7 cognitive biases in board decision-making and how to overcome them

18 min read
Mar 12, 2024 11:53:09 AM

Cognitive biases influence individual and collective decision-making, and in high-stake environments such as boardrooms they can impact an organisation and its culture if left unchecked. Navigating these biases requires board members and other stakeholders to be critically aware and adopt countermeasures to overcome them.

This article outlines 7 cognitive biases that may exist in the boardroom, explores their origins, implications, and offers strategies to mitigate their effects.

This is the second of a series of 3 articles that explore cognitive bias in governance. The first article ‘Navigating cognitive biases for better governance’ explores the evolutionary perspective of cognitive and behavioural bias in the boardroom, and the third article ‘Building your mitigation toolbox: essentials for effective governance’ offers practical tools to address cognitive bias. 

Cognitive biases: systematic errors in thought and perception

Cognitive biases represent systematic patterns of deviation from norm or rationality in judgement, whereby inferences about other people and situations may be drawn in an illogical fashion. Individuals create their own "subjective social reality" from their perception of the input. An individual's construction of social reality, not the objective input, may dictate their behaviour in the social world. Thus, cognitive biases may sometimes lead to perceptual distortion, inaccurate judgement, illogical interpretation, or what is broadly called irrationality.

Cognitive biases are tendencies to think in certain ways that can lead to systematic deviations from a standard of rationality or good judgement They are often a result of our brain's attempt to simplify information processing. Biases can affect our thinking, decision-making, and the judgements we make about others in our everyday lives. For board directors, who are tasked with making high-stakes decisions that affect the direction and success of their organisations, an awareness and understanding of these biases are critical.

Behavioural biases: actions influenced by perception and judgement

Behavioural biases are systematic patterns in behaviour that deviate from rationality in judgement, affecting the decisions and actions of individuals. These biases stem from the way we process information and how this processing influences our behaviour. Unlike cognitive biases, which primarily affect our thought processes and belief systems, behavioural biases directly impact our actions, often leading to suboptimal outcomes. In the context of board governance, understanding behavioural biases is crucial as it directly influences the strategic direction and operational effectiveness of organisations.

Behavioural biases arise from various psychological factors, including emotions, social pressures, and cognitive shortcuts that affect decision-making processes. These biases can lead to decisions that are not aligned with the best interests of the organisation or its stakeholders. For example, Overconfidence Bias can lead directors to take on excessive risk without adequate consideration of potential downsides. Loss Aversion, another common behavioural bias, causes individuals to prefer avoiding losses to acquiring equivalent gains, which can result in overly conservative strategies that stifle growth and innovation.

In the boardroom, these biases can manifest in several ways, influencing not only individual directors but also the collective decision-making process. The interplay between individual and collective behavioural biases necessitates a deliberate approach to governance that actively seeks to mitigate their influence. This involves creating an environment where diverse viewpoints are encouraged, and critical thinking is valued over conformity. 

Common biases found in the boardroom

1. Confirmation bias: unveiling the veil of preconception

At its core, Confirmation Bias is a psychological phenomenon that permeates human reasoning, characterised by the inclination to seek, interpret, favour, and recall information in ways that affirm our pre-existing beliefs or hypotheses. This bias is not merely an abstract psychological concept but a tangible force that shapes decision-making processes, especially in high-stakes environments like boardrooms. In these settings, the bias can distort perceptions and lead to decisions that may not be anchored in a balanced analysis of the information at hand. Understanding Confirmation Bias requires recognising its pervasive nature and the subtle ways it can influence strategic thinking and decision-making within the boardroom.

The genesis of Confirmation Bias lies deeply embedded in the human psyche, stemming from an innate desire for cognitive consistency and ease. Humans naturally gravitate towards information that aligns with their existing worldview, a tendency that helps in reducing cognitive dissonance—the psychological discomfort experienced when confronted with conflicting beliefs or information. This inclination towards coherence is amplified in high-pressure environments like the boardroom, where the stakes are significantly higher, and the consequences of decisions are far-reaching. The board's collective desire for unanimous decisions can further intensify this bias, leading to a situation where dissenting voices are marginalised, and only corroborating evidence is given due consideration. Such a scenario is ripe for strategic missteps, as it narrows the board's perspective and limits its ability to engage with a full spectrum of strategic possibilities.

