A firm is thinking about making a huge new investment. After consultation and deliberation, the CEO and the employees unanimously decide the project should go ahead and initial investment begins. As time passes more and more members of the organization realize that the investment is not a good idea after all. It is better to cut and run. Some costs are sunk and the NPV looking forward is negative.
The CEO is in charge of the continuation decision but his incentives are not aligned with the organization’s. Privately, he was actually reluctant to pursue the project. Publicly, he boasted about the investment, how great it was all going to be, how great the firm would be when the investment paid off. The CEO cannot go back on his word. The market will judge him purely on whether the investment is made and whether it pays off. He cannot cancel the project and instead he forces it through. If it pays off, his career takes off; if it fails, his career is a shambles but is is also in a tailspin if he cancels the project. The employees watch anxiously. They will give him a year and if nothing works, they will look for opportunities elsewhere.