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Copyright

Copyright 2011 Harvard Business School Publishing Corporation

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First eBook Edition: April 2011

ISBN: 978-1-4221-7239-1

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Contents

Copyright

The Harvard Business Review

The Hidden Traps in Decision Making

John S. Hammond, Ralph L. Keeney, and Howard Raiffa

Delusions of Success: How Optimism Undermines Executives’ Decisions
Dan Lovallo and Daniel Kahneman

Conquering a Culture of Indecision
Ram Charan

Evidence-Based Management
Jeffrey Pfeffer and Robert I. Sutton

What You Don’t Know About Making Decisions
David A. Garvin and Michael A. Roberto

Who Has the D? How Clear Decision Roles Enhance Organizational Performance
Paul Rogers and Marcia Blenko

How (Un)ethical Are You?
Mahzarin R. Banaji, Max H. Bazerman, and Dolly Chugh

Make Better Decisions
Thomas H. Davenport

Why Good Leaders Make Bad Decisions
Andrew Campbell, Jo Whitehead, and Sydney Finkelstein

Stop Making Plans; Start Making Decisions
Michael C. Mankins and Richard Steele

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The Hidden Traps in Decision Making

by John S. Hammond, Ralph L. Keeney, and Howard Raiffa

MAKING DECISIONS IS THE MOST important job of any executive. It’s also the toughest and the
riskiest. Bad decisions can damage a business and a career, sometimes irreparably. So where do
bad decisions come from? In many cases, they can be traced back to the way the decisions were
made—the alternatives were not clearly defined, the right information was not collected, the
costs and benefits were not accurately weighed. But sometimes the fault lies not in the decision-
making process but rather in the mind of the decision maker. The way the human brain works
can sabotage our decisions.

Researchers have been studying the way our minds function in making decisions for half a
century. This research, in the laboratory and in the field, has revealed that we use unconscious
routines to cope with the complexity inherent in most decisions. These routines, known as
heuristics, serve us well in most situations. In judging distance, for example, our minds
frequently rely on a heuristic that equates clarity with proximity. The clearer an object appears,
the closer we judge it to be. The fuzzier it appears, the farther away we assume it must be. This
simple mental shortcut helps us to make the continuous stream of distance judgments required to
navigate the world.

Yet, like most heuristics, it is not foolproof. On days that are hazier than normal, our eyes
will tend to trick our minds into thinking that things are more distant than they actually are.
Because the resulting distortion poses few dangers for most of us, we can safely ignore it. For
airline pilots, though, the distortion can be catastrophic. That’s why pilots are trained to use
objective measures of distance in addition to their vision.

Researchers have identified a whole series of such flaws in the way we think in making
decisions. Some, like the heuristic for clarity, are sensory misperceptions. Others take the form
of biases. Others appear simply as irrational anomalies in our thinking. What makes all these
traps so dangerous is their invisibility. Because they are hardwired into our thinking process, we
fail to recognize them—even as we fall right into them.

For executives, whose success hinges on the many day-to-day decisions they make or
approve, the psychological traps are especially dangerous. They can undermine everything from
new-product development to acquisition and divestiture strategy to succession planning. While
no one can rid his or her mind of these ingrained flaws, anyone can follow the lead of airline
pilots and learn to understand the traps and compensate for them.

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Idea in Brief

Bad decisions can often be traced back to the way the decisions were made—the

alternatives were not clearly defined, the right information was not collected, the costs and
benefits were not accurately weighed. But sometimes the fault lies not in the decision-
making process but rather in the mind of the decision maker: The way the human brain
works can sabotage the choices we make. In this article, first published in 1998, John S.
Hammond, Ralph L. Keeney, and Howard Raiffa examine eight psychological traps that can
affect the way we make business decisions. The anchoring trap leads us to give
disproportionate weight to the first information we receive. The status-quo trap biases us
toward maintaining the current situation—even when better alternatives exist. The sunk-cost
trap inclines us to perpetuate the mistakes of the past. The confirming-evidence trap leads us
to seek out information supporting an existing predilection and to discount opposing
information. The framing trap occurs when we misstate a problem, undermining the entire
decision-making process. The overconfidence trap makes us overestimate the accuracy of
our forecasts. The prudence trap leads us to be overcautious when we make estimates about
uncertain events. And the recallability trap prompts us to give undue weight to recent,
dramatic events. The best way to avoid all the traps is awareness: forewarned is forearmed.
But executives can also take other simple steps to protect themselves and their organizations
from these mental lapses to ensure that their important business decisions are sound and
reliable.

