Decision-Making Bias

Discuss about the New Trends impacting Global Busienss.

A person’s characteristics, including personality and experience, can affect the means people use to make decisions. Therefore, a person’s susceptibility can either be a positive or a negative influence on decision making process. From a psychological point of view, the decision is always determined by needs and enlarged by a person’s preference.

To measure the personality traits of individuals, the Myers-Briggs Type Indicator (MBTI) is used to diagnose the traits. This is accomplished by categorizing these traits into four major divisions—thinking and feeling, extroversion and introversion, judging and perception, and sensing and intuition—this indicator offers a glimpse into a person’s inclinations in regards to decision-making.

Everyone is affected by biases in their own personal way. Biases can warp and damage the objective contemplation of a decision by adding disruptions to the procedure of decision-making. These disruptions are usually separate from the point in the decision. Bias is simply the susceptibility towards error. To put it simply, bias is preconception to arrive at decisions while already affected by a latent belief. We are commonly unconscious of these biases which can influence our decisions. Through proper channels and installation of various system, we are able to find out ways to evade these biases. Learning form mistakes, reviewing decisions (both good and bad) and always double-checking al the decisions made are some of the ways managers, investors can overcome the biases. This report tackle the major biases in a business setting. Listed below are some of the most common cognitive biases and strategies that can be applied to overcome them.

Confirmation bias, a cognitive bias, is a habit to understand information in a way that confirms or agrees with a prior assumption, meanwhile ignoring those explanations that disagree the previous assumptions (Palminteri, Lefebvre, Kilford & Blakemore, 2017). Psychologically speaking, confirmation bias can be seen even in situations where the idea being proven is a difficult one, this further proves the kind of influence this bias has on human beings.  Individually, this bias can affect customer decisions, for example, if a client has previous information about a product (even if the information is wrong), it has a big influence on the decision of whether to purchase a product (Charness & Dave 2017). Confirmation bias, whether looked at from an individual perspective or a corporate one, is influential, meaning, people will automatically choose what hit closer to home and ignore everything else. To curb this bias, one needs the ability to question and evaluate their opinions and decisions and the decisions of others. Sources of information are the main influence in this instance, therefore, information sources have to be screened before the information is taken seriously.

Excessive Optimism

Excessive optimism is related to the overestimation of the number of likeable results in compared to the unlikeable ones (Clark, Robert & Hampton, 2016 ). This kind of bias exists in a huge array of fields. For example, for the issue of the debt-equity ratio for financing, the main cause for debt problems presently is corporate management’s previous unrestrained optimism.  In addition, introducing a fresh product into the market is rarely rid of forecasting bias; Therefore, several of the forecasts contain very many errors. But this is not surprising at all because several of the companies may unwillingly be engaged in unrestrained optimism, especially when their existence is dependent on favourable forecasts (Leong & Zaki, 2018). In addition, it’s not only corporations that suffer this bias, people also show it, both when they are deciding on their investments and in how they live their lives.  In a study to investigate the effects of emotion on the value of stocks, it was concluded that emotion surely has an effect on asset valuation.

It is very important to stress that the concept of the optimism is not solely considered when judging probable outcomes.  Optimism, which is a requirement to have a positive consideration for oneself, is closely connected with a mental health and well-being. Several cognitive research from the 70s and 80s had proved that moderately depressed people have an absence of optimistic view of the future which proposes that accurate self-knowledge may not always be positively related to psychological well-being and that focusing attention on the self may cause negative cognitive state (Leong & Zaki, 2018). This is not to propose that managers should be mildly depressed. Stress and depression have, in fact, been proven to have a negative effect on one’s health and well-being.

Sunk cost. This refers to an amount already spent and cannot be retrieved at any major capacity (Minard, 2015). For instance, an entrepreneur an idea for a new business venture, the business idea looks economically promising. So the entrepreneur invests his own personal equity finance to the idea, as well as a big start-up investment from investors. After the business has been operating for a while, it becomes clear the business is not going to succeed, but instead of admitting to failure, the entrepreneur spends more of the investors’ money instead of returning it to them. Here, the sunk cost bias has led the entrepreneur to betray his financial investor’s trust and fail to spend their investment responsibly (Feldman & Wong 2018). Sunk cost misconception mostly added to risk aversion to produce decisions that will not incur any further expenses because it is mostly concentrated on the minimizing cost of already spent resources rather than maximizing future expenses (Feldman & Wong, 2018). This type of decision making is grounded upon the over-commitment of people or managers to make an idea/ project work even if it is economically inadvisable. Once a decision is related to a person with high responsibility, the financial resources dumped into that project will be unreasonable. This proves that there is a relationship between the weight of assumed responsibility and the resources invested in a project as argued by Minard (2015).

