Thinking, Fast and Slow

by Daniel Kahneman

  The Social Costs of Hindsight

  The mind that makes up narratives about the past is a sense-making organ. When an unpredicted event occurs, we immediately adjust our view of the world to accommodate the surprise. Imagine yourself before a football game between two teams that have the same record of wins and losses. Now the game is over, and one team trashed the other. In your revised model of the world, the winning team is much stronger than the loser, and your view of the past as well as of the future has been altered be fрy that new perception. Learning from surprises is a reasonable thing to do, but it can have some dangerous consequences.

  A general limitation of the human mind is its imperfect ability to reconstruct past states of knowledge, or beliefs that have changed. Once you adopt a new view of the world (or of any part of it), you immediately lose much of your ability to recall what you used to believe before your mind changed.

  Many psychologists have studied what happens when people change their minds. Choosing a topic on which minds are not completely made up—say, the death penalty—the experimenter carefully measures people’s attitudes. Next, the participants see or hear a persuasive pro or con message. Then the experimenter measures people’s attitudes again; they usually are closer to the persuasive message they were exposed to. Finally, the participants report the opinion they held beforehand. This task turns out to be surprisingly difficult. Asked to reconstruct their former beliefs, people retrieve their current ones instead—an instance of substitution—and many cannot believe that they ever felt differently.

  Your inability to reconstruct past beliefs will inevitably cause you to underestimate the extent to which you were surprised by past events. Baruch Fischh off first demonstrated this “I-knew-it-all-along” effect, or hindsight bias, when he was a student in Jerusalem. Together with Ruth Beyth (another of our students), Fischh off conducted a survey before President Richard Nixon visited China and Russia in 1972. The respondents assigned probabilities to fifteen possible outcomes of Nixon’s diplomatic initiatives. Would Mao Zedong agree to meet with Nixon? Might the United States grant diplomatic recognition to China? After decades of enmity, could the United States and the Soviet Union agree on anything significant?

  After Nixon’s return from his travels, Fischh off and Beyth asked the same people to recall the probability that they had originally assigned to each of the fifteen possible outcomes. The results were clear. If an event had actually occurred, people exaggerated the probability that they had assigned to it earlier. If the possible event had not come to pass, the participants erroneously recalled that they had always considered it unlikely. Further experiments showed that people were driven to overstate the accuracy not only of their original predictions but also of those made by others. Similar results have been found for other events that gripped public attention, such as the O. J. Simpson murder trial and the impeachment of President Bill Clinton. The tendency to revise the history of one’s beliefs in light of what actually happened produces a robust cognitive illusion.

  Hindsight bias has pernicious effects on the evaluations of decision makers. It leads observers to assess the quality of a decision not by whether the process was sound but by whether its outcome was good or bad. Consider a low-risk surgical intervention in which an unpredictable accident occurred that caused the patient’s death. The jury will be prone to believe, after the fact, that the operation was actually risky and that the doctor who ordered it should have known better. This outcome bias makes it almost impossible to evaluate a decision properly—in terms of the beliefs that were reasonable when the decision was made.

  Hindsight is especially unkind to decision makers who act as agents for others—physicians, financial advisers, third-base coaches, CEOs, social workers, diplomats, politicians. We are prone to blame decision makers for good decisions that worked out badly and to give them too little credit for successful movesecaр that appear obvious only after the fact. There is a clear outcome bias. When the outcomes are bad, the clients often blame their agents for not seeing the handwriting on the wall—forgetting that it was written in invisible ink that became legible only afterward. Actions that seemed prudent in foresight can look irresponsibly negligent in hindsight. Based on an actual legal case, students in California were asked whether the city of Duluth, Minnesota, should have shouldered the considerable cost of hiring a full-time bridge monitor to protect against the risk that debris might get caught and block the free flow of water. One group was shown only the evidence available at the time of the city’s decision; 24% of these people felt that Duluth should take on the expense of hiring a flood monitor. The second group was informed that debris had blocked the river, causing major flood damage; 56% of these people said the city should have hired the monitor, although they had been explicitly instructed not to let hindsight distort their judgment.

  The worse the consequence, the greater the hindsight bias. In the case of a catastrophe, such as 9/11, we are especially ready to believe that the officials who failed to anticipate it were negligent or blind. On July 10, 2001, the Central Intelligence Agency obtained information that al-Qaeda might be planning a major attack against the United States. George Tenet, director of the CIA, brought the information not to President George W. Bush but to National Security Adviser Condoleezza Rice. When the facts later emerged, Ben Bradlee, the legendary executive editor of The Washington Post, declared, “It seems to me elementary that if you’ve got the story that’s going to dominate history you might as well go right to the president.” But on July 10, no one knew—or could have known—that this tidbit of intelligence would turn out to dominate history.

