Risk management and cognitive biases

If you’ve ever had the pleasure of putting many people in a room to discuss and assess risks you’d know that not everyone assesses every risk the same way. To some a particular risk is high, while to others it is low or non-existent (“C’mon, that’s not a risk!”)

But why is that?

In a 2011 article by Dan Lovallo and Daniel Kahneman, they explain that executive are “overoptimistic” which can be traced to “cognitive biases – to errors in the way the mind processes information – and to organizational pressures”.

They go on to write that this optimism is “unavoidable” and “it’s unlikely that companies can, or would ever want to, remove the organizational pressures that promote optimism. Still, optimism can, and should, be tempered.”

Finally, on the subject or managing the risks associated with projects, they write:

When forecasting the outcomes of risk projects, executives all too easily fall victim to what psychologists call the planning fallacy. In its grip, managers make decisions based on delusional optimism rather than on a rational weighting of gains, losses, and probabilities. They overestimate benefits and underestimate costs. They spin scenarios of success while overlooking the potential for mistakes and miscalculations. As a result, managers pursue initiatives that are unlikely to come in on budget or on time – or ever deliver the expected returns.

Perhaps the next time you hire someone to perform a risk assessment or to manage a project, you should consider someone with a background in psychology instead of a professional accountant or PMP.

Quotes courtesy: Delusions of Success by Dan Lovallo and Daniel Kahneman. Harvard Business Review on Making Smart Decisions by Harvard Business Review (Apr 12 2011)

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Dan Gardiner, optimism and iceberg risk

Dan Gardner writes in Chapter 3 of his book Future Babble: “Overconfidence is a universal human trait closely related to an equally widespread phenomenon known as ‘optimism bias’.”

This overconfidence often leads us to assess our risks poorly. We all know about the captain of the Titanic who must have been extremely optimistic before that dreaded voyage. He probably thought: “Sure there are icebergs in the North Atlantic but I’ve never hit one in thirty years at sea. Of course I won’t hit one. Isn’t that why I was chosen to captain the greatest ship ever built? Isn’t this the reason why they honour me on this, my final voyage before my retirement?”

His overconfidence and optimism surely would have caused him to assess that Iceberg Risk before leaving on the voyage lower that it probably should have been.

Gardner also explains:

“Ask smokers about the risk of getting lung cancer from smoking and they’ll say it’s high. But their risk? Not so high. Starting a business? Most fail, but mine won’t. Getting married? Other people should have a prenuptial agreement. But not me, my love is forever.”

So don’t let your bias and overconfidence affect the way you assess your risks.

Be honest.

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