In this article, we examine a number of well-documented psychological traps that are

particularly likely to undermine business decisions. In addition to reviewing the causes and
manifestations of these traps, we offer some specific ways managers can guard against them. It’s
important to remember, though, that the best defense is always awareness. Executives who
attempt to familiarize themselves with these traps and the diverse forms they take will be better
able to ensure that the decisions they make are sound and that the recommendations proposed by
subordinates or associates are reliable.

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The Anchoring Trap

How would you answer these two questions?

Is the population of Turkey greater than 35 million?

What’s your best estimate of Turkey’s population?

If you’re like most people, the figure of 35 million cited in the first question (a figure we
chose arbitrarily) influenced your answer to the second question. Over the years, we’ve posed
those questions to many groups of people. In half the cases, we used 35 million in the first
question; in the other half, we used 100 million. Without fail, the answers to the second question
increase by many millions when the larger figure is used in the first question. This simple test
illustrates the common and often pernicious mental phenomenon known as anchoring. When
considering a decision, the mind gives disproportionate weight to the first information it receives.
Initial impressions, estimates, or data anchor subsequent thoughts and judgments.

Anchors take many guises. They can be as simple and seemingly innocuous as a comment
offered by a colleague or a statistic appearing in the morning newspaper. They can be as
insidious as a stereotype about a person’s skin color, accent, or dress. In business, one of the
most common types of anchors is a past event or trend. A marketer attempting to project the
sales of a product for the coming year often begins by looking at the sales volumes for past years.
The old numbers become anchors, which the forecaster then adjusts based on other factors. This
approach, while it may lead to a reasonably accurate estimate, tends to give too much weight to
past events and not enough weight to other factors. In situations characterized by rapid changes
in the marketplace, historical anchors can lead to poor forecasts and, in turn, misguided choices.

Because anchors can establish the terms on which a decision will be made, they are often
used as a bargaining tactic by savvy negotiators. Consider the experience of a large consulting
firm that was searching for new office space in San Francisco. Working with a commercial real-
estate broker, the firm’s partners identified a building that met all their criteria, and they set up a
meeting with the building’s owners. The owners opened the meeting by laying out the terms of a
proposed contract: a ten-year lease; an initial monthly price of $2.50 per square foot; annual
price increases at the prevailing inflation rate; all interior improvements to be the tenant’s
responsibility; an option for the tenant to extend the lease for ten additional years under the same
terms. Although the price was at the high end of current market rates, the consultants made a
relatively modest counteroffer. They proposed an initial price in the midrange of market rates
and asked the owners to share in the renovation expenses, but they accepted all the other terms.
The consultants could have been much more aggressive and creative in their counterproposal—
reducing the initial price to the low end of market rates, adjusting rates biennially rather than

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annually, putting a cap on the increases, defining different terms for extending the lease, and so
forth—but their thinking was guided by the owners’ initial proposal. The consultants had fallen
into the anchoring trap, and as a result, they ended up paying a lot more for the space than they
had to.

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What Can You Do About It?

The effect of anchors in decision making has been documented in thousands of experiments.
Anchors influence the decisions not only of managers, but also of accountants and engineers,
bankers and lawyers, consultants and stock analysts. No one can avoid their influence; they’re
just too widespread. But managers who are aware of the dangers of anchors can reduce their
impact by using the following techniques:

Always view a problem from different perspectives. Try using alternative starting points
and approaches rather than sticking with the first line of thought that occurs to you.

Think about the problem on your own before consulting others to avoid becoming
anchored by their ideas.

Be open-minded. Seek information and opinions from a variety of people to widen your
frame of reference and to push your mind in fresh directions.

Be careful to avoid anchoring your advisers, consultants, and others from whom you
solicit information and counsel. Tell them as little as possible about your own ideas,
estimates, and tentative decisions. If you reveal too much, your own preconceptions may
simply come back to you.

Be particularly wary of anchors in negotiations. Think through your position before any
negotiation begins in to avoid being anchored by the other party’s initial proposal. At
the same time, look for opportunities to use anchors to your own advantage—if you’re the
seller, for example, suggest a high, but defensible, price as an opening gambit.

