Columbia University

Graduate School of Business

B7619: Behavioral Economics and Decision Making

EMBA Class Spring 2012 - Warren 310

Professor Eric Schoenberg

Uris 218

ejs2011@columbia.edu

Course obj ectives

TA Or Skolnik

o skolnik 12@gsb.columbia.edu

The purpose of this course is to inform future managers, consultants, and advisors of the psychological processes and biases underlying the decisions made by customers, competitors, colleagues, and themselves, with emphasis on how to incorporate such insights into business, marketing, and investing strategies. The seminar has two facets. First, it gives students a broad overview of important results from various behavioral sciences (e.g., behavioral decision research, social and cognitive psychology, consumer research) that clarify how people make decisions. Second, it provides students with practical discussions about applying these findings to topics in marketing, management, and finance (each the focus of approximately 1/3 of the class material). Classroom time will be devoted to a combination of lectures, discussions, and exercises illustrating the main concepts.

Obviously, successful business strategies depend on a thorough understanding of how customers/ employees/competitors make decisions. However, traditional models of decision making, especially so-called normative or rational models, have serious limitations. Rather than making decisions in the manner postulated by these models, people often use a variety of rules and processes that lead to (sometimes counterintuitive) decision behavior. For instance, individuals have an exaggerated tendency to select compromise or middle options when making choices and are easily seduced by features of a product that seem to differentiate it from other products, even when these features in fact add no value. Seemingly "irrational" decision phenomena such as these abound. The premise of the

course is that a series of similar findings from research in decision-making have powerful business implications. While you may have been exposed to this material lightly in other courses, we will pursue it in depth, and apply it to topics in marketing, management, and finance, related to both strategic decision-making and customer behavior.

Materials

A readings packet will be distributed. Readings are also available in PDF format on Angel.

Evaluation

Class Participation (25%). Given how directly relevant decision making is to everybody's day-to-day life, it is particularly informative when students share their own experiences and introspections.

The class participation grade will be determined by

• Class attendance and the quality of the student's involvement in the class's activities and discussions (20%). While missing many classes will ensure a poor participation grade, coming to all classes will not guarantee you a good class participation grade; you will not receive a high participation grade unless you speak in class and make a contribution to the class discussion.

• Participation in the inDclass and outDoftJclass exercises, including submitting two suggested exam questions (5%)

Written/oral Assignments (35%). You must submit FOUR assignments to receive a passing grade in this course, but you can do this in a number of different ways.

• "Regular" short writing assignments (each counts as ONE assignment). These are due prior to the class under which they are listed. Since we will be discussing this material in class, I cannot allow any late submissions.

• "Wildcard" short writing assignment (can only be used to fulfill ONE assignment). This is due by 10 pm Thursday, May 3.

* In-class oral presentation (counts as TWO assignments subject to available class time awarded on a first come, first serve basis). I will set aside at least an hour of the final class period for presentations and you are also welcome to request class time for a presentation at any point in the semester, which I will do my best to accommodate.

'" "Regular" short writing assignments (each counts as ONE assignment)

There are 6 short writing assignments listed in the syllabus. These assignments are due BEFORE the class for which they are assigned in the syllabus. A primary reason for the short papers is to get you thinking seriously about the topics for the week so that the class discussion is more informed and sophisticated. These papers have a strict 600-word limit Please print the word count on your paper. All papers should be double spaced with wide margins and l2-point font.

® "Wildcard" short writing assignment (can only be used to fulfill ONE assignment)

In addition to the specific options offered, you may also submit ONE assignment which you present an application of a principle in this course to your current or future business. These should be very practically minded and essentially of the form "how has this course helped me think about possible explanations for andlor solutions to this problem or puzzle?"

Ii In-class oral presentation (counts as TWO assignments subject to available class time)

A brief (4-5 minutes; 6 minutes MAXIMUM) talk which applies course material to a business or personal question of interest. These should be very practically minded and essentially of the form "how has this course helped me think about possible explanations for and/or solutions to this problem or puzzle?"

Final Exam (40%) There will be an in-class, open-book final exam at a time TBD (by the registrar). No later than 10 pm on April 27, everyone must submit 2 exam questions suitable for use in an all essay exam. I will then

compile and distribute a list of 20-40 potential exam questions. The final will consist of a subset of these questions with some choice, e.g., answer 4 of these 6 questions.

All assignments (and the final exam) will be graded using a five point system. The grades can be interpreted as follows:

1 = Some evidence of reading, but little understanding of the psychology or how it works, and minimal application of the course concepts to the actual question that was asked.

2 = An attempt at applying the course material, but with little or no depth of analysis (possibly just repeating ideas from the reading).

3 = A solid application of the course material, with some good points but few creative insights; the majority of papers will receive this grade.

