Sunday, March 23, 2008

Behavioral Finance - Bias from over-influence by Authority

This is the tenth in a series of posts about common human misjudgments. The series is based on a Charlie Munger speech at the Harvard Law School in 1995.

Why study human behavior in relation to finances?
Recognizing and understanding why people do the things they do, what drives them, and what are innately human tendencies is the first step in overcoming your own self and making sound decisions! We want to make rational, logical decisions, but emotions and irrational tendencies get in the way.

These behaviors are not all bad, many are good in some way - that is why they survived. In fact, these behaviors served some purpose that helped extend life at some time in the evolutionary process.

10. Bias from over-influence by authority
One of the best and most extreme examples of this human behavior is the famous Milgram experiment. The study was devised by Yale University psychologist Stanley Milgram to answer this question: "Could it be that Nazi war criminal Adolf Eichmann and his million accomplices in the Holocaust were just following orders? Could we call them all accomplices?

In the experiments, volunteers were asked to administer a shock to another "subject" (actor) each time the subject got a question wrong. With each incorrect answer, the intensity of the shock increased. A tape recorder integrated with the electro-shock generator played pre-recorded sounds for each shock level. When the volunteer hesitated to administer additional shocks, for example, when the actor was screaming in agony or the gauge indicated that the intensity had reached a lethal level the test administrator simply said, "The experiment requires that you go on," or "It is absolutely essential that you continue."

The results were horrifying: 65 percent (26 of 40) of experiment participants administered the experiment's final, deadly 450-volt shock, though many were very uncomfortable. At some point, every participant paused and questioned the experiment. However, no participant steadfastly refused to administer shocks before the 300-volt level.

It’s amazing how ordinary people, simply doing their jobs, and without any particular hostility on their part, can become agents in a terrible destructive process. Even when the destructive effects of their work become clear, and they are asked to carry out actions incompatible with fundamental standards of morality, relatively few people have the resources needed to resist authority.

There are probably very few of us that believe we would do any thing like this. Yet, similar, but less outrageous situations occur all of the time in life. For instance, as investors, we tend to defer to perceived authority figures, including successful investors, investing newsletters, strategies, and market prognosticators. We tend to place too much stock in the opinions of those who seem to know more than us.

I have seen this quite frequently in the workplace. For example, from time to time, a consultant is brought in to work an unusual or persistent problem. That consultant only needs to make one or two credible statements or predictions and he/she is immediately anointed by management. No more questions asked, this consultant is now deemed the authority and we are expected to proceed according to his/her direction. In all fairness, the program manager is primarily interested in getting the problem solved to move on to the next milestone, whereas, the engineer wants a more thorough understanding of the issue and has a lot more questions.

As a final note, it’s important not to view the conclusions of such behavior as yet another indication of just how helpless we are to these tendencies, but rather simply recognize it as a handicap that we all have. Once we become aware of these tendencies, perhaps we will be become better able to “catch” ourselves in the act and modify the behavior to our advantage.

No comments:

Post a Comment