Matthew Leitch investigates how underlying and subconscious factors affect the level of risk people are prepared to take in corporate decision-making.
Macho management
A surprisingly large amount of scientific research has been done to study the links between testosterone (in men and women), power and risk-taking. For example, if an influential male executive, about to go into an important meeting, is reminded of a time when he was particularly powerful and successful, gets a nice smile from an attractive woman, and then sits down in the meeting on a wide, comfortable chair, the scene is set for some bold, perhaps reckless, perhaps unethical decisions.
All three of those cues – the reminder, the attractive smile, and the chair – have been shown to lead to measurable changes in testosterone, feelings of power, and risk-taking driven by optimism. Who knows what else could have a similar effect? What about an argument, an impressive office building, or a history of life experiences leading to a sense of personal invincibility? Is it any wonder that major banks occasionally gamble themselves into oblivion?
These factors can influence decision-making but they should not. Unfortunately, there is less research on how to avoid these particular biases. A sense of the responsibility that comes with power seems to be helpful, and so is being aware of possible biases.
Narcissism
Temporary debilitation
A sense of the responsibility that comes with power seems to be helpful, and so is being aware of possible biases.
Personal interests and risk taking
Does it make any difference if she says that the strategies are within her “risk appetite”? No, because her job is to take into consideration the legitimate interests of all stakeholders, not just her own.
Conversely, suppose all your non-executive directors are established and successful, and so feel they have no need to improve their reputations, but don’t want to ruin the last decade of their careers with a high-profile failure. Should their personal preference for low-risk strategies be allowed to influence decisions made on behalf of the company? Again the answer should be “no”.
Risk attitude
Each year I teach on a masters course in risk management at the University of Southampton and one of my challenges is to help the students overcome misconceptions and confusions about the idea of risk attitude. I begin by teaching them to say “risk averse” not “risk adverse”. After that things get more subtle.
The phrase “risk averse” is used in at least two completely different senses. Obviously, it can mean an aversion to the possibility of a bad outcome. If we are averse to an outcome then we are also averse to the possibility of that outcome. This is true even for people who love to gamble or take part in dangerous sports. They may enjoy the adrenaline rush but the gamblers would still prefer a system that guaranteed winning and the skydivers still take safety precautions. Their desire for the adrenaline rush outweighs their aversion to the potential bad outcomes.
Unfortunately, “risk averse” is also used to mean a tendency to see monetary losses as more important than gains of the same monetary amount. This is more of an aversion to a spread in results than to bad outcomes. Writers almost never distinguish between these two uses of the phrase so it is hardly surprising that people get confused.
Another crucial distinction not made often enough is between attitudes to risky behaviours and attitudes to risk itself. Almost all surveys described as measuring risk attitude actually just ask about risky behaviours and people do those behaviours for many reasons, including their perceptions of the potential consequences.
Most students begin the course thinking there is evidence that people differ in their inherent attitude towards risk and that these differences are large and account for differences in behaviour. In fact, separating out the effect of true risk attitude, if it exists, from all the other factors that drive our behaviour is probably impossible. Alternative measures of risk attitude do sometimes correlate but not very well. Apparent risk attitude in different situations sometimes correlates but, again, not very well. It is usually much easier to explain differences in behaviour by differences in perceived consequences.
When things are going badly we are most at risk of carrying on with the actions that got us into a mess in the first place.
Exploring objective circumstances
What might be the consequences of each alternative course of action in the decision? For a large, risky decision this is much more than just making a best estimate of the direct financial consequences reduced to a net present value.
What alternative outcomes are possible and how would we stand financially at different points in time bearing in mind our financial reserves and the possible results of other activities? What if the predicted results occurred, but not at the predicted times? Could we face insolvency or breach limits on borrowing? What might be the implications for other investments we need to make?
We need to consider factors such as the predictability of cash from other activities, the amount of information, flexibility, and control we have, and how quickly problems could emerge – even if they are too complicated to model quantitatively.
A financial manager helping colleagues with risky decisions can provide valuable reminders of these key factors in a decision, can explore and quantify the direct and indirect consequences of alternatives, and can provide helpful information about the future context of predicted results.
Different stakeholders
It may also be important to consider how consequences will be distributed. Making decisions using only averages is dangerous. For example, if employees are to be paid more on average but a quarter of them are to be paid less, that quarter may create strong resistance.
Relevant personal factors
Well, if he is set to remain your chief executive then they should. Personal performance under pressure affects how he is likely to perform and makes a risky plan that much riskier.
Conversely, a top team with directly relevant specialist knowledge is better equipped to take on a risky plan that others should reject.
Conclusion
The secret of good risk-taking decisions is not to look inwards and explore your feelings; it is to look outward and forwards to understand what the future might bring and how outcomes of decisions will look in circumstances we might face in future.
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Bias, personality and risk-taking decisions
Business & Management Magazine, Issue 261,February 2018
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Update History
- 08 Feb 2018 (12: 00 AM GMT)
- First published
- 16 Sep 2022 (12: 00 AM BST)
- Page updated with Related resources section, adding further reading on personality and risk-taking behaviour. These new articles provide fresh insights, case studies and perspectives on this topic. Please note that the original article from 2018 has not undergone any review or updates.