Human Decision in The Firm: Bsba Financial Management 2

PALAWAN STATE UNIVERSITY
College of Business and Accountancy

Department of
Puerto Princesa City
MODULE 1:
HUMAN DECISION IN THE FIRM
E2302: BEHAVIORAL FINANCE
1st Semester | SY: 2020-2021
BSBA FINANCIAL MANAGEMENT 2

TABLE OF CONTENTS
Title Page 1
Table of Contents 2
Overview 3
Course Outcome 3
Learning Outcomes 3
Summary of Topics 3
Content
Topic 1: Definitions of Cognitive/Psychological bias and Overconfidence 4
Topic 2: Effects of Biases to Individuals 7
Topic 3: Factors that Contributes to Better Decision Making 9
Module Activity No. 10

References 11
E2302: Behavioral Finance| Module 1: Human Decision in the Firm

MODULE 1
HUMAN DECISION IN THE FIRM

Overview
Hello BSBA major in Financial Management students in the Pamantasan ng mga eStudyanteng
numero Uno! We are glad to have you despite the pandemic that the world is experiencing right now,
though inevitable, but it is still your choice whether you will push through your education or not.
For this particular subject matter you will learn more of the biases that a person consciously or
unconsciously doing in terms of making decisions. Oftentimes, we regretted unto what we have
decided, only to realize that you could have just decided better if you only have enough time to think of
it. There are times that we need to decide as quickly as possible, but there are things that we need to
think many times before we can make a decision, especially when it involves our finances.
Course Outcome:
Develop a decision making skill.
Intended Learning Outcomes:

 Explain Cognitive/Psychological bias and Overconfidence.
 Describe the effects of biases faced by individuals.
 Discuss factors that contribute to the improvement in decision making.
Topics:
1. Definitions of Cognitive/Psychological bias and Overconfidence
2. Effects of Biases to Individuals
3. Factors that Contributes to Better Decision Making

Topic #1: Definition of Cognitive/Psychological bias and Overconfidence
Activity Number 1
Describe a time you tried to change someone else’s mind, either about a decision they
made or their views on an issue. Were you successful? Why or why not? (See Rubrics
at the last page of this module as your guide in answering Reflective Questions)
Psychological bias that is also known as cognitive bias - is the tendency to

make decisions or take action in an illogical way. It is the opposite of common sense and
clear, measured judgment. It can lead to missed opportunities and poor decision making.
Source:https://www.google.com/search?q=common+cause+of+cognitive+bias&source=lmns&bih=657&biw=1366&hl=en-
GB&sa=X&ved=2ahUKEwj2nJ_5pffrAhXMx4sBHYj1CMUQ_AUoAHoECAEQAA
Other factors that can also contribute to these biases:

 Emotions
 Individual motivations
 Limits on the mind's ability to process information
 Social pressures
A cognitive bias is a systematic error in thinking that occurs when people are processing and
interpreting information in the world around them and affects the decisions and judgments that
they make. The human brain is powerful but subject to limitations. Cognitive biases are often
a result of your brain's attempt to simplify information processing.
Biases often work as rules of thumb that help you make sense of the world and reach
decisions with relative speed.

Some of these biases are related to memory. The way you remember an event may
be biased for a number of reasons and that, in turn, can lead to biased thinking and
decision-making.
Other cognitive biases might be related to problems with attention. Since attention
is a limited resource, people have to be selective about what they pay attention to in the
world around them.
The concept of cognitive bias was first introduced by researchers Amos Tversky and Daniel
Kahneman in 1972. Since then, researchers have described a number of different types of
biases that affect decision-making in a wide range of areas including social behavior, cognition,
behavioral economics, education, management, healthcare, business, and finance.
If you had to think about every possible option when making a decision, it would take a lot of
time to make even the simplest choice. Because of the sheer complexity of the world around
you and the amount of information in the environment, it is necessary sometimes to rely on
some mental shortcuts that allow you to act quickly.
Cognitive biases can be caused by a number of different things, but it is these mental
shortcuts, known as heuristics, that often play a major contributing role. While they can often
be surprisingly accurate, they can also lead to errors in thinking.
Overconfidence
It may be defined as the belief that one’s decision-making, thinking and other abilities are
greater than what they actually are. Lobao, Julio Cambridge Scholars Publishing. (2016)
Behavioral Corporate Finance.
Overconfidence has two components: overconfidence in the quality of your information, and
your ability to act on said information at the right time for maximum gain. Studies show that
overconfident traders trade more frequently and fail to appropriately diversify their portfolio.
One study analyzed trades from 10,000 clients at a certain discount brokerage firm. The study
wanted to ascertain if frequent trading led to higher returns. After backing tax loss trades and
others to meet liquidity needs, the study found that the purchased stocks underperformed the
sold stocks by 5% over one year and 8.6% over two years. In other words, the more active
the retail investor, the less money they make. This study was repeated numerous times in
multiple markets and the results were always the same. The authors concluded that traders
are, "basically paying fees to lose money."
How to Avoid This Bias

