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In an article which appeared in the Journal of Psychology and Financial Markets( 1), John Payne and Arnold Wood pointed out that this tendency towards bad decisions could potentially escalate when investment decisions are made in groups.
That should definitely give us all pause for thought. Arnold Wood says that more than US$6 trillion in investments is overseen by investment committees of one form or another worldwide. In SA, investment committees are probably responsible for more than R1 trillion in pension fund investments alone(2).
The magnitude of influence that these groups hold absolutely demands that we understand the counterproductive forces at work in the group decision-making process and help trustees develop ways to mitigate them.
Surely this all seems counterintuitive.
We know that individuals make mistakes and have flawed cognitive processes. The "group" should theoretically control against individual error by introducing counterbalancing views and by expanding the information and experiential base from which a decision is made. But research outcomes are suggesting a different reality.
Payne and Wood point out that as long as the task at hand is straight problemsolving or of a purely technical nature (such as formulating an accurate member profile for a fund) the group decisionmaking process can be quite constructive.
However, it's when groups are faced with issues that demand judgmental inputs that the group process dynamic does its greatest damage. Unfortunately, decisions such as: What's our tolerance for risk? How should we formulate an investment policy? What asset classes should we include? and which managers are best for the jobs? are all judgmental decisions. So the prognosis for investment committee processing is clearly not good.
What goes wrong when groups make decisions?
What goes wrong here? Simply put, the group dynamic is a social one: where the primary activity is spent on determining whether one belongs or doesn't belong or in assessing (not necessarily consciously) how one might go about increasing one's acceptance into the group.
It's a phenomenon Barton Biggs neatly summed up in the title of his paper:
"Groupthink = Groupstink"(3). He cites Yale psychologist Irving Janis when he says that Groupthink is "a mode of thinking that people engage in when they're deeply involved in a cohesive in-group, when the members' striving for unanimity overrides their motivation to realistically appraise alternatives... a marked distortion in information processing, reality testing and mental efficiency that results from in-group pressures".
The dynamic of "Groupstink" builds upon many of the issues initially cited by the behavioural finance academics but adds a few of its own special twists.
For example, Wood and Payne have identified a litany of common pitfalls that have their own special meaning in the group decision-making processes:
Illusion of effectiveness/overconfidence
Starting at the top, groups typically have this illusion that a collection of good minds is a better bet than depending on one mind (75% of people in a Wood and Payne study of investment committee members believed that the decision they reach in a group would be better than the decision they would make on their own) in spite of evidence in some of the work by Terrance Odean that the contrary is usually the case.
When more than one member of a group agrees to a specific point or when a particularly influential member of the group presents their views, the illusion quickly forms that that must be the right answer - and typically one sees the rest of the group generally migrating to this "right answer".
This example of overconfidence, egged on by bias amplification, becomes even more pronounced if the initial sponsor of the idea was the alpha, or dominant, member of the group.
Bias amplification/leadership sway
I've run a little experiment to illustrate the power of bias amplification with at least 30 different live audiences in SA - and not once has the exercise failed in getting the audience to arrive at the wrong investment conclusions.
Construct a list of well-known fund manager names, picking managers that represent recent performance extremes.
Alongside the list, list a series of investment performances by one of the publicly available funds actually managed by each of these managers. Ask the audience to match the manager to the performance.
On the left hand side were the answers given by the audience. On the right hand side are the correct answers. Clearly, the audience thought they knew the correct answer because they had pre-existing biases towards the different managers thanks to the power of media coverage and marketing.
But the really disturbing aspect of the exercise was not that I was able to trick the audience; in fact, there's usually some bright spark in every audience who comes up with the right answer. Rather, it was the speed with which I was able to manipulate the audience into a consensus regarding the wrong answers.
That's the dynamic that occurs in the group when there's bias amplification and leadership sway. In the investment committee setting, the magnitude of this overconfidence invariably emboldens groups into taking decisions that individuals in their own right would feel they lacked enough information or insight to make.
Sponsorship and confirmation bias/ knowledge bartering
Sponsorship and confirmation bias and knowledge bartering are reflected in situations where members of an investment committee, for example, may over commit to an idea if they believe it will help curry favour with other group members.
Similarly, instead of expanding on each other's knowledge base, group members will introduce information if it helps confirm a powerful chairman's view or withhold information if it helps curtail the power of another group member.
The more homogeneous the group, the more likely the group is to reaffirm and accentuate that bias rather than work to dissipate it.
As Biggs says: "On an investment committee it's almost better to be wrong with the group than to express a contrary view, even if it's right, because if by any chance you're both wrong and a dissident you're finished as a functioning member of the committee."
Addressing the problem - the first baby steps
The clear message is not that the group dynamic is hopelessly flawed. Without question the starting point for change is to first recognise and properly label the problem. The next step is to identify ways to minimise counterproductive behaviour before it even starts.
For example, decision science experts seem to agree that the more heterogeneous the group is in terms of cultural background, values, education and experience the higher the probability of controlling against counterproductive behaviours.
From that perspective, SA investment committees would appear to have a distinct advantage in being able to assemble such a population - particularly as pension fund boards of trustees are required to draw 50% of its representatives from the employee ranks. But that advantageous starting point can be easily diluted if there are too many trustees in total (more than 10 starts to become counterproductive because then consensusbuilding becomes the exclusive activity).
The perfect investment committee?
But research has shown that it's not so much the different cultural backgrounds that reduce the counterproductive behaviour (there are alpha males in just about every advanced culture). Rather, true diversity comes when you've completely different operational modes represented in the group dynamics. As such, the fastest way to introduce a diversity of mindsets is to simply introduce members of the opposite sex(4).
Simplistically, these two populations bring to the table the type of diversification in group behaviour and information processing that's essential to an effective working committee. The table below provides a broad summary of general characteristic differences - both the good and the bad:
But beyond this "fix" of enhanced committee composition there are other "behaviours" that investment committees can introduce that can contribute significantly to ensuring a more rigorous and fruitful decision-making process. In summary, these are:
* Create the time, space and culture for debate.
* Don't fall back on what you know, know what you don't know.
* Take time as a group to understand likely cognitive errors.
* Push process planning before task planning - neutralise railroading.
* Don't work on lowest common denominator principles.
* No "loafing". Give everyone an area of responsibility - and make them deliver.
* Take time to go through a governance budgeting exercise so that everyone knows who decides what and where each member's responsibilities begin and end.
* Make sure to create the time to get to the right decisions.
* Maintain good records of why decisions were made.
* Choose a leader with wisdom - not answers.
Footnotes:
(1) John Payne and Arnold Wood, "Individual decision-making and group decision processes"; The Journal of Psychology and Financial Markets; Vol 3, No 2, 2002.
(2) Alexander Forbes Survey 2004 (3) Barton Biggs; "Groupstink" Strategy and Economics; Morgan Stanley Dean Witter; May 1999.
(4) Jonathan Myers; "Sex, Conflict and Investment Style!; Psychonomics Research; June 2004.
Behavioural Difference in Groups
MALE
Constructive
* Assertive
* Single-minded
* Takes decisions
* Strong negotiator
* Goal-orientated/results
* Fact-based
* Risk tolerant
* Competitive
Destructive
* Testosterone
* Power is paramount
* Ego - overconfident
* Low e.g. - doesn't build consensus
FEMALE
Constructive
* Consensus builder
* Process orientated - it's a journey, not an end
* Draws inputs from multiple sources - intuitive
* Multi-focused
* Better understanding of member issues
* Safety conscious
Destructive
* Poor negotiation skills
* Tends to personalise
* Acquiesces to preserve group
* Reflective - needs confirmation
