This thesis investigates systematic biases of human decision-making in three operations management contexts: newsvendor ordering, project continuation/abandonment, and salesforce compensation.

In the first essay, we model newsvendor behavior using prospect theory‒a theory of decision making under uncertainty. The newsvendor problem, with its simple normative solution, is a building block of the literature on inventory management. Yet laboratory studies have repeatedly shown that instead of making profit-maximizing decisions, subjects consistently under-order (over-order) when profit margins are high (low). Current understanding in operations management is that prospect theory cannot systematically explain the ordering behavior observed in these experiments. We suggest this is...[ Read more ]

This thesis investigates systematic biases of human decision-making in three operations management contexts: newsvendor ordering, project continuation/abandonment, and salesforce compensation.

In the first essay, we model newsvendor behavior using prospect theory‒a theory of decision making under uncertainty. The newsvendor problem, with its simple normative solution, is a building block of the literature on inventory management. Yet laboratory studies have repeatedly shown that instead of making profit-maximizing decisions, subjects consistently under-order (over-order) when profit margins are high (low). Current understanding in operations management is that prospect theory cannot systematically explain the ordering behavior observed in these experiments. We suggest this is because the newsvendor's reference point is assumed to be the status quo, i.e., zero payoff. We propose an alternative based on newsvendor's salient payoffs and show that prospect theory can, in fact, account for experimental results.

The second essay studies abandonment decisions in multi-stage projects. In uncertain environments, project reviews provide an opportunity to make 'continue or abandon' decisions and thereby maximize a project's expected payoff. We experimentally investigate continue/abandon decisions in a multi-stage project under two conditions: when the project is reviewed at every stage and when review opportunities are limited. Our results confirm findings in the literature that project abandonment tends to be delayed, yet we also observe premature termination. Decisions are highly path dependent; in particular, subjects are more likely to abandon after observing reduced project value, and abandonment rate is higher near the middle‒rather than near the beginning or end‒of a project. Interestingly, when reviews are limited, subjects are less likely to continue a project that should be abandoned. Our data are explained well by a model that incorporates three behavioral concepts‒gains or losses from comparing the project value with an internal adaptive reference point, sunk cost bias, and status quo bias. Our work suggests that more frequent reviews need not lead to better project performance, and it also identifies contexts in which outside intervention is most valuable in project decision making.

In the third essay, we study a firm's wage transparency policy when its employees (sales agents) have social comparison preferences. If wage information is known, social comparison theory posits that agents experience feelings of gains/losses by comparing their wages with those of others. We identify the optimal compensation scheme for a firm in this context, characterize the conditions under which wage transparency benefits the firm, and analyze how changes in the work environment (such as desirability of collaboration) affect these conditions. Our results show that, contrary to conventional wisdom, stronger social comparison effects do not always reduce collaborative effort among agents, and wage transparency may benefit firms with high collaborative needs.