Decision Making and Cognitive Bias

“A cognitive bias refers to a systematic pattern of deviation from norm or rationality in judgment, whereby inferences about other people and situations may be drawn in an illogical fashion.  Individuals create their own “subjective social reality” from their perception of the input.  An individual’s construction of social reality, not the objective input, may dictate their behaviour in the social world.  Thus, cognitive biases may sometimes lead to perceptual distortion, inaccurate judgment, illogical interpretation, or what is broadly called irrationality.”  – Wikipedia

Managers often engage in irrational decision making. Their behavior may be attributed to cognitive biases and “effects” which have been scientifically documented through various social and psychological research experiments. Awareness of these biases and how they can impact our ability to make rational decisions is extremely valuable in the business world and in our personal lives. Below, we highlight eight common cognitive biases that affect our ability to make sound, rational decisions.

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8 Common Cognitive Biases that Affect Decision Making

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  1. Availability Bias: as a rule, we rely on information that is more recent, and therefore more vivid and retrievable. We also tend to make associations within limited boundaries of easy recollection.

Example. In the months following 9/11, many travelers felt that it would be safer to travel by car than by plane. In reality, those months were some of the safest months to fly due to the heightened security measures in place. As well, those months contained major U.S. holidays which historically translated to increased drivers on the roads, and increased accidents. According to statistics, those months following 9/11 had a higher than usual number of accidents on the road, while commercial air travel was in-line with historical safety averages. Comparatively, flying was much, much safer during those months than driving.

 

  1. Anchoring & Adjustment Bias: when estimating numerical values, we tend to anchor on a preset reference point, and not adjust sufficiently. We rely too heavily on the first piece of information provided when making decisions.

Example. In a social experiment, students at MIT were asked to bid on items in an arbitrary auction using the last two digits of their social security numbers. If a bottle of wine was put up for auction, students would write down their last two digits as if that was the price of the bottle. Then the students were asked to bid on the bottle. People with high social security numbers bid up to 346% more than those with low numbers. This observation was repeated throughout the auction.

 

  1. Framing Bias: we tend to evaluate risk differently depending on whether the outcome is framed as being negative or positive. When an outcome is framed as a potential loss, our tendency to seek risk goes up. However, when an outcome is framed as a potential gain, our tendency is to avoid risk.

Example. A group of 20 college students were asked to participate in a study. They were all told they had received a sum of money, and then some were told they could keep a portion of the money and gamble, while some were told they could lose a portion of the money and gamble. Those whose option was framed positively (‘keep a portion’) were more risk averse than those whose option was framed negatively (‘lose a portion’).

 

  1. Confirmation Bias: we have a tendency to seek out evidence that supports our pre-existing theories and expectations. We tend to discount information or evidence that contradicts these beliefs and expectations.

Example. In an experiment, psychologists were asked to review a research paper that was submitted for potential publication. They were asked to rate the paper’s methodology, data presentation, and scientific contribution. When the paper provided results that were more consistent with their own beliefs on the topic at hand, they were more inclined to rate it favorably.

 

  1. Hindsight Bias: we tend to overestimate our ability to predict something happening, after it has already happened (e.g., we “knew it all along”), even though there is no objective evidence that we possessed the ability to predict the event.

Example. Closely related to Survivorship Bias, which is the tendency to try to “learn” from the winners, despite a tremendous number of losers, Hindsight Bias has been seen in the financial markets where traders misattribute luck for skill, and due to a lack of appreciation of basic probability (particularly in their successes) make mistakes in their bets.

 

  1. Fundamental Attribution Bias: we tend to focus on people rather than situations or systems when considering why things failed.

Example. When observing a driver swerving and crashing into a tree, our tendency is to assume that the person is under the influence, not paying attention, or in an emotional state. However, the real cause of the driver’s actions was due to a small child running into the street unexpectedly in front of her vehicle. Under most circumstances, the assumption is that something about the person’s traits caused the issue, and in far fewer examples is the immediate attribution of the issue tied to external factors.

 

  1. Self-serving Bias: we tend to view ourselves in a positive light by concluding that successes result from stable, internal factors (e.g., ability) whereas failures result from unstable, environmental factors (e.g., difficulty of the environment, or bad luck).

Example. A student performs well on an exam that is graded on a curve, and attributes his success to good preparation, rather than to under preparation by his classmates.

 

  1. Endowment Bias: we tend to assign more value to things merely because we own them.

Example. Students were given the option of having either a coffee mug or a bar of chocolate. Most of the students chose the chocolate bar. Students were given a coffee mug, and then asked if they would trade it for a chocolate bar. In this instance, the students overwhelmingly chose to keep the coffee mug, despite their preference for chocolate over coffee mugs.

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Numerous cognitive biases, effects, and heuristics have been documented and supported through scientific research.  This article is far from exhaustive, and is written with the intention of simply highlighting a few commonly observed biases in the business world. Below is a great infographic that highlights some of these, and more.  As well we are big fans of the book “Fooled by Randomness,” by Nassim Taleb.  If you’re looking for a great read on hindsight bias, this book is widely regarded as one of the best.  Hopefully, after reading this, you’ll start to observe your own decision-making with a stronger awareness of how cognitive bias impacts your own business decision making, and can start to incorporate measures that will help you to avoid them.  Cheers and happy reading!

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