Core Management Concepts – Block 10 – Bias & Decision Making

University of London
B.Sc

Core Management Concepts

Block 10:
Bias & Decision Making?
Summary

Lecturer: M.Nageb

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Core Management Concepts – Block 10 – Bias & Decision Making

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1 Learning Objectives

•Explain the development of the field of decision making, using

the key elements of rational decision making theory, bounded
rationality, and behavioural economics and psychological
approaches to structure their answer

•Explain with relevant examples the key principles of bias,

heuristics, and specific biases in the context of business and
management practice.

•Identify suitable debiasing techniques to deal with

biased decision making, basing responses on context

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2. Introduction

Prescriptive vs. descriptive theories of decision making

There are two literatures looking at decision-making within organisations:

rational and logical analysis of the decision task and the use of
prescriptive deductive methods to derive the behaviour of rational
actors (e.g. expected utility theory in economics)

descriptive empirical, often psychological, seeking general

principles to explain observed preferences and actions
(e.g. identification of heuristics and decision biases).

2.1 Rational Decision Making: Prescriptive

• Decision Makers are rational actors. Examples of rational decision

(whose roots are in traditional economic theory) are Utility Maximisation
and Expected Utility Hypothesis

Examples of Rational Decisions

Utility maximization Expected Utility

Hypothesis
Suggest a decision process:
• identification of problems • decision maker chooses the
• assess the outcome of each utility based on own risk
action appetite and preferences
• derive a utility for each
action
• compute the probabilities
of all outcomes
• choose the action

• The above rational approaches can only be applied to simple problems

(programme decisions) where all actions, consequences and outcomes can be
identified. It works well for repetitive decisions e.g stock re-ordering as

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there is cognitive limitations to the human brain. If preferences are less

clear (something new) then due to limitation of cognition of the brain,
rational decision making cannot be applied

2.2 The Rational Model / Conditions for Rationality

Sometimes known as the “classical” or “economic man model”, this model

is based on the assumption that managers should be able to make logical
decisions.

• The decision-maker operates to achieve objectives that are known and

agreed
• The decision-maker tries for the condition of certainty (gathering
complete information): all alternatives and potential results of each are
calculated.
• The criteria for evaluating alternatives are known. The decision-maker
selects the alternative that will maximise the economic return to the
organisation.
• The decision-maker is rational and uses logic to assign values, order
preferences, evaluate alternatives and make the decision that will
maximise the achievement of the organisational objectives

This is a normative approach which prescribes the process of how the

decision-maker should make decisions. The stages in the process are well-
defined. This model would appear to be ideal; however, in real life, it is
not always possible to have complete information or to behave completely
rationally.

2.3 Bounded Rationality Descriptive Theories

Sometimes known as the “Administrative model”, this describes how

managers actually make decisions – especially in difficult (non-
programmed) situations

• For non-programme decisions, there are difficulties in getting available

data, they are vague, unclear or subjective. Nonetheless decisions have to
be made and therefore Simon (1960) has developed a concept that
considers cognitive limits to rationality, “Bounded Rationality”. Simon
answers has two key concepts:

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Simon’s Two Key Concepts

Satisficing Behaviour Bounded Rationality

• the practice of selecting an • people only have time and

acceptable objective or ability to process a limited
alternative which be easier to amount of information on
identify and obtain – less which to base their decisions
controversial, ‘safe’
• how long will the search
• actor searches for take place for the optimum –
‘satisficing’ rather than and whether it is worth it.
‘optimising’ (that is less than
the best or that which will
do) – ‘Satisficing Behaviour’

3 Stages in Decision Making

3.1 The Process of Decision-Making

Managers always face constant dilemma, how much to base decisions on:

• Quantitative structured data; evidence

• Qualitative unstructured data; hunches/judgement (Boddy, 2012)

Two broad views of the decision making process

Rational / Prescriptive Descriptive view

View
• psychological
• deductive method e.g expected • using principles to explain
utility theory behaviour / actions
• optimal solution – derived • reliance on psychological /
from algorithm / mathematical sociological factors
logic • heuristics / biases

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3.2 Stages in Decision Making

What is a Decision?

• Commitment to a certain course of action through allocation of resources

• Solves some problems

Stages in Decision making (Boddy,2012)

Using Ford as an illustrative examples, in the 1970s

Stages In Decision Description

making
1 Recognise a • Due to high oil prices Ford faced cash flow problems
problem/Opportunity as its cars were big using a lo fuel.

2 Set Objectives • shut down; sell off; merge; or produce smaller cars
with fuel efficiency

3 Set weights and • all the above strategic options were given
decision criteria quantitative weightage, for example shut down had
low weightage

4 Develop • based on the weightage given, Ford was able to rank

alternatives the strategic options to solve its cash flow problems

5 Implement chosen • Ford selected the production of small cars with fuel
alternatives efficiency. It invested heavily in R&D to compete
with Japanese smaller fuel efficient cars

6 Evaluate • Fortunately sales of Ford new fuel efficient cars

effectiveness of picked up and Ford has able to solve its cash flow
solution problem

4 Short Cut Thinking

In 1970s, psychologist became interested in how actually decisions are

made. They came to the conclusion that people make the same errors in
reasoning. These errors lead to people making sub-optimal decisions. For
example during interviews candidates who dressed smart are likely to be
selected; marketers price an item at £999 and by doing so the brain
anchors the price to be less than £1,000. There are many such examples
in everyday encounters.

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These predictable errors that lead to sub-optimal result are heuristics, biases,
‘rules of thumb’ or mental short-cuts and are elucidated as hereunder;

Predictable errors in making decisions are known as:

Heuristics Biases Rule of

• According to • Certain heuristics thumb/mental
Kahneman (2012), often lead to short-cuts
heuristics are a systematic errors • The brain cannot
simple procedure called biases – devote to everything
that helps find these are around us. It will
adequate though reasoning errors develop short-cuts.
often imperfect that lead to For example lady
answers to difficult irrational decisions drivers are not good
questions most – discrimination at in judgement or men
often using work is an e.g of are not good in
intuitive heuristic being bias nursing – these are
processes stereotypes and
influence our
decisions

Note: Biases come from heuristics, and whilst biases may be

problematic, heuristics are not: they are the shortcuts that we use to
help our busy brains – to protect us or to speed up our decision
making.

