Loss Aversion and Managerial Decisions: Evidence from Major League Baseball

Pedace, Roberto; Smith, Janet Kiholm

doi:10.2139/ssrn.1627368

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Loss Aversion and Managerial Decisions: Evidence from Major League Baseball

Claremont McKenna College Robert Day School of Economics and Finance Research Paper No. 2010-03

26 Pages Posted: 20 Jun 2010 Last revised: 8 Feb 2012

See all articles by Roberto Pedace

Roberto Pedace

Claremont Colleges, Scripps College - Department of Economics

Janet Kiholm Smith

Claremont McKenna College - Robert Day School of Economics and Finance

Date Written: February 4, 2012

Abstract

Previous research indicates that management changes are important events for organizations, partly because they lead to reversals of poor prior decisions. An unanswered question is why replacing the manager seems to be necessary for reversing poor decisions. One explanation is that managers have an irrational behavioral aversion to admitting mistakes (loss aversion). We test this hypothesis with a research design that mitigates many of the measurement problems associated with investment decisions in traditional corporate settings, and that allows us to distinguish agency cost from loss aversion as explanations. Using Major League Baseball data, we find that new managers, compared to continuing managers, are more likely to divest low-performing players. Moreover, when the manager is new and the previous manager was responsible for acquiring a player who is under-performing, the likelihood of player divestiture is significantly higher relative to low performers acquired by earlier managers. Experience of the acquiring manager does not affect the likelihood that the manager retains a low performer, suggesting that it is loss aversion, and not career concerns, that motivates acquiring managers to retain low performers. The findings suggest that loss aversion plays a significant role in managerial decisions and managerial turnover.

Keywords: Cognitive Bias, Agency Cost, Managerial Economics, Loss Aversion

JEL Classification: J6, L8, D8

Suggested Citation: Suggested Citation

Pedace, Roberto and Smith, Janet Kiholm, Loss Aversion and Managerial Decisions: Evidence from Major League Baseball (February 4, 2012). Claremont McKenna College Robert Day School of Economics and Finance Research Paper No. 2010-03, Available at SSRN: https://ssrn.com/abstract=1627368 or http://dx.doi.org/10.2139/ssrn.1627368