, A2, if any only if P0 >

P1. This axiom is so compelling and persuasive, it does not seem necessary to formulate. It serves the purpose of excluding alternatives which are consistent with living dangerously. Engaging in extreme sporting activities would be considered irrational in terms of this axiom. Simply expressed, the axiom states that if there are two alternatives (tickets in Gold Lottery or

231 Powerball) which provide identical outcomes (prize money), an individual will prefer the alternative with the higher probability of winning; and (5) The axiom of compound probabilities. It is not necessary to express this axiom formally. It is complex and requires considerable explanation (Luce and Raiffa, 1957, Chapter 2). Its meaning can be obtained from a simple example. If an individual is offered a lottery ticket which offers prizes in other lottery tickets, it is assumed that an individual’s attitude to the compound lottery ticket will be identical to that if she calculated all the probabilities to determine what ultimate chance of winning and losing this compound lottery ticket actually provides.

232 APPENDIX E

AN ALTERNATIVE FORMULATION OF CONSUMER BEHAVIOUR: REVEALED

PREFERENCE THEORY

Revealed preference theory is an alternative model of individual consumer behaviour in terms of economic market variables. This approach is of interest because: • it removes the concept of “utility” from consumer behaviour; • it allows investigation of whether market behaviour is consistent with “rational” behaviour; • it allows the development of the minimum number of assumptions required on preferences necessary to explain observed behaviour; and • it is the theoretical basis of the theory of index numbers and has contributed to the development of the characteristics of goods theory; the economic equivalent of psychological attribute theory.

FIGURE 1 The Consumption Possibility Set

X1

D(p,m) = C[B(p,m)]

P1 x Pu B(p,m)

D(p,m)

1 2 X2 P1 x x P u

233 Let B(p,m) be defined as the budget set {x/px ≤ m} and D(p,m) as the chosen set from B(p,m). For simplicity consider X> 0, p> C, and M>O. The following assumptions about the demand curve D(p,m) are made: (1) For all (p,m) there exists a unique X = D (p,m). This ensures that only one element from the consumption set is chosen which in turn ensures that individual demand curves are not only possible but unique. (2) For all X there exists a (p,m) such that X = D(p,m). This assumption is equivalent to the axiom of “infinite sensitivity”. It ensures that commodities, prices and income are continuous so that the individual consumer is able to purchase exactly what she commands subject to her budget constraint. (3) For all D(p,m) there exists pD(p,m) = M. This assumption ensures that the individual consumer spends her entire income. These are obviously strong assumptions to make about demand functions. However, they do permit an uncomplicated statement of revealed preference theory (Houthakker, 1950; Samuelson, 1948). Now suppose is observed a consumer choosing Xo = D(p,m). It might be concluded that Xo is preferred to all other X ∈ B(po,mo). This reasoning is accepted to derive the preferences of a consumer from her choices. More formally the preferences are XRy for some (p,m), X=D(p,m), and YEB(p,m), X‡y. This simply means that X is revealed “preferred to xy.” So that XPy if X is chosen at some (po,mo) so that mo = po X ≤ po y and X ‡ Y. It would seem “irrational” if it were the case that XRy and YRX

FIGURE 2 Irrational Choice

1 B (p,m)

B(p,m) Given B(p,m) and XRy

x then with B (p,m), the y choice of yRX would be “irrational”.

234 Samuelson (1948) suggested that demand functions should satisfy a regularity condition to exclude such “irrational” possibilities. Formally, the regularity condition is the weak axiom of revealed of preference. (W.A.R.P.). It is an indifference ordering of preferences rather than a preferred ordering. W.A.R.P. is defined as: XRy and not yRX That is R is asymmetric so that x ≥ y. From this axiom is obtained a fundamental result of consumer theory. Suppose mo = poXo ≥ po X1 where Xo = X1 (Xo PX1) and Xo = D(po,mo) Therefore, p1Xo p1x1 = m1 where X1 = D(p1m1) otherwise, X1 RXo which contradicts W.A.R.P. Therefore, po (Xo – X1) ≥ o and p1 (Xo – X1) > o.

Suppose prices change from p1 to po and the consumer is compensated so that she can just purchase the original bundle X1 = D(p1, m1) (Slutsky compensation). That is mo = poxo = pox1. Then po (Xo – X1) = o which implies that p1 (Xo – X1) > o and so (po – p1) (Xo – X1) < o. That is demand curves slope downward to the right.

Samuelson (1948) asked whether it was possible that the derived preference relation R was equivalent to the actual preference relation underlying the consumer’s choices. To satisfy the preference axioms it is required that if XoRX1 and X1RX2 then X1RX2 i.e. transitivity of preferences. Unfortunately, it is easy to observe that transitivity of R need not hold. Consider the following example where XoRX1 and X1RX2.

235 FIGURE 3 Intransitivity of Preferences

xo Even though X0RX1 and X1RX2 it cannot x3 be concluded that X0RX2 for the diagram indicates that when X0 and X2 can be chosen, the consumer purchases X3. 2 x Therefore it cannot be concluded that 0 2 x1 X RX

As a reaction against the intransivity of R, Houthakker (1950), proposed the strong axiom of revealed preference (SARP). Suppose there exists a finite sequence of commodity bundles such that Xo RX1, X1 RX2,… Xm-1 RXm then Xo is indirectly revealed preferred to Xm (Xo SXm) where S denotes “indirectly revealed preferred.” That is, Xo SXm means that there exists a finite sequence of bundles Xo…Xm such that Xi RXi=1 for i=1…m=1. Expressed simply SARP states that: Xo SXm and not Xm SXo …(2) It should be noted that Xo RX1 → Xo SX1 but Xo SX1 does not imply that Xo RX1. Further, it should be noted that S is transitive by definition. Technically, it can be said that the transitive closure of R. Houthakker, (1961) has shown that S is equivalent to P where P is the preference relationship underlying the choices of the consumer. This equivalence holds only to the extent that continuous demand functions exist. Essentially, the problem is to reconstruct an individual’s consumption indifference map by using the preferreds set relation. Otherwise, if the R relationship developed by the weak axiom of revealed preference (WARP);is used, the situation results in the situation depicted in Figure 4. A situation which does not allow anything to be said about the relationship between Xo and X2.

236 FIGURE 4 This Existence of Ignorance about Preferences

X1

pox = mo preferred region

xo

area of inferior 2 ignorance region X1 X

X2

However, by rotating the price line around Xo, the preferred region is obtained which then allows a statement about the relationship between Xo and X2 to be made. This is achieved by using the indirectly revealed preferred relationship to extend the inferior regions which in turn allows statements about the area of previous ignorance to be made. The problem of the possible intransitivity of R arises from the specific consideration of choices being made over “infinite” sets. The budget sets B(p,m) are special cases of “choice sets”; the sets over which choices are made by the consumer. It has been assumed the budget sets to be infinite sets, although in reality they are more than likely “finite”. This is a problem of the axiomatic development of the theory and the question naturally arises whether there is a need to restrict the class of choice sets to the class of infinite budget sets? The simple answer is that there is no need to impose such restrictions. Suppose the consumer is faced with a choice set which is not a budget set. Is there any reason for thinking the consumer will make choices in a different kind of way to that which have been predicted from the theory? Consider the consequences of extending the class of choice sets to include all sets of pairs and triplets of the consumption set X. Further, consider this situation when it is no longer the situation that consumers are assumed to spend all of their income or make unique choices.

