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The Impact of Psychology on Corporate Decision Making

This article discusses—and gives examples of—some of the most common ways in which business decisions are affected by cognitive biases. The lack of awareness of the widespread operation of cognitive biases reduces the possibilities for good decision making.

Since executives make hundreds of decisions daily, the time consuming demands of rational decision making are often not viable. Many significant decisions are made by judgment. Mintzberg (1973) found that the average manager engages in a different activity every nine minutes. In addition, he found that in making decisions, managers tend to avoid systemic or analytical data and rely more on intuitive judgment.

Just as individuals are subject to cognitive weaknesses in decision-making, research suggests that these flaws can be amplified in the group context. In particular, it has been shown that group dynamics can bind group members together and blind them to their failings and excesses. Group deception can become dominant and prevent individuals from ‘reality testing’ their actions.

One particularly influential theory to describe how such dysfunction can occur is groupthink. This argues that strongly cohesive groups can become captured by group blindness, group pressure and self-interest.

By employing simple decision making strategies, individuals may sometimes be able to arrive at equally accurate predictions as individuals who have extensive knowledge of the subject matter of the decision.

One example used to demonstrate poor practices is the decision by Disney Corporation on where to build Euro Disney. In 1982 French officials took Disney executives on tours of possible sites for a new theme park in northern and eastern France. Tokyo Disney had just opened and become an instant success, and the mood was positive for the creation of a European Disneyland. To sweeten the deal, French officials offered to sell Disney 4,800 acres, seventy miles out of Paris. With cheap land, low property taxes and the size of the market in Europe, Disney thought the venture was guaranteed to be a strong financial success.

In reality, however, initial decisions were not well made. Because of early commitment to the suggested location, the subsequent analysis that was carried out focused on bolstering that decision rather than on checking its accuracy. Overconfidence dominated the decision making. Anticipated costs were estimated at $2.5 million whereas the actual cost ended up being over $4.4 million. Based on the experience in Tokyo, attendance projections were set at eleven million and ticket prices were increased by thirty percent. A 5,200 room hotel was also constructed with an assumed occupancy of seventy six percent.

These decisions cost Disney dearly. The assumptions on which they were based did not meet reality. Executives failed to realize that the location near Paris made it easier for visitors to do a day trip to the park rather than to make an overnight visit. In addition, the increase in prices put visitors off. By 1994, losses from the Park had reached nearly $400 million. The damage to Disney’s image was widespread.

The decision making involved in EuroDisney was flawed. Two of the key traps that executives fell into were stifling dissent and over confidence. People in top management at Disney ’went along to get along’. When questions about the park stopped, Eisner took this as a sign of support for EuroDisney and the park location.

Executives were also overconfident of their success with the new park. Because Tokyo had been a success from the beginning, there was an unquestioning confidence that Eisner and Disney could to it again. There was quick commitment to the location so that other ideas and locations were never fully explored. Once the decision on the location was made, executives took a defensive position and collected information to justify their decision. Disney spent considerable time and money evaluating the deal and comparatively little asking hard questions about other possibilities.

Going for the Summit
By May 11, Fischer, Hall and three other climbers were dead. Others only just escaped with their lives after wandering around for many hours in sub-zero temperatures. In the years that followed, many people asked what happened. How could these experienced climbers have risked their own lives and those of their clients when they knew the possible consequences?

Whilst various factors influenced what happened that day, the most important was faulty decision making. Hall and Fischer were under enormous pressure to succeed on that trip. Both had allowed important press personalities to join their teams and they knew their reputations were on the line. Fischer had a New York writer who was filing daily diaries on an NBC World Web site. Hall had a journalist from Outside magazine. Both knew that getting these individuals to the top was going to be the best publicity their companies could get. And neither wanted to fail.

Yet Hall and Fischer were also over-confident in their ability to get their clients to the top. “Experience is overrated.” Fischer is quoted as having said. “It’s not the altitude that’s important, it’s your attitude … We’ve got the big E figured out, we’ve got it totally wired. These days, I’m telling you, we’ve built a yellow brick road to the summit.” (Krakauer 1998, p 84)

This attitude led Fischer and Hall to make one of their most fundamental mistakes; the decision to push on to the summit after the agreed turn back time. For the six weeks before the ascent, Hall and Fischer had made it clear to their groups that they would turn back at 1.00 or 2.00pm no matter how close to the summit they were. Hall had stated ‘I will tolerate no dissension up there. My word on this will be absolute law, beyond appeal.’

Yet both leaders went well over time in letting clients make it to the top. Hall reached the summit at 2.30 pm along with several other clients. These clients then rested for before beginning the descent. When Fischer reached the summit it was 3.45pm. Hall was still there waiting for another client to arrive. This client did not reach the summit until 4.00pm.

Corporate World
High-risk, high-image decisions are also common in corporate disasters. Collapses such as Enron and WorldCom in the United States, and HIH and Onetel in Australia, involved executives in high-risk activities pursuing dynamic and aggressive business strategies. Overwhelmingly, the executives involved in these scandals were high- image successful individuals working in high-image successful corporations. Yet the effect of this was that the chance of poor decision making was seriously increased. When individuals are under pressure to perform, their desire to succeed and, more particularly not to fail, can compound the flaws in their decision making.

Yet executives are generally used to making high-risk decisions. Their confidence in their own decision making ability makes it easier for them to believe that the risks can be managed and that any challenge can be met by the exercise of skill. “In this idealized self-image, these executives are not gamblers but prudent and determined agents, who are in control of both people and events.” (Lovallo and Kahneman 2003, p 59) When it comes to making decisions about the future, they tend to exaggerate the accuracy of their predictions and downplay the possibility of uncontrollable events.

This sort of decision making is common with corporate mergers and acquisitions. Over the last ten years research has considered the question of why so many mergers and acquisitions by corporations fail. Executives typically cite a number of reasons for the failures including cost savings that didn’t materialize, integration problems and cultural differences. Acquisitions, they say, are inherently risky undertakings.

Although the adverse weather was not apparent at this time, it soon became a life threatening issue. As the climbers started down the South Summit, snow began to fall. Within 20 minutes there was a blizzard with whiteout conditions and a wind chill factor of 50 degrees below zero. Only the first climbers to leave the summit made it safely back to camp. Others become lost in the snow and collapsed. Some wandered around for hours trying to find the camp. As for Hall and Fischer, they were caught in the blizzard and never made it down.

Although high altitude climbing is inherently dangerous, both Hall and Fischer were affected by shortcuts in their decision making. These included three of the most common shortcuts – the commitment bias, the confirmation bias and the assumed reality bias. Because of these shortcuts they increased their commitment to get to the top, even when circumstances suggested they shouldn’t. They failed to appreciate the escalating risk they were taking or to respond appropriately to the deteriorating weather and condition of their climbers. They did not check the accuracy of their decisions or the assumptions on which they were based. They were caught in high- risk, high-image decision making.

Source: Hall, Kath, Looking Beneath the Surface: The Impact of Psychology on Corporate Decision Making. Managerial Law: The International Journal of Law and Management, Forthcoming. (Link)

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