Large Assignment Needed
Edward1111Dr. Kip Kiefer
Judgment and Decision Making
(Heuristics and Biases)
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Competing values in organizations
Admin
Revised syllabus posted
Very slight modification…practically non-noticeable
Revised class schedule posted
Assignments filled in
Papers, exercises, discussion boards, cases
Cousepack link to buy cases will be provided very soon
Guest Speakers posted
But some dates not confirmed yet
Today’s Lesson Objectives
Understand how managers use information and “rational” decision making processes to evaluate and solve complex managerial problems
Understand the role of biases, heuristics, framing and prospect theory on decision making.
Light Brain Stretching…
What was the first country in the world to introduce an income tax, in 1789?
What Michael Jackson album spawned five chart-topping singles?
What country considered German, French and Greek as official languages, before settling on English?
Cogitate the following…
How do you fix a cracked pumpkin?
What kind of award did the dentist receive?
Britain
Bad
The United States
With a pumpkin patch
A little plaque
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Course Thesis
#-5
Managers, leaders, policymakers, and individuals (particularly “Intellectual Giants”) should think critically…
Gather information and use models
(which consider heterogeneity, not just the average)
to make decisions and solve problems that attempt to
increase positive outcomes and
insure against negative outcomes.
(subject to search and implementation costs)
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Types of Decisions
Programmed: routine and repetitive; structured and occur frequently
What should I wear in the morning?
Non-Programmed: unfamiliar circumstances; unstructured and tend to be more complex and important
Where should I live in Elon?
Programmed Decisions
Programmed decisions are those that a manager has encountered and made in the past. The decision the manager made was correct because she used the assistance of company policies, computations or a set of decision-making guidelines. In addition to being well structured with predetermined rules regarding the decision-making process, programmed decisions may also be repetitive or routine as their outcome was successful in the past. It generally does not take a manager as long to come to a conclusion when faced with a business-related programmed decision because the challenge faced is not new. As a result, programmed decisions allow a manager to make streamlined and consistently effective choices.
Examples of Programmed Decisions
Individuals naturally make programmed decisions on a daily basis. For example, in an emergency, most people automatically decide to call 9-1-1. From a business perspective, a company may create a standard routine for handling technical issues, customer service problems or disciplinary matters. An employee’s duties may become routine with repetition, like the process a mechanic uses to troubleshoot problems with a customer’s car.
Programmed decisions minimize the need for managers to exercise discretion. This factor is important because discretion costs money. The more non-programmed decision making a manager is required to do, the greater the judgment needed. Because sound judgment is an uncommon quality, it costs more to acquire the services of managers who possess it.
Non-programmed Decisions
Non-programmed decisions involve scenarios that are new or novel and for which there are no proven answers to use as a guide. In such a case, a manager must make a decision that is unique to the situation and results in a tailored solution. Non-programmed decisions generally take longer to make because of all the variables an individual must weigh; and the fact that the information available is incomplete, so a manager cannot easily anticipate the outcome of his decision.
Examples of non-programmed Decisions
An individual may make an non-programmed decision when she visits a new restaurant, is unfamiliar with the menu and the menu is in a language she does not understand. In the business world, the makers of the earliest personal computers had to make non-programmed decisions regarding the type of marketing to use to attract customers who possibly had never used a computer in the past. Fast-food companies also had to make an non-programmed decision regarding consumer concerns about high fat contents and lack of healthy menu options.
Examples of non-programmed decisions include deciding whether to acquire another organization, deciding which global markets offer the most potential, or deciding whether to sell off an unprofitable vision. Such decisions are unique and non-recurring. When a manager confronts an ill-structured problem no cut and dried solution is available. A custom made non programmed response is required.
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Decision Making Conditions
Certainty Risk Uncertainty Ambiguity
BUSINESS Evaluation Tools/Models
For example, in making management decisions we employ tools such as:
cost-benefit analysis -- 4Ps, 3Cs
feasibility analysis -- ratio analysis
time-to-market analysis -- Porter’s five forces
net present value -- MADM
strategic prioritization -- SWOT
etc.