237 Let C(S) denote the chosen set from choice set S. Two derived preference relationships can now be defined: Def. 1. XRy – for some S,X∈C(S), y∈S. Where R means “revealed at least as good as” Def. 2. Xṕy – for some S,X∈C(S) y∈S,y∉C(S) Where ṕ means “revealed preferred to” The difference between the two definitions can be illustrated by the following examples of choice situations.

Let the following be the chosen sets: (a) (b) (c) (d) C(X,y), C(y,z), C(X,z), C(X,y,z)

Let the consumer make the following choices X=C(X,y), y=C(y,z) X=C(X,z) y=C(X,y,z)

By Definition 1 XRy, YRz, XRz, y,RX & yRz ∴ XIy, yRzn not zRy, XRzn not zRX, yIX From definition 1, XRy and yRX, therefore XIy so that a consumer is indifferent I between X and y. By Definition 2 Xṕy, Yṕz, Xṕz, yṕX & yṕz ∴ yṕzn not zṕy, Xṕzn not zzn not zṕX From definition 2, Xṕy and yṕX, therefore XIy so that a consumer is indifferent between preference sets X and y. In the context of these examples, the following axiom developed by Houthakker (1961) called the weak congruence axiom (W. C. A.) can be considered. W. C. A. can be stated as follows: If XRy then for any choice set S such that Y∈C(S) and X∈S, then X∈C(S). This axiom has the desirable property that R is reflexive, complete and transitive which is a definition of rationality. The proof of this property is as 238 follows: since all pairs of bundies are among the choice sets, R is both reflexive and complete. Now consider S = {X,y,Z} such that XRy and yRz. By W. C. A. if z∈C(S) then Y∈C(S) and so X∈C(S). Therefore X∈C(S) and therefore XRz. i.e., transitivity has been established. It should be noted that W. C. A. is equivalent to W. A. R. P. which, in the present notation may be written as follows: W. A. R. P: If y is available and Xṕy then it follows that not yRx. Chipman, et. al, (1971), considered the problem of revealed preference when the assumptions of spending all income and singleton choice functions are not made for competitive budget sets. They were interested in the conditions which imply that there is a complete reordering underlying the choices made by the consumer. Again, they were required to consider the transitive closure of R. As a consequence a strong congruence axiom (SCA) was assumed. This states: If X is indirectly revealed to be at least as preferred to y(XWy) then for any B such that y∈C(B) and X∈B, then X must also belong to C(B) I, ∈ (X∈C(B). W is the indirect relation produced from the transitive closure of R. They showed that SCA is equivalent to rationality in this context. Furthermore, they showed that SCA is the equivalent to the existence of a “representation” for the consumer. A representation is a single-valued function that when maximised produces the choices actually made by consumers for competitive budget sets. It should be noted that a representation for a consumer is not necessarily the same as her utility function. For example, lexicographic preferences may possess a representation.

CONCLUSION Revealed preference theory is the underlying theoretical structure which enables valid and reliable predictions to be made about the future expenditure patterns of consumers from observing their present expenditure patterns and preferences for expenditure. It is not a theory which seeks to explain why individuals choose a particular expenditure patterns of consumption. It merely seeks to predict what they will choose to purchase by providing the justification for

239 the conduct of positive forms of analysis into the determination of consumer choice. The motivational concept of utility has disappeared from revealed preference analysis. High degrees of consistency are observed for the choice of particular consumption items by individuals over time, and over a considerable range of their available expenditure. Consistency is associated directly with the strength and formation of learned habits rather than indirect motivational antecedents. For revealed preference theory it is sufficient that these consistencies in the choice of available consumption items exist. It is not necessary to explain why they exist. Revealed preference theory is a powerful deterministic model which enables for example, the distribution and availability of existing retailing merchandise to be managed more effectively. It also provides a reliable means of determining the revenue effects of a change in price of a consumption item on the supermarket shelf for example. The major limitations of the theory are twofold. Firstly, it is not possible to determine individual consumption choice behaviour when it assumes stochastic dimensions. Secondly, the theory is unable to contribute directly to the prediction of consumer choice outcomes when the choices of preferences involve imperfect information. Thus, the theory is of little direct assistance in determining the prospects of new products on supermarkets shelves or consumer products which either have very short life cycles or whose appeal is determined predominantly by the dictates of fashion. The use of fundamental differences in the price of consumer products as the basis of prediction is of little direct use in these circumstances.

240 APPENDIX F

WORLD EXPOSITIONS

ORIGIN AND NATURE Modern world expositions, commonly called world fairs or expos, have their origin in the Crystal Palace Exhibition in London in 1851 (Olds, 1988). This exhibition became the model for later world expositions in London (1862), New York (1853), Paris (1855, 1867 and 1878) and Philadelphia (1878). World expositions are distinguished from the numerous general and specialised displays of art, science, industry and technology for stimulating public interest, promoting commerce and expanding trade. These displays have their origin in medieval commercial fairs that evolved in Europe where they served as centres of trade (Benedict, 1983; Roberts, 1995:497). Notable modern general displays include the Milan Fair, the International Trade Fair in Greece and the International Samples Fair in Valencia. Popular specialised fairs include the International Textile and Clothing Exhibition in Ghent, the International Exhibition of Electrical Equipment in Paris, the International Furniture Fair in Cologne and various international and national motor vehicle exhibitions. In contrast, staging of world expositions is regulated internationally by the Bureau of International Exhibitions (BIE). Approval to stage a world exhibition is granted by the BIE to the national government of the country which has applied. The official purpose of world exhibitions is for nations to gather together to illustrate and celebrate progress and accomplishments in one or several fields of human endeavour (BIE, 1928; World Expo 88, 1984). Until 1928 any country could organise a world exposition at any time. The increasing frequency of world exhibitions, their considerable cost, the possibility that revenues would be diminished by competing exhibitions, the potential embarrassment for countries asked to provide exhibits at competing exhibitions and the absence of a mechanism to handle complaints between international participants led to diplomatic attempts to regulate them (Carroll, 1989). On 22 November, 1928, 35 countries signed a diplomatic convention in Paris to regulate the frequency and method of organising world expositions. The convention established the Bureau International des Expositions to regulate the frequency,

241 location and method of organising world expositions. Under the convention, a secretariat was established in Paris and a general assembly which meets there twice yearly. All members to the convention are entitled to attend the assembly at which applications submitted by national governments to host a world exposition are decided. Australia signed the convention in 1935 but subsequently withdrew its membership in 1945. At the time, the Commonwealth government viewed world exhibitions as restricted means of trade promotion. As Prime Minister Robert Menzies explained in response to a question from Gough Whitlam: “… Australia’s special requirements in the matter of export promotion are better served by avoiding the limitations, as to the nature and scope of promotion activities, which ratification of the Convention could impose” (Commonwealth Parliament Debates, Vol H of R 45:38). Australia renewed its membership in 1972 and relations between the Commonwealth government and the BIE are handled through the specialist Commonwealth government unit, the Australian Exhibit Organisation (AEO). World Expo 88 was the first and so far only world exposition held in Australia. It was held in Brisbane and organised by the Queensland government. The application was made by the Commonwealth government. Under BIE rules state governments are not permitted to deal with the BIE. Where a national government does not organise the exhibition, it must recognise the organisers and guarantee the fulfilment of the obligations of the organisers (BIE, ch. 111). These requirements are conducted through the office of a Commissioner-General. Under BIE rules a national government has to appoint a Commissioner-General who is formally responsible for ensuring that a world exposition is held in accordance with BIE rules and that the national government hosting the exhibition meets its obligations (BIE, ch. IV, Carroll, 1989:42). World Expo 88 was a specialised exhibition which adopted the theme “Leisure in the Age of Technology”. The BIE classifies world expositions as universal and specialised. Universal exhibitions are held at intervals of not less than ten years and celebrate several fields of human endeavour. Specialised exhibitions are smaller, celebrate one or a small number of fields of human endeavour and may be held at intervals of not less than one year in different

242 countries/cities. The BIE specifies that an interval of five or more years must elapse between the staging of a universal and a specialised exhibition in the same country (BIE, ch. II).

