Texas Tech University



I. 6th to 7th edition changes

A. Chapter topics

1, 2, 9, 10, & 12 same topics; 3 is now 4; 4 is now 5; 5 is now 6;

6 + 8 is now 7; 7 is now 8; 11 is now 3

II. Chapter 1: Introduction

A. Book is about problems in decision making

i. Auditor Examples (page 1)

a) Arthur Anderson

• Sued by SEC for Waste Management cover up June 2001

• Questions on auditing of Sunbeam & Baptist foundation of Arizona

• Enron: March 2002 AA sued for shredding of documents

• June 2002 found guilty & collapsed

b) Coopers and Lybrand: Phar-Mor (federal conviction, inventory inflation)

c) Savings & Loan crisis

ii. Why?

a) Very bright people

b) Generally honest even though critics say neglect & corruption

c) Because it is psychologically impossible for auditors to remain completely objective.

d) Unconscious biases

iii. Auditing not the only disaster relating to faulty decision making

a) September 11, 2001

• World Trade Center Bombing 1993

• 1994 Air France hijacking to bomb Eiffel Tower

• 1997 Al Gore commission report on “Airline Safety”

• August 6, 2006 Daily Briefing: “Bin Laden determined to attack U.S.”

iv. Collusion? Between FAA inspectors and Airlines 2008

v. Self-serving bias:

a) “People tend to confuse what is personally beneficial with what is fair or moral”

b) human tendency to maintain positive illusions, to discount evidence & overlook easily available relevant information

c) Book Goal: “to clarify common errors even very bright people make on a regular basis”

B. Anatomy of a Decision (Examples p. 3 + Microsoft-Yahoo 2008)

i. Define the Problem:

“solve the problem not just eliminate its symptoms”

ii. Identify the criteria:

iii. Weight the criteria:

iv. Generate alternatives: continue until search cost > benefits

v. Rate each alternative on each criterion

vi. Compute the optimal decision

C. System 1 & System 2 Thinking (new in 6th edition)

i. System 1

a) intuitive system: fast, automatic, effortless, implicit, emotional

b) most decisions in life made using this method

ii. System 2

a) “rational reasoning”

b) slower, conscious, effortful, explicit, logical

iii. Primary idea;

a) Complete System 2 reasoning not required every time

b) Many System 2 decisions will use System 1 inputs

D. Bounds of Decision Making (Bounds of Rationality in 5th edition)

i. What is rationality

a) how decision should be made rather than how is made

b) Simon: “bounded rationality”

• actual rather than normative

• lack important information

• small amount of information in memory

• limitations of intelligence and perceptions

• => Satisficing decisions

c) decision making bounded in 2 ways not precisely captured by bounded rationality

• will power is bounded: greater concern for present than long term

(ex: saving for retirement)

• self interest is bounded, we do actually care for others

ii. two general models used in decision research

a) prescriptive: methods for making optimal decisions

b) descriptive: bounded ways in which decisions are really made

iii. Bounded ethicality: ethics limited in ways we are not even aware of

iv. Bounded awareness: focusing failure, failure to notice the obvious & important

E. Heuristics

i. Availability heuristic: “what is most available in memory”

ex: emotions or employee in neighboring office review will be more critical

ii. representativeness heuristic: stereotypes

ex: botanist categorizing new plant or new product success

ex: discrimination

iii. Affect (Anchoring and Adjustment in 5th edition):

initial values created by effective or emotional evaluations before cognition

often not conscious but used anyway, especially when people are busy

ex: good meal first time in a restaurant

ex:ice cream overfilled small cup rather than underfilled large cup

ex:stock prices go up on sunny days

F. Overview of book:

“Why should I change? I have always been good at decisions and am successful in my business career.”

Chapters 2 – 4 provide foundation

Chapters 5 – 8 use foundation in decision making lessons

Chapters 9 – 10 use foundation in negotiations

Chapter 11 new research on bounded awareness

Chapter 12 gives strategies on improving judgment

III. Chapter 2: Common Biases

ex1: larger sales in Fortune 500

ex2: student undergrad major

A. Heuristics

i. rules-of-thumb

ii. good “most of time”

iii. really bad sometimes & results in “cognitive bias”

B. Example problems 1 – 11 (all in outline as discussed)

C. Biases from the: Availability Heuristic

“A Lifetime of experience makes us believe that we recall frequent events rather than infrequent events”

i. Ease of Recall -- (p18 Prob 3: causes of death)

a) Many decisions based on vividness of recall

b) Particularly prone to overestimating unlikely events

ex(p18): C.J. spreading AIDS

ex(p19): purchasing agent chose supplier whose name was familar

ex(p19): proximity and employee reviews

ii. Retrievability -- (p19-20 Prob 4a&b: Words in a 2000 page novel)

ex20: store locations

iii. Presumed Associations

a) dichotomous events & decision matrix

ex20: delinquency & marijuana use

ex20: Married under 25 with large family

b) probability of 2 events co-occurring is judged by availability in our minds

D. Biases from the: Representativeness Heuristic

i. Insensitivity to Base Rates

ex22 Prob5: MBA to art or Internet startup

ii. do use base rate info when no other information provided (look at above without personal info

ex22:prenuptial agreement

iii. Insensitivity to sample size

ex 23: 6000 heads out of 10000 or 6 out of 10 or 4 out of 5 dentists

iv. Misconceptions of Chance

ex23 Prob 7: next stock has to be good

ex24: random events must “look” random (coin toss HHHTTT or HTHTHT)

ex: gambler's fallacy

ex24:basketball player makes four shots bound to make 5th one

ex25:”hot hand”

ex25:initial surveys in research

v. Regression to the mean

ex26 Prob8: department store sales prediction

ex24: heredity, student siblings, baseball rookies

a) sometimes do expect regression to the mean, “extreme success cannot last”

