The Dilution Effect in Investment Decisions

Abstract

Investment decisions are among the most important managerial decisions. The purpose of this study is to examine whether non-diagnostic information in investment decisions elicits a dilution effect such that decision outcomes deviate from a Net Present Value (NPV) assessment. We also answer the question of whether the dilution effect is contingent upon the level of uncertainty in investment decisions. We provide theoretical explanations and experimental evidence on how non-diagnostic information affects decision makers and how that reflects in their investment behavior. Based on a lab experiment we find – in line with our expectation – that non-diagnostic information creates a dilution effect in investment decisions and influences investments. We show that the amount of non-diagnostic information is related to the magnitude of the dilution effect. Our results also indicate that decision makers reduce investment amounts when facing uncertainty and that information cue characteristics alter decision outcomes, even if the information provided is non-diagnostic.