Merits and Demerits of Heuristics

Merits
• efficient thinking strategy
without spending time in analysing
information faced with resource
and time constrains
• can be seen as rational without
being too demanding on brain’s
resources (Gigerenzer)
• rapid and accurate – when faced
with complicated procedures
• Gerg Gigerenzer – traders
performed better in financial
Demerits
• Carnegie Mellon School – there
is absence of rationality hence
decisions are flawed
• can lead to errors in judgement
– Gigerenzer – can make
intelligent people look dump
• Fama – unnecessarily delay
decision making in markets –
“anomalies dredging”. No
rationality. Just make decisions
difficult

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markets using heuristics than using

quantitative methods

5 Types of Biases ( Article 1 – Bias is a big problem but so is noise)

Video

V1a Definition of Bias

a Anchoring Bias

Anchoring effect occurs when individual decisions are influenced by an anchor

point of reference. According to Kahneman (2012), there are two types of
anchoring

i. Unconscious
ii. Deliberate

Video
V8 Damage Bias Cause at the Workplace
V9 How to Manage Unconscious Bias
V10 The Anchoring Bias – What is it?
V11 The Anchoring Bias

Two types of Anchoring

Anchoring by Suggestion Anchoring by Adjustment

• Number acts as a form of • Adjustment occurs after you
suggestion e.g how many African are given an initial figure
nations are part of UN. • E.g What is Nageb’s salary?

1st Group 2nd Group Group 1 Group 2

• suggestion – • suggestion • average • average
low figure – high figure given £60,000 given £30,000
• group gave • group gave • adjustment • adjustment
low answer high answer was lower was higher

• error creeps in is failure to adjust

the figure sufficiently

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Important to note here is the working out what anchor to place in the
mind of someone you are negotiating with e.g price over consumer goods or
salary negotiation

b Availability Bias

• It is a mental short-cut which helps us to make a decision based on how

easy it is to bring something to mind i.e. think of examples in making a
decision or judgement e.g if newspaper report crime we might think that
the crime rate has increased but it may not have.

• Availability Bias is a problem for managers if managers rely on memory

alone in making decision.

c Overconfidence and Optimism

• Lovallo & Kaheneman (2003) asserts that the major reason for poor
decision making is ‘Planning Fallacy’ that is people tend to underestimate
costs or overestimate the benefit of a proposal.
The source of this fallacy is ‘optimum bias’ – people tend to see things in
a positive light by experience.

• Inherent optimism leads to overconfidence and affects our ability to be

self-critical.
• Overconfidence may lead to costly outcomes for example investments
that are risky should be avoided, which may not be so.

• Overconfidence and optimism are also linked to gender. These seem to

be bigger problem for men than women. Nageb’s view is that ladies who
work in military or police or take up martial arts tend to suffer from
these biases. One of my students, based on my advice, took up martial arts
class in school, became very confident in class and challenged me to a
fight – jokingly.

d Loss Aversion / Prospect Theory

This uses approach drawn from cognitive and behavioural, psychology,

coupled with finance and economics to explore how and explain why
people make seemingly irrational decisions.

• Behavioural Economics (BE) is based on observation of anomalies

which appear to contradict the assumptions at the heart of
economics. E.g. Anomalies observed at the level of the market –

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too much trading, stock picking, and selling a falling stock – are
seen as evidence of cognitive bias to explain anomaly.

• Prospect here means that the future is uncertain and hence

cognition is applied to explain the behaviour of people.

The theory describes decision processes in two stages:

i. editing
ii evaluation

Two stages

Editing Evaluation

• Framing effect – High Utility / Value

cognitive bias – how the
brain thinks
• seek risk – negative
frame e.g Nick Leeson –
action taken to
avoid/overcome loss Losses Gains
• avoid risk – positive s
frame – e.g buyers do not
want to lose discounts

Low Utility / Value

How to reduce Loss Aversion?

• Work in teams – there is check and balance as people will question the
validity of decisions and so arrive at a consensus.

• Employ emotionally stable and competent traders who know when to cut
loss and not succumb to loss aversion and move on.

• Trading guidelines of stock exchange – avoid loss aversion. Those who

are irresponsible rogue traders, like Nick Leeson, must be prosecuted by
law to set as an example for others not to follow. ( See Articles 2,3&4)

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Article

A2 Nick Leeson the Rogue Trader

A3 Behavioural Economics
A4 Loss Aversion in Soccer

Video

V1 “A” Level Economics

V2 What are Heuristic?
V3 Heuristic – Plane 1
V4 Heuristic – Plane 2
V5 Behavioral Economics
V6 Types of Heuristics

e Confirmation Bias

• This is where we seek confirmation of the view we already hold. Let’s

take an example as follows:

Compiling Stock Portfolio

• ignore • focus on
negative positive
information on information that
decision e.t substantiate
avoid stock not good decisions
doing well are made

Implications

• Manager should be aware of confirmation bias so that they can become

good critical thinkers and make the right decision.

• It is important for managers to be open to evidence which question their

confirmation and therefore right decisions can be made.

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• To overcome the confirmation bias of individual managers, it is good to

have a diverse team. The diversity with wide ranging views can help make
rational decisions.

• One of the problem of confirmation bias is managers may mistrust

sources that go against their confirmation and hence may resort to
erroneous decisions.

• If managers succumb to confirmation bias then they learn nothing as

anything and everything which questions their confirmation is rejected and
ignored.

• Another serious problem of confirmation bias is “attitude polarisation”.

People with opposing views will move apart from each other. Each group
knows they are right due to their confirmation bias and therefore have no
interest in debates. For example Republican support against gun control in
America.

