Executive Decision Making – EMBA 718

Executive Decision Making – EMBA 718 What Psychological factors influence decision making? In what contexts are decisions made? What types of tools and techniques can be employed to help formulate decisions? What does it mean to make a “good decision’?

In-class Exercise In small groups, identify the characteristics or qualities of “good” executive decisions. Work on this exercise individually for the first 2 to 3 minutes, then discuss as a group for 8 to 10 additional minutes. Appoint one person in each group to present your answer

Exec. D.M vs. Strategy Implementation StrategyImplementation Exec. DM ProcessesContextsToolsTechniques Judgment &Decision Making StrategiesProgramsProcessesStructure

Psychological Process & Decision Making Judgments and decisions are influenced or filtered by a variety of psychological processes, including: • Selective perception • Cognitive dissonance • Biases in memory • Changes in context

Selective Perception Much of what we see is determined by what we expect to see, as well as what we want to see. Examples: • Drinking alcohol and making a favorable impression • Observed infractions in the Dartmouth v. Princeton football game Solutions: • Question you prior expectations • Are you motivated to see things a certain way?

Cognitive Dissonance People often feel they need to reduce or eliminate psychological inconsistencies between attitudes and/or behaviors. Examples: • The Jewish tailor • Telling a lie for $1 or $20 • Sales of mouthwash, introduced at $0.39 or $0.25 • Greater confidence of horse winning race after placing a wager • Assessed higher probability of candidate winning election after casting vote

In-class Exercise In small groups, describe a business situation in which people might naturally experience cognitive dissonance. Suggest a potential remedy. Work on this exercise individually for the first 2 to 3 minutes, then discuss as a group for 8 to 10 additional minutes. Appoint one person in each group to present your answer.

Memory and Hindsight Bias Human memory is unlike computer memory; we construct memory when called upon. Examples: • How fast were the cars going?

Memory and Hindsight Bias Examples (cont’d): • Item #34 Reader Survey – “ants eating jelly”

Hindsight Bias Hindsight bias, or the “I knew it all along” effect, is the tendency to view what has already happened as inevitable and/or obvious. People find it difficult to disregard information they already possess. Examples: • President’s Nixon’s trip to China • MBA / EMBA case studies Solutions: • Consider how past events might have turned out differently. • Keep accurate records

Context Dependence Decisions are not made in isolation; information is interpreted and integrated in light of past experience and knowledge. Examples of context dependence include: • Contrast effect • Primacy effect • Recency effect • Halo effect

Contrast Effect When information or stimuli can be compared, differences may loom large. Example: Pair A Pair B

Primacy and Recency Effects Primacy Effect -- Information or stimuli presented first often have the strongest effect. Recency Effect -- Information or stimuli presented last often have the strongest effect. So which effect is the strongest? When debating an opponent, should you speak first or last?

Halo Effect A halo effect occurs because decision makers are unable to treat an individual as a collection of independent qualities. Examples: • Attractive individuals are often seen as smarter than unattractive individuals • People who are seen as healthy or more physically fit might be viewed as more sincere than less healthy or unfit individuals • Item #4 Reader Survey – Jim is intelligent, skillful, …

… In Summary … Judgments and decisions are influenced or filtered by a variety of psychological processes, including: • Selective perception • Cognitive dissonance • Biases in memory • Changes in context Psychological Processes Judgment &Decision Making

In-class Exercise In small groups, design and describe a business situation where a company might purposefully take advantage of biases in psychological processes. Work on this exercise individually for the first 2 to 3 minutes, then discuss as a group for 8 to 10 additional minutes. Appoint one person in each group to present your answer.

How Question Wording and Format Affect Answers: Understanding Survey Results Executives are often faced with approving survey projects or instruments, or interpreting information gleaned from survey results. To be effective, these executives must understand how survey answers are affected by the wording or format of a question.

