Improving decision-making to maximise value creation in private equity

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Kiddy & Partners

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Human decision-making is much less rational than any of us would like to admit. In reality, much of it is unconscious, automatic, and intuitive, allowing us to make decisions fast and relatively effortlessly.

We don’t interpret information objectively or consider all of the potential evidence, since our cognitive capacity is limited.1 Instead, we use subconscious ‘mental-short cuts’ to simplify information processing, which lead to cognitive biases. Even when we think we’re making a call based on facts and figures, our judgements are biased by the way data is presented, the weight we give to different factors, and other contextual factors that influence how we interpret it. The bad news is that no amount of experience or expertise make us impervious to unconscious biases. In fact, experience can provide a false sense of confidence, making us less likely to question our judgements or consider the alternatives. When you apply this to human capital decisions in investments the consequences can be costly.

Research by Kiddy has identified a number of key decision-making biases which appear to be common place in Deal Teams, Investment Committees, and Portfolio reviews, and threaten to significantly undermine decisions around leadership performance and human capital management across the lifecycle of a deal. 

“Falling in love with the management team.”

Given the natural importance of deal teams forming strong relationships with management teams in order to secure a deal, and conversely, the reduced likelihood of them doing a deal with a management team they dislike, it’s almost inevitable that their perception of the management team’s capability will be positively skewed. It will be very difficult for those involved in making deals to subsequently try to step back and be objective in evaluating performance of those management teams. In the words of operating specialists in our research:

“There’s a dynamic with the investing guys… they fall in love with management. Everyone’s on their best behaviour during a deal, and then reality kicks in and you meet them and think really? Are you sure?”

“This management team helped them to win the deal. So when I then go in and say ‘that CEO sucks and that CFO has no clue with numbers’ there is an immediate conflict.”

And recognised by colleagues on the deal side:

“There’s always a sense that you have to be net positive on everything to get a deal through. Therefore, particularly when a deal drags on, and you just want to get it done… people probably convince themselves that people are better than they are.”

“That is a drag on decision-making and there have to be some really serious and obvious misconducts and shortcomings, before we then finally land where we could have landed much before that.”

We’re also biased to prefer people who appear similar to ourselves; the ‘in-group’ bias or ‘similar to me’ effect, which can invalidate many selection and performance evaluations. Not only do people tend to recruit people in their own self-image, but stakeholders and directors tend to rate CEOs more favourably if they view them as similar to themselves.2 

The problem is that these are similarities in respect to criteria likely to be irrelevant to performance. Demographic and cultural variables such as leisure pursuits, experiences, and how someone presents themselves have all been shown to erroneously bring more favourable judgements of performance.3 Research in top-tier investment banks, law firms and management consulting firms reveals that concerns about cultural similarity significantly influences the selection decision-making process, and often outweighs concerns about actual productivity and performance.4 Not only does this bias open firms up to potential for discrimination, but management selection and performance decisions influenced by in-group bias have also been shown to lead to a number of destructive outcomes, including increased groupthink and decreased constructive conflict.5

Wishful thinking

Optimism is considered the most ubiquitous bias in investment decisions.6 Our research demonstrates how optimism biases can influence portfolio performance beyond the signing of a deal, by masking the need for more proactive human capital management.

In the words of some of the Investment Directors and Operating Partners in our research:

“It’s human nature to hope that a problem will go away rather than having the honesty with oneself to recognise that the chief exec didn’t turn out to be the person that we thought he was, or she was.”

The additional risk with unrealistic optimism is that it can lead to knock-on biases such confirmation bias. An investment team that’s already optimistic about a management team will subconsciously give more weight to evidence that suggests their performance is good, and less weight to any contrary indicators. Rarely do we go looking for evidence to counter our opinions.

As a result, there’s a risk that deal teams overlook underperformance, or at least don’t spot the signs early enough:

“Not recognising, and not grasping underperformance early enough; we’re all guilty of that - not recognising the signs of defensiveness and lack of openness, either pre-deal or post-deal.”

“We usually take longer than we should to change management or do whatever is needed. We give people a second chance, and a third chance… In a lot of cases, we haven’t been decisive enough to move to that decision pretty quickly. Eventually when you end up having to change a CEO it’s always easier in hindsight - in that scenario, people always say we should have done it six months ago."

