A person's characteristics, including personality and experience, can affect the means people use to make decisions. Therefore, a person's susceptibility can either be a positive or a negative influence on decision making process. From a psychological point of view, the decision is always determined by needs and enlarged by a person’s preference.
Biases can warp and damage the objective contemplation of a decision by adding disruptions to the procedure of decision-making. These disruptions are usually separate from the point in the decision. Bias is simply the susceptibility towards error. To put it simply, bias is preconception to arrive at decisions while already affected by a latent belief. We are commonly unconscious of these biases which can influence our decisions. This report tackle the major biases in a business setting, specifically, Wesfarmers: Risk Management department. Listed below are some of the most common cognitive biases that affect the decision-making process of the managers at Wesfarmers.
Excessive optimism is related to the overestimation of the number of likeable results in compared to the unlikeable ones (Clark, Robert & Hampton 2016, p. 87). This kind of bias exists in a huge array of fields. For example, for the issue of the debt-equity ratio for financing, the main cause for debt problems presently is corporate management’s previous unrestrained optimism. In addition, introducing a fresh product into the market is rarely rid of forecasting bias. Therefore, several of the forecasts are never rid of errors. But this isn't surprising at all because many of the companies may unwillingly be engaged in unrestrained optimism, majorly when their existence is dependent on favourable forecasts (Leong & Zaki 2018, p. 170). Plus to corporations, being affected by unrestrained optimism, people also show it, both, when they are deciding on their investments and in how they live their lives. In a study on the effects of emotion on the value of stocks, it was concluded that emotion surely has an effect on asset valuation.
In a 2017 risk management sustainability report under ethics and responsibility, Wesfarmers pride themselves with their ability to deliver favourable outcomes to their shareholders. They state that their framework involve policie and codes of conduct that govern the behaviour of their managers and employees. This is their primary goal. The company is highly optimistic and overconfident. With this optimistic coed of conduct the decisions of managers are limited and directed by them. One can be innovative but only through our codes of conduct.
The illusion of control can be defined as the habit of individuals to trust that which they can control and/ or affect the result of in real life than that which they have no control over (Stefan & David 2014, p. 89). This kind of bias is seen in everyday life, for example, it may include situations like successfully rolling a dice to a double sixes or picking winning lottery numbers. The illusion of control grants people the wrong idea that result can be affected by individual involvement when the real life is quite different. Plus as Yarritu, Matute and Vadillo (2014, p. 38) stated, individuals usually show overconfidence and illusion of control, confirming their assumption towards the mistake. The easiest way to deal with the illusion of control is to maintain the course of the transaction, for example, in the case of investors, it would assist if the investor kept a list of the characteristics that are identified to be in favour of the investment. Case study in this case is the debacle which is Homebase. When acquiring Homebase, Wesfarmers had he illusion that the company would continue to be profitable, but less than two years down the line, they are faced with the challenge of having to consider leaving the business which is bleeding cash. The company is due to post a loss of A$ 97 million when Wesfarmers release their interim results this year. It has been reported that some investors have questioned the procedure followed during the acquisition of Homebase.
The familiarity heuristic argues that individuals’ capacity to views actions as likely to occur is dependent on their ability to remember particular information linked to that action (Schwikert & Curran 2014, p. 2341). The familiarity they have with that information will surely affect their decision making. Familiarity heuristic can be defined as what that proves how the bias of availability is linked to how easy one can recall. Familiarity bias is most prominent in marketing. Bui, Hamilton & Kemp (2015, p. 739) argue that the insight people have over a certain brand is dependent on how much they are familiar with products from that brand. So when a customer is doing a purchasing their decision to buy one product over the other is affected by their level of familiarity with that product, if their familiarity with the product is high, their decision to buy the product will be fast and easy (Huang 2016, p. 665).