How Plastic or Malleable Are We?Items That Affect Survey Responses Research has shown that the following items may affect answers to survey questions: • Order effects • Pseudo-opinions • Open v. closed response categories • Range of response category • Framing as gains or losses • Psychological accounting • Social desirability

Plasticity and Inconsistency Examples: • “traveling with a young Chinese couple” • “rushing off to a seminary seminar” • “Most important problems facing our country” • “Losing a $10 bill or a ticket worth $10” • Item #2 Reader Survey • Item #27 Reader Survey • Item #26 Reader Survey

Solutions: • Check the order of response categories • Note the context of the survey question • Note the (open or closed) format of the question • Use filters to avoid pseudo-opinions • Avoid catch phrases or socially desirable responses • Consider the range of response categories • Note if “middle” categories were provided • Consider how the question was framed • Use multiple measures

… In Summary … Measuring attitudes and opinions is not as simple as asking a question. Executives must understand how survey answers are affected by the wording or format of a question Information, opinions and survey results Judgment &Decision Making

In-class Exercise In small groups, design a couple of survey questions to honestly assess peoples attitudes about storing nuclear materials at Yucca Mt. Then, revise your questions to favor a particular side of this issue. Work on this exercise individually for the first 2 to 3 minutes, then discuss as a group for 8 to 10 additional minutes. Appoint one person in each group to present your results.

Models of Decision Making Should we assume that decision makers are “rational actors” who seek to maximize their self-interests (utility)? What alternative models have researchers developed?

St. Petersburg Paradox How much would you be willing to pay for the following bet? (See Item #30 Reader Survey) A fair coin is tossed repeatedly until it lands on tails. You earn $2K, where K is the number of consecutive heads. Utility Wealth

Expected Utility Theory Expected utility (EU) theory was proposed as a normative theory of behavior – how decision makers should behave. EU is generally based on a set of axioms – if you accept and adhere to the axioms, you maximize your expected payoff (utility). • Ordering • Dominance • Cancellation • Transitivity • Continuity • Invariance

The Allais Paradox Demonstrates violation of the “cancellation” axiom – the choice between two risky alternatives should only depend on those outcomes that differ. Item #28a and #28b Reader Survey

Ellsberg’s Paradox Another demonstration of violation of the “cancellation” axiom

… In Summary … With EU models, DMs generally accept the individual “axioms” of rationality, yet often make choices that violate these axioms. Can other (descriptive) models of decision making account for these violations? • Satisficing – Herbert Simon • Regret Theory • Prospect Theory – Kahneman & Tversky • Non-compensatory Strategies

Value -$500 Gains Losses +$500 Prospect Theory • Value of losses differs from value of gains • Loss aversion or “endowment effect” • Choice depends on how problem is framed.

Prospect Theory “Decision weights” are used in place of probabilities. DMs tend to overweight small probabilities and underweight high probabilities. Decision weights Probability

Example of Prospect Theory Which would you prefer? • 50% chance of gaining $1000 • Sure gain of $500 Which would you prefer? • 50% chance of losing $1000 • Sure loss of $500

Non-compensatory Strategies When confronted with multi-attribute choice problems, DMs often use decision rules that disallow trade-offs. • Conjunctive rule – when an attribute falls outside some pre-specified range • Disjunctive rule – alternatives are evaluated on their best attributes, regardless of how poor other attributes may be. • Lexicographic rule – DM evaluates alternatives on most important attribute first, then 2nd most important, and so on. • Elimination-by-aspects – similar to lexicographic, except that order of evaluation is determined stochastically.

In-class Exercise In small groups, consider an important business decision that you or your firm has made. Which model of decision making seems to best describe the decision process. Work on this exercise individually for the first 2 to 3 minutes, then discuss as a group for 8 to 10 additional minutes. Appoint one person in each group to present your results.

Heuristics and Biases When faced with complex and uncertain choices, DMs often use heuristics or “rules of thumb” to simplify the task of selecting an alternative. These heuristics can often lead to predictable biases in decision making.