vi. Conjunction Fallacy:

a) a combination of two or more descriptors cannot be more probable than any one of the descriptors

ex27 Prob9: Linda's career

ex28: Flood in North America with 1K dead or Earthquake + Flood in CA

E. Biases beyond availability & representativeness (Anchoring and adjustment in 5th )

i. Insufficient anchor adjustment

ex29 Prob10: Stock IPO

ex27: African nations in UN using initial random starting number

ex30: pay increases based on current salary

ex30: Group C children in education

ex30: first impressions

ex31: executive fraud estimate

(before & after Enron)

ii. Conjunctive & Disjunctive Events

a) General bias toward

• overestimating conjunctive events

• underestimating disjunctive events

ex31 Prob11: red & white marbles

ex32: completing dissertation

ex32: construction projects

b) Complex Systems have lots of conjunctive problems

ex32:human body or nuclear reactor

ex33:morning flights to Chicago

iii. Overconfidence

a) moderate to difficult problems yield most overconfidence

b) How to overcome:

• try to find WRONG answers

• feedback

• communication

• ask why might their answers be wrong

ex35:Surgeon

ex35:Lawsuit

ex35:Marketing Plan

iv. Confirmation Trap

ex35: 2-4-5 three ascending numbers

a) people almost almost always look for confirmations

b) should look for dis confirming examples

v. Hindsight & the Curse of Knowledge

ex37:football fan and final play

ex37: driving, make choice get lost -> “I told you so”

a) when assessing others' knowledge people are unable to ignore knowledge that they have that others do not

b) Advantages: a. flattering to believe in own judgment, b. allows us to criticize others

c) Disadvantages: inability to learn from past

ex38: Driving directions

ex38:David & new restaurant

F. Overview & summary on Page 39 – 40

IV. Chapter 3: Framing & the Reversal of Preferences

(Judgment under Uncertainty in 5th edition)

“how subtle aspects in the presentation of information, referred to as framing, can significantly impact decision making –particularly when uncertainty is involved”

ex41:Asian disease a)save 200, kill 400 or b)1/3 prob save all 2/3 kill all

ex42:Big positive gamble: a)$10 Mil for sure or b) coin toss and $22M

ex42:Lawsuit:50% chance of loosing %500,000, $240,000 out of court

risk averse (gamble), risk seeking (lawsuit)

ex42: restated Asian disease

People treat risks about gains differently from risks about losses

Framing of choice can dramatically affect choice

Importance of reference points, initial quick evaluation

ex 43: XYZ stock (if $0 will be risk averse, if $20 risk seeking)

When facing a choice identify your reference point & look for other possible ones

A. Framing of Information

i. People evaluate gains and losses relative to a neutral reference point

ii. People tend to be risk averse concerning gains

iii. People tend to be risk seeking concerning losses

iv. People tend to overweight probability of low-probability events and underweight probability of moderate & high probability events

v. Therefore: how the problem is framed (thus setting up the neutral reference point) makes a very large difference

vi. Framing of Choices

ex44-45: sure $240 & 75% $0 or loss of $750 & 75% $1K loss or lose $0

B. Pseudo certainty: “people value the creation of certainty over an equally valued shift in the level of uncertainty”

ex46:full protection against fire or reduced overall protection

ex46:vaccine protecting half or full against 1 of 2 diseases

ex47:sure $30 or 80% chance of $45 vs

two stage 25% chance getting to sage 2 and then sure $30 or 80% 45 vs

25% chance 30 or 20% chance 45

The certainty effect: more likely to reduce likelihood of certain than uncertain

Insurance helps protect against risk AND eliminate worry due to uncertainty

C. Framing & overselling of Insurance

a) Social norms

ex48:insurance & extended warranties on new cars

The word “insurance or warranty” triggers pervasive social norms

b) vividness of costly repair

D. What's it worth (utility)

ex49:cost of beer on beach from fancy hotel or run-down grocery store

a) Acquisition Utility: value on the object (beer in above ex)

b) Transactional Utility: quality of the deal (what “should” it cost)

ex50:high-tech mouse deal versus laptop computer deal

Spend more time on search when $$ at stake are larger

E. Endowment effect: Value placed on what we own because we own it

ex51:selling a painting

ex51:mugs-sellers $7.12, buyers $2.87, choosers $3.12

Ownership makes item much more valuable

Understanding of endowment effect critical to decision making

Mental Accounting

people have a variety of “mental accounts” used to organize info & decisions

ex52:talk & travel in Switzerland vs talk in NY & travel in Switzerland

ex52:cost to drink bottle of 1982 Bordeaux

ex53:two losses of $100 or 1 loss of $200

ex53:”loss fund” setup at beginning of year

F. Do no harm, the omission bias & the status quo

ex54:organ donation (US opt in Others opt out)

either of changes save lives: preferential treatment for donors or opt out

People follow rule of thumb: “Do no harm” action generate more short-term regret than in action, omission produce more regret over long-term

ex55:vaccinations that can harm

Status Quo;

ex55: Trading stock

ex55: pharmaceutical research & new vaccines

ex56: ”by stander laws”

G. Bonus versus Rebate framing

ex56:September 2001 rebate to stimulate growth vs 2008 stimulus $

study 1-56: rebate spent 25% bonus (lowered gov. costs) spent 87%

study 2-56: $50 rebate (spent 10), $50 bonus (spent $22)

study 2-57: $25 rebate($2.43) bonus(11.16)

H. Joint versus separate evaluations

ex57: ice cream cups example from chapter 2 either together or individually

ex57: salary packages

ex57: music dictionaries

want (System 1) in separate evals versus should (System 2) in joint evals

Attributes that are hard to value will be underweighted

--- from 5th edition of Bazerman book ---

I. Avoiding Uncertainty: A common response

i. People tend to “wish away” or ignore uncertainty

ii. Risk is not bad; it is simply unpredictable!

