Tuesday, October 25, 2011

Kahneman: Bias, Blindness and How We Truly Think - Bloomberg

Daniel KahnemanImage via WikipediaNobel laureate Daniel Kahneman writing for Bloomberg:

Kahneman: Bias, Blindness and How We Truly Think - Bloomberg:

The evidence suggests that an optimistic bias plays a role -- sometimes the dominant role -- whenever people or institutions voluntarily take on significant risks. More often than not, risk-takers underestimate the odds they face and, because they misread the risks, optimistic entrepreneurs often believe they are prudent, even when they are not. Their confidence sustains a positive mood that helps them obtain resources from others, raise the morale of their employees and enhance their prospects of prevailing. When action is needed, optimism, even of the mildly delusional variety, may be a good thing.

But optimism, like many things, is best in moderation:

"In the market, of course, belief in one’s superiority has significant consequences. Leaders of large businesses sometimes make huge bets in expensive mergers and acquisitions, acting on the mistaken belief that they can manage the assets of another company better than its current owners do. The stock market commonly responds by downgrading the value of the acquiring firm, because experience has shown that such efforts fail more often than they succeed. Misguided acquisitions have been explained by a “hubris hypothesis”: The executives of the acquiring firm are simply less competent than they think they are.
The economists Ulrike Malmendier and Geoffrey Tate identified optimistic chief executive officers by the amount of company stock that they owned personally and observed that highly optimistic leaders took excessive risks. They assumed debt rather than issue equity and were more likely to “overpay for target companies and undertake value-destroying mergers.” Remarkably, the stock of the acquiring company suffered substantially more in mergers if the CEO was overly optimistic by the authors’ measure. The market is apparently able to identify overconfident CEOs."

Read the full article here. Especially if you are in my behavioral class! :)

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