Another bias is loss/risk aversion or prospect theory. This is linked to people's strong wish to avoid losses and instead make any sort of gain (Aperjis & Balestrieri 2017, p. 203). It is important to note that loss aversion will be more severe when the issue is viewed from a negative angle; people make a much worse decision when facing a negatively formulated dilemma (Heeren, Markett, Montag, Gibbons & Reuter 2016, p. 50). Risk aversion theory specifically states that losses are felt twice as much by individuals compared to similar profit (Imas, Sadoff & Samek 2017, p. 1271). The theory of loss aversion is evident in both business and in everyday life. In a research that viewed the acknowledgement made in negotiation when the issue was put forward in both positive and negative angles, the study deduced that the loss view gave much fewer acknowledgements than a gain view, affirming once more that people are less ready to enter a negotiation when they are less likely to gain for it, this is because they are not prepared to deal with that loss (Piccolo & Pignataro 2018,p. 49). Psychologically speaking, individuals have a tendency to deceive and shun all in a bid to maintain the ownership of a property rather than getting it in the first place. Say, as an example, that one commits an unavoidable mistake, this mistake has a possibility for physical ramifications, but in a bid to avoid this, the person would deceive just to blanket the mistake. A case study would be the Wesfarmers where the risk aversion bias is more present, the risk management policy there is reviewed annually by a qualified Board members. The last review was done in May 2017. The aim is build a policy of risk aversion and report. This policy will contain a procedure for risk reporting and avoidance of group risk alongside a detailed manifesto of risk management functions among the Board, top management, finance director and audit and risk committee. This just shows the lengths such big companies go to avoid any loss. They involve the council of top management.
Sunk cost. This refers to an amount already spent and cannot be retrieved at any major capacity. For instance, an entrepreneur an idea for a new business venture, the business idea looks economically promising. So the entrepreneur invests his own personal equity finance to the idea, as well as a big start-up investment from investors. After the business has been operating for a while, it becomes clear the business is not going to succeed, but instead of admitting to failure, the entrepreneur spends more of the investors’ money instead of returning it to them. Here, the sunk cost bias has led the entrepreneur to betray his financial investor's trust and fail to spend their investment responsibly. Sunk cost misconception mostly added to risk aversion to produce decisions that will not incur any further expenses because it is mostly concentrated on the minimizing cost of already spent resources rather than maximizing future expenses (Feldman & Wong 2018, p. 537). This type of decision making is grounded upon the over-commitment of people or managers to make an idea/ project work even if it is economically inadvisable. Once a decision is related to a person with high responsibility, the financial resources dumped into that project will be unreasonable. Meaning there is a relationship between the weight of assumed responsibility and the resources invested in a project (Minard 2015, p. 413).
The perfect example in this case is the misery caused by Coles to Wesfarmers. For the period of ten years that Coles and Wesfarmers have been operating, the annual input of Wesfarmers has reduced. In fact, in 2006, the total returns for Wesfarmers was 27.7%, in 2017 it was 12.4%. The 9.4% returns of Coles has brought the company down just as it has been doing since 2008. And yet for all that while, Wsfarmers has continued to be in business with Coles.
Group factors that influence decision making
In groups, most people desire the peace and state of agreement in the group and would go to various lengths to protect that harmony. This is called Groupthink. It is arguably the most influencing factor in the process of decision-making in a group setting. Groups like this remove themselves from outside influences and cast a shadow that does not allow for input from without the group. According to the members this removes any room for conflict and shuns the group form discussing different opinions. The dynamics of the group demands members to shun from making controversial remarks, this leads to a loss of a person's intelligence, liberty and their distinct personality. The non-functional structure of that group produces a mirage that trick its member in the decision-making abilities of the group. And since every group has an opponent, this might lead them to undermine their rival group. In addition, groupthink can result in some activities that dehumanize other groups (Griffiths, Erlinger, Beesley & Le Pelley 2018).
Groups are only very well productive when all opinions and alternatives are considered. As a matter of fact, Wesfarmers has created governance polices for groups. They check the challenges facing these groups and the activities if the group. And just as stated earlier, decisions are made in accordance to these regulations. In a way, this is good for group decision-making processes since one of the guidelines states that any inputs are considered to be beneficial to the company and has to be considered
Another bias is overconfidence which influences decision making, both in the business world and in personal investments. Overconfidence can be defined as how firmly individuals grasp their own abilities and the boundaries of their knowledge (Jeong-Ho & Daecheon 2018, p. 144). Generally, individuals tend to overestimate their capability to well perform. And, in turn, it causes impulsive decisions because managers who assume they know more than they really do are too confident in their own capabilities (Salehi, Abdoli & Eskandari 2017, p. 857). They, then fail to seek advice and help when making any major decisions. It is for this reason that emerging entrepreneurs are prone to conducting research and asking for help, before starting out, than the more seasoned ones. This assumption is confirmed by the overconfidence portrayed by most successful entrepreneurs (Navis & Ozbek 2017, p. 148).