6 Debiasing

There are a couple of ways of debiasing so that rational decisions can be

made by managers. Managers should make use of such techniques to
outsmart or avoid biases.

It is difficult to challenge ourselves or engage in self-criticism. If we

allow this to happen we let biases creep into our decision making
process. Managers must therefore learn to spot biases when they occur
and have the sense to identify, recognise and outsmart or avoid them in
the process of decision making. Managers therefore have a role in
encouraging their teams to do this.

a Accountability

During presentation we need to be sure that our decisions are rational in

case we are questioned by others. This avoids embarrassment and
therefore forces us to avoid biases. Avoiding biases impresses others that
we are a good decision maker. However becoming obsessive to avoid
biases, managers may not be so wholesome in their decisions.

b Incentives

Goods decisions should be rewarded. It shows that managers have

considered a range of options which avoid biases

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c Take Outside View.

Take for example, expenditure on R&D. Our firm looks at costs and hence
it is suffering from availability bias. Our competitors are engaging also in
R&D, we also have to do it to maintain our competitor edge and by doing it
overcomes availability, confirmation, and availability biases.

d Training

Managers can be trained on decision making to identify the types of

biases, spotting them and then challenging them by outsmarting them.
Such training can help in recruitment interviews as well as appraisals.

e Pre-Mortem

This can be conducted at the planning stage of a project, to identify what

might go wrong . This can reduce overconfidence and planning fallacy. At
an early stage it allows ideas and worries to be expressed which might be
suppressed to prevent biases from creeping in at later stages of the
project.

f Decision Making and Decision Support System

This uses prescriptive process. It makes use of algorithm and breaks up

complex process into simple component to aid in analysis of project, for
example using Critical Path Analysis

Article

A5 Algorithm

g Group Decision making

By having diversity in teams with different backgrounds and expertise

tend to overcome biases and enables decisions to be more rational. Also
diversity has an effect of overcoming groupthink which may polarised some
group members. If group think happens then the use of ‘devil’s advocate’
would be one way to overcome such problems.

Summary

By having some prior planning managers can include some techniques of

ways of overcoming biases to happen and in the end better decisions are
made.

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Video

V7 Decision Making Theorists

7 Key Concepts

• Prescriptive and Descriptive approaches to decision making

• Bounded Rationality, Satisficing approaches
• Stages in decision making process
• Short cut thinking – heuristics, biases, ‘rules of thumb’
• Biases – anchoring, availability, overconfidence and optimism, Loss
aversion (prospect theory), confirmation
• Debiasing

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8 Concepts & Theories linked to References

Concepts / Theories References

Economic Man / Classical Model / Mullins (2007)
Rational Model
Administrative Man / Bounded Simon (1947, 1997)
Rationality / Satisficing approach to
decision making
Simon’s approach was subjected to Elster (1989); Sen (1977)
brutal criticisms by social theorists and
philosophers
Simon was concerned with application
to administrative decisions rather than
intellectual content
Heuristics – cognitive limitations in Simon (1947)
decision making; Simon Bounded Kahneman and Tversky (1979)
rationality model provided the initial
basis for the development of heuristics;
Behavioural psychologist later
expounded and developed into
‘prospect theory’
Framing of results mattered. People Kahneman and Tversky ( 1979)
preferred things that were positively
framed (focusing on good outcomes) to
those that were negatively framed (
showing the same figures, but
mentioning the bad). Gain frame are
risk-averse and the loss frame are risk-
seeking (behavioural economics)
Heuristics are mental short cuts ( most Kahneman and Tversky (1979)
often work)
Biases are departure from rationality Bazerman (2002)
and affect the rational decision making
process
Heuristics are not bias can lead to bias
and thus affect decision making process
Supporter of heuristics – those who Gigerenzer (2008)
work on cognitive illusions have been
seen to profit at the expense of those
who do not in financial markets.
(behavioural finance)
Homo Heuristics -Ecological –
effectiveness of heuristics depends on
interaction with the environment

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Tutorial Question

1. What is a rational decision? Describe some of the barriers to rational

choice in organisation and how they can be overcome.

Willman’s Answer

1 What is a rational decision? Describe some of the barriers to rational

choice in organisations and how they can be overcome.
Reading for this question:

Subject guide chapters 10

Good answers will refer to the following;

• Chapter 10 stressed internal cognitive limitations, both in terms of limited

processing capability and costly search for alternatives, and also systematic
biases in choice (It also points to other factors, such as incentive structures, and
organisational cultures which are not conducive too good decision.

• Different approaches to rationality including three meanings of the term

‘bounded rationality’ are described and should be in a good answer

• The corrective actions suggested in the lectures have been training, use of
models, tools and data, making explicit contrasts and opportunity costs in order
to make choice more explicit, surfacing multiple perspectives and frames, so that
the decision maker does not get trapped in any one.

• Answers should refer to the biases that affect all four of the phases of
decision making described – information gathering and processing, decision making
and decision review.

Mock 2015

Describe ‘prospect theory’. What are the implications of prospect theory for
the design of financial incentives?

Core Resources
Course Guide; Chapter 10
The question requires a presentation of prospect theory defining the key
terms of risk aversion and loss aversion. It then requires a discussion of the
key problems of performance measurement and the problems of designing a
performance measurement system based around financial rewards.
Good answers will

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. Define and discuss prospect theory, indicating why risk aversion and loss
aversion may occur

. Indicate the key problems of measuring individual performance and allocating

rewards

. Discuss how the allocation of financial rewards may generate either

risk or loss aversion

. Indicate the limitations of prospect theory in certain reward contexts – e.g.

collective vs individual incentive systems.

Nageb’s addenda

• Not gaining bonuses – greater loss than gaining normal increment. If individual
makes a loss then he or she will be more risk seeking and take drastic measures
so that he achieves his target. His action therefore is a departure from his
rational behaviour.
So in fixing target it is better to get the subordinate(s) involve and so they so
they subordinate feels that he has committed or owns the target and will avoid
losing its by working harder

• Car Workshop – Team are giving points for every month – say 100 points. If
they are no complains the team gets full bonus. But if any customer complains
then points are deducted. At the end of the month the bonus will be based on
the number of points. So the group a lot to lose and they are already
accustomed ( endowment effect ) to the 100 points

• In the sale of exercise equipment – firms allow the customers to take home
the equipment for two weeks and try them out. If they do not like it then they
can return back with money return back.
The thought of losing something you own is greater than not losing it (
endowment effect ). So the customer will decide to keep the equipment.

