Management of Organisations

Introduction, Overview and Decision-Making

Biases

James M. Schmidtke, Ph.D.

Craig School of Business
California State University Fresno

Two Types of Decisions

Programmed Decisions
Routine
Automatic processing

Non-programmed Decisions

Decision Making Process

Rational decision-making model

Understand the situation

Define the problem
Identify all the issues
Weight the issues
List all the alternatives
Rate each alternative
Choose best alternative

Problems with the Rational DM Model

Decision makers have incomplete information
Costs of obtaining complete information may be
prohibitive or inefficient
Decision makers have limited cognitive ability

Bounded Rationality
Satisficing: satisfy and suffice, is a decision-making
strategy that attempts to meet an acceptability threshold.

Choosing acceptable alternative to resolving a problem or

pursuing an opportunity
Focus on key criterion
Not all alternatives are considered
Focus is on acceptable alternative rather than optimal
solution

Herb Simon

Bounded Rationality
Satisficing
Human beings lack the cognitive resources to optimise :
We usually do not know the relevant probabilities of
outcomes,
We can rarely evaluate all outcomes with sufficient
precision, and our memories are weak and unreliable.
So we choosing acceptable alternative to resolving a
problem or pursuing an opportunity. Usually cost, time
frame, resources
Herb Simon

2 modes of thinking
System 1 (Automatic System)

System 2 (Reflective System)

Effortlessly, subconsciously, skilled,

associative, fast

factors abstraction, Rule following,

self aware, deductive, effortful

Rules of thumb, Framing biases

Weigh multiple options, choose

rationally

Humans*

Econs*

Econs: Efficient calculators, imagined in economic theory! able to

weigh multiple options, forecast all the consequences of each, and
choose rationally. Home economicus
Humans: Ordinary people, us! Humans operate by rules of thumb
(heuristics and biases) that often lead them astray. They are too prone
to generalize, biased in favour of the status quo, more concerned to
avoid loss than make gains, among other shortcomings.

Thaler and Sunstein, Nudge 2010

Sources of Error in Decision Making

Cognitive Heuristics and
Biases

Motivational Biases

Confirmation Bias
Hindsight Bias
Escalation of Commitment
Positive (ego-centric) Illusions

Availability
Representativeness
Anchoring and Adjustment
Framing
Emotion-related Biases
Priming

And decisions are based on our thinking

Availability Bias
Ease of recall
Retrievability
Presumed associations

Deaths in the U.S. (MGTO 2013)

Cause of Death

Estimated

Actual #
of Deaths

Homicide

59%

18,361

Alzheimers

41%

74,632

Words with n

Number of words

Estimated

Actual #
of Deaths

Start with n

54%

18,361

For Which n is the third

letter

46%

74,632

Words in a Novel

Seven Letter
words that have
the 6th letter n.

____i

ng

_____n _

1-2

3-4

5-7

8-10

11-15

16+

1
12
24
44
44
89
Which should be the bigger number?

21

19

30

45

42

21

40

Representative Bias

Insensitivity to base rates

Insensitivity to sample size
Misconceptions of chance
Regression to the mean
Conjunction fallacy

Sample size exercise

A v large urn of white and red balls. Prithvi draws 4 balls at a
time. Biswajit draws 7 balls at a time.
Statistical explanation: extreme outcomes (both high and low) are
more likely to be found in small than in large samples. This
explanation is not causal.
Even now, you must exert some mental effort to see that the
following two statements mean exactly the same thing: Large
samples are more precise than small samples. Small samples yield
extreme results more often than large samples do.
System 1 is highly adept in one form of thinking it automatically
and effortlessly identifies causal connections between events,
sometimes even when the connection is spurious.

Number of male babies born

Which hospital had more
days where more than 69%
of babies were male

Actual #
of Deaths

Hospital A

7%

Hospital B

40%

18,361

About the same (within

5% of each other)

53%

74,632

Regression to mean: talent & luck

Success = talent + luck
1st 2 days of golf tournament: assume that on both days
the average score of the competitors was at par 72.
focus on a player who did very well on the first day,
closing with a score of 66. What can we learn from that
excellent score?
focus on a player who scored 5 over par on that day,
you have reason to infer both that he is rather weak
and had a bad day.

Regression to mean: talent & luck

Success = talent + luck: Plausable inference
above-average score on day 1 = above-average talent + lucky (day 1)

And
below-average score on day 1 = below-average talent + unlucky (day 1)

On day 2
The golfer who did well on day 1 is likely to be successful on day 2 as
well, but less than on the first, because the unusual luck he probably
enjoyed on day 1 is unlikely to hold.
The golfer who did poorly on day 1 will probably be below average on
day 2, but will improve, because his probable streak of bad luck is not
likely to continue.

