Hidden Traps in Decision Making

Hidden Traps in Decision Making

THINKING ABOUT… I In making decisions, your own mind may be your worst enemy. most important job of any executive. It’s also t h e toughest and the riskiest. Bad decisions can damage a business and a career, sometimes irreparably. So where do bad decisions come from? In many cases, they can be traced back to the way the decisions were m a d e – t b e alternatives were not clearly defined, the right information was not collected, the costs and benefits were not accurately weighed. But sometimes the fault lies not in tbe decision-making process but rather in tbe mind of the decision maker.

The way the human brain works can sabotage our decisions. Researchers have been studying the way our minds function in making decisions for half a century. This research, in the laboratory and in the field, has revealed that we use unconscious routines to cope with tbe complexity inherent in most decisions. These routines, known as heuristics, serve us well in most situations. In judging distance, for example, our minds frequently rely on a heuristic that equates clarity with proximity. The clearer an object appears, the closer we judge it to be. The fuzzier it appears, the farther away we assume it must be.

This simple mental sbortcut helps us to make the continuous stream of distance judgments required to navigate the world. Yet, like most heuristics, it is not foolproof. On days that are hazier M AKING DECISIONS iS t h e than normal, our eyes will tend to trick our minds into thinking that things are more distant tban tbey actually are. Because the resulting distortion poses few dangers for most of us, we can safely ignore it. For airline pilots, though, tbe distortion can be catastrophic. Tbat’s why pilots are HIDDEN TRAPS IN DECISION MAKING by ]ohn S. Hammond, Ralph L Keeney, and Howard Raiffa S.

Hammond is a consultant on decision making and a former professor at the Harvard Business School in Boston, Massachusetts. Ralph L. Keeney is a professor at the Marshall School of Business and the School of Engineering at the University of Southern California in Los Angeles. Howard Raiffa is the Frank Plumpton Ramsey Professor of Managerial Economics Emeritus at the Harvard Business School. Their book. Smart Choices: A Practical Guide to Making Better Decisions, will be published in October by the Harvard Business School Press. trained to use objective measures of distance in addition to their vision.

Researchers have identified a whole series of sucb flaws in the way we think in making decisions. Some, like the heuristic for clarity, are sensory misperceptions. Others take the form of hiases. Others appear simply as irrational anomalies in our thinking. What makes all these traps so dangerous is their invisibility. Because they are hardwired into our thinking process, we fail to recognize them-even as we fall right into them. For executives, whose success hinges on the many day-to-day decisions they make or approve, the psychological traps are especially dangerous.

They ean undermine everything from newproduet development to acquisition and divestiture strategy to succession planning. While no one can rid his or her mind of these ingrained flaws, anyone ean follow the lead of airline pilots and learn to understand the traps and compensate for them. In this article, we examine a number of well-documented psychological traps that are particularly likely to undermine business decisions. In addition to reviewing the causes and manifestations of these traps, we offer some specific ways managers can guard against them. It’s important to remember, tbough, that the hest defense is always awareness.

Executives who attempt to familiarize themselves with these traps and tbe diverse forms they take will be better able to ensure that tbe decisions they make are HARVARD BUSINESS REVIEW September-October 1998 THINKING ABOUT… THE HIDDEN TRAPS IN DECISION MAKING sound and that the recommendations proposed by subprdii^tes . or associates are reliable. not enough weight to other factors. In situations characterized by rapid changes in the marketplace, historical anchors can lead to poor forecasts The Anchoring Trap and, in turn, misguided choices. How would you answer these two Because anchors can establish the questions? erms on which a decision will be made, they are often used as a barIs the population of Turkey gaining tactic by savvy negotiators. greater than 35 millioni Consider the experience of a large What’s your best estimate consulting firm that was searching of Turkey’s population} for new office space in San Francisco. If you’re like most people, the figure Working with a commercial realestate broker, the firm’s partners of 35 million cited in the first quesidentified a building that met all tion (a figure we chose arbitrarily) infiuenced your answer to the sec- their criteria, and they set up a meeting with the building’s owners.

The ond question. Over the years, we’ve owners opened the meeting by laying out the terms of a proposed conDecision makers display a tract: a ten-year lease; an strong bias toward alternatives initial monthly price of $2. 50 per square foot; anthat perpetuate the status quo. nual price increases at the prevailing inflation rate; all interior improvements to be posed those questions to many groups of people. In half the cases, we the tenant’s responsibility,- an option for the tenant to extend the lease for used 35 million in the first question; ten additional years under the same in the other half, we used 100 milterms.