BRISBANE EXPOSITION: WORLD EXPO 88 Formal approval for Queensland to host the exhibition was granted by BIE on 5 December, 1983. According to the General Manager of BESBRA (Minnikin, 1987:3) “The South Brisbane site won approval because of its central position, its suitability for an event such as World Expo 88 and its potential for development from a run-down area to one of the most valuable, attractive precincts in Brisbane.” In response to the approval the Queensland government established a statutory authority, the Brisbane Exposition and South Bank Redevelopment Authority (BESBRA) on 18 February, 1984. BESBRA was given responsibility to develop the designated site, operate the exposition and then dispose of the site for commercial and residential redevelopment. The authority was extinguished on 7 May, 1989. BESBRA was replaced by the South Bank Corporation (SBC), a new authority established by the Queensland government on 8 May, 1989. Table 5 summarises significant events associated with SBC. The Brisbane exposition operated for 184 days between 30th April and 30th October, 1988 on 30 hectares of land in three separate parcels at South Brisbane. The main block occupied 800 meters of riverfront land which extended back to the rail line that had two stations to service the site (South Brisbane and Vulture Street). An additional 200 meters of adjoining riverfront was set aside for the development of the Queensland Performing Arts Complex (see figure 1). Most of the land used for the exposition was compulsory acquired by BESBRA between 1984 and 1988 (see appendix G, table 2). The cost, including holding costs was $92.7 million. In December, 1988 the market value of the land exceeded $234 million (see appendix G, table 7). If the disposal of the land had proceeded, as intended by the Queensland government, the financial outcome for BESBRA would have been a surplus of several million dollars in historical cost accounting terms (see appendix G, tables 1 to 5). The land disposal intensions of the Queensland government were not realised. This was because of the reaction

243 of the public, by central business district commercial interests who anticipated the adverse economic impact of the release of so much land for commercial use and dominant commercial real estate agencies and developers who were concerned about the devastating effects on prices of so much land becoming available for intensive residential and commercial development. “When moves were made to sell the site, public reaction forced a change of heart. Brisbane had become proud and fond of the South Bank site and wanted it to remain a place for the community to enjoy” (SBC, Annual Report 1999/2000, p1). A summary of the financial performance of SBC between 1989 and 2002 is provided in appendix G, tables 9 and 10. A list of significant events associated with the South Bank site during this period is set out in table 4 of this appendix. The official number of visits to World Expo 88 was 18,560,447. This included 2,799,553 visitations by authority staff, the volunteer workforce and official visitors. The authority employed 1300 authority staff, accredited more than 30,000 persons and employed a total staff of 24,000 during the operating period that comprised mainly volunteers. There were 54 government exhibitors (table 1), 32 corporate participants (table 2) and 10 operators who were awarded concessions to operate retail outlets for the supply of food and beverages (table 3). The majority of these outlets were overseas owned and operated. Table 4 provides a list of the sponsors and official supplies to BESBRA. A total of 21 international pavilions were constructed together with 18 purpose built merchandise buildings that housed 40 retail outlets. There were four special pavilions constructed to house the Australian Pavilion, the Pacific Village, the Primary Industries Pavilion and the Queensland Pavilion. In terms of the official purpose of world expositions, World Expo 88 did not attract a representative number of national governments. Of the 54 government participants, 14 were state or provincial governments, and 7 were Pacific Island nations housed in the one purpose built pavilion and provided with substantial assistance to attend. A further 13 country participants were developing nations. Participants actively promoted their country or state as tourist destinations and most sold either merchandise or food and beverages though purpose built restaurants.

244 FIGURE 1 (A)

245 FIGURE 1 (B)

246 TABLE 1

INTERNATIONAL / NATIONAL PARTICIPANTS AT EXPO 88

Australia Japan • Australian Capital Territory • Kobe City • New South Wales • Saitama Prefecture • Northern Territory (No Rent Kenya charged) Korea (Republic) • Queensland Malaysia • South Australia Nepal • Tasmania New Zealand • Victoria Papua New Guinea (Pacific Islands) • Western Australia Pakistan Britain Philippines Brunei San Marino Canada Seychelles • British Columbia Singapore China (Peoples Republic) Solomon Islands (Pacific Islands) Cook Islands (Pacific Islands) Spain Cyprus Sri Lanka European Community Switzerland Fiji (Pacific Islands) Thailand France Tonga (Pacific Islands) Germany (Federal Republic) United Nations Greece USA Holy See • Alaska Hungary • California Indonesia • Hawaii Italy USSR Vanuatu (Pacific Islands) Western Somoa (Pacific Islands) Yugoslavia Source: Report to Queensland Parliament (1989) World Expo 88, Brisbane Australia, 30th April – 30th October, 1988. Queensland State Archives, Expo 88 Master File 1-28-01 to 1-28-63.

247 TABLE 2

CORPORATE PARTICIPANTS AT EXPO 88

Australia POST (715m2) Primary Industries Pavilion (736m2) Cadbury (366m2) Queensland Maritime Museum Captain Cook (524m2) Queensland Newspapers (541m2) Communities Of Aust (540m2) Queensland Teachers’ Credit Union (361m2) FM 104 Royal Australian College Surgeons Ford (550m2) Suncorp Building Society (542m2) Fujitsu (533m2) Techno Plaza IBM (1066m2) • Hitachi Magna Caria (715m2) • Idemitsu Opal Search (514m2) • Japan External Trade Organisation Pavilion Of Promise (1288m2) • Leisure Development Centre Plaza Telecom • Australian Airlines Univations (468m2) • National Campaign Drug Abuse Universal Telecasters (600m2) • India Centre Westpac (ATM Machines) • Lits Travel and Tourist Centre • Mater Adult Hospital • Comet Express Source: Report to Queensland Parliament (1989) World Expo 88, Brisbane Australia, 30th April – 30th October, 1988; Expo 88 Master File 1-28-01 to 1-28-63.