“There is always, for want of a better term, self-doubt of how much of this is the person doing a bad job versus did we just get the wrong investment thesis, and did we not understand how complex it is.”

Reluctance to admit to mistakes

Many investors are familiar with the sunk costs fallacy at play with any investment decision. Kiddy research highlighted that this bias extends to decision-making around portfolio leaders’ performance
and capability:

“If you’ve backed somebody, then to say that they’re not up to the job means somewhere along the line you were wrong…they don’t really want to face up to the fact that they’ve made a mistake.”

“You’re putting your money behind a team, whether that’s an incoming team or one that’s already in place. So when you have to say, six months or a year down the line, hmm, I’ve probably made a mistake here, it’s a hard mistake to recognise. You tend to take much longer to actually effect change than you would normally.”

“We spend too long with the existing course of action, either with the same people, or the same partners, or the same strategy, or whatever. And it’s basically a sunk costs fallacy, you have so much invested, financial, emotional, and reputational that you find it hard to break out of it and move in a different direction.”

Previous research has already demonstrated that when CEO misconduct or poor performance occurs, it is difficult for the Directors involved in their appointment to confront the situation. Holding the CEO liable contradicts their belief that they appointed a highly capable person. As a result, they become even more committed to backing them despite evidence to the contrary.7

To reduce the discomfort of cognitive dissonance, we’re subconsciously driven to paint a picture of events (such as a dip in portfolio company EBITDA) and their causes in a way that is self-serving. In other words, we explain a situation or interpret data in a way that suits us best; over-fit the data about a portfolio company to support our original view or look for patterns where they don’t exist. This leads to attribution errors, alluded to by a number our interviewees:

“If an investment is off track in some shape or form, a common mistake is to attribute it to the market rather than to the performance of the chief exec or other members of the management team.”

“There is always, for want of a better term, self-doubt of how much of this is the person doing a bad job versus did we just get the wrong investment thesis, and did we not understand how complex it is.”

“The question is really are there external factors or is it the way the business is being led, the focus of resources and so on? I think that’s the hard part. It’s a natural defence mechanism to blame something else, or as an investor, you’re looking at performance and think ‘this isn’t great, but it could be internal, could be external…’ that’s the challenge.”

This means that when you’ve backed a management team, you’re more likely to over-attribute subsequent dips in organisational performance to external factors such as the market, and own play or overlook the role that the CEO and management team could (or should) have played in it. Conversely, if you don’t feel a sense of loyalty or vested interest in the incumbent management team, you may over-attribute their role in the demise of company performance, when external factors should actually be given more weight.


  1. Fabre & François-Heude (2009), Optimism and overconfidence investors’ biases: a methodologicalnote, Finance, 2009/1 (Vol. 30), p.
  2. Weber & Wiersema (2017) Dismissing a Tarnished CEO? Psychological Mechanisms and Unconscious Biases in the Board’s Evaluation, California Management Review,59, 3, 22-41.
  3. Bagues & Perez-Villadoniga (2012), Do recruiters prefer applicants with similar skills? Evidence from a randomized natural experiment, Journal of Economic Behavior & Organization, 82, 1, 12-20; Prewett-Livingston et al. (1996), Effects of Race on Interview Ratings in a Situational Panel Interview, Journal of Applied Psychology 81,178-186; Rivera (2012), Hiring as Cultural Matching: The Case of Elite Professional Service Firms, American Sociological Review, 77, 6, 999-1022.
  4. Rivera (2012), Hiring as Cultural Matching: The Case of Elite Professional Service Firms, American Sociological Review, 77, 6, 999-1022.
  5. Gholipour et al. (2008), The Effect of Similar-to-me Bias on the Selection and Appointment of Governmental Managers, Iran Journal of Management Sciences, 3(10), 7-36.
  6. Prosad, Kapoor, & Sengupta (2015), Exploring optimismand pessimism in the Indian equity market,Review of Behavioral Finance, 7(1), pp. 60-77.
  7. Weber & Wiersema (2017) Dismissing a Tarnished CEO? Psychological Mechanisms and Unconscious Biases in the Board’s Evaluation, California Management Review,59, 3, 22-41.

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