The strategic ramifications of Confirmation Bias in the boardroom are profound and multifaceted. Primarily, it can entrench the status quo, stifling innovation and adaptability. Boards may find themselves clinging to outdated strategies or continuing investments in underperforming ventures due to past successes, neglecting signals that point towards the need for change. This bias towards affirming the existing strategy, irrespective of its current relevance or effectiveness, can blindside the board to emerging opportunities and threats, leaving the organisation ill-prepared to navigate future challenges.

Moreover, Confirmation Bias can severely impair a board's ability to pivot in response to shifting market dynamics. In an era where technological advancements and consumer preferences evolve at an unprecedented pace, the ability to adapt swiftly and decisively is invaluable. Confirmation Bias, however, can create a cognitive lock-in, where board members discount or overlook critical data that contradicts their preconceived notions, leading to strategic inertia.

A pertinent instance of Confirmation Bias is the downfall of ABC Learning, once the world's largest provider of childcare services. Founded in 1988, ABC Learning expanded rapidly, both domestically and internationally, through aggressive acquisitions funded by significant debt. The board of ABC Learning exhibited Confirmation Bias by consistently favouring optimistic growth forecasts and the apparent initial success of their expansion strategy, disregarding signs that pointed to unsustainable debt levels and operational inefficiencies.

This Confirmation Bias led the board to overlook critical warnings from financial analysts and internal reports about the company's over-leveraged position and the risks associated with rapid expansion. The board's unwavering belief in the company's business model and growth prospects, despite mounting evidence to the contrary, prevented them from taking necessary corrective actions in time. 

The culmination of these issues became apparent in 2008 when ABC Learning declared bankruptcy, leading to a massive financial fallout affecting thousands of employees and families reliant on their services. The case of ABC Learning serves as a stark reminder of the dangers posed by Confirmation Bias in board-level decision-making, emphasising the importance of critical scrutiny and the consideration of dissenting viewpoints in strategic planning and risk assessment.

What to do about it: Cultivating an awareness of this bias is the first step; acknowledging its presence is essential for any substantive effort to counteract its effects. From there, boards can implement more deliberate and structured approaches to decision-making.

Make board governance easier for everyone with board management software

Learn more

2. Overconfidence Bias: navigating the perilous waters of certainty

Overconfidence Bias is a cognitive distortion where individuals overestimate their own capabilities, the accuracy of their knowledge, and their control over uncertain outcomes. In the context of boardroom decisions, this bias can manifest as an unwavering belief in the infallibility of the board's strategic choices, often influenced by past achievements or the perceived expertise within the group. Such overconfidence may result in the marginalisation of contrary opinions, insufficient due diligence, and the pursuit of overly ambitious objectives without a realistic appraisal of their viability, or the risks entailed.

The psychological foundations of Overconfidence Bias are multifaceted, encompassing the illusion of control and optimism. These elements foster a mental environment where board members might mistakenly believe they wield greater influence over outcomes than is actually the case, exhibit undue optimism regarding their success probabilities, and misattribute past successes to their own endeavours, neglecting the role of external factors or fortuitous circumstances.

The strategic repercussions of Overconfidence Bias are significant, potentially steering organisations towards the allocation of resources to unfeasible projects, neglect of emerging market shifts, and ignorance of looming threats. An overconfident board may embark on aggressive expansions into unfamiliar territories without a comprehensive understanding of local market dynamics or competitive landscapes, culminating in expensive misadventures. Moreover, this bias can compromise the organisation's agility and responsiveness, vital attributes in today's rapidly changing business environment.

The collapse of Dick Smith Electronics, a once-prominent electronics retailer, provides a stark example of overconfidence bias at the board level. Acquired by private equity firm Anchorage Capital Partners in 2012 and then listed on the Australian Securities Exchange (ASX) in 2013, Dick Smith embarked on an aggressive expansion and inventory accumulation strategy. The board and management demonstrated Overconfidence Bias by significantly overestimating the company's capacity to sell a large volume of inventory quickly and at high margins, despite clear signals from market trends and consumer demand that suggested otherwise.

