Chapter 11 Decision Making

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Department
Business Administration
Course
Business Administration 2295F/G
Professor
Bill Irwin
Semester
Winter

Description
Chapter 11: Decision Making Opening Vignette – The 2008-2009 Economic Meltdown: - Due to rash of political activity that led to movement which suggested that home ownership should be a right instead of privilege - Through weak (“self” regulation) banks were encouraged to provide mortgages to subprime borrowers on financially inflated real estate - Series of risky decisions were founded upon assumptions that economy would stay strong, real estate prices would continue to rise, and subprime borrowers would somehow find a way to pay their mortgages even though they had no money - Arguments of Born, head of Commodity Futures Trading Commission (from 1998) were ignored - In hindsight, seems global financial crisis could have been avoided - But meltdown results from series of decisions founded upon principles created and backed by American people through office of presidency, voted with their money or their homes What is Decision Making? - Decision making: the process of developing a commitment to some course of action 1. Making a choice among several action alternatives 2. A process that involves more than the final choice; how this decision was reached 3. Usually involves some commitment of resources (time, money, personnel, etc.) - Process of problem solving - Problem: a perceived gap between an existing state and a desired state Well-Structured Problems - Well-structured problem: a problem for which the existing state is clear, the desired state is clear, and how to get from one state to the other is fairly obvious - Problems are simple, their solutions arouse little controversy - Problems are repetitive and familiar - Program: a standardized way of solving a problem o Short-circuit the decision-making process; decision maker goes from problem identification  solution o Rules, routines, standard operating procedures, rules of thumb - Many org.’s problems; programmed decision making provides useful means of solving - Programs are only as good as decision-making process that led to adoption of program Ill-Structured Problems - Ill-structured problems: a problem for which the existing and desired states are unclear and the method of getting to the desired state is unknown - Generally unique; unusual and have not been encountered - Complex, involved high degree of uncertainty - Arouse controversy and conflict among decision-stakeholders - Entail high risk and stimulate strong political considerations - Concentration of this chapter!!! The Compleat Decision Maker—A Rational Decision-Making Model 1. Identify problem 2. Search for relevant information (clarifies the problem) 3. Develop alternative solutions to the problem 4. Evaluate alternative solutions 5. Choose best solution 6. Implement chosen solution 7. Monitor and evaluate chosen solution (ensure immediate and continued effectiveness) 8. Repetition or recycling (if difficulties occur) Perfect versus Bounded Rationality - Perfect rationality: a decision strategy that is completely informed, perfectly logical, and oriented toward economic gain o Information gathered without cost o If A>B, B>C then A>C o Economic gain is sole criterion - Bounded rationality: a decision strategy that relies on limited information and that reflects time constrains and political considerations - Operation of bounded rationality and impact of emotions and mood on decision illustrated: o Framing: aspects of the presentation of information about a problem that are assumed by decision makers  Assumptions about the boundaries of a problem  Possible outcomes of a decision  Reference points used to decide if a decision is successful o Cognitive biases: tendencies to acquire and process information in an error-prone way  Constitute assumptions and shortcuts that can improve efficiency  But frequently lead to serious errors in judgement Problem Identification and Framing - Difficulties in problem identification: o Perceptual defence: perceptual system defend perceiver against unpleasant perceptions o Problem defined in terms of functional specialty: problem viewed as being domain of their own speciality o Problem defined in terms of solution: jumping to conclusions effectively short-circuits the rational decision-making process o Problem diagnosed in terms of symptoms: concentration on surface symptoms; few clues about adequate solution - Rational DM should note: o How they have framed problems o Try out alternative frames o Avoid overarching, universal frames Information Search - Perfect: free and instantaneous access - Rational (reality): slow and costly Too little information 1. Tendency to be mentally lazy; use most readily available information a. Vivid, recent events 2. Confirmation bias: the tendency to seek out information that conforms to one’s own definition of or solution to a problem - US invasion of Iraq: overconfidence and confirmation bias; 1986 Challenger space launch: limited range of date examined; 2008-2009 