The Bounded Rationality Bias in Managerial Valuation of Real Options: Theory and Evidence from IT Projects

Although real options theory normatively suggests that managers should associate such real options with project value, little field research has been conducted to test whether they suffer from systematic biases in doing so. We draw on the notion of bounded rationality in managerial decision making to explore this understudied phenomenon. Using data collected from managers in 88 firms, we show that managers exhibit what we label the bounded rationality bias in their assessments: They associate real options with value only when a project’s easily quantifiable benefits are low, but fail to do so when they are high. The study also contributes the first set of empirical measures for all six types of real options. The study contributes to managerial practice by identifying the conditions under which managers must be vigilant about inadvertently neglecting real options and by providing a simple approach for assessing real options in technology development projects. Subject Areas: Bounded Rationality, Decision Errors, Empirical Study, Judgment Heuristics, Managerial Biases, Project Assessment, Project Management, Real Options, Satisficing, Selective Search, Software Development, and Technology Development Decisions. ∗The authors gratefully acknowledge inputs from Ashley Bush, Jan Stoehr, Patricia Chebat, and Jae Lee. †Corresponding author.