How Managers Can Curb
Overconfidence
Taking the time to
consider unknowns helps executives make better decisions.
In Thinking, Fast and Slow,
Nobel Prize in Economics winner Daniel Kahneman called overconfidence “the most
significant of the cognitive biases” because it is ubiquitous and has many
negative consequences. For example, overconfidence has been implicated in a
wide range of errors in decision making, from medical misdiagnoses to
overtrading in the stock market to misallocation of corporate investment to
economic recessions. Overconfidence has also been suggested as a contributing
factor to many infamous disasters, such as the Chernobyl meltdown, the sinking
of the Titanic and the Deepwater Horizon oil spill.
Understanding
the sources of overconfidence and developing effective techniques to improve
calibration -- knowledge about accuracy -- has been the subject of a great deal
of research. In work I’ve conducted with Philip Fernbach (University of
Colorado Boulder), Craig Fox (UCLA) and Steven Sloman (Brown
University), we have developed a new technique to reduce overconfidence by
prompting people to explicitly consider the missing pieces of information in a
judgment. Our paper, “Known Unknowns: A Critical Determinant of Confidence
and Calibration”,
was published in Management
Science.
Reining
in overconfidence
In
the first of our three studies, participants answered ten general-knowledge,
multiple-choice questions and indicated their level of confidence for each.
They were also asked to list the reasons that made them more as
well as less confident about their answers. These reasons were
later rated on the degree to which they concerned either known or unknown
evidence. For example, if the question was “Does a Subway meatball sandwich or
McDonald’s Quarter Pounder with cheese have more calories?”, not knowing the number
or size of meatballs in the Subway sandwich could be a reason for being less
confident that involved unknown evidence.
The
average confidence rating of participants (67 percent) overshot their accuracy
(62 percent). However, those participants who paid more attention to unknown
evidence when rating their confidence were better calibrated in their
assessment, and no less accurate.
Our
second study involved participants who answered multiple-choice questions. We
asked a group of them to specify two pieces of missing information that would
have helped them determine the correct answer to each question. We instructed
another group to write down two reasons why an answer they didn’t select could,
in fact, have been the correct one. In other words, the first group considered
the unknowns, while the second one considered the alternative,
a technique also known as playing “devil’s advocate”. Control participants
merely answered the questions, stating their level of confidence for each
answer.
While
both considering the unknowns and playing devil’s advocate reduced
overconfidence, considering the unknowns was more effective. It resulted in an
8 percentage point decrease in overconfidence relative to the control group (16
vs. 24 percent) whereas considering the alternative only resulted in a 6
percent decrease from the control group.
The
third study allowed us to test whether considering the unknown reduced
confidence or improved calibration. In many domains, people demonstrate
underconfidence and are overly cautious. A true improvement in calibration
would mean that considering the unknowns reduces confidence when people are
overconfident, but not when people are well-calibrated or underconfident. In
this study, participants answered two sets of general knowledge questions. The
questions were divided into nine knowledge domains (e.g. state populations,
calorie counts), for which participants varied in their level of overconfidence
versus underconfidence. As in the second study, participants either considered
the unknown, or considered the alternative (the devil’s advocate technique).
Both interventions were compared with a group which had no prompting to ponder
additional information.
As
we predicted, considering the unknowns only reduced confidence when it was misplaced
(in overconfident domains), whereas playing devil’s advocate had an equal
impact in the subject areas that encouraged overconfident and underconfident
responses. The figure below shows confidence and overconfidence for each of the
two techniques across different domains.
Striking the right balance
A
great deal of research on overconfidence has attributed this phenomenon to
confirmation bias, the systematic tendency to seek or overweight evidence for a
preferred hypothesis over its alternatives. However, our research shows that
the classic devil’s advocate technique can be a blunt instrument: When people
start considering all the reasons they could be wrong, some lose confidence
unnecessarily. If their assessments had been well calibrated to begin with,
prompting people to second-guess themselves can lead them to underconfidence.
For instance, consider a CFO evaluating a potential acquisition. While no
shareholder wants the CFO to be overconfident, underconfidence may be equally
costly and result in missed opportunities.
In
our view, overconfidence often arises when people neglect to consider the
information they lack. Our suggestion for managers is simple. When judging the
likelihood of an event, take a pen and paper and ask yourself: “What is it that
I don’t know?” Even if you don’t write out a list, the mere act of mulling the
unknowns can be useful. And too few people do it. Often, they are afraid to
appear ignorant and to be penalised for it. But any organisation that allows
managerial overconfidence to run amok can expect to pay a hefty price, sooner
or later.
Daniel
Walters, INSEAD Assistant Professor of
Marketing | September 12, 2018
Read more at
https://knowledge.insead.edu/marketing/how-managers-can-curb-overconfidence-10036#W3Q2kKYkYBmrrBSW.99
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