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Steps in making a judgment
Identify a Problem
Identification Decision Criteria
Allocate weights to the criteria
Develop alternative courses of action
Analyze/evaluate alternative courses of action
Estimation of outcome probabilities
Select a course of action (an alternative)
Implementation the course of action
Evaluate Decision Effectiveness (Justify your decision)
Biases and other
influences on
perceptions and
decision making
(heuristics)
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BIASES – a preference, inclination or predisposition that inhibits impartial judgment
HEURISTICS – ways in which we formulate speculations in order to investigate and solve a problem. STEP-BY-STEP PROBLEM SOLVING TECHNIQUES
People are plagued more by bad decision making than ethical breaches in reasoning.
Overwhelming evidence that people do not always make decisions in a rationally optimal manner (Kahneman & Tversky, 2000).
Various heuristics and biases lead most people to systematically diverge from optimal decision-making.
Rational Actors Optimal Decision-Making Models
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Behavioral research has shown…
Heuristics and Cognitive Biases
What is a heuristic?
Ways in which we formulate speculations in order to investigate and solve a problem
Mental shortcut to reduce complexity…
What is a cognitive bias?
a preference, inclination or predisposition that inhibits impartial judgment
“Deviation in judgment due to a distorted view”
“Human tendency to make systematic errors in reasoning”
We have lots of them…
Just before we go over the answers to the in-class exercise, let’s talk about heuristics/biases.
What is a heuristic? Mental shortcut to reduce complexity of judgment
What are biases? You hear people talk about cognitive biases. They are the inevitable ‘cognitive illusions’
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The world
of rationality
The world
of non-rationality
Logic
Purpose
Objectivity
Reasonableness
“Good common sense”
Practicality
Emotions
Stress Reactions
Creativity
Feelings
Needs
Conformity
forces
Loyalties
Impulsiveness
Energy
Groupthink
Are we typically rational?
Reading A – Tversky, Amos and Kahneman, Daniel, 1974. Judgment under Uncertainty: Heuristics and Biases, American Association for Advancement of Science.
How people create the ‘missing’ probabilities when operating in environments of uncertainty.
Reading B – Tversky and Kahneman, 1979. Prospect Theory: An Analysis of Decision under Risk, Econometrica.
Losses and Gains…do we perceive them the same?
Background Readings…
2 readings
Tversky & Kahneman – decision making under uncertainty
It’s the 4th quarter, time for one last play, your tied and you have a chance at a 56 yard field goal to win it. You’ve got a good kicker, but this will push his limits, what do you do? What will happen? What are the chances that you will win this game on this kick? Give me some estimates? Could you have predicted what happened in the video? Heck no, but that doesn’t stop us from using heuristics and getting influenced by biases!
It’s the end of the 4th quarter (12 seconds left), you’re up by 2 points and it is 4th down and 6 yards to go from your opponents 45 yard line…What do you do and what will happen? What are the chances that you will win this game? Give me some estimates?
Could you have predicted what happened in the video? Heck no, but that doesn’t stop us from using heuristics and getting influenced by biases!
Prospect theory – decision making under risk
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Decision Making Exercise
Please answer the questions on the handout…
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Decision Making Exercise
We love numbers.
We make many decisions based on numbers.
We think this makes us rational decision makers.
But sometimes we are relatively poor with numbers and/or suppressing the influence of biases!
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Decision Making Heuristics
Representativeness
Probabilities are evaluated by the degree to which A is representative of B; the degree to which A resembles/is similar to B.
Tendency to generalize from a small sample or single event.
Question 2 & 6: Did we ignore sample size?
Question 2 & 6: Did we ignore prior probabilities?
You have statistics on 100 men with high paying jobs. 70% of the men are lawyers and 30% are engineers.
“Tim is a 30-year old man. He is married with no children. A man of high ability and high motivation, he promises to be quite successful in his field. He is well liked by his colleagues.”
Representativeness: People neglect relative base rates of occurrence
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Decision Making Heuristics
Availability
People assess the probability of an event by the ease with which instances or occurrences can be brought to mind. Using information readily available from memory/experience.
Question 4: Were we sensitive to retrievability, salience?
What is really worse…Lightning or Tornadoes?
Representativeness: People neglect relative base rates of occurrence
Availability: Instances of large classes of events are recalled better and faster than instances of less frequent classes
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Decision Making Heuristics
Anchoring & Adjustment
People make estimates by starting from an initial value that is adjusted to yield the final answer; different starting points yield different estimates, which are biased toward the initial values.
