Thoughts from reading the books Thinking Fast and Slow by Daniel Kahneman and The Halo Effect by Phil Rosenzweig.
- Humans are prone to cognitive biases which can lead to suboptimal decision making. Many of these biases are driven by our desire to make sense of what is happening around us and to create stories that logically explain major events.
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Halo effect is the tendency to attribute traits (independent variables) based on outcome (dependent variable). For example, if a company has several years of growth, its CEO will be praised for being pioneering and aggressively entering an adjacent market. In the counterfactual situation where the company struggled, the same CEO might be criticized for taking wantonly taking risks and neglecting the core business.
- People, particularly experts and optimists, greatly overestimate their impact or understanding. Leaders of organizations, such as the President, CEOs, etc., are seen as responsible for the overall outcome of their organizations. Studies have shown that a better CEO is only likely to outperform his or her counterparts 6 out of 10 times (i.e. a 10% improvement from flipping the coin). CFOs of major companies were asked to predict the movement of the S&P 500 markets. Not only were they significantly off, they were overtly confident about their predictions.
- People go for simplistic explanations because it's easier to comprehend and follow. Complex explanations such as "growing a business requires a careful analysis of the competitive landscape, assessment of potential disruptive innovations, and managing risks through a balanced portfolio" is harder to follow than a simple explanation such as "building a great company is about focusing on customers and empowering employees". The reason why the first is more complex is not that there's more steps - it's that it focuses not on concrete actions (e.g. promote employees within your organization to groom leaders), but on a mindset (e.g. assess various scenarios in how 3D printing can affect this industry).
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Survivor bias can lead us to idolizing risk-taking companies because we are not as aware about that failures.Rather than taking into account the risk inherent in big movies such as acquisitions or entering a new market, people focus on the successful stories. Michael Raynor wrote a book The Strategy Paradox: Why Committing to Success Leads to Failure that covers this issue.
- System 1 is the lizard brain - it feeds off emotions and generates our gut reactions. System 2 is the higher order thinking brain. It can carefully consider tradeoffs, but it takes significant energy to use it, so we conserve energy by not using it whenever possible.
- The framing of a choice makes a big impact in how people respond -- even professionals (such as doctors about medical decisions). People consistently are risk-averse when given a choice of a guaranteed win (100% to win $500) over a very likely win (80% chance to win $650). People are risk-taking when given two bad choices and have a chance to entirely avoid the bad outcome (although with a smaller expected value).The prospect theory helps explain these decisions by focusing on the gains and losses vs. the final state, which is what expected utility theory focused on. Prospect theory also emphasizes the importance of the reference point, which is typically the previous states.
- The two selves are the remembering self which is how you think about your memories and what you use to make future decisions and the experiencing self which is how you feel at a given moment.