How Not to Make Bad Risk Decisions
Guest Post by Ed Perkins (first posted on CERM ® RISK INSIGHTS – reposted here with permission)
Why are there “bad” decisions? No one starts out to deliberately make a bad decision. If you look into available thought papers and reports, you can find some evidence that can provide some understanding of how bad decisions are made.
COSO in 2012, commissioned a report on “Enhancing Board Oversight” focusing on challenges and biases in making professional judgments.
More recently, several HBS faculty authored a study an “attribution error”, where decisions are biased by unjustified attributions of goodness to applicants based on “luck” rather than ability.
COSO Risk report
The COSO report, authored by KPMG, describes decision making as a five-step process:
- Defining the problem and identifying fundamental objectives
- Consider alternatives
- Gather and evaluate information
- Reach a conclusion
- Articulate and document the rationale (for the conclusion)
Step 5, documenting the rationale is a “quality control“ step, in that if the rationale cannot be clearly articulated, the decision process may be suspect.
COSO notes that “the judgment tendencies and shortcuts that human beings often rely on can short-circuit such a process, and as a result, our decisions can be biased.” The authors then go on to enumerate several “traps” and several tendencies that can bias the decision-making process.
“Rush to solve” – the pressure to have an immediate solution, without due diligence and care. This provides an ego benefit of appearing decisive; but you can be decisively incorrect as well as correct. This short-circuits step 1 of the process, figuring out what the problem really is so the optimal solution is found.
“Judgment trigger” – aka “Incomplete problem” – the decision to be made is presented as a compelling solution – but the real problem to be addressed and objective is not stated, leading to a lack of diligence to consider alternatives (step 2). Judgment triggers are best addressed by inquiring the “what and why” of the proposed solution.
“Incorrect framing” – this trap affects the gathering and evaluation of the information needed (step 3) to reach a conclusion. Frames are the mental perspectives that are used to consider and evaluate the information gathered to reach a decision. Frames affect the understanding and interpretation of the information being considered. How an issue is framed can effect/bias risk assessment and appetite. Risk may lead to reward but it can also lead to failure.
A recent post in Linked-in attributes bad decisions to “framing error”, and provides a slideshow “course” on framing and its role in decision making.
Overconfidence – decision makers can be prone to overestimate their abilities to gather information and make accurate assessments of risks or other factors in reaching a conclusion and making a decision. This is a subconscious tendency, resulting from personal motivation or self-interest. Even when trying to be objective. This shows up in mis-estimating outcomes or likelihoods when evaluating risks.
Confirmation tendency – when decision makers do not seek out objective evidence but rather look for confirmation for their initial beliefs or preferences for the conclusion. Sort of like “stacking the deck”.
Anchoring – when some initial information is used as a starting point and incremental adjustments are made regardless of whether the starting point is reasonable or the adjustments relevant. For example, starting by reusing an existing document and editing rather than creating a new document. The new document is constrained by the structure and content in the original.
Availability tendency – when decision makers weight easily retrievable information, say from memory or recent subjective experience as being more likely, more relevant, and more important for making a judgment than objective evidence. This can be either a positive or negative bias depending on the memory or recent experience.
In their study, “Inflated Applicants: Attribution Errors in Performance Evaluation by Professionals” the authors note this in their abstract:
When explaining others’ behaviors, achievements, and failures, it is common for people to attribute too much influence to disposition and too little influence to structural and situational factors. We examine whether this tendency leads even experienced professionals to make systematic mistakes in their selection decisions, favoring alumni from academic institutions with high grade distributions and employees from forgiving business environments. We find that candidates benefiting from favorable situations are more likely to be admitted and promoted than their equivalently skilled peers. The results suggest that decision-makers take high nominal performance as evidence of high ability and do not discount it by the ease with which it was achieved. These results clarify our understanding of the correspondence bias using evidence from both archival studies and experiments with experienced professionals. We discuss implications for both admissions and personnel selection practices.
A fundamental principal in the study is “correspondence bias”, first noted by psychology researchers in the 1970’s. This occurs when decision-makers “forget” situational factors that contribute to the performance or results of an alternative. This alternative can be a person (candidate), product, or theory. As the authors note, organizations and managers often assume “that performance in one domain will predict performance in another domain”. They cite a study that implies that CEOs who are good at golf have higher compensation, implying they are also good executives; but in reality they are not. An underlying issue is the difficulty in having visibility into both performance and the associated situational environment. They conducted experiments on admissions, selection and promotion, and reviewed actual decisions and concluded that correspondence bias and attribution error is a factor in evaluation decisions.
As a result of the effect of correspondence bias, organizations may reject sufficiently qualified candidates while systematically selecting lower performing candidates. The consequences could be substantial.
As we have seen, here’s the way to make a bad decisions: start with an agenda, be very confident that you don’t need to bother fully defining the issue or setting any objectives, set a tight deadline, look for easily available evidence that supports your preconceived notions, or select a “star” solution that obviously will work in your situation, and viola! To make things worse don’t consider any risks associated with the decision or ignore any consequences.
 Enhancing Board Oversight by Avoiding and Challenging Traps and Biases in Professional Judgment
The Committee of Sponsoring Organizations of the Treadway Commission; March, 2012
 Inappropriate framing is the root cause of most bad decisions.
Coach’s Guide to Framing, by Baker Street Publishing; September 2013
 Inflated Applicants: Attribution Errors in Performance Evaluation by Professionals
Samuel A. Swift, Don A. Moore, Zachariah S. Sharek, Francesca Gino; July 2013