Questions 7 & 8: Did we anchor? Did we under-adjust?
Let’s find out…What did you estimate the population of Turkey to be?
Anchoring & adjustment: Occurs in the presence of uncertainty regarding the correct or appropriate response
People ‘anchor’ / fixate on an irrelevant reference point and no matter how irrelevant the point, they cannot sufficiently adjust.
In this case, the numbers were clearly garbage, yet we still anchored and failed to adjust.
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Key Aspect of Prospect Theory: Loss Aversion
People detest losses more than they enjoy gains, about twice as much.
Endowment effect - the notion that we easily attach ourselves to things and then value them much more than we valued them before we identified with them.
People will make decisions in order to protect their endowment that they would never have made in the first place to accumulate that endowment.
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For example, companies may cover up damning evidence about unsafe products after safety problems have been detected:
BIG TOBACCO - The leaking of thousands of documents by disgruntled Brown & Williamson clerk Merrell Williams in 1994 cast new light on the inner workings of the cigarette makers.
In a 1996 deposition, Brown & Williamson's assistant general counsel (J. Kendrick Wells III) testified that during the past 15 years, through scores of lawsuits, the firm released only between 500 and 800 documents; the rest of the potentially tens of thousands of documents requested by plaintiff's lawyers, including all relating to several key research projects, were stored under the attorney-client privilege.
Dalkon Shield
Decision Making Heuristics
Question #1:
Conservative with gains?
Gambling with losses?
Question #9:
Conservative with gains?
Gambling with losses?
Compare to #1—are you consistent?
Prospect Theory
There is a bigger impact of losses than of gains (loss aversion)
People seem to be risk averse (conservative) with respect to gains, and risk-taking (willing to gamble) with respect to losses.
FRAMING EFFECT / PROSPECT THEORY
People are risk averse in the domain of gains and risk seeking in the domain of losses
Losses loom larger than gains
Tend to overestimate small probabilities and underestimate large probabilities
Tendency to evaluate positively presented info as favorable & negatively presented info as unfavorable
i.e., is the glass half empty or half full?
Advertising agents are very good at using the framing effect
E.g., a leading brand of cat litter says that it is 99% dust free and a shampoo claims to be fortified with 1% protein. Consumer tend to perceive the cat litter to have very little dust and the shampoo to have lots of protein
E.g., an executive search firm might advertise that 50% of its clients get $100,000 jobs right out of school; students might ignore the fact that the other 50% either got low-paying jobs or no jobs at all
Managers often frame results: E.g., you are interviewing 2 candidates for 1 job; they have identical skills, experience, etc. but you prefer 1 over the other for some reason; when writing up the results of the interview and your preference, you will make the candidate that you like better look better on paperhomosocial reproduction
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Decision Making Heuristics
Which do you prefer for question #3…
If Program A is adopted, 400 people will die?
If program B is adopted, there is a 1/3 probability that nobody will die and a 2/3 probability that 600 people will die.
Were you consistent for #3 & #5??
Framing
The manner in which a rational choice problem has been presented. Tversky and Kahneman have shown that framing can affect the outcome (i.e., the choices one makes) of choice problems, to the extent that several of the classic axioms of rational choice do not hold.
FRAMING EFFECT / PROSPECT THEORY
People are risk averse in the domain of gains and risk seeking in the domain of losses
Losses loom larger than gains
Tend to overestimate small probabilities and underestimate large probabilities
Tendency to evaluate positively presented info as favorable & negatively presented info as unfavorable
i.e., is the glass half empty or half full?
Advertising agents are very good at using the framing effect
E.g., a leading brand of cat litter says that it is 99% dust free and a shampoo claims to be fortified with 1% protein. Consumer tend to perceive the cat litter to have very little dust and the shampoo to have lots of protein
E.g., an executive search firm might advertise that 50% of its clients get $100,000 jobs right out of school; students might ignore the fact that the other 50% either got low-paying jobs or no jobs at all
Managers often frame results: E.g., you are interviewing 2 candidates for 1 job; they have identical skills, experience, etc. but you prefer 1 over the other for some reason; when writing up the results of the interview and your preference, you will make the candidate that you like better look better on paperhomosocial reproduction
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The death rate in the city hospital emergency room is 3%.
