Not so Rational Decisions

By: Sheila Moorcroft

Recent research into power, status, stress and aspirational gadgets reveals the extent to which decisions are anything but rational. Investment decisions and governance could be subject to new forms of scrutiny.

What is changing?

Research into power and status, and the way they interact to affect decisions, judgement and behaviour, confirms the old adage that power corrupts, but also explains how perceived status changes how people exploit power over others. The first project confirmed that those in positions of power were hypocritical when judging the morality of their own and other people’s behaviour. The greater the person’s sense of power and entitlement, the greater the hypocrisy: their own actions were deemed far less immoral than those of others. The second demonstrated very clearly the way in which those who felt low in status would use the power they had to the maximum, often to demean others if the opportunity arose, which in the experiment it did.

A separate piece of research examined the impact of the hormones testosterone and cortisol on trader behaviour. Success brings raised levels of testosterone and breeds a sense of immunity, encouraging people to discount risk levels and so continue taking risks. Failure and stress raise cortisol, over extended periods making people overly fearful and more likely to be risk averse or overestimate risks. The stress levels create a vicious cycle which can all but destroy rational thought.

Status symbols may not be all they are cranked up to be, according to new consumer research. People who are insecure, wanting to differentiate themselves and demonstrate their status, are more worried about people ‘below them’ who own gadgets such as iPhones, than they aspire to look like those above them. It is more a case of keeping ahead of the janitor, not up with the Joneses.

Why is this important?

Volatility in financial markets may be as much about hormones as it is about the reality of markets, money and companies. The combination of 24 hour news and chronic stress hormone levels may mean that we are well into the realms of irrationality and fear driven decisions. We are talking ourselves into crises. Perhaps we should ignore the news for a few days, in the interest of longer term economic development.

There have been calls for more women on trading floors, and on company boards, saying that they would be a calming influence: such calls may be right. Diversity and reflecting the workforce and the marketplace aside, and that too is important, women have about 10% of the amount of testosterone that men have, making them far less prone to ‘irrational exuberance’. Hedge funds run by women do, also, in fact appear to outperform those of their male colleagues, based on a small but relevant sample in a high risk business.

As corporate governance becomes ever more of an issue, may we see more specific tests around the nature of decision making, such as hormone tests on traders and senior executives, as part of transparency and governance as well as employee health? Will metrics such as diversity on boards and senior teams become part of performance indicators and investment decisions, if they are seen as indicators of more effective decision making? In the mean time will companies which truly achieve greater diversity have distinct competitive advantage?

Open organisations, as discussed recently in ‘The challenge of relative values’, are more innovative and ready to adopt ideas. By implication, they may also be less vulnerable to the kinds of exploitation of power and status identified in the research, the development of tyrants and hypocrisy. Culture and values based management may become a more tangible part of not only of investment decision making but also how future employees judge companies.

Economics assumes that decisions by consumers and executives are rational: perhaps it is time for a rethink, they would appear to be proven anything but.

By Sheila Moorcroft