Executive Decision Making

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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?

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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

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

5
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?

6
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

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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.

8
Memory and Hindsight Bias

• Human memory is unlike computer memory we
  construct memory when called upon.
• Examples
• How fast were the cars going?

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Memory and Hindsight Bias

• Examples (contd)
• Item 34 Reader Survey ants eating jelly

10
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
• Presidents Nixons trip to China
• MBA / EMBA case studies
• Solutions
• Consider how past events might have turned out
  differently.
• Keep accurate records

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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

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Contrast Effect

• When information or stimuli can be compared,
  differences may loom large.
• Example

Pair A
Pair B
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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?

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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,

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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
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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.

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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.

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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

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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

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• 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

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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
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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.

23
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?

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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
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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

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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

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Ellsbergs Paradox

• Another demonstration of violation of the
  cancellation axiom

Red Black Yellow
First Choice First Choice
Red 100 0 0
Black 0 100 0
Second Choice Second Choice
Red or Yellow 100 0 100
Black or Yellow 0 100 100
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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

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Prospect Theory

• Value of losses differs from value of gains
• Loss aversion or endowment effect
• Choice depends on how problem is framed.

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Prospect Theory

• Decision weights are used in place of
  probabilities. DMs tend to overweight small
  probabilities and underweight high probabilities.

Decision weights
Probability
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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

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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.

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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.

34
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.

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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

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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.

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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

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In Summary

• DMs often fall prey to representativeness.
  Methods to improve judgment and decision making
  skills include
• Dont 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

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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

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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?

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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)

42
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

43
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

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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

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Social Influences of Judgment andDecision Making

• What are the effects of making decisions in
  groups?
• Are groups of people still susceptible to
  systematic biases?

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Most Notable Types of Social Influence

• Social facilitation
• Social loafing
• Conformity
• Groupthink

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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

48
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?

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Conformity

• When will people conform to an incorrect majority
  view?

50
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

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GroupThink

• How to avoid GroupThink
• Encourage dissent and criticism
• Leaders should refrain from stating personal
  preferences at the outset
• Start discussion with lowest-ranking member, then
  next-lowest-ranking member, etc.
• Set up other groups with same charge
• Invite outsiders
• Appoint devils advocate

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In-class Exercise

• In small groups, consider the advice that
  President Bush may have received from his staff
  prior to ordering the invasion of Iraq. Which
  social influences were most likely? Why?
• 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 act as spokesperson.

53
Biases in Group Decision Making

• Results seem to suggest that individual-level
  biases continue to operate at the group level.
  Several additional findings include
• Group polarization
• Risky shift
• Group accuracy better than average individual,
  but
• Best individual outperforms group

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Common Traps in Decision Making

• DMs often experience traps that, even with
  experience, may be hard to escape. Examples
  include
• Overconfidence
• Self-fulfilling prophecies
• Behavioral traps

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Overconfidence

• DMs often estimate the accuracy of their
  judgments far above actual levels
• Details
• Overconfidence greatest near chance levels
• Increases with information content
• Not related to DMs intelligence
• Can be improved with calibration feedback
• Example
• Items 21a 21b Readers Survey
• Items 9a 9b 10a 10b Readers Survey

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Self-fulfilling Prophecies

• An incorrect judgment of a situation that leads
  to a new behavior which then makes the original
  judgment come true misconceptions that
  ultimately prove true
• Examples
• in the minds of men
• Item 39 Readers Survey confirmation bias
• Solutions
• Focus on motivational factors
• Frame question to elicit disconfirming answer
• Consider why judgment may be wrong

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Behavioral Traps

• A once-promising course of action that later
  becomes undesirable and difficult to escape from
• Many types including
• Time delay (smoking)
• Ignorance (DDT, pesticides)
• Investment (sunk cost - Items 6 Readers Survey)
• Deterioration (drug addiction)
• Collective (Prisoners Dilemma)

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In-class Exercise

• In small groups, consider the common traps just
  presented. Identify a real-life business
  example where DMs may have encountered one or
  more decision traps.
• 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 act as spokesperson.