Timid choices and bold forecasts: a cognitive perspective on risk taking:

Daniel Kahneman and Dan Lovallo

Decision makers have a strong tendency to consider problems as unique. They isolate the current
choice from future opportunities and neglect the statistics of the past in evaluating current plans.
Overly cautious attitudes to risk result from a failure to appreciate the effects of statistical
aggregation in mitigating relative risk. Overly optimistic forecasts result from the adoption of an
inside view of the problem, which anchors predictions on plans and scenarios.

Two isolation errors when making risky decisions:

- Anchor: forecasts are based on success scenarios instead of past events  over-optimism
- Not pooling risks: risks are seen individually  over-cautiousness

Timid choices: three hypotheses about individual preferences for risky prospects:
- Risk aversion. Exceptions: lottery ticket price > expected value. Risk-seeking in losses
o Loss aversion: losses are weighted more than gains (certainty effect)
- Near-proportionality: people have near-proportional risk-aversion for small and large
gambles which is unreasonable. (small gambles: lower consequences + occur often (statistical
aggregation)  should not be proportional
- Narrow decision frames: people display different risk preferences based on the framing of
the prospect and view risky prospects independent from other risky prospects (isolation) 
this leads to suboptimal choices

Risk-Taking in Organizations: Implications and Speculations

Risk aversion and loss aversion visible in organizations as well due to asymmetry between gains
and losses and between credit and blame  (accountability / responsibility)
Risk aversion in organizations hypotheses:
- Threshold for accepting risks is high. Acceptable options are perceived as low-risk
- For isolated problems, willingness to take risks constant over differently sized risks
- Decisions will be narrowly framed instead of viewed as an aggregate of similar decisions
 Organizations are risk-averse

Narrow framing: a broader frame can only be adopted under two conditions:
- Ability to group problems together that “seem” different
- An appropriate procedure for evaluating outcomes and the quality of performance
Antidote: “you win a few, you lose a few” mentality

Near-proportionality of risk attitudes  problematic. Managers should encourage higher risk-

acceptance for its employees, otherwise the risk-aversion of the employees on small problems is higher
than the risk-aversion of the manager on large problems.  inefficiency costs

Bold forecasts: taking large risks does not always reflect true risk acceptance, but rather
misjudgement off one’s odds of success  managers should take an outside view to mitigate this

Inside and outside views: people believe themselves to be much more successful than others while
there is nothing relevant substantially differentiating them favourable from others  overconfidence:
- Unrealistically positive self-evaluations
- Unrealistic optimism about future events and plans
- Illusion of control: e.g. in M&As

Organizational optimism: managers view risks as “challenges to be overcome”. Causes:

- Forecasts are developed by people that have already invested time and interest in the plan
- Setting high goals for a project  manager will be optimistic about it as well
- Group-think: pessimism is demoralizing in companies

Costs of optimism: high costs and unrealizable plans based on unrealistic forecasts

Conclusion: Bold forecasts and timid attitudes to risk tend to have opposite effects