Managers and their not-so rational decisions * Two cognitive systems that influence decision making: * System 1 refers to a process that is fast, effortless, and intuitive. * System 2 is a slow, controlled, and rule-governed decision making process. * also susceptible to biases that interfere with our ability to make good decisions * biases also affect System 2 processes, causing managers to make irrational decisions. * most decisions that executives face are yes/no decisions * the rational model of choice follows the everyday assumption that human behavior has some purpose * Yet Simon (1957) suggests that managers make imperfect decisions due to a variety of factors including lack of information, inadequate time, and cognitive limitations. * Decision making biases * Framing and loss aversion * When executives make decisions, they may frame the potential outcomes of their decisions differently relative to an earlier status quo. * When options are framed as potential for loss, prospect theory describes how managers may be irrationally unwilling to incur loss. * their “value function” is twice as steep when they consider losses than when they consider gains. * Risk seeking * Risk seeking behavior works in two different ways * First, individuals will take irrational risks when the alternative is a certain loss, despite the fact that System 2 processes should lead them to the opposite conclusion * For example, managers may prefer a product development project with a high probability of large loss over a development project with a certain, but much smaller, loss. * Second, individuals will take irrational risks when the potential payoff is unusually large. * Contrary to the principles of rationality, risk seeking