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The Status-Quo Trap

We all like to believe that we make decisions rationally and objectively. But the fact is, we all
carry biases, and those biases influence the choices we make. Decision makers display, for
example, a strong bias toward alternatives that perpetuate the status quo. On a broad scale, we
can see this tendency whenever a radically new product is introduced. The first automobiles,
revealingly called “horseless carriages,” looked very much like the buggies they replaced. The
first “electronic newspapers” appearing on the World Wide Web looked very much like their
print precursors.

On a more familiar level, you may have succumbed to this bias in your personal financial
decisions. People sometimes, for example, inherit shares of stock that they would never have
bought themselves. Although it would be a straightforward, inexpensive proposition to sell those
shares and put the money into a different investment, a surprising number of people don’t sell.
They find the status quo comfortable, and they avoid taking action that would upset it. “Maybe
I’ll rethink it later,” they say. But “later” is usually never.

The source of the status-quo trap lies deep within our psyches, in our desire to protect our
egos from damage. Breaking from the status quo means taking action, and when we take action,
we take responsibility, thus opening ourselves to criticism and to regret. Not surprisingly, we
naturally look for reasons to do nothing. Sticking with the status quo represents, in most cases,
the safer course because it puts us at less psychological risk.

Many experiments have shown the magnetic attraction of the status quo. In one, a group of
people were randomly given one of two gifts of approximately the same value—half received a
mug, the other half a Swiss chocolate bar. They were then told that they could easily exchange
the gift they received for the other gift. While you might expect that about half would have
wanted to make the exchange, only one in ten actually did. The status quo exerted its power even
though it had been arbitrarily established only minutes before.

Other experiments have shown that the more choices you are given, the more pull the status
quo has. More people will, for instance, choose the status quo when there are two alternatives to
it rather than one: A and B instead of just A. Why? Choosing between A and B requires
additional effort; selecting the status quo avoids that effort.

In business, where sins of commission (doing something) tend to be punished much more
severely than sins of omission (doing nothing), the status quo holds a particularly strong
attraction. Many mergers, for example, founder because the acquiring company avoids taking
swift action to impose a new, more appropriate management structure on the acquired company.
“Let’s not rock the boat right now,” the typical reasoning goes. “Let’s wait until the situation
stabilizes.” But as time passes, the existing structure becomes more entrenched, and altering it
becomes harder, not easier. Having failed to seize the occasion when change would have been
expected, management finds itself stuck with the status quo.

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What Can You Do About It?

First of all, remember that in any given decision, maintaining the status quo may indeed be the
best choice, but you don’t want to choose it just because it is comfortable. Once you become
aware of the status-quo trap, you can use these techniques to lessen its pull:

Always remind yourself of your objectives and examine how they would be served by the
status quo. You may find that elements of the current situation act as barriers to your goals.

Never think of the status quo as your only alternative. Identify other options and use them
as counterbalances, carefully evaluating all the pluses and minuses.

Ask yourself whether you would choose the status-quo alternative if, in fact, it weren’t the
status quo.

Avoid exaggerating the effort or cost involved in switching from the status quo.

Remember that the desirability of the status quo will change over time. When comparing
alternatives, always evaluate them in terms of the future as well as the present.

If you have several alternatives that are superior to the status quo, don’t default to the
status quo just because you’re having a hard time picking the best alternative. Force
yourself to choose.

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The Sunk-Cost Trap

Another of our deep-seated biases is to make choices in a way that justifies past choices, even
when the past choices no longer seem valid. Most of us have fallen into this trap. We may have
refused, for example, to sell a stock or a mutual fund at a loss, forgoing other, more attractive
investments. Or we may have poured enormous effort into improving the performance of an
employee whom we knew we shouldn’t have hired in the first place. Our past decisions become
what economists term sunk costs—old investments of time or money that are now irrecoverable.
We know, rationally, that sunk costs are irrelevant to the present decision, but nevertheless they
prey on our minds, leading us to make inappropriate decisions.

Why can’t people free themselves from past decisions? Frequently, it’s because they are
unwilling, consciously or not, to admit to a mistake. Acknowledging a poor decision in one’s
personal life may be purely a private matter, involving only one’s self-esteem, but in business, a
bad decision is often a very public matter, inviting critical comments from colleagues or bosses.
If you fire a poor performer whom you hired, you’re making a public admission of poor
judgment. It seems psychologically safer to let him or her stay on, even though that choice only
compounds the error.