This overconfidence was further reflected in their optimistic financial projections and the decision to pursue rapid expansion without adequately assessing the inherent risks of such a strategy in a highly competitive and rapidly evolving retail electronics market. The failure to recognise and respond to the changing retail environment, including the shift towards online shopping and the intense price competition, led to a significant overstocking issue.

By late 2015, it became evident that the company could not sustain its operations due to its untenable inventory levels and poor sales performance. Dick Smith Electronics was forced into administration in early 2016, leading to the closure of over 300 stores and the loss of nearly 3,000 jobs. This case highlights the critical importance of grounding board decisions in realistic assessments of market conditions and internal capabilities, rather than succumbing to Overconfidence Bias that can blindside a company to emerging challenges.

What to do about it: Addressing Overconfidence Bias necessitates the cultivation of a boardroom culture steeped in humility, the active solicitation of diverse viewpoints, and a commitment to rigorous, evidence-driven decision-making. 

3. Groupthink: the consensus trap

Groupthink is characterised by a collective drive for harmony or conformity within a group, which can culminate in irrational or dysfunctional decision-making outcomes. In environments where critical decisions are made, such as boardrooms, the desire to maintain group cohesion and avoid conflict can significantly impair the decision-making process. This phenomenon is marked by several symptoms, including but not limited to, self-censorship, the illusion of unanimity, and direct pressure on dissenters to conform. The result is often a consensus decision that lacks a comprehensive assessment of the situation and fails to consider viable alternatives or the full spectrum of potential risks.

The psychological underpinnings of Groupthink are deeply rooted in the basic human needs for social belonging and esteem. Board members, driven by the desire for approval and acceptance from their peers, may sideline their critical evaluation faculties in favour of maintaining group harmony, especially in high-stakes or high-pressure environments. The presence of a strong, persuasive leadership figure or a highly cohesive group can further exacerbate this tendency, propelling the group towards a premature consensus that circumvents thorough analysis and critical debate.

Amplifiers of Groupthink include:

  • Strong Leadership: Dominant leaders who express strong preferences can inadvertently suppress dissenting views among board members.
  • High Group Cohesion: While cohesion can be beneficial for teamwork, excessive cohesion may lead to a reluctance to express contrary opinions, for fear of ostracism.
  • Isolation from External Opinions: Groups that operate in isolation, without seeking or valuing external input, are more prone to Groupthink as they lack exposure to diverse perspectives.
  • Stressful Situations: High-pressure contexts, such as urgent decision-making deadlines, can heighten the group’s inclination towards quick consensus, sidelining thorough evaluation.

The strategic consequences of Groupthink can be profound, leading to decisions that may jeopardise the organisation's competitive position, financial health, and capacity for innovation. Boards afflicted by Groupthink may fail to adequately challenge failing strategies, overlook emerging threats, or miss out on opportunities for innovation and growth. Such oversight can result in significant setbacks, including the loss of market share, reputational damage, and financial decline. The insular nature of Groupthink-laden decisions also means that organisations may be slower to adapt to market changes or technological advancements, further eroding their competitive edge.

The case of the Australian Wheat Board (AWB) and the Iraq kickbacks scandal serves as a vivid illustration of Groupthink impacting board-level decisions. In the early 2000s, the AWB was found to have paid kickbacks to the Iraqi government to secure wheat contracts, in violation of United Nations sanctions. This scandal, uncovered by the Cole Inquiry in 2006, highlighted how the AWB's board and senior management were involved in or willfully ignorant of the payment of hundreds of millions of dollars in kickbacks.

The board's decision-making process was characterised by a collective rationalisation that overlooked the ethical and legal implications of their actions, under the guise of maintaining market share and national interest in Iraq. The desire for unanimity and the board's cohesive nature discouraged dissenting opinions and critical questioning of the sales strategy to Iraq. This environment of Groupthink contributed to a lack of scrutiny over the deals being made and a failure to consider the long-term repercussions of their actions on the company’s reputation and legal standing.

The AWB scandal underscores the dangers of Groupthink in corporate governance, demonstrating how a culture that discourages dissent and critical evaluation can lead to unethical decisions and significant legal and reputational damage.

What to do about it: Counteracting Groupthink requires deliberate efforts to cultivate an environment where critical evaluation is encouraged, and diverse viewpoints are valued. Implementing structured decision-making processes can help ensure a comprehensive exploration of all options and risks. 

