What can leaders learn from the field of behavioural economics?

February 10, 2012

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By David Lancefield, Economics Partner


Advances in behavioural economics – the combination of psychology, and real world experiments, with traditional economic theory – tell us something about the agenda for leaders of the future. Naturally, people have emotions, prejudices and biases. And often we’re not fully aware of them when we make choices in our day to day lives.

Leaders can spend time understanding these biases– then designing incentives, and ways of working that encourage behaviours that deliver the most value, and mitigate any risks.

Themes from the academic literature are particularly pertinent to leaders

1. Frame decisions in the appropriate context:

People need help in making decisions especially when there is information overload, otherwise they walk away, choose familiar options or make the wrong choice. Leaders should think carefully about how information is presented so that choices can be made easily.

2. Recognise that many people are more averse to losses than gains:

People tend to hate losses from something they own more than they love gains  even if they may be equivalent in financial terms. Risk-averse behaviour follows. Persuading people to take more risk in a controlled way can be problematic as well - over-incentivising risk-taking can lead to problems of the kind we’ve seen in some parts of the financial services sector. So a key role for a leader is to find the right amount of risk-taking, navigating a way through this impasse through the right organisational culture, incentive systems, and risk control mechanisms.

3. Create something novel or new in order to create the momentum for change:

People are prone to sticking to what they know, whether through habit or laziness. Leaders can inject some something new or different to the rest of the organisation– to create the platform for change in behaviours.

4. Encourage a fairness culture:

People put a much higher value on perceived fairness than simple rational decision-making models would suggest. A desire for fairness seems to be wired into the human mind. So making sure that an organisation is seen to be fair to its people (and other stakeholders) can be critical to its long-term success, particularly in people-led businesses. Leaders should be champions of the 'fairness agenda'.

5. Identify and manage over-confidence:

Leaders need to guard against over-confidence in their teams. This can result in over-ambitious timescales and projects with unrealistic aims. Leaders need to understand where this is likely to manifest itself in the organisation (e.g. in sales or trading environments), and put in place appropriate safeguards.

6. Think of the long-term, but focus on change in the immediate term:

Preferences, and behaviours, vary at different points in time. People are often impulsive, making decisions based on how they feel at the time. Leaders should recognise that people live in the here and now – therefore immediate feedback, reward and penalties can have a big impact on future behaviour, more so than the promise or threat in the future.

7. Use the best of herd behaviour:

Herding is associated with behavioural traits such as copying each other, clustering together or general conformity in a world in which people are afraid of being left behind. People judge their happiness often more based on their position relative to others, than in absolute terms. Leaders can use herd behaviour positively when moving to new, more effective norms if they can tap in to what motivates and inspires people, whilst avoiding the pitfalls of group-think. They can encourage social action, such as the generation of ideas or momentum to do something.

Contact: David Lancefield  |  +44 (0)20 7213 2263