The sunk-cost bias shows up with disturbing regularity in banking, where it can have
particularly dire consequences. When a borrower’s business runs into trouble, a lender will often
advance additional funds in hopes of providing the business with some breathing room to
recover. If the business does have a good chance of coming back, that’s a wise investment.
Otherwise, it’s just throwing good money after bad.

One of us helped a major U.S. bank recover after it made many bad loans to foreign
businesses. We found that the bankers responsible for originating the problem loans were far
more likely to advance additional funds—repeatedly, in many cases—than were bankers who
took over the accounts after the original loans were made. Too often, the original bankers’
strategy—and loans—ended in failure. Having been trapped by an escalation of commitment,
they had tried, consciously or unconsciously, to protect their earlier, flawed decisions. They had
fallen victim to the sunk-cost bias. The bank finally solved the problem by instituting a policy
requiring that a loan be immediately reassigned to another banker as soon as any problem arose.
The new banker was able to take a fresh, unbiased look at the merit of offering more funds.

Sometimes a corporate culture reinforces the sunk-cost trap. If the penalties for making a
decision that leads to an unfavorable outcome are overly severe, managers will be motivated to
let failed projects drag on endlessly—in the vain hope that they’ll somehow be able to transform
them into successes. Executives should recognize that, in an uncertain world where
unforeseeable events are common, good decisions can sometimes lead to bad outcomes. By
acknowledging that some good ideas will end in failure, executives will encourage people to cut
their losses rather than let them mount.

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What Can You Do About It?

For all decisions with a history, you will need to make a conscious effort to set aside any sunk
costs—whether psychological or economic—that will muddy your thinking about the choice at
hand. Try these techniques:

Seek out and listen carefully to the views of people who were uninvolved with the earlier
decisions and who are hence unlikely to be committed to them.

Examine why admitting to an earlier mistake distresses you. If the problem lies in your
own wounded self-esteem, deal with it head-on. Remind yourself that even smart choices
can have bad consequences, through no fault of the original decision maker, and that even
the best and most experienced managers are not immune to errors in judgment. Remember
the wise words of Warren Buffett: “When you find yourself in a hole, the best thing you
can do is stop digging.”

Be on the lookout for the influence of sunk-cost biases in the decisions and
recommendations made by your subordinates. Reassign responsibilities when necessary.

Don’t cultivate a failure-fearing culture that leads employees to perpetuate their mistakes.
In rewarding people, look at the quality of their decision making (taking into account what
was known at the time their decisions were made), not just the quality of the outcomes.

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The Confirming-Evidence Trap

Imagine that you’re the president of a successful midsize U.S. manufacturer considering whether
to call off a planned plant expansion. For a while you’ve been concerned that your company
won’t be able to sustain the rapid pace of growth of its exports. You fear that the value of the
U.S. dollar will strengthen in coming months, making your goods more costly for overseas
consumers and dampening demand. But before you put the brakes on the plant expansion, you
decide to call up an acquaintance, the chief executive of a similar company that recently
mothballed a new factory, to check her reasoning. She presents a strong case that other
currencies are about to weaken significantly against the dollar. What do you do?

You’d better not let that conversation be the clincher, because you’ve probably just fallen
victim to the confirming-evidence bias. This bias leads us to seek out information that supports
our existing instinct or point of view while avoiding information that contradicts it. What, after
all, did you expect your acquaintance to give, other than a strong argument in favor of her own
decision? The confirming-evidence bias not only affects where we go to collect evidence but also
how we interpret the evidence we do receive, leading us to give too much weight to supporting
information and too little to conflicting information.

In one psychological study of this phenomenon, two groups—one opposed to and one
supporting capital punishment—each read two reports of carefully conducted research on the
effectiveness of the death penalty as a deterrent to crime. One report concluded that the death
penalty was effective; the other concluded it was not. Despite being exposed to solid scientific
information supporting counterarguments, the members of both groups became even more
convinced of the validity of their own position after reading both reports. They automatically
accepted the supporting information and dismissed the conflicting information.

There are two fundamental psychological forces at work here. The first is our tendency to
subconsciously decide what we want to do before we figure out why we want to do it. The
second is our inclination to be more engaged by things we like than by things we dislike—a
tendency well documented even in babies. Naturally, then, we are drawn to information that
supports our subconscious leanings.

