Decisions – Best or Second Best?

A recent article in the Wall Street Journal (WSJ) was headlined “How You Make Decisions Says a Lot about How Happy You Are”. The journalist then asked the question, “Are you a ‘Maximizer’ or a ‘Satisficer’”? She then reported that ‘Satisficers’ are happier.

But what does this mean for business decision-making, if anything?

Maximize or Satisfice
Although Elizabeth Bernstein’s article in the WSJ is dated October 2014 [1], it was in fact reporting on research published several years ago by Dr Barry Schwartz, a US professor of psychology and author of ‘The Paradox of Choice’ [2]. Not that the reasoning is ‘old hat’. Far from it, in fact the concepts in the article are very topical, as the popularity of the bestselling book by Nobel Prize-winner Daniel Kahneman ‘Thinking Fast and Slow’ illustrates [3].

Dr Schwartz describes a ‘Maximizer’ as a person who ‘seeks and accepts only the best’, whereas a ‘Satisficer’ is someone who settles for something that is ‘good enough’. The conventional wisdom, and that taught in business schools, is that managers are/ should be Maximizers, logically and methodically examining all of the options before coolly and clinically making a decision and sticking with it. But as we all know, the world is a much messier place than that portrayed on MBA courses and people have sometimes to do the best they can, although the resulting decision is rarely sold as being ‘second best’.

The term ‘Satisfice’ was coined by Nobel Prize-winner Herbert Simon, the father of Decision Theory. Simon, one of the most original management thinkers, pointed out that people cannot make perfect decisions, because their ‘rationality’ is ‘bounded’, or limited, by: the amount of information that they have at hand; the time they have to make a decision; and unfortunately, the ‘cognitive limitations’ of their minds. In other words, smart as we are, we don’t have enough time, access to information or ‘smarts’ to make the perfect decision. We know intuitively that no matter how hard we try we cannot make the perfect decision so we are all Satisficers, to one degree or another. But of course, if we personally are Maximizers, we will still try to do the best we can.

In Ms Bernstein’s article, she shows a quiz, developed by Schwartz and colleagues, which asks the reader to answer 13 questions, on a scale of 1 to 7 (Strongly Agree to Strongly Disagree). I took the test and found (like most people tested by Dr Schwartz), that I was at neither end of the spectrum but somewhere in the middle (in my own case, more Maximizer than Satisficer).

Dr Schwartz’s papers and books are primarily about ‘choice’ and how people go about making choices between several options. While Ms Bernstein’s article and Dr Schwartz’s work concentrate how we make day to day choices, such as what car or brand of cereal to buy, it is probable that we are Maximizers or Satisficers in all aspects of our lives, home and business, and we don’t magically change from one mode of operation to the other when we enter our offices.

Decision-Making
When faced with making a decision choosing from multiple options, Maximizers will ‘worry’ the problem to death, looking at the problem from all sides, trying to collect more information, building complex spreadsheets to analyse the options and eventually arrive at a decision (often under the pressure of time). On the other hand, Satisficers will no less diligently look at the options, but intuitively discard a number of options because they ‘know from experience’ what will work and what won’t. Everybody makes decisions based on experience. For example, we don’t pull out a speed camera to cross a busy road but guess how fast traffic is flowing and try to cross in a suitable break. These, so-called, ‘heuristics’ are tried and tested shortcuts that some psychologists argue will often result in people making better decisions, because humans have evolved to be ‘heuristics machines’. But, of course, heuristics are not fool proof, sometimes some of us misjudge traffic speed with fatal consequences.

But Maximizers and Satisficers have one thing in common – neither are completely happy about the decisions that they do make!

Granted Satisficers show less ‘regret’, but Maximizers are unhappy because they set out to make the best decision and they know they have not done so (because they didn’t have time or money to analyse all of the options fully). On the other hand, Satisficers always know that there is a possibility that there was a better option out there that they either didn’t consider or consider in enough detail. All decisions of any consequence are therefore a compromise in satisficing.

So how do decision-makers deal with this inevitable ‘regret’?

As might be expected, Maximizers worry about the fact that they didn’t (because they couldn’t) cover all the bases possible, so they tend to search for confirmation from people they respect that at least they had tried hard enough. So a group of decision-makers, such as a corporate Board, when considering a major decision will, if they are predominantly Maximizers, seek confirmation from one anther that they are doing the right thing. This can lead to a bias known as Groupthink! And having convinced themselves they are doing the right thing, they will be loathed to break rank down the tracks if things start to go wrong – swimming or sinking together.

