Seeking Wisdom

by Peter Bevelin

  A very significant fraction of the people in the world will steal if (A) it's very easy to do and, (B) there's practically no chance of being caught. And once they start stealing, the consistency principle will soon combine with operant conditioning to make stealing habitual. So if you run a business where it's easy to steal because of your methods, you're working a great moral injury on the people who work for you...

  It's very, very important to create human systems that are hard to cheat. Otherwise you're ruining your civilization because these big incentives will create incentive-caused bias and people will rationalize that bad behavior is OK.

  Then, if somebody else does it, now you've got at least two psychological principles: incentive-caused bias plus social proof. Not only that, but you get Serpico effects: If enough people are profiting in a general social climate of doing wrong, then they'll turn on you and become dangerous enemies if you try and blow the whistle.

  Frank Serpico became known after exposing corruption at the New York Police Department in the 1970s. When Frank Serpico entered the New York Police force in 1960, payoffs and kickbacks were rampant in the department.

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  When he refused to take money, his fellow officers saw him as a potential danger. Then he blew the whistle on them, and became their enemy. In a 1971 testimony before the Knapp commission, Serpico said: "I hope that police officers in the future will not experience the same frustration and anxiety that I was subjected to for the past five years at the hands of my superiors because of my attempt to report corruption ... We create an atmosphere in which the honest officer fears the dishonest officer, and not the other way around."

  john's acquisition experience caused him stress and cost TransCorp money.

  John said, "I was dissatisfied having done so little for TransCorp last year. All of the other guys made acquisitions. If I could find a good acquisition, maybe I could move up the ranks. I needed a promotion.

  I found a good-looking business, and saw the possibility of making TransCorp a lot of money. The CEO of the business was a nice guy and we always met in their relaxing conference room. The asking price was low in relation to past profits. I had experts telling me what a great company it was. I was presented entertaining information on new products. The investment banker did me a favor by bringing the deal and I wanted to reciprocate.

  The banker told me that other people I admire would jump at the opportunity. I made a commitment to the financiers and told TransCorp's CEO about the deal. I committed myself publicly and felt a need to follow-through. I concentrated my search on evidence that confirmed the greatness of the deal. I denied reality and thought nothing bad could happen. I didn't say what I thought for fear of social disapproval. The CEO of the company I wanted to acquire continuously gave me good reasons to pursue the deal. The more effort I put into the deal, the more I felt I had to do it. I finally signed the papers. When reality kicked in and the deal turned sour, I was in deep trouble. And so was TransCorp."

  '1 don't want to go against the CEO and risk losing my $250,000 directors fee."

  Is the board of directors an effective corrector to deal with CEO mediocrity? Charles Munger says: "The psychological nature of the board of directors system makes it an ideal system for causing people to follow the lead of the CEO."

  A board may be a legal creation, but it is a social animal. Warren Buffett says:

  When people meet every couple of months and come from different parts of the country

  - and they have the normal social instincts - they don't like to have rump meetings or sort of talk behind people's backs. So it's very difficult in a group - particularly if it's a group

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  like Charlie described where the directors' fees for a significant number of them are important to their well-being, and they'd love to be recommended for another board and add another $100,000 a year to their income- for someone to lead a charge all of a sudden at a regular meeting or to try to arrange a rump meeting of some sort to say, "We think the guy at the head of the table is no good."

  So dealing with mediocrity- or, like I say, a notch above it - is a difficult problem if you're a board member. ..

  I've been on 19 boards. And I've never seen a director on any of the 19, where the director's fees were important to them, object to an acquisition proposal or a CEO's compensation.

  The CEO of TransCorp tells his board: "This is the decision, now let's start the discussion. "

  Apart from incentive-caused bias, liking and social approval, what are some other tendencies chat operate here? Authority - the CEO is the authority figure who directors tend to trust and obey. He may also make it difficult for those who question him. Social proof - the CEO is doing dumb things but no one else is objecting so all directors collectively stay quiet - silence equals consent; illusions of the group as invulnerable and group pressure (loyalty) may also contribute. Reciprocation - unwelcoming information is withheld since the CEO is raising the directors fees, giving them perks, caking them on trips or letting chem use the corporate jet. Association and Persian Messenger Syndrome - a single director doesn't want to be the carrier of bad news. Self-serving tendencies and optimism

  feelings of confidence and optimism: many boards also select new directors who

  are much like themselves; chat share similar ideological viewpoints. Deprival - Directors don't want to lose income and status. Respecting reasons no matter how illogical - the CEO gives them reasons. Believing first and doubting later - believing what the CEO says even if not true, especially when distracted. Consistency- directors want to be consistent with earlier decisions - dumb or not.