4. Anchoring bias: the first impression's hold

Anchoring Bias refers to the human tendency to rely heavily on the first piece of information offered when making decisions. In the context of board meetings, this means that initial estimates, figures, or data points can unduly influence the final decision, regardless of the additional, potentially more relevant information presented later. This cognitive shortcut is a natural part of human decision-making, as it helps simplify complex judgements by establishing a reference point. However, when the initial anchor is arbitrary, based on incomplete information, or irrelevant to the decision at hand, it can lead to skewed analysis and biased outcomes.

The roots of Anchoring Bias lie in the fundamental ways humans process information. The mind seeks patterns and references to make sense of complex situations, and an anchor provides a convenient starting point. This cognitive shortcut becomes particularly pronounced in high-pressure situations or when faced with complex decisions, conditions often found in boardrooms. The desire for quick, decisive action can make board members more susceptible to anchoring, especially if they are presented with a compelling initial estimate or piece of data.

Several factors can amplify the effects of Anchoring Bias:

  • Complexity of Information: The more complex a decision, the more likely individuals are to rely on anchors as shortcuts to navigate the decision-making process.
  • Pressure to Act Quickly: Urgent decision-making environments can exacerbate the reliance on initial information as there is less time to gather and analyse additional data.
  • Expertise and Experience: Ironically, experienced individuals or experts can be more prone to Anchoring Bias, as they may give undue weight to their initial analysis or assumptions.
  • Emotional Involvement: Emotional investment in a particular outcome can reinforce the anchor, making individuals less likely to adjust their judgements based on new information.

The strategic implications of Anchoring Bias are far-reaching. Boards may make misaligned resource allocations, set unrealistic targets, or continue down strategic paths that are no longer viable based on outdated or irrelevant initial information. For instance, anchoring to a particularly successful financial quarter without considering market volatility could lead to setting unachievable future targets, resulting in misallocated resources and potential strategic misalignments.

Anchoring can also affect investment decisions, where an initial valuation or a past investment's performance unduly influences the board's perception of a new opportunity's potential, potentially leading to either excessive caution or unwarranted risk-taking.

An example that illustrates the impact of anchoring bias in board-level decision-making involves the National Australia Bank (NAB) and its UK banking acquisitions in the late 1990s and early 2000s. NAB, one of Australia's largest banks, embarked on an expansion strategy that included the acquisition of several UK banks, including Clydesdale Bank and Yorkshire Bank. The decision to acquire and invest in these UK entities was heavily influenced by the initial success and perceived potential for growth in the UK banking market.

The anchoring bias manifested when NAB's board became overly committed to their initial valuation and optimistic projections for these acquisitions, despite emerging signs that the UK market was becoming increasingly challenging and competitive. This bias towards their initial assessments led to a failure to adequately adjust their strategy in response to changing market conditions and operational issues within the acquired entities.

The consequences of this anchoring bias became apparent when NAB was forced to write down the value of its UK assets by billions of dollars over the following years. The bank ultimately divested these assets at a significant loss, a move that was seen as an admission of the flawed initial strategy and the failure to adapt to the reality of the situation.

What to do about it: Mitigating the effects of Anchoring Bias requires a conscious effort to recognise the presence of anchors and deliberately adjust decision-making processes to minimise their influence. 

5. Availability Heuristic: the bias of recency and salience

The Availability Heuristic operates on the principle that if something can be recalled easily, it must be important or at least more common than alternatives that are not as readily recalled. This can significantly affect boardroom decisions, where directors might judge the likelihood of risks, or the potential of opportunities based on how easily similar instances come to mind. For example, the memory of recent high-profile cyberattacks could cause a board to focus disproportionately on cybersecurity risks, potentially overshadowing other critical issues that are less prominent but equally important.

The underlying cause of the Availability Heuristic lies in the way humans process information. Our brains are wired to prioritise information that is easily retrievable, which is often influenced by:

  • Recency: Events that have occurred recently are easier to recall and hence might be perceived as more frequent or likely to reoccur.
  • Emotional Impact: Incidents that have had a significant emotional impact on an individual are more memorable and can be overrepresented in decision-making.
  • Media Coverage: Extensive media coverage of specific events can enhance their perceived importance or frequency due to increased exposure.
  • These factors can amplify the Availability Heuristic, especially in high-pressure environments like board meetings, where there is a need to make quick decisions based on the information that is most readily available.

