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I'm Only Human

Optimize Blog - September 21, 2015 - 0 comments

Significant strategic decisions are never simple to make and at the end of the day, these tend to be hard to reverse decisions and so the impact of getting them wrong can destroy organizational value very quickly.
One thing we see quite regularly affecting the strategic process is the issue of shortcomings within us as human beings. Behavioral economics asserts that we all have a host of biases – perhaps over optimism, an oversized ego or an unhealthy dose of hubris – which can influence our strategic decision making. Such biases create the situation where the objectives of certain employees are misaligned with the interests of the organization – something termed by economists as the “principle agent factor”.
These biases, which distort the way people collect and process information, can also be enabled by the corporate culture.
We find that the two biggest impacts of these biases are over optimism and loss aversion (the human tendency to experience losses more acutely than gains) and this is because all major strategic decisions have an element of risk, each of which has two distinct components – likelihood [of the risk happening] and impact.
When judging likelihood human beings have an overwhelming tendency to be over optimistic or over confident. This manifests itself in unrealistic forecasts but also leads people to underestimate or not even consider the more subtle risks that exist. Over optimism affects judgement of probability and tends to produce over commitment.
Loss aversion on the other hand, influences outcome preferences and leads to inaction or under commitment. Loss aversion should not be considered the same as risk aversion although all too often we find that the ‘risk aversion’ label actually reflects loss aversion.
Few companies that we come across recognize that this issue creates harmful patterns of deception and distortion throughout the organization which ultimately leads to the lack of success in delivering the value identified within the strategic decision making process.
These distortions lead to misalignment of objectives and priorities between individuals and the organization. For example a product manager might be keen to introduce short term product incentives that will provide short term gain but, without a longer term perspective, might undermine the overall brand value. Equally a disconnect between an individual’s risk appetite and the risk appetite of the organization can have damaging consequences.
So how can this organizational deception be tackled?
First individual leaders need to become more aware of how their biases can affect their own decision making and take action to counter those biases. Second, the organization must review and amend the way it makes decisions by embedding safeguards into the formal decision making processes. Third the corporate culture should have the right values and behaviors to counteract any deceptions and distortions pursued by individuals – creating a culture of constructive debate and decision making.
Corporate leaders need to improve the organization’s decision making ability by identifying the prevailing biases and by using relevant tools to shape a productive decision-making culture. Tracking and providing honest feedback on actual performance against forecasts will temper over confidence and utilizing third parties as an objective arbitrator can limit too many corporate biases. Alignment of goals, objectives and incentives will ensure that the individual is working in the best interests of the company and framing a risk appetite statement will ensure alignment of risk decision making at all levels.
Ultimately no organization can afford to ignore the human factor in the making of strategic decisions but it can greatly improve the chances of making good decisions by becoming more aware of the way in which cognitive biases influences the outcomes.

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