Page 152 - COSO Guidance

4 | Enhancing Board Oversight: Avoiding Judgment Traps and Biases

Our intuitive Judgment Processes Can Betray Us

Although this five-step judgment process is simple and We will refer to the following example as we describe in the
intuitive, it is important to realize that the judgment rest of this paper how directors can proactively frame and
tendencies and shortcuts that human beings often rely reframe issues to more effectively evaluate and challenge
on can short-circuit such a process, and as a result, our judgments and how they can identify and mitigate the
decisions can be biased. It is an interesting paradox that effects of common, systematic human tendencies that can
the human mind is capable of solving complex problems result in predictably biased judgment:
and developing new and creative solutions and, yet, can
be subject to predictable judgment traps and biases. The CEO and CFO of ABC Manufacturing Inc. call an
Consider the act of driving a car through traffic, which urgent meeting of the full board over a weekend. The issue
people regularly perform with relative ease. In terms of at hand is a business opportunity to acquire 100 percent
the judgments that are required, this is a very complex of the common equity of a supplier of raw materials used
task—so complex that even the most powerful computers in the company’s manufacturing process. The CEO starts
cannot perform it as well as humans. And yet, history off the meeting, “First off, I want to thank you for taking
is replete with examples of the devastating results of time out of your weekend to meet. We have an incredible
flawed judgment. To efficiently navigate complexity, we opportunity to vertically integrate our operations, ensure
often unknowingly use mental shortcuts and simplifying uninterrupted supply of critical raw materials, reduce
strategies. On balance, these simplifying shortcuts production time, and increase market share through this
and tendencies serve us well. However, because they acquisition. We assembled you on such short notice
are shortcuts, situations can arise in which they can because I want to be in a position to present our offer
systematically and predictably lead to suboptimal early next week.” The meeting is then handed off to the
judgments. Suboptimal judgments on trivial tasks are of CFO who says, “In front of you is a package of schedules
little consequence, but on critical high-stakes judgments, and analyses that we used in arriving at the offer price
they can be devastating. we are suggesting. The analyses are detailed and
comprehensive.” The CFO then walks the board members
As a simple illustration of how mental processes that through the calculations at a high level and shares a list
normally serve us very well can sometimes lead to bias, of factors that management considered in arriving at the
consider how our eyes can fool us when we see an optical offer price. “In conclusion,” says the CFO, “I believe you
illusion. Our eyes and related perceptual skills ordinarily will find that our figures align very well with what we know
are quite good at perceiving and helping us accurately of the raw material supplier and are fairly conservative in
judge shapes and motion. Just as with optical illusions, nature given the tremendous opportunity for synergistic
there are instances when the intuitive judgment of even cost savings, as well as gain in market share. Based on
the smartest and most experienced people falls prey to our analysis, we are confident that our offer price of $800
systematic cognitive illusions, referred to as judgment million is on target. In our view, this acquisition should be
traps and biases. Unfortunately, when it comes to judgment a slam dunk.” The CEO and CFO have made their decision
traps and biases, experience is not always the best to move forward and feel a sense of urgency to extend
teacher. The good news is that once we are aware of these the offer quickly, and they ask the board to step up and
traps and biases, we can deploy logical steps to reduce demonstrate decisiveness and vision by approving the
their impact and improve our judgment skills. extension of an offer.

“A hasty judgment is a first step to recantation.”
– Publilius Syrus (Roman writer)

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