--- imagine life without uncertainty ---

J. A Normative background to Risk

i. Individuals are neither rational nor consistent when making decisions under uncertainty

ii. Thus a normative structure is useful as a guideline

a) Probability:

the likelihood that any particular outcome will occur

b) Expected Value

the weighted sum of all potential outcomes

• a simple rule is to select alternative with highest expected value

• however....

ex42 from above: coin toss for $0 or $22M or $10M for sure

ex42 from above: Lawsuit out of court settlement

c) Risk Considerations

• Certainty equivalent: a decision makers indifference point

• Risk Neutral: Certainty Equivalent == Expected Value

• Risk Averse: Certainty Equivalent < Expected Value

• Risk Seeking: Certainty Equivalent > Expected Value

• utility: degree of pleasure or satisfaction with each outcome

iii. Response to loss is more extreme than response to gain

V. Chapter 4: Motivational Biases

ex61:gained weight at Xmas want to lose it but eat at party

A. When Affect and Cognition Collide (Motivation versus Cognition 5th)

ex62: Ulysses & the Sirens

exs62: Various short ones

ex62: enjoyable low status job versus higher paying one he “should” take

When what we want to do and what we think we should do collide

i. inappropriately high discounting people apply to the future

hyperbolic discounting: view all gains in future as worth less

ex65: value of free soda today, tomorrow, or in 100 days

ex65: cleaning off desk

ii. Multiple selves in general

iii. Planner and the Doer

a) Changing the doers preferences (planner finding exercise doer will like)

b) Monitoring the doers behavior (weekly diet club weighins)

c) Altering incentives (Antabuse for alcoholics)

d) Altering rules (Student forbid use of TV during exam times)

iv. Want versus Should (decision makers overweight proximal (temperal, physical or sensory) attributes)

v. hyperbolic discounting: all future gains worth less than NOW

vi. Should (or Planner) is not always right

a) transient desires are often responsive to the environment

b) sometimes if time is given for careful consideration, opportunity lost

Christine Lavin's song “The Moment Slipped Away”

c) at times the planner is too conservative, risk averse, or timid

vii. What to do:

a) Umpire self: Get agreement between planner & doer

b) Questioning both selves to see who is wrong

c) Empower the want or doers

• Require both sides to agree

• Agreement should be Pareto efficient (no other agreement better)

ex: diet or exercise versus diet & exercise

B. Unrealistic Positive Illusions (enhance & protect self esteem)

i. Constrained by objectivity, credibility, etc

ii. harder when they are “inconsistent with reality”

ex68: easier to believe honest than good tennis player

iii. Unrealistically positive views of the self

we tend to perceive our selves at being better than others

ex69:driving, intelligence, health, skill, etc

ex69:Student donations, MBA self ratings

iv. unrealistic optimism

believe our future will be brighter than others (p69)

those most incompetent are most deluded (Fig 4.1 on p70 & 4.2 on p71)

ex69: accomplish more in a day than is possible

We seem immune to continual feed back showing “reality”

can lead to turning down best offer for house, best job offer, etc

v. illusion of control

ex: The Matrix :-), or choosing own lottery numbers

ex: Superstitious behaviours

ex: Richard Bach's Illusions & Rhonda Byrne's The Secret

vi. self-serving attributes

We interpret causality in a biased manner

Take a disproportionately large share of credit for success

“Victory has a thousand fathers but defeat is an orphan” JFK

vii. Group Illusions (exs: 72)

We extend self-enhancement to groups we belong to

& invert for opponents

exs72: less successful MBA students, student self ratings, Watergate

viii. Are the illusions good for us?

a) Contribute to psychological well being

b) deal with tragedy

c) employment problems

d) Also a form of emotional procrastination

e) exs74: Irreplaceable employee, high levels of well being → frustration

C. Egocentrism or Self Serving Reasoning

ex74: west blames burning the rain forests, third world blames autos

ex74: legal costs

i. we first determine preference then justify it by changing importance of attributes

ii. Interpret events based on what the want or prefer

ex: percentage work on book or effort in marriage

ex75: football game film, cold war conference in Iceland

ex76: US legal system, Enron's auditors

D. Affective Influences on Decision Making

Emotional state can have significant effect on nature of endowment effect

sad people more affected by anchors than neutral people thus worse decisions

people in good moods more optimistic, bad moods more pessimistic

ex77:get to gate at 8:57 what is more aggravating if plane left at 8:30 or at 8:55

ex78:Olympics Silver versus Bronze metal winners

more regret for acts of commission than for omission

i. decision makers distort their decisions to avoid regret

ii. few decision makers list “avoiding regret” as decision criteria

E. Summary

Knowledge of affect of emotions can help limit

“Just like everyone else, I am affected by my emotional state”

Accountability can help

Government “Accountability” Agency ????????

VI. Chapter 5: Nonrational Escalation of Commitment

“If at first you don't succeed, try, try again. Then Quit...” W. C. Fields

A. In a series of decisions people are prone to escalate their commitment to their original decision.

ex81: consulting firm position that does not pay off

ex82: $2 Mil in startup venture, additional $1M or will loose all

ex82: sinking money in old car

Inertia leads to continuing same course. when does this become irrational?

i. sunk costs: evaluate future costs & future benefits ignoring past

reference point should be current state, consider all alternative courses from here

ex83: Quit Doctoral Program?

ii. Need to identify irrational behavior & “unfreeze”

B. Unilateral escalation

i. When outcome previous decision negative decision makers tend to escalate funds

ii. How do you separate rational from non-rational tendency to escalate?

