News highlights for May 2012

Many faulty business decisions can be traced to “confirmation bias” that leads people to unwittingly seek information that bolsters what they want to believe, says Brigham Young University accounting professor Doug Prawitt.

“We don’t realize it when we do that, but it’s a very, very powerful human bias,” he said during a telephone interview.

Prawitt is co-author of Enhancing Board Oversight: Avoiding Judgment Traps and Biases, a white paper on business judgment released by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

The white paper is available at tinyurl.com/77l2ygc. It speaks primarily to boards of directors in their strategy-setting role. But Prawitt said the process described in the white paper applies to anybody who makes important decisions.

Prawitt identified confirmation bias and a phenomenon the white paper calls judgment “triggers” as two particularly damaging “traps” that lead to poor judgment and decisions. He said considering other points of view is essential to avoiding confirmation bias and making good decisions.

“As you evaluate information, always sit back and take time to make the opposing case,” Prawitt said. “… If I’m [a lawyer who’s] going to go into the courtroom, I want to know my opposing attorney’s case better than he knows it.”

Judgment triggers often result from a possible solution’s being misidentified as a problem that needs to be overcome, the white paper says. When a problem is improperly defined, decision-makers sometimes move forward without considering other, better alternatives.

Prawitt said that, about 2½ years ago, he and co-author Steven Glover, also an accounting professor at BYU, began working with KPMG to create a professional application for their research on business judgment and decision-making. What emerged was a professional judgment framework put into practice by KPMG, which also co-authored the COSO white paper. The framework describes a five-step process for decision-making:

• Define the problem and identify fundamental objectives.
• Consider alternatives.
• Gather and evaluate information.
• Reach a conclusion.
• Articulate and document rationale.

According to Prawitt, the guidance is spreading rapidly, particularly among accounting firms. He said that, as a result of PCAOB reviews of audits, public accounting firm leaders are eager to review decision-making processes undertaken by their employees.

“If you’ve carefully laid out the rationale for your judgment,” he said, “you’re in a lot better position to justify the judgment that you made.”

The white paper mentions additional common traps:

• Rush to solve: The quickest judgments aren’t always the best ones.
• Overconfidence.
• Anchoring: This often occurs in negotiation when a faulty initial value is set and decision-makers fail to adjust sufficiently far from it.Availability: This is the tendency to consider information that’s easily retrievable from memory rather than the best information.