Although the price was at the lion. Without fail, the answers to the high end of current market rates, second question increase by many the consultants made a relatively millions when the larger figure is modest counteroffer. They proposed used in the first question. This simple test illustrates the common and an initial price in the midrange of market rates and asked the owners often pernicious mental phenomenon known as anchoring. When con- to share in the renovation expenses, but they accepted all the other terms. sidering a ecision, the mind gives disproportionate weight to the first The consultants could have been much more aggressive and creative information it receives. Initial imin their counterproposal-reducing pressions, estimates, or data anchor the initial price to the low end of subsequent thoughts and judgments. market rates, adjusting rates bienniAnchors take many guises. They ally rather than annually, putting a can be as simple and seemingly innocuous as a comment offered by a cap on the increases, defining different terms for extending the lease, colleague or a statistic appearing in and so forth-hut their thinking was the morning newspaper.

They can be as insidious as a stereotype about a guided by the owners’ initial properson’s skin color, accent, or dress. posal. The consultants had fallen into the anchoring trap, and as a reIn business, one of the most common types of anchors is a past event or sult, they ended up paying a lot more trend. A marketer attempting to pro- for the space than they had to. What can you do about it? ject the sales of a product for the The effect of anchors in decision coming year often begins by looking making has been documented in at the sales volumes for past years. thousands of experiments.

Anchors The old numbers become anchors, influence the decisions not only of which the forecaster then adjusts managers, but also of accountants based on other factors. This apand engineers, bankers and lawyers, proach, while it may lead to a reasonconsultants and stock analysts. No ably accurate estimate, tends to give one can avoid their infiuence; they’re too much weight to past events and 48 just too widespread. But managers who are aware of the dangers of anchors can reduce their impact hy using the following techniques: a Always view a problem from different perspectives.

Try using alternative starting points and approaches rather than sticking with the first line of thought that occurs to you. Q Think about the problem on your own before consulting others in order to avoid becoming anchored by their ideas. a Be open minded. Seek information and opinions from a variety of people to widen your frame of reference and to push your mind in fresh directions. a Be careful to avoid anchoring your advisers, consultants, and others from whom you solicit information and counsel. Tell them as little as possible about your own ideas, estimates, and tentative decisions.

If you reveal too much, your own preconceptions may simply come back to you. a Be particularly wary of anchors in negotiations. Think through your position before any negotiation hegins in order to avoid being anchored by the other party’s initial proposal. At the same time, look for opportunities to use anchors to your own advantage-if you’re the seller, for example, suggest a high, but defensible, price as an opening gambit. The Status-Quo Trap We all like to believe that we make decisions rationally and objectively. But the fact is, we all carry biases, and those biases influence the choices we make.

Decision makers display, for example, a strong bias toward alternatives that perpetuate the status quo. On a broad scale, we can see this tendency whenever a radically new product is introduced. The first automobiles, revealingly called “horseless carriages,” looked very much like the buggies they replaced. The first “electronic newspapers” appearing on the World Wide Weh looked very much like their print precursors. On a more familiar level, you may have succumbed to this bias in your personal financial decisions. People sometimes, for example, inherit September-October 1998

HARVARD BUSINESS REVIEW THINKING ABOUT… THE HIDDEN TRAPS IN DECISION MAKING shares of stock that they would never have bought themselves. Although it would he a straightforward, inexpensive proposition to sell those shares and put the money into a different investment, a surprising number of people don’t sell. They find the status quo comfortable, and they avoid taking action that would upset it. “Maybe I’ll rethink it later,” they say. But “later” is usually never. The source of the status-quo trap lies deep within our psyches, in our desire to protect our egos from damage.

Breaking from the status quo means taking action, and when we take action, we take responsihility, thus opening ourselves to criticism and to regret. Not surprisingly, we naturally look for reasons to do nothing. Sticking with the status quo represents, in m,ost cases, the safer course because it puts us at less psychological risk. Many experiments have shown the magnetic attraction of the status quo. In one, a group of people were randomly given one of two gifts of approximately the same value-half received a mug, the other half a Swiss chocolate bar.

