Mastering Strategic
Management
Chapter 10.3 to End
Decision Making and Bias
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Sound Familiar?
Rational Choice Model
SOLVE
• S - State the problem in
precise language
• O - Outline your usual
response
• L - List your alternatives and
their consequences
• V - Vitalize the concept by
a) selecting best alternative,
b) formulate plan of action,
& c) implement plan
• E - Evaluate the success of
your choice
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Mastering Strategic Management
Chapter 10.1 & 10.2: Leading an Ethical Organization:
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Rational Choice Model
Only problem with this model is that most
people indicate that it is rarely the way they
make decisions…
Several concern when applying model
within org complex
• Rational decision-making assumes that
options are clear and that a single best
solution exists
• Many strategic decisions are not
presented in obvious ways
• Also assumes no time or cost constraints
• And, that accurate information is available
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Making Choices: Rational vs
Organizational Reality
Goals
Processing
Information
Evaluation
Timing
Standards
Info Quality
Decision
Objective
Rational: Clear, compatible, agreed upon
Reality: Ambiguous, conflicting, lack agreement
Rational: People can process all information
Reality: People process only limited information
Rational: Choices evaluated simultaneously
Reality: Choices evaluated sequentially
Rational: Evaluate against absolute standards
Reality: Evaluate against implicit favourite
Rational: People rely on factual information
Reality: Quality of information limited
Rational: Maximization-optimal
Reality: Satisfying-“good enough”
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Limitations Rational DecisionMaking
In reality, decision making is not rational because there
are limits on our ability to collect and process
information.
Because of these limitations, Nobel Prize-winner Herbert
Simon argued that we can learn more by examining
scenarios where individuals deviate from the ideal.
These decision biases provide clues to why individuals
such as CEOs make decisions that in retrospect often
seem very illogical— especially when they lead to
actions that damage the firm and its performance.
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How about this one?
Knowledge-based Decision Making
• Identify the Mega Question
• Background Materials
• Informing the Issue
• Identifying the Choices
• Analyzing the Choices
• Determining Areas of Con census
• Identify Action, Intent and Accountability
(Handout)
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Decision-Making Styles
High
Analytic
Conceptual
Directive
Behavioural
Tolerance
for
Ambiguity
Low
Rational
Intuitive
Way of Thinking
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Intuition!
A ball and a bat together cost $1.10. The bat cost a
dollar more than the ball. How much does the ball cost?
Over 50% of Harvard and M.I.T. students got this wrong.
Why? They did not bother to check. They relied on their
intuition that happened to deceive them.
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Mastering Strategic Management
Chapter 10.1 & 10.2: Leading an Ethical Organization:
Corporate Governance, Corporate Ethics, and Social Responsibility
1 - Anchoring and
Adjustment Bias
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Pick a card – any card
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Did I remove your Card?
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Anchoring & Adjustments
When individuals react to arbitrary or irrelevant numbers
when setting financial or other numerical targets.
Might be tempting to compare your post-grad starting
salary with wages earned pre-grad, or compare to
siblings, friends, parents, & others with different majors
Instead, research average starting salary for graduates
with your background, experience, & other relevant
characteristics
This bias can undermine firm performance when
executives make decisions about potential ROI by
comparing to previous deals rather than based on a
realistic & careful study of potential choices
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Example
• A Roulette wheel, marked 0 to 100
• But, only stops on 65 or 10!
• Question - Is the % of African nations among UN
members larger or small than the number you just
‘spun’?
• Same effect (without wheel) if you ask whether Ghandi
was older than 114 when he died? How old was he?
• Interestingly, answers are higher than if you ask
whether he was older than 35 when he died? How old
was he?
Why?
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Adjusting….
While anchoring has some effect, people often try to
adjust for anchors they know are wrong by adjusting
But, they will only adjust until the point where they no
longer sense that they have to adjust
Which suggests that they will adjust until reaching the
edge of the unknown quantity or area of unknown
You Adjusting…..
Adjust more!
Zone of Probable
Solution…
Overcome, by going a little further than you think is necessary!
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2 - Availability Bias
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What keeps you up at Night?
(Terrorist Attack or Driving?)
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Availability Bias
The availability bias occurs when more readily available
information is incorrectly assessed to also be more likely
• Do you think that the odds of dying in a auto accident
are high or lower than dying from stomach cancer?
• Perhaps your are influenced by media coverage, which
tends to report accidents, but not deaths by stomach
cancer, which kills more than 100x more people!
• This bias affects companies which focus on readily
available information such as their own performance
figures, while failing to collect meaningful data on their
competitors or industry trends
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Availability Bias
• Directly affected by the number of examples we can
quickly come up with, &
• Especially ease at which we come up with them!
