Behavioural Finance
Week 4
Monday: Fairness & Ethics B&M CH 8
Wednesday: Negotiation B&M CH 10/11
Chapter 8: Fairness and Ethics in Decision Making
Research on fairness has focused on the distribution of scarce resources or the fairness of
distribution procedures.
“Money illusion” – Tendency to rely on nominal quantities Think about money in terms
of actual buying power (real dollars) rather than arbitrary unit of a dollar (nominal dollar)
which changes as a result of inflation
When we resist ‘unfair’ ultimatums – People often rely on attaining what they consider to
be fair or justifiable. They are often willing to pay to punish their opponent if he or she asks
to much (persistent desire for fairness)
‘Dictator’ game: Proposer could simply decide how the resources would be split without the
responder’s acceptance (pay-want-you-want pricing in real life)
We are concerned about the outcomes of other – If we asses one option at a time, social
comparisons serve as reference points we use to assess our outcomes. When multiple
options exist, easier to compare across them and less useful comparison to others.
Why do fairness judgments matter?
- Other people will punish us for behaving unfairly. ‘Altruistic punishment’ allows
people to teach a lesson to a cheater
- Permeate organizational life, fairness judgments which affect our emotions and
behavior (pay raises, distribution scarce budgets, promotions, grades, prices)
- People will use fairness and social-comparison information to judge your actions
Bounded ethicality – Unethical behavior that occurs without the awareness of the actor /
Psychological processes that lead people to engage in ethically questionable behaviors that
are inconsistent with their own preferred ethics.
Six examples of bounded rationality:
- Overclaiming credit – Everyone thinks they do much work than they actually do
(above 100%)
- In-group favoritism – We tend to identify with people who are a lot like us. We are
more comfortable doing favors for those with whom we identify than for those
noticeably different from us. Bad for minorities because when majority of people
allocates scare resources among similar people, discriminate against those who are
, different. People tend to associate positive characteristics with ‘in-group’ and
negative characteristics with ‘out-group’.
- Implicit attitudes – People think their attitude are being within the scope of their
conscious awareness and under their control. But it is shown that when we meet
someone our minds automatically activate stereotypes. Tool to examine our implicit
attitudes: Implicit Associations Test (IAT). Difference between ‘old-fashioned racism’
(explicit and accompanied by hostility) and ‘modern racism’ (subtle but affects
managers’ professional judgment). Some evidence that we become less prejudiced,
when more members of stigmatized groups have high-status (Barack Obama), less
prejudiced the society is.
- Indirectly unethical behavior – When others do not know about our selfish behavior,
it will be easier for people to act selfish. Besides, when people choose to not know
the answer instead of knowing the consequences, will give the other people more
understanding unless the outcome is the same.
- When values seem sacred. Value pluralism = world rarely allows us to hold a single
principle as sacred – life is full of difficult choices that demand that we balance one
value against another.
The psychology of conflicts of interests
Conflicts of interest exists in many examples between receiving personal benefits and doing
what is best for clients, patients or society at large (court/lawyers, surgeons/operations,
financial advisors/transactions).
Most people believe that disclosure is the best solution to conflicts of interest – parties need
to report what they are doing (most common response). However, evidence also suggest
that this makes the bias even bigger.
Motivated blindness – When people have an incentive not to notice data, they are able to
overlook it.
Sometimes auditors do not see fraud. But the company also pays their bills and they want to
maintain a good relationship… True independent judgment not possible.
Chapter 10: Making rational decisions in negotiations
Game theory: Mathematical models to analyze the outcomes that will emerge in multiparty
decision-making contexts if all parties act rationally. Provides a prescriptive advice available
to negotiations. However, it relies on the ability to completely describe all options and
associated outcomes for every possible combination. Also, it requires that all players
consistently act in a rational manner (individuals often behave irrational).
A decision-analytic approach to negotiations (Raiffa) Focus on how people actually
behave instead of how they should behave if they were smarter, thought harder, more
consistent, all-knowing.
Prescriptive from the point of view of party receiving advice, descriptive from point of view
competing party.
, Framework for approaching negotiations (3 key sets of information):
- Each party’s alternative to a negotiated agreement
- Each party’s set of interests
- The relative importance of each party’s interests
Determine structure of the negotiation game.
Alternatives:
Best Alternative to a Negotiated Agreement (BATNA) – provides a lower bound for
determining the minimum outcome we require of a negotiated agreement. Determines
reservation point (indifference point) = the point at which the negotiator is indifferent
between a negotiated agreement and impasse.
However, many people accept below their BATNA and not accept above their BATNA
(emotions).
Important to identify all of the parties’ interests. There is a difference between the stated
positions and their underlying interests.
Claiming value in negotiation
Bargaining zone framework: Each party has some reservation point below (or above) which
the negotiator would prefer impasse to settlement
- Positive bargaining zone: Optimal to reach a settlement
- Negative bargaining zone: Reservation points of two parties do not overlap, no
settlement acceptable for both parties
Creating value in negotiation
One-issue negotiations involve claiming of value but not creating value.
Case of 1978 Camp David Accords: Egypt and Israel about control of Sinai Peninsula.
Contingent contracts: an agreement that states which actions under certain conditions will
result in specific outcomes (voorwaarderlijk contract). For example, book publishers pay
money up front and royalties (percentage of revenue).
These contracts can improve the outcomes because:
- Bets build on differences to create joint value (different predictions)
- Bets help manage biases (overconfidence, endowment etc)
- Belts diagnose disingenuous parties (bluffing? He will back off)
- Bets establish incentives for performance
The tools of value creation
1) Build trust and share information
2) Ask questions
3) Strategically disclose information
4) Negotiate multiple issues simultaneously
5) Make multiple offers simultaneously
6) Search for post-settlement settlements
Week 4
Monday: Fairness & Ethics B&M CH 8
Wednesday: Negotiation B&M CH 10/11
Chapter 8: Fairness and Ethics in Decision Making
Research on fairness has focused on the distribution of scarce resources or the fairness of
distribution procedures.