The strategic implications of relying on the Availability Heuristic can be far-reaching. Boards may end up misjudging priorities, leading to an imbalanced assessment of risks and opportunities. This bias can divert attention and resources away from strategic initiatives that are crucial to the organisation's long-term success, focusing instead on addressing risks or pursuing opportunities that are perceived as more immediate or salient due to recent exposure. Such misallocation can hinder the organisation's ability to effectively strategise and allocate resources efficiently, potentially impacting its competitive edge and future growth.

The downfall of the retail giant Myer following its 2009 initial public offering (IPO) is a compelling case of the Availability Heuristic impacting board-level decisions. Myer, one of Australia's largest department store chains, was taken public in what was then one of the largest IPOs in Australian retail history. The board and executive leadership were influenced by the availability heuristic, drawing heavily on recent retail success stories and the pre-financial crisis retail boom when deciding to proceed with the IPO.

This cognitive bias led them to overestimate the continued strength of consumer spending and the resilience of the traditional retail sector in the face of emerging online shopping trends. They were overly optimistic about Myer's market position and growth prospects, underestimating the rapid shift in consumer behaviour towards online shopping and the increasing competition from international retailers entering the Australian market.

As a result, Myer's performance post-IPO did not meet expectations. The company faced significant challenges, including declining sales, reduced foot traffic in physical stores, and a struggling adaptation to the digital marketplace. This case highlights how the Availability Heuristic can lead boards to make overly optimistic projections based on recent successes, without adequately considering changing market dynamics and potential risks, ultimately impacting company performance and shareholder value.

What to do about it: Countering the influence of the Availability Heuristic requires a conscious effort to broaden the information base used for decision-making.

6. Status Quo Bias: the comfort of the familiar

Status Quo Bias refers to the predisposition to prefer things to remain the same, avoiding changes that could disrupt the current state of affairs. In boardroom settings, this bias can manifest as a reluctance to embrace new technologies, explore untapped markets, or implement necessary organisational changes, even when such actions are clearly in the organisation's best interest. For instance, boards may resist transitioning to more sustainable business practices due to perceived short-term costs and disruptions, neglecting the long-term benefits and innovation opportunities such shifts can engender.

These tendencies are amplified in uncertain environments, where the costs of change are immediate and tangible, while the benefits appear delayed and speculative. The complexity of strategic decisions, the fear of making wrong moves, and the inherent uncertainty of business environments can all exacerbate the Status Quo Bias.

The strategic consequences of succumbing to Status Quo Bias are significant. Organisations risk missing out on opportunities for innovation and growth, diminishing their competitiveness, and failing to adapt to changing market conditions. An adherence to outdated technologies, business models, or practices can render a company increasingly irrelevant in a rapidly evolving marketplace. Moreover, the resistance to change can stifle creativity and innovation within the organisation, leading to a culture that is risk-averse and inward-looking, ultimately hindering potential advancements and growth.

Blockbuster Australia's decline in the face of the digital streaming revolution offers a stark illustration of Status Quo Bias within corporate decision-making. As the digital age dawned, bringing with it the rise of online streaming platforms like Netflix, Blockbuster Australia, much like its US counterpart, clung to its traditional brick-and-mortar rental model. This decision was deeply influenced by a Status Quo Bias, wherein the board and management overvalued their existing business model, underestimating the speed and impact of technological advancements and changing consumer preferences towards digital content consumption.

Despite clear signals from the market and technology trends indicating a shift away from physical rentals towards online streaming, Blockbuster Australia's leadership remained focused on its physical stores. This reluctance to innovate or pivot towards an online presence was underpinned by a misplaced confidence in the strength of the brand and the habitual preference of customers for in-store experiences, ignoring the convenience and growing popularity of online streaming.

The consequence of this bias was Blockbuster Australia's gradual decline, culminating in the closure of its remaining stores. This case underscores the critical need for businesses to remain adaptable and forward-thinking, highlighting how adherence to the status quo in an era of rapid technological change can lead to obsolescence and failure.

