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MANAGERIAL JUDGMENT: When Good Managers Make Bad Decisions Professor Jill Klein Melbourne Business School.

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Presentation on theme: "MANAGERIAL JUDGMENT: When Good Managers Make Bad Decisions Professor Jill Klein Melbourne Business School."— Presentation transcript:

1 MANAGERIAL JUDGMENT: When Good Managers Make Bad Decisions Professor Jill Klein Melbourne Business School

2 Why Good Decisions Are Hard Our brains developed to make hunter-gatherer decisions that enhanced survival. In the modern world this leads to systematic mistakes in decisions, management and leadership.

3 Hope…  Cognitive and social psychologists have worked for years to understand these problems  New scientific knowledge allows us to pinpoint our deficiencies and uncover remedies

4 Overconfidence Framing Anchoring Confirmatory Bias

5 For each of the following ten items, provide a low and high guess such that you are 90 percent sure the correct answer falls between the two. Your challenge is to be neither too narrow (i.e., overconfident) nor too wide (i.e., under confident). If you successfully meet this challenge you should have 10 percent misses – that is, exactly one miss. LowHigh 1. What is the weight of an empty Airbus A340-600 (in kilograms or tons?) 2. In what year did John Steinbeck win the Nobel Prize for literature? 3. What is the distance (in kilometers or miles) from the Earth to the Moon? 4. What is the air distance (in kilometers or miles) from Madrid to Baghdad? 5. In what year was the construction of the Roman Coliseum completed? 6. What is the height (in meters or feet) of the Aswan High Dam? 7. In what year did Magellan’s crew complete the first naval circumnavigation of the globe? 8. In what year was Mohandas K. Gandhi born? 9. What is the surface area (in square kilometers or miles) of the Mediterranean Sea? 10. What is the gestation period of the great blue whale? * “Winning Decisions,” by Russo and Schoemaker (2002) 90% Confidence Range

6 Overconfidence Quiz: Answers 1. Weight of an Airbus A340-600? 2. Year of Steinbeck’s Nobel Prize? 3. Miles to the moon? 4. Miles between Madrid and Bagdad? 5. Year the Coliseum was completed? 218,000 kilograms or 240 tons 1962 238,850 (384309 km) 2,677 (4307 km) A.D. 80

7 6. Height of Aswan High Dam? 7. Year of first circumnavigation of the globe? 8. Year of Gandhi’s birth? 9. Surface area of Mediterranean? 10. Gestational period of great blue whale? 114 meters or 375 feet 1522 1869 970,000 square miles ( 1561067 square km) 335 days Overconfidence Quiz: Answers

8 Overconfidence: Robust Finding  Study of 2000 managers around the world  Less than 1% got only 1 wrong  Most miss 4 – 7 questions  No strong cross-cultural differences

9 Overconfidence  Having a greater degree of confidence in one’s knowledge, forecasts, etc. than is justified  Thinking you will be correct more often than you are

10 Overconfidence Percentage of Misses Type of People Tested Types of Questions Asked Ideal Target Actually Observed Harvard MBA’sTrivia Facts2%46% Employees of a Chemical Company Chemical Industry Facts10%50% Company-Specific Facts50%79% Managers of a Computer Company General Business Facts5%80% Company-Specific Facts5%58% Physicians Probability that a Patient has Pneumonia 0-20%82%

11 Overconfidence Among Experts There is no correlation between how confident a person is (or how confident he or she appears to be) and accuracy.

12 Overconfidence  82% of people say they are in the top 30% of safe drivers  Project management  Almost all cost estimates for construction projects exceed initial estimates by at least 20% (the median is 100%)  Overconfident to finish on time  Final Offer Arbitration  70% of bidders believe that their bid will be preferred by the arbiter

13 Overconfidence Bias: Remedies  Average judgment of a group is almost always better than an individual judgment – The Wisdom of Crowds  Collect other opinions  Averaging even 1 other option with yours is an improvement  Averaging even your own 2 nd opinion with your 1 st opinion is an improvement

14 Overconfidence Bias: Remedies  Think about extremes before the middle  Separate “deciding” from “doing”  Be a realist when deciding; confine optimism to implementation

15 Overconfidence Bias: Remedies  Be contrarian  Ask yourself “why might I be wrong?”  Don’t demand high confidence and narrow intervals from others  Try to better calibrate your metaknowledge  Practice and look for feedback

16 Overconfidence Bias: Remedies  Keep a Decision Diary  Be honest with yourself  Don’t rationalize failures (all failures must count)  Define specific objectives and what constitutes success at the outset

17 Decision Diary Date Decision to be Made Decision Definition of Success Date for Evaluation EvaluationLearnings

18 Overconfidence Framing Anchoring Confirmation

19 Framing A story is told about two monks who were heavy smokers. Concerned that smoking was inconsistent with their commitment to a life of prayer and devotion, they decided to ask their prefect for guidance. The first asked, “Father, would it be permitted to smoke while I am praying to the Lord?” The answer was a resounding no. The second asked, “Father, when in moments of weakness I smoke, would it be permitted to say a prayer to the Lord?” “Yes,” the prefect replied, “of course!”

