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Decision biases in the boardroom
Individuals tend to make biased decisions. For instance, heuristics guide our judgements to help us cope with human limitations in cognition and complex circumstances. Unfortunately, heuristics may result in cognitive biases that deviate from rational thinking with potentially severe errors.
Directors on corporate boards are no different. They also have decision biases. Working towards reducing decision biases should be a focus of high-impact boards. This is more important with the increasing volatility, uncertainty, complexity and ambiguity of the global business landscape.
Common decision biases in corporate boards
Research on human judgment and decision science has identified a number of biases that lead to predictable deviations from rationality.
An article, “Intelligent boards know their limits”, published in INSEAD Knowledge in 2017 highlighted some common biases readily observed in board meetings.
For instance, confirmation bias occurs when decision-makers unconsciously seek out information that confirms (or ignore information that contradicts) their initial judgment. This bias can potentially lead directors to continue pursuing the status quo when change may be a better alternative.
Decision-makers also tend to be more confident in their judgments than is warranted by the evidence. The overconfidence bias can be a barrier to effective professional decision-making as overconfident directors pursue actions predicated on an overestimation of their knowledge or abilities.
The two biases mentioned above are just the tip of the iceberg. There are other individual-level and group-level biases, such as groupthink, that can derail sound decision-making in areas that concern corporate boards.
Corporate boards in Singapore should be alert to decision biases, especially in the areas that deserve more attention from directors moving forward. Judgements in risk management, corporate governance and compliance, and strategy execution, for example, are prone to biases.
For instance, the Global Risks Report 2018 by the World Economic Forum highlighted the importance of cognitive and behavioural factors in risk management, and urged individuals and institutions to overcome biases such as confirmation bias and hyperbolic discounting bias, which prioritises short-term goals at the expense of long-term value creation.
Reducing decision biases is important when developing sound governance and strategies of a company, especially for non-executive directors. They not only have to deal with potential biases in their own decisions but also be alert to such biases in executive directors whom they monitor and advise. For instance, there is some evidence that overpayments for acquisitions occur because of a CEO’s overconfidence bias.
Corporate boards must equip themselves to reduce decision biases given their responsibility for the long-term success of their companies.
Max Bazerman, a Harvard Business School professor, proposes five complementary strategies for making better decisions in his book, Judgment in Managerial Decision Making. From this analysis, corporate boards can adopt two key actions.
First, developing expertise to recognise biases is a good start. Corporate boards can arrange for regular training by experts who do research on cognitive biases and decision-making. Essentially, building awareness of biases, and the tendency towards certain biases, is key.
Second, corporate boards can develop procedures or processes to reduce biases.
One such process is for corporate boards to include an outsider’s view in decision-making instead of solely relying on an insider’s view. Studies suggest that there are two perspectives on decision-making. An insider perspective treats each decision as unique and is more prone to biases. In contrast, an outsider perspective identifies similarities and abstracts generalities which aid objective decision-making.
The key is to give the outsider perspective more weight in decision-making. This may involve non-executive directors, as outsiders, playing the devil’s advocate and actively challenging the assumptions of the insider management team. Interestingly, this also suggests some merit for non-executive directors to refrain from active involvement in strategy development or they risk losing their outsider perspective. Alternatively, corporate boards may invite independent outsiders or consultants with relevant experience to share their insights on the insiders’ perspectives.
Another procedure involves embracing diverse boards with relevant experience for key corporate decisions. For instance, a 2019 article “CEO overconfidence and CSR decoupling” in Corporate Governance: An International Review found that outside directors with corporate social responsibility (CSR) expertise reduce the tendency of overconfident CEOs engaging in overly optimistic CSR reporting that deviates from actual CSR performance.
Corporate boards with diverse points of view are also conducive for constructive dissent, if properly managed. Some turnover of directors, leading to board tenure diversity, may combat decision biases from prolonged involvement by allowing fresh perspectives into strategic deliberations.
Debiasing judgment requires constant attention. Regular and timely reviews of decision-making processes and outcomes can help reduce biases for current and subsequent decisions. While corporate boards cannot eliminate all decision biases, efforts to reduce biases can reap benefits in the form of making better decisions.
The writer is a member of the Advocacy and Research Committee of the Singapore Institute of Directors.