Separate the effect from the person making the decision

ex83: high & low responsibility investment then reinvest 3 years later

iii. One way to eliminate cognitive dissonance is to escalate and attribute problems to temporary factors, success is imminent

iv. Easier to escalate when failure can be easily explained by outside factor: economy

v. groups tend to do this less than individuals, but those that do are worse

ex84: hiring decisions & performance evaluations

vi. Managers should be very aware of these tendencies

C. Competitive Escalation

ex85: company A, B, & C

Most $ benefit from merger mania went to sellers

ex85-86: Auctioning off $20 bill

i. Strategies to avoid

ex85:organize class to not escalate $20 bill auctioning

ex87:American & United Airlines

ex87:Norfolk Southern's acquisition of Conrail

Successful decision makers MUST learn to identify traps

ii. the desire to WIN can shift objective from original to beating the other party

D. Why does Escalation Occur

first step is to identify psychological factors

i. Perceptual Biases

a) pay more attention to confirming than disconfirming choices

ex: number sequence

b) Should diligently search for disconfirming evidence

ii. Judgmental Biases

a) any loss from initial investment will distort judgment on continuing

Framing as loss initiates risk seeking behavior

ex82: $2Mil investment being asked for another $1M

b) Decision makers must learn to assess decision from neutral reference point

iii. Impression Management

a) save face

b) initial decision makers look at confirmation not disconfirmation

c) try to appear consistent to others

ex89: Carter & JFK “most difficult decisions President makes is to change course”

How does this compare to President Bush's (W) record of no change no matter what?

d) best decision is to focus on what is best for organization

• managers must convey to all the impression management is not ok

• reward system must reflect

iv. Competitive Irrationality

a) look very carefully at what looks like opportunity but might be large problem

E. Integration

Be aware of why you are making decisions.

Open our minds to other courses of action

Final caveat: sometimes it is important to consider the other side of the spectrum. It is important to realize that ending a commitment can result in loss of all future benefits and can cause problems, especially in personal realm.

VII. Chapter 6: Fairness in Decision Making

ex93: MBA job offer @$90K like people, etc. find other job offer @ $95K

ex93: Hurricane Andrew & building supplies

A. Judgment vs Supply & Demand

ex94:sell snow shovels at $20 after snow and $15 before (loss of future business?)

ex94:inflation 0% decrease salaries by 5%, inflation 12% increase salaries 7%

ex95:car list $20K but dealer selling at $22K due to demand and shortage

i. fairness considerations lead to systematic deviation from the laws of Supply & Demand

ii. Loss of future business from customer for the shovel ex above

iii. framing of problem is very important (salary example below)

ex94:Co small profit, lots unemployment-- 0 inflation lower wages, 12%..

iv. we seem to carry “rules of fair behavior” around like “no salary decrease”

v. list price or status quo seems to act as critical anchor (see car ex above)

vi. status quo seems to be really important

vii. lots of other critical anchors (Internet quotes)

B. The Influence of ULTIMATUMS

ex96-97:rich lady on airplane offers $5K if you & business man can agree on split

i. do you reject offer, if so why do you reject the offer in ex above

ii. people want a “fair deal” and are willing to pay to punish their opponent for “unfair” deals

iii. in ex above initial offer acts as anchor?

iv. dictator game: when can say you have to take this 64% still shared ie $5K

v. ex above: player1s act strategically player2s act morally and reject when player1s are acting immorally

vi. MRIs show brain activity greater for unfair than fair & greater when offer came from human than computer

vii. availability in memory is important thus vivid example makes a difference

ex98:JFK Cuba missile Crisis & air controllers' strike

viii. Other cultures studied also have “fairness model.” Fairness is a universal concept

ex98: new car purchase, why is splitting difference at end considered fair?

ix. Not everybody has the same fairness model

x. fair does not equal optimal

C. Concern for the outcomes of Others

i. People care about how others are treated

a) thus job grade systems

b) concealing salaries & reward systems

ii. The outcomes of others act as a key reference point, an anchor

ex100: $500 / $500 more satisfactory than $600 / $800 split

iii. positive correlation between pay equity and quality

iv. employees compare within industry mostly

v. single choice versus multiple choices

ex101: Co4 for $75k or Co9 for$85k (only one known versus both known)

vi. fairness of the procedures used is also important

ex102: two job offers one for $60K at procedurally fair co other for $75K at co where you have no say in the processes thus unfair

vii. When assess on option at a time use social comparison, when multiple use more cognitive assessment.

VIII. Chapter 7: Common Investment Mistakes

Key point is that over time YOU CANNOT BEAT INDEX FUNDS

ex103: Best friend advises switch from index fund to actively managed fund

you trust your friend so tendency is to take his advice

A. Introduction

i. Substantial evidence demonstrates that past stock performance is not predictive of future performance.

ii. “Best” funds happen roughly at random

iii. Over time any large family of funds will have those that outperform (Fidelity)

But will also have those that under perform. Will only advertise “good” ones.

ex105: Marketing mutual funds

ex105: Returns on 5 portfolios & index fund for 7 year period ending June 30, 2000

iv. Creative strategies used by mutual-fund cos

v. Behavioral finance: nobody expects to underperform

B. Psychology of poor investment decisions

i. even bright people make poor decisions

ii. active investing is BAD

iii. Overconfidence

generally overconfident in ability to pick stocks/funds better than others

discount likelihood of failure

ex107: Turnover in 66,465 households

(avg investor 16.4% just 1.5 lower than market)

