Tips for making better decisions, according to a Nobel laureate

Nobel laureate Richard Thaler was interviewed by McKinsey and Company and discussed several ways that companies can ensure they make better decisions.

One of the first issues that Thaler discussed was “hindsight bias”. This is being wise after the event or what Thaler refers to as “Monday morning quarterbacking”.

Thaler believes that CEOs exacerbate this problem because they have hindsight bias. He notes that when a decision is made the CEO will say, “Yeah, great. Let’s go for that gamble. That looks good”. Later, when things didn’t turn out as expected, Thaler says, the CEO often says, “I never really liked this idea”.

Thaler’s suggestion to overcome this problem is to ensure things are written down. If a memo is circulated noting that all the senior management approved of a decision, they can’t turn around afterwards and claim they didn’t support it. This will encourage managers to take risk and put forward proposals without fearing they will be blamed after the event if things don’t work out as planned.

Another issue Thaler considers is problems with forecasting in business. He believes that most forecasters make the mistake of having too narrow a range of forecasts and this can result in them becoming too optimistic.

He gives the example of forecasts of the stock market leading up to the financial crisis. Respondents to a survey were asked to predict the market with 80% confidence. Based on history, Thaler notes this should’ve resulted in a range between minus 10% and plus 30%. Yet in a survey taken by Duke University, respondents gave a single estimate and the most pessimistic forecast was for no change.

Thaler notes that people are over confident and want to appear knowledgeable, so they will give a single point forecast. While giving a wide band of outcomes might make you appear uncertain, it is more likely to encompass the eventual outcome. A wide band of forecasts based on history or data allows the business to plan for all the likely scenarios when making decisions.

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