Risk from the Managers Perspective (Part 2)

Today I will write about the implications of the risk understanding by managers covered in Part 1 of this series. After observing the mentioned factors on how managers perceive risks the authors categorize their conclusions in three areas.

Insensitivity of Risk Taking to Probability Estimates

[Decision makers] do not trust, do not understand, or simply do not much use precise probability estimates.

This quote summarizes one of the major findings. Probabilities – not risk at large – are not well understood and handled by managers. This is especially fatal when considering disruptions, events with low probabilities but high adverse effects. Because these events are then ignored since managers are overwhelmed by their sheer number. And of course this leads to organizations which are always surprised by events that they did not think of.

In some of my interviews during my research with business executives I spotted the same behavior: supply chain managers that never have thought of the possibility of a strike, a fire or another catastrophe. But the number of managers on the other end – so really managing these risks – seems to be even lower.

The Importance of Attention Factors for Risk Taking

Empirical research – as for example in Part 1 – indicate that risk preference varies with the context in which the decision has to be made. This includes everything from individual feelings of the manager, how and by whom the data is presented, the company context, etc.

In human decision making there is always the tendency to focus on a few key aspects of a problem at a time. Therefore it is of the utmost importance to define and calculate the key metrics correctly, but often not only the measures may pose a problem but also the target levels to assess performance (eg. break even) and survival levels. These two reference points partition possible states into three: success, failure, and extinction; and with that massively influence decision making in each of the three categories

Risk Taking, Gambling, and Managerial Conceit

Managers do care a lot about their reputations for risk taking, on the other hand are eager talk about how they assess the qualities of others in this regard and on the inadequacy of organizational incentives for making risky decisions intelligently. So risk taking seems to be a very important part of their definition of life as a manager. It is important to take risks, but not to “gamble”.

Hence, it is amazing to see that managers are still rewarded for good outcomes rather than good decisions (making).
The authors see this point very critical

Society values risk taking but not gambling, and what is meant by gambling is risk taking that turns out badly. Thus, risky choices that tum out badly are seen, after the fact, to have been mistakes. The warning signs that were ignored seem clearer than they were; the courses that were followed seem unambiguously misguided.

Conclusion

The authors conclude with the following recommendations for the proceeding:

• Short run: Measures have to be designed which accommodate for these findings, but more importantly there has to be a concept on how to steer risk taking by managers.
• Long run: These findings might have implications for the education of managers to improve the individual risk taking.

We may prefer to have managers imagine (sometimes falsely) that they can control their fates, rather than suffer the consequences of their imagining (sometimes falsely) that they cannot.

This article has been written in 1987, nearly one generation ago, but to be honest I believe most of the results are still true nowadays (to my knowledge there has not been another similar study, yet). Sadly, I do not think that neither companies have improved decision making nor education has picked up much. In my point of view the handling of decision making under uncertainty should be supported by IT and the organization.