• Interestingly, once we push harder (i.e. to come up with
more examples), it quickly becomes harder! Let’s try!
• Think of the last few times you rode your bike?
• Now, try to identify the last 12 times you rode your
bike?
• First few were (probably) easy! But then harder…
• Odd result, people who do come up with 12 (rather than a
few) are less confident…
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Assuming you’re a Couple... What
% of the cleaning do you do?
Bet if I asked both of you, it adds to more than 100%.
Why? Easier to Remember what I did!
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Availability & Risk
Great days to be selling insurance…
Assessing risk, Which is higher danger?
2x
Stroke vs accidental death
20x Tornadoes vs asthma
52x Death by lightning vs botulism
18x Accidental death vs Death by disease
4x
Death by accident vrs dying from diabetes
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3 - Escalation of
Commitment Bias
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Escalation of Commitment
The idea of “throwing good money after bad” illustrates the bias of
escalation of commitment – when individuals continue on a failing
course of action even after it becomes clear that this may be a poor
path to follow. Sunk costs are Sunk!!
Regularly seen at Casinos when individuals, on a losing streak,
think the next spin is increasingly likely to win
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Principal / Agent Problem
• You work for owners
/shareholders
• You are managing a big
project that appears to be
heading for disaster…
• No one knows yet & you
may be able to ‘double
up’ and still win! (i.e.
invest even more $$ in a
dubious project)
Do you do it?
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4 - Fundamental
Attribution Error
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Fundamental Attribution Error
• Fundamental attribution error occurs when good
outcomes are attributed to personal characteristics but
undesirable outcomes are attributed to external
circumstances.
• Teachers often note when student does well on test, it’s
attributed to intelligence & hard work! But when student
performs poorly, test was hard!
In a similar vein, some CEOs quick to take credit when
firm performs well, but often attribute poor performance
to external factors such as the state of the economy
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Halo Effect
• Hitler loved dogs and little
children…
• Halo effect, inclines us to
match our view of all the
qualities of a person to our
judgment of one attribute
that is particularly significant
• Story of Facebook or
Google
• “I knew the market was
going to crash in 2008”
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5 - Hindsight Bias
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Hindsight Bias
• Tendency to overestimate our ability to have predicted an outcome
that could not possibly have been predicted
• Bias also occurs when mistakes seem obvious after they have
already occurred - “Monday morning quarterback”
• When gearing up to go camping, a father says that he just knows
someone is going to forget something. It turns out that his son forgot
his fishing rod. "I was sure it would happen," says the father.
• Three friends decide to bet on a horse race. One of them breaks
from the other 2 & chooses a horse with very low winning odds,
saying that he has a good feeling about that horse. The long shot
ends up winning, prompting him to claim he’d been certain of
outcome.
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Kodak
The decline of photography firms such as Kodak resulting from
increasing popularity of digital cameras may seem obvious in
retrospect
But, it is easy to overlook poor quality of early digital technology &
dismiss any notion that Kodak had good reasons not to view this
new technology as a significant threat to film, when digital cameras
were first introduced
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The Black Swan
• Flawed stores of our past that
shape our world views
• We continuously try and make
sense of the world
• But the stories we invent to explain
• Are simple
• Concrete rather than abstract
• Assign a larger role to talent, stupidity
and intentions than blind luck
• Focus on a few striking events that
did happen rather than on countless
other events that failed to happen
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Where were you when your
first heard about 911?
• Flashbulb memories
• The day after the Space Shuttle Columbia blew up,
Prof asked 1st year students to write down where they
were when they first heard the news
• Kept the pages (in student’s own hand writing)
• Asked students again, 5 years later
• Interestingly, many students had changed their
location, and when presented with the evidence, in
their own handwriting, even denied it was their
handwriting!
• False Memories…
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Base-Rate Neglect
(Or, When You Hear Hoofbeats, Don’t Expect a Zebra)
Mark is a thin man from Germany with glasses who likes
to listen to Mozart. Which is more likely?
A) Mark is a truck driver?
B) He is a professor of literature in Frankfurt?
• How many truck drivers are there in Germany?
• How many Literary Profs are there in Frankfurt?
Advice – always try to examine the most common or
typical result in considering a course of action.
Should I invest in this new company (data – only 20% of new
companies survive for 5 years…)
Should I run away and join the circus? (Data 83% of circus
performers rate themselves ‘very happy’)
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6 - Correlation and
Causality
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Correlation & Causality
• Lead to problems when individuals make inaccurate
attributions about the causes of events.
