I recently re-read an article in a McKinsey’s Strategy & Finance newsletter, Overcoming a bias against risk. (I strongly recommend subscribing.)
Although it starts with “Risk-averse midlevel managers making routine investment decisions can shift an entire company’s risk profile,” the main point I got from the piece was that individual managers at any level, including on the board, can be overly risk-averse. They can also be overly risk-taking.
Why? Because their individual bias for or against taking risk gets in the way of objective decision-making.
Here are some excerpts:
- Much of the commentary about behavioral economics and its applications to managerial practice, including our own, warns against overconfidence—that biases in human behavior might lead managers to overstate the likelihood of a project’s success and minimize its downside[1]. Such biases were certainly much debated during the financial crisis.
- Often overlooked are the countervailing behavioral forces—amplified by the way companies structure their reward systems—that lead managers to become risk averse or unwilling to tolerate uncertainty even when a project’s potential earnings are far larger than its potential losses[2].
- …dynamics like this play out many times per year across companies, where decisions are driven by the…