248 TABLE 3

EXPO 88: FOOD AND BEVERAGE, AMUSEMENT AND MERCHANDISING

OPERATORS (A) FOOD AND BEVERAGE Gary Balkin Moreton Bay Rock Oysters Isasaki Sangyo O’Brien Catering (S: Ice-cream) Jochen Reiss Salus Resources (Plough Inn, 145 Grey • Fast Food BBQ Outlet St) • European and North American Sanders International Food Plaza Sebastians • Munich Festhaus Tangle Berry (S: Taverns) Morris Catering

(B) AMUSEMENTS/RIDES KFL – Kataro Australian Flight Hovercraft Services City and Country Helicopters

(C) MERCHANDISING Bulkships Gaffney International Licensing P/L Sydney G. Hughes (Agents) P/L QGC Products Starbuck Merchandising Sources: Queensland State Archives: Expo Authority Files, Finance and Administration 1.57 to 1-60. Note: S Denotes official supplier

249 TABLE 4

EXPO 88: SPONSORSHIPS/OFFICIAL SUPPLIERS(S) Australian Consolidated Press & (S: National Car Rental Magazines Programs) Natures Alternative Australian Airlines & (S: Air Services) Nettlefold Advertising & (S: Annard & Thomson & (S: People Movers) Illuminated signs) APD Snack Foods P/L & (S: Snack Foods) New Zealand Breweries & (S: Ansett Airlines Steinlager) ATCO Qantas Airways & (S: Air Services) Bass (NSW) P/L Queensland Independent Bisley (QLD) P/L & (S: Solar Hot Water) Wholesalers BP Queensland United Foods P/L (S: Brisbane Computer Supplies Milk) Brother Industries & (S: Typewriters) Queensland Holden Dealers Team Budget Chauffer Drive & (S: Limousines) Queensland Regional Dailies Bunzel & (S: Disposable Catering Products) Queensland Fish Board Campbell Bros & (S: Cleaning) Queensland Newspapers & (S: City and Country Helicopters Newspapers) Coca-Cola & (S: Softdrink) Rank Xerox & (S: Photocopying) Commonwealth Industrial Gases & (S: Gas) Rydge Visual Communications C-ITOH Seiko & (S: Clocks) Conrad Hilton Sign Fronics Data Point & (S: Video/Voice) Southern Pacific Hotel Corp. & (S: Delta Office Equipment & (S: Cash Accommodation Catering) registers) Sky Channel Evan Evans Flags & (S: Flags) Stereo FM 4KQ & (S: Internal Radio) Evans Deakin Industries & (S: floats) Stereo FM Brisbane: FM104 & (S: Ford Motor Corporation & (S: Vehicles) Radio) Fuji Corporation & (S: Film) Superguasse P/L Greyhound & (S: Coaches) Selcom/Syme Electronics & (S: Hastings Deering & (S: Generators) Audiovisual) Hayden Spike Surf Life Saving Association Hitachi & (S: Air conditioning) Tangle Berry (Operated Taverns) Iberia Airlines Thomas Hardy & Sons & (S: Wine) Johnson & Johnson TNT Groups P/L Kimberley-Clark Universals Telecasters & (S: Kona Coffee Co & (S: Coffee) Television) KMG Hungerfords Volvo Australia Lansing Australia Von Rol – Harberger Lend Lease International P/L Warana LEP/Finney Bryce Westpac & (S: ATM, Banking) Lorraine Martin & (S: Attendants) Woolworths & (S: Fruit and Magna Techtronics Vegetables) MPB Society Wormald Fire Systems Multiscreens Zycorp P/L

250 Source: Queensland State Archives: Expo 88 Authority Files: Finance and Administration Master File, KWOC 1. 24. Note: 1. The corporate participant Cadbury was the official supplier of confectionary. 2. Official suppliers of staff who were not sponsors where Price Waterhouse (Managerial), Drake (Office), Cordon Blue (Food and Beverage), Slade (Merchandising) and C. E Services (Attendants). Services clubs staffed the Hospitality Suite on a voluntary basis. 3. Telecom and IBM (Corporate participants) supplied the PABX system and Australia Post (a corporate participant) provided postal/courier services. 4. Pies were supplied by the Great Australian Pie Company, a non sponsor. 5. Corporate support was provided by the Mater Hospital. The Service Clubs that provided Support (hospitality) were Lions, Rotary: South Brisbane, Quota International and Zonta.

251 TABLE 5

SOUTH BANK CORPORATION

SOUTH BANK SIGNIFICANT EVENTS

1988/1989 Establishment of South Bank Corporation on 8 May 1989 1990/1991 • Sale of first block of land for TAFE development. • Contracts awarded for Parklands and carparking and proposals received for Brisbane Convention and Exhibition Centre. 1991/92 • Practical completion of several redevelopment contracts. • Contract awarded for first residential leasehold land. • Cumulative capitalised site development costs of $82 million incurred. • Parklands officially opened to public on 20th June, 1992. 1992/93 • Friday evening markets (later extended to Saturday and Sunday) opened in November. • Construction of Park Avenue Apartments began. • 4 millionth visitor on January 15th. • 6 millionth visitor on May 23rd. 1993/94 • Developers appointed for construction of convention hotel. • Grey Street reinstatement and northern infrastructure contracts awarded. • 12 millionth visitor in June. • 5.3 million visitors during the year spent $26.7 million 1994/95 • Park Avenue apartments completed in February. • Construction of Queensland Conservatorium of Music began. • Brisbane Convention and Exhibition Centre (BCEC) completed at a cost of $170 million • 15 millionth visitor recorded on January 26th. • 5.1 million visitors during the year spent $26.8 million. 1995/96 • Rydges South Bank Hotel completed. • Conservatorium of Music completed at cost of $25 million. • 20 millionth visitor recorded in February. • 5.2 million visitors during the year spent $26.4 million. 1996/97 • Finalisation of New Master plan. • At 30th June, 1997 the combined assets of the SBC amounted to $339.9 million consisting of BCEC ($192m), the parklands ($104.2m),

252 land for resale and commercial buildings ($27 m), other operating assets ($10.7m). • 5 million visitors during the year spent $26.8 million • 33% of international visitors to Brisbane visited Parklands. 1997/98 • New Master Plan launched with an estimated implementation cost of $81 million • Two Grey Street sites approved for development; the IMAX theatre ($20m) that closed in 2003 and the Thiess headquarters building ($30m). • Commencement of 800 space underground carpark. • South Bank Parklands is Brisbane’s number one event venue. 1998/99 • New South Bank House for SBC staff commenced. • At 30th June, 1999 the total assets of SBC were $400 million consisting of property plant and equipment ($322m), land for resale ($25.2m) and capitalised development works ($276m). • The 16.5 hectares of land controlled by SBC was valued for the first time. The value was $44.5 million. • The Arbour development project consisting of 3000 sq.m of office space, 4000 sq.m of retail space and 170 residential apartments approved at estimated construction cost of $100 million. 1999/2002 • New Master Plan completed. • Griffith University complex on Grey Street completed. • Arbour project completed in 2002. • Several substantial blocks of land on Grey Street remain for sale. • Effective use of the site surrounded by Melbourne, Merivale, Russell and Cordelia Streets has not been found. It remained occupied by a Mazda distributorship. Source: South Bank Corporation, Annual Reports 1991 to 2002; Queensland government Budget Papers, 1988-1996.

253 APPENDIX G

SUMMARY OF FINANCIAL POSITIONS OF BESBRA AND SBC

Tables 1 to 4 summarise the financial position of BESBRA between 18th February, 1984 and 31st December, 1988. Footnotes extend the financial position to 7th May, 1989. Table 2 presents the record of revenues and expenditures in current and constant price terms.

