The Psychological Design of Firm Boundaries: Preempting Escalating Commitment through Buy vs. Make

This is the authors' abstract. We don't add key points for this paper.

Strong ownership of the product development process, while facilitating the generation of new products, can exacerbate escalating commitment and impede timely termination. We examine how managers, with foresight, use buy vs. make decisions to create psychological and organizational distance from a product and preempt escalating commitment. Using detailed product-level data from the fashion industry and its unique features, we show that managers contract manufacture risky products even when they can be readily manufactured in-house, especially core products that are central to a firm’s identity and hence more prone to escalating commitment. Our findings highlight cognitive bias as a source of internal transaction cost and bring its preemption to the forefront of buy vs. make decisions. Our study develops a cognitive foundation for transaction cost theory that does not depend on opportunism or asset specificity and highlights the psychological designing of firm boundaries as a strategy for improving the decision environment.