Misbehaving

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11 interesting paragraph from the book “Misbehaving” by the noble prize winner “Richard H. Thaler”

1) The core premise of economic theory is that people choose by optimizing. Of all the goods and services a family could buy, the family chooses the best one that it can afford. Furthermore, the beliefs upon which Econs make choices are assumed to be unbiased. That is, we choose on the basis of what economists call “rational expectations.” If people starting new business on average believe that their chances of succeeding is 75 %, then that should be a good estimate of the actual number that do succeed. Econs are not overconfident.

2) I call this phenomenon the “endowment effect” because in economists’ lingo, the stuff you own is part of your endowment, and I had stumbled upon a finding that suggested people valued things that were already part of their endowment more highly than things that could be part of their endowment, that were available but not yet owned.

3) I found the concept of hindsight bias fascinating, and incredibly important to management. One of the toughest problems a CEO faces is convincing managers that they should take on risky projects if the expected gains are high enough. Their managers worry, for good reason, that if the projects workout badly, the manager who championed the project will be blamed whether or not the decision was a good one at a time. Hindsight bias greatly exacerbates this problem, because the CEO will wrongly think that whatever was the cause of the failure, it should have been anticipated in advance, and, with the benefit of hindsight, he always knew this project was a poor risk. What makes the bias particularly pernicious is that we all recognize this bias in others but not in ourselves.

4) At some point in pondering these questions, I came across a quote from social scientists Donald McIntosh that profoundly influenced my thinking: “The idea of self-control is paradoxical unless it is assumed that the psyche contains more than one energy system, and that these energy systems have some degree of independence from each other.” The passage is from an obscure book, “The Foundation of Human Society.” I do not know how I came by the quote, but it seemed to me to be obviously true. Self-control is, centrally, about conflict and, like tango, it takes (at least) two to have a conflict. Maybe I needed a model with two selves.

5) In order to get managers to be willing to take risks, it is necessary to create an environment in which those managers will be rewarded for decisions that were value-maximizing ex-ante, that is, with information available at the time they were made, even if they turn out to lose money ex-post. Implementing such a policy is made difficult by hindsight bias. Whenever there is a time lapse between the times when a decision is made and when the results come in, the boss may have trouble remembering that he originally thought it was a good idea too. The bottom line is that in many situations which agents are making poor choices, the person who is misbehaving is often the principle, not the agent. The misbehaving is failing to create an environment in which employees feel that they can take good risks and not be punished if the risks fail to pay off. I call these situations “dumb principle” problems. We will discuss a specific example of such a case a bit later in the context of sports decision-making.

6) When people are given what they consider to be unfair offers, they can get angry enough to punish the other party, even at some cost to themselves. That is the basic lesson of the ultimatum game. As the willow tree story illustrates, the same can occur in situations in which the Coase theorem is often applied. After a lawsuit, both the sides are typically upset with each other, and this is particularly true for the person who loses the case. For the Coase theorem to work, that losing party has to be willing to make an offer to the other side if he puts a greater value on the property right he just lost. But if people are angry, the last thing they want to do is talk to the other side. Law professor Ward Farnsworth documented this reluctant by interviewing attorneys from over twenty civil cases in which injunctive relief was sought and either granted or denied after full litigation before a judge. In not a single case did the parties even attempt to negotiate after the court had issued its order.

7) We also analyzed the speeches each players makes before the big decision. Not surprising, the speeches all have the same flavor: “I am not the sort of person who would steal, and I hope you are not one of those evil types either.” This is an example of what game theorists’ calls “cheap talk.” In the absence of penalty for lying, everyone promises to be nice. However, there turns out to be one reliable signal in all these noise. If someone makes an explicit promise to split, she is 30 percentage point more likely to do so. (An example of such a statement, “I promise you I am going to split it, 120%) This reflects a general tendency. People are more willing to lie by omission than commission. If I am selling you a used car, I do not feel obligated to mention that the car is burning a lot of oil, but if you ask me explicitly, “Does this car burn a lot of oil.” You are likely to wangle an admission from me that yes, there has been a small problem along those lines. To get at the truth, it helps to ask specific questions.

8) Furthermore, if the household is going to miss its ideal saving target, it seems better to overshoot the desired retirement nest egg than to save too little. I am not taking position on how people should allocate their consumption over their lifetimes, and surely there are many miserable lives. Instead, I am concerned with the difficulty to forecasting the rate of return on savings, and the ease of making adjustments later in life. Someone turning sixty who finds herself flush with surplus savings has numerous remedies, from taking an early retirement to going on lavish vacations, to spoiling the grandchildren. But someone who learns at sixty that she has not saved enough has very little time to make up lost ground, and may find that retirement must be postponed indefinitely.

9) He was already off to a good start. He had read the work of psychologist Robert Cialdini, author of the classic book Influence. Many people have called Danny Kahneman the most important living psychologist and I would hardly disagree, but I think it would be fair to say that Cialdini is the most practical psychologist alive. Beyond Cialdini’s book, Nick Down had also received some advice from a consulting firm that is affiliated with Cialdini to help him think about how he might get people to pay their taxes promptly.

10) Whenever anyone asks me to sign a copy of Nudge. I always add the phrase “nudge for good.” Nudges are merely tools, and these tools existed long before Cass and I gave them a name. People can be nudged to save for retirement, to get more exercise, and to pay their taxes on time. But they can also be nudged to take out a second mortgage on their home and use the money on a spending binge. Business or governments with bad intentions can use the findings of the behavioral sciences for self-serving purposes, at the expense of the people who have been nudged. Swindlers have a lot of wisdom by carefully selecting nudges based on science, and then subjecting these interventions to rigorous tests.

11) Of course, not all financial economists have renounced their allegiance to the efficient market hypothesis. But behavioral approaches are taken seriously, and on many issues, the debate between the rational and behavioral camps has dominated the literature in financial economics for over two decades.

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