“Money illusion” – Tendency to rely on nominal quantities Think about money in terms
of actual buying power (real dollars) rather than arbitrary unit of a dollar (nominal dollar)
which changes as a result of inflation
When we resist ‘unfair’ ultimatums – People often rely on attaining what they consider to
be fair or justifiable. They are often willing to pay to punish their opponent if he or she asks
to much (persistent desire for fairness)
‘Dictator’ game: Proposer could simply decide how the resources would be split without the
responder’s acceptance (pay-want-you-want pricing in real life)
We are concerned about the outcomes of other – If we asses one option at a time, social
comparisons serve as reference points we use to assess our outcomes. When multiple
options exist, easier to compare across them and less useful comparison to others.
Why do fairness judgments matter?
- Other people will punish us for behaving unfairly. ‘Altruistic punishment’ allows
people to teach a lesson to a cheater
- Permeate organizational life, fairness judgments which affect our emotions and
behavior (pay raises, distribution scarce budgets, promotions, grades, prices)
- People will use fairness and social-comparison information to judge your actions
Bounded ethicality – Unethical behavior that occurs without the awareness of the actor /
Psychological processes that lead people to engage in ethically questionable behaviors that
are inconsistent with their own preferred ethics.
Six examples of bounded rationality:
- Overclaiming credit – Everyone thinks they do much work than they actually do
(above 100%)
- In-group favoritism – We tend to identify with people who are a lot like us. We are
more comfortable doing favors for those with whom we identify than for those
noticeably different from us. Bad for minorities because when majority of people
allocates scare resources among similar people, discriminate against those who are
, different. People tend to associate positive characteristics with ‘in-group’ and
negative characteristics with ‘out-group’.
- Implicit attitudes – People think their attitude are being within the scope of their
conscious awareness and under their control. But it is shown that when we meet
someone our minds automatically activate stereotypes. Tool to examine our implicit
attitudes: Implicit Associations Test (IAT). Difference between ‘old-fashioned racism’
(explicit and accompanied by hostility) and ‘modern racism’ (subtle but affects
managers’ professional judgment). Some evidence that we become less prejudiced,
when more members of stigmatized groups have high-status (Barack Obama), less
prejudiced the society is.
- Indirectly unethical behavior – When others do not know about our selfish behavior,
it will be easier for people to act selfish. Besides, when people choose to not know
the answer instead of knowing the consequences, will give the other people more
understanding unless the outcome is the same.
- When values seem sacred. Value pluralism = world rarely allows us to hold a single
principle as sacred – life is full of difficult choices that demand that we balance one
value against another.
The psychology of conflicts of interests
Conflicts of interest exists in many examples between receiving personal benefits and doing
what is best for clients, patients or society at large (court/lawyers, surgeons/operations,
financial advisors/transactions).
Most people believe that disclosure is the best solution to conflicts of interest – parties need
to report what they are doing (most common response). However, evidence also suggest
that this makes the bias even bigger.
Motivated blindness – When people have an incentive not to notice data, they are able to
overlook it.
Sometimes auditors do not see fraud. But the company also pays their bills and they want to
maintain a good relationship… True independent judgment not possible.
Chapter 10: Making rational decisions in negotiations
Game theory: Mathematical models to analyze the outcomes that will emerge in multiparty
decision-making contexts if all parties act rationally. Provides a prescriptive advice available
to negotiations. However, it relies on the ability to completely describe all options and
associated outcomes for every possible combination. Also, it requires that all players
consistently act in a rational manner (individuals often behave irrational).
A decision-analytic approach to negotiations (Raiffa) Focus on how people actually
behave instead of how they should behave if they were smarter, thought harder, more
consistent, all-knowing.
Prescriptive from the point of view of party receiving advice, descriptive from point of view
competing party.
, Framework for approaching negotiations (3 key sets of information):
- Each party’s alternative to a negotiated agreement
- Each party’s set of interests
- The relative importance of each party’s interests
Determine structure of the negotiation game.
Alternatives:
Best Alternative to a Negotiated Agreement (BATNA) – provides a lower bound for
determining the minimum outcome we require of a negotiated agreement. Determines
reservation point (indifference point) = the point at which the negotiator is indifferent
between a negotiated agreement and impasse.
However, many people accept below their BATNA and not accept above their BATNA
(emotions).
Important to identify all of the parties’ interests. There is a difference between the stated
positions and their underlying interests.
Claiming value in negotiation
Bargaining zone framework: Each party has some reservation point below (or above) which
the negotiator would prefer impasse to settlement
- Positive bargaining zone: Optimal to reach a settlement
- Negative bargaining zone: Reservation points of two parties do not overlap, no
settlement acceptable for both parties
Creating value in negotiation
One-issue negotiations involve claiming of value but not creating value.
Case of 1978 Camp David Accords: Egypt and Israel about control of Sinai Peninsula.
Contingent contracts: an agreement that states which actions under certain conditions will
result in specific outcomes (voorwaarderlijk contract). For example, book publishers pay
money up front and royalties (percentage of revenue).
These contracts can improve the outcomes because:
- Bets build on differences to create joint value (different predictions)
- Bets help manage biases (overconfidence, endowment etc)
- Belts diagnose disingenuous parties (bluffing? He will back off)
- Bets establish incentives for performance
The tools of value creation
1) Build trust and share information
2) Ask questions
3) Strategically disclose information
4) Negotiate multiple issues simultaneously
5) Make multiple offers simultaneously
6) Search for post-settlement settlements