20 Framing  Frames draw attention to certain aspects of a problem, while leaving others in the shadows, hidden from our view  Mindset or mental model: simplifies our understanding of a complex reality  But… can limit our view and the options we consider

21 Framing One FrameAlternative Frame Negotiation Competition, win-lose Joint problem solving, win-win Training CostInvestment Buyer-Seller Exchange A transactionPart of a relationship

22 Frame Dependence Remedies: Awareness What issues does the frame address most? What boundaries do I put on the problem? In particular, what aspects of the situation do I leave out of consideration? What yardsticks and reference points do I use to measure success? What metaphors, if any, do I use in thinking about this issue? (football, war, family) Why do I think about this question this way? What training or experiences frame the way I view the world? What does the frame emphasize or minimize? Do other people in my profession or industry think abut this problem differently? How? Why? Are their frames successful? * “Winning Decisions,” by Russo and Schoemaker (2002)

23 Frame Dependence Remedies: Falsify Frame  Try to falsify your frame  Role play devil’s advocate Customers care mostly about price, secondarily service Customers care mostly about service, secondarily price

24 Frame Dependence Remedies: Find or Build Better Frames  Talk to someone with different training or background or from a different industry  Ask “How do you see it?” “What am I overlooking?”  Pharma moving to OTC… brought in people from P&G  Talk to other stakeholders (suppliers, citizens)

25 Overconfidence Framing Anchoring Confirmation

26 Anchoring Bias What are the last three digits of your mobile number? 1. __________ Add 400 to your answer from 1 above and total 2. __________ Do you think Attila the Hun was defeated in Europe before or after (use date from 2 above) A.D. Before____ After _____ In what year do you think Attila the Hun was actually defeated? _________ A.D.

27 Last Three Digits of Phone Number plus 400 Average Estimate of the Year of Attila’s Defeat 400 to 599 629 600 to 799 680 800 to 999 789 1000 to 1199 885 1200 to 1399 988 Actual date = 451 Anchoring Bias

28 Version 1 What is your best guess of the annual Australian egg production (in millions)? ____________ Version 2 What is your best guess of the annual Australian egg production (in billions)? ____________ Mean: 1098 m ≈ 1.1 billion Mean: 18.9 billion What units do you do your budgeting in? Actual production: 2.44 Billion

29 Anchoring Bias  Often observed in  Project Completion Time Estimates  Revenue Estimates  Budgeting  Resourcing projects

30 Anchoring Bias: Remedies  Be aware of the anchor you may be using  Try multiple anchors  Most recent similar project completion time  Average of last 10 projects  An optimistic forecast (nothing goes wrong)  A pessimistic forecast (everything goes wrong)

31 Overconfidence Framing Anchoring Confirmation

32 Confirmatory Bias: Confirming Expectations Rich Hannah Poor Hannah Grade Level

33 Confirmation Bias  Preference for information that is consistent with beliefs rather than information that goes against beliefs  More likely to draw conclusions that suggest  Desired option is best  Pre-existing beliefs are correct  You have status and are successful  Also referred to as “motivated reasoning”

34 Examples Of 161 studies on risks of four chemicals used in drugs Funded by Industry 14% found harmful effects Funded Independently 60% found harmful effects Of 100 clinical studies to see if a new drug is more effective than an old drug Funded by Drug Companies 13% favored old drug Funded Independently 87% favored old drug

35 Enron Mr. Skilling's testimony revealed that he increasingly sought validation for what he believed, rather than listening carefully when he was told about problems at the company. Mr. Skilling sought assurances that everything happening in California's newly deregulated electricity market was on the up and up. Enron has to be "absolutely pure as the driven snow," Mr. Skilling told Richard Sanders, then an Enron lawyer. "So one more time," he said. "We're pure as the driven snow, right?” From NYT (April 21, 2006)

36 Leadership and the Confirmatory Bias  Executives who are more likely to display confirmatory bias:  Interact only with a small circle of managers, employees, etc.  Have barriers around them (e.g., admin assts) who protect them  “Solicit” input but only smile and nod at select comments  Shoot the Messenger: Contrary positions are taken as “disloyal”  Involve an “expert” with an established point of view to offer advice consistent with own point of view  Choose the data—or ways of looking at the data—that are consistent with their point of view

37 Confirmatory Bias: Remedies  Be aware that you will tend to confirm your beliefs  Ask disconfirming questions  Try to obtain information that disconfirms your opinion or your data sources  Think of reasons why your opinions or data might be wrong  Entertain and test multiple opinions  At least temporarily, pretend others are right (even if you don’t think they are)  Engage in Prospective Hindsight

38 Further Reading

39 Dan Ariely

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