Critical Thinking and Managerial Decision Making

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MGMT 20135: CRITICAL THINKING AND MANAGERIAL DECISION-MAKING

Week 8 – Lecture

Outline

Introduction of two theories relevant to decision making

Prospect theory

Psychological contract theory

Workshop exercise, scenario role play

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Quick Introduction to Prospect Theory

Theory developed in 1979 by Professors Daniel Kahneman and Amos Tversky.

Kahneman won the Nobel Prize for this work in 2002.

Tversky had passed away before the Award but would have no doubt been awarded the prize.

“Prospect theory: An analysis of decision under risk” was published in 1979 and led the way to the development of behavorial economics.

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Prospect Theory shows that, as individuals, we make decisions based on the value of potential losses and gains rather than the final outcome.

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The horizontal x axis measures the value of our gain or loss,

whilst the vertical y axis measures how we value that gain or loss.

Looking at the red arrow (shown as ‘A’) on the right-hand

side of the graph, it shows the objective value of a certain gain.

The blue arrow pointing upwards reflects the subjective value

we attach to this gain. The observation to take note of is that the

subjective value we place is less than the actual objective gain.

Looking at the other red arrow (measured at the same value,

that is ‘A’) on the left-hand side of the graph, it shows the same

value, but this time as a loss. The blue arrow pointing downwards

is longer than the red arrow, showing that the subjective value we

attach to this loss is much larger than the actual loss itself.

If the value of A, be it a gain or a loss, was R100, it shows that

we place a larger value on a loss of R100 than on a gain of R100.

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Focuses on:

How people make probabilistic decisions not optimal probabilistic decisions.

Understanding bias and level of risk averseness.

The ways in which consumers and others not always rational.

Attempts to understand the people’s cognitive biases/frames.

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Some examples from marketing

Mental accounting

Unexpected gains.

Example:

Mr and Mrs X go on a fishing trip, and catch some salmon. The fish are lost by the airline, and the airline pays insurance of $300 a week later. Mr and Mrs X go out for dinner at an upmarket restaurant, spending $225 on a seafood meal. They have never spent this on a meal before.

Humans treat money as if they are in different bank accounts.

What happens at Christmas, birthday time, tax refund time? How do businesses capitalise?

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"mental accounting is the set of cognitive operations used by individuals and households to organize, evaluate and keep track of financial activities." Read more: Mental Accounting https://www.investopedia.com/terms/m/mentalaccounting.asp#ixzz5Po86qJlx  Follow us: Investopedia on Facebook

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Another example

Segregation and integration of losses and gains.

Example:

Mr A was given 2 lottery tickets. He won $50 in one and $25 in the other.

Mr B was given a single lottery ticket. He won $75.

Who is happier?

Most would say A.

Example:

One of the reasons why marketers push for monthly and not quarterly debits – people don’t notice the smaller loss as much as the larger loss.

Tolls are from an electric device rather than in the form of coins. You notice lack of coins more.

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One more example

Losses are weighted more heavily than gains.

Example:

Mr A bought his first lottery ticket and won $100. On the same day, he spilled juice on the carpet in his apartment and had to pay $80 to have it cleaned.

Mr B bought his first lottery and won $20.

Who is happier?

Mr A was told that if he insulated his home he would be 75c better off per day.

Mr B was told that if he did not fully insulate his home he would be 75c a day worse off.

Who was more likely to fully insulate his home?

Normally, most would say B.

Marketers focus on framing the benefit in terms of avoiding a loss.

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How is the knowledge of the Prospect Theory going to impact your decision making? Examples?

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Reflection

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Introduction to psychological contracts

Rousseau (2004)

Provides a briefing of her research to date into psychological contracts.

These are implied or explicit contracts.

Psychological contracts can be defined as:

Beliefs based upon promises expressed or implied, regarding an exchange agreement between an individual and, in organizations, the employing firm and its agents.

Changes in the psychological employment contract - by Denise Rousseau

https:// www.youtube.com/watch?v=EKGYUyFn6rA

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Six features

Voluntary choice;

Belief in mutual agreement;

Incompleteness;

Multiple contract makers;

Managing losses when contract fail;

The contract as model of the employment contract.

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1. Presence of voluntary choice

Psychological contracts are more likely to be successful and the source of motivation if they involve voluntary choice.

For instance, the employee is more motivated to stay if they say “I agree to stay with the firm for a minimum of a year.”

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2. Belief in mutual agreement

An individual’s psychological contract refers to their own understanding of the commitments made with each other.

A vague undertaking may be interpreted to be something more specific by the employee, for example, occasional travel is interpreted as travel may be required every couple of months, not every couple of weeks.

More experienced recruits are better at probing what is mutually understood (and getting things made clear in writing).

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3. Incomplete nature of contracts

By their nature, it is never possible to have a complete contract.

Hard to define each party’s commitment in the first instance so there is a need to re-define at later dates.

“Interestingly, aspects of employment that workers find satisfying but that are not part of the psychological contract (eg. camaraderie of colleagues) can, over time, come to be viewed as part of the promises status quo.”

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4. Multiple contract makers

Information sources of the contract can include top management, human resource managers and prospective/current immediate supervisor.

Co-workers can also be a source of information.

Thus, if information sources send different or conflicting messages, the mutuality of the psychological contract is eroded.

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5. Managing losses when contract fail

If an anticipated commitment was not fulfilled then a failure of the contract is interpreted to have occurred.

They can lead to negative reactions and this can be two-way, involving employee and/or the employer.