May 2015 Exams – Zone A

What is a rational decision? Describe some of the barriers to rational choice

in organizations and how they can be overcome.

Reading for this question

This question relates to Chapters 10 of the subject guide. Chapter 10 stresses
internal cognitive limitations, both in terms of limited processing capability and
costly search for alternatives, and also systematic biases in choice. It also points
to other factors, such as incentive structures and organisational cultures which

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are not conducive to good decision-making.

Approaching the question
Good answers should outline:
• Different approaches to rationality (the three meanings of the term ‘bounded
rationality’ must be described and should appear in a good answer).

• The corrective actions suggested in the lectures have been training, use of
models, tools and data, making explicit contrasts and opportunity costs in order
to make choice more explicit, surfacing multiple perspectives and frames, so that
the decision-maker does not get trapped in any one action.

• The biases that affect all four of the phases of decision-making described:
information gathering and processing, decision-making and decision review.

The corrective actions are: training, use of models, tools and data, making explicit
contrasts and opportunity costs in order to make choice more explicit, surfacing
multiple perspectives and frames, so that the decision-maker does not get
trapped in any one action.

May 2017 Zone A and Zone B Q8

Evaluate the role of heuristics in business decision making, using appropriate

examples.

Reading for the question

Most relevant section of the subject guide: Chapter 10.

Learning outcomes being examined

• Discuss the impact of biases and heuristics on managerial decision

making

Approaching the question

• We were expecting answers which firstly identified what heuristics are,

using one or more examples to do so.

• Candidates were then likely to evaluate the positive and negative roles
that heuristics can play in business decision making, making use of the
language from the decision making chapter, including specific biases

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and relevant examples.

• We felt it was important that answers did not just focus on the
negative elements of heuristics. We need heuristics so that we do
not have to routinely rediscover the world. They are the sort of
mental shortcuts that allow us to function at the speed and in the
ways expected of us. Making assumptions about someone’s ability to
do a job based on the way they walk into an interview room can be
problematic, but they can also save us a lot of time in that we can use
all the information about how they are dressed, how they walk, how
they shake hands, how they talk, to try to work out if they might fit
our company culture.

• However, we wanted candidates to recognise that, on the negative

side, they can lead to suboptimal decision making. Again using the
interview example, there might be someone who would be amazing
for our company and really fit the culture, but who is very nervous in
interviews, or who ruined their best interview suit on the way to the
interview and has had to run into the nearest shop to buy a new one,
which does not fit very well.

• Heuristics and thus biases can be particularly problematic for

managers who are routinely judged on the basis of their decisions and
their outcomes.

• A good conclusion would be likely to balance the positive and negative

aspects of heuristics.

A satisfactory answer would:

• Make attempts to outline what heuristics are

• Attempt to use examples to elaborate on answers
• Recognise that heuristics can have both positive and negative consequences for
managers and managerial decision making (see
above, Approaching the question).

An excellent answer would:

• Give a good description of what heuristics are

• Use useful examples to elaborate on answers, using the language (for

example naming biases or discussing prospect theory in detail) of the
key readings for this topic.

Where candidates could have done better

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• Answers that made good use of examples to show how heuristics affect
business decision making (negatively and/or positively) did very well.
This is because, if a question specifies that it would like you to use
examples, you will be awarded marks for doing so.

• There were some big misunderstandings in the weaker answers

regarding the implications of heuristics. It is important to remember
that heuristics have positive, as well as negative, consequences, for
example saving us time and preventing us from constantly having to
rediscover basic aspects of the world. In a business context, building
up a knowledge base is critical to success.

• Weaker answers did not grasp that we often use heuristics

unconsciously; we do not necessarily ‘choose’ to use them. It is
important, even with the more difficult aspects of the syllabus, to make
sure that you have a good grasp on the complexities. It can be really
good to try to explain the complex aspects of the syllabus to a friend
and see if you can do this.

May 2018 Zone A Q4

What is ‘loss aversion’ according to Kahneman? Can an understanding of loss

aversion lead to better decision making in organization

Reading for this question

• Block 10, VLE

Learning outcomes being examined

• Explain the prescriptive and descriptive approaches to decision-making in

organisations

• Discuss the impact of biases and heuristics on managerial decision making.

Approaching the question

Define loss aversion. For example as ‘engaging in high-risk behaviour to avoid the
experience of loss relative to a reference point’.

Define in more detail: The theory says that when we deal with gains (i.e. when
we have gains), we then tend to be risk averse (because we do not want to lose
them). However, when we deal with losses (i.e. when we have just encountered
losses), we tend to be risk seeking: we will take bigger risks to eradicate a loss.

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Explain that loss aversion is a form of bias. Biases are deviation from the norm or
rationality at times of judgement. Therefore, they are an irrational way to
behave.

Make use of examples to illustrate how loss aversion works. Such examples
can be hard to explain, so we anticipate that writing these out is likely to
consume quite a lot of the time in the examination. We will give credit for
examples being well-explained and linked back to the question.

• In the case of Nick Leeson, he made considerable losses on the stock

market. However, rather than writing them off, he continued to ‘throw
good money after bad’ (i.e. to waste additional money trying to fix what
is expected to be a hopeless case) in an attempt to make up what he
had lost. He hid this behaviour until he could hide it no longer. He was
prosecuted for fraudulent, unauthorised speculative trading and sent to
prison. He demonstrated loss aversion because he didn’t want to write off
his losses, but acted in a risk seeking way to try to get them back.