They were then told that they could easily exchange the gift they received for the other gift. While you might expect that about half would have wanted to make the exchange, only one in ten actually did. The status quo exerted its power even though it had been arbitrarily established only minutes before. Other experiments have shown that the more choices you are given, the more pull the status quo has. More people will, for instance, choose the status quo when there are two alternatives to it rather than one: A and B instead of just A. Why?

Choosing hetween A and B requires additional effort; selecting the status quo avoids that effort. In business, where sins of commission (doing something) tend to be punished much more severely than sins of omission (doing nothing), the status quo holds a particularly strong attraction. Many mergers, for example, founder because the acquiring company avoids taking swift action to impose a new, more appropriate management structure on the acquired company. 50 “Let’s not rock the hoat right now,” the typical reasoning goes. “Let’s wait until the situation stabilizes. But as time passes, the existing structure becomes more entrenched, and altering it becomes harder, not easier. Having failed to seize the occasion when change would have been expected, management finds itself stuck with the status quo. What can you do about it? First of all, remember that in any given decision, maintaining the status quo may indeed be the best choice, but you don’t want to choose it just because it is comfortable. Once you become aware of the status-quo trap, you can use these techniques to lessen its pull: D Always remind yourself of your objectives and examine how they would be served by the status quo.

You may find that elements of the current situation act as barriers to your goals. n Never think of the status quo as your only alternative. Identify other options and use them as counterbalances, carefully evaluating all the pluses and minuses. a Ask yourself whether you would choose the status-quo alternative if, in fact, it weren’t the status quo. a Avoid exaggerating the effort or cost involved in switching from the status quo. a Remember that the desirability of the status quo will change over time. When comparing alternatives, always evaluate them in terms of the future as well as the present.

D If you have several alternatives that are superior to the status quo, don’t default to the status quo just hecause you’re having a hard time picking the best alternative. Force yourself to choose. The Sunk-Cost Trap Another of our deep-seated biases is to make choices in a way that justifies past choices, even when the past choices no longer seem valid. Most of us have fallen into this trap. We may have refused, for example, to sell a stock or a mutual fund at a loss, forgoing other, more attractive investments.

Or we may have poured enormous effort into improving the performance of an employee whom we knew we shouldn’t have hired in the first place. Our past decisions hecome what economists term sunk costs-old investments of time or money that are now irrecoverable. We know, rationally, that sunk costs are irrelevant to the present decision, but nevertheless they prey on our minds, leading us to make inappropriate decisions. Why can’t people free themselves from past decisions? Frequently, it’s because they are unwilling, consciously or not, to admit to a mistake.

Acknowledging a poor decision in one’s personal life may be purely a private matter, involving only one’s self-esteem, but in business, a bad decision is often a very public matter, inviting critical comments from colleagues or bosses. If you fire a poor performer whom you hired, you’re making a public admission of poor judgment. It seems psychologically safer to let him or her stay on, even though that choice only compounds the error. The sunk-cost bias shows up with disturbing regularity in banking, where it can have particularly dire consequences.

When a borrower’s husiness runs into trouble, a lender will often advance additional funds in hopes of providing the business with some breathing room to recover. If the business does have a good chance of coming back, tbat’s a wise investment. Otherwise, it’s just throwing good money after had. One of us helped a major U. S. bank recover after it made many bad loans to foreign businesses. We found that the bankers responsible for originating the problem loans were far more likely to advance additional funds-repeatedly, in many cases-than were bankers who took over the accounts after the original loans were made.

Too often, the original bankers’ strategy-and loansended in failure. Having been trapped by an escalation of commitment, they had tried, consciously or unconsciously, to protect their earlier, flawed decisions. They had fallen victim to the sunk-cost bias. The bank finally solved the problem by instituting a policy requiring that a loan be immediately reassigned to another banker as soon as any probSeptember-October 1998 HARVARD BUSINESS REVIEW THINKING ABOUT… THE HIDDEN TRAPS IN DECISION MAKING lem arose.

