BM 2265:

Managerial Decision Making

Prepared by: Dr. Chin Han Wuen

Week/Date Topic(s) and lesson(s) planned
01 (13/01) Introduction to Managerial Decision Making
02 (20/01) Individual Decision Making
03 (27/01) Individual Decision Making; Human Judgment and Decision Making
04 (03/02)
05 (10/02)
06 (17/02)
07 (24/02) Public Holiday: National Day Holiday
(03/03) Semester Break
08 (10/03)
09 (17/03)
10 (24/03)
11 (31/03) Public Holiday: Hari Raya Aidil Fitri (31 Mar to 2 Apr)
12 (07/04)
13 (14/04)
14 (21/04)
 Managerial Decision Making Topics

➢ Individual Decision Making

➢ Human Judgment and Decision Making
➢ Group Decision Making
➢ Prescriptive Theories
➢ Negotiation and Bargaining
➢ Decision Modelling
➢ Case Study of Decision Making
Topic: i) Individual Decision Making
ii) Human Judgment & Decision Making

Main learning objective:

• Analyze the different theories and techniques of decision-making process;
• Relate theories to real managerial and business practices.
 Topic: Individual Decision Making

Sub-Learning Objective:
• Decision Framing;
• Implications of Effective Decision Making; and
• Process Theories (Dual Process Theory; Mental Accounting).
 Decision Framing

• A decision framing refers to the mental model of the decision making

process that individuals use to solve the problem.

• The information from a particular problem may remain the same, but it
may be perceived, organized, and interpreted differently.
 Decision Framing

Mental
Decision
Representation Judgment Decision/Choice
Problem
of Problem

Diagram 1: The Mental Representation of Decision Making

Diagram 2: An example of decision frame in business company
 Decision Framing

• The implication of a personal mental model is that two individuals who

are presented with the same problem might actually be solving
different “mental” problems.

• The true objects of evaluation and choice are not real objects, nor their
verbal descriptions; but rather their mental representations.
 Implications for Effective Decision Making
Financial Performance Non-Financial Performance

• Profitability (Sales growth). • Quality Enhancement.

• Returns (ROI; ROA). • Innovation.
• Customer Satisfaction/Retention.
• Employee Productivity.

- Objective-based measurement - Subjective-based measurement

 Process Theories

• Although framing is a spontaneous and subconscious process,

decision makers can also be deliberative in creating frames.

• This leads to various process theories being introduced to explain how

decision makers derived their decision frame.
 Process Theories

• Process theories serve as frameworks which outline the steps and

stages involved in making a decision-making process.

• This requires a structured approach to gather information, evaluate the

alternatives, and select the best alternatives.

• As discussed in Lecture 1, the structured approach involves identifying

the problem, analyzing options, weighing potential outcomes, and
implementing the chosen alternative.
 Process Theories: Dual-Process Theory

• One of the process theories used as the extension of the information-

processing perspective is Dual Process Theory.

• Dual Process Theory depicts decision makers having two modes of

thinking based on specific characteristics which are categorized into
two different properties.
 Process Theories: Dual-Process Theory
Some Characteristics of Some Characteristics of
System 1 System 2

• Unconscious • Controllable
• Automatic • Conscious
• Highly associative • Constrained by working memory
• Rapid • Rule-based
• Contextualized • Serial
• Parallel • Develops with age
• Evolved early
• Related to language
• Independent of language
• Generate feelings of certitude • Less characterized by feelings
of certitude
 Process Theories: Mental Accounting

• Individuals can follow a cognitive version of cost accounting to

organize and interpret information as the basis for making a decision.

• This cognitive structure is conceptualized as mental accounting.

 Process Theories: Mental Accounting

• Mental accounting is defined as the processes used by individuals to

record, summarize, and analyze their expenses and consumption with
the objective of making a decision.

• One important factor of mental accounting is the manner in which the

monetary outcome is framed.

• Mental accounts can be comprised of:

• A single transaction level; or
• A broader spending category level.
 Process Theories: Mental Accounting

• The framing from mental accounting can be used to further explain:

• the gain and loss aversion of prospect theory and/or other
descriptive theory; and
• the specific context biases derived from unacceptable normative
manner.
 Human Judgment & Decision Making

Sub-Learning Objective:
• Heuristic and Biases;
• Common Biases; and
• The Effects of Mood, Emotion, and Stress in Decision Making.
 Heuristic and Bias

• Different brain areas are activated when we consider either immediate

rewards we want or larger delayed rewards we feel we should choose.