Tables 5 and 6 identify off balance sheet financial support provided to BESBRA by the Federal and Queensland governments and the Brisbane City Council. The support is presented in current and constant price terms. Table 7 provides an analysis of the present value of land transactions undertaken by BESBRA. The land was compulsorily acquired between 1984 and 1988. Most of the land was transferred to SBC in 1991/92. Table 8 summaries the estimation of the effects of Expo 88 on the Balance of Payments. Tables 9 and 10 summarise the financial history of SBC between 1989/90 and 2001/02.

254 TABLE 1

BRISBANE EXPOSITION AND SOUTH BANK REDEVELOPMENT AUTHORITY: SUMMARY OF

CUMULATIVE FINANCIAL POSITION FROM 18TH FEBRUARY, 1984 TO 31ST DECEMBER, 1988 REVENUE $’000 Interest on Accumulated funds 7,257 Property (Rent) 4,484 Operating Income • Ticket Sales 175,475 • Rent / Royalties 36,061 Other 63,427 Total Revenue 274 963

EXPENDITURE $’000 Land Acquisition/Holding Costs 92,725 Site Development 168,340 Administration/Operating Expenses 145,108

Total Operating Expenses 406,173

Financial Charges 76,744 Total Expenditure 482,917 South Bank Corporation 313

Financial Surplus/(Deficit) (208, 267) Source: Annual Reports of the Brisbane Exposition and South Bank Redevelopment Authority (BESBRA) Notes: 1. At 31st December, 1988 the closing financial position was an audited surplus of $654,000 (see notes 1, 4 and 5 attached to table 3). The surplus derives from recognising accruals in the cash accounting system. 2. Originally it was intended that BESBRA would be wound up on 31 December, 1988. The Authority actually was wound up on 7 May, 1989 and the consolidated accounts tabled in the Queensland Parliament on 5 October, 1989.

255 During the period from 1 January, 1989 to 7 May, 1989, the financial position of the Authority changed from the position presented in the audited Final Financial Report ending 31 December, 1988. Revenue increased to $307,685,000 through debt recovery and various sales including the amusement park and dismantled building materials. Expenditure increased to $532,607,000 predominantly through increases in financial charges and the expensing of previously identified commitments (note 1, table 3). Assets were valued at $231,600,000 and liabilities increased to $242,748,000. The final position became: Revenue $ 307,685,000 Expenditure/Charges 532,607,000 Operating Short fall 224,922,000

Assets • Land/Buildings 213,775,000 • Claims 17,825,000 231,600,000 Liabilities 242,748,000 Financial Loss 11,148,000

256 TABLE 2

WORLD EXPO 88: RECORD OF REVENUE AND EXPENDITURE FOR THE PERIOD 18TH FEBRUARY,

1984 TO 31ST DECEMBER, 1988 ($’000)

30 June 30 June 30 June 30 June 30 June 31 Dec Cumulative 1984 1985 1986 1987 1988 1988 Revenue Property Associated 10 1,332 801 2,215 103 23 4,484 Operating Income - 55 640 11,395 150,520 100,612 263,222 Interest Income - 3,382 924 512 1,293 1,146 7,257 Total Revenue 10 4,769 2,365 14,122 151,916 100,781 274,963 In 1988/89 Prices Dec’ 88 14 6,712 2,856 17,185 169,164 104,832 300,763 In 1988/89 Prices Jun’ 89 15 6,992 2,975 17,902 176,221 109,206 313,311 Expenditure Land Acquisition 6,249 62,397 8,637 1,574 235 10,356 89,448 Land Holding Costs 303 821 749 531 494 379 3,277 Site Development 198 2,792 23,013 33,414 88,999 19,924 168,340 Admin/Operating Expenses 698 1,759 4,055 9,835 71,876 56,885 145,173 Total Operating Expenses 7,448 67,769 36,454 45,354 161,604 87,544 406,173 Financial Charges - 8207 17061 17287 17649 16540 76744 Total Expenditure 7,448 75,976 53,515 62,641 199,253 104,084 482,917 In 1998/99 Prices Dec’ 88 10,843 106963 70644 76248 221939 115934 602571 In 1998/99 Prices Jun’ 80 11,292 111,394 73,570 79,406 231,132 120,737 627,531 South Bank Corporation 313 313 Surplus/(Deficit) (7,438) (71,207) (51,150) (48,519) (27,337) (2,616) (208,267) Inflation Rate (%) 3.45 6.65 8.45 9.28 7.05 4.02 (-0.65) (8.36) Source: Annual Financial Reports including Closing Financial Report: World Expo 88, Brisbane and Australian Bureau of Statistics; Consumer Price Index. Notes: 1. The inflation rate between January and June, 1984 was 0.65%; for the 1988/89 finance year it was 8.36%. 2. The inflated value of revenue and expenditure for period ending June, 1989 incorporates receipts and payments incurred between 1 January, 1989 and 7 May, 1989.

257 TABLE 3

WORLD EXPO 88: RECORD OF ASSETS AND LIABILITIES, AT 30TH JUNE, 1988 AND 31ST

DECEMBER, 1988 ($’000)

30th June, 1988 31st December, 1988 Assets Current Assets 20,645 5,879 South Bank - 313 Total Current Assets 20,645 6,192 Capitalised Development and Operating Costs 126,559 118,506 Fixed Assets Land 79,092 89,448 Total Assets 226,296 214,146 Liabilities Cash at Bank (473) (2) Loan: Qld Treasury Corporation 226,604 214,144 Commonwealth Govt. Advance 165 Total Liabilities 226,296 214,146 Source: World Expo 88, Brisbane Australia, April – October Closing Financial Report, for the Period 31st December, 1988. Notes: 1. Closing Financial Position at 31st December, 1988 ($’000) Cash at Bank 5,877 Debtors 22,422 Land/Sales 193,235 Sub Total 221,534 Less Commitments 6,736 Loan Redemption 214,144 Balance 654

258 2. Capitalised Development and operating costs at 30th June, 1988 and 31st December, 1988 comprise: 30 June, 1988 31 December, 1988 ($‘000) ($’000) Balance Brought Forward 99,457 126,559 Site Development Costs 88,999 19,924 Land Holding Costs 494 379 Admin/Operating Expenses 71,876 56,885 Financial Charges 17,649 16,540 Less Non Capital Receipts 151,916 101,781

3. Queensland Treasury Corporation Loan Arrangements: Temporary Loan Advances 137,400,000 Capitalised Financial Charges 76,744,000 Total (see Balance Sheet) 214,144,000

4. Outstanding Debtors totalled $22,400,000 at 31st December, 1988. At the time the Auditor General audited the accounts on 3rd March, 1989 a total of $4,000,000 had been recovered. 5. World Expo 88 officials used a cash accounting system. At 31st December, debts in the form of outstanding commitments involved $6,736,000 consisting of commitments involved with the future development of the site ($2.623m), operations ($1.059m) and land expenses ($3.054m). 6. In the report accompanying the Closing Financial Report the assets of the Authority were recorded at $184.2 million comprising land in three separate blocks (riverside, triangular piece off Glenelg Street and the block surrounded by Merivale, Melbourne, Cordelia and Russell Streets) and buildings (Expo House, Plough Inn, Broadwalk, Allgas Building and Collins Place).

