1. Chelst & Canbolat Value Added Decision Making 04/08/12 1 Chapter 14 Chapter 14 - Decision Making Biases  Forecasting Biases  misinformation to be used in making Decisions  Decision Bias   Information can still lead to biased decisions  Confirmation bias  Decision tendencies to go with …..  Status quo  Ignore sunk cost

2. Chelst & Canbolat Value Added Decision Making 04/08/12 2 Chapter 14 Sunk Cost  Made initial (even limited) investment & small return  Sunk cost and decision – choose the option you invested in rather than one you prefer (Ski trip)  Sunk cost with escalation  continued investment even though future yield would not warrant additional investment  Big Dig – once a billion dollars have been sent can you cancel project  After taking 1 or 2 courses in a degree program  continue  Future investments or commitments should be based on future value and not on past investments  Psychology –  do not want to appear wasteful personally  Affects your image in organization – made mistake

3. Chelst & Canbolat Value Added Decision Making 04/08/12 3 Chapter 14 Sunk Cost Examples  Affects choice: You have bought tickets for a weekend skiing trip in Michigan for $100. You later buy $50 tickets for a similar vacation in Wisconsin. Based on past experience, you anticipate that you will enjoy the weekend in Wisconsin even more than the weekend in Michigan. But then you realize that the tickets are for the same dates. Your only option is to choose one weekend over the other.  In a survey of 61 students, 54% chose Michigan over Wisconsin as the preferred ski trip  With escalation of commitment  War with continuing deaths  Dessert or rented movie (escalation continue on)  First drafts in basketball & Playing time  Continued employment of incompetent employees

4. Chelst & Canbolat Value Added Decision Making 04/08/12 4 Chapter 14 Faulty analysis and de-Escalation of Commitment  Costs already spent should have no affect on analysis of ROI for future investments.  Consider only future benefits and future costs  Escalation – tendency to want to recover the investment previously made  not give up  De-escalation – Calculate the amount that was already lost and include the spent money as part of the investment in the ROI calculation.  Need higher return on future investment to reach goal of ROI on total investment  Overvalue that things did not go well so far.

5. Chelst & Canbolat Value Added Decision Making 04/08/12 5 Chapter 14 Your own examples – Sunk Cost  Your organization  Sunk cost bias  Overcame sunk cost bias  Your personal  Sunk cost bias  Overcame sunk cost bias

6. Chelst & Canbolat Value Added Decision Making 04/08/12 6 Chapter 14 Overcome bias  New decision maker not tied to original investment  Eliminating car brands  loans to failing clients  Ending war  Require financial justification

7. Chelst & Canbolat Value Added Decision Making 04/08/12 7 Chapter 14 Framing  Scenario I: Choose the program you would prefer to implement.  A: Two hundred people will be saved.  B: There is a one-third probability that 600 will be saved and a two- third probability that no one will be saved.  Scenario II: Choose the program you would prefer to implement.  A: Four hundred people will die.  B: There is a one-third probability that no one will die and two- third probability that 600 people will die.  Scenario I  A selected by 72% people (Positive frame)  Scenario II  B selected by 78% people (Negative frame)  Led to Prospect Theory.

8. Chelst & Canbolat Value Added Decision Making 04/08/12 8 Chapter 14 Examples  Coca Cola Classic  framed as continuing loss of market share (Take more risk)  Doctors present information focus on  Likelihood of survival  Likelihood of bad outcome  100% of less is preferred to 99% of more  overvalue certainty.  Insurance policies with deductibles or rebates  Credit card or cash  discount for cash or premium for card  Overuse of percentages instead of absolute values  Frame election outcome relative to expectations  Buy 1 get one free or two for the price of one

9. Chelst & Canbolat Value Added Decision Making 04/08/12 9 Chapter 14 Status Quo (and Omission)  Define – tendency to stay with what you have even when limited vested interest in original decisions  Examples with little or no transition cost  Inherit a portfolio of stocks  Change health insurance plans  Personal experience  Endowment effect (own something)  With transition costs – often uncertainty with new alternative  Brand loyalty for satisfied customer  Linked with Omission bias – More regret with doing something and negative outcome that with doing nothing and negative outcome.

10. Chelst & Canbolat Value Added Decision Making 04/08/12 10 Chapter 14 Status quo examples  Higher selling price than buying price  No cost trial  Money back guarantee  Subscription free for first few months but can cancel any time  Status quo of pension policies  Social benefit of status quo??

