Management of Organizations

Themes Session Topic

1 Introduction and Systems Thinking

Systems
2 Incentives and Motivation
3 Judgment and Decision Making
Skills and 4 Ethical Decision Making
Self
Awareness 5 Leadership Dilemmas
6 Social Influence
7 Power and Managing Up
Challenges 8 Stereotyping in Organizations
9,10 Leading Change

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Session 3 Overview
Carter Racing
▪ Read the case & make the decision to race
▪ Case debrief

Individual Decision Making

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 Carter Racing Debrief

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Carter Racing: Payoffs for Racing

Finish in the money Do Not Finish (blown engine)

+$2,000,000 Goodstone contract +$25,000 Goodstone race sponsorship

+$25,000 Goodstone sponsorship -$50,000 Expense for replacing the engine
(other $15,000 guaranteed) -----------------------------------------------------
+$800,000 oil company sponsorship -$25,000
--------------------------------------------------
+$2,825,000 Do Not Finish (other reason)

Finish out of the money (below 5th) +$800,000 oil company sponsorship
+$25,000 Goodstone race sponsorship
+$25,000 Goodstone race sponsorship -----------------------------------------------------
+$800,000 oil company sponsorship +$825,000
--------------------------------------------------
+$825,000

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Payoff for Not Racing

+ $800,000 oil company sponsorship

+ $15,000 entry-fee reimbursement
----------------------------------------------
+ $815,000

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 Note from Robin Burns
BJ,

I got the data on the gasket failures from Pat. We have run 24 races this season,
with temperatures at race time ranging from 53 to 82 degrees. Pat had a
good idea in suggesting we look into this, but as you can see, this is not our
problem. I tested the data for a correlation between temperatures and gasket
failures, and found no relationship.

In comparison with some of the other teams, we have done extremely well this
season. We have finished 62.5% of the races, and when we finished, we
were in the top five 80% of the time. Our rate of blown engines is 29%, but
we are running fast, so we have to expect some difficulties. I am not happy
with the engine problems, but I will take the four first-place finishes and
50% rate of finishing in the money over seven engines any day. If we
continue to run like this, we will have our pick of sponsors.

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Case Facts
Racing Record
▪ 24 Races Entered
▪ 15 finished (63%); 9 not finished (37%)
Races Finished
▪ 12 in Top 5 (50%)
▪ 3 not in Top 5 (13%)
Races Not Finished
▪ 7 with blown engine (29%)
▪ 2 for other reasons (8%)

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Carter Racing Decision Tree
Finish, Top 5 $2,825,000
p = .50

p = .13 Finish, other $825,000

EV = $1,578,500
p = .29
Blown engine -$25,000
Race p = .08

Other $825,000

Not Race
$815,000

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Expected Value Calculations – Race/No Race
DECISION Outcome value Probability Expected value Probability Expected value

RACE
Finish in money $2,825,000 .50 $1,412,500 .004 $11,300
(top 5)
Finish out of $825,000 .13 $107,250 .001 $825
money (lower than
5th)
Not Finish (blown -$25,000 .29 -$7,250 .994 -$24,850
engine)
Not finish (other $825,000 .08 $66,000 .001 $825
reason)
Subtotal race 1.00 $1,578,500 1.00 -$11,900

Current finances -$80,000 -$80,000

Net expected value $1,498,500 -$91,900

NOT RACE
$815,000 1.00 $815,000 1.00 $815,000
Current finances -$80,000 -$80,000

Net expected value $735,000 $735,000

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 Temperature and Gasket Failures

4
Breaks in Head Gasket During Race

0
45 50 55 60 65 70 75 80 85 90 95

Ambient Temperature (degrees Fahrenheit)

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Temperature and No Gasket Failure

4
# of Races w/o Gasket Failure

0
45 55 65 75 85 95
Ambient Air Temperature (degrees Fahrenheit)

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Temperature and Gasket Failure/No Failure

4
# of Breaks Per Race

0
45 55 65 75 85 95

Ambient Air Temperature (degrees Fahrenheit)

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Full Sample of Previous Races

Temp <=65 Temp >65

Gasket
4 3
Failure
No Gasket
0 17
Failure

Conditional
Probability 100% 15%
of Failure:

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 Probability of a Blown Gasket

Logistic Regression:
100%

Estimating the
probability of failure 80%

as a function of Probability of Failure

temperature 60%

40%

20%

0%
30 40 50 60 70 80 90 100

Temperature (F)

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Expected Value Calculations – Race/No Race
HISTORICAL LOGISTIC
PROBABILITIES PROBABILITIES
DECISION Outcome value Probability Expected value Probability Expected value