• Three things are necessary to determine cause—or
why one element affects another
1. correlation
2. temporal order
3. ruling out other potential causes
• Also includes tendency to misread randomness
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Correlation & Causality
• For example, understanding marketing’s impact on
sales involves
1. correlation (do sales increase after more marketing),
2. temporal order (does marketing spending occur before sales
increase), and
3. ruling out other potential causes (sales increase from better
products, more employees, a recession, a competitor went
bankrupt, etc.)
• The first two items can be tracked easily, but the 3rd is
almost impossible to isolate because there are always
so many changing factors.
• ceteris paribus (all things being equal or constant) is almost
never true
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Causal Direction…
• I collected a bunch of data on
male baldness, including age
of patient & degree of hair loss
• Statistically - THERE IS A
CORRELATION!!
• But, which direction?
• Is the hair loss making these
guys old, or is age contributing
to hair loss?
SO, WHAT’S CAUSING WHAT?
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Causal Direction…
• I collected a bunch of data on the
temperature in pot & number of
kernels that pop per sec.
• Statistically - THERE IS A
CORRELATION!!
• But, which direction? Is the heat
making the kernels pop or are
the popping kernels heating up
the pot?
SO, WHAT’S CAUSING WHAT?
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Causal Direction…
• They’ve been building a lot of
houses near me over the last 10
years, and I believe that crime is
increasing too…
• So, I collected a bunch of crime
data, & pop density
• Statistically - THERE IS A
CORRELATION!!
But, which direction?
Is increasing pop. density leading to
more crime? or does the increasing
crime rate attracting more people?
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Which is more Probable?
• That there will be a massive flood somewhere in North America
next year, in which more than 1000 people die
OR
• That there will be a major earthquake in BC sometime next year,
causing a flood in which more than 1000 people die
Let’s try again! I have a standard 6-sided dice, with 4 green sides
and 2 red sides. Rolling it 20 times, what sequence is most
probable within 20 rolls?
1 - RGRRR
2 - GRGRG
3 - GRRRR
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7 - Sampling Bias
If women have 1.53 children and men
have 1.38 children, does this mean that
women have more children than men?
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Sampling Bias
• Misunderstandings about sampling may occur when
individuals draw broad conclusions from a small sets of
observations instead of reliable sources of information
derived from large, randomly drawn samples
• Or, asking the wrong people - bias samples (i.e. near
Hospitals, ask people about health issues; survey
every shopper from 9-noon, M-F)
• Or no sample - Many CEOs have been known to make
major financial decisions based on their own instincts
rather than on careful number crunching
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Dice
• Roll the dice until you get the same number twice in a
roll (3s or 6s…)
• Now, what do you think the odds are of the next roll
also being the same number?
• How about a 4th identical number? [No dice, flip a coin]
No matter what you “feel”… what are the real odds?
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Law of Small Numbers…
• A study of USA kidney cancer in 3,141 counties of USA
reveals a remarkable pattern!
• Kidney cancer is lowest in mostly rural, sparsely
populated and located in traditionally Republican states
• Your thoughts?
• You probably started to think about links & causes… Maybe
discarded Republican, and focused on rural…
• But, also turns out that kidney cancer is highest in mostly
rural, sparsely populated and located in traditionally
Republican states…
• Turns out extremes (high or low), are easier to find in small
samples…
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My Magic Vase!
• In this giant vase, I placed 1000 marbles with numbers
1 to 1000 printed on them
• So the ‘average’ is 500
• If you pick 1 marble, what is the odds that you will pick
the average – the one labeled 500? Be ‘near’ 500?
• What if you could pick 2 marbles? Have your odds of
(the average) being nearer 500 improved? 3 marbles?
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The Archer
Might help to think of an archer, sometimes high,
sometimes low… but on average somewhere near the
middle…
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8 – Overconfidence
Hot Streaks…
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Overconfidence
• Overconfidence bias occurs when individuals are more
confident in their abilities to predict an event than logic
suggests is actually possible
• For example, two-thirds of lawyers in civil cases believe their
side will emerge victorious.
• But as the famed Yankees player/manager Yogi Berra
once noted, “It’s hard to make predictions, especially
about the future.”
• Such overconfidence is common in CEOs that have
had success in the past and who often rely on their
own intuition rather than on hard data and market
research.
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It’s Due…
Runs, Streaks, Hot Hands
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Regression to the Mean
• Pilot Training – Yelling is effective.
Every time I yell at a rookie pilot for
a bad landing, the next one is
better. Every time I praise a pilot
for a good landing, the next one is
worse. Ergo, Yelling works &
Praise doesn’t!
• On average, why are tall people’s
kids shorter than they are, and
short people’s kids taller? [PS if it
wasn’t this way, what would we
look like in a couple of centuries?]
