A bias against investment?

Companies should be investing to improve their performance and set

the stage for grow th. They’re not. A survey of executives suggests
behavioral bias is a culprit.
September 2011 • Tim Koller, Dan Lovallo, and Zane Williams
Source: Corporate Finance Practice

On e of t h e pu zzles of th e slu g g ish g loba l econ om y toda y is w h y

com pa n ies a r en ’t in v estin g m or e. Th ey cer ta in ly seem to h a v e
g ood r ea son s to: cor por a te coffer s a r e fu ll, in ter est r a tes a r e low ,
a n d a sla ck econ om y in ev ita bly offer s ba r g a in s. Yet m a n y
com pa n ies seem to be h oldin g ba ck.

A n u m ber of fa ctor s a r e dou btless in v olv ed, r a n g in g fr om

m a r ket v ola tility to fea r s of a dou ble-dip r ecession to u n cer ta in ty
a bou t econ om ic policy . On e fa ctor th a t m ig h t g o u n n oticed,
h ow ev er , is th e su r pr isin g ly str on g r ole of decision bia ses in th e
in v estm en t decision -m a kin g pr ocess—a r ole th a t r ev ea led itself
in a r ecen t McKin sey Globa l Su r v ey . Most ex ecu tiv es, th e su r v ey
fou n d, believ e th a t t h eir com pa n ies a r e too stin g y , especia lly for
in v estm en ts ex pen sed im m edia tely th r ou g h th e in com e
sta tem en t a n d n ot ca pita lized ov er th e lon g er ter m . In deed,
a bou t tw o-th ir ds of t h e r espon den ts sa id th a t th eir com pa n ies
u n der in v est in pr odu ct dev elopm en t, a n d m or e th a n h a lf th a t
th ey u n der in v est in sa les a n d m a r ketin g a n d in fin a n cin g
sta r t-u ps for n ew pr odu cts or n ew m a r kets (Ex h ibit 1 ). By pa ssed
oppor tu n ities a r en ’t ju st a m issed oppor t u n ity for in div idu a l
com pa n ies: th e in v estm en t dea r th h u r t s w h ole econ om ies a n d
job cr ea tion effor ts a s w ell.
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Su ch bia ses, left u n ch ecked, a m plify th is con ser v a tism , th e

su r v ey su g g ests. Ex ecu tiv es w h o believ e th a t th eir com pa n ies
a r e u n der in v estin g a r e a lso m u ch m or e likely to h a v e obser v ed a
n u m ber of com m on decision bia ses in th ose com pa n ies’
in v estm en t decision m a kin g . Th ese ex ecu tiv es a lso displa y a
r em a r ka ble deg r ee of loss a v er sion —th ey w eig h t poten tia l losses
sig n ifica n tly m or e t h a n equ iv a len t g a in s. Th e clea r im plica tion
is th a t ev en a m id m a r ket v ola tility a n d u n cer ta in ty , m a n a g er s
a r e r ig h t n ow pr oba bly for eg oin g w or th y oppor tu n ities, m a n y of
w h ich a r e in -h ou se.

Th e su r v ey r espon den ts1 h eld a w ide r a n g e of position s in both

pu blic a n d pr iv a te com pa n ies. A ll h a d ex posu r e to in v estm en t
decision m a kin g in t h eir or g a n iza tion s. Nea r ly tw o-th ir ds of
th em r epor ted th a t th eir com pa n ies g en er a ted a n n u a l r ev en u es
a bov e $1 billion , a n d th e fin din g s a r e con sisten t a cr oss
in du str ies, g eog r a ph ies, a n d cor por a te r oles.
More bias means less investment
Th e su r v ey r esu lts w er e a lso con sisten t w ith ea r lier fin din g s t h a t
bia ses a r e com m on w ith in th e in v estm en t decision -m a kin g
pr ocess. 2 Mor e th a n fou r -fifth s of r espon den ts r epor ted th a t th eir
or g a n iza tion s su ffer fr om a t lea st on e w ell-kn ow n bia s. Mor e th a n
tw o-fifth s r epor ted obser v in g th r ee or m or e.