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What Can You Do About It?

It’s not that you shouldn’t make the choice you’re subconsciously drawn to. It’s just that you
want to be sure it’s the smart choice. You need to put it to the test. Here’s how:

Always check to see whether you are examining all the evidence with equal rigor. Avoid
the tendency to accept confirming evidence without question.

Get someone you respect to play devil’s advocate, to argue against the decision you’re
contemplating. Better yet, build the counterarguments yourself. What’s the strongest
reason to do something else? The second strongest reason? The third? Consider the
position with an open mind.

Be honest with yourself about your motives. Are you really gathering information to help
you make a smart choice, or are you just looking for evidence confirming what you think
you’d like to do?

In seeking the advice of others, don’t ask leading questions that invite confirming
evidence. And if you find that an adviser always seems to support your point of view, find
a new adviser. Don’t surround yourself with yes-men.

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The Framing Trap

The first step in making a decision is to frame the question. It’s also one of the most dangerous
steps. The way a problem is framed can profoundly influence the choices you make. In a case
involving automobile insurance, for example, framing made a $200 million difference. To reduce
insurance costs, two neighboring states, New Jersey and Pennsylvania, made similar changes in
their laws. Each state gave drivers a new option: By accepting a limited right to sue, they could
lower their premiums. But the two states framed the choice in very different ways: In New
Jersey, you automatically got the limited right to sue unless you specified otherwise; in
Pennsylvania, you got the full right to sue unless you specified otherwise. The different frames
established different status quos, and, not surprisingly, most consumers defaulted to the status
quo. As a result, in New Jersey about 80% of drivers chose the limited right to sue, but in
Pennsylvania only 25% chose it. Because of the way it framed the choice, Pennsylvania failed to
gain approximately $200 million in expected insurance and litigation savings.

The framing trap can take many forms, and as the insurance example shows, it is often
closely related to other psychological traps. A frame can establish the status quo or introduce an
anchor. It can highlight sunk costs or lead you toward confirming evidence. Decision researchers
have documented two types of frames that distort decision making with particular frequency.

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Frames as Gains Versus Losses

In a study patterned after a classic experiment by decision researchers Daniel Kahneman and
Amos Tversky, one of us posed the following problem to a group of insurance professionals:

You are a marine property adjuster charged with minimizing the loss of cargo on three
insured barges that sank yesterday off the coast of Alaska. Each barge holds $200,000
worth of cargo, which will be lost if not salvaged within 72 hours. The owner of a local
marine-salvage company gives you two options, both of which will cost the same:

Plan A: This plan will save the cargo of one of the three barges, worth $200,000.
Plan B: This plan has a one-third probability of saving the cargo on all three

barges, worth $600,000, but has a two-thirds probability of saving nothing.
Which plan would you choose?

If you are like 71% of the respondents in the study, you chose the “less risky” Plan A, which
will save one barge for sure. Another group in the study, however, was asked to choose between
alternatives C and D:

Plan C: This plan will result in the loss of two of the three cargoes, worth $400,000.
Plan D: This plan has a two-thirds probability of resulting in the loss of all three

cargoes and the entire $600,000 but has a one-third probability of losing no cargo.

Faced with this choice, 80% of these respondents preferred Plan D.
The pairs of alternatives are, of course, precisely equivalent—Plan A is the same as Plan C,

and Plan B is the same as Plan D—they’ve just been framed in different ways. The strikingly
different responses reveal that people are risk averse when a problem is posed in terms of gains
(barges saved) but risk seeking when a problem is posed in terms of avoiding losses (barges lost).
Furthermore, they tend to adopt the frame as it is presented to them rather than restating the
problem in their own way.

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Framing with different reference points

The same problem can also elicit very different responses when frames use different reference
points. Let’s say you have $2,000 in your checking account and you are asked the following
question:

Would you accept a fifty-fifty chance of either losing $300 or winning $500?

Would you accept the chance? What if you were asked this question:

Would you prefer to keep your checking account balance of $2,000 or to accept a fifty-
fifty chance of having either $1,700 or $2,500 in your account?

Once again, the two questions pose the same problem. While your answers to both questions
should, rationally speaking, be the same, studies have shown that many people would refuse the
fifty-fifty chance in the first question but accept it in the second. Their different reactions result
from the different reference points presented in the two frames. The first frame, with its reference
point of zero, …