behavioral economics at work nunnally, steadman, baxter las vegas final

Society for Consulting Psychology

Mid-Winter Conference

Las Vegas

January 30, 2011

Karen Steadman, PhD

Leadership Futures

Dirk Baxter, PhD, SPHR,

Leadership Futures

Tyler Nunnally,

CEO, Upside-Risk

Format for Session

• Introduction

• Audience Participation #1

5 to 10 minutes

• Panelists rotate 20/20/20 – share information &best practices.


60 minutes

• Facilitated Q & A


20 minutes

Decision-making and Risk-taking

• Approximately 315 marriage licenses are issued every day in Vegas.– How long did the 1998

marriage last between celebrities Dennis Rodman and Carmen Electra?

• 3 months

• 4 weeks

• 9 days

• 24 hours

Source: www.vegas.com


Almost 2/3rds of Las Vegas gambling revenue comes from slot machines.– Approximately 3% to 25% of

each bet in a slot machine goes to the casino. Which of the following is a factor in the player winning?

• The machine and the casino

• Pulling the handle vs. pressing “spin”

• The timing of the last payout on the same machine

Source: www.goingtovegas.com


– In 2007, the Bellagio reportedly had 22 bars staffed by160 bartenders*

– Las Vegas has one of the highest average number of drinks consumed per person in the country. What is the average # of drinks per person attending black tie events in Vegas?**

• 2.75

• 3

• 5.5

Sources: *The Bar and Beverage Book (2007) Katsigris & Thomas.**Successful Catering, Managing the Catering Operation for Maximum Profit (2003) Sony Bode

Behavioral Economics at Work

Presented by:

Tyler D. NunnallyFounder & CEO

Upside Risk

Presentation Topics

© 2010 Upside Risk Corporation. All rights reserved.

What is Judgment Risk?

Behavioral Economics 101

Judgment Bias

Risk Appetite

Best Practices: Managing Judgment Risk

Presenter Background


‘92 Summer Olympic Games (Barcelona, Spain)

‘93 Nunnally International Trade, Inc. (Prague, Czech Republic)

‘03 University of St Andrews (St Andrews, Scotland)

‘04 Global Business Consulting (Barcelona, Spain)

‘06 Oxford Risk Research & Analysis Ltd (Oxford, England)

’09 Upside Risk (Atlanta, Georgia, USA)


PART I:

Judgment Risk

Key Risk Factors in the Decision-Making Process

What is Judgment Risk?


Probability

of

Occurrence

Judgment Bias

RiskX

Severity

of

Likely Impact

Risk Appetite

“JUDGMENT RISK”

Risk Management Failures


Alan Greenspan commenting on how human factor risks caused forecasting models to fail in subprime crisis

“I do not say that the current systems of risk management or econometric forecasting are not in large measure soundly rooted in the real world… But these models do not fully capture what I believe has been, to date, only a peripheral addendum to business-cycle and financial modeling—the innate human responses that result in swings between euphoria and fear that repeat themselves generation after generation with little evidence of a learning curve.

…Forecasters’ concerns should be not whether human response is rational or irrational, only that it is observable and systematic”.

Source: Alan Greenspan, “We will never have a perfect model of risk”, Financial Times, March 16, 2008.


PART II:

Behavioral

Economics

101

Behavioral Economics 101


Combines scientific disciplines of psychology and economics

“Bounded rationality” introduced by Herbert Simon (’78 Nobel Prize)

Prominence of study led by Kahneman & Tversky (’02 Nobel Prize)

Heuristics and biases

Way People Make Decisions


SYSTEM 1

(Intuitive)

SYSTEM 2

(Reason)

Automatic

Spontaneous

Unconscious

Instinctive

“Gut feel”

Thoughtful

Controlled

Informed

Deductive

Analytical

Decision Making Under Risk and Uncertainty


Diagnosis:

person scans, appraises and questions available information

Assessment:

risk versus rewards analysis made of available options

Action:

commitment to chosen course of action

Adjustment:

evaluate decision outcomes and adjust accordingly

Diagnosis

▼

Assessment

▼

Action

▼

Adjustment

Behavioral Economics Goes Mainstream


NY Times Business Best Sellers

PREDICTABLY IRRATIONAL, by Dan Ariely

FREAKONOMICS, by Steven D. Levitt and Stephen J. Dubner

SWAY, by Ori Brafman and Rom Brafman

NUDGE, by Richard H. Thaler and Cass R. Sunstein

What the Critics Say…


“Perhaps the greatest challenge facing behavioral economics is demonstrating its applicability in the real world”

Source: Levitt, Steven and List, John “Homo Economicus Evolves,” Science, February 15, pp. 909–10.

http://pricetheory.uchicago.edu/levitt/Papers/homo.pdf

Real World Applications


• Public Policy

• Consumer Choice

• Upside Risk’s approach: Risk Management


“Risk management is a form of engineering: it uses science,

but ultimately depends on judgement… The ultimate

protection against risk is good judgement and alertness:

your own and that of your colleagues”.

