If introducing a new product line creates a small probability
of losing a few million dollars and a large probability of
earning many billions of dollars, it seems clear that the
new product line should be introduced. But does what we know
about managerial decision making suggest that the new product
line will be introduced?
Unfortunately, a great deal of research suggests that many
decisions involving uncertainty go awry. It appears that people
make systematic errors in reacting to the probabilities of
events. In particular, decision makers may exaggerate the
importance of small probabilities, understate the importance
of large probabilities, and be generally insensitive to changes
in probability that fall between those two extremes.
In the study, "Money, Kisses, and Electric Shocks: On
the Affective Psychology of Risk," University of Chicago
Graduate School of Business professor Christopher Hsee and
Yuval Rottenstreich of Duke University found that this pattern
of exaggeration, understatement, and intermediate insensitivity
is especially pronounced when the outcomes of a decision are
emotionally charged-as they so often are in crucial business
decisions.
An exaggeration of the small probability of a loss and an
understatement of the large probability of a gain may inappropriately
discourage a manager from making an important decision, such
as launching a new product line.
What can be done? As a first step, organizations need to
recognize when emotions influence decisions. There are two
key steps in the managerial decision making process:
o Managers must thoroughly research and accurately assess
the likelihood of various possibilities.
o Managers must properly and expertly apply their knowledge.
Then, says Rottenstreich, the simplest remedy is to separate
the two steps of decision making. One manager should be charged
with the task of assessing the likelihood of success and failure.
Another manager should be responsible for making decisions
based on the given assessments.
"This sort of separation makes it more likely that the
person who makes the final decision will be emotionally detached
from the outcome and will react to the probabilities of the
relevant possibilities," says Rottenstreich. Only then
can one ensure that decisions are made in a more rational
and calculated way.
The Buck Stops Here
Errors in reacting to the probability of an event can be
explained as follows. One famous study found that the typical
person was indifferent between receiving a 1 percent chance
of winning $200 and receiving $10 without doubt, and was also
indifferent between receiving a 99 percent chance of winning
$200 and receiving $188 for certain.
That is, people reacted to probabilities in a way that made
the first hundredth of probability worth $10, the last hundredth
worth $12, but the ninety-eight intermediate hundredths worth
only $178, or about $1.80 per hundredth.
The impact of the small 1 percent probability is even more
exaggerated when emotions come into play.
In an experiment conducted by the authors, a group of students
imagined that they could receive either the opportunity to
meet and kiss their favorite movie star or $50 in cash. Most
preferred the cash to the kiss.
However, when another group of students was asked to imagine
that they could take part in either a lottery offering a 1
percent chance of winning the opportunity to meet and kiss
their favorite movie star or a lottery offering a 1 percent
chance of winning $50 in cash, most bet on the movie star.
Despite the fact that in certain conditions, the cash was
preferred to the kiss, in uncertain situations, the kiss was
preferred to the cash.
When making decisions, people are likely to react to the
image and affect conjured up by these possibilities, such
as the relatively exciting and emotion-laden kiss as compared
to the relatively pallid and emotion-free cash, and not to
the assessed likelihood of these possibilities.
Emotionally Rich Possibilities
How might emotionally laden consequences influence people's
reactions to probabilities? Rottenstreich and Hsee offer the
following thought experiment. Picture a terrible car crash
involving your closest friends. This image is likely to remain
essentially the same-equally vivid and harrowing-whether one
is told the chances of such a crash are, say, one in 100,
one in 1,000, or one in 100,000.
Moreover, the thought of such an image might make a person
drive more carefully the next time he/she gets into a car.
But in deciding to drive more safely, a person is reacting
to the mental image conjured up by this scenario, not its
stated probability of crashing. Essentially the same process
may hold for all emotionally rich possibilities.
In its most extreme form, such a process implies that any
probability would be treated like any other: Managers might
grossly exaggerate the impact of small probabilities, grossly
understate the impact of large probabilities, and be entirely
insensitive to any probability variations.
When an executive is emotionally attached to the possible
outcomes, the person making the final decision concerning
the product line introduction may inappropriately "ignore"
the odds of success and the odds of failure.
Clouding Judgment
"Instead of making a decision that is based solely on
the judged likelihood of success, managers may be swayed by
emotional thoughts and affective images concerning how hard
the company's team has worked, or how thrilling it would be
to read news detailing the success of the project," says
Rottenstreich.
A manager who erroneously reacts to these emotions rather
than to the judged probability of success, he says, will essentially
treat every probability in the same way.
"As a result, the manager may be severely overaggressive
or severely underaggressive when the probability of success
is low," Rottenstreich says.