(20% with highest turnover 11.4%)

a) costs of buying & selling

b) women are better at sitting still than men, women did less badly than men

iv. Optimism

a) People are optimistic about a variety of behaviors

career, driving, marriage, etc

b) optimistic recollection

ex108-9: Simulation of 9 largest firms & index in MBA class

false optimism, optimistic recollection

c) psychological need to perceive good news can insulate one from “reality”

“Have you ever compared your returns to the market?”

d) Financial Magazines

v. Denying that Random events are random

a) great deal of randomness in investment arena

b) very difficult to predict future from past

c) loser portfolios outperformed winners over next 5 years

d) momentum effect at first then tends to reverse itself

in following years “loser portfolios” outperformed “winner's”

vi. Anchoring, the Status Quo, & Procrastination

a) people think way too little about long term investments

ex111: Professor retirement funds 50% stock 50% bonds & never changed

ex111: Company retirement funds

b) Status Quo Effect

ex112: Inheritance as $ or stocks, bonds, etc

c) Procrastination in making investments

ex112: opt-in versus automatic enrollment in 401k plans

vii. Prospect Theory, selling winners, keeping losers

a) use a reference point, an anchor

b) risk averse with gains

c) risk seeing with losses

d) regret minimization strategy: avoid “booking” a loss

C. Active Trading

i. short-term capital gains

ii. lots trading costs

iii. “why do day traders think they know more than the party on the other end of the trade?”

D. Beardstown Gang

i. dues included in returns

E. Action Steps

i. Clearly identify your goal

ii. want / should problems & “Save More Tomorrow” plan

iii. Use tax incentive based investments IRAs, Keoghs, etc

iv. long-term investment portfolios – stocks

v. Annuities: use well known providers with low fees, charitable organizations too

vi. appropriate asset allocation, low-cost investing, adding regular investments

Chapter 8: Bounded Ethicality

F. Corporate scandals

i. media looked for underlying cause

a) few “bad apples”

b) business leaders

c) business schools

ii. Bazerman: cognitive biases

a) unethical behavioral without realizing it

b) contradict our own standard of ethics

c) Traditional ethics:

• choosing self rewarding behavior

• assumption of conscious agent

d) Bounded Ethicality

• protected cognitions --> behaviors would not otherwise think of doing

• omissions bias --> less responsibility for harms due to omission

• demands of executive life

• apply to the best & brightest of us

ex122: Supreme Court, Cheney v. U.S. District Court, Scalia

• “rules generated to guard only against intentional corruption”

• friendship between 2 people makes it impossible to be objective

e) This chapter: 5 examples of bounded ethicality

G. Overclaiming Credit

i. coauthors, Nobel Prize winners, married couples, academia, fundraising, etc

ex123: 1923 Nobel Prize winners

ex123: Harvard MBA study group % of effort (total was 139%)

ii. important implications for the longevity of groups

iii. important to realize colleague is biased not dishonest

iv. Why joint ventures so often result in disappointment

a) contribute mediocre talent to joint venture, save best for direct contributions where 100% invested

b) each side will be biased, will believe other's behavior unfair theirs justified

H. Implicit Attitudes

ex124: John Smith Venture Capitalist & funding decision

i. Implicit Association Test: ¾ who visit show some

ii. explicit attitudes (thoughtfully formed) & implicit attitudes (automatic),

surprise is in importance of implicit

iii. Societal shift from “old fashioned racism” (explicit) to “modern racism” (implicit) much harder to detect

iv. implicit stereotypes

ex126: Morgan Stanley $54M sex discrimination suit

I. In-Group Favoritism

i. more comfortable doing favors for those we identify with

ii. in-group positive associations, outside-group negative

iii. few set out to exclude underrepresented minorities

iv. in-group favoritism is == to punishing people for being different from you

J. Discounting the Future

i. Natural Environment: we all say want to save but little effort

ii. Widespread bias toward increasing consumption

explicitly stated long-term desire collides with implicit desire to consume

iii. Extremely high discount rates for the future:

exs127: Homeowners, Universities, Orgs, etc

K. Psychology of Conflict of Interest

i. Financial Advisors, Surgeons, Doctors, Commission-Paid Lawyers, real estate agents, Supreme Court Justices

ii. We tend to believe professionals advising us can overcome conflict

ex128: Real Estate agent advising raising offer

ex128-9: Sale of company simulation: seller, buyer, seller's auditor, buyer's auditor

iii. Disclosure agreement does not solve

a) we sign disclosure forms all the time & then never think about them

ex129-130: Jar of coins example,estimator & advisor

iv. As long as auditors are dependent upon clients for future business no way to be completely unbiased

ex130: NASDAQ dropping 60%, brokerage houses “Strong Buy”, “Buy”, or “Hold”

v. Deeply ingrained institutional conflicts of interest

L. What can be done:

i. try to eliminate by avoiding advice from biased source

ii. recognize that honest people are biased also

iii. finally: do not make the mistake of viewing yourself as immune

M. Conclusion

i. Corporate Scandals: not possible for just few people with others being ethical

ex131: Bystanders

ii. ethics training is of little help,

focus is mostly limited to explicit (thoughful) behavior, focus on psychological tendencies & implicit behavior will help

iii. bounded ethicality is based on innate tendency of people to engage in self-deception & “ethical cleansing”

IX. Chapter 9: Rational Decisions in Negotiations

A. Judgment in multi-party contexts

i. Structure for System 2 thinking in negotiations

ii. Negotiation central to many parts of organizational & personal life

iii. lots of variation in outcome even in very homogeneous groups

iv. goal of chapter is:

a) provide a framework for thinking about 2-party negotiations

b) prescriptive suggestions for improving decision making in this context

c) help improve quality of outcome for both parties

v. Cognitive biases due to competition

vi. Game Theory (134): mathematical models used to analyze and predict negotiations

a) In completely rational situations game theory is great

b) Problem 1: cannot describe all possible actions

c) Problem 2: people are almost never completely rational

B. Decision-Analytic Negotiation (134)

How people really behave rather than how all knowing, completely rational..