Source: Risk Management, November 2005


PART III:

Judgment

Bias

Probabilities & Statistics: Sample Size Bias


Suppose the mean credit score of a sample population of 49 senior citizens is

650. The next senior citizen that you review has a credit score of 800.

What do you think the mean credit score of this group of 50 senior citizens will

be?

A. 598

B. 650

C. 653

D. 725

Judging Risk


Decision traps people fall into when judging risk:

• Overestimate/underestimate real value

• Overestimate/underestimate chances of success

• Overestimate/underestimate chances of failure

• Overweight small probabilities

• Underweight large probabilities

• Failure to adapt to changing business conditions

• Erroneous forecasts, estimates and projections

Availability


Perception of how “risky” something is often determined by how readily

examples come to mind from memory. Bias occurs when probability

assumptions become inflated by recent events.

US AIRLINE INDUSTRY PASSENGER REVENUES 1999-2004

Risk Exposure:

- Overly cautious

- Lost opportunities

- Falling profits

Confirmation Bias


Suppose you and a colleague disagree whether it would be a good idea to

launch a new product. You believe that launching the product would be a

mistake. Your colleague believes that, if introduced, the product would be a

big success.

In this situation, what would you do?

A. Seek a third opinion from someone who I know would agree with my position

B. Seek out information that supports my position

C. Seek out information that contradicts my colleague’s position

D. Seek out information that could either support or contradict my position

Confirmation Bias in Practice


FDIC v. Van Dellen et al - (Failed Bank Litigation)

31. Prior to the reorganization of HBD in 2006, Shellem had the power to object to a loan being approved by the Junior Loan Committee. … Van Dellen also directed credit officers to report to a single head credit administrator, Camp, who in turn was reporting to the CLO and lead Production officer, Rothman. This reorganization of HBD created the very blurring between credit and production functions that existed when Van Dellen first arrived at HBD in 2002, and about which regulatory agencies had previously complained. Both Koon and Shellem described Van Dellen’s reorganization as having created a serious conflict of interest.

Booms and Busts


U.S. House Prices: 1988 - 2008

Key Risk Factors:

- Time discounting

- Confirmation bias

- Herding

- Overconfidence

Are things getting worse?

Karen Steadman, PhD

Presenter Background

• BS, Industrial and Systems Engineering, Georgia

Institute of Technology

• MS, Rehabilitation Counseling, Georgia State

University

• PhD, Counseling Psychology, University of Georgia,

• Founder, CEO – Leadership Futures, Inc.

Technology

• The system by which a society provides

its members with those things needed

or desired (Websters).

• Any tool that helps people make

decisions, act and achieve their goals.

Hard Soft

Vicente, KJ (2003) The Human Factor, Knopf Canada

http://en.wikipedia.org/wiki/File:The_Earth_seen_from_Apollo_17.jpg

Risk for Errors at all Levels

Political

Organizational

Team

Psychological

Physical

Mechanist HumanistOptimized

Leader

Assessment and Coaching

Physical

Psychological

Team

Organizational

Political

Healthy Work Environments

Assessment, Training, Coaching

Team Simulations & Action Learning

Organizational Design, Incentive Systems

Research and Social Change

Role of Consulting Psychologists

in Minimizing Risk of Error

Risk Appetite


PART IV:

Risk

Appetite

Risk Preferences


A person’s level of comfort in taking risk often determines business decisions

Risk Preference↓Risk Appetite

Risk Averse↓Risk Avoiding

Risk NeutralRisk Prone↓Risk Seeking

ConservativeDecisions

Middle of the Road Decisions

AggressiveDecisions

Job Performance


Risk-taking behavior has a significant bearing on job performance

Risk Aversion Behavior:

Cause decision delays

Failure to take any action

Reliance on others to make

decisions

Risk Seeking Behavior:

Ignore underlying evidence

Lack of objectivity between options

Confirmation bias

Quantifying Risk Appetite


You have a significant sum invested in a project to develop a new product. If

successfully completed, the project could have a considerable financial impact on

your company. However, the project is overdue and over-budget. To complete the

project it will now cost double the original projected cost. You must now decide to

make the additional investment in order to complete the project, or to terminate it

altogether.