The new banker was able to take a fresh, unbiased look at the merit of offering more funds. Sometimes a corporate culture reinforces the sunk-cost trap. If the penalties for making a decision that leads to an unfavorable outcome are overly severe, managers will be motivated to let failed projects drag on endlessly-in the vain hope that they’ll somehow be able to transform them into successes. Executives should recognize that, in an uncertain world where unforeseeable events are common, good decisions can Don’t cultivate a failure-fearing culture that leads employees to perpetuate their mistakes. In rewarding people^ look at the quality of their decision making (taking into account what was known at the time their decisions were made), not just the quality of the outcomes. The Confirming-Evidence Trap Imagine that you’re the president of a successful midsized U. S. manufacturer considering whether to call off a planned plant expansion. For a while you’ve been concerned that your company won’t he able to sustain tbe rapid pace of growtb of its exports. You fear tbat the value of tbe U.

S. dollar will strengthen in coming months, making your goods more costly for overseas consumers and dampening demand. But before you put the brakes on the plant expansion, you decide to call up an acquaintance, the chief executive of a similar company that recently mothballed a new factory, to check her reasoning. Sbe presents a strong case that other currencies are about to weaken significantly against tbe dollar. What do you do? You’d better not let that conversation be tbe clincher, because you’ve probably just fallen victim to the confirming-evidence bias.

This bias leads us to seek out information that supports our existing instinct or point of view while avoiding information that contradicts it. What, after all, did you expect your acquaintance to give, other than a strong argument in favor of her own decision? The confirming-evidence bias not only affects wbere we go to collect evidence but also how we interpret the evidence we do receive, leading us to give too much weight to supporting information and too little to conflicting information. We tend to subconsciously decide what to do before figuring out why we want to do it. sometimes lead to bad outcomes.

By acknowledging that some good ideas will end in failure, executives will encourage people to cut their losses rather than let them mount. What can you do about it? For all decisions with a history, you will need to make a conscious effort to set aside any sunk costswhether psychological or economic that will muddy your thinking about the choice at hand. Try these techniques: a Seek out and listen carefully to the views of people wbo were uninvolved with the earlier decisions and who are hence unlikely to be committed to them. D Examine wby admitting to an earlier mistake distresses you.

If the prohlem lies in your own wounded self-esteem, deal with it bead-on. Remind yourself tbat even smart choices can have bad consequences, through no fault of tbe original decision maker, and tbat even tbe best and most experienced managers are not immune to errors in judgment. Remember the wise words of Warren Buffet: “When you find yourself in a hole, the best thing you can do is stop digging. ” n Be on the lookout for the influence of sunk-cost biases in the decisions and recommendations made by your suhordinates. Reassign responsibilities when necessary. 52

In one psychological study of tbis pbenomenon, two groups-one opposed to and one supporting capital punishment-each read two reports of carefully conducted research on the effectiveness of the death penalty as a deterrent to crime. One report concluded that the death penalty was effective; the other concluded it was not. Despite being exposed to solid scientific information supporting counterarguments, the memhers of both groups became even more convinced of the validity of their own position after reading both reports. They automatically accepted the supporting information and dismissed the conflicting information.

There are two fundamental psychological forces at work here. The first is our tendency to subconsciously decide what we want to do before we figure out why we want to do it. The second is our inclination to be more engaged by tbings we like than hy things we dislike – a tendency well documented even in bahies. Naturally, then, we are drawn to information that supports our subconscious leanings. What can you do about it? It’s not that you shouldn’t make the choice you’re subconsciously drawn to. It’s just tbat you want to he sure it’s the smart choice. You need to put it to the test.

Here’s bow: n Always check to see whether you are examining all the evidence with equal rigor. Avoid the tendency to accept confirming evidence without question. n Get someone you respect to play devil’s advocate, to argue against the decision you’re contemplating. Better yet, build tbe counterarguments yourself. What’s the strongest reason to do something else? The second strongest reason? Tbe tbird? Consider the position with an open mind, n Be honest with yourself ahout your motives. Are you really gathering information to help you make a smart choice, or are you just looking for evidence confirming what you think you’d like to do?

D In seeking the advice of others, don’t ask leading questions tbat invite confirming evidence. And if you find that an adviser always seems to support your point of view, find a new adviser. Don’t surround yourself with yes-men. The Framing Trap The first step in making a decision is to frame the question. It’s also one of the most dangerous steps. The way a September-October 1998 HARVARD BUSINESS REVIEW THINKING ABOUT… THE HIDDEN TRAPS IN DECISION MAKING Plan B: This plan has a onethird probability of saving the cargo on all three barges, worth $600,000, but has a two-thirds probability of saving nothing.

