Biases and Foibles in Decision Making
Behavioral economics gives us
some interesting insights to that mushy
gray thing we call a brain. Our circuitry is great for some tasks and
so great for others. This article discusses some classic ways
in their decision making.
brain is probably not an option, however a little
self-knowledge can make people more aware of the psychological traps
that influence their decision making.
We make decisions in real time. Every day we must make decisions where
we do not have all the information. Sometimes significant acquisitions
are made without the CEOs knowing as much as they should.
It's a competitive, fast-moving world. When you are plunging into the
unknown you have to be willing to let a few things go. Some people
thrive in this environment; others do not.
The smart decision maker should be aware of the biases and foibles that
we as human beings are susceptible to in our decision-making process.
The way you set up or “frame” a decision question can affect the choice
you make. The way a question is phrased may influence you to choose a
different alternative. Busy decision makers generally do not spend
enough time framing the issues.
Frame blindness is sneaky; many professionals are not aware that the
problem is at work. To forestall it, try changing your mental structure
or frame of reference. Look at the problem from different
angles. Are you really working on the right problem? Pose the question
in a new, imaginative way. Reverse the context -- what if you were the
seller instead of the buyer? How would you see the situation then?
Should we sell the company or raise capital? A better question is --
How can we optimize what we have built so far? Asking a higher level
question might provoke different alternatives. Another good question:
What is the total cost of ownership? This is often a better question
than ‘what is the price?’ Whether buying a company or a new software
application, management and training costs add significantly to the
total cost of ownership.
Knowing other peoples’ frames can help you communicate with them. The
best negotiators and salesmen discern the other party's frame and then
sell the decision within the context of that frame.
People make inconsistent choices when focusing on positive qualities or
negative qualities. Imagine that you have made reservations at two
hotels. After gathering information about each one, when asked to
confirm a reservation -- you choose the first hotel. When asked to
cancel a reservation you cancel the first and choose to stay at the
second hotel. Why? The first hotel has more positives but also more
negatives. When viewing the positive attributes you choose hotel one;
when viewing negative attributes you reject hotel one.
Assumptions are powerful and subtle. Sometimes we are not even aware of
the assumptions we make as we approach a problem. Assumptions
come in many flavors: there are assumptions about the problem,
assumptions about the data, assumptions about the availability of more
information, and assumptions about the alternatives. Beware of your
Sometimes we assume actions are mutually exclusive when, in fact, they
are not. Sometimes companies assume that they cannot raise capital to
grow at the same time they are seeking a larger partner or acquirer.
Pursuing parallel paths makes sense in many cases and can speed up the
time frame to take the company to the next level of growth. These
decisions are serial. The decision to identify a set of acquirers is
not a decision to sell the company. See what price you can command,
then make the decision to either sell, partner or continue building the
We are prisoners of our analogies. Humans naturally draw analogies and
see identical situations where they don't often exist. With only a
little information people can evoke a picture that they are familiar
with, that may only remotely represent the current situation.
For example, managers often analogize that selling a technology company
is similar to selling a house or car, something they are familiar with.
It is not. The value ranges are considerably different. For a house,
value usually falls within a fairly narrow range and there are market
comparables. This is not the case with selling a company, especially a
technology company. The range of values can be quite large depending on
the strategic importance of the technology to the buyer. The analogy
inhibits the manager's understanding of the process. Bogus analogies
can conceal important aspects of a situation.
We tend to give a disproportionate weight to the first information we
gather on a topic. Initial impressions or estimates “anchor” our
thoughts and prejudice our thinking. Initial impressions are hard to
shake. Rather than calculate from scratch, we take some starting point
and make adjustments.
An art dealer's opening gambit is designed to anchor the buyer. The
anchoring phenomenon is especially pernicious when buying or
negotiating intangible goods, such as art or technology.
Wall Street has many examples of anchoring–you anchor the value of a
stock around its recent trading price, even if a rational analysis
would tell you that the price is out of line.
Other Fun Biases
We humans are susceptible to some other interesting foibles including:
fear of regret, asymmetric loss aversion, overestimation, the sunk cost
fallacy, overconfidence and confirmation bias.
The desire to avoid feeling stupid is a strong one among human beings.
Research shows that people generally feel worse when making a dumb move
than when they fail to make smart moves. For example, if you sell one
stock to buy another, you will feel more regret if the first one
doubles in price, than you would if you didn't buy the second one and
your first one lost half its value.
People often behave inconsistently when making financial
decisions. People seek to avoid losses more than they seek to
protect gains. The pain from losing money feels twice as bad as the joy
of making money. The pain from losing $500 is greater than the amount
of pleasure received from gaining $500. We all know the sunk cost
good money after bad—but
it is difficult for
human beings to come to grips with this one. It is not easy to sell off
a division at a loss, even if it is sapping management's energy that is
needed elsewhere. We don't want to appear wasteful but it is important
to see the bigger picture.
Confidence is a good thing, but it is often exaggerated and gets us
into trouble with our decisions. Our minds seek out patterns naturally,
but sometimes we see patterns where none really exist. People often
pick mutual funds based on a few years of performance. If you stumbled
across a mutual fund that had gained 25% each year for six years in a
row, wouldn't you be just a little bit tempted to invest? Is this a
pattern? Research has shown for decades that past performance
is not an
indicator of future performance of mutual funds. We overestimate our
abilities to see patterns or make judgments, putting meaning onto
things where it is not warranted. Overconfidence in our
judgment can also dampen our interest to seek additional necessary
Confirmation bias is our natural inclination to confirm what we already
think we know and look for facts that support it. We avoid asking
questions and discount new information that might challenge our
Most of the time, your decisions will only be as good as the
alternatives available to you. Creating additional options and
out-of-the-box alternatives is more work but generally it is time well
spent. The process can force some very creative thinking.
Here are a few pointers to help you overcome your human biases. The
first step is to recognize that you are prone to these foibles.
the right questions to ask?
flexible plans. Be willing to
change direction and admit mistakes.
what your alternatives are.
decision. (That's why they pay
you the big bucks.) Don't be like the mule that died of hunger because
it was equidistant from two hay bales and couldn't decide which one to
Go as far
as you can see and when you
get there you can see farther.
second opinion. Access your board
of advisors. Their mental patterns are different from yours.
that the type of thinking
required to solve a problem must be different from the type of thinking
that created the problem. As Einstein said, problems cannot be solved
at the same level of awareness that created them.