Kahneman’s 24th chapter, “The Engine of Capitalism” discusses five major themes: “Optimists”, “Entrepreneurial Delusions”, “Competition Neglect”, “Overconfidence”, and “The Premortem: A Partial Remedy”.  In the last chapter we learned about how overconfidence was associated to the insider’s view and how an outside view of similar projects’ past results are necessary to provide a baseline from which to predict the future of a project.

Overconfidence may also be part of a personality trait – that of an optimist. Everyone loves an optimist, rather than a pessimist.  Optimists live longer, tend to be happier and as Kahneman stated,  they tend to make more money (at least for themselves). Despite optimists making themselves rich, they tend to loose value for their companies and projects. Especially, when they are an optimistic risk-taking Chief Executive Officer in a big company. These CEOs’ optimism can garner much money for themselves and investment in their companies but tend not to show similar returns in productivity of themselves or value for their company. Nevertheless, optimists and their overly confident and risk-taking behavior tend to be in positions of “greatest influence” over others lives. This can be a good thing when their optimistic personality is good for moral and motivation, even when delusional (pp.256).  Unfortunately, their delusional perspective often leaves them with the belief that they can control events.  This can be a bad thing when their risky behavior negatively impacts an entire company or country – putting everyone at risk.

Kahneman describes optimism as a lucky genetic trait passed on through families. I think this viewpoint may be influenced by one’s life circumstances, such as being born into poverty or being born into wealth.  An extremely wealthy life experience is often described as one of privilege.   These lucky few are often provided with greater opportunities and greeted by people who cater to them in every way. They are also more able to avoid criticism and punishment for poor decisions and poor behavior due to the influential people that surround them.  Whereas, the less privileged may experience harsh criticism, punishment, and prejudice for poor decisions and poor behavior and have far less opportunities presented to them.

Kahneman describes the optimistic entrepreneur as one who tends to take bigger risk, even when they have more personally on the line. Of course, a million dollars may not seem like a big risk if one is coming from a multi-million, billion, or multi-billion dollar background. It might even be a good tax write off to loose.  Whereas, a million dollars may seem unattainable and an inconceivable amount of money to loose to someone from meager means. These differing consequences may influence a more cautious perspective.

That brings us to Kahneman’s section on “Entrepreneurial Delusions”. Americans are often taught, “you can be whatever you want to be” or “you can accomplish anything you put your mind to”.  The reality is that only approximately 35% of small businesses succeed.  Yet, the small businessmen have been found to estimate the average success rate as being around 60%  and their personal chance at 70% or higher (pp. 256-257).  Furthermore, it’s been found that approximately “33% of Americans said their chance of failing was zero” (pp. 257).  Kahneman points out that seeking out the outside view (the baseline success rate of others in similar business ventures) may not have even occurred to the optimistic entrepreneur – an example of  “competition neglect”, a term that was coined by Colin Camerer and Dan Lovallo (pp. 258 – 260).  Kahneman describes competition neglect as when people only focus on themselves (e.g.,  their goals, their plans, what they want to do, and what they can do) while ignoring what their competition may want to do and what they can do. Also they “neglect the role of luck” and ignore what they don’t know –  developing a “planning fallacy” and a sense of “overconfidence” (pp. 259).

Kahneman illustrates a case of overconfidence with a study from Duke University on 11,600 chief financial officers’ (CFOs) forecast accuracy.  They found their predictions of the S&P index to be less than 0% accurate. That’s right, if they predicted the S&P to go one way it was more likely to go in the opposite direction.  Unfortunately, they developed a coherent story based on information that easily came to mind while ignoring what they don’t know. This again is an example of the System 1 (i.e., quick to mind) and WYSIATI (i.e., what you see is all there is).  Kahenman further points out that if the CFOs were to have accurately predicted the actual range (which was quite a wide range from -10% -+30%), they would have been “laughed out of the room” (pp.262).  Basically, the CFOs tend to be paid to be overconfident and unrealistically optimistic because no one really wants to hear the truth. They don’t want to hear that there is no way to know or that their head person doesn’t really know the answer – or worse, that there is a chance of failure/loss.  He warned that “Organizations that take the word of overconfident experts can expect costly consequences” (pp. 262).  Yet, people, firms, and the media tend to “reward the providers of dangerously misleading information more than they reward truth tellers” (pp. 262).

Kahneman described the entrepreneurs of the world as an optimistically minded group of individuals with a “ cognitive bias” towards “WYSIATI” (i.e., what you see is all there is).  For example, the “Inventor’s Assistance Program” in Canada was set up to provide entrepreneurs a realistic evaluation of the likelyhood of their success.  They found that approximately 70% of all their participants were “likely to fail”.  Nevertheless, 47% of those entrepreneurs “likely to fail”, persisted with their plans – often loosing twice as much money as they originally intended to spend.  Camerer and Lovallo referred to these type of failing entrepreneurs as “optimistic martyrs”  (pp. 261). The optimistic martyrs’ failures tend to lead to improvements in the systems by those who follow, having learned from their predecessor’s failure or history.  The optimistic martyrs’s failures create new information to add  to the baseline estimate of what is required for predictable success in the future.

The “premortem” is a process to combat overconfidence which was developed by Gary Klein (Kahneman’s self proclaimed “adversarial collaborator”).  Basically, after a decision has been made by a group of people, the team is told to “Imagine that we are a year into the future. We implemented the plan as it now exists. The outcome was a disaster. Please take 5 to 10 minutes to write a brief history of that disaster” (pp. 264). This exercise has been shown to overcome the problem of “groupthink” and stop “the suppression of doubt” by the other team members, especially in a hierarchical structure where the leader has expressed an opinion in one direction.  It also has been found to encourage people to consider any possible threats that may have been overlooked.

 

Reference:

Kahneman, D. (2011).  The Engine of Capitalism.  In Thinking Fast and Slow  (pp. 255-265). New York, NY: Farrar, Straus, and Giroux.