Sunk Cost

The illusion of control can be defined as the habit of individuals to trust that which they can control and/ or affect the result of in real life than that which they have no control over (Stefan & David, 2014). This kind of bias is seen in everyday life, for example, it may include situations like successfully rolling a dice to a double sixes or picking winning lottery numbers. The illusion of control grants people the wrong idea that result can be affected by individual involvement when the real life is quite different. Plus as Yarritu, Matute and Vadillo (2014) state that individuals usually show overconfidence and illusion of control,  confirming their assumption towards the mistake. The easiest way to deal with the illusion of control is to maintain the course of the transaction, for example, in the case of investors, it would assist if the investor kept a list of the characteristics that are identified to be in favor of the investment.

The familiarity heuristic argues that individuals’ capacity to views actions as likely to occur is dependent on their ability to remember a particular information linked to that action (Schwikert & Curran, 2014). The familiarity they have with that information will surely affect their decision making. Familiarity heuristic can be defined as what that proves how the bias of availability is linked to how easy one can recall. Familiarity bias is most prominent in marketing. Bui, Hamilton & Kemp (2015) argued that the insight people have over a certain brand is dependent on how much they are familiar with products from that brand. So when a customer is considering a purchase their decision to buy one product over the other is affected by their level of familiarity with that product, if their familiarity with the product is high, their decision to buy the product will be fast and easy (Huang, 2016).

Another bias is loss aversion or prospect theory. This is linked to people’s strong wish to avoid losses and instead make any sort of gain (Aperjis & Balestrieri, 2017). It is important to note that loss aversion will be more severe when the issue is viewed from a negative angle, people make a much worse decision when facing a negatively formulated dilemma (Heeren, Markett, Montag, Gibbons & Reuter, 2016). Risk aversion theory specifically states that losses are felt twice as much by individuals compared to similar profit (Imas, Sadoff & Samek, 2017). The theory of loss aversion is evident in both business and in everyday life. In a study to determine individual tendency towards loss and profit, it was deduced that the loss  view gave much fewer acknowledgments than a gain view, affirming once more that people are less ready to enter a negotiation when they are less likely to gain from it, this is because they are not prepared to deal with that loss (Piccolo & Pignataro, 2018). Psychologically speaking, individuals have a tendency to deceive and shun all in a bid to maintain the ownership of a property rather than getting it in the first place. A case study would be the Wesfarmers where  the risk aversion bias is more present, the risk management policy there is reviewed annually by a qualified Board members. The last review was done in May 2017. The aim is build a policy of risk aversion and report. This policy will contain a procedure for risk reporting and avoidance of group risk alongside a detailed manifesto of risk management functions among the Board, top management, finance director and audit and risk committee. This just shows the lengths such big companies go to avoid any loss. They involve the council of top management.

Illusion of Control

In groups, most people desire the peace and state of agreement in the group and would go to various lengths to protect that harmony. This is called Groupthink (Griffiths, Erlinger, Beesley & Le Pelley, 2018).. It is arguably the most influencing factor in the process of decision-making in a group setting. Groups like this remove themselves from outside influences and cast a shadow that does not allow for input from without the group. According to the members this eliminates any room for conflict and shuns the group from discussing different opinions. The dynamics of the group demands members to shun from making controversial remarks, this leads to a loss of a person’s intelligence, liberty and their distinct personality (Griffiths, Erlinger, Beesley & Le Pelley, 2018).. The non-functional structure of that group produces a mirage that trick its member in the decision-making abilities of the group. And since every group has an opponent, this might lead them to undermine their rival group. In addition, groupthink can result in some activities that dehumanize other groups (Griffiths, Erlinger, Beesley & Le Pelley, 2018).

Groups are only very well productive when all opinions and alternatives are considered. Team leaders have a responsibility to create an environment rid of discrimination.

Another bias is overconfidence which influences decision making, both in the business world and in personal investments. Overconfidence can be defined as how firmly individuals grasp their own abilities and the boundaries of their knowledge (Jeong-Ho & Daecheon, 2018). Generally, individuals tend to overestimate their capability to well perform. And, in turn, it causes impulsive decisions because managers who assume they know more than they really do are too confident in their own capabilities (Salehi, Abdoli & Eskandari, 2017). They, then fail to seek advice and help when making any major decisions. It is for this reason that emerging entrepreneurs are prone to conducting research and asking for help, before starting out, than the more seasoned ones.  This assumption is confirmed by the overconfidence portrayed by most successful entrepreneurs (Navis & Ozbek, 2017).