i. Assess three sets of information

a) Each parties alternative to a negotiated solution

• Before begin negotiation consider what will do if fail to reach agreement:

• Best Alternative to a Negotiated Agreement (BATNA)

• Provides lower bound for agreements

• logically determines negotiation reference or indifference point

• When negotiations fail carefully consider your BATNA and look for emotional issues

b) Each parties sets of interests

• There is almost always a difference between stated positions and underlying interests

• positions: stated requirements

• interests: ancillary, underlying issues

• sometimes a focus on deeper issue can identify useful sets of concerns and reveal alternatives

ex135: exclusive health care product from European Co, cousin was hangup

“All I did was ask them why”

c) Relative importance of each parties interests

• best agreements are reached by trading unimportant issues for important ones

ex136: job offer salary, vacation, starting, health benefits

• prepare ahead to recognize these issues so will be ready for the 2 primary tasks in negotiation: creating & claiming value

C. Claiming Value in negotiations

i. bargaining zone framework p. 137

ex137: MBA Salary

a) Each party has a reservation point below or above which BATNA sets in

b) When they overlap there is a positive bargaining zone

c) When they do not overlap there is a negative bargaining zone

d) Key negotiation skill is to recognize other parties reservation point

Ben Franklin (138):

“...worst outcome is when, by overreaching greed, no deal is struck”

D. Creating value in negotiations

ex138-139: Egypt & Israel Camp David, Sinai Peninsula

not really all or nothing as it seemed

multiple issues that provided possibility of creative trade

(Egypt wanted sovereignty over its land Israel wanted security)

Redefinition of the bargaining zone

E. Pareto efficient: no other agreement where both better or one better & other same

F. Differences are opportunities:

easiest way to create value is to trade different value issues

G. Ask questions & look for evidence that dis confirms your analysis

H. Creating value through bets

i. very efficient technique for differing predictions: bet on your opinion

ii. Ch3: people tend to overvalue what they own

ex146: selling major sitcom to local station

ex: LotSale: share profit on future sale

iii. contingent contracts

a) bets on differences to create value

b) bets help manage biases

c) bets diagnose disingenuous parties

d) bets establish incentives for contractual performance

I. Using Risk, Temporal, & Other Differences

i. differing tolerances for risk can be critical role in negotiations

ii. differing time preferences

ex: divorce & custody of children on holidays, summer, etc

iii. skill differences can be complementary

ex148: Butterfields & eBay

J. Gathering information to create value

Do not assume you or the other party know everything important!

i. Build trust and share information (specifically value placed different issues)

ii. ask questions & LISTEN

Don't see negotiations as only requiring you to manipulate the other party

iii. strategically disclose information

can expand the pie of possible outcomes

iv. make multiple offers simultaneously

(might learn more) (also can avoid “anchor”)

v. use outside consultants to search for post settlement settlements (PSS)

K. High quality preparation requires answers to these questions: (from p152)

i. What is your BATNA?

ii. What is your reservation price?

iii. What are the issues in this negotiation?

iv. How important is each issue to you?

v. What do you think the other party's BATNA is?

vi. What do you think their reservation price is?

vii. How important do you think each issue is to them?

viii. Are there variable trades that create value?

ix. Are you & the other party in disagreement about future events?

If so, is a bet viable?

x. How can you go about identifying the information you do not currently know?

X. Chapter 10: Negotiator Cognition

Biases that occur due to System 1 thinking

Primary idea is: 1) awareness is very important 2) identify these traits in others

Chapter explores the Most common cognitive mistakes we make

A. Mythical Fixed Pie of Negotiations

i. Assumption is that interests of two parties directly conflict

ii. rooted in win-lose mentality & desire for “largest piece of pie”

iii. happens in many environments: diplomatic, marriage disputes, strategic alliances...

ex154-Spence: SALT if it is in the best interests of the Russians it can't be in ours

Even when both sides want the same thing stalemate results due to win-lose assumption

iv. incompatibility bias: assumption that our interests are incompatible with...

v. leads us to devalue any concessions made by others

ex154: employee training

ex154: arms reduction USSR& US

vi. Not easy first or hard first but simultaneously to help break fixed pie mental

B. Framing of Negotiator Judgment

ex155: selling condo cost $250 listed $299 target $290 offer $280

ex155: labor relations $12-$14 per hour required co says < $12 only option

each views as what they have to lose so will be risk seeking

i. anchor is really important because it leads to gain or loss perception

ii. “must get” anchor leads to perception of loss, “what I have to lose,” risk seeking behavior, and negative frame

iii. possible gain anchor leads to risk averse behavior and positive frame

iv. goal is to frame agreement as gain to other side (for mediators both sides)

C. Non rational Escalation of Conflict

ex157: baseball strike in 1994 due to “beat the other side” mentality

owners gleeful response to cancellation of 94 world series $1B loss

i. extreme demands

ii. too much invested to quit

iii. public announcements make it difficult to retreat

ex158:buyers and sellers of real estate are focused on what seller paid

“sunk costs”

D. Negotiator Overconfidence

ex158-9:Matt Harrington baseball salary negotiations

i. negotiators are overconfident that their propositions will prevail if they do not “give up”

ii. leads to extreme reservation points

iii. happens most where knowledge is lower ... when in doubt be overconfident

iv. Harringtons simply forgot to say yes

E. Negotiator Egocentrism: Self Serving Biases in negotiations

i. tendency to regard our assessment as well as our overall world view as objectively fair

ii. view arguments supporting our case as more convincing (look for dis confirmations)

ex160: Motorcycle Automobile collision

iii. social dilemmas: the tragedy of the commons

ex161:herdsman in common field all want more cattle but bad for all

iv. real world social dilemmas: asymmetry in parties contributions and willingness to cooperate

v. discussion of issues helps a lot (fishing ex 161)

vi. Source of problem is not our desire to be unfair but our difficulty in interpreting information in an unbiased manner

vii. Build communication links!