  Can we get rid of a bad CEO? Warren Buffett and Charles Munger says:

  Buffett: When certain boards consisting of prominent people are embarrassed publicly by the media attention, I think that acts as kind of an early warning signal to some other boards because big shots - and they look for big shots frequently in terms of dressing up boards - do not like to look foolish, at least publicly...

  Munger: ...in terms of the director's actually rebelling against the CEO, it tends to happen in one or two cases: One is when they reduce the directors' perks - which most CEOs are wise enough not to do. The ocher is when the situation gets so bad chat it threatens to

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  disgrace the directors. But you rarely see people taking action before they're threatened with disgrace.

  Warren Buffett says that we need true independence from directors i.e. a: "willingness to challenge a forceful CEO when something is wrong or foolish." He continues: "In addition to being independent, directors should have business-savvy, a shareholder orientation and a genuine interest in the company."

  Charles Munger adds:

  The correct system is the Elihu Root System. Elihu Root, who had three different cabinet appointments, ifI remember right, said no man was fit to hold public office who wasn't perfectly willing to leave it at any time. And if Elihu Root didn't approve of something the government asked him to do, he could always go back and be the most sought-after lawyer in the world. He had an identity to go back to - so he didn't need the government's salary.

  Well, I think that also ought to be more the test in corporate directorships. Is a director really fit to make tough calls who isn't perfectly willing to leave the office at any time? My answer 1s no.

  CONTEXTUAL INFLUENCES

  Most social acts have to be understood in their setting, and lose meaning if isolated.

  No error in thinking about social facts is more serious than the failure to see their place and function.

  - Solomon Asch (American social psychologist, 1907-1996)

  Our behavior is influenced by social situational factors, conditions and circumstances, the structure or description of a problem or choice, and our desires, mood and expectations.

  We tend to overestimate personal characteristics and motives when we explain the behavior of others. We underestimate situational factors like social pressure, roles or th
ings over which there are no control. An example is, blaming an individual rather than a poorly designed system for failure. Chance also matters. Maybe we sometimes give too much blame to people who had bad luck, and too much credit to those who were simply lucky.

  We expect people to be consistent in their behavior. But we behave differently in different situations. For example, we behave differently at home, in school, at work, and among friends; when alone and when in a group; when seen and when anonymous.

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  "I shouldn't have been so fast judging him as a bad person. Who knows, I may have done the same if put in the same situation."

  Extreme circumstance and conditions can cause people to do things they would never do under normal circumstances. Put good people in a bad situation and their normal behavior changes. The Zimbardo prison experiment at Stanford studied the roles people play in prison situations. Students were randomly assigned to the roles of prisoners and guards for a two-week period. Tests showed that all students were normal people and physically and mentally healthy. A simulated prison environment was created to mimic real-life prison conditions, where they lived for several days. Students playing guards behaved aggressively and students playing prisoners behaved helplessly. Guards rapidly began to treat the prisoners as if they were non-humans. The prisoners began acting depressed and showed extreme stress. The more the prisoners acted like non-humans, the more the guards mistreated them. The experiment ended after six days.

  In a statement prepared for the U.S. House of Representatives Committee on the Judiciary, the originator of the experiment, Philip Zimbardo, said: "We were horrified because we saw some boys treat other boys as if they were despicable animals, taking pleasure in cruelty, while other boys became servile, dehumanized robots who thought only of escape, of their own individual survival, and of their mounting hatred of the guards."

  Often when we are in a role, we tend to act as others expect. Zimbardo said: "Even when they thought they didn't have to meet anyone's expectations, the role of prison guard determined their actions."

  An American Indian proverb says: "Don't judge a man until you've walked two moons in his moccasins." How would we behave if we were anonymous, part of a group, tired and exhausted, and others had been labeled as enemies, evil or worthless?

  "Why is John tense when people watch his golf swing?"

  Are our actions observed or not? People may change their behavior merely because they are being observed.

  "No one can see me. "

  Anonymity can create destructive behavior. Studies show that peaceful students can become aggressive when they are made to feel anonymous by having their identity masked.

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  The less knowledgeable we are about an issue, the more influenced we are by how it is framed.

  The answers we get depend on the questions we ask. The British philosopher

  Herbert Spencer said: "How often misused words generate misleading thoughts." Consider how a statement, problem, consequence, or question is presented. How is it worded? What is its context? Are we considering certain features and ignoring others? Emotional, selective and appealing frames influence us.

  How a choice is presented influences our preferences. For example, we prefer a product that is presented as "95% fat free" rather than "5% fat". We respond differently depending on whether something is presented in terms of gains or in terms oflosses. A surgical procedure that has a 40% chance of success seems more appealing than one that has a 60% chance of failure.