The negative side of overconfidence only shows itself in situations where individuals do not admit to their weakness and hence, make wrong decisions on a large scale (Porto & Jing Jian, 2016). In regards to ethical issues, it is due to the overconfidence bias that individuals will always take ethical issues for granted. People just assume that they are of good character and are, therefore, going to do the right thing should they come across an ethical challenge. Recently studies have shown that the overconfidence bias might make individuals to over-calculate the amount or the frequency at which they will volunteer, at the very least, their time to charitable organizations or work (Navis & Ozbek, 2017). So, overconfidence  being a part of our innate personality makes us act without any genuine thought and that is the major cause for unethical behavior.

Familiarity Heuristic

Investors and managers need to validate their information to avoid the problem of mistaking the amount of information received with the worth of that information (Porto & Jing Jian, 2016). Managers also have to double check on the accuracy of their judgment. Gaining more information on something does not necessarily increase the accuracy of judgment but instead increases the quantity of the information which may only look like an improvement in the accuracy of said information.

Other forms of bias include; Outcome bias- judging and making a decision based on previous outcomes (Griffiths, Erlinger, Beesley & Le Pelley, 2018). Entrepreneurial environments overly emphasis on outcome  which is culturing a generation bent on outcome. This has hardened the environment in such a way that the only option to succeeding is to win. The culture then sieves out the losers who get to watch their counterparts succeed. A good example would be the booming social media business, where in the course of its rise only a handful of people warned of the means by which these companies were gaining popularity. They obtained client information which was used to fuel the growth. Today everyone is bearing witness to the outcome bias in social networking business.

Recency. This is the habit to heavily regard new and latest information over the old ones (Nelson 2014). Take the example of Wesfarmers where in almost all the reports released, they inform their investors how much they intend to learn for their challenges and encourage their managers to use new and latest information to make decisions. This is from a 2015 report ‘Some of the sustainability challenges are common across the company. But as you will read in this report, many more are unique to our individual divisions…’ and ‘…That’s why we encourage our managers and employees to bring their own diverse experiences and expertise to the table and to think innovatively about how to meet these challenges so they are connected to the most appropriate solution’.

Selective perception or self-attribution bias. This is the act of allowing expectations to shadow how people perceive the world (Costa, Carvalho, Moreira & Prado, 2017). There are only two categories of self-attribution bias; self-enhancing bias- a situation where a manager or an investor gives themselves too much credit for instances where they made a good decision and self-protecting bias- a situation where managers vehemently deny their wrong-doing and mistakes when making a crucial decision. To deal with this bias, it is first important to note that generally, everyone tends to give themselves more credits for their success than failure. It is for this reason that managers and investor need to look as objectively as possible any and all decisions facing them.

Loss Aversion

Lastly, availability heuristic. people usually underestimate the information in front of them (Lieder, Griffiths & Hsu 2018 ), for example, a person might argue that smoking does not kill simply because they know someone who smoked four packs a day and lived for one hundred years. This would then affect their decision-making process and even hinder him from accepting advice from anyone. There are four major classifications of availability bias, returnability bias, availability bias through categorisation, narrow range of experience and resistance (Lieder, Griffiths & Hsu, 2018). To avoid availability bias, Costa, Carvalho, Moreira & Prado (2017) states, managers need to strictly and carefully research their decision making sources. And for investors, studies have shown that individuals tend to favour new information as opposed to old news, they should refrain from that and consider investing in long-term investments rather than new and cheesy short-term investments.

Conclusion

In conclusion, given the obvious nature and abundance of cognitive biases that surround us, it is important to devise ways to deal with these biases. Setting up systems that review and consider all the decisions made is a sincere way to make sure that there is always an objective perspective on all decisions. Managers should also admit and learn from their previous mistakes to better equip their decision-making process.

References

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Clark, B, Robert, C, & Hampton, S (2016). The Technology Effect: How Perceptions of Technology Drive Excessive Optimism’, Journal Of Business & Psychology, 31, 1, pp. 87-102.

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Piccolo, S, & Pignataro, A (2018). Consumer loss aversion, product experimentation and tacit collusion’, International Journal Of Industrial Organization, 56, pp. 49-77.

Porto, N, & Jing Jian, X (2016).Financial Literacy Overconfidence and Financial Advice Seeking’, Journal Of Financial Service Professionals, 70, 4, pp. 78-88.

Salehi, S, Reza Abdoli, M, & Eskandari, M (2017). The Relationship between Managers’ Overconfidence and Financing Decisions with Special Focus on Ownership Structure’, International Journal Of Management, Accounting & Economics, 4, 8, pp. 857-879.

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Yarritu, I, Matute, H, & Vadillo, M (2014). Illusion of control: The role of personal involvement’, Experimental Psychology, 61, 1, pp. 38-47.