To complete the project, what probability of success would be required before you

would make an additional investment? Please choose one of the following

probabilities:

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%


FDIC v. Van Dellen et al - (Failed Bank Litigation)

43. Only five weeks later, on November 30, 2006 at a meeting of the Bank’s senior managers, which included Van Dellen, corporate management warned of the declining market, describing among other things, a decline of 9.7% in the median price of new homes since September 2005 and mentioning that home builder volumes and margins were “under pressure.” The presentation was entitled the “wall of worry.” Nonetheless, Van Dellen continued, as late as the first quarter of 2007, to push for HBD to “grow production at double digit rates over the next five years.”

Excessive Risk Appetite

and Catastrophic Outcomes

Excessive Risk Appetite


FDIC Troubled Bank List: 2007 – 2010

Risk Aversion and Falling Profits


Prospect Theory


People generally dislike

loss twice as much as

they like gains

People become risk

seeking in the face

of loss and risk averse

in the face of gains

Risk Domains


A persons’ risk propensities are compartmentalized and divided into separate domains

• For instance, a heavy drinker and smoker may take health risks, but he is not necessarily the same guy who makes high risk investments with his 401(k).


PART V:

Best Practices:

Managing Judgment Risk


“The best behavioral risk management strategy is to try and

arrest problem development earlier in the behavioral stage”.

Source: Rudy M. Yandrick, Behavioral Risk Management, 1996

Job Success & Failure


Success: Failure:Embrace risk Too risk averseThinking ahead Short-term focusSeize opportunities Miss opportunitiesCalculated risk-taking “Betting the farm”Consider all the facts Ignore evidenceConfidence OverconfidenceCut losses Good money after bad Disruptive to market Follow the crowd Weigh cost vs. benefit Disregard risks

Judgment Risk Indicator


Key Risk Factor Category Risk Exposure

Judgment Bias

Sample Size Bias Probabilities and Statistics Low

Base Rate Bias Probabilities and Statistics Very High

Conjunction Fallacy Probabilities and Statistics Very High

Gamblers Fallacy Probabilities and Statistics Very Low

Overconfidence (Perception) Behavioral Bias High

Time Discounting Behavioral Bias Very High

Overconfidence (Actual) Behavioral Bias Moderate

Confirmation Bias Behavioral Bias Low

Illusion Of Validity Behavioral Bias Very High

Status Quo Bias Behavioral Bias Very Low

Herding Behavioral Bias Moderate

Framing Effects Behavioral Bias Moderate

OVERALL High

Risk Appetite

Status Quo Choice Dilemmas High

Sunk Cost Loss Choice Dilemmas High

Sunk Cost Gain Choice Dilemmas Low

Perception Investment Decisions Low

Benefits Investment Decisions Moderate

Behavioral Bias Investment Decisions Moderate

Willingness to Pay Risk vs. Reward Very High

Low Stakes Lottery Choice Moderate

High Stakes Lottery Choice Moderate

OVERALL High

Judgment Risk Indicator Matrix


0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.20 0.30 0.40 0.50 0.60 0.70 0.80

Risk Appetite

Ju

dg

men

t B

ias

John Doe

Sample Population

HRisk Analytics


0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.20 0.30 0.40 0.50 0.60 0.70 0.80

Risk Appetite

Ju

dg

men

t B

ias

A

B

C

D

E

F

Sample Population

Organizational Benchmarks


Benefits & Uses


SELECTION

DEVELOPMENT

TALENT BENCHMARKING

RISK MANAGEMENT

Putting Science into Practice:

Top Takeaways

Takeaways

1. The time is now.

2. Recognize your own biases in client selection or consulting work.

3. Consider the business need before determining the risk appetite required.

4. Do not translate derailing behavior of a client in one domain to all of the other domains.

5. Consider the human factor in all of your consulting deliverables.

Takeaways

6. Trust behavioral change, not compliance to process checklists.

7. Understand at what level you need to need to intervene to make change.

8. Do not contribute to the problem if someone is in the wrong role or in the wrong organization.

9. Realize that sometimes things have to get worse before they get better.

10.Assess well rather than coach poorly.

Takeaways

Do not play the slots while in

Vegas

Karen Steadman, PhD

karen.steadman@ leadershipfutures.com

678.431.7354

Dirk Baxter, PhD, SPHR

dirk.baxter@ leadershipfutures.com

678.595.4770

http://www.leadershipfutures.com/

http://www.linkedin.com/home?trk=hb_logo


Tyler Nunnally

CEO, Upside Risk

tnunnally@ upside-risk.com

404.320.6047

http://www.linkedin.com/home?trk=hb_logo


behavioral economics at work nunnally, steadman, baxter las vegas final

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