4 = A deeper level of thinking than the obvious answer, clearly written, perhaps with creative examples.

5 = An exceptional paper, with an original insight and clear analysis. Such papers make us say, "I wish I had thought of that!" Very few of these grades are gIven.

Other Recommended Readings

H. Arkes and K. Hammond, Judgment and Decision Making. New York: Cambridge University Press 1986.

Dan Ariely. Predictably Irrational. New York: Harper Collins 2008.

Bazerman, M.H. (2001). Judgment in Managerial Decision Making (5th edition). New York: John Wiley & Sons.

Gary Belsky and Thomas Gilovich, Why Smart People Make Big Money Mistakes, Simon and Shuster, 1999.

Bernstein, P.L. (1998). Against the Gods: The Remarkable Story of Risk. New York: John Wiley & Sons

Thomas Gilovich, Dale Griffen, and Daniel Kahneman, Heuristics and Biases: The Psychology of Intuitive Judgment, Cambridge University Press 2002.

Reid Hastie and Robyn Dawes, Rational Choice in an Uncertain World, Cambridge Univ. Press, 2001.

John Hammond, Ralph Keeney, and Howard Raiffa, Smart Choices, 1999.

Daniel Kahneman, Paul Slovic, and Amos Tversky Judgment Under Uncertainty: Heuristics and Biases, Cambridge University Press, 1992.

Daniel Kahneman and Amos Tversky, Choices, Values and Frames. Cambridge University Press, 2000.

Russo, J.E. & Schoemaker, P.l.H. (2001). Winning Decisions: Getting It Right the First Time. New York: Doubleday.

Richard H. Thaler, Quasi Rational Economics, Russell Sage Foundation, 1991.

Richard Thaler & Cass Sunstein. Nudge: Improving Decisions about Health, Wealth, and Happiness. New Haven: Yale University Press, 2008

Richard H. Thaler, The Winner's Curse: Paradoxes and Anomalies of Economic Life, Princeton University Press, 1992

CLASS SCHEDULE

IMPORTANT NOTE: THE ORDER OF THE SESSIONS IS SUBJECT TO CHANGE BASED ON THE AVAILABILITY OF POTENTIAL GUEST SPEAKERS.

BEFORE CLASS BEGINS

REQUIRED Assignment: Class survey

Complete the on-line survey at

https://columbia.gualtrics.com/SE/?SID=SV SvSwfxcHFxefCSM

SESSION 1: JAN 13, 12:35-3:20

Preferences: Prospect Theory and Loss Aversion

Applications: Endowment Effect, Defaults and Sunk Costs

Readings

Kahneman and Tversky (1984): Choices, Values, and Frames

Johnson and Goldstein (2003): Do Defaults Save Lives?

SESSION 2: JAN 14, 8:45-11:35

Probabilities: heuristics and biases

Applications: Availability, Representativeness, Anchoring and Overconfidence

Readings

PIous (1993): The Psychology of Judgment and Decision Making, Chapters 10-13

SESSION 3: JAN 28, 3:40-6:30

Mental Accounts: reference frames and hedonic editing

Applications: Framing customer decisions: the Toro case

Readings:

Thaler (1999): Mental Accounting Matters

HBS: The Toro Case

Short Writing Assignment 1: the Toro case

Read the HBS case entitled The Toro Company S 'No Risk Program. Write a memo to Pollick giving him some insights on what Toro should do the following year and why.

SESSION 4: FEB 10,3:40-6:30

Time: Hyperbolic discounting and dynamic inconsistency, reference points, myopia and impatience

Applications: Self-control, marketing virtues and vices

Readings:

Loewenstein & Thaler (1990) "Intertemporal choice" (Chapter 8 of The Winner' s Curse)

Chase and Dasu (2001): Want to Perfect your Company's Service? Use Behavioral Science

Short Writing Assignment 2; choose ONE ofthe following:

a) To deal with selfiJcontrol problems, many people use the equivalent of sunk costs to commit themselves to an activity. Examples include paying a large annual health club fee rather than paying per visit, or buying season tickets for the theater. Can you suggest other products that might benefit from using prepayment as a selfiJcontrol device? Devise a marketing strategy to implement this plan.

b) Although people usually procrastinate by postponing the completing of unpleasant tasks, there are also situations in which people procrastinate the enjoyment of something enjoyable, such as drinking a special bottle of wine or finishing a box of gourmet chocolates. For some reason, no occasion ever seems special enough to finish it off, and the activity is continuously postponed. Suppose that you are a seller of luxury goods that have this problem (such as fine wines). How do you get your customers to quit delaying consumption?

SESSION 5A: MAR 2,8:45-10:00

Choosing: similarity, regularity, attraction, compromise and decoy effects

Applications: Product mix selection

Readings:