Trade less and invest more. Understand that by entering into trading activities you're trading
against computers, institutional investors and others around the world with better data and
more experience than you. The odds are overwhelmingly in their favor. By increasing your
time frame, mirroring indexes and taking advantage of dividends, you will likely build wealth
over time. Resist the urge to believe that your information and intuition is better than others in
the market.
Reducing Regret
Admit it, you've done this at least once. You were confident that a certain stock was value
priced and had very little downside potential. You put the trade on but it slowly worked against
you. Still feeling like you were right, you didn't sell when the loss was small. You let it go
because no loss is a loss as long as you don't sell the position. It continued to go against you
but you didn't sell until the stock lost a majority of its value.
Behavioral economists call it regret. As humans, we try to avoid the feeling of regret as much
as possible and often we will go to great lengths, sometimes illogical lengths, to avoid having
to own the feeling of regret. By not selling the position and locking in a loss, a trader does not
have to deal with regret. Research shows that traders were 1.5 to 2 times more likely to sell a
winning position too early and a losing position too late, all to avoid the regret of losing gains
or losing the original cost basis.

Set trading rules that never change. For example, if a stock trade loses 7% of its value, exit
the position. If the stock rises above a certain level, set a trailing stop that will lock in gains if
the trade loses a certain amount of gains. Make these levels unbreakable rules and don't trade
on emotion.
Limited Attention Span
There are thousands of stocks to choose from but the individual investor has neither the time
nor the desire to research each. Humans are constrained by what economist and
psychologist Herbert Simon called, "bounded rationality." This theory states that a human will
make decisions based on the limited knowledge they can accumulate. Instead of making the
most efficient decision, they'll make the most satisfactory decision.
Because of these limitations, investors tend to consider only stocks that come to their attention
through websites, financial media, friends and family, or other sources outside of their own
research. For example, if a certain biotech stock gains FDA approval for a blockbuster drug,
the move to the upside could be magnified because the reported news catches the eye of
investors. Smaller news about the same stock may cause very little market reaction because it
doesn't reach the media.

Recognize that the media has an effect on your trading activities. Learning to research and
evaluate stocks that are both well-known and "off the beaten path" might reveal
lucrative trades that you would have never found if you waited for it to come to you. Don't let
media noise impact your decisions. Instead, use the media as one data point among many.
Chasing Trends
This is arguably the strongest trading bias. Researchers on behavioral finance found that 39%
of all new money committed to mutual funds went into the 10% of funds with the best
performance the prior year. Although financial products often include the disclaimer that "past
performance is not indicative of future results," retail traders still believe they can predict the
future by studying the past.
Humans have an extraordinary talent for detecting patterns and when they find them, they
believe in their validity. When they find a pattern, they act on it but often that pattern is already
priced in. Even if a pattern is found, the market is far more random than most traders care to
admit. The University of California study found that investors who weighted their decisions on
past performance were often the poorest performing when compared to others.

If you find a trend, it's likely that the market identified and exploited it long before you. You run