What to do about it: Countering Status Quo Bias requires deliberate and strategic efforts to cultivate an organisational culture that embraces change and innovation. This could include things like implementing a 'fail-fast' approach where employees are encouraged to test new ideas on a small scale, learn from failures quickly, and iterate. This can be framed through a question like, "How can we test this idea with minimal risk?". Strategic questions such as, "What can we learn from industries outside our own?" can open up thinking to new methodologies, technologies, and approaches. 

Leaders can also ask questions such as "What will our organisation miss if we don't change?" This question highlights the risks of stagnation and the opportunities that change can bring. By making the case for change a part of the organisation's narrative, leaders can inspire a collective effort towards transformation, ensuring that the drive for innovation is shared across all levels of the organisation.

7. Loss Aversion: the disproportionate fear of loss

Loss Aversion describes a cognitive bias wherein individuals show a preference for avoiding losses over acquiring equivalent gains. This bias can manifest in boardroom decision-making through a tendency to opt for risk-averse strategies, such as shying away from investing in new ventures, technologies, or markets, driven by the fear of loss or failure. This conservative approach can hinder an organisation's ability to capitalise on significant growth opportunities or innovate in the face of competitive pressures.

The psychological underpinning of Loss Aversion lies in the asymmetrical impact of gains versus losses on an individual's state of mind. Humans are intrinsically more sensitive to the notion of losing what they already possess than to the prospect of gaining something of similar value. This sensitivity is heightened in environments like the boardroom, where decisions carry substantial financial implications, and the outcomes are highly visible.

Several factors can amplify Loss Aversion within the boardroom:

  • High-Stakes Decisions: The greater the perceived risk associated with a decision, the more pronounced the Loss Aversion bias can become.
  • Past Experiences: Previous encounters with loss or failure can increase the fear of similar outcomes, reinforcing a cautious approach to decision-making.
  • Peer Comparison and Social Proof: Observing peers or competitors who have experienced losses can heighten Loss Aversion, leading to a herd mentality aimed at avoiding similar fates.

The strategic consequences of Loss Aversion are far-reaching. Organisations may miss out on crucial opportunities for innovation and market leadership, leading to stagnation and a diminished ability to respond effectively to competitive threats or changes in consumer preferences. For example, a company overly focused on minimising risks might ignore or delay investments in emerging technologies or business models that could secure its future success.

Additionally, Loss Aversion can result in:

  • Underutilisation of Resources: Resources may be allocated to "safe" projects with lower returns, rather than to more innovative or risky ventures with higher potential rewards.
  • Delayed Decision-Making: The fear of making the wrong choice can lead to procrastination or indecision, further compounding the opportunity cost.
  • Erosion of Competitive Advantage: As competitors who are willing to take calculated risks move forward, organisations crippled by Loss Aversion may find themselves lagging behind.

The experience of Kodak’s Australian operations with digital photography innovation presents a compelling case of Loss Aversion impacting strategic decisions at the board level. Kodak, a global leader in photographic film products, faced the disruptive challenge of digital photography's rise in the late 1990s and early 2000s. Despite having developed some of the earliest digital camera technologies, Kodak Australia, mirroring its parent company's stance, displayed significant Loss Aversion by prioritising its lucrative film business over the nascent digital market.

This cognitive bias, where the fear of losses from cannibalising existing film sales outweighed the potential gains from leading the digital photography revolution, led to a reluctance to fully commit to and invest in digital technologies. Kodak’s board and management were concerned that a pivot to digital would undermine their existing film business, which had been the cornerstone of their success for decades.

As a result, Kodak Australia moved slowly in embracing digital photography, allowing competitors who were less invested in traditional film businesses to capture substantial market share in the emerging digital space. By the time Kodak recognised the inevitability of digital photography's dominance, it had lost critical ground. This case study illustrates how Loss Aversion can lead companies to miss transformative opportunities, emphasising the importance of overcoming biases to embrace innovation and adapt to technological advancements.

What to do about it: Addressing Loss Aversion in the boardroom requires a multifaceted approach that includes shifting perspectives, fostering a culture of calculated risk-taking, and implementing structured decision-making frameworks.

Where to next?
BoardPro demonstration

Click me

Get Email Notifications