RACE
Finish in money $2,825,000 .50 $1,412,500 .004 $11,300
(top 5)
Finish out of $825,000 .13 $107,250 .001 $825
money (lower than
5th)
Not Finish (blown -$25,000 .29 -$7,250 .994 -$24,850
engine)
Not finish (other $825,000 .08 $66,000 .001 $825
reason)
Subtotal race 1.00 $1,578,500 1.00 -$11,900

Current finances -$80,000 -$80,000

Net expected value $1,498,500 -$91,900

NOT RACE
$815,000 1.00 $815,000 1.00 $815,000
Current finances -$80,000 -$80,000

Net expected value $735,000 $735,000

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 Session 3 – Decision Making
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 Four Cells: CEOs and their Pets

Fact: 94% of Fortune 500 CEOs had a childhood pet

The respondents asserted that pet ownership

had helped them to develop many of the
positive character traits that make them good
managers today, including responsibility,
empathy, respect for other living beings,
generosity, and good communication skills.

--Management Focus Magazine

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 Four Cells: CEOs and their Pets
Critical Question: How many
non-CEOs had childhood pets? No Pets Pets
(i.e., what is the “base rate”
of pet ownership?) CEO

Mgmt Focus Tip for Success:

100% of Fortune 500 CEOs brush Not
their teeth! CEO
Lesson 1: Need to look at all 4
cells to detect relationship.
Beware incomplete search!
Lesson 2: Correlation does not imply causality
• Third variable problem
• Reverse causality
E.g., Waterbed Ad: “People who sleep on waterbeds have fewer back problems!”

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 Individual Decision Making

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Gut Feeling

Imagine that you are interviewing someone for a job.

You will work closely with the person that you hire. On
paper the person looks great; this is by far the most
qualified candidate that you’ve seen. At the interview,
the candidate has impeccable social skills and gives
flawless responses to your questions. However, you
have a feeling that something is wrong with this
candidate. You cannot place your finger on it, it’s just a
gut feeling. Do you hire this person?

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Should You Rely on Gut Feeling/Intuition?

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Should You Rely on Gut Feeling/Intuition?
A Ball and bat cost $1.10 in total. The bat costs $1.00
more than the ball. How much does the ball cost?

From a sample of random Americans…

22% said 5 cents 34% said 5 cents

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Should You Rely on Gut Feeling/Intuition?
2X2=?

1X2X3X4X5X6X7X8=?

512

8X7X6X5X4X3X2X1=?

2250

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Should You Rely on Gut Feeling/Intuition?

http://www.michaelbach.de/ot/sze_shepardTables/
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A Tour of Decision Traps

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Decision Traps / Biases Already Covered
1) Availability Heuristics
2) Framing effect – Loss / Gain Frame
3) Risk Taking
4) Anchoring
5) Overconfidence

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Trap 1

How we judge the goodness or badness

of “X” depends on what it’s compared to.

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Trap 1 – Comparing Salaries Example
Imagine that you have recently completed your PgP Pro program
and have accepted an offer in your industry of choice. The
application process was very competitive, so you didn’t press too
hard in negotiating your salary. You ended up with a slightly better
deal than the initial offer. Several months later, you are still very
happy with your job. Then you inadvertently learn the salary of a
colleague hired into the same position as yours. This colleague has
a similar background, education, and experience to your own.
Your salary is 38 lakhs, and you discover that your colleague makes
35 lakhs.

How happy would you be with your pay?

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Trap 1: Comparing Salaries (cont.)

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Trap 1 – Comparing Salaries Example
Imagine that you have recently completed your PgP Pro program
and have accepted an offer in your industry of choice. The
application process was very competitive, so you didn’t press too
hard in negotiating your salary. You ended up with a slightly better
deal than the initial offer. Several months later, you are still very
happy with your job. Then you inadvertently learn the salary of a
colleague hired into the same position as yours. This colleague has
a similar background, education, and experience to your own.
Your salary is 42 lakhs, and you discover that your colleague makes
45 lakhs.

How happy would be with your pay?

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Trap 1: Comparing Salaries (cont.)

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Trap 1 (example 2)
You drive off to buy a large-screen TV at what you believe to be
the cheapest store in your area. The tv costs 120,000. A friend
comes by and tells you that the same TV sells for 119,000 at
another store that is a 10-minute drive away. Would you go to the
other store?
44.44% would drive.

You drive off to buy wireless headphones at what you believe to be

the cheapest store in your area. The wireless headphone costs
5000. A friend comes by and tells you that the same wireless
headphone sells for 3000 at another store that is a 10-minute drive
away. Would you go to the other store?
96.15% would drive.