Gen er a lly , th e m ost com m on bia ses th a t a ffect decision s cou ld be

tr a ced to th e pa st ex per ien ces of th ose w h o m a ke or su ppor t a
pr oposa l. Th e con fir m a tion bia s, for ex a m ple, w a s th e m ost
com m on on e—decision m a ker s focu s th eir a n a ly ses of
oppor tu n ities on r ea son s to su ppor t a pr oposa l, n ot to r eject it .
Depen din g on th e pr oposa l, th is bia s ca n r esu lt in decision s t o
u n der in v est or n ot t o in v est a t a ll ju st a s ea sily a s in decision s to
ov er in v est. A n oth er com m on bia s w a s a ten den cy to u se
in a ppr opr ia te a n a log ies ba sed on ex per ien ces th a t a r en ’t
a pplica ble to th e decision a t h a n d. A th ir d w a s th e “ ch a m pion ”
bia s—m a n a g er s defer m or e th a n is w a r r a n ted to th e pers on
m a kin g or su ppor tin g a n in v estm en t pr oposa l th a n to m er its of
th e pr oposa l itself.

Th e pr esen ce of beh a v ior a l bia s seem s to h a v e a su bsta n tia l effect

on th e per for m a n ce of cor por a te in v estm en ts. Respon den ts w h o
h a d r epor ted obser v in g th e few est bia ses w er e a lso m u ch m or e
likely to r epor t th a t th eir com pa n ies’ m a jor in v estm en ts sin ce
th e g loba l fin a n cia l cr isis beg a n h a d per for m ed better th a n
ex pected. By con tr a st, th ose w h o r epor t ed obser v in g th e m ost
bia ses w er e m or e likely to r epor t th a t th eir com pa n ies’
in v estm en ts h a d per for m ed w or se th a n ex pected (Ex h ibit 2 ).
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Th e bia ses r epor ted by r espon den ts cor r ela te w ith th e

per for m a n ce of in v estm en ts—a n d a ppea r to con str a in th eir
ov er a ll lev el, a s w ell. In deed, r espon den ts r epor tin g few er bia ses
w er e sig n ifica n tly less likely th a n th ose r epor tin g m or e to st a te
th a t th eir com pa n ies h a d for g on e ben eficia l in v estm en ts
(Ex h ibit 3 ).
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Wary executives
Ex ecu tiv es a lso r epor ted a h ig h deg r ee of loss a v er sion in th e
in v estm en t decision s th ey ’d obser v ed. Th ey ex h ibited th e sa m e
ten den cy th em selv es, ev en w h en th e v a lu e th ey ex pected fr om
a n in v estm en t a ppea r ed str on g ly positiv e. Wh en a sked to a ssess
a h y poth etica l in v estm en t scen a r io w it h a possible loss of $1 00
m illion a n d a possible g a in of $4 00 m illion , for ex a m ple, m ost
r espon den ts w er e w illin g to a ccept a r isk of loss on ly betw een 1
a n d 2 0 per cen t, a lth ou g h th e n et pr esen t v a lu e w ou ld be
positiv e u p to a 7 5 per cen t r isk of loss. Su ch ex cessiv e loss
a v er sion pr oba bly ex pla in s w h y m a n y com pa n ies fa il to pu r su e
pr ofita ble in v estm en t oppor tu n ities. 3

Th is deg r ee of loss a v er sion is a ll th e m or e su r pr isin g beca u se it

a ppa r en tly ex ten ds to m u ch sm a ller dea ls: r espon den ts w er e ju st
a s a v er se to loss w h en th e size of a n in v estm en t w a s $1 0 m illion
a n d th e poten tia l g a in $4 0 m illion . Ev en if it m a de sen se to be so
loss a v er se for la r g er dea ls, it still w ou ldn ’t m a ke sen se to be a s
a v er se to loss for sm a ller on es, especia lly con sider in g h ow m u ch
m or e fr equ en tly sm a ller oppor tu n ities occu r .
 Ex ecu tiv es m a y be lim itin g th e in v estm en ts of th eir com pa n ies
beca u se of econ om ic fu n da m en ta ls a n d policy u n cer ta in ties. Bu t
th eir decision m a kin g is a lso ta in ted by bia ses a n d loss a v er sion
th a t h a r m per for m a n ce a n d ca u se com pa n ies to m iss poten t ia lly
v a lu e-cr ea tin g oppor tu n ities.

About the Authors

Tim Koller is a partner in M cKinsey’s New York office, where Zane W illiams is a consultant; Dan Lov allo is a
professor at the University of Sydney Business School and an adviser to McKinsey.

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Notes
1
Including more than 1,500 executives, from 90 countries, who completed our February 2011 survey.
2
See Dan Lovallo and Olivier Sibony, “The case for behavioral strateg y,” mckinseyq uarterly.com, March 2010.
3
Loss aversion, a decision maker’s preference for avoiding losses over acq uiring g ains, is a central part of what’s
commonly called risk aversion.

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