Working In Uncertainty
What circumstances are relevant to decision making under uncertainty?
This study was first reported in March 2009 on www.internalcontrolsdesign.co.uk and has been slightly reworded and reformatted for Working In Uncertainty.
It explores the factors that people consider relevant to rational decision making under risk and uncertainty, revealing a widespread appreciation of several objective, rational factors that have not been considered adequately in theorising about 'risk attitude'.
The phrase 'risk appetite' has been used a lot by risk management consultants in the UK in the last few years, promoting the idea that important business decision making should be controlled by eliciting personality-driven limits or weights. Do people generally agree that such personality-driven considerations should be part of decision making under uncertainty in business? The results of this survey, using a hypothetical decision under uncertainty, clearly show that most people do not.
In the hypothetical situation a person is asked to guarantee a business loan. Although no money is needed now, it would be if the borrower's business fails or the loan is otherwise not repaid. The decision is about how much to guarantee, if any. Respondents were then asked which of a number of factors should be relevant to a rational decision on how much to guarantee.
Factors that most respondents thought should be relevant were as follows. (The numbers are the percentages of respondents rating the factor as Somewhat Relevant or Highly Relevant.):
However, the following factors were seen as not relevant by most respondents:
Questions and results
The questions asked and percentage of respondents choosing each answer were as follows. The survey itself concerned a hypothetical scenario:
"Imagine that Bob is out one day when he meets Jill, who used to be a close friend but then moved away and dropped out of contact. (In fact part of Bob is still in love with Jill, and the meeting stirs up old feelings he thought had died.) When Bob and Jill get together later for a drink and a chat Bob learns that Jill is raising money for her new business venture. She is looking for money from a variety of sources but asks if Bob will guarantee some of her debt. This would involve agreeing to pay back some of Jill's loans if she can't, up to a maximum to be agreed up front. Jill will promise to pay Bob 5% of the amount he guarantees at the end of each of the first five years. After five years the contract will end."
"In this deal Bob doesn't have to provide any money now, but he might at some point in the next five years if Jill gets into financial difficulty."
"It's not the conversation Bob was expecting but the business idea is intriguing and based on a new gadget Jill says could save a lot of energy in homes all around the world. Bob agrees in principle but says he'll think about it and let her know how much he is prepared to guarantee."
"All the following questions are about what factors you think should rationally affect how much Bob is prepared to guarantee."
Respondents were then asked to consider ten factors and say how relevant each was, choosing between 'Not relevant', 'Somewhat relevant', and 'Highly relevant'. Each factor was revealed only when the previous one had been rated.
Each factor was described in such a way as to make it fairly clear what was to be considered and to give some information about why the factor might be relevant to the decision. The descriptions and percentages of respondents choosing each level of relevance were as follows:
Implications of results
These results have practical and theoretical importance.
The practical value is that, if you want to lead people in a discussion about an important decision to be made under uncertainty then most participants will see the value of considering such objective factors as wealth, variability and predictability of future wealth, money reserves as a buffer against business/lifestyle disruption, and so on. However, most will not be see any rational relevance in discussions of personal preferences for 'risk taking'.
The theoretical significance is that these results begin to open up a wider range of factors driving decision making than has been considered in most theorising to date. Most attempts to model decision making under uncertainty assume an aversion to 'risk' per se or 'uncertainty' per se for reasons that are not discussed, or try to explain apparent aversion in terms of the shape of a utility curve applied to the outcomes of the decision. I think there's more to it and these survey results suggest that most people agree.
Participants in the survey were invited to join through two professional discussion lists, RISKANAL (for risk analysts) and AuditNet (for internal and external auditors) and given a link to a web page with the survey.
Most respondents who started the survey also finished it. Here are the respondent numbers for both sources:
On the whole both groups of respondents gave similar ratings of most factors.
'The real reasons we avoid risk' points out some practical circumstances that are often relevant to decision making with uncertain outcomes.
'Making sense of risk appetite, tolerance, and acceptance' discusses problems with some of the practices currently being advocated and clarifies a lot of terminology.
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Words © 2012 Matthew Leitch