• At the other end of the spectrum, if workers have recently brought in a

large amount of revenue from a sale, and they have the choice to reinvest
this money in a new piece of work with a similar level of risk, they would be less
willing to do it because they would be more risk averse than necessary, not
wanting to lose what they had already gained.

Explain that, if we can be aware of loss aversion, at both ends of the spectrum,
we can try to guard against it in business practice and make our decision making
more ‘rational’. Although absolute rationality is shown by Kahneman and Tversky
to be hard, if not impossible, to achieve, it is much more possible to try to
achieve it if we are aware that the bias exists in the first place.

Give examples (again, such examples can be hard to explain so will likely
consume quite a lot of the time in the examination. Credit is given for good
explanations linked back to the question):

• For example, organisations might want to pay closer attention to workers

who are investing large amounts of company resources (particularly
money). Rather than leaving them to operate unchecked, having regular
check-in points, as well as encouraging them to work in teams to share
their workload, might reduce the problem.

• They may also want to pay close attention to teams who have just
experienced a considerable gain, particularly where their pay is based on
commission or they have a profit-sharing scheme or a performance-related

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bonus. All of these variables may make them more risk averse as they stand to
lose out personally from a loss.

Critique loss aversion theory (e.g. it does not totally explain human behaviour). It
does a better job than assumptions of total rationality, but we are all different
and will be subject to our own psychologies and circumstances. Thus, we cannot
assume a ‘standard’ level of loss aversion across a workforce.

Conclude overall, on the impact of loss aversion of firm-based decision

making.

A satisfactory answer would:

• Define loss aversion, recognising somewhere in the answer that there are two
different behaviours described: risk-avoiding after making a gain; risk seeking
after making a loss

• Make a reasonable attempt at providing example(s) of what loss aversion is

• Provide an explanation of how the theory of loss aversion could be used to help
organisations make better decisions (it’s fine to focus on just one end of the
spectrum at this level)

• Conclude on the utility of loss aversion for decision making in

organisations.

An excellent answer would:

• Define loss aversion, recognising that there are two different behaviours
described: risk avoiding after a gain; risk seeking after a loss
• Reference Kahneman & Tversky, and mention behavioural economics as the
wider field from which the theory of loss aversion is drawn
• Give examples of what loss aversion is at both ends of the spectrum
• Provide an explanation of how the theory of loss aversion could be used to help
organisations make better decisions, at both ends of the spectrum
• Conclude on the utility of loss aversion for decision making in
organisations, possibly saying how behavioural economics is one of the
biggest developments in management and economic theory for decades.

Common mistakes in responding to the question:

• Not knowing the theory of loss aversion in detail. Better answers were
comfortable with loss aversion and could describe it clearly and in a
detailed way. They were able to build up their answers through good
discussion of how an understanding of it can be used to improve decision

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Core Management Concepts – Block 10 – Bias & Decision Making

making in firms.

• Talking too much about prospect theory, biases or heuristics. Better

answers used prospect theory and/or biases and/or heuristics as helpful
additional concepts rather than making them the central basis of their
response.

• Not using enough examples to illustrate the answer. Although the

question didn’t specifically ask for examples, one of the best ways to show
the benefits for organisational decision making was to explain using
examples. Better answers were confident in doing this, either with real life
examples or with made-up hypothetical examples. We were very happy to see
either/both, with no preference over which was used as both were able to
clarify the response to the question that the candidate gave.

May 2018 Zone B Q7

How does behavioural economics influence our understanding of managerial

decision making? How does it differ from earlier accounts of managerial
decision making? You should use materials from theory and practice to
illustrate your answer.

How does behavioural economics influence our understanding of

managerial decision making? How does it differ from earlier accounts of
managerial decision making? You should use materials from theory and
practice to illustrate your answer.

Reading for this question

• Block 10

Learning outcomes being examined

• Explain prescriptive and descriptive approaches to decision-making within

organisations
• Explain the rational approach to decision making with reference to
examples
• Discuss the impact of biases and heuristics on managerial decision making
Approaching the question
As with all the questions in this paper, there is no ‘one right answer’. What
follows is a reasonably comprehensive list of points we might expect to see, in
roughly the order we might expect to see them. We also do not expect that
even an excellent answer would have the time to cover all of the points.

Define Behavioural Economics (BE) and/or managerial decision making:

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Core Management Concepts – Block 10 – Bias & Decision Making

• Behavioural economics: a significant area of research which uses

approaches drawn from cognitive and behavioural psychology, coupled
with finance and economics to explore how and explain why people make
seemingly irrational decisions.

• Managerial decision making: considering how managers make decisions that

relate to their work or that of others.

Explain that BE influences our understanding of decision making because it

removes the idea that people act rationally, rather showing how people may
often think they are trying to act rationally but are actually acting in a range
of other ways.

Explain that it then tries to explore what some of these ways are, building up,
through experiment, a catalogue of biases and heuristics that our brain defaults
to when undertaking decision making, whether we are aware of it or not (and
often we are not). Some key biases it has revealed/explicated are (NB: there are
lots more that students could talk about and we are happy to consider anything
as they will have covered lots in the handbook/in the essential reading):

• The action bias (preferring action to inaction)

• The retrievability bias (tending to have our thinking shaped by information
we can easily recall rather than that which we cannot)
• Loss aversion (Acting in a fashion that is risk averse when we may lose
something we have gained; and in a fashion, that is risk seeking when we
try to regain something we have lost)

Explain that these findings all help to influence our understanding of

managerial decision making, because they allow us to understand why
managers often make the decisions they do, despite seeming somewhat
irrational, and they help us to become more aware or ‘mindful’ of our thinking
and thus to be able to try to correct it (although of course this isn’t always
possible).

Give examples, e.g., if we have a bias towards action then when we are
desperate to act rather than wait, despite the fact that this might lead to a
bad management decision as we may not have all the information or resources we
need to make a decision, we may be able to try to override this instinct in
ourselves or in others. (NB: action bias is just one example and again students
could use anything from the handbook or their own reading/research: we will give
credit for anything that we deem relevant).

