Recognising how cognitive bias can influence decision-making
A Deloitte study revealed how neither the amount if capital expenditures nor the growth in capital expenditure confirmed a meaningful correlation with return on investment (ROI). More than 60% of the finance executives in another study could confirm confidently that capital was being allocated optimally in their organisations. Whilst it may appear practical for all to support priorities set by leadership, however, behavioural science suggests that this may not always be the case. Behavioural science suggests that a bais of sorts is most likely to affect an individual’s course of action—be it optimistic or through a narrow lens.
While covered at length in academia, these biases are not so prominent in the case of capital planning and allocation. In this issue of CFO Insights—the first of a two-part discussion on capital allocation—we look at attributes to help identify bias and how it manifests during the capital planning and allocation process.
Like picking out jam at a grocery store where we often fall prey unconscious decision-making, so it is in the case of capital planning and allocation. Of more than 80 different cognitive biases, three reign supreme in the case of causing mayhem in capital decision-making—the optimism bias, expert bias, and narrow framing.
Often, financial decisions are made less on capital and more by the people tasked with driving decisions. With this in mind, before deciding where to spend your capital, determine how those decisions will be made.