How Wishful Thinking Porpagates

The way that a decision maker handles the risks involved in a decision, risk-behavior, could have great impact on the future success or failure of that decsion. Therefore, it is useful to know where this risk-behavior comes from.

Is a decision maker's risk-behavior mostly influenced by the personality of that individual, or is it mostly influenced by the decision making environment?

Saybert and Bloomfield in their article, Contagion of Wishful Thinking in Markets, which appeared in May-2009 issue of the Management Science, show that the interaction of decision makers with each other can impact their risk-behavior. More specifically, they try to show how wishful betting might lead to wishful thinking when decision makers interact with each other.

In one of their experiments, the authors examine the decision making behavior of two groups of individuals who have to make a risky decision (a bet). The first group have access to the objective probabilities. That is, the first group are individuals who know the probability of each possible outcome of their decisions (bets). The experiment results show, although people in this group have unbiased belief about the probabilities of the outcomes, they have a tendency toward making the decisions as if the probability of their favorable outcome is higher than what this probability actually is. This is what they call wishful betting.

This observation can explain the risk-seeking behavior of a decision maker in some cases. The authors then examine the second group who do not have access to the objective probabilities of outcomes, but can observe the decisions of the first group. The results of the experiment show that the second group actually come to believe that the probability of their favorable outcome is higher than what that probability actually is. Hence, they bet accordingly. This is what they call wishful thinking.

I found this research interesting, since it shows how risk-behavior of a decision maker, if observable to others, can impact the risk-behavior of other decision makers.

So, one might naturally ask:

"if we can change the observability of individuals' risk-behavior in an organization, can we influence the risk-behavior of each decision maker?"

A positive answer suggests that, if we want more risk-seeking behaviors in the organization, in an R&D department for example, we should announce publicly any bold move carried out by each researcher. On the other hand, if we want more risk-aversion behaviors, we should cover up any risky decision made by individuals.

What do you think?

UMASS Boston students and faculty can click here to see a PDF version of the paper by Saybert and Bloomfield.

Risk Behavior and the Fall of Successful Companies

Jim Collins in his latest book, How the Mighty Fall and Why Some Companies Never Give In, investigates the roots and reasons that many successful companies have declined to a level of irrelevance or even death. The author also tries to show how companies can avoid this fall.

He argues that the first stages of decline can start while all the evidences suggest that a company is still climbing the ladder of success, "The Silent Creep of Doom" he names it. Collins characterizes five stages in this decline:

1- Hubris Born of Success: When the success of a company turns its managers to arrogantly believe that they are entitled to win the game no matter what.
2- Undisciplined Pursuit of More: Managers' excessive self confidence makes them to pursue goals way beyond their reach or expertise.
3- Denial of Risk and Peril: The Managers' strong belief that they are destined for success, leads them to amplify the positive data and ignore all signs of possible danger ahead.
4- Grasping for Salvation: When the evidence for the decline of the company become more obvious than anyone can deny it, instead of trying to solve the roots of the problem, the managers try to convince (fool) everyone, including themselves, that there is a dramatic solution that can overhaul the company overnight.
5- Capitulation to Irrelevance or Death: If the company cannot avoid stage 4 by reaching for a solution that addresses the roots of the problem, there is no destination but irrelevance or death.

Although the author does not make his argument in the context of risk management, we can find interesting risk management lessons in the way he describes the fall of a successful company. Here are two:

a) The author's notion of "the silent creep of doom" reminds us of the fact that in many cases the source of disaster might be already in the making, hidden in the plain sight, while everyone thinks that nothing is wrong with this successful company. Therefore, it is imperative for companies to put in place detection mechanisms that can warn us before it is too late (early risk detection).

b) Successful companies are poised to suffer from a false sense of security. A sequence of successful results might create this illusion that they are going to do fine no matter what! In other words, success can result in excessive risk-taking behaviors. The false sense of security might even reach a level of risk denial. That is, decision makers might ignore evidences of potential risk. Many of this evidences could be in the form of "near misses". Analyzing near misses is a powerful tool for early detection of risk. However, the decision makers' excessive risk taking and/or risk denial attitude prevent them from learning from near misses.

You can listen to an interview with the author on the "Business Week Cover Story" podcast page.

An excerpt of the Collin's new book appeared in BusinessWeek, May 25, 2009. UMASS Boston students and faculty, click here to find the excerpt.