Dan Lovallo is a professor who works in applying psychology on biases to management topics. A simple test he did at an investment bank showed that if you applied the CEO’s risk tolerance to all the investment decisions made at lower levels rather than the more junior decision makers’ risk tolerance, the decisions would have had a 32 percent better outcome. So, there is this tax of risk aversion, and it makes sense: if you’re the CEO, you feel pretty diversified because there are probably 20 or 30 bets sitting in your portfolio, so you can afford a few fails. But you are asking your business-unit leaders to take undiversified risk, and then get killed on their key performance indicators when they don’t hit the numbers. It should be little surprise then that a lot of the risk gets edited out of the system.
Author: Chris Bradley
Source: McKinsey Quarterly
Subjects: Management, Organizational Behavior, Risk Management, Strategy