  Because adherence to standard operating procedures is difficult to second-guess, decision makers who expect to have their decisions scrutinized with hindsight are driven to bureaucratic solutions—and to an extreme reluctance to take risks. As malpractice litigation became more common, physicians changed their procedures in multiple ways: ordered more tests, referred more cases to specialists, applied conventional treatments even when they were unlikely to help. These actions protected the physicians more than they benefited the patients, creating the potential for conflicts of interest. Increased accountability is a mixed blessing.

  Although hindsight and the outcome bias generally foster risk aversion, they also bring undeserved rewards to irresponsible risk seekers, such as a general or an entrepreneur who took a crazy gamble and won. Leaders who have been lucky are never punished for having taken too much risk. Instead, they are believed to have had the flair and foresight to anticipate success, and the sensible people who doubted them are seen in hindsight as mediocre, timid, and weak. A few lucky gambles can crown a reckless leader with a halo of prescience and boldness.

  Recipes for Success

  The sense-making machinery of System 1 makes us see the world as more tidy, simple, predictable, and coherent than it really is. The illusion that one has understood the past feeds the further illusion that one can predict and control the future. These illusions are comforting. They reduce the anxiety that we would experience if we allowed ourselves to fully acknowledge the uncertainties of existence. We all have a need for the reassuring message that actions have appropriate consequences, and that success will reward wisdom and courage. Many bdecрusiness books are tailor-made to satisfy this need.

  Do leaders and management practices influence the outcomes of firms in the market? Of course they do, and the effects have been confirmed by systematic research that objectively assessed the characteristics of CEOs and their decisions, and related them to subsequent outcomes of the firm. In one study, the CEOs were characterized by the strategy of the companies they had led before their current appointment, as well as by management rules and procedures adopted after their appointment. CEOs do influence performance, but the effects are much smaller than a reading of the business press suggests.

  Researchers measure the strength of relationships by a correlation coefficient, which varies between 0 and 1. The coefficient was
defined earlier (in relation to regression to the mean) by the extent to which two measures are determined by shared factors. A very generous estimate of the correlation between the success of the firm and the quality of its CEO might be as high as .30, indicating 30% overlap. To appreciate the significance of this number, consider the following question:

  Suppose you consider many pairs of firms. The two firms in each pair are generally similar, but the CEO of one of them is better than the other. How often will you find that the firm with the stronger CEO is the more successful of the two?

  In a well-ordered and predictable world, the correlation would be perfect (1), and the stronger CEO would be found to lead the more successful firm in 100% of the pairs. If the relative success of similar firms was determined entirely by factors that the CEO does not control (call them luck, if you wish), you would find the more successful firm led by the weaker CEO 50% of the time. A correlation of .30 implies that you would find the stronger CEO leading the stronger firm in about 60% of the pairs—an improvement of a mere 10 percentage points over random guessing, hardly grist for the hero worship of CEOs we so often witness.

  If you expected this value to be higher—and most of us do—then you should take that as an indication that you are prone to overestimate the predictability of the world you live in. Make no mistake: improving the odds of success from 1:1 to 3:2 is a very significant advantage, both at the racetrack and in business. From the perspective of most business writers, however, a CEO who has so little control over performance would not be particularly impressive even if her firm did well. It is difficult to imagine people lining up at airport bookstores to buy a book that enthusiastically describes the practices of business leaders who, on average, do somewhat better than chance. Consumers have a hunger for a clear message about the determinants of success and failure in business, and they need stories that offer a sense of understanding, however illusory.

  In his penetrating book The Halo Effect, Philip Rosenzweig, a business school professor based in Switzerland, shows how the demand for illusory certainty is met in two popular genres of business writing: histories of the rise (usually) and fall (occasionally) of particular individuals and companies, and analyses of differences between successful and less successful firms. He concludes that stories of success and failure consistently exaggerate the impact of leadership style and management practices on firm outcomes, and thus their message is rarely useful.

  To appreciate what is going on, imagine that business experts, such as other CEOs, are asked to comment on the reputation of the chief executive of a company. They poрare keenly aware of whether the company has recently been thriving or failing. As we saw earlier in the case of Google, this knowledge generates a halo. The CEO of a successful company is likely to be called flexible, methodical, and decisive. Imagine that a year has passed and things have gone sour. The same executive is now described as confused, rigid, and authoritarian. Both descriptions sound right at the time: it seems almost absurd to call a successful leader rigid and confused, or a struggling leader flexible and methodical.

  Indeed, the halo effect is so powerful that you probably find yourself resisting the idea that the same person and the same behaviors appear methodical when things are going well and rigid when things are going poorly. Because of the halo effect, we get the causal relationship backward: we are prone to believe that the firm fails because its CEO is rigid, when the truth is that the CEO appears to be rigid because the firm is failing. This is how illusions of understanding are born.

