Question

First explain what is a sunk cost investment and what factors should be considered for it? Then explain what is a post investment holdup and what factors should be considered for it?

Answer 1

A sunk cost investment is the fixed component of the investment that is made at the beginning that can't be recovered by the investors and hence the fixed costs involved are known as sunk costs. The factors to be considered for sunk cost are the capital and the infrastructure that is required for initiating the business. For example, while starting a garment factory, some weaving equipments must be installed and advertisement costs incurred a priori and can't be recovered entirely later on. These are the fixed sunk costs.

The post investment hold up occurs when the investment involves a pact between two parties but it is too costly to make a complete contract for the agreement and this part of the contract is held up by the parties as a non binding commitment. This leads to holding up or cancelling investments that may have been mutually beneficial. Here, the contractual obligations that are difficult or very costly to be formalised have to be considered.