Explain how BE differs heavily from earlier accounts of managerial decision

making, which initially assumed ‘homo economicus’ as a standard model, and

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Core Management Concepts – Block 10 – Bias & Decision Making

that managers would always make the optimal decision and be in a condition of
perfect information – both of which are only theoretical and not possible in the
real world.

Explain that BE could be linked to Simon’s work on bounded rationality, which

describes how people routinely make sub-optimal decisions as it’s not realistic to
consider everything when making a decision.
Conclude, e.g., BE has made a very significant contribution to our
understanding of decision making and has the potential to have a big impact on
workplace and management practice. However, at its heart is the idea that we
cannot overpower our irrational side, caused by busy brains and shortcut
thinking. But we can try to be mindful of it in ourselves and others some of the
time.

A satisfactory answer would:

• Define behavioural economics

• Discuss at least two ways in which it influences our understanding of
managerial decision making
• Compare it to earlier accounts of decision making: either economic theory
or the work of Simon (or both).
• Conclude on the value of behavioural economics in developing our
understanding of managerial decision making.

An excellent answer would:

• Define behavioural economics and attribute it to Kahneman

• Discuss at least three ways in which it influences our understanding of
managerial decision making.
• Compare it to earlier accounts of decision making: both economic theory
and the work of Simon on bounded rationality/satisficing.
• Conclude on the significant value of behavioural economics, recognising in
some way the big impact it has had, and continues to have, on the way we
understand decision making.

Common mistakes in responding to the question:

• A lack of clarity on what behavioural economics is, and thus misdirecting

this part of the answer towards bounded rationality. Better answers may
have discussed bounded rationality briefly, but spent the majority of
the time talking about theories/theorists clearly in the BE field, such as
Prospect Theory, Loss Aversion, Kahneman & Tversky, etc.

• A failure to link the topic of BE specifically to managerial decision making (as

opposed to decision making in general). This question required a focus on how it

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Core Management Concepts – Block 10 – Bias & Decision Making

might help managers to make decisions.

• Insufficient theory/practice examples. This question clearly required both and

better answers were able to provide them.
• Not enough discussion of how it differs from previous accounts of decision
making. The question clearly states that it wants to see where BE sits
in relation to other theories (such as traditional, ‘rational’, descriptive
economic theories, for example).

May 2019 Zone A & Zone B Q3

Identify three biases that managers may experience when recruiting a new
staff member. Discuss how, and to what extent, it is possible to reduce
these biases. You should make use of relevant theories in behavioural
economics to answer this question.

Reading for this question

• Block 10 and its essential reading

Approaching this question

Analysis

This question asked for: An identification of three different biases that might be
relevant when a manager is recruiting a new staff member. A discussion of
whether, and if so to what degree, these biases can be reduced. An application
of relevant theories (for example, those in Block 10 which focuses on behavioural
economics) to illuminate the answer.
Sensible areas to focus on would be:

• Definitions of ‘bias’ and related terms, such as behavioural economics,

heuristics, or irrational thinking. Theorists such as Kahneman and Tversky
may also be mentioned
• Choosing three biases that might be relevant during recruitment. Discussing
less than three biases will make it very hard to pass. Discussing more than three
biases will mean that candidates will not have the time/space to go into as much
detail on each as would be required for a good mark.
• Because the recruitment process requires information gathering,
information processing, decision taking and a reaction to decision
outcomes, these could be drawn from anywhere in the four tables (from the
addenda) how those biases are
relevant to the recruitment process – making a clear link. For example:

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Core Management Concepts – Block 10 – Bias & Decision Making

- The Framing Effect – generally where different weights are assigned to

first versus last in a list (for example, where the first or last CV looked at is
seen to be better or worse than others)
- Confirmation bias – generally where a search is biased towards
confirming rather than disconfirming evidence (for example, where a
recruiter liked someone’s CV, they look for confirmatory evidence in
the interview that they are the right person to recruit)
- Ego-involvement – generally where too little or too much emotional
attachment is given to events or outcomes (for example, where a
recruiter feels too emotionally attached to the recruitment process to
be able to see that there is no one suitable being interviewed and to
start again)
-Representativeness bias – generally where isolated events or
information are assumed to be representative (for example, where the
few examples that someone has time to give in their interview or their
application form are taken to be representative of their whole life or
career).

• Recognising that we can work to reduce these biases. Using the same
biases as an example:
- Framing effect: ask recruiters to use a ranking system when they
recruit and if there is a team of recruiters ensuring they all receive the
CVs in a different order
-Confirmation bias: encouraging recruiters to question whether they
are starting the process of interviewing from a neutral perspective or
if they are going in with favoured candidates. Again, using a ranking
system here may help
-Ego involvement: Reminding recruiters that it’s important to get the
right person, even if that means starting the process again. Again, a
ranking system here may help.
-Representativeness bias: this is often built into the recruitment
process, where candidates are asked to give examples of, e.g., when
they took a stand or were very organised. Moving to different styles of
interview, such as competency testing, may help

• Discussing that if we create processes which stand in the way of the biases,
particularly ones which encourage us to ‘think slowly’, we can reduce our biases
• However, we wouldn’t be able to overcome all biases at all times.

A weak answer would

• Fail to identify three recognised biases
• Fail to link real biases to the context: in this case recruitment
• Spend too much time focusing on the recruitment context and not
enough on the bias element of the question (which the wording clearly

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Core Management Concepts – Block 10 – Bias & Decision Making

shows to be the most important element).

A satisfactory answer would

• Choose three biases that are relevant to recruitment decisions
• Explain how the biases are relevant to recruitment decisions
-An example of such might be the framing effect. A candidate could
explain that this is when different weights are assigned to the first
and/or last in a sequence. They could then say that this would come
into play during recruitment if a manager preferred the first CV that
they looked at over others that they saw. A way to overcome this bias
could be to have clear criteria that you are rating each CV against, so
that the possibility of a framing effect is heavily reduced.
• Explain how each of the biases can be reduced
• Talk about how biases can generally be reduced but it is hard to totally
eradicate them.