the risk of buying at the highs - a trade put on just in time to watch the stock retreat in value. If
you want to exploit an inefficiency, take the Warren Buffett approach; buy when others are
fearful and sell when they're confident. Following the herd rarely produces large-scale gains.
Activity Number 2
Watch the link below and answer Reflective Questions. Please refer to the rubrics at the
last page for your guide in answering reflective Questions.
https://www.youtube.com/watch?reload=9&v=RCA0yxdedNU
Reflective Questions:
1. Do you think that strong character is necessary for ethical action? Is it sufficient? Explain.
2. What can you do to safeguard against being too biased?
_________________________________________________________________________
Topic #2: Effects of Biases to Individuals
Unconscious bias affects us all. Lost wages, lowered morale, less engaged employees, and
lawsuits are just some of the effects to both the individual person and the business.
Biased tendencies can also affect our professional lives. They can influence actions and
decisions such as whom we hire or promote, how we interact with people of a particular group,
what advice we consider, and how we conduct performance evaluations.
Without being aware of it, we all have biases that affect how we view the world. Such biases
can potentially cause us to make decisions that are neither wise nor fair. But do they make us
bad people? Absolutely not. It simply means we are human beings, influenced by our life
experiences and those around us. We are conditioned by the movies and television programs
we watch and the books and articles we read, as well as by the social media and gatherings in
which we participate and the people we surround ourselves with. We have different
perspectives based on our race, gender, ethnicity, religion, sexual orientation, socioeconomic
status, nationality, and a whole array of other factors.
Fortunately, we can be proactive in addressing and reducing our biases.
Becoming Aware of Biases. Once you are aware of any biases you harbor, you have the
power to change your way of thinking. Start by learning about the group, or groups, you have
a bias against. Make an effort to engage with members of that group. Spend time with them
and genuinely get to know them. But remember, you need to experience these people as
individuals, not as representatives of a group. You will eventually realize that your previous
assumptions about them were false or do not apply to each member of this population.
Another helpful technique in overcoming biases is practicing mindfulness: Simply be aware
when you have a biased thought. Pay attention to what you are thinking. Take it a step further
by asking yourself why you are having this thought about this person. Thought awareness can
help you eliminate negative thinking and replace it with positive imagery.
Preventing Bias in the Workplace. Biases can also cause us to make discriminatory
decisions regarding a protected class, which can result in complaints of discrimination being
filed against the company or institution. Again, bias awareness can help you make fair
business decisions. Consider this example: Pretend you are an alumni of Harvard University
and, as such, tend to believe that Harvard graduates are more intelligent. You are responsible
for filling a position and are conducting final interviews. You have identified two final
candidates: One went to Harvard, while the other attended a less prestigious university.
Fortunately, you are aware of your bias and remind yourself that your job is to make the best
hiring decision based solely on qualifications. To prohibit your personal preferences regarding
educational background from influencing your decision, carefully review both candidates’
qualifications, writing down the concrete reasons that one candidate is more qualified than the
other.
“It is essential for all organizations — universities, publicly and privately held
companies, and government entities — to communicate the importance of treating all
employees, applicants, customers, and students with respect and fairness — from the
top down”.
Another way to guarantee bias-free decisions is to invite colleagues to participate in the

selection process. Ideally, a panel of diverse people would be involved in the hiring process,
increasing the likelihood of your making the fairest decision.
It is essential for all organizations — universities, publicly and privately held companies, and
government entities — to communicate the importance of treating all employees, applicants,
customers, and students with respect and fairness — from the top down.
In higher education work environments, employees are more likely to interact with people of
various ethnicities, nationalities, religious beliefs, and socioeconomic backgrounds. For
individuals who grew up in isolated areas where they may not have been exposed to diverse
and underrepresented groups, this lack of exposure could potentially cause some initial
challenges. In these situations, it is still imperative to focus on treating everyone with respect.
This requires realizing that everyone’s views — no matter how different they may be from your
own — have merit.
By becoming aware of your biases, practicing mindful thinking, and treating each individual
with respect, you can evolve beyond your biases and engage with all people in a positive
manner in any environment.
Activity Number 3
During a team-building event, Matthew tells his co-worker Jasmine about his
uncomfortable experience he had the other day where he was singled out, without
listening to the whole story Jasmine immediately responds, “That’s awful! As a woman,
I know exactly how that feels.” Matthew feels bad with her response and end the
conversation with Jasmine. What do you think that happened in the conversation? If
you are in Jasmin’s situation what would be your response? Why do you think Matthew
feels uncomfortable with what Jasmine’s is responding to? See the rubrics at the last
page of this module.
Topic #3: Factors that Contributes to Better Decision Making
There are several important factors that influence decision making. Significant factors include
past experiences, a variety of cognitive biases, an escalation of commitment and sunk
outcomes, individual differences, including age and socioeconomic status, and a belief in
personal relevance.
Factors that Influence Decision Making https://www.conovercompany.com/teaching-