  The halo effect and outcome bias combine to explain the extraordinary appeal of books that seek to draw operational morals from systematic examination of successful businesses. One of the best-known examples of this genre is Jim Collins and Jerry I. Porras’s Built to Last. The book contains a thorough analysis of eighteen pairs of competing companies, in which one was more successful than the other. The data for these comparisons are ratings of various aspects of corporate culture, strategy, and management practices. “We believe every CEO, manager, and entrepreneur in the world should read this book,” the authors proclaim. “You can build a visionary company.”

  The basic message of Built to Last and other similar books is that good managerial practices can be identified and that good practices will be rewarded by good results. Both messages are overstated. The comparison of firms that have been more or less successful is to a significant extent a comparison between firms that have been more or less lucky. Knowing the importance of luck, you should be particularly suspicious when highly consistent patterns emerge from the comparison of successful and less successful firms. In the presence of randomness, regular patterns can only be mirages.

  Because luck plays a large role, the quality of leadership and management practices cannot be inferred reliably from observations of success. And even if you had perfect foreknowledge that a CEO has brilliant vision and extraordinary competence, you still would be unable to predict how the company will perform with much better accuracy than the flip of a coin. On average, the gap in corporate profitability and stock returns between the outstanding firms and the less successful firms studied in Built to Last shrank to almost nothing in the period following the study. The average profitability of the companies identified in the famous In Search of Excellence dropped sharply as well within a short time. A study of Fortune’s “Most Admired Companies” finds that over a twenty-year period, the firms with the worst ratings went on to earn much higher stock returns than the most admired firms.

  You are probably tempted to think of causal explanations for these observations: perhaps the successful firms became complacent, the less successful firms tried harder. But this is the wrong way to think about what happened. The average gap must shrink, because the original gap was due in good part to luck, which contributed both to the success of the top firms and to the lagging performance of the rest. We have already encountered this statistical fact of life: regression to the mean.

  Stories of how businesses rise and fall strike a chord with readers by offering what the human mind needs: a simple message of triumph and failure that identifies clear causes and ignores the determinative power of luck and the inevitability of regression. These stories induce and maintain an illusion of understanding, imparting lessons of little enduring value to readers who are all too eager to believe them.

  Speaking of Hindsight

  “The mistake appears obvious, but it is just hindsight. You could not have known in advance.”

  “He’s learning too much from this success story, which is too tidy. He has fallen for a narrative fallacy.”

  “She has no evidence for saying that the firm is badly managed. All she knows is that its stock has gone down. This is an outcome bias, part hindsight and part halo effect.”

  “Let’s not fall for the outcome bias. This was a stupid decision even though it worked out well.”

  The Illusion of Validity

  System 1 is designed to jump to conclusions from little evidence—and it is not designed to know the size of its jumps. Because of WYSIATI, only the evidence at hand counts. Because of confidence by coherence, the subjective confidence we have in our opinions reflects the coherence of the story that System 1 and System 2 have constructed. The amount of evidence and its quality do not count for much, because poor evidence can make a very good story. For some of our most important beliefs we have no evidence at all, except that people we love and trust hold these beliefs. Considering how little we know, the confidence we have in our beliefs is preposterous—and it is also essential.

  The Illusion of Validity

  Many decades ago I spent what seemed like a great deal of time under a scorching sun, watching groups of sweaty soldiers as they solved a problem. I was doing my national service in the Israeli Army at the time. I had completed an undergraduate degree in psychology, and after a year as an infantry officer was assigned to the army’s Psychology Branch, where one of my occasional duties was to help evaluate candidates for off
icer training. We used methods that had been developed by the British Army in World War II.

  One test, called the “leaderless group challenge,” was conducted on an obstacle field. Eight candidates, strangers to each other, with all insignia of rank removed and only numbered tags to identify them, were instructed to lift a long log from the ground and haul it to a wall about six feet high. The entire group had to get to the other side of the wall without the log touching either the ground or the wall, and without anyone touching the wall. If any of these things happened, they had to declare itsigрЉ T and start again.

  There was more than one way to solve the problem. A common solution was for the team to send several men to the other side by crawling over the pole as it was held at an angle, like a giant fishing rod, by other members of the group. Or else some soldiers would climb onto someone’s shoulders and jump across. The last man would then have to jump up at the pole, held up at an angle by the rest of the group, shinny his way along its length as the others kept him and the pole suspended in the air, and leap safely to the other side. Failure was common at this point, which required them to start all over again.

  As a colleague and I monitored the exercise, we made note of who took charge, who tried to lead but was rebuffed, how cooperative each soldier was in contributing to the group effort. We saw who seemed to be stubborn, submissive, arrogant, patient, hot-tempered, persistent, or a quitter. We sometimes saw competitive spite when someone whose idea had been rejected by the group no longer worked very hard. And we saw reactions to crisis: who berated a comrade whose mistake had caused the whole group to fail, who stepped forward to lead when the exhausted team had to start over. Under the stress of the event, we felt, each man’s true nature revealed itself. Our impression of each candidate’s character was as direct and compelling as the color of the sky.