Three ways to get it wrong

imageIn last week’s post we discussed some of the decision-making traps that board members–or, indeed, any decision-making group–can fall into.

At the heart of our understanding of these biases is the work of Daniel Kahneman.  He was awarded the Nobel Prize for Economics for his work in this area, with co-worker Amos Tversky. in 2002.  Sadly Tversky died in 1996 and was ineligible for the prize, under Nobel rules.

Behavioural Economics

Daniel KahnemanKahneman is perhaps the leading psychologist in the field of behavioural economics – very much a field du jour.  His research was carried out with many collaborators including Paul Slovic, an expert in the field of perception of risk, and Richard Thaler, most notable for his use of the term “nudge” to describe how we can use perceptions to shift behaviour.

The classic paper that Kahneman and Tversky wrote was ‘Judgment under Uncertainty: Heuristics and Biases’, published in the Journal Science in September 1974.

Heuristic: A rule of thumb or simple procedure for reaching a decision or solving a problem.

In this article, they introduced three important heuristics, which guide many of our decisions – and frequently let us down.

Representativeness

We tend to believe a possible event is more likely when we can recognise it as a part of a familiar pattern.  It is as if we like to create stories about our world that follow standard arcs or plots (see for example Christopher Booker’s wonderfully argued The Seven Basic Plots: Why We Tell Stories.  If a potential event slips easily into one of these plots, we rate it as more likely than if the plot seems to need adjusting.

Availability

Recent salient examples render a possible event more likely in our minds than other events that do not trigger such easy recall.  Immediately after a rail accident, people fear rail travel more than normal and take to their cars.  The resulting spike in road deaths usually exceeds the immediate effects of the road accident.

Anchoring

We make estimates and decisions from a starting point and the point we choose can bias our estimate or decision.  Surprisingly, even an unrelated figure presented randomly can skew a later numerical estimate.

Kahneman won’t stand still

In 2007, Kahneman received the American Psychological Association’s Award for Outstanding Lifetime Contributions to Psychology and this year, he was included in Bloomberg 50 most influential people in global finance.  He says that all he knows about economics, he learned from co-workers like Richard Thaler.  He is a much sought-after speaker and commentator in the business arena, and you can find recent work documented on TED (see below), in an extended interview, and in two excellent articles on the websites of prominent global strategy consulting firms,McKinsey and Booz & Company:

Daniel Kahneman: The riddle of experience vs. memory

Using examples from vacations to colonoscopies, Kahneman reveals how our “experiencing selves” and our “remembering selves” perceive happiness, and why experience does not influence decisions, in this 2010 TED talk.

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