• Why do we tend to notice these
abnormalities or exceptions
anyways?
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9 – Representativeness
& Framing Bias
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Which Sample is More
Random?
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Framing
• Framing bias occurs when the way information is
presented alters the decision an individual will make.
• One cause of Poor framing is employees’ reluctant to
bring bad news to CEOs
• To avoid an unpleasant message, they might be
tempted to frame information in a more positive light
than reality, knowing that individuals react differently to
news that a glass is half empty versus half full.
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WWII Bombs in London
(http://bombsight.org/#15/51.5050/-0.0900)
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Representativeness
• Representativeness bias occurs when managers use
stereotypes of similar occurrences when making
judgments or decisions.
• In some cases, managers may draw from previous
decisions to ground current decisions when, in fact,
impact resulted from changes in the environment.
• In other cases, representativeness can lead to
discriminatory behaviors that may be both unethical
and illegal
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The Stroop Effect, 1st Read
Out loud…
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Corporate Governance, Corporate Ethics, and Social Responsibility
10 - Satisficing
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Mastering Strategic Management
Chapter 10.1 & 10.2: Leading an Ethical Organization:
Corporate Governance, Corporate Ethics, and Social Responsibility
Satisficing
• Occurs when individuals settle for acceptable
alternative instead of seeking best
• GOOD IS THE ENEMY OF BEST!!
• While this bias might actually be desirable when others
waiting behind you at vending machine, research
shows CEOs commonly satisfice major decisions such
as mergers & takeovers
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Mastering Strategic Management
Chapter 10.1 & 10.2: Leading an Ethical Organization:
Corporate Governance, Corporate Ethics, and Social Responsibility
BONUS! – Loss Aversion
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Mastering Strategic Management
Chapter 10.1 & 10.2: Leading an Ethical Organization:
Corporate Governance, Corporate Ethics, and Social Responsibility
Losing vs Gaining
• As a species, we are a loss-aversion group! Perhaps
driven by our evolutionary path where risk = death and
risk adverse people survived to breed, becoming our
ancestors by default!!
• Today, losing $100 of your money is more painful than
if I suddenly gave you $100, about TWICE as painful…
• So, intrinsically, the fear of loosing something has
greater motivational force than gaining the same thing
• Let’s practice this bias
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Mastering Strategic Management
Chapter 10.1 & 10.2: Leading an Ethical Organization:
Corporate Governance, Corporate Ethics, and Social Responsibility
Breast Self Examination (BSE)
• Which statement will be more effective?
• A – Research shows that women who
do BSE have an increased chance of
finding a tumor in the earlier, more
treatable stage of the disease
• B – Research shows that women who
do not do BSE have an decreased
chance of finding a tumor in the earlier,
more treatable stage of the disease
PS do you know that Men get breast
cancer too? Buys, check the data…
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Mastering Strategic Management
Chapter 10.1 & 10.2: Leading an Ethical Organization:
Corporate Governance, Corporate Ethics, and Social Responsibility
Which statement will be more effective?
• A – Increasing your home’s insulation will save you $500/yr
• B – Not increasing your home’s insulation costs you $500/yr
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Mastering Strategic Management
Chapter 10.1 & 10.2: Leading an Ethical Organization:
Corporate Governance, Corporate Ethics, and Social Responsibility
Summary - Decision Biases
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Mastering Strategic Management
Chapter 10.1 & 10.2: Leading an Ethical Organization:
Corporate Governance, Corporate Ethics, and Social Responsibility
Summary - Decision Biases
(con’t)
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Mastering Strategic Management
Chapter 10.1 & 10.2: Leading an Ethical Organization:
Corporate Governance, Corporate Ethics, and Social Responsibility
Key Takeaways
• A wildly successful manager/executives will take the
time to learn about the numerous decision biases that
exist, and often impede effective decision making
• And, take steps to overcome them, especially for the
critical decisions!
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Mastering Strategic Management
Chapter 10.1 & 10.2: Leading an Ethical Organization:
Corporate Governance, Corporate Ethics, and Social Responsibility
In Conclusion
This final chapter has examined
• Role of boards of directors in the corporate
governance, including the principal / agency problem
• When boards fail to do their duties, numerous scandals
have ensued, resulting in tighter Canada & USA
legislation
• Inter-generational personal differences
• Decision making biases, and overcoming them for
improved decision making
This work is licensed under a
Creative Commons Attribution 3.0 Unported License (CC-BY).
Mastering Strategic Management
Chapter 10.1 & 10.2: Leading an Ethical Organization:
Corporate Governance, Corporate Ethics, and Social Responsibility