FBR - Bias in Decision-taking

Bias in Decision-taking

Miguel Rosique

Publicación
Publicado el
18 de Abril de 2016
Company managers employ intuition much more than reasoning.

Decision-taking is the subject of much analysis, research and many courses and seminars.  Deciding is a process, not an action, for which it is possible to train, and, with practice, you can acquire a well-organized thought process in order to choose between one or another option.

Decision-taking is the subject of much analysis, research and many courses and seminars.  Deciding is a process, not an action, for which it is possible to train, and, with practice, you can acquire a well-organized thought process in order to choose between one or another option.

If it is true that a manager has to take decisions frequently, and that these decisions often have a more analytical than intuitive component, then there are times when there are patterns of behaviour in the decision-taking process which are definitely surprising.  These are behaviour patterns which bring little science or sure research which are familiar to you.

Companies have always had a strategy of risk diversification, by which some business units are offset against others, commonly known as “not putting all your eggs in one basket”, but the reality is stubbornly the contrary.  In a study by Weber and Baucells, it is clear that there is a behaviour pattern which they call “escalation of commitment”, under which, when one business line is not going well, rather than loosen ties and let it fall by the wayside, more money is invested in order to try to save it.  Did they not diversify precisely to avoid healthy business units being affected by another causing a drain on cash flow?  I think that you will come across more examples where this is a fact.

In decision-taking, everybody assumes that company managers take rational decisions based on an analysis of the alternatives, but this is not always the case, and in the corporate world irrational decisions are sometimes taken.

Why does this occur?  For two reasons: (1) because there are a number of biases which distort the thought process in certain scenarios at the point of deciding; (2) because very often the mind simplifies reality, when that reality is sometimes much more complex.  

We like to think of the decision-taking process as a rational process, based on an analysis of the alternatives, which looks at the pros and cons and the consequences of the decision, but this is not so.  Company managers employ intuition much more than reasoning, turning decision-taking into a kind of roulette where it seems that you already know the numbers that are going to come out.

This is especially dangerous in situations of high uncertainty, where the final outcome of the decision can have major deviations with respect to the options.  It is at this moment that every manager’s aversion to risk comes into play.  Risk aversion is a measure of how a manger feels when he has to take decisions without having all (or some) of the data.  We know cases of executives who are the paradigm of paralysis by analysis, those managers who are incapable of overcoming the vertigo of a decision based on little analysis, and is this not a paradox, bearing in mind what has just been said?  It certainly is, managers decide in a more intuitive than analytical manner, but are unable to take decisions in uncertain situations.  The explanation of this is overconfidence.

Overconfidence is what is called retrospective distortion.  This very technical term expresses a very common occurrence that is rarely given its due importance.   When we are already aware of the result of a decision, it is very simple to explain it, what we call explanation hindsight or “I told you so”.

In terms of decisions, managers are very confident.  When a company is doing well, they say that it is thanks to its management, but when the situation gets ugly, the causes are attributable to changes in the market or the economy in general.

We set out to take decisions almost always with preconceived ideas, and so, what happens happens.  Vanity, in this case, plays a decisive role.  It is proven that managers who think they are above average, act with a greater excess of confidence than the rest when, in truth, their results are not outstandingly better.

We said that risk aversion is a definitive variable in the equation of appropriate decision-taking and so it is.  Weber and Baucells explain that when things are going well and the company is making money, risk alternatives are not in the decision-taking equation.  Neither when some things are good and others bad.  But if things are going badly, this is when the process of rational decision-taking founders due to bias.  In this case, the manager stops seeing likely outcomes and begins to gamble against the odds.

Let us look at an example: a man is gambling in a casino and things start to go wrong, increasingly he is left with fewer chips, he is playing roulette on red and black (50% probability), but is still losing.  The solution is a stroke of luck allowing him to recover his losses or gambling everything on one number (less than 3% probability).  The same thing happens in companies.  In this crisis, we have seen companies on the verge of bankruptcy that, with one decision, would have been saved; had they cut and run before the escalation of commitment, they would not have succumbed to an excess of confidence through the simplification of the problem, or, once the situation became very complicated, they should have kept a cool head to salvage something and not risk everything.

Company managers employ intuition much more than reasoning.

 

Miguel Rosique
Sobre Miguel Rosique: Ha sido directivo de primer nivel en empresas nacionales y multinacionales. Habiendo trabajado también para empresas participadas por fondos de capital riesgo. Es un experto en rescate y relanzamiento de empresas. Ha conseguido hacer viables compañías muy est...
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