Failure needs to be managed because reaction to the failure could be quite negative.

Management could involve offering someone an interesting project instead as a result of a promotion not eventuating as originally promised.

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6. As model of employment contract

Can create an “enduring mental model of the employment relationship.”

Can make it easier to function in an employee-employer relationship even though information is incomplete about who expects what.

Sometimes the old contract is no longer relevant and an elaborate change process needs to be undertaken.

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Three types

Also identifies that there are 3 types of psychological contracts:

Relational;

Transactional; and

Hybrid or balanced.

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Relational

Include such terms as loyalty (meeting each other’s needs) and stability (open-ended commitment to be in a relationship in the future.)

Workers in these contracts will be more willing to do overtime, help co-workers, support change, etc.

But get very upset if they perceive the contract has been violated.

Failure to remedy will lead to turnover, reduced contributions, and other break-downs.

On the positive side, employers will take on more risk and more responsibility, for example, Malden Mills CEO paid salaries after the mill burned down.

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Transactional

Involve work where tasks tends to be narrower or limited in duration.

Workers tend to adhere to the specific terms and will move on if conditions change without any compensation, etc.

Risk is more weighted towards workers.

Generally, employees tend to be good at fulfilling the specific terms of the contract.

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Hybrid or balanced

Involve the open-ended timeframes of relational contracts and with the performance demands and renegotiable aspects of transactional contracts.

To some extent, some job security is being traded in return for risk being spread more evenly, ability to learn on the job and be paid for performance.

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Ensuring success

What is universally understood and is more likely to lead to a successful psychological contract:

Mutuality. If both parties agree to the terms and understand them to be the same thing, then more likely to have a successful outcome.

Allow for the fact that perceptions though can differ between parties, including different employees and agents.

Be aware of the fact that it can be difficult to understand the point when re-negotiation is required.

Appreciate that one has to be sensitive to what constitutes a breach of the psychological contract. A breach could lead to many dysfunctional outcomes and behaviours.

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Employers’ role

Ensure employee is properly socialised, trained and involved in activities that make clear the terms of the commitment.

Managers need to be consistent at all levels.

Success of the contract largely dependent on the immediate manager.

To be effective, manager must put psychological contract in place that is satisfactory and leads to a commitment to ensure that employees’ individual contracts are fulfilled in mutually satisfactory way.

Employee selection processes can be critical and the “right” employees tend to interpret and act upon the contract appropriately.

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Main findings

Important to:

Strive to consistently implement the contract.

Establish clear boundaries, including articulate goals, interests and constraints.

Build flexibility into the contract so that no-one is surprised when the contract has to be re-negotiated.

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Organisational change management, in fact, any change within organisations involves many decisions and constantly balancing:

Strategic and operational goals

External and internal factors

Rational and non-rational/emotional responses

Reactive and proactive behaviours

Getting the best out of people, processes and systems for the future in the long-run

Reflection

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How is the knowledge on Psychological Contract going to impact your decision making, from either a managerial perspective or an organisational employee’s perspective?

MGMT20135: CRITICAL THINKING AND MANAGERIAL DECSION-MAKING

Week 8

Be prepared

To work in groups

To nominate someone from your group to stand up and explain your group’s findings

Share your findings with the rest of the class via a class-wide discussion

Get involved in a role play

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Kevin and the Call Centre

The facts about the Case:

Kevin:

Kevin is a new employee at a call centre. Kevin has been consistently late – 10 minutes on average and has just been 25 minutes late.

Today he is late because the babysitter’s father died, his children were slow getting ready for school and he got stuck in traffic. He couldn’t call as his mobile battery was flat.

Kevin is not fitting in with the other staff, who are younger and cliché (the don’t talk much to people who they don’t know).

Kevin has found it difficult to learn the computer system and no-one seems interested in training him.

Kevin is generally very conscientious and has a talent for dealing with difficult customers over the phone.

Kevin is a single dad and we do not know why he is bringing up his children by himself.

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Andrea the Call Centre Boss

Andrea:

Andrea knows she must discuss Kevin’s lateness with him as it is impacting on her and her staff’s ability to perform.

Andrea has been given lots of project work by her bosses and has not been able to personally train Kevin as she would normally, which meant the other staff have to train him.

She does not know no-one is seriously helping Kevin. She does know, however, that Kevin is brilliant dealing with difficult customers and does it better than anyone else.

Andrea knows that she will be short-staffed if Kevin leaves and is aware of the fact that she should act professionally when addressing Kevin’s lateness with him………

She doesn’t know if being tough will get her the results she needs in the first instance.

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The proposed meeting

When Kevin arrived over 30 minutes late and looking a little frazzled, Andrea asked Kevin to meet her in her office at 11 am to discuss some issues.

She isn’t smiling but she doesn’t look cross either. Kevin can’t read her expression at all……

Kevin looks a little nervous at the prospect of having a meeting with Andrea at 11 am.

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Role Play

In Groups of 3-4 people discuss the case study.

What do you think Andrea would say at the meeting and what do you think Kevin would say?

What would be the sorts of things a bad manager (the boss from hell) would say?

What would be the sorts of things a good manager (the sort we all want) would say?

Be prepared to role play a bad conversation and outcome, and then a good one.

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Learnings

What did we learn?

How can you translate your understanding of the Prospect Theory into better decisions?

How can you use the Psychological contract theory to make better managerial decisions?

How might your learnings be applied to the management of whole groups of people in an organisational change scenario?

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