economic meltdown: inadequate information to executives (didn’t understand risk of complicated financial products) Too much information - Information overload: the reception of more information that is necessary to make effective decisions - Can lead to errors, omissions, delays, and cutting corners - DM get confused and permit low-quality information or irrelevant information to influence their decisions - Why DM think more is better 1. Confidence in the decisions will increase 2. Associate possession of information with power - Managers tend to:  Gather much irrelevant info  Use info after decision to justify  Request info they don’t use  Request more regardless of available info  Complain there’s not enough when ignoring available info 3. Cognitive bias to value paid advice > free advice of equal quality Alternative Development, Evaluation, and Choice Perfect rationality: - Maximization: the choice of the decision alternative with the greatest expected value Bounded rationality: - Satisficing: establishing an adequate level of acceptability for a solution to a problem and then screening solutions until one that exceeds this level is found  Firms often invest little money in exploring alternatives in strategic decision making - May not know all alternative solutions, may be ignorant of ultimate values and probabilities of success - Cognitive biases:  Avoid incorporating known existing data of “base rates”  Give small favourable samples more weight  Overestimate the odds of complex chains of events occurring  Anchoring effect: the inadequate adjustment of subsequent estimates from an initial estimate that serves as an anchor - To reduce CB: increase before-the-fact accountability Risky Business - When problem is framed as  Choice between losses  tend to make risky decisions  Choice between gains  tend to make conservative decisions - Learning history can modify these general preferences Solution Implementation - DM often dependent on others to implement their decisions  Difficult to anticipate their ability & motivation - Sequential process leads to confusion conflict, delay unless cross-functional teams are used  Success  teams are sensitive to implementation process Solution Evaluation - When examining possibility of new problem:  Does (new) existing state match desired state?  Has decision been effective? - Perfect rationality: evaluates effectiveness of decision with calm, objective detachment - Bounded rationality: Justification - Tendency to be overconfident of adequacy  arousal of dissonance 1. Bad news is avoidable  avoid careful tests of adequacy of the decision 2. Bad news is unavoidable  justification - Sunk costs: permanent losses of resources incurred as the result of a decision - Escalation of commitment: the tendency to invest additional resources in an apparently failing course of action 1. When DM is responsible, motivated to escalate commitment due to: a. Dissonance reduction b. Social norm that favours consistent behaviour 2. When DM is not responsible: a. To not appear wasteful b. Due to the way the problem is framed (loss  risky decision) c. Situational causes, personality, moods, emotions o High neuroticism and negative affectivity less likely to escalate (try to avoid stressful predicaments) - Situations:  Competitive: prompt escalation; involve emotional arousal (time pressure, rivalry, interested audiences, desire to be first mover)  Non-competitive: can also prompt escalation - To prevent tendencies to escalate commitment:  Reframe problem to saving instead of spending  Set specific goals to be met if more resources are invested  Accountability: more emphasis on how decision was made  Separate initial and subsequent decision making - Note: groups are more prone to escalation Ethical Focus: Rogue Traders Get Trapped in Escalation - Motivated by:  Personal gain  Cover-up (please employer, save face) Hindsight - Can prove useful - But often reflects cognitive bias 1. Knew-it-all-along effect: our faulty memory adjusts the probabilities that we estimated before making the decision to correspond to what actually happened 2. Tendency to take personal responsibility for successful decision outcomes while denying responsibility for unsuccessful outcomes How Emotion and Mood Affect Decision Making Emotion - We often become emotionally attached to failing course of action - Absence of emotion often useful in caution-focused decisions - Strong emotions frequently figure in decision making process that corrects ethical errors - Strong (positive) emotion implicated in creative decision making and proper use of intuition to solve problems - Strong emotion often self-focused and distracted from actual demands of problem at hand  CEO with excessive pride; pay too much for acquisition  CEO angry; lose their heads in competitive acquisition bidding - Excessive emotional conflict  questionable business decisions Mood - Mood affects what and how people think when making decisions - Has greatest impact in uncertain, ambiguous decisions - Tendencies in positive mood:  Remember positive inform
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