Satisficers on the other hand adopt a different tactic when making decisions, in that they identify early on what an acceptable outcome will be for the particular decision and then consider the options until they find one which fits the acceptability criteria. Such an approach can be perfectly rational as, for example, in real life it doesn’t matter how fast you cross the road just that you do. The regret that Satisficers have is that they know that there is a strong possibility that there is a much better, more acceptable option out there but they will never know how good that option was. (In other words, Satisficers would like to be Maximizers but don’t have the time or energy).

How do Satisficers handle this regret? In the same way as Maximizers, by gaining assurance from their peers that the acceptability criteria are good; again a search for ‘concurrence’ that can lead to a Groupthink bias. Satisficers also face the problem that the decision-making process can be gamed. For example, if a CEO knows that his/her Board is made up mainly of Satisficers, then by manipulating or ‘framing’ the acceptability criteria, he/she can get their preferred option accepted by presenting it first (or even better using the old sales trick of presenting the option after first showing a particularly unacceptable one).

Good and Bad Decisions
What is a bad decision? Certainly not one that has a ‘bad outcome’! A bad decision may turn out to have a good outcome because of circumstances outside of the decision-maker’s control, for example betting one’s house on a long shot that just happens to win. On the other hand, a good decision may have a bad outcome, again because of uncontrollable factors, such as, for example, buying an AAA rated CDO before the GFC, which many investors did for very sound reasons at the time.

Since all decisions are subject to the biases, conflicts of interest and ‘bounded rationality’ of the individuals or groups responsible for making them, the participants cannot themselves decide whether a decision is ‘good’ or not. A good decision then is one that can be explained to, and in the case of business be audited by, an independent observer such as a Risk Manager or Auditor.

To make a good decision then, decision-makers must then be transparent about how they went about making a particular decisions. In other words, they must document the processes that they followed, the information they used, the assumptions they made, the options they considered, the reasons why they did not consider other options, the criteria they used to select the preferred option and most importantly the steps they took to recognise and remove biases and conflicts of interest.

In other words, to make the best decision they can, decision-makers must follow a sound, transparent and auditable decision-making process and be accountable for following that process.

Sounds – Pie in the Sky?

Not really. The US Federal Reserve Board’s Open Market Committee (FOMC), surely one of the most important decision-making bodies in the world as it sets interest rate policy for the USA, records all of its meetings and publishes a full transcript of the committee’s deliberations after five years. Since everyone can see the decision-making process in action (albeit with hindsight), the committee members are forced to be diligent in their deliberations and in the arguments that they put forward. It doesn’t mean that all of the FOMC decisions are correct but at least they are ‘good’, i.e. they are made within a sound, transparent,auditable process.

People Risk Management
The risk that an employee deliberately or inadvertently makes a bad decision is a People Risk as it can lead to significant losses even the bankruptcy of the firm. This blog is one of a planned series that will discuss facets of People Risk in general and Decision-Making in particular. It is obvious that managers and assurance functions, such as Risk Management, Audit, Compliance and Human Resources, must understand the concept of People Risk, particularly the influence of individual and group biases on decision-making, because badly-made decisions may result in significant damage to the firm.

References
[1] See Wall Street Journal, http://online.wsj.com/articles/how-you-make-decisions-says-a-lot-about-how-happy-you-are-1412614997
[2] See Schwartz, B., 2009, The Paradox of Choice, HarperCollins
[3] See Kahneman, D., 2011, Thinking Fast and Slow, Allen Lane

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3 responses to “Decisions – Best or Second Best?”

  1. Cait says :

    great lead in to future postings will you consider Taleb’s anitifragie?

    Like

    • pjmcconnellrisk says :

      Cait
      Many thanks for your comment
      To be truthful, we were not planning to consider ‘anti-fragility’ not because it is not worthy of consideration, but merely because we are concentrating on the individual and smaller groups rather than systemic disruptions. But food for thought so will open mind to it
      Regards, Pat

      Like

  2. Caryl Anne says :

    Very interesting and informative post! It’s definitely provides an open mindset to new and different things. Thanks for sharing!

    Like

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