11. Chelst & Canbolat Value Added Decision Making 04/08/12 11 Chapter 14 Overcome status quo  Treat status quo and alternatives equally  Zero based budgeting  Force consideration of a change  Request bids from other suppliers  Force rank low performers in a company  Sunset laws – Bush tax cuts  Experts – standards for medical testing

12. Chelst & Canbolat Value Added Decision Making 04/08/12 12 Chapter 14 Your own examples – Status Quo  Your organization  Status Quo bias  Overcame Status Quo bias  Your personal  Status Quo bias  Overcame Status Quo bias

13. Chelst & Canbolat Value Added Decision Making 04/08/12 13 Chapter 14 Sunk Cost & Status Quo

14. Chelst & Canbolat Value Added Decision Making 04/08/12 14 Chapter 14 Regret (powerful emotion) Aversion  Anticipatory regret – insurance deductibles, extended warranty  Can be manipulated  Car rental companies raise your awareness (possible accident)  Health care behavior  Linked to responsibility – less to regret if going with industry leader  Retrospective long term regret – looking back on life  Regret inaction  Retrospective short term (hot) regret – linked to actions gone bad  Regret as compared to the normative  Try everything for someone dying  Not in immediate danger – fear action might make things worse  Regret greater in presence of feedback

15. Chelst & Canbolat Value Added Decision Making 04/08/12 15 Chapter 14 Propositions in Regret Regulation Theory 1. Regret is an aversive, cognitive emotion that people are motivated to regulate in order to maximize outcomes in the short term and learn maximizing them in the long run. 2. Regret is a comparison-based emotion of self-blame, experienced when people realize or imagine that their present situation would have been better had they decided differently in the past. 3. Regret is distinct from related other specific emotions such as anger, disappointment, envy, guilt, sadness, and shame and from general negative affect on the basis of its appraisals, experiential content, and behavioral consequences. 4. Individual differences in the tendency to experience regret are reliably related to the tendency to maximize and compare one’s outcomes. 5. Regret can be experienced about past (“retrospective regret”) and future (“anticipated or prospective regret”) decisions. 6. Anticipated regret is experienced when decisions are difficult and important and when the decision maker expects to learn the outcomes of both the chosen and rejected options quickly. 7. Regret can stem from decisions to act and from decisions not to act: The more justifiable the decision, the less regret. 8. Regret can be experienced about decision process (“process regret”) and decision outcomes (“outcome regret”). 9. Regret aversion is distinct from risk aversion, and they jointly and independently influence behavioral decisions. 10. Regret regulation strategies are decision-, alternative-, or feeling-focused and implemented based on their accessibility and their instrumentality to the current overarching goal.

16. Chelst & Canbolat Value Added Decision Making 04/08/12 16 Chapter 14 Towards Fairness “Bias”  Willingness to give up something in order to achieve a more fair situation – contradicts fundamental utility theory  Ultimatum Game – allocate $100  Wage fairness –  two tiered workers  CEOs have adopted a different measuring yardstick – other CEOs and not their own workers  In 1965, CEO salaries averaged 24 times the average salary of a worker. By 1978 this number had grown to 35 and by 1989 to 71. By 2005, CEO salaries were a staggering 262 times the average worker’s salary.  Taking advantage of a financial handicap or threat of lost jobs

17. Chelst & Canbolat Value Added Decision Making 04/08/12 17 Chapter 14 Your own examples – Fairness  Your organization  Fairness bias – exits or non-existent  Your personal  Fairness bias

18. Chelst & Canbolat Value Added Decision Making 04/08/12 18 Chapter 14 Mood - incidental  Anger  actions to regret: e-mails  Do not consider many alternatives  Eagerness to act  Risk prone – optimistic actions will have impact  Anxiety  low risk/low reward but  Sad  high reqard and less security  Good mood  risk averse to mood changing loss  Provide Example  Chapter  Personal experience  Overcome bias

19. Chelst & Canbolat Value Added Decision Making 04/08/12 19 Chapter 14 Your own examples – Mood  Your organization  Mood of executives?  Your personal moods

20. Chelst & Canbolat Value Added Decision Making 04/08/12 20 Chapter 14 Groupthink  Define  Provide Example  Chapter  Personal experience  Overcome bias

21. Chelst & Canbolat Value Added Decision Making 04/08/12 21 Chapter 14 Boston Consulting Group  Use Biases to define features  Use biases to define sequence of decisions  How information is displayed.

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31. Chelst & Canbolat Value Added Decision Making 04/08/12 31 Chapter 14 IE 7720 Engineering Decision & Risk Analysis © Chelst Week 10 31

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