How Behavioral Science Can Help Prevent Business Disasters

How Behavioral Science Can Help Prevent Business Disasters

In the wake of the 2008-2009 mortgage crisis, millions of lenders, bankers, mortgage brokers and others in both the real estate and mortgage industries all fell back on the position that it was something that no one could have seem coming. In fact, many did see it coming, but no one wanted to listen to them because no one wanted to believe what they had to say. In fact, any number of disasters ranging from oil spills to public relations nightmares can actually be avoided with the application of behavioral science.

Behavioral science is the science of studying how people act and behave in certain situations. In turn, this gives behavioral scientists the ability to also predict how people are likely to act and behave in a given set of circumstances. For the most part, the majority of business disasters actually stem more from cognitive bias than completely unpredictable and unavoidable events.

The three main cognitive biases that tend to be responsible for the majority of business disasters are the overconfidence effect, optimism bias and the planning fallacy.

1. Overconfidence effect: It is a strange conundrum that on the one hand, confidence is one of the most strongly admired traits in leaders and yet on the other hand, over-confidence may be their greatest downfall.

Overconfidence is the belief that nothing can go wrong that you can't fix, no job too big that you can't handle or nothing you don't know about a certain topic or facet of your business.

Overconfidence has led to the crashing of many ships and the doom of many businesses.

2. Optimism Bias: The optimism bias can rear its ugly head in a number of ways, all of which can create some significant repercussions. Optimism bias is the belief that everything will go as well or better than can possibly be expected. It's the belief that everyone will execute their role in a given plan flawlessly and that no safety or security precautions are necessary. The optimism bias only looks at results and fails to count adequate costs. The optimism bias will often lead businesses and even government organizations to accept the lowest bid on a contract, even when renowned experts tell them that no one can safely deliver on a bid that low.

3. Planning fallacy: The planning fallacy is closely related to the optimism bias. It is the unwillingness to pad budgets for unexpected costs or leave ample time for things to go wrong. Even average individuals fall into the planning fallacy when they only leave themselves 15 minutes to get to an important meeting when Google tells them it is a 15 minute drive.

Understanding these three inherent weaknesses can help any number of businesses prevent any number of disasters. Boards are often put in place to help compensate for overconfidence in their CEO or other executives, but often fail to act when the CEO plays on their own optimism biases.

Similarly, even executive boards can fall into the trap of planning fallacy when presented with an opportunity that seems too attractive to pass up. Only when boards, CEO's and other executives admit to their own propensity towards these cognitive biases can true business disasters be avoided.

Edward Schinik has been with the Investment Manager since 2009 and has been with one Affiliated Investment Manager since 2005.