decision-making-factors-that-influence-decision-making/
In order to become good decision makers, you need to learn about several factors that
influence decision making. Things like behavior style, authority figures, courage, too much
information, and your personal values all influence the way decisions are made.
Behavior Style
Behavior styles influence decision-making tendencies. It is easy, for example, to follow the 8-
step decision making process if there is plenty of time and resources. But when under stress,
people with certain behavior styles tend to make decisions based on impulse or emotion.
Some people tend to make a decision very quickly because they often rely on their first
impulse or impression of the situation. Making an impulsive decision could lead to some very
bad decisions.
On the other hand, some people may make decisions very slowly and tend to take longer than
the time available to reach a decision. The decision may be correct, but if it is too late to solve
the problem, it is not correct. Following the process, even when under stress, will help to avoid
a bad decision.
Authority Figures
Not every decision is ours to make. It is important to know when and to whom authority should
be delegated to make a decision. Before delegating that power, however, be sure the person
being trusted to make that decision has the skills needed to make a good decision.
Courage
Courage, or bravery, is a necessary ingredient in good decision making. It takes a lot of
courage and confidence to act on decisions. You must believe in what you are doing before
you are able to convince others to go along with your decision. Understanding the decision-
making process will help give you the confidence and courage to act on your decisions and to
inspire others to help implement them.
Too much information

More detailed information does not always mean a better decision. In fact, too much
information could mean the opposite and cloud the decision making process. With all the
information readily available to us today via the internet, we don’t always use our creative
thought processes the way we should. This can lead to decisions that are founded on fact
rather than using new and innovative ways of looking at things. We also may believe that more
facts allow for more accuracy in the decision making process. This is simply not true. The best
decision makers are actually those who do not rely only on facts; rather, they use their
creativity to find the best solution.
Your personal values

Once you know what you value, you can better understand your behavior. You must
understand that your beliefs produce your attitudes, your attitudes produce feelings and your
feelings lead to your behavior. Decision making demands that you use your value system.
Decisions that match your values are more likely to be the right choices for you. Complete the
following exercise to better understand your values.
Activity Number 4
Have you ever called or texted your best friend only to receive no reply? What would
you think about your best friend? Justify your answer.
See the rubrics at the last page of this module.
RUBRICS:
Exemplary (10 pts.) Proficienct (7points) Incomplete (5points)
Evidence of strong reflective Evidence of some reflective Few reflective thoughts

thought pertaining to personal thought pertaining to pertaining to personal
perspectives and personal personal perspectives and perspectives and personal
development. Reflective personal development. development. Few
statements go beyond simply Reflective statements contain statements contain little
answering one or two questions some rationale underlying the rationale underlying the use
to include rationale underlying the use of specific strategies or of specific strategies or
use of specific strategies or materials. materials.
materials.

REFERENCES
Book
1. Lobao, Julio Cambridge Scholars Publishing. (2016) Behavioral Corporate Finance.
On line sources
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AWEB4yBggAEBYQHjoICAAQsQMQgwE6AggAOgUIABCxAzoICC4QsQMQgwE6AgguOgsILhC
xAxDHARCjAjoFCC4QsQM6DQgAELEDEIMBEEYQ-QE6BwgAEEYQ-
QE6CAghEBYQHRAeOgUIIRCgAToHCCEQChCgAVCoEFjflgFg86oBaAVwAHgAgAGmAogBvSe
SAQYwLjI1LjeYAQCgAQGqAQdnd3Mtd2l6&sclient=psy-ab
2. https://www.verywellmind.com/what-is-a-cognitive-bias-2794963
3.https://www.google.com/search?ei=UhFBX4SGIs6moATYkJDIDw&q=definition+of+decision+maki
ng&oq=definition+of+decision+making&gs_lcp=CgZwc3ktYWIQARgFMgYIABAHEB4yBggAEAc
QHjIGCAAQBxAeMgYIABAHEB4yBggAEAcQHjICCAAyBggAEAcQHjIGCAAQBxAeMgYIABA
HEB4yBggAEAcQHjoECAAQRzoICAAQCBAHEB5Q4VFY7Whg2qgCaABwAXgAgAH9AYgBgw
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4. https://www.merriam-webster.com/dictionary/decision-making
5. https://www.merriam-webster.com/dictionary/overconfidence
6.https://www.investopedia.com/articles/investing/050813/4-behavioral-biases-and-how-avoid-them.asp
7.https://www.insightintodiversity.com/the-impact-of-biases-and-how-to-prevent-their-interference-in-
theworkplace/#:~:text=Biased%20tendencies%20can%20also%20affect,how%20we%20conduct%20pe
rformance%20evaluations.

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PALAWAN STATE UNIVERSITY

College of Business and Accountancy

BSBA FINANCIAL MANAGEMENT 2

Module Activity No. 10

E2302: Behavioral Finance| Module 1: Human Decision in the Firm