An excellent answer would

• Explain very clearly and in detail the three chosen biases and their link to
recruitment
• Choose highly appropriate examples and explain them clearly
• Justify successfully how the interventions suggested might reduce the
biases
• Clearly explain that it is difficult to eradicate biases completely because
they are hard-wired
• Biases come from heuristics, and whilst biases may be problematic,
heuristics are not: they are the shortcuts that we use to help our busy
brains – to protect us or to speed up our decision making.

Learning outcomes
• Discuss the impact of biases and heuristics on managerial decision
making.

Common errors made by candidates

• Treating heuristics as a ‘type’ of bias, rather than seeing biases as a type of
heuristic that creates problems (not all heuristics create problems)
• Not talking about enough biases
• Forgetting to explore how to reduce the impact of the biases
• Not making use of the recruitment context, and so providing a generic
answer.

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Core Management Concepts – Block 10 – Bias & Decision Making

2021 – Nageb Preliminary Examination

Section A

d. What is a bias? List two specific biases with one example of each in a
business context.

Heuristics are mental shortcuts that usually involve focusing on one aspect of a
complex problem and ignoring others. These work under most circumstances, but
they can lead to systematic deviations (errors) from logic, probability or rational
choice theory. The resulting errors are called “cognitive bias” and many different
types have been documented.
Heuristics are not biases but can lead to biases. In the real world biases affect
judgment and therefore decisions and hence can be unreliable. Cognitive bias can
be used to explain the pattern of behaviour that brings anomalies which appear
to contradict the assumptions at the heart of economics. Bias can creep into the
four stage optimizing approach to decision making affecting the process of
information gathering, processing, decision-making, and post-decision review and
thus decisions may be a departure from the economic concept of rationality.
Bazerman (2002) has provided a list where the nature and derivation of each bias
can be found. Two examples which may affect decision making process are
Framing and order effects – People tend to avoid risk when a positive frame is
presented but seek risk when a negative frame is presented; Representative bias
– isolated events or information are assumed to be representative – ladies are no
good in engineering work
(5 marks)
(205 words)

2021 Additional Pointers – in preparation for Exams

1 Explain the rational model of decision making. Discuss why managers do

not always make rational decisions.
Support your answer with reference to theory and examples where
appropriate.

Approaching the question

The rational model needs to be clearly described and the assumptions

clearly stated. Decision making is seen as a rational and objective process
to achieve predictable results. The assumptions are clearly laid out in the
reading materials. Some are, full information is available; manager is able
to compute and is fully aware of the situation in which decisions have to
be made; there is absence of politicking that may affect the decision
making process.

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Core Management Concepts – Block 10 – Bias & Decision Making

Better answers should attempt to evaluate the model although this was
not specifically asked. Some issues concerning that of the rational model
is that it is based on assumptions and as such may not hold in reality. A
good example is the expected utility theory of Bernoulli (1738) which is
essentially a prescriptive economic theory.

In the second section, reference could be made to the other decision

making models discussed in the course. Managers do not always make
rational decisions because humans are not always rational; also they do
not have all the information available and are under pressure to make a
decision quickly (bounded rationality), as well as are pressured by other
interested parties to make certain decisions (Simon, 1947.)
This discussion should make reference to other models in more detail with
some examples to illustrate the points made, for example, heuristic
(Gigerenzer, 2008) and prospect theory (Kahneman & Tversky, 1979
A good conclusion would be appropriate here. For example, prima facie (on
the face of it), the decisions made by the managers using bounded
rationality theory, heuristics and prospect theory seem to be irrational but
under the present circumstances it may be the best course of action to
take and as such even though it seems irrational yet they are rational.
Reference should be made to some examples like in stock exchange during
crisis or manager facing a situation never experienced before, like the
present pandemic.

Comment

The above answer answers all parts of the questions. Also the conclusion
relates back to the question. In addition, there is the relevant literature
and references.

May 2021 Online Examinations

Section A

c. Give one example of how a heuristic can be helpful and one example of
how an heuristic can be harmful in the context of business decision
making.

Reading for this question

Elements on Heuristics in the Bias and Decision Making unit, and associated
readings.

Approaching the question

A heuristic can be helpful by:

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Core Management Concepts – Block 10 – Bias & Decision Making

• Allowing us to save time on thinking through repetitive decision and

tasks, allowing us to work on ‘auto-pilot’ . They reduce cognitive load
and save us from decision paralysis

• For example, if you are working in a shop and someone comes in wearing
a balaclava, which is covering most of their face. Here, a useful heuristic
may send your finger to the panic button under the counter until the
person removes their balaclava and goes to the milk fridge to buy a carton
of milk. The heuristic here is helping to keep you safe in a situation that
is potentially dangerous.

A heuristic can be harmful by:

• Allowing us to engage in lazy or shortcut thinking when something more

deliberate is required. For example, if you are interviewing staff and you
are making decisions based on their appearance because ‘someone in a suit
looks qualified to do this job’ rather than looking at their skills on their
CV.You may end up recruiting someone on the basis of a smarter suit which
is not a good measure of aptitude in the profession that you are recruiting
for.

Better answers were able to give good suggestions for both types of
heuristics. Weaker answers gave spurious examples. A common, and
problematic, example was managers ‘saving time’ by making a quick
judgement on someone based on what they were wearing to an interview.
Such an approach is ethically unsound, and in some countries also legally
problematic. Such answers received poor marks.

2022 March Preliminary Examinations

Section C Q1.

1 Discuss whether economists or psychologists have contributed most to

our understanding of decision making.

Reading for this question

Block 10, Bias & Decision Making

Approaching the question

This question calls for a discussion of contribution to understanding in the
context of decision making. The discussion needs to assess what contributions
have been made and by which group of academics. The discussion should

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Core Management Concepts – Block 10 – Bias & Decision Making

lead to a decision on which of these groups have made the most contribution.
There is no correct answer.

Answers are likely to:

Explain there are different academic perspectives on decision making and

detail their characteristics, prior to evaluation.

