Behavioral Economics – what does research in behavioral economic entail?
Consulting for enterprises is impossible without knowledge of the corresponding behaviors of customers, employees, and suppliers.
Consulting from FehrAdvice & Partners AG is thus based on the most modern insights from behavioral economics. FehrAdvice & Partners AG meld these insights into a usable form for consulting and further develop them with empirical and theoretical studies. This results in an independent consulting approach, the Behavioral Economics Approach BEA™, developed through the cooperation with one of the worldwide leading behavioral economics researchers, Prof. Dr. Ernst Fehr of the University of Zurich. The scientific basis behind BEA™ stems from the newest knowledge from
Traditional economic research assumes that managers, employees, customers, and suppliers usually make rational decisions and thus do not make systematic decision errors. Behavioral economics, however, has found numerous proofs that people make systematic decision errors that limit their own welfare and also diminish efficiency, perceived fairness, and the profitability of firms.
For example, behavioral economics has proven that many people tend to overestimate small probabilities of success while underestimating large probabilities of success. It is obvious that this distorted perception of probabilities will promote unprofitable investments, as almost all ventures are associated with uncertainties and risks. Every change in a company′s pricing policies carries chances and risks that will be falsified by the distorted perception of probabilities.
Behavioral economic research has also shown that people are risk averse in profitable areas but often choose extremely risky behaviors in unprofitable areas. If, for example, losses are unavoidable in a firm due to unfavorable general conditions outside of the company, there is a danger that management will opt for particularly risky activities – a peril that could be a matter of life and death in some circumstances.
Behavioral economic research has also delivered proof that explicit material incentives in the form of bonus payments can be contra productive for a firm. For example, bonus programs are particularly damaging to a company in those cases
The list of examples of systematic decision errors could be extended infinitely (an exemplary list and description can be perused under "see also"). Current research constantly delivers new insights that are relevant for decision making in firms. A decisive characteristic of almost all decision errors is that the decision makers are not aware of the faultiness. Suboptimal pricing policies and organizational cultures and dysfunctional incentives – just to mention a few consequences of systematic decision errors – can therefore exist for a long time without potential for improvement being noticed.
It was for this reason that FehrAdvice & Partners AG developed the consulting approach BEA™ that is based on empirical insights about the human tendency to make erroneous decisions. This approach systematically includes this knowledge in consulting activities.
Erroneous decisions:
Consulting from FehrAdvice & Partners AG is thus based on the most modern insights from behavioral economics. FehrAdvice & Partners AG meld these insights into a usable form for consulting and further develop them with empirical and theoretical studies. This results in an independent consulting approach, the Behavioral Economics Approach BEA™, developed through the cooperation with one of the worldwide leading behavioral economics researchers, Prof. Dr. Ernst Fehr of the University of Zurich. The scientific basis behind BEA™ stems from the newest knowledge from
- psychological research on making judgments and decision behavior;
- experimental economic research; and
- game theory with a strong orientation towards a scientific understanding of behavior.
Traditional economic research assumes that managers, employees, customers, and suppliers usually make rational decisions and thus do not make systematic decision errors. Behavioral economics, however, has found numerous proofs that people make systematic decision errors that limit their own welfare and also diminish efficiency, perceived fairness, and the profitability of firms.
For example, behavioral economics has proven that many people tend to overestimate small probabilities of success while underestimating large probabilities of success. It is obvious that this distorted perception of probabilities will promote unprofitable investments, as almost all ventures are associated with uncertainties and risks. Every change in a company′s pricing policies carries chances and risks that will be falsified by the distorted perception of probabilities.
Behavioral economic research has also shown that people are risk averse in profitable areas but often choose extremely risky behaviors in unprofitable areas. If, for example, losses are unavoidable in a firm due to unfavorable general conditions outside of the company, there is a danger that management will opt for particularly risky activities – a peril that could be a matter of life and death in some circumstances.
Behavioral economic research has also delivered proof that explicit material incentives in the form of bonus payments can be contra productive for a firm. For example, bonus programs are particularly damaging to a company in those cases
- if they are – which is often the case – linked to poor performance indicators;
- if they do not reward an employee′s aggregate performance, but only individual aspects of it;
- if they are perceived to be unfair; and
- if they promote a "culture of egoism" in such a way that every voluntary additional task is only done if it is associated with an increase in the bonus.
The list of examples of systematic decision errors could be extended infinitely (an exemplary list and description can be perused under "see also"). Current research constantly delivers new insights that are relevant for decision making in firms. A decisive characteristic of almost all decision errors is that the decision makers are not aware of the faultiness. Suboptimal pricing policies and organizational cultures and dysfunctional incentives – just to mention a few consequences of systematic decision errors – can therefore exist for a long time without potential for improvement being noticed.
It was for this reason that FehrAdvice & Partners AG developed the consulting approach BEA™ that is based on empirical insights about the human tendency to make erroneous decisions. This approach systematically includes this knowledge in consulting activities.
Erroneous decisions:
- Hindsight Bias
- Overconfidence
- Anchoring
- Loss Aversion
- Hyperbolic Discounting
- Representivity Bias
- Availability Bias
- Sunk Cost Fallacy
- Planning Fallacies
- Peak End Rule