  Frequencies appeal to our emotions. What is the chance that a mental patient commits an act of violence within 6 months after discharge? Studies show that experienced psychologists and psychiatrists judge the patient as more dangerous when the risk of violence were presented as relative frequencies (e.g., 20 criminals out of 100 similar to the patient are estimated to be violent to others...) than when the risk was presented as a probability (e.g., it is estimated that similar patients has a 20% chance of being violent to others ...). One study showed that a disease that kills 1,286 of 10,000 people (12.86%) was rated as riskier than one that kills 24.14 of 100 people (24.14%).

  We are influenced by the order, first or last, in which a presentation happens. The key variable is the amount of time that separates the presentations, the time when we have to make a judgment, and which presentation is the most easily remembered.

  Assume that two presidential candidates are speaking on an issue, one directly after the other. If some time passes before we have to make a judgment, we are likely to be more influenced by the first presentation. Assume now that some time passes between the first and last presentations, but we have to make a judgment immediately after the last presentation. Then we are more likely to be influenced by the last presentation.

  '1 put my paycheck in the bank at 4% interest, and borrowed money for a car loan at 10% interest. "

  We create our own frames by doing mental accounting. We treat assets of the same value differently depending on where they come from or their importance. We put different values on the same dollar, and are more willing to risk money we have won than money we have earned. A gain of $1,000 from playing roulette

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  has less value than $1,000 earned from hard work. '1 didn't gamble with my

  $1,000, I only gambled with the $1,000 I won on the casino." But it is the same amount of money.

  In one experiment psychologists found that people who lost a $10 theater ticket on the way to the theatre were reluctant to buy a second ticket. Those who instead lost a $10 bill on the way to buy a $10 theatre ticket saw the loss of the money and the purchase of the ticket as unrelated, so they would buy the ticket. But, in both cases, the loss was the same.

  We should view our assets in terms of their entirety. A dollar is a dollar independent of where it comes from. What counts is what we put in or take out of our pocket.

  There is a difference in behavior whether we deal with someone we know and a stranger or under the eye of an experimenter.

  "[ expect you to understand what Tm saying. I know you can do this. "

  "Things are not always what they seem," said the 1st Century Roman philosopher Phaedrus. Our behavior can be influenced by the expectations of others- teachers, coaches, bosses, etc. For example, to please the observer, a research subject may read in a desired result. A patient may wish to respond to a treatment in what they see as the correct way. We live up to what is expected of us.

  Studies show that patients can have faster heartbeats and higher blood pressure when examined by a doctor compared to a nurse.

  We often see what we want or expect to see. A doctor may see an effect in a patient because he expects to see it. We often don't see what we don't expect to see.

  Do we treat people according to our expectations?

  Assume Mary is on her way to meet someone for the first time. Does it matter if this person has been described as friendly or emotionally cold? Yes, it produces a change in Mary's expectations of that individual and a change in her behavior. Mary will expect friendliness or hostility and behave according to her expectations. The person may react to Mary in a way that confirms her expectations. We treat people like we expect them to be. If we expect people to be bad, we treat them in a certain way, which may cause them to behave badly.

  Assume that a new teacher is told that half of the class has high IQs and half has low IQs. The teacher is given the names of the supposed intelligent kids and the supposed not so intelligent ones. In reality, someone has randomly selected the two groups. By the end of the year, the experimental premise will become a

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  self-fulfilling prophecy. The kids the teacher thought had high IQs will be doing better than the kids with supposedly low IQs. This has been demonstrated in studies of elementary school students. Teachers taught much better when they expected a lot from their students.

  Irrational behavior in one context may cause good results in another.

  We aren't stupid - judgments
are often a function of context. The judgments of others can be informative, obedience to an authority is important for order, being careful in getting involved in a dangerous situation may save our life.

  What about all the evidence from lab experiments?

  Lab experiments can't resemble reality.

  There is a difference between real life and the controlled and somewhat artificial context of the lab. What is happening in some lab experiments may not happen in a natural situation. For example, many experiments are often played anonymously without repetition. What is the structure of the problem? The environment? Assumptions? Importance? Cost of being wrong? Often there exists more than one right answer. The context of the task matters. In a more realistic, concrete, and social context, many tasks are often solved correctly.

  Studies show that we are overconfident. Does this mean we are always overconfident? No, the studies only show that some people are overconfident in some tasks in a certain context.

  SOME FINAL ADVICE FROM CHARLES MUNGER

  Follow these three pieces of advice from Charles Munger:

  I don't want you to think we have any way oflearning or behaving so you won't make a lot of mistakes. I'm just saying that you can learn to make fewer mistakes than other people - and how to fix your mistakes fosterwhen you do make them. But there's no way that you can live an adequate life without [making] many mistakes. In fact, one trick in life is to get so you can handle mistakes. Failure to handle psychological denial is a common way for people to go broke: You've made an enormous commitment to something. You've poured effort and money in. And the more you put in, the more that the whole consistency principle makes you think, "Now it has to work. If I put in just a little more, then it'll work."