The death rate in the rural hospital emergency room is 2%.
You are exactly 15 minutes from both hospitals.
You need emergency care.
Which hospital would you go to?
We are Horrible with Numbers sometimes,
especially Statistics.
Another example*** DEATH RATE AT CITY HOSPITALS ***
Why do we love those numbers so much? They tell us nothing, but we love them.
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Who would you choose??
New Law School Experienced litigator who
Grad with a high who has been sanctioned
BAR exam score in the past
“Availability Bias”
“Representation Bias”
“Stereotyping”
Lesson Summary
Biases
Representativeness
The tendency to generalize from a small sample or single event
Availability
Managers use information readily available from memory/experience to make judgements
Anchoring & Adjustment
The tendency to make decisions based on an initial figure
Prospect Theory
There is a bigger impact of losses than of gains (loss aversion)
People seem to be risk averse (conservative) with respect to gains, and risk-taking (willing to gamble) with respect to losses.
Framing
The manner in which a rational choice problem has been presented can affect the outcome (i.e., the choices one makes) of choice problems, to the extent that several of the classic axioms of rational choice do not hold.
Why teach about heuristics and biases?
Sensitize employees to various forms of ethical dilemmas.
Educate employees regarding their own cognitive and behavioral susceptibilities
Educate employees about potential non-formal organizational influences and pressures
Inoculate employees against weaknesses in their own decision-making processes.
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Limitations:
Evidence shows that some of these tendencies are very difficult to debias, even with experience and training.
Nonetheless, not all attempts to debias have been failures.
Common sense dictates educating students and employees about these biases and heuristics.
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Limitations in effective methods to debias people.
Judgment and Decision Making Take-Aways
We love numbers.
We make many decisions based on numbers.
But we need to be careful with numbers!
Heuristics are human nature and very valuable, but beware!
Biases can be dangerous—beware!
Statistics are extremely powerful, but very often misused—beware!
I’m sure you are smarter than me
(you are “Intellectual Giants”), but:
An MBA hasn’t made me immune!
A PhD hasn’t made me immune!
Teaching this material hasn’t made me immune!
Many life experiences hasn’t made me immune!
Beware!
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When I woke up today…
…I realized that this program is not living up to the expectations set by the brochures and the website. The classes are much harder and more time consuming than I expected. I realized how much I am sacrificing to be in this program and I miss my (parents, children, siblings, friends). Plus, I realized that I am taking on a lot of debt to be in this program…
…I realized that I live in a beautiful, desirable location. I am at a very reputable school and in a program with a diverse, yet like-minded/goal-oriented individuals. I am only a couple of (years/ semesters) away from earning my Masters degree! I am gaining some incredible friendships and learning a lot of valuable life and work lessons. With my Masters degree, I have the chance to move up or start over in my career and that is very exciting!
“Anchoring & Adjustment Bias”
Tendency to make a decision based on an initial figures, feel, or frame.
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Looking ahead…
Sunk Cost Bias and Escalation of Commitment
Readings:
The Psychology of Sunk Costs (pgs 1-13)
The Escalation of Commitment
Mental Accounting Matters (Optional) (pgs 1-15)
Discussion Board Input Due (before class begins)
Directions will be posted soon
Back-up Slides
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“The development of general ability for independent thinking and judgment…
…should always be placed foremost, not the acquisition of special knowledge”
Classes of Decisions (Risk Continuum)
Certainty
Know all info regarding the states of nature (environment) and also has full knowledge of alternatives
Risk
More than one possible state of nature and probabilities can be articulated
Uncertainty
More than one possible state of nature and probabilities cannot be articulated
Ambiguity
Don’t even know what questions to ask
4 Approaches to Decision Making
Rational Decision Making
Bounded Rational Decision Making
(Informed) Intuition
Gut, Feelings, Emotions, Experience, knowledge and training
Evidence-Based Management
The evolution of understanding how people make decisions
Rational Decision Making Models
Expected Value
Behavioral Theories
Expected Utility
Prospect Theory
Expected Value Briefly Explained
In the presence of risky outcomes, a decision maker could use expected value to govern their choice
Higher expected value investments are simply the preferred ones.