Which plan would you choose^ If you are like 7r% of the respondents in the study, you chose the “less risky” Plan A, which will save one barge for sure. Another group in the study, however, was asked to choose between alternatives C andD: Plan C: This plan will result in the loss of two of the three cargoes, worth $400,000. Plan D: This plan has a twothirds probability of resulting in the loss of all three cargoes and the entire $600,000 but has a one-third probability of losing no cargo. Faced with this choice, 80% of these respondents preferred Plan D.

The pairs of alternatives are, of course, precisely equivalent – Plan A is the same as Plan C, and Plan B is the same as Plan D-they’ve just been framed in different ways. The strikingly different responses reveal that people are risk averse when a problem is posed in terms of gains (barges saved) but risk seeking when a problem is posed in terms of avoiding losses (barges lost). Furthermore, they tend to adopt the frame as it is presented to them rather than restating the problem in their own way. Framing with Different Reference Points. The same problem can also elicit very different responses when frames use different reference points.

Let’s say you have $2,000 in your checking account and you are asked the following question: Would you accept a fifty-fifty chance of either losing $300 or winning $5001 Would you accept the chance? What if you were asked this question: Would you prefer to keep yom checking account balance of $2,000 or to accept a fifty-fifty chance of having either $i,joo or $2,500 in your account} Once again, the two questions pose the same problem. While your answers to both questions should, rationally speaking, be the same, studies have shown that many people would refuse the fifty-fifty chance in the first question hut accept it in the second.

Their different reactions result from the different reference points presented in the two frames. The first frame, with its reference point of zero, emphasizes incremental gains and losses, and the thought of losing triggers a conservative response in many people’s minds. The second frame, with its reference point of $2,000, puts things into perspective by emphasizing the real financial impact of the decision. What can you do about it? A poorly framed problem can undermine even the best-considered decision.

But any adverse effect of framing can be limited by taking the following precautions: a Don’t automatically accept the initial frame, whether it was formulated by you or by someone else. Always try to reframe the problem in various ways. Look for distortions caused by the frames. a Try posing problems in a neutral, redundant way that combines gains and losses or embraces different reference points. For example: Would you accept a fifty-fifty chance of either losing $300, resulting in a bank balance of $1,700, or winning $500, resulting in a bank balance o Think hard throughout your decision-making process about the framing of the problem.

At points throughout the process, particularly near the end, ask yourself how your thinking might change if the framing changed. a When others recommend decisions, examine the way they framed the problem. Challenge them with different frames. problem is framed can profoundly influence the choices you make. In a case involving automobile insurance, for example, framing made a $200 million difference. To reduce insurance costs, two neighboring states. New Jersey and Pennsylvania, made similar changes in their laws.

Each state gave drivers a new option: by accepting a limited right to sue, they could lower their premiums. But the two states framed the choice in very different ways: in New Jersey, you automatically got the limited right to sue unless you specified otherwise; in Pennsylvania, you got the full right to sue unless you specified otherwise. The different frames established different status quos, and, not surprisingly, most consumers defaulted to the status quo. As a result, in New Jersey about 80% of drivers chose the limited right to sue, but in Pennsylvania only 25 % chose it.

Because of the way it framed the choice, Pennsylvania failed to gain approximately $200 million in expected insurance and litigation savings. The framing trap can take many forms, and as the insurance example shows, it is often closely related to other psychological traps. A frame can establish the status quo or introduce an anchor. It can highlight sunk costs or lead you toward confirming evidence. Decision researchers have documented two types of frames that distort decision making with particular frequency: Flames as Gains Versus Losses.

In a study patterned after a classic experiment by decision researchers Daniel Kahneman and Amos Tversky, one of us posed the following problem to a group of insurance professionals: You are a marine property adjuster charged with minimizing the loss of cargo on three insuxed barges that sank yesterday off the coast of Alaska. Each barge holds $200,000 worth of cargo, which will be lost if not salvaged within j2 hours. The owner of a local marine-salvage company gives you two options, both of which will cost the same: Plan A: This plan will save the cargo of one of the three barges, worth $200,000. 54 Estimating and Forecasting Traps

Most of us are adept at making estimates about time, distance, weight, and volume. That’s because we’re constantly making judgments about these variables and getting quick feedback about the accuracy of those September-October 1998 HARVARD BUSINESS REVIEW THINKING ABOUT… THE HIDDEN TRAPS IN DECISION MAKING Jones Industrial Average. To account for uncertainty, they were then asked to estimate a range within which the closing value would hkely fall. In picking the top number of the range, they were asked to choose a high estimate they thought had only a i % chance of being exceeded by tbe closing value.

