Managing Biases in Strategic Judgment

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  • Topic: Daniel Kahneman, Heuristics, Heuristic
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SEP 2012 Managing Biases in Strategic Judgment

Managing Biases in Strategic Judgment

Professor Ilya Strebulaev

© Ilya Strebulaev 2012

SEP 2012 Managing Biases in Strategic Judgment

© Ilya Strebulaev 2012

SEP 2012 Managing Biases in Strategic Judgment

Heuristics and Rules of thumb
• People rely on various heuristics when making most decisions –Evolutionary reasonable strategy –Helpful but can lead to severe errors –Can result in biases –People are unaware of using heuristics most of the time –Why important to understand

• Can correct/debias yourself • Understand what others are doing in deciding on your actions/strategies

• Example: Recognition heuristic

–Which city has a large population

• Detroit vs Milwaukee: 86% for Detroit

• Seattle vs Chandzyan: 62% for Chandzyan

– Of those who attended U.S. High School: 55% – Detroit (#18; 714,000); Milwaukee (#28, 595,000)

© Ilya Strebulaev 2012

SEP 2012 Managing Biases in Strategic Judgment

Availability Heuristic
• Ease of recall/Retrievability
–Do more seven-letter words end with “ing” or have “n” in the 6th place? • Average “n”: 21% • Average “ing” 27% • 77% responses: “ing”>”n”

• Events readily “available” in memory have disproportionate influence

–E.g.: Purchasing insurance after earthquakes –E.g.: Annual evaluation: last three months more important; bigger events more important than daily –E.g.: A subordinate who works in close proximity to the manager’s office is likely to receive a more critical review –E.g.: Successful investors are more likely to share experiences

© Ilya Strebulaev 2012

SEP 2012 Managing Biases in Strategic Judgment

Availability Heuristic

• Lesson: Ask yourself whether your recollections/data points which lead you to make a decision are truly representative of the relevant pool of information?

© Ilya Strebulaev 2012

SEP 2012 Managing Biases in Strategic Judgment • Lisa is thirty-three and is pregnant for the first time. She is worried about birth defects such as Down syndrome. Her doctor tells her there is only 1 in 1,000 chance that a woman of her age will have a baby with Down syndrome. Lisa remains anxious and decides to obtain a test, known as the Triple Screen. The test is moderately accurate: When a baby has Down syndrome, the test delivers a positive result 86 percent of time. There is, however, a small “false positive” rate: 5 percent of babies produce a positive result despite not having Down syndrome. Lisa takes the Triple Screen and obtains a positive result for Down syndrome. Given this test result, what are the chances that her baby has Down syndrome? 80 70 60 50 40 30 20 10 0 1 2 3 4 5

 0-20% chance  21-40% chance  41-60% chance  61-80% chance  81-100% chance

© Ilya Strebulaev 2012

SEP 2012 Managing Biases in Strategic Judgment

The Representativeness Heuristic
• “Bayesian”: Insensitivity to Base Rates
–Lisa and Down syndrome: 1.7% –Prospective entrepreneurs spend too much time thinking about success and far too little time considering the rate for business failures –If an entrepreneur reminds a founder of Google, a VC is more likely to fund –“Four out of 5 dentists surveyed recommend sugarless gum for their patients”

• Judgment depends on previously formed stereotypes • Insensitivity to sample size

© Ilya Strebulaev 2012

SEP 2012 Managing Biases in Strategic Judgment

The Representativeness Heuristic
• Regression to the mean
–Typical example: employee who performs extremely well during evaluation later performs worse –Another typical example: most projects cost more than initial budget • Only projects with positive expected return are accepted • Projects with overoptimistic assumptions are more likely to feature positive expected returns

© Ilya Strebulaev 2012

SEP 2012 Managing Biases in Strategic Judgment

What is the rule? Suggest other sequences to find out

2-4-6

© Ilya Strebulaev 2012

SEP 2012 Managing Biases...
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