For example, suppose there is a gamble in which the probability of getting a $100 payment is 1 in 80 and the alternative, and far more likely, outcome, is getting nothing. The expected value of this gamble is $1.25.
Therefore, given the choice between this gamble and a guaranteed payment of $1, by this simple expected value theory people would choose the $100-or-nothing gamble.
Along came Expected Utility Theory
Under expected utility theory…
Some people would be risk averse enough to prefer the sure thing, even though it has a lower expected value,
While other less risk averse people would still choose the riskier, higher-mean gamble.
Daniel Bernoulli proposed that a mathematical function should be used to correct the expected value depending on probability.
This provides a way to account for risk aversion, where the risk premium is higher for low-probability events than the difference between the payout level of a particular outcome and its expected value.
Then came Prospect Theory
Then behavioral finance proponents said, but there is more to this and produced several generalized expected utility theories to account for instances where people's choice deviate from those predicted by expected utility theory. These deviations are described as "irrational" because they can depend on the way the problem is presented, not on the actual costs, rewards, or probabilities involved.
Particular theories include prospect theory, rank-dependent expected utility and cumulative prospect theory and SP/A theory
Misconceptions of regression
:
“Regression to the mean is one of the trickiest threats to validity. Even Excellent researchers sometimes fail to catch this…”
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“Don’t Ask, Don’t Tell…”
“The military should repeal its Don’t ask, don’t tell policy and allow homosexuals to serve openly…”
The Burlington Gay & Lesbian Pride Center
General (retired) Shalikashvili, former CJCS, 2 Jan ‘07 NYT
“Source Bias”
The Citadel Case – Gerald F. Smith
How sad that the rights of 2,000 male cadets at The Citadel, a 152 year-old college in Charleston, SC, are about to be trampled.
Why? Because The Citadel, where my son graduated, has been ordered to admit a female, Shannon Faulkner, into its Corps of Cadets on 12 Aug. She is backed by the US Justice Dept and the ACLU.
Institutions of higher learning in SC have traditionally been separated by gender…The Citadel should not be forced to change merely for what is politically correct in 1995…that agenda might well change once the results of the next presidential election are known. With the Citadel’s tradition broken, what the male cadets bargained for in good faith will be lost.
“Historical Precedence”
95% of all legal claims are settled out of court…
Precedence / Case Law
Historical Basis
Times have changed…
Cats had a 30% increase in kidney failure
…due to food contamination… - 04/10/07 NPR
“Magnitude” Still only 3 per 10,000
Sample: Telephone Interviews with 1029 Adult Americans June 29, 2007 Source: CNN
How was the question asked? “Source Bias”
“Confirmation Bias”
3%
30%
67%
“Representation Bias”
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Although USAFA only produces 35% of the Air Force’s lieutenants, 50% of its generals come from USAFA. This justifies spending $350,000 for each USAFA cadet’s education…
USAFA
Graduate
General
Pilot Slot
AF inclined
Causality?
Self-selection
Heterogeneity
Simultaneity
Research has shown that 80%...
…of today’s high schoolers have cheated at some point during their high school career.
Therefore, we should expect 80% of Rollins College students to cheat at some point in their career…
2. “Distribution”
3. “Heterogeneity”
Mixed / Incongruence (Webster)
Be careful of broad-based claims about individuals and populations.
Several faults with this statement, for instance…
1. Statement speaks about HS cheating and says nothing about college-level cheating.
Satisficing versus Optimizing
Choosing a solution based on finding what is satisfactory = satisficing
Managers who satisfice seek alternatives until they find satisfactory solution, but not necessarily the optimal solution
Time constraints, money, values, and skills all factor into satisficing
Recruit vs. Retention:
How hard did you look for your “match?”
My Decision to come to Rollins
Generally, speaking, you are “Intellectual Giants”!!
Did you know???
Rollins College Admissions Data:
Average SAT score is over 1800!
That is greater than 600 per test category!!
Rollins average incoming High School GPA is 3.33!!
Over 20% have HS GPAs over 3.75!!
Looking ahead…
Sunk Cost Bias and Escalation of Commitment
Readings:
The Psychology of Sunk Costs (pgs 1-13)
The Escalation of Commitment
Mental Accounting Matters (Optional)
Discussion Board Input Due (before class begins)
Board will be posted soon