Similarly, for the bottom end, they were told to pick a low estimate for which they thought there would be only a 1% chance of the closing value falling helow it. If they were good at judging their forecasting accuracy, you’d expect the participants to be wrong only about 2 % of the time. But hundreds of tests have shown that the actual Dow Jones averages fell outside the forecast ranges 20% to 30% of the time. Overly confident about the accuracy of their predictions, most people set too narrow a range of possibilities. Think of the implications for business decisions, in which major initiatives and investments often hinge n ranges of estimates. If managers underestimate the high end or overestimate the low end of a crucial variable, they may miss attractive opportunities or expose themselves to far greater risk than they realize. Much money has been wasted on illfated product-development projects because managers did not accurately account for the possibility of market failure. costs. Knowing the purpose of the estimates, each department slanted its forecast to favor building more cars-“just to he safe. ” But the market planners took the numhers at face value and then made their own “just to be safe” adjustments.

Not surprisingly, the number of cars produced far exceeded demand, and the company took six months to sell off the surplus, resorting in the end to promotional pricing. Policymakers have gone so far as to codify overcautiousness in formal decision procedures. An extreme example is the methodology of “worstcase analysis,” which was once popular in the design of weapons systems and is still used in certain engineering and regulatory settings. Using this approach, engineers designed weapons to operate under the worst possible combination of circumstances, even though the odds of those circumstances actually coming to pass were infinitesimal.

Worstcase analysis added enormous costs with no practical benefit (in fact, it often backfired by touching off an arms race), proving that too much prudence can sometimes be as dangerous as too little. The Recallabiiity Trap. Even if we are neither overly confident nor unduly prudent, we can still fall into a trap when making estimates or forecasts. Because we frequently base our predictions about future events on our memory of past events, we can be overly influenced by dramatic events – tbose that leave a strong impression on our memory.

We all, for example, exaggerate the probability of rare but catastrophic occurrences such as plane crashes because they get disproportionate attention in the judgments. Through daily practice, our minds become finely calibrated. Making estimates or forecasts about uncertain events, however, is a different matter. While managers continually make such estimates Even though most of us are not very good at making estimates, we tend to be overconfident about our accuracy-which can lead to bad decisions. and forecasts, they rarely get clear feedback about their accuracy.

If you judge, for example, that the likelihood of the price of oil falling to less than $ 15 a harrel one year hence is about 40% and the price does indeed fall to that level, you can’t tell whether you were right or wrong about the probability you estimated. Tbe only way to gauge your accuracy would be to keep track of many, many similar judgments to see if, after tbe fact, tbe events you thought had a 40% chance of occurring actually did occur 40% of the time. That would require a great deal of data, carefully tracked over a long period of time.

Weather forecasters and bookmakers have the opportunities and incentives to maintain such records, but the rest of us don’t. As a result, our minds never become calibrated for making estimates in the face of uncertainty. All of the traps we’ve discussed so far can influence the way we make decisions when confronted with uncertainty. But there’s another set of traps that can have a particularly distorting effect in uncertain situations because they cloud our ability to assess probabilities. Let’s look at three of the most common of these uncertainty traps: The Overconfidence Trap.

Even though most of us are not very good at making estimates or forecasts, we actually tend to he overconfident about our accuracy. Tbat can lead to errors in judgment and, in turn, bad decisions, hi one series of tests, people were asked to forecast tbe next week’s closing value for the Dow 56 The Prudence Trap. Another trap for forecasters takes the form of overcautiousness, or prudence. When faced with high-stakes decisions, we tend to adjust our estimates or forecasts “just to be on the safe side. ” Many years ago, for example, one of the Big Three U. S. utomakers was deciding how many of a new-model car to produce in anticipation of its busiest sales season. The market-planning department, responsible for the decision, asked other departments to supply forecasts of key variables such as anticipated sales, dealer inventories, competitor actions, and A dramatic or traumatic event in your own life can also distort your thinking. media. A dramatic or traumatic event in your own life can also distort your thinking. You will assign a higher probability to traffic accidents if you bave passed one on the way to work, and you will assign a September-October 1998

HARVARD BUSINESS REVIEW higher chance of someday dying of cancer yourself if a close friend has died of the disease. In fact, anything that distorts your ability to recall events in a balanced way will distort your probability assessments. In one experiment, lists of well-known men and women were read to different groups of people. Unbeknownst to the subjects, eacb list had an equal number of men and women, but on some lists tbe men were more famous than the women while on others the women were more famous. Afterward, the participants were asked to estimate the percentages of men and women on each list.