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Trap 2

We find tradeoffs difficult, so we

use simple rules to decide.

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Trap 2
Common intuitive rule: Take the one that beats something else

From Predictably Irrational, by Dan Ariely

86% 16%

14% 0%

84%

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Decoy Effect
Choice Set 1 Choice Set 2

A B A B A-

Star 3* 4*
Star 3* 4* 2.5*
Distance 14 26
Distance 14 26 11
Choice 41% 59%
Choice 64% 36% 0%

Choice Set 2

A B B-

Star 3* 4* 4.5*

Distance 14 26 44

Choice 10% 76% 14%

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Trap 3

We are poor intuitive statisticians

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Trap 3 (example 1: drawing inferences from small samples)

• Two identical plants except for number produced

• Technology is set to have a defect rate of 1%
• Quality is flagged when defect rate > 2% in a given day
• Which plant has more flagged days?

A) The small plant 18.87%

B) The large plant 30.19%
C) The same number on average 50.94%

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Beliefs about Punishment and Praise
Officer in the Israeli Air Force—

“Punishment is more effective than praise. Whenever

I punish a pilot after a really poor flight, I see better
performance the next time. Whenever I praise a pilot
after an excellent flight, I see worse performance the
next time.”

Why might this happen?

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Trap 3 (example 2, regression to the mean)
There are two components to performance:
▪ In informal terms: Real Tendency + Luck
▪ In more formal terms: y = x + e,
▪ x = true ability, and
▪ e = temporary influences (“error”), randomly distributed
around 0.

What happens when we sample on extreme performance? What

underlies extreme success and failure?

▪ Extreme success = f(superior ability, good luck)

▪ Extreme failure = f(inferior ability, bad luck)

Consequence: Sample mean regresses to population mean

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Trap 3 (Mutual Funds Example)

A study was recently conducted examining the

performance of 408 stock mutual funds that existed
during the 2000s. The study divided the 2000s into an
early period (2000-2004) and a late period (2005-2009).
Below are the 10 funds that had the highest rate of
return in the early period (with their names disguised),
ranked from 1 to 10. Predict their rank for the late
2000s.

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Mutual Funds – Survey Results

Early 2000s Late 2000s Late 2000s

Fund & Rank Estimated Rank (median) Actual Rank
A 1 9 1
B 2 8.5 264
C 3 8.5 119
D 4 9 114
E 5 15 387
F 6 14 270
G 7 15 322
H 8 20 69
I 9 13 197
J 10 20.5 372

Total # funds = 408 Avg. = 13.25 Avg. = 211.5

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FAIRX Mutual Fund was #1 in both periods

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Trap 4

Argument Dilution

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 Dinnerware Preference
How much would you pay for a dinnerware set that includes:
8 Dinner Plates, all in good condition
8 Soup/Salad bowls, all in good condition
8 Dessert plates, all in good condition

Rs. 5794
8 Dinner Plates, all in good condition
8 Soup/Salad bowls, all in good condition
8 Dessert plates, all in good condition
8 Cups, 2 of them are broken
8 Saucers, 7 of them are broken

Rs. 5369
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Argument Dilution
Who will get a better grade/GPA (Zukier, 1982)
▪ Tim spends 31 hours studying outside of class in
an average week
▪ Tom spends 31 hours studying outside of class in
an average week. Tom has one brother and two
sisters. He visits his grandparents once every 3
months. He once went on a blind date. He shoots
pool once every 2 months.

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Argument Dilution
Averaging Effect
▪ Affording equal weight to each information
▪ Hence, non diagnostic information dilutes overall
judgment

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Pharmaceutical Ads (DTC Ads)

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 F(1,398)=6.43, p=.012, d=.25

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Why it is important
While making an argument, focus only on
• Strong points
• Do not make more arguments
• Less is more

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Remedies
Make a habit of asking critical questions
▪ Do I have the relevant data to form a judgment?
▪ Have I considered alternative ways to frame the problem?
▪ Extreme performance or small N?
Play devil’s advocate with yourself
Shift from insider to outsider perspective
Analogic exercises
Use models or regressions to decide (decision
making electives)
***Use teams to generate multiple perspectives
▪ Helps with problem definition, generating alternatives, etc.
▪ But, team composition & process matters!
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Future Reading

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Key Takeaways
1) Make sure that you have complete information to make a decision.
Remember to search all four cells. Beware incomplete search!

2) People underestimate uncertainty. They are overconfident, they draw

conclusions from small samples, they assume the future will look like the
past (and so don’t regress their predictions).

3) Given the above, you should seek of the opinions of others (ideally
independent), broaden your perspective, and make plans contingent on
uncertainty.

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