Allocation of Projected Sales

Store

2005

$12,000,000

$11,500,000

$11,000,000

$10,500,000

$10,000,000

$9,500,000

$9,000,000

$8,500,000

$8,000,000

total

$90,000,000

2008

$99,000,000

Allocation of Projected Sales - 2014

Store

2005

2008

$12,000,000

$13,159,588

$11,500,000

$12,140,823

$11,000,000

$11,630,902

$10,500,000

$11,173,406

$10,000,000

$10,784,104

$9,500,000

$10,591,434

$9,000,000

$9,302,815

$8,500,000

$9,079,831

$8,000,000

$8,400,617

$90,000,000

$99,000,000

total

Linda

Linda is active in the feminist

movement
Linda is a bank teller

Linda is a bank teller who is active in

the feminist movement

3.61
Which of
these should
have the
5.25
lowest
probability?

4.77

Anchoring and Adjustment

Insufficient anchor adjustment
Conjunctive and disjunctive event biases
Overconfidence

How much would you pay for the beer?

LOCATION
Fancy Resort Hotel
Small Grocery Store

Should there be a
difference in the
numbers?

311 IR

227 IR

Engineers salary

My secretarys estimate 100,000

Which estimate do
you expect to be
higher?

My secretarys estimate 20,000

41,482

84,424

Framing
Version 1 (Gain Frame)

Version 2 (Loss Frame)

Plan A

This plan will save one of the

three plants and 2,000 jobs.

This plan will result in the loss of two

of the three plants and 4,000 jobs.

Plan B

This plan has a 1/3 probability of

saving all three plants and all
6,000 jobs, but has a 2/3
probability of saving no plants and
no jobs.

This plan has a 2/3 probability of

resulting in the loss of all three
plants and all 6,000 jobs, but has a
1/3 probability of losing no plants
and no jobs.

Plan A: 57%
Plan B: 43%

Plan A: 41%
Plan B: 59%

Overcoming Heuristics
Recognize when you are using them
Distinguish between situations when they are used
appropriately vs. inappropriately
Is more information available
Is attaining more information cost effective

Sources of Error in Decision Making

Cognitive Heuristics and
Biases

Motivational Biases

Confirmation Bias
Hindsight Bias
Escalation of Commitment
Positive (ego-centric) Illusions

Availability
Representativeness
Anchoring and Adjustment
Framing
Emotion-related Biases
Priming

Motivational Biases

Escalation of Commitment
Confirmation Bias
Hindsight Bias
Positive (Ego-centric) Illusions

500 Rupee Auction

Bidding starts at Rs. 50 and proceeds in 50 rupee
increments
Two highest bidders have to pay
Only the highest bidder gets the 500 rupee note

What leads to Escalating Commitment

Initial decision followed by negative consequences
Which you think you can overcome (think future gains are possible;
optimistic that the project can be turned around)
More likely to commit to a failing course of action when you:

Had free choice at the very beginning

Have been publicly identified with the project
Have made a big investment the bigger the investment, the more
severe the possible loss, the more prone you are to honor sunk
costs
Two types of escalation of commitment
Unilateral

Competitive

Why do we get trapped Escalating Commitment

Logically Expected results are
Probability of positive outcome
Value of positive outcome
Are coloured by

Motivation to justify previous actions (through need to demonstrate

competence)
Norms for consistency (through socialization)

(More detail in your article by Staw)

$3 billion error - Escalation example in airlines

1981, American Airlines introduced the first frequent-flyer program.

All their competitors jumped on the bandwagon and provided a similar frequentflyers program.

Several competitors enhanced what they offered by doubling the air miles.

They also offered points for car rentals, hotel accommodations and other innovative
tactics.

The airlines continued this escalating competition through the early 1980s as each
airline tried to outdo their competitors.

In 1987, Delta Airlines offered triple miles to any passenger who charged their
tickets on their American Express card for all of the year of 1988.

Analysts took a hard look what this would actually mean as a cost to the airline
industry. They estimated that the airlines combined would end up owing their
passengers somewhere between $1.5 and $3 BILLION dollars in free trips. Whew!
This was not small change to say the least.

Competitive Escalation: Viacom v. QVC

The Players:

Paramount (Martin Davis) the prize

Viacom (Sumner Redstone) looking for a friendly merger

- QVC (Barry Diller) looking for a hostile takeover

Viacom paid more than it should have ($52 $107)
-

Overpaid by $2B dollars

Time was running out on the Viacom executives and advisers who
hunkered down to a Sunday-afternoon skull session Unless Viacom
came back fast and hard, everyone present knew, the fight would soon be
over one thought dominated all those at the meeting: how to throw a
knockout punch that would be, as one of them put it, a Diller-killer.