259 TABLE 4

WORLD EXPO 88: RECEIPTS AND PAYMENTS, 30TH JUNE, 1987 TO 31ST DECEMBER, 1988 ($’000)

30 June, 1987 30 June, 1988 31 December, 1988 Balance 1 July 8,406 4,108 21,118 Receipts Loans (Qld Gov. Devel. Auth.) 27,000 30,000 6,000 Interest 512 1293 1,146 Property 2,215 103 23 Operating Revenue 10,676 Ticket Sales 115,304 58,171 Rent/Royalties 17,846 15,215 Other 14,462 16,840 Total Receipts 40,403 179,008 97,395 Payments Loan Redemption 35,000 Land Acquisition 1,574 235 10,356 Land Holding Costs 531 494 379 Site Development 33,403 88,950 16,295 Admin/Operation Expenses 9,126 69,017 50,128 South Bank Corporation - - 313 Total Payments 44,634 158,696 112,471 Excess Revenue Over Payments 4,231 30,312 15,076 Commonwealth Govt. Funds Withdrawal (650) (3,540) (172) Interest 583 238 7 Balance 4,108 21,118 (165) In the form Investment 586 20,480 5,879 Loans Fund (CG) 3,467 165 - Cash 53 471 (4) Treasury Trust Fund 2 2 2 Source: World Expo 88: Annual Reports 1987, 1988 and Closing Report 1989.

260 TABLE 5

OPPORTUNITY COST OF REAL VALUE OF CAPITAL EXPENDITURE BY QUEENSLAND

GOVERNMENT AND BRISBANE CITY COUNCIL ON EXPO 88 RELATED PROJECTS

Years 1983/84 1984/85 1985/86 1986/87 1987/88 1988 Total Jul-Dec/Jun (8.45) (9.28) (7.05) (4.02) 8.36 Item 1. Upgrading of Rail 14,477,898 11,522,102 914,000 26,914,000 Services Inflated Prices: ‘Dec’ 88 34,145,086 Inflated Prices: ‘Jun’ 89 35,569,712 Interest Forgone 2,171,684 2,171,684 2,171,684 1,085,842 7,600,894 1,728,315 1,728,315 864,258 4,320,888 37,100 68,550 205,650 Total Interest Payments 2,171,684 3,899,999 4,037,099 2,018,650 12,127,432 Adjustment for Inflation 2,355,191 4,261,918 4,321,714 2,099,800 13,038,623 2,187,409 13,126,232 Discounted Value (6.5%) 2,508,278 4,538,944 4,602,626 2,236,287 13,886,135 2,329,591 13,979,439 2. Upgrading of Road 1,000,000 1,000,000 Services Inflated Prices: ‘Dec’ 88 1,216,870 Inflated Prices: ‘Jun’ 89 1,267,412 Interest Forgone 150,000 150,000 75,000 375,000 150,000 450,000 Adjustment for Inflation 163,920 160,575 78,015 402,510 16,540 487,035 Discounted Value (6.5%) 174,575 171,012 83,086 428,673 173,105 518,692 3. Car parking/Ferry 3,000,000 - 3,000,000 Services Inflated Prices: ‘Dec’ 88 3,340,602 Inflated Prices: ‘Jun’ 89 3,479,981 Interest Forgone 450,000 450,000 900,000 225,000 675,000 Adjustment for Inflation 481,725 234,045 715,770 487,620 969,345 Discounted Value (6.5%) 513,037 249,258 762,295 519,318 1,032,355 Source: Queensland Government Budget Papers; Brisbane City Council, Annual Reports.

261 TABLE 6

ADDITIONAL GOVERNMENT ASSISTANCE

(A) OTHER SUPPORT BY QUEENSLAND GOVERNMENT FOR EXPO 88 ($’000)

Jul-Dec/Jun 1985/86 1986/87 1987/88 Total 1988 8.45 9.28 7.05 4.02 8.36 1. Planning Construction and Operation of Queensland Pavilion 1,000 3,181 10,900 1,900 (assumed demolished & recoveries of $2m)

2. Brisbane Visitors Programme 2,052 2,000

3. Additional Services (a) Police 3,861 3,928 2000 (b) Other (s) 1,000 1,000 3,500 1,500

4. Interest Support 11,000

Total Outlays 2,000 8,042 20,380 18,400 48,822 Less Recoveries (2,000) Net Outlays 46,822

Adjustment for Inflation 2,639 9,786 22,693 19,139 52,257 2,750 10,194 23,640 19,938 54,522

Future Present Value at Dec 88 3,292 11,460 24,954 51,982 91,688 Future Present Value at Jan 89 3,537 12,315 25,658 55,855 97,365 Source: Queensland Budget Papers and Expo Authority. Note: The opportunity cost of the stamp duty not collected from the land acquired was $3.5million,

(B) OTHER SUPPORT BY COMMONWEALTH GOVERNMENT FOR EXPO 88 ($’000)

30,000 Non Discounted 31,206 Inflated Prices 32,508 Source: Queensland government: Budget papers : Department of Finance, Canberra Note: 1. (B) included in final year total present value in (A)

262 2. Commonwealth Government assistance involved the cost of construction and operation of the Australia Pavilion ($20m), the operation of the Office of the Commissioner General ($7m), contributions for overseas promotion, Australian states and territories participation and developing country participation ($3m). Additional uncosted contributions involved customs and immigration services, support for security services operations and support for protocol arrangements.

263 TABLE 7

THE BRISBANE EXPOSITION AND SOUTH BANK DEVELOPMENT AUTHORITY PRESENT VALUE AT

30TH DECEMBER, 1988 OF LAND TRANSACTIONS ($’000)

1988 Cumulative Year 1983/84 1984/85 1985/86 1986/87 1987/88 July/Dec Total A. Expenditure on Land

Holding and Acquisition: a: Money outlays 6,552 63,218 9,386 2,102 12,085 186 93,529 b: Inflated value of 9,089 84,074 11,516 2,359 12,568 190 119,796 outlays c: Real discounted

value of outlays (i) at 5.0% 11,324 99,559 13,014 2,539 12,882 190 139,708 (ii) at 6.5% 12,072 104,858 13,485 2,594 12,976 190 146,176 (iii) at 10.0% 13,973 117,498 14,631 2,725 13,196 190 162,213

B. Income on Sale of

Land Holdings (3): a: Money receipts 1,831 10,000 234,000 245,831 b: Inflated value of 2,055 10,400 203,150 215,605 receipts c: Real discounted

value of receipts (i) at 5.0% 2,212 10,660 186,786 199,658 (ii) at 6.5% 2,260 10,738 182,580 195,578 (iii) at 10.0% 2,374 10,920 173,732 187,026

C. Surplus / (Deficit) on

Sale of Land: a: Money Value 152,302 b: Inflated value 95,809 c: Real discounted at

value (i) at 5.0% 59,950 (ii) at 6.5% 49,402 (iii) at 10.0% 24,813 Note: 1. The value of land operations has been determined from the market value private sector operators were willing to pay for most of the land in 1988. The Riverside 2000 Consortium (Kern Corporation, Pidgeon and Son, Conrad Hilton Hotel Group and the Queensland Superannuation Fund Investment Trust) offered $204,000,000 for most of the land with an initial payment of $54m and six annual instalments of $25m. The discounted present value of the offer was between $140m and $160m depending on the discount rate chosen and the assumed inflation rate. The balance of the land was valued by the Valuer General at $30,000,000. In the event that a purchaser of the land was not forthcoming, the Brisbane City Council offered to purchase the entire land holding for more than $239,000,000. As the then Lord Mayor of

264 Brisbane, Sallyanne Atkinson announced “…if all else fails, the council will buy it” (The Australian, 27 May, 1988:2). 2. At 31st December, 1988 the value of the land and buildings held by BESBRA was assessed at $182 million (see World Expo 88, Closing Financial Report).

