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Mastering Strategic Management Chapter 10.3 to End Decision Making and Bias. 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

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sound familiar rational choice model
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
rational choice model
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
making choices rational vs organizational reality
Making Choices: Rational vs Organizational Reality

Goals

Rational: Clear, compatible, agreed upon

Reality: Ambiguous, conflicting, lack agreement

Processing

Information

Rational: People can process all information

Reality: People process only limited information

Evaluation Timing

Rational: Choices evaluated simultaneously

Reality: Choices evaluated sequentially

Standards

Rational: Evaluate against absolute standards

Reality: Evaluate against implicit favourite

Info Quality

Rational: People rely on factual information

Reality: Quality of information limited

Decision Objective

Rational: Maximization-optimal

Reality: Satisfying-“good enough”

limitations rational decision making
Limitations Rational Decision-Making

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.

how about this one
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)

decision making styles
Analytic

Conceptual

Directive

Behavioural

Decision-Making Styles

High

Tolerance

for

Ambiguity

Low

Rational

Intuitive

Way of Thinking

intuition
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.

anchoring adjustments
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

example
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?

adjusting
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

Zone of Probable Solution…

You Adjusting…..

Adjust more!

Overcome, by going a little further than you think is necessary!

availability bias
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
availability bias1
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…
assuming you re a couple what of the cleaning do you do
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!

availability risk great days to be selling insurance
Availability & RiskGreat days to be selling insurance…

Assessing risk, Which is higher danger?

2xStroke vs accidental death

20xTornadoes vs asthma

52x Death by lightning vs botulism

18x Accidental death vs Death by disease

4x Death by accident vrs dying from diabetes

escalation of commitment
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

principal agent problem
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?

fundamental attribution error
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

halo effect
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”
hindsight bias
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.
kodak
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

the black swan
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
where were you when your first heard about 911
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…
base rate neglect or when you hear hoofbeats don t expect a zebra
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’)

correlation causality
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
    • correlation
    • temporal order
    • ruling out other potential causes
  • Also includes tendency to misread randomness
correlation causality1
Correlation & Causality
  • For example, understanding marketing’s impact on sales involves
    • correlation (do sales increase after more marketing),
    • temporal order (does marketing spending occur before sales increase), and
    • 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
causal direction
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?

causal direction1
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?

causal direction2
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?

which is more probable
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

slide41

7 - Sampling BiasIf women have 1.53 children and men have 1.38 children, does this mean that women have more children than men?

sampling bias
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
slide43
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?

law of small numbers
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…
my magic vase
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?
the archer
The Archer

Might help to think of an archer, sometimes high, sometimes low… but on average somewhere near the middle…

overconfidence
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.
regression to the mean
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?
framing
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.
wwii bombs in london http bombsight org 15 51 5050 0 0900
WWII Bombs in London(http://bombsight.org/#15/51.5050/-0.0900)
representativeness
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
satisficing
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
losing vs gaining
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
breast self examination bse
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…

slide64
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
key takeaways
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!
in conclusion
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
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