F. Anchoring: People are overly affected by initial anchor without realizing it

ex162:students& brokers asked to appraise property

both affected by listing price, students admitted that they were affected, brokers would never admit that they were

i. anchors must seem reasonable to other side

ii. even subtle shifts matter:

ex163: list of prices $1000 top to $0 bottom or $0 top to $1000

G. Vividness in negotiations

i. tendency to overweight vivid concerns and underweight more important non-vivid

ex164: MBA student job search

ex164: civil trial

ex164: group of executives allocation R&D $

ii. in labor negotiations vividness of costs made real difference

iii. arbitration sometimes allows transfer of blame to arbiter

ex165: buying new car that is very dependable, then using vivid example like $1200 engine to sell you service contract

Chapter 11: Bounded Awareness

H. Do initial problems p167-169

P1. - $60 largest, P2 – 3 boxes always, P3 – buying company Y, P4 - $60 min, P5 – 3 boxes sometimes, P6 – 9 dots, 4 lines connect all

i. Ch1 – bounded rationality

ii. Ch4 – bounded willpower

iii. Ch6 – bounded self interest (fair)

iv. Ch8 – bounded ethicality

v. This – bounded awareness:

a) when individuals do not attend to important available information

b) misalignment between information needed for good decision & info aware of

P6-169: Look at the dots problem P6

c) “fictional” bounds created by the mind eliminate the solution

vi. Most critical problem is allowing assumptions to guide what we consider

vii. Tendency to place false perceived bounds

“How could I have missed that?”

I. Inattentional Blindness

ex171: passing basketball & woman with umbrella or gorilla costume

i. people tend to not see what they are directly looking at when focused on different issue

ex172: airplane on runway, car accident while using cell phone, wife says she told me something

ex172: Tournament bridge game

J. Change Blindness

ex172-173: auditor of large honest firm 1) fast change, 2) slow change

much more likely to refuse to sign in first case

i. Slippery slope theory: much more likely to become unethical a little at a time than..

ex173: boiling frog

ii. Change detection research example:

ex173: asking pedestrian for directions while holding basketball

ex173-174: camera position change

ex174: select more attractive person, flash, change position of people

K. Focalism and the Focusing Illusion

i. focalism: tendency to focus too much on particular event & too little on other events

a) Results in overestimation of future importance of focal event

ex174: Over estimate importance of sports, political candidate wins/losses

even overestimate effect of major medical condition on happiness

ii. focusing illusion: tendency of people to make judgment based on attention to only subset of available info & underweight unattended info

ex174: college students in southern California & midwest about life satisfaction

ex175: Challenger space shuttle disaster: o-rings at cold temps, not all data used

Major error is limiting analysis to the data in the room, rather than asking what data would best answer the question being asked

L. Bounded awareness in groups

i. information discussed by group has major influence on decision

ii. information known by members but not discussed little influence

ex176: Student A running for student council president

iii. strategies to resolve: telling group in advance of unique knowledge or experience

iv. people tend to ignore very + or very – info about one product if similar info not known about other products

v. also tend to overweight info if is known about all products

ex177: use of SAT scores

M. Bounded Awareness in Negotiations

i. Multiparty Ultimatum Games: P1–dividing the pie–largest, P4-dividing pie-smallest

Over estimate conjunctive events, underestimate disjunctive

P1: Someone likely to say $10, P2: Someone likely to say $1

Research results on p178

a) Minor changes in rules or decisions of others can make MAJOR differences

ii. The Monty Hall Game: P2-”Monty always opens”, P5-”Mean Monty”

P2: 1 in 3 chance. When box opened remaining door holds 2 in 3

P5: Computer will never open a door if contestant has prize

Most people made same decision in both versions

iii. P3: Acquiring a Company:

problem is high likelihood firm will take offer only when firm is of least value to acquirer (analysis pg 180)

So counter intuitive that only 9 out of 120 got it right (distribution p182)

iv. “winner's curse”

ex180:”winner's curse” buy gemstone then wonder ditto for company

v. tendency to ignore the decisions of others

Marx: “I don't want to be a member of any club that will admit me”

vi. Best route is to think in perspective of other side

vii. we tend to act as if other party is fairly inactive in negotiations

ex182: choose a number from 1-100, winning # will be one closest to ½ avg

viii. better to verbalize other party's views

N. What do people actually do

Negotiators tend to ignore rules of the game and decisions of the other party

i. reference group neglect:

ex183: better easy, worse hard problems

ex183: deadlines for one group are for other too many times

ii. System neglect: tendency to undervalue general context of decision

ex183: Campaign finance reform

iii. limited awareness of impact of decisions on those outside negotiations

ex183: prisoner dilemma game: both better off if cooperate vs. one better

also price setting in 2 or more cos. but customers not considered

O. Bounded Awareness in Auctions

ex184: hire new highly regarded MBA student

ex184: bid on a firm

ex184: buy beautiful new rug

i. “winner's curse” tends to happen when buyer fails to consider perspective of seller

ii. if bidder thinks will win auction then has probably bid too high (fig 11.2 p 185)

ex186: corporate takeovers in1980s: 1/3 failures, 1/3 underperformed, most synergistic benefit to acquired firm

iii. What is effect of eBay ?

