How behavioural science can help managers make better decisions

• Managers need to utilise their biases to make better decisions
• Chengwei Liu looked into how such biases can be turned on their head
• Ideas for this include a pre-mortem on mergers and acquisitions
• Research also found a novel way of investors to go forward with their plans

Researchers believe that rather than trying to think rationally managers and business strategists should use their own biases to come to better decisions.

Managerial biases such as overconfidence, nepotism and myopia can explain many failures in M&A deals, business succession and anticipating disruptive technologies.

Conventional approaches to eliminating biases focus on ‘changing the mind’: if people can be trained to recognise their biases and think more logically and carefully like a rational person, better outcomes are likely.

However, increasing evidence suggests that the de-biasing approach is not enough for effective decisions, because it only deals with our conscious half - what Nobel laureate Daniel Kahneman, who founded prospect theory which is the foundation of much of behvaioural economics, famously called System 2 in his book Thinking Fast and Slow.

Our automatic half - Kahneman’s System 1 - also plays a role in determining a decision and it is sensitive to our surrounding environment. Even contextual factors, such as the weather being sunny or cloudy, can significantly influence the decisions made. 

Are these biases fixable? In the paper Strategizing with Biases: Engineering Choice Contexts for Better Decisions using the Mindspace Approach, published in California Management Review, Chengwei Liu, Ivo Vlaev, Jerker Denrell, and Nick Chater, of Warwick Business School, and Christina Fang, of Stern School of Business, suggest they are.

They looked at how biases could be turned on their head, where better decisions are more likely by “changing the context” - engineering the context to “initiate a bias” to overcome a damaging bias.

In the paper managers are introduced to the Mindspace framework, which is the mnemonic of nine contextual forces grounded in the latest findings in behavioural science: Messengers, Incentives, Norms, Defaults, Salience, Prime, Affect, Commitment and Ego.

“Mindspace offers a toolbox for managers to reframe the decision context so that different contextual forces can be employed to induce behavioural changes,” said Dr Liu, Associate Professor of Strategy and Behavioural Science.

“We argue such changes are more likely when we ‘go with the grain’ and work with, rather than fighting against, human nature.”

The researchers investigated how the Mindspace approach can help counter systematic biases, such as M&A where studies have estimated the failure rate to be between 70 and 90 per cent. Failure is partly the result of overpaying, with higher bids most likely to fail.

How do you handle a CEO's ego?

A reason for this may be Ego, suggests Professor Chater, as larger deals are often prompted by CEOs’ desire for greater power, status, and bonuses rather than rigorous evaluations of synergies.

Firms could counter this bias with Mindspace, he argues.

“Firms can pre-commit to two defaults for all M&A deals,” said Professor Chater. “At least three similar deals that failed should be presented and every manager has to present a ‘pre-mortem’ by first imagining that the deal has failed and then working backwards to determine what potentially could lead to the failure.”

Professor Vlaev added: “These techniques can break groupthink (Norm) and remind people about the possible losses (Incentive) and attenuate the emotion associated with the fear of losing to competitors (Affect).”

Another example is how a Silicon Valley venture capitalist DFJ successfully identified the next big thing by utilising some of their “biases”. 

In particular, DFJ only invests in a start-up as long as at least one partner feels very strongly about the idea. In fact, DFJ has a default of rejecting a proposal if there is a strong consensus among the partners.

Dr Liu said: “This 'default' combats three components of the Mindspace framework, namely: Norm, Affect and Ego, as we feel happier when others agree with us.

“DFJ wants to invest in the most radical ideas because a moderate winning means losing in the context of venture capitalists. If all partners agree on the potential of an idea, this idea is perhaps not radical enough.

“Research on groupthink also suggests that discussions and consensus among partners may also lead to more risk-averse decisions, inconsistent with DFJ’s goal. Moreover, competition will be more intense when commercialising such ideas because other venture capitalists may also see it coming.

How do you stop bias in an investment decision?

“Instead of de-biasing their risk aversion and neglect of competition using System 2 techniques, DFJ resort to 'default' to engage several predictable biases in their System 1 thinking. DFJ believe that ‘the basis for any investment decision is not a compromise but strong beliefs by individual partners’.

“This new Mindspace framework does not offer easy solutions, since applying it requires strategists to have a profound understanding of the strategic and human context.

“But we believe that it does offer a promising, alternative toolbox to address key strategic challenges associated with competition, search, and innovation.

“The same errors that cause us to stumble can also be used to help us make better choices.”

Further reading:

Mastering your unconscious biases for better decisions

To avoid the competency trap means being irrational

How to reduce AI bias

Chengwei Liu teaches Strategic Advantage on the Executive MBA (London). He also teaches Behavioural Sciences for the Manager on the Executive MBA.

Nick Chater is Professor of Behavioural Science and teaches Behavioural Science for Managers on the Executive MBA and Executive MBA (London) plus Judgement and Decision Making on MSc Finance, MSc Business & Finance, MSc Accounting & Finance, and MSc Finance & Economics. 

Ivo Vlaev is Professor of Behavioural Science and lectures on Behavioural Science for Managers on the Executive MBA and Global Online MBA.

Jerker Denrell is Professor of Behavioural Science and teaches Quantitiative Methods for Business on MSc Business with Marketing, MSc International Business, and MSc Business with Operations Management.

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