265 TABLE 8

EXPO 88 OPERATIONS IMPACT ON THE BALANCE OF PAYMENTS

Number of Non-staff/VIP visits 15,760,447 Average Expenditure per visitation $25 $30 Total Expenditure 390,401,170 472,813,410 Cost of Sales/Wages (50%) 195,200,585 236,406,705 Gross Profit 195,200,585 236,406,705 Taxation (42.3) 82,569,845 100,000,000 Gross Profit/Surplus 112,630,740 136,406,702 Less Surplus Retained Domestically 45,052,296 54,562,680 Balance 67,578,444 81,844,022 Plus Additional Imports 15,760,447 18,912,536 Plus Repatriated Earnings of Overseas Workers 2,000,000 2,000,000 Total 85,338,891 102,756,558 Source: Department of Finance, Canberra: Australian Tax Office. Note: 1. The financial impacts are estimated. The estimates are underestimated to the extent that the expenditure of employees are not included. Authority staff and the volunteer workforce accounted for an additional 2.8 million visitations. The size of the balance payments leakage was due to the selling activities of international exhibitors and the retail activities of the predominantly international concessionaires.

266 TABLE 9

SOUTH BANK CORPORATION: SUMMARY OF CONSOLIDATED

FINANCIAL POSITION FROM 1989/90 TO 1992/93

30 June 30 June 30 June 30 June 1990 1991 1992 1993 Total Assets 1,778,397 2,667,214 11,6912,313 194,152,000 Total Liabilities 10,841,944 40,300,776 125,614,774 26,600,000 Net Assets 167552000 Loans (Qld Treasury Corp.) 9,948,000 39,444,800 111,014,800 2,790,000 Income 580,000 4,151,603 13,190,000 • Land Sales 2,175,000 - • Rent 1,190,000 880,000 • Parkland Income 787,000 7,892,000 Expenditure (includes Capital) 29,230,000 90,300,000 - Expenditure (excludes Capital) 7,861,000 13,190,000 • Administration 3,984,000 11,316,000 • Cost of Land Sales and Development 2,836,000 566,000 • Land and Building Operation Costs 1,041,000 1,308,000

ACCUMULATION FUND AT 30TH JUNE, 1993

1992 1993 Operating Result (3,709) - Accumulated Deficit (37,624) (10,741) Less Government Grants 10,741 Less: Capital Costs Previous Year 30,592 3,561 TOTAL (10,741) 3,561 Govt Grants to Capital 1,217 TOTAL 4,778 Value of Disposable land Transferred 60,966 Value of Aboriginal Paintings Transferred 100 TOTAL 65,844 Government Investment Converted Advance 99,503 TOTAL ACCUMULATED FUNDS 165,347 Source: South Bank Corporation: Annual Reports for 1991, 1992 and 1993. Notes: 1. The South Bank Parklands were officially opened on 20th June, 1992. Friday night markets commenced on 6th November, 1992. 2. By 30th June, 1993 the Parklands had recorded 6.3 million visitors who had spent $27.9 m on food and beverages ($21m), parking ($1.1m), attractions ($3.6m), retail outlets ($2m) and entrance fees ($0.2m). 3. At 30th June, 2002 the Corporation had invested $112m in on site developments. During 1992/93 the Convention and Exhibition Centre was completed ($170m) the Conservatorium of Music was constructed at a cost of $25m and the Park Avenue Apartments were completed.

267 4. In 1992/93 the Queensland government provided Parklands grants of $7.89m. 5. The New Master Plan (see appendix F, table 5), launched in 1997/98 and implemented over the next five years at a cost in excess of $80m was designed to stimulate additional public patronage to the parklands. Patronage had remained relatively constant since opening in 1992 at five million visitors per annum. The new parklands has had little impact on stimulating additional patronage as David Bently reported in The Courier Mail on Saturday, June 8, 2002, page 31. Government operating grants effectively have provided a subsidy in excess of $2 per visitor per-annum since the Parklands opened in June, 1992. The average visitor spends less then $30 per visit.

268 TABLE 10

SOUTH BANK CORPORATION: SUMMARY OF FINANCIAL STATEMENTS: INCOME, EXPENDITURE, ASSETS AND LIABILITIES

1989/90 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 2001/02 ($’000) ($’000) ($’000) ($’000) ($’000) ($’000) ($’000) ($’000) ($’000) ($’000) ($’000) ($’000) ($’000) INCOME GRANTS (10,741) 7,892 10,934 11,405 10,506 9,182 10,000 9,000 9,000 11,235 12,174 TOTAL 223 584 4,152 13,084 17,422 18,361 16,402 36,236 38,031 38,241 51,744 46,137 48,848 EXPENSES 8,972 29,144 7,860 13,084 15,168 17,826 18,467 30,797 31,978 34,360 47,950 58,628 62,163 SURPLUS / (DEFICIT) (8,749) (28,560) (3,708) NIL 2,254 555 (2,065) 5,439 6,053 3,881 3,794 (12,487) (13,315) ASSETS 1,778 2,677 116,912 194,152 198,428 198,548 189,400 339,965 337,935 399,968 384,238 379,130 416,029 LIABILITIES 9,064 37,623 125,615 26,600 24,872 28,691 19,414 16,290 18,154 58,239 53,274 49,392 55,771 NET ASSETS (9,064) (37,623) (8,702) 167,552 173,556 169,857 169,986 323,675 319,781 341,729 330,964 329,738 360,258 Source: South Bank Corporation, Annual Reports from 1990 to 2002. Notes: 1. At the end of 1991/92, accumulated operating expenses were $10,740,706. This amount was extinguished by a government grant. Most expenses recorded between 1989/90 and 1991/92 were associated with site development costs. These costs which amounted to $30,591,580 were capitalised at the end of 1990/91. Site development costs (capitalised) were $81,699,962 in 1991/92. 2. The annual excess of operating expenditure over operating revenue, including land sales, has been offset through the provision of Queensland government operating grants. Between 1991/92 and 2001/02, total operating grants were $112,069,000. 3. Capital grants from the Queensland government between 1992/93 and 1999/2000 have totalled $45,129,000. 4. In 1992/93, the Queensland government transferred to the Corporation land and paintings valued at $61.066 million and its investment in the form of capital advances to the Corporation of $99.503 million.

269 5. In the 1996 annual report assets were recorded at $210.3 million, liabilities at $29.2m and net assets at $181.1 million. These were revised in the 1997 annual report. The revised values are recorded in the table. 6. In the 1997 annual report, government operating grants were recorded as $10,506 million for 1995/96. In the 1996 annual report the amount was shown as $7.693 million. 7. The value of the completed Brisbane Convention and Exhibition Centre was recognised and recorded as $222 million in 1996/97. The South Bank Parklands including the land occupied by the Convention Centre was valued at $43 million in the 1996/97 financial year. The total area of the land under corporation management was 16.5 hectares.