• These different brain regions may also be associated with automatic

(System 1) and deliberative (System 2) thought.

• It is necessary to examine the two key concepts of “bias” and

“heuristics.”
 Heuristic

• Heuristic is considered to be a simplified methods to cope with the

humans’ limited processing capacity.

• Although this can lead to decision making to be acceptable estimate

(but imprecise), it is also prone to errors and systematic biases.

• This contrasted with algorithms (i.e., explicit rules) which guarantee a

correct result, but impractical if there are limited effort, time, and
cognitive capability.
 Biases

• The concept of a bias is a systematic deviation from a norm (i.e., an

inclination towards one judgment rather than another).

• Biases can be the result of the individuals’:

• cognitive limitations;
• processing strategies;
• perceptual organizing principles;
• an egocentric perspective;
• having specific motivations; and
• cognitive styles.
 Categories and Types of Common Biases
No. Category Type of Bias
1 Ease of Recall
Biases from availability heuristic
2 Retrievability
3 Insensitivity to base rates
4 Insensitivity to sample size
Biases from representative
5 Misconceptions of chance
heuristic
6 Regression to the mean
7 The conjunction fallacy
8 The confirmation trap
9 Anchoring
Biases from the confirmation
10 Conjunctive and disjunctive event bias
heuristic
11 Hindsight of knowledge
12 Overconfidence
 Biases from
Availability Heuristics
• Ease of recall:
• Individuals judge events that are more easily recalled from memory,
based on vividness or recency over other events which are less easily
recalled but of equal frequency.

• Retrievability:
• Individuals are biased in their assessments of the frequency of events
based on how their memory structures affect the search process.
 Biases from
Representatives Heuristics
• Insensitivity to base rates:
• When assessing the likelihood of events, individuals tend to ignore
base rates if any other descriptive information is provided—even if it is
irrelevant.

• Insensitivity to sample size:

• When assessing the reliability of sample information, individuals
frequently fail to appreciate the role of sample size.

• Misconceptions of chance:
• Individuals expect that a sequence of data generated by a random
process will look “random,” even when the sequence is too short for
those expectations to be statistically valid.
 Biases from
Representatives Heuristics
• Regression to the mean:
• Individuals tend to ignore the fact that extreme events tend to regress
to the mean on subsequent trials.

• The Conjunction Fallacy:

• Individuals falsely judge that conjunctions (two events co-occurring)
are more probable than a more global set of occurrences of which the
conjunction is a subset.
 Biases from
Confirmation Heuristics
• The Confirmation Trap:
• Individuals tend to seek confirmatory information for what they think is
true and fail to search for dis-confirmatory evidence.

• Anchoring:
• Individuals estimate values based upon an initial value (i.e., derived
from past events) and make insufficient adjustments from that anchor
when establishing a final value.

• Conjunctive and Disjunctive Events Bias:

• Individuals exhibit bias in overestimating the probability of conjunctive
events and underestimating the probability of disjunctive events.
 Biases from
Confirmation Heuristics
• Hindsight bias:
• After finding out whether or not an event occurred, individuals tend to
overestimate the degree to which they would have predicted the
correct outcome. Furthermore, individuals fail to ignore information
they possess that others do not when predicting others’ behavior.

• Overconfidence:
• Individuals tend to be overconfident of the correctness of their
judgments, especially when answering difficult questions.
 The Effect of
Mood, Emotion and Stress
• In recent decades, researchers have made important progress toward
understanding how specific emotions can influence our judgments.

• Researchers have identified a small set of basic emotions (i.e.,

happiness, sadness, fear, disgust, and anger) whose expressions are
the same across cultures.

• Each of these emotions activates a set of feelings and “appraisal

tendencies” that prepare us to respond to the world in a certain way.
 The Effect of
Mood, Emotion and Stress

• Happy people are more optimistic.

• Sad people are more pessimistic.

• Fear and anxiety create risk-averse behavior.

• Angry people are willing to endure risk, and even be optimistic with
respect to risk.

• Emotions are tightly wound up with our perception of risk.

 The Effect of
Mood, Emotion and Stress
• Evidence suggested that:
• Good mood increases reliance on heuristics and results in more
biased judgments.

• Bad moods may trigger deliberative thought processes that could

reduce biases in judgment.
• Sad people are more affected by anchors than are those in a more
neutral state, and sad people make worse decisions as a result.
End of Lecture Session