The extraordinary power of the spoken or written word, to persuade, is undisputed. Leaders routinely rely upon them to convince stakeholders to adopt the preferred direction or option. But rarely do they use the principles of Behavioural Economics to shape their narratives.
In his Nobel Prize winning work on Prospect Theory, Daniel Kahneman, the father of Behavioural Economics, showed that our choices vary depending on how we intuitively perceive them. When faced with say two alternatives both of which offer gains (of health, wealth, or happiness) we tend to be risk averse. Faced with choices between losses we become risk seeking even though circumstances, uncertainty, and consequences are exactly the same as the situation perceived as gain.
How can CEOs and leaders leverage this nugget to influence managers and other leaders to pursue a preferred course of action?
Let us look at a specific example, albeit hypothetical, to explore how it can be done.
Imagine your Company is facing a court case whose outcome is by no means certain. The Court is likely to impose an unpleasant cost if the judgement is unfavourable.
You, the CEO, can stem the loss by negotiating an out-of-court settlement ahead of the verdict. It won’t come cheap but the cost will be significantly less than the court-imposed penalty. You believe it is the better option but you need the Board’s approval.
Choosing between the devil and the deep sea
In my October edition of Perspectives on Strategy I had invited two large groups of my readers to participate in a survey centred on the above problem. They were asked to anonymously cast their votes as directors of the Company you lead as CEO. Half the readers were presented choices that appeared as gains; the other half responded to options presented as losses.
58% of respondents (n=76) presented with options between LOSSES chose to settle out of court. This was opposite of risk seeking behaviour (awaiting court’s judgement) one would have expected. However the so-called majority response did not stand the test of statistical significance at 1%. In other words we could not be sure 58% was an unqualified majority and not a random occurrence (50:50).
People presented choices between GAINS however were unequivocal. 69% (n=90) chose to settle out of court. Their position in the management hierarchy (proxy for experience), interest in related subjects like economics, behavioural economics, psychology, or decision making made no difference. Finding was valid at 1% significance (99% confidence).
Here was empirical data that if directors were asked to choose one of the following options (between gains), they would choose A.
A. Settle out of court with 50% chance of saving INR 30 Crores (300 million) [saving in comparison with INR 40 Crores (400 million) penalty if the case is lost],
B. Await the Court’s judgement and take 50% chance of saving Rs. 400 million if the case is won.
On the other hand, if they were told they had to vote on the following (loss frame), the CEO could not be sure he will get go-ahead to settle out of court.
1. Settle out of court and accept sure loss of INR 10 Crores (100 million).
2. Await the Court’s judgement and take 50% chance of losing INR 40 Crores (400 million) if the case is lost.
The smart CEO in this case would present only the choices between gains to the Board and ask them to vote. He will be sure the Board will authorise him to settle out of court.
There are countless, interesting and very useful ways in which tenets of Behavioural Economics can be applied to decision problems in organisations. They can be embedded in marketing promotions, selection and recruitment, reward and recognition programmes, and in encouraging adoption of key policies. All it requires is interest in this fascinating subject, and a little imagination.