P. Integration – Discussion

i. Growing new research on ways critical information escapes notice of decision makers

ii. Chapter documents bounded awareness in following contexts:

a) Inattentional Blindness

b) Change Blindness

c) Focalism

d) Bounded Awareness in Groups

e) Bounded Awareness in Negotiations

f) Bounded Awareness in Auctions

iii. Research in very early stage of development

XI. Chapter 12: Improving Decision Making

“Most of our decisions are good enough to get us by...”

“The critical question is, What can be do” to be better?

Good news is that recent research & implementations have been successful in changing the decision process.

ex189:long baseball ex about statistics

-- High school players overvalued & college players undervalued

-- Executives overgeneralized from personal experiences

-- Overly influenced by players' recent performances

-- Overly influenced by what they saw compared to multiyear records

Why did it take so long to figure out problems?

Probably more severe in other industries.

Executives tend to trust intuition, heuristics, traditions, habits

This chapter concludes the book with six concrete & complementary strategies.

A. Strategy 1: Acquiring Experience & Expertise

Is book biases cause uses students? Do pros learn from previous decisions?

Quote about “winner's curse” (p 191)

i. Get unbiased, honest, non-threatening feedback from past decisions

a) Response learning requires accurate, honest, immediate feedback

• which is rarely, if ever available in the real world

• outcomes are delayed

• variability in environment could be cause

• no info on what outcome would have been if...

• most important decisions are unique

ex192:acquiring a company experience

only 5 of 72 participants “learned” correct answer

ii. Experience as repeated feedback does not work,

iii. Strategic Conceptualization: Therefore, try to abstract lessons learned and experience so that they are applicable in other domains.

Benjamin Franklin: “Experience is a dear teacher yet fools will learn in no other [school].”

iv. The key is to develop a “strategic conceptualization” of decision making that avoids the biases discussed in this book

a) Helps transferability of lessons learned

b) Helps reinforce lessons even in existing context

B. Strategy 2: Debiasing Judgment

“reducing or eliminating biases from the cognitive strategies of decision maker”

Simple warning & training does not work in long term (teachers p193-194)

Specific suggestions for debiasing judgement

i. Unfreeze from old strategies

a) hard to do because

• we are ok at making decisions the way we do

• we have achieved some success doing it this way

• the idea that we are doing something basic wrong clashes with our view of ourselves

b) quiz-feedback pattern in this book designed to help the process

c) Reread (or skim) book when making decisions rely on quiz and feedback format to recall specifics and to raise awareness of possible problems

ii. Change

will be hard, internal resistance is probable

a) abstract from examples that are used so can see specific problems in variety of situations

b) Use bias explanations to understand reasons behind problems

c) Believe that some or all of these techniques may help

iii. Refreeze

a) Consciously use new strategy in multiple contexts

b) Continue to examine your decisions over time.

C. Strategy 3: Analogical Reasoning

i. people can learn from cases, simulations, etc if can take abstract form of learning message away

ii. one episode at a time: surface-level characteristics limit learning

iii. lots episodes: abstracting similar lessons -- more generalized insight

iv. underestimating similarities & difference across problems

ex196: five problems from Chapter 11

D. Strategy 4: Taking an outsider's View

ex198: Chapter 2, estimate 10 obsure quanties, typically 3 right but 98% accuracy estimated, however said probably about 3 right when asked

i. We all have two perspectives on problems: insider & outsider

ii. Sometimes outsider can generalize and extrapolate to previous experiences better than insider who is intimately involved

ex198: new home or major remodel over budget 20-50%

ex198: estimate of time to finish curriculum book, dissertation, or major paper

iii. Outsider makes better estimates and decisions than insider

iv. Outsider tends to incorporate more information into decision

v. Then why do we tend to trust the insider?

vi. Therefore: invite an outsider to share their insight

E. Strategy 5: Using Linear Models & Other Statistical Techniques

i. De biasing is book's central strategy but are others things that can help

ii. Are some negative opinions on mathematical models (ex199-200)

iii. linear models

iv. Regression Analysis

a) essence of idea

b) large number of similar cases

c) regression equation describes expert's idiosyncratic model for decisions

v. People are better at choosing the important factors in a decision than they are at integrating it together to find solutions

ex200: PhD student admission problem

ex200: Hodgikin's disease

(docs not good at projections but good at picking variables

mathematical models as the above help

We tend to be unreliable, given same data will not always make same decision cause of mood, subjective interpretations, environment, deadlines, random fluctiaions

ex201: PhD student, Mark Sonet & new student rejected

vi. Why not used more?

a) Arbitrary bias

b) Not been widely used

c) Ethical concerns (Quote page 201)

d) Change is threatening

vii. Have all the evidence you can

F. Strategy 6: Understanding Biases in others

“The task of evaluating the decisions of other is fundamentally different from the task of auditing our own decisions”

ex202: sales at new store, current $2M to $4M her estimate $3.8M

--ok estimate all her data look good

--but what about regression to the mean

--forecast should be between her estimate and mean

i. Rough guide to adjusting the decisions of others

a) Select a comparison group:

what set of past observations will I compare the current decision to

b) Assess the distribution of the comparison group

characteristics of past observations that current decision is being compared to

c) Incorporate intuitive estimate:

what is the expert opinion

d) Assess the predicted results

Correlation between decision or forecast & comparison group

e) Adjust the intuitive estimate

Calculate adjustment required

(adjusted estimate = group mean + correlation(initial est. – group mean)

G. Conclusion:

i. Chapter showed six strategies for correcting deficiencies in decision process

a) first three see broad change in intuitive responses

b) last three provide techniques for improving decisions in specific contexts

ii. Remember: “Creating lasting internal improvement in decision making is a complex process that occurs gradually over time... (not all at once while) in the midst of a crisis”

iii. I hope the class and the book have at least raised your awareness of the problem and helped to provide possible solutions

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