Those who had heard the list with the more famous men thought there were more men on the list, while those who had heard the one with the more famous women thought there were more women. Corporate lawyers often get caught in the recallabiiity trap wben defending liability suits. Their decisions about whetber to settle a claim or take it to court usually binge on their assessments of the possihle outcomes of a trial. Because the media tend to aggressively publicize massive damage awards (wbile ignoring other, far more common trial outcomes), lawyers can overestimate the probability of a large award for the plaintiff.

As a result, they offer larger settlements than are actually warranted. What can you do about it? The best way to avoid the estimating and forecasting traps is to take a very disciplined approach to making forecasts and judging probabilities. For each of the three traps, some additional precautions can be taken: To reduce the effects of overconfidence in making estimates, always start by considering tbe extremes, the low and high ends of the possible range of values. This will help you avoid being anchored by an initial estimate. Tben challenge your estimates of the extremes.

Try to imagine circumstances where the actual figure would fall below your low or above your high, and adjust your range accordingly. Challenge the estimates of your subordinates and advisers in a similar fashion. They’re also susceptible to overeonfidence. aI E X E C U T I V E P R0 GR A Graduate School of Business In Ihe Heart of Silicon Valley Powerful Ideas, Innovative Practice General Management Programs Stanford Executive Program June 20-August 3, 1999 Executive Program for Growing Companies February 28 – March 12; ]uly 18-30, 1999 Stanfofd-N.

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Test estimates over a reasonable range to assess their impact. Take a second look at the more sensitive estimates. ° To minimize the distortion caused by variations in recallability, carefully examine all your assumptions to ensure they’re not unduly influenced by your memory. Get actual statistics whenever possible. Try not to be guided by impressions. Forewarned Is Forearmed When it comes to business decisions, there’s rarely such a thing as a no-brainer. Our brains are always at work, sometimes, unfortunately, in ways that hinder rather than help us. At every stage of the decisionmaking process, misperceptions, biases, and other tricks of the mind can influence the choices we make.

Highly complex and important decisions are the most prone to distortion because they tend to involve the most assumptions, the most estimates, and the most inputs from the most people. The higher the stakes, the higher the risk of being caught in a psychological trap. The traps we’ve reviewed can all work in isolation. But, even more dangerous, they can work in concert, amplifying one another. A dramatic first impression might anchor our thinking, and then we might selectively seek out confirming evidence to justify our initial inclination. We make a hasty decision, and that decision establishes a new status quo. As our sunk costs mount, we become trapped, unable to find a propitious time to seek out a new and possibly better course.

The psychological miscues cascade, making it harder and harder to choose wisely. As we said at the outset, the best protection against all psychological traps-in isolation or in combination-is awareness. Forewarned is forearmed. Even if you can’t eradicate the distortions ingrained into the way your mind works, you can build tests and disciplines into your decision-making process that can uncover errors in thinking before they become errors in judgment. And taking action to understand and avoid psychological traps can have the added benefit of increasing your confidence in the choices you make. FoT further discussions of decision traps, see: J. Edward Russo and Paul J- H.

Schoemaker, Decision Traps: The Ten Barriers to Brilliant Decision Making and How to Overcome Them (New York: Simon &) Schuster, 1989) and Max Bazerman. Judgment in Managerial Decision Making (New York: John Wiley &) Sons, fourth edition, 1998). Reprint 98505 To Older r^rints, see the last page of this issue. “Sorry, but I don’t discuss my financial portfolio on a first date. 58 HARVARD BUSINESS REVIEW September-October 1998 Harvard Business Review Notice of Use Restrictions, May 2009 Harvard Business Review and Harvard Business Publishing Newsletter content on EBSCOhost is licensed for the private individual use of authorized EBSCOhost users.

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