DeKalb, Ill. – Earlier this year, NIU management professor Devaki Rau was recognized for her “A” publication — which she co-authored with Professor Philip Bromiley at the University of California, Irvine — titled “A review of cognitive biases in strategic decision making.” The article appeared in the June issue of Long Range Planning.
Rau’s research focused on a full literature review of empirical research on cognitive biases that affect decision makers in established organizations as they make strategic decisions.
“From the outside, strategic planning — and strategic decision-making more generally — seems to exemplify a rational process: Managers work together to identify a problem, gather all relevant information, evaluate the pros and cons of alternative courses of action, decide on what to do and implement their decision flawlessly,” Rau said. “However, managers are human beings and, as such, make decisions that deviate from ‘rationality’ in ways that are probably familiar to all of us.”
Rau noted that a manager’s perspective on a problem is influenced by their organizational role, often causing them to gather only information they deem relevant while overlooking other crucial details. Additionally, managers may rely on mental shortcuts and unconscious biases that shape their decisions.
The Value of Bias in Decision-making
“Strategic decisions, though seemingly rational, may be biased in ways that are not immediately obvious to others or even to the managers themselves. These biases have a hugely important impact on organizations,” she said. “For example, companies may continue to invest in a project long after the point where it should have been discontinued.”
Rau found that this disconnect between “rational” decision-making and the actual decisions implemented in organizations drew her to the study of cognitive biases.
“Specifically, I wanted to examine what biases managers are subject to, and what we really know about the impact of these biases in firms. What have we learned from our many years of research on this topic?” she said.
Rau’s research provides a review of the 169 empirical articles on cognitive biases in strategic decision-making which were published between 2000 and 2023. The study examines patterns in the measures, causes and outcomes of two broad categories of biases: Systematic biases that operate similarly across individuals (such as overconfidence, escalation of commitment and loss aversion); and idiosyncratic biases that depend on the decision maker’s experience and past interactions (such as myopia and local search bias). The study also distinguishes between findings with strong empirical evidence and those with less empirical support.
Rau’s review indicates that researchers measure both systematic and idiosyncratic biases using one or more of three broad approaches: Assuming or inferring the bias, measuring it directly, and experimentally manipulating the bias and observing its effects.
Common and Uncommon Biases in Senior Managers
Overall, Rau’s review found that we understand the most about two biases in senior managers. The first is loss aversion, which shows that a loss of money is more painful than a gain of the same amount of money is attractive. This is reflected in a managerial avoidance of choices with negative potential outcomes. The second bias is overconfidence.
“Across studies, we find that loss aversion has strong but mixed (positive or negative) effects on outcomes such as diversification or internationalization, acquisitions, research and development intensity or investments, and risk-taking,” she said.
On a practical level, leaders and strategic thinkers may think they want people in their organizations to make unbiased decisions. However, they need to remember that identifying bias in decision-making — and distinguishing it from a deliberate decision or a sensible response to the incentives or environment faced by the manager — is difficult.
“In spite of its negative connotation, biased decision-making is not necessarily bad,” Rau said. “It may even have a positive effect on a firm. For example, biased expectations may serve positive functions in organizations such as motivating people to work toward a desired goal. Though overconfidence has negative effects on corporate social responsibility, performance and forecasting, it has mostly positive effects on innovation and risk-taking.”
Further, if biases can be potentially corrected by learning or other mechanisms, we need to remember that different debiasing techniques come with their own costs and vary in effectiveness. It may well be, as some scholars have said, that bias is a design feature of decision-making, not a bug.
Rau noted that a few studies find some interesting effects of overconfidence on strategic planning or foresight, expectations for future performance and responsiveness to feedback.
“Specifically, some studies find that managerial hubris leads to a lower level of strategic foresight,” she said. “Founder CEOs of large S&P 1500 companies appear to be more overconfident than their nonfounder counterparts, with the former using more optimistic language on earnings conference calls and being more likely to not only issue earnings forecasts that are too high but also perceive their firms to be undervalued. Additionally, firms led by overconfident CEOs appear to be less responsive to corrective feedback in improving management forecast accuracy.”
Another interesting finding in this context relates to flattery and overconfidence. One study argues that CEOs who have acquired positions of relatively high social status in the corporate elite tend to be attractive targets of flattery and opinion conformity from colleagues. This can increase CEOs’ overconfidence in their strategic judgment and leadership capability, leading to biased decision-making.
“The study [of U.S. CEOs] finds that strategic persistence that results from high levels of flattery and opinion conformity directed at the CEO can result in the persistence of low firm performance and may ultimately increase the likelihood of CEO dismissal,” Rau said.
One unexpected bias that was discovered during the review is the “success bias.” One study finds that this occurs when a previous successful outcome leads to the “red queen” effect: Organizations adapt, but being well adapted from one context makes moving into new contexts more hazardous. Meanwhile, managers in such organizations have a biased assessment of their organization’s ability to change (success bias) and therefore undertake disruptive exploratory change. This bias explains failure rates when organizations successful in one market move into another market.
While there are a number of tools available to “de-bias” decision-making, Rau noted that she would caution managers to do a few things before starting any interventions.
“They should make sure they are actually observing a bias rather than a sensible response to a complex situation,” she said. “And they should be aware of the costs (and varying effectiveness) of de-biasing, including that the ‘bias’ may be serving a positive function in their organization.”
About NIU
Northern Illinois University is a student-centered, nationally recognized public research university, with expertise that benefits its region and spans the globe in a wide variety of fields, including the sciences, humanities, arts, business, engineering, education, health and law. Through its main campus in DeKalb, Illinois, and education centers for students and working professionals in Chicago, Naperville, Oregon and Rockford, NIU offers more than 100 courses of study while serving a diverse and international student body.
Media Contact: Jami Kunzer
Main Photo by Vitaly Gariev on Unsplash