Economists (prescriptive theories)

• Rational approaches to decision making assume decision makers are rational

actors. One example of the rational approach to decision making is outlined
in utility maximisation and the expected utility hypothesis in economics.
• Managers make a rational choice based on the information generated. Utility
maximisation in economics suggests a decision process in which the individual
decision maker:

• thinks of all conceivable actions

• assesses all the consequences of each action
• derives a utility for each action, retrieved from the decision-maker’s own
preferences
• computes the probabilities of all outcomes
• chooses the action

As in much traditional economic theory, the belief that people act rationally is
taken as a central assumption.

Psychologists

• In the 1970s, psychologists undertook research that began to demonstrate

that people make errors in reasoning that are both common, and predictable.
• Different people make the same sorts of errors as one another, time and
again, as though our brain is wired to be irrational.
• These common errors result in people making sub-optimal decisions on the
basis of these errors.
• These predictable errors are known as heuristics, biases, ‘rules of thumb’
or mental short- cuts.

According to Daniel Kahneman (2012), one of the founders of research into

heuristics and biases, a heuristic is:

“A simple procedure that helps find adequate, though often imperfect,

answers to difficult questions”. Our minds use these intuitive heuristic
processes when engaging in problem solving. However, certain heuristics have
been proven to lead to systematic errors. These systematic errors are called

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Core Management Concepts – Block 10 – Bias & Decision Making

biases. These can lead to reasoning errors, in a systematic and predictable

way.

Use heuristic examples to illustrate this concept.

Sensible areas to focus on would be: Assumptions of both models (rational actor,
ability to be aware of heuristic influences). Limitations/benefits of both
approaches. Contexts in which one approach works better than the other, or
there is no choice (eg: if full data is not available for the decision)

Might also link to:

• Satisficing behaviour. The actor searches until they find a satisfactory

outcome, rather than searching for the optimum outcome
• Bounded rationality. The actor cannot know how much longer the search for
the optimum will take, and hence whether it is worth it or not

Discussion may also consider the usefulness of theory:

• Economic view
• Strengths
• Can work in simplified decision contexts, and stages can be followed
by managers for repetitive tasks eg: staff holiday requests
• Model outlines stages, which can help to structure decisions, even if
they are not fully rational
•
• Weaknesses
• Assumes rational actors can make optimum decisions, which can make
managers over-confident of decision outcomes
• Assumes this is the best approach to all decisions, but not all decisions
meet criteria, information may be missing, for example

• Psychological view
• Strengths
• Makes managers aware of potential pitfalls in the way that complex
decisions are made
• Suggests ways to reduce the impact of heuristics

• Weaknesses
• Addressing the impact of heuristics can lengthen the decision process
• Heuristics are difficult to overcome

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Core Management Concepts – Block 10 – Bias & Decision Making

• Conclusion – which is clear about which academic group have contributed

most to our understanding of decision making, and draws key arguments
together

Weaker answers:
• Fail to provide a clear description of contributions from either group
• Focus on one group, but have little to say about the other, undermining the
discussion
• Talk generally about decision making
•
Satisfactory answers:
• Cover the key areas of the question, clearly outlining contributions from both
sets of academics.
• Draw a conclusion about which group made the most contribution, linked to key
points in the discussion

Excellent answers:
• Provide a more nuanced discussion, recognising that models and theories can
help with evaluation, even if they do not accurately represent the real world.
• Make a balanced evaluation, not spending too long on either group
• Make good use of theory and examples to justify the answer given.

Nageb’s Marking Comments

Very few scripts were outstanding. Most answers were not convincing. Students
did not conclude whether economists or psychologists approach contributed most
to our understanding of decision making. They simply had a descriptive approach
to their explanation of each approach. No conclusion. See hereunder answer, the
conclusion.

1 Introduction

• decision making is necessary to solve the problem that has come to light.
• there are two approaches as suggested by the question. i. Economists approach
and ii. Psychologist approach

2 Economists Approach

• Rational model of decision making

• Origin is from classical theory – prescriptive approach – how manager should
make decisions – assumptions of rational decision making must be mentioned
• Examples of rational decision – utility maximisation and expected utility theory

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Core Management Concepts – Block 10 – Bias & Decision Making

• Should follow the stages or steps to rational decision making – to arrive at

optimality
• Seeks optimality – Economic Man approach that is maximisation.
• Advantages – use for programmable or routine decisions, seeks maximisation, more
convincing as quantitative based
• Disadvantages – takes time as such cannot be used for emergency situation,
cannot be applied for new or innovative decisions, assumptions of rationality does
not hold in reality.

3. Psychologists Approach

• Simon – assumption of rational decision does not hold. Decision maker does not
seek optimality but satisficing behaviour, “ that which will do” or “less than the
best”; bounded rationality – how long will the search takes place for the optimum
– whether it is worth it.
• Kahneman and Tversky – decisions are made based on heuristics, biases or rule
of thumb. Heuristics are intuition or gut feeling – people put more weights on
losses than gains – irrational decisions; biases are errors in decision making – many
biases exist e.g stereotyping or anchoring; heuristics may not be a problem but
biases are and therefore can lead to suboptimal decisions. Gigerenzer – heuristics
can be fully rational as they are rapid, can be made without full information and
can be as accurate than complicated procedures
• Advantages – efficient thinking strategy – without facing time and resources
constrains, decisions are good enough without being demanding on the brain’s
resources, Gigerenzer – in financial markets can lead to better decisions than
rational models.
• Disadvantages – heuristics can lead to errors and judgement (make intelligent
people to make dumb decisions), no algorithm so difficult to accept decisions, cannot
be applied to perfect market situation.

Conclusion

Economist approach to decision making is rational and optimum under near perfect
situation but sadly these do not exist. Rationality, some would say, is a myth, a
golden fleece, something that does not happen. Psychologists approach, Simon,
Kahneman & Tversky and Gigerenzer has gained traction in the imperfect world.
Although prima facie is irrational but get things done and hence can be rational.

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