No I am not trying to depress you, or claim
superiority… I am making
bad decisions, too.
You see, I have just read
Daniel Kahneman’s book,
“Thinking, Fast and
Slow.” For those who are
not familiar with Daniel Kahneman, he is a
behavioral psychologist, and is the only person
to win the Nobel Prize for Economics
without actually being an economist. He
applies his work to key areas of study like
business; it is because of his work, for example,
that we know that individuals irrationally
protect against losses more than they try to
achieve gains.
Here are a few topics and insights from the book
that may be particularly relevant to you and me:
• Experts rarely are better at predicting things
in their domain of expertise than non-experts.
• We are way too easily influenced by bad information.
• We don’t understand basic logic.
• We are really bad at estimating.
Experts versus non-experts
That first one might be a bit shocking, or it
might not have sunk in, so let me repeat it:
EXPERTS ARE RARELY BETTER AT PREDICTING
THINGS IN THEIR DOMAIN
OF EXPERTISE THAN NON-EXPERTS.
Besides the obvious things you should be
thinking (like you need to fire your stockbroker),
this fact has immense implications. For
example, if we want the answer to a complex
problem that deals with uncertainty, we may
be better off asking a group than a known
individual expert (like crowdsourcing).
Most importantly, experts are often wrong
because they simply over-estimate their own skill
– validated by everyone calling them an expert.
Could this be you or I in our businesses? We
should work together as a team to ensure that we
don’t individually get too confident. We should
put mechanisms in place at work to avoid “groupthink”
and ensure we seek out contrarian views
and allow all the members of the team to have
input when we are making decisions. And you
should probably not try to pick stocks based on
analysts’ recommendations.
We are too influenced
by bad Information
Examples in the book include the need to somehow
explain every day’s increase or decrease in the
stock market (which we blindly believe when we
hear it). Or problems our minds have with
anchoring – for example, if I ask you two questions:
1) “Did Gandhi die before or after age
144?” (quite obviously before), then 2) “How old
was Gandhi when he died?”, you will give me a
higher answer than someone who was asked a different
first question (“Did Gandhi die before or
after age 25?” – quite obviously after).
We don’t understand basic logic
Jar A contains 10 marbles, of which one is red. Jar
B contains 100 marbles, of which 8 are red. I give
you one chance to pick a marble for $1 million –
which do you pick? What if I told you that you
would get cancer unless you selected a red marble?
Incorrect answers to questions like this happen
all the time. It is why Kahneman won the Nobel
prize for economics – he essentially disproved the
rational markets theory of investing. We all know
(now) that humans generally fear losses more than
we seek gains, and we get invested in previous
outcomes that shouldn’t matter (like the stock
used to be at $50, so I’m not going to sell at $30
even though my best evidence says it is going to
fall further to $20). We also over-value losses
against each other, which is why we are (stupidly)
more afraid of a shark attack than a car accident.
So in our teams at work, we can do a few things:
Make sure everyone understands what a sunk cost
is and work to make decisions based on the future,
not the past – like if a software system isn’t working
and the plug needs to be pulled, PULL IT!
Don’t get lost in thinking you have to make it
work because we’ve already invested $xx million
on it. Make sure you leverage your finance teams
who are (hopefully) trained in things like statistics
and presenting information in a neutral way.
We are really bad at estimating
The average homeowner who renovates a
kitchen thinks it will cost $19,000 when in
reality it ends up costing $39,000.
When people are asked whether their restaurant
will succeed, the response rate is overwhelmingly
positive, above 80-90%. Even though most
restaurants fail. When told this, respondents said
what we would all say…’that won’t happen to me’.
Kahnenman faced this problem on a project he
was working on: He was working with a group
of experts on writing a textbook. They finished
some of it in a year, then assessed how long they
estimated it would take to finish, concluding two
years felt right. When they asked someone who
had been around these types of projects what the
typical results were, they said 40% never finished,
and it always took at least 7 years! The
group, of course, rejected this evidence as not representative
of THEIR project. The results? They
completed the book 8 years later…
So, finally some good news: Next time you
get critiqued for estimating poorly, tell the
person that you indeed also hope to win a
Nobel prize someday.
But seriously, the call to action here is to start
including way more contingency in your projects,
whether in dollars for a capital project or in time
for the process. In addition, find benchmarking
information and use it – if a software product
hasn’t worked for any of your competitors, don’t
be naïve and determine that you can make it work
because “you are better than those guys.”
Conclusion
If you aren’t scared about your decision-making
ability after reading this, you should be! For me
the moral of this story is that we need to work
together to ensure we make good decisions,
because left to our own devices, we are going to
struggle. For those of us who are leaders, we need
to find ways to ensure diverse opinions from our
teams are heard, and seek out feedback and information.
For all of us, we need to speak up when
we have an idea that goes against the grain,
because we may just be right!
external reporting, along with assisting in
corporate finance matters. He was recently
named to Treasury