Types of Heuristics and Biases Some of the most notable heuristics and biases include: • Representativeness • Availability • Perception of risk • Anchoring and adjustment • Correlation and causation • Hindsight bias

Representativeness Heuristic DMs often judge probabilities by “the degree to which A is representative of B. Example: • Item #1 Reader Survey – is it more likely that Linda is a “bank teller” or “bank teller and feminist”? • Item #11 Reader Survey – what is more likely, “nuclear war” or “nuclear war triggered by actions of third country”.

Representativeness Heuristic Relying on representativeness can be seen in: • The law of small numbers • The gamblers’ fallacy (Item #31 Readers Survey) • The hot hand • Perceptions of randomness (item #38 Readers Survey) • Neglecting base rates • Non-regressive predictions – the “Sports Illustrated Jinx”

… In Summary … DMs often fall prey to representativeness. Methods to improve judgment and decision making skills include: • Don’t be mislead by detailed scenarios • Pay attention to and use base rates. • Note that chance is not self-correcting • Consider why result may “regress toward the mean”

The Availability Heuristic DMs often judge probabilities by the ease with which instances or occurrences can be brought to mind Examples: • Item #7 Readers Survey – causes of death • Item #8 Readers Survey – causes of death • Item #37 Readers Survey – number of paths through structure How should we judge probabilities? – Bayes’ Theorem

An Intuitive Approach to Bayes’ Theorem Assume that 1 in 100 women have breast cancer, and a mammogram correctly identifies malignant tumors 80% of the time, and correctly identifies benign tumors 90% of the time. If mammogram indicates a positive result for cancer, what is the probability that the woman has cancer? p(cancer | positive) Consider the example (pp. 131-134) in the text. Why did so many physicians err? Is it just physicians, or do business executives make similar mistakes?

… In Summary … • DMs often perform poorly with risk and probability assessment tasks. • Perceptions of risk are highly subjective • DMs accept far greater “voluntary” risks than “involuntary” risks • DMs tend to overestimate compound events (A and B) • DMs tend to underestimate disjunctive events (A or B) • What DMs learn following an outcome often depends on their opinion or belief prior to the outcome (Three Mile Island)

Anchoring and Adjustment DMs tend to make an insufficient adjustment – up or down –from their original anchor, when confronted with new information. Anchoring and adjustment is very robust – does not disappear with monetary incentives or expertise Examples: • Number of countries in the United Nations • Real estate prices in Tucson • Item #12a Readers Survey – width of folded paper • Item #17 Readers Survey - size of storage tank

Correlation an Causation DMs often err in noticing statistical correlations between two or more items. DMs tend to seek confirmatory evidence Examples: • Item #14 Readers Survey – dizziness and brain tumors • Item #18 Readers Survey – Rorschach inkblot test and male homosexuality • Item #39 Readers Survey – “vowels / even numbers” • Smoking and lung cancer • Eating read meat and colon cancer

Fundamental Attribution Error …one reason why DMs may perform poorly with correlation an causation tasks • DMs tend to attribute the behavior of others to dispositional factors • DMs tend to attribute their behavior to situational factors

Social Influences of Judgment andDecision Making What are the effects of making decisions in groups? Are groups of people still susceptible to systematic biases?

Most Notable Types of Social Influence • Social facilitation • Social loafing • Conformity • Groupthink

Social Facilitation The performance of above average “players” tend to improve with the presence of onlookers, while the performance of below average players tends to degrade with the presence of onlookers

Social Loafing People tend to work harder as individuals than when members of groups Example: • Shouting, clapping, “tug-of-war” • “bystander apathy” What are the implications of this social facilitation and social loafing for HR / business decisions?

Conformity When will people conform to an incorrect majority view?

GroupThink Occurs when cohesive, insulated groups succumb to group loyalty and pressures to conform. Results – possible deterioration of efficiency and decay in moral judgment. Examples: • Bay of Pigs • Space shuttle challenger disaster Symptoms of GroupThink: • Invulnerability • Inherent morality • Evil adversaries • Discount warnings • Illusion of unanimity • Pressure to conform

Executive Decision Making – EMBA 718