Reducing Escalation and Confirmation Biases

Set minimum targets for performance
Have multiple individuals examine the issues
Have different individuals assess initial and subsequent decisions
about a project
Attain more frequent feedback about project completion and costs
Reduce penalties or risk for failure
Make costs of persistence explicit

Positive (Egocentric) Illusions

We view ourselves, the world, and the future in a considerably more

positive light than is objectively likely or than reality can sustain
Unrealistically positive views of the self
Unrealistic optimism (Entrepreneurs, Restaurants)
Illusion of control (Dice Throw)
Self-serving attributions (Internalize Success, Externalize Failure)
Implications:
Happy/Functioning but delusional
Egocentric interpretations of what is fair can result in conflict
Consider others perspective

Positive (Egocentric) Illusions

Things go well

Things go badly

Us

Our effort caused it.

Externalities beyond our control

Them

Externalities

Direct result of their input

Abilities
Item
Your decision making abilities

76

Your bargaining abilities

64

Your intelligence

Your driving abilities

Your health

76
On average,
what should
70
these
numbers be?
70

Your contributions to charitable organizations

59

Your physical attractiveness

62

The number of good friends you have

60

Newsweek Survey
Whos going to heaven?

O.J. Simpson
Bill Clinton
Michael Jordan
Mother Theresa
Yourself

19%
52%
65%
79%
87%

Newsweek Survey
Whos going to heaven?

O.J. Simpson
Bill Clinton
Michael Jordan
Mother Theresa
Yourself

19%
52%
65%
79%
87%

Sources of Error in Decision Making

Cognitive Heuristics and
Biases

Motivational Biases

Confirmation Bias
Hindsight Bias
Escalation of Commitment
Positive (ego-centric) Illusions

Availability
Representativeness
Anchoring and Adjustment
Framing
Emotion-related Biases
Priming

Rational vs. Emotional Brain

Irrational choice most likely to occur
Stress
Information overload 7 rule

Too much rationality may limit decision making as well

What is meant by intuitive thinking?

Intuitive thinking means to get an idea or

understanding, without being able to explain
how you have developed it.
(Mental flash, example: Archimedes in the
bath tub or Newton under an apple tree)

Intuition
Do we have expertise?
Does it fit the situation?
Are you close or close enough?

Expert intuition

All heard such stories of expert intuition: the chess master who walks
past a street game and announces White mates in three without
stopping, or the physician who makes a complex diagnosis after a
single glance at a patient. Expert intuition strikes us as magical, but it is
not
Perhaps the best short statement of it is by the great Herbert Simon,
who studied chess masters and showed that after thousands of hours
of practice they come to see the pieces on the board differently from
the rest of us.

The situation has provided a cue; this cue has given the expert access
to information stored in memory, and the information provides the
answer. Intuition is nothing more and nothing less than
recognition.

De-biasing Yourself 1 of 2

Availability Heuristic

Use detailed documentation rather than recall

Dont rely on the first thing that comes to mind
Involve individuals with varied points of view
Counter with vivid examples
Role play

Representative Heuristic
Seek out and use base rates
Dont make strong conclusions based on small samples
Be aware of making causal inferences when chance and regression to the mean
are equally plausible explanations
Make events or individuals more unique, harder to categorize (e.g., describe
inconsistencies in personal characteristics)
Present disconfirming evidence within logic of bias
Increase diversity, i.e., involve more individuals with varied biases

De-biasing Yourself 2 of 2

Anchoring and Adjustment

Actively consider information that is inconsistent with the anchor
Change reference point

Framing effects
Re-frame the problem frame all problems in terms of both gains and losses
Discuss arguments in terms of both losses and gains
Be very mindful of language and associations (if someone is talking about the
avian flu what are they invoking?

Positive illusions
Seek outside-alternate (non-ego) view points
Seek disconfirming evidence

Role of Information Technology

Can reduce biases and heuristics
Links managers and employees at different levels and from
different departments which offers multiple perspectives
May help routinize decisions that were formerly non-programmed
and change them to programmed decisions

Example of pre-mortem at work

Summary
Purely rational decision making is rarely used and often not
practical
Individuals rely on heuristics to make decisions
These are often biased
Are sometimes not appropriate

Individuals need to be aware of their heuristics and the conditions

under which they are used
Decision making can be improved using IT, structure, and more
conscious processing of information