When it comes to already established and prospering companies, the overconfidence bias is present in all their activities. For example, in a 2008 sustainability report, Wesfarmers include in their report that the organisation is proud of their corporate culture which is special and well regulated. They continue to note their belief in their rate of success in all quantifiable activities that will effect a quantifiable result. The level of overconfidence in their actions is staggering. They are always sure all they do will result in a good outcome. This can obviously affect the decision-making process of their managers.
The negative side of overconfidence only shows itself in situations where individuals do not admit to their weakness and hence, make wrong decisions on a large scale (Porto & Jing Jian 2016, p. 58). In regards to ethical issues, it is due to the overconfidence bias that individuals will always take ethical issues for granted. People just assume that they are of good character and are, therefore, going to do the right thing should they come across an ethical challenge. Recently studies have shown that the overconfidence bias might make individuals to over-calculate the amount or the frequency at which they will volunteer, at the very least, their time to charitable organizations or work. So, overconfidence being a part of our innate personality makes us act without any genuine thought and that is the major cause for unethical behavior.
Investors and managers need to validate their information to avoid the problem of mistaking the amount of information received with the worth of that information. Managers also have to double check on the accuracy of their judgment. Gaining more information on something does not necessarily increase the accuracy of judgment but instead increases the quantity of the information which may only look like an improvement in the accuracy of said information.
Other forms of bias include; Outcome bias- judging and making a decision based on previous outcomes (Griffiths, Erlinger, Beesley & Le Pelley 2018). Entrepreneurial environments overly emphasis on outcome which is culturing a generation bent on outcome. This has toughed the environment in such a way that the only option to succeeding is to win. The culture then sieves out the losers who get to watch their counterparts succeed. Take the case of Westfarmers, every year they release a public sustainability report. This report shows the gains of the company, their sustainability challenges and their future plan. The most notable parts of these reports are the lengths to which the company goes to show much improvement in each sector they have made. To paraphrase a quote, the Wesfarmers for the financial year 2008 made an improvement of $ 264 million as compared to the other financial years 2006 and 2007. They show improvements in their energy use and their contribution to the economies of Australia and New Zealand. This has created a trend in the country where most big companies wish to 'prove their worth' to investors by releasing their own sustainability reports.
Recency. This is the habit to heavily regard new and latest information over the old ones (Nelson 2014, p. 211). In almost all the reports released by Wesfarmers, they inform their investors how much they intend to learn for their challenges and encourage their managers to use new and latest information to make decisions. In a 2015 report, Wesfarmers write that they experience some sustainability problems from all over the company while others are specific to departments. To deal with these problems they encourage their employees (managers included) to be innovative in their problem-solving skills. This even includes collecting diverse ideas from managers and employees and tabling them for discussion and evaluation.
Selective perception or self-attribution bias. This is the act of allowing expectations to shadow how we perceive the world. There are only two categories of self-attribution bias; self-enhancing bias- a situation where a manager or an investor gives themselves too much credit for instances where they made a good decision and self-protecting bias- a situation where managers vehemently deny their wrong-doing and mistakes when making a crucial decision. From the previous example of Homebase, it is clear to see how the expectations of Wesfarmers management led them to make a bad decision that is currently costing the company. This is projected to be so costly that the UBS has warned Wesfarmers investors to get ready for a reduction on the dividend from $2 last year to $1.94 this financial year.
And finally, availability heuristic. people usually underestimate the information in front of them (Lieder, Griffiths & Hsu 2018, p. 1), for example, a person might argue that smoking does not kill simply because they know someone who smoked four packs a day and lived for one hundred years. This would then affect their decision-making process and even hinder him from accepting advice from anyone. There are four major classifications of availability bias, return ability bias, availability bias through categorization, narrow range of experience and resistance. To avoid availability bias, Costa, Carvalho, Moreira & Prado (2017, p. 1775) states, managers need to strictly and carefully research their decision making sources. And for investors, studies have shown that people tend to favour new information as opposed to old news, they should refrain from that and consider investing in long-term investments rather than new and cheesy short-term investments.
In conclusion, given the obvious nature and abundance of cognitive biases that surround us, it is important to devise ways to deal with these biases. Setting up systems that review and consider all the decisions made is a sincere way to make sure that there is always an objective perspective on all decisions. Managers should also admit and learn from their previous mistakes to better equip their decision-making process.
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