daniel chigunwe
Elgin Chetsanga
Risk management has evolved over the years to become a data-driven and structured discipline.
The methodological underpinnings of risk management, which involve identifying, assessing, and mitigating potential threats, have become the template for modern-day risk practice.
This systemic approach is trusted by most practitioners, and rightly so. However, an important aspect that has sometimes been overlooked is the impact of human behaviour and human psychology on risk management.
Human psychology and biases influence decision-making in risk management and businesses need to be alive to the implications and mitigants.
Risk: Different things to different people
Different people undoubtedly have varying perceptions of risk. Risk perception refers to the way individuals and groups assess and react to potential dangers, both real and perceived.
While risk management is mostly standardised and objective discipline, human perception of risk is often subjective and influenced by emotional, cognitive, and social factors.
It is this mismatch between objective risk and perceived risk that can lead to challenges in managing and mitigating risk effectively. For example, a risk manager might overreact to a minor risk, even when the risk is statistically small, or vice versa. Let’s dive into a few biases in more detail.
Psychological biases and risk management
Confirmation bias
Confirmation bias, a well-researched psychological phenomenon, is defined as the tendency to search for, interpret, and recall information that confirms one’s preexisting beliefs or hypotheses. In the risk management context, this bias can prevent a business from recognizing potential threats that contradict its existing assumptions.
Confirmation bias is particularly detrimental because it leads businesses into a false sense of control, which may eventually result in unexpected losses if the risk materialises.
For instance, a business may be overly focused on a specific type of risk (such as credit risk) and ignore or downplay other risks (such as reputational risks) that could be just as impactful.
Anchoring bias
Anchoring occurs when individuals rely too heavily on the first piece of information they encounter (the “anchor”) when making decisions. In risk management, this can manifest when decision-makers fixate on an initial risk estimate or historical precedent and fail to adjust their expectations, even in the face of new, contradictory data.
Anchoring is dangerous because it prevents risk managers from properly re-evaluating risks in light of new information.
For example, if a business experiences a theft, future decisions about premise security might be overly influenced by that incident, even if the likelihood of another theft is minimal.
Availability bias
Another bias that can affect the execution of a successful risk management system is the availability bias. This occurs when people estimate the likelihood of an event based on recent experiences rather than looking at all relevant data objectively.
For example, if one company goes through a highly publicised negative social media story, managers for a different company might perceive reputational risk as more pressing, even if that company’s actual threat level has not increased.
The main danger of availability bias is that it leads to an overemphasis on certain risks while neglecting others that are less visible but equally, or more, important. As a result, the business might become more reactive rather than taking a comprehensive, forward-looking approach to risk assessment.
Optimism bias
The effective execution of risk management can also be hindered by optimism bias. Optimism bias causes individuals to overestimate the likelihood of positive outcomes while underestimating potential risks. In risk management, optimism can lead to behaviours such as investing in high-risk ventures without fully considering the downside.
It’s important to note that optimism bias is often misinterpreted as a prohibition against being hopeful, however, optimism only guard against excessive focus on positive outcomes, which can lead to poor decision-making as risks are downplayed or ignored.
Group-think and risk oversight
Finally, one social psychology bias worth noting is groupthink. Groupthink occurs when the desire for harmony and conformity within a group leads to irrational or dysfunctional decision-making.
In a risk management context, groupthink has the undesirable potential to cause businesses to underestimate or ignore risks because team members are reluctant to voice contrary but helpful views.
The impact of groupthink becomes more pronounced in high-stakes situations where challenging the common view is crucial for identifying potential risks. For example, a risk manager may be reluctant to raise potential issues with a new product that has already consumed a significant amount of budget.
Living with and managing psychological biases
Psychological biases in risk management will continue to be a factor that businesses need to be aware of. Sometimes the biases are insidious and unavoidable because most biases are automatic and operate below the level of conscious awareness, making them difficult to counteract.
However, there are some mitigants which businesses can put in place to manage biases. One such mitigant is conducting regular training on cognitive biases, decision-making processes, and risk perception.
This training can help individuals become more aware of their psychological tendencies and how they affect risk management.
To counter the impact of biases such as groupthink, businesses can encourage diverse perspectives and allow for different viewpoints, challenging assumptions put forward by team members.
The use of objective data and analytics to assess risks can also help overcome subjective biases and provide a more accurate view of potential threats.
Furthermore, businesses can implement structured decision-making frameworks, such as standardized processes, that help reduce emotional and cognitive biases in decision-making.
Conclusion
Businesses need to remain alert to the fact that risk management efficiency is inherently linked to human behaviour.
By understanding the psychological factors that impact decision-making, businesses can make more informed, balanced risk management decisions.
In today’s world, where risk is constantly changing, psychological insights can be used to ensure that businesses are better prepared for the risks they face.
Elgin Chetsanga is a risk management expert. He can be contacted at 0774 438 480 or via email at [email protected]
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