270 APPENDIX H

STATISTIC DATA ON THE EFFECTS OF EXPO 88 ON TOURISM

The data illustrate that the effect of Expo 88 on tourism was a temporary unsustainable phenomenon. It involved the temporal and spacial redistribution of tourism flows within Australia and within Queensland. One of the objectives of Expo 88 was the promotion of international tourism. Table 1 and figure 1 illustrate the effects on international tourism during the bicentennial year. Research undertaken by the Bureau of Tourism Research (BTR) attributes most of the increase in international visitors in 1988 to Expo 88 (BTR, 1991). In 1991, 2,370,400 short term visitors arrived in Australia, 7 percent more than in 1990 and 5 percent more than in 1988. It is obvious from these data that arrivals in 1988 were abnormally high. If 1988 is excluded, there was a steady increase in growth between 1986 and 1991 which averaged 7.3 percent per annum. Between 1993 and 1997 growth accelerated to more than 10 percent pre annum (ABS, 1998). In 1997, short term visitor arrivals in Australia were 4,317,9000. Since 1997, growth rates in international tourism have declined. In 2003, there were 4,745,900 short term visitor arrivals, 186,000 less than in 2000 (ABS,2004). Expo 88 had no discernable effect on short term departures from Australia in 1988. It may have had some influence in encouraging Australian residents to travel overseas in the years immediately following Expo 88 (BTR, 1990). Between 1980 and 1988 moderate growth of 4 percent per annum was experienced in the number of short term residents departing from Australia. The growth rates increased substantially over the next two years due mainly to the strong Australian dollar and relative price differences (BTR, 1991). In 1989, 2,169,900 persons departed for short term overseas travel, an increase of 17 percent over 1988. The increase in 1990 over 1989 was 9 percent. Growth rates declined during the 1991 recession but increased to 7 percent per annum in 1995. This average annual of growth was maintained until 2000. The average annual rate of growth between 2001 and 2003 was negative mainly due to fears about terrorism (ABS, 2004).

271 Table 2 shows the number and proportion of short term international visitors by region of stay in Australia. The table indicates that Expo 88 had a significant effect in attracting international visitors to Queensland during 1988. The proportion of international visitors who stayed in Queensland in 1988 was 48.7 percent. The number of international visitors increased by 222 percent between 1986 and 1988 to 1,021,100 persons then fell to 822,800 persons in 1989 which was consistent with the underlying growth rate at that time. Table 3 summaries the growth of tourism visitor nights in commercial accommodation in Queensland during the period 1985/86 to 2000/01. The table shows the effect on commercial accommodation in 1988 not only from international visitors but also from interstate and intrastate visitors. The data illustrate the abnormal increase in visitor night demand (length of stay) for commercial accommodation during the Expo 88 period. Demand for commercial accommodation during the period by intrastate visitors was subdued. There was an increase in the number of Brisbane residents who chose to stay at home and in the number of residents from outside South East Queensland who changed their destination preferences to visit Brisbane. Table 4 records the total number of visitor nights by intrastate and interstate in Queensland between 1986/87 and 2000/01. The data show the abnormal increase in interstate visitors were predominantly from New South Wales and Victoria (BTR, 1989, 1991). Tables 5, 6 and 7 summarise the patterns of domestic tourism recorded before, during and after Expo 88. They have been reproduced from the BTR publication Australian Tourism Trends 1992. The tables illustrate the abnormal and temporary effects of Expo 88 on domestic tourism. Domestic tourism increased in Queensland during the Expo 88 period above the level expected from the underlying growth trend. Table 8 summarises the significant increases in domestic visits and visitor nights in Brisbane during the Expo 88 period. Table 9 illustrates the effects that Expo 88 had on rail and bus services in the Brisbane metropolitan region. The effect of Expo 88 was to temporarily arrest the long term decline in these public transport services.

272 TABLE 1

SHORT TERM INTERNATIONAL ARRIVALS AND DEPARTURES

Year Arrivals Departures 1980 904,600 1,203,600 1981 936,700 1,217,300 1982 954,700 1,286,900 1983 943,800 1,253,000 1984 1,015,100 1,418,600 1985 1,142,600 1,512,000 1986 1,429,400 1,539,600 1987 1,784,900 1,622,300 1988 2,249,300 1,697,600 1989 2,080,300 1,989,800 1990 2,214,900 2,169,900 1993 2,996,200 2,267,100 1999 4,459,500 3,210,000 2000 4,931,400 3,498,200 2003 4,745,900 3,388,000

Source: Australian Bureau of Statistics, Overseas Arrivals and Departures, Australia (Cat. No 3401.0) various issues between 1980 and 2004.

273 FIGURE 2

274 TABLE 2

Number and Proportion of Short-term Visitor Arrivals by Region of Stay, 1984, 1985, 1986, 1988 and 1989 (a)

Source: BTR International Visitor Survey (IVS)

275 TABLE 3

VISITOR NIGHTS IN COMMERCIAL ACCOMMODATION IN QUEENSLAND : 1985/86 TO 2000/01

YEAR INTRASTATE INTERSTATE OVERSEAS TOTAL (‘000) (‘000) (‘000) (‘000) 1985/86 12,868.7 12,981.3 2,309.0 28,159.0 1986/87 11,436.6 14,940.1 2,801.3 29,180.0 1987/88 11,772.3 16,161.9 5,320.8 33,255.0 1988/89 10,344.2 17,287.0 7,433.8 35,065.0 1989/00 13,150.9 12,842.2 5,969.9 31,000.0 1990/01 12,568.3 15,499.7 5,673.1 33,741.1

Source: Bureau of Tourism Research, International Visitor Survey and Domestic Tourism Monitor, various issues.

TABLE 4

ORIGIN OF TOURISTS TO QUEENSLAND : 1986/87 TO 2000/01 (VISITOR NIGHTS)

YEAR INTRASTATE INTERSTATE TOTAL (‘000) (‘000) (‘000) 1985/86 30,743 22,626 53,369 1987/88 30,508 25,163 55,671 1988/89 31,493 30,229 61,722 1989/90 34,527 20,474 55,001 2000/01 34,780 20,918 55,698

Source: Bureau of Tourism Research, Domestic Tourism Monitor, various issues.

276 TABLE 5

277 TABLE 6

278 TABLE 7

279 TABLE 8

DOMESTIC VISITS AND NIGHTS IN BRISBANE 1984/1985 – 1988/1989

Year Visits Nights Av nights per visit

1984 - 1985 2,175,000 9,453,000 4.3

1985 - 1986 2,164,000 10,018,000 4.6

1986 - 1987 2,359,000 10,489,000 4.4

1987 - 1988 2,393,000 11,733,000 4.9

1988 - 1989 3,217,000 17,932,000 5.6

Av. annual % 10.3 % 17.4 % growth 85 - 89 Source: Bureau of Tourism Research, Domestic Tourism Monitor, Canberra; various issues.

TABLE9

PASSENGERS ON BRISBANE METROPOLITAN RAIL AND BUS SERVICES: 1986/87 – 1990/01

YEAR INTRASTATE TOTAL (‘000) (‘000) 1986/87 38,886 41,066 1987/88 44,953 43,512 1988/89 49,971 47,985 1989/90 43,248 42,500 1990/91 42,067 42,258 Source: Australian Bureau of Statistics, Queensland Year Book 1993: Summary of Transport Statistics.

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