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
“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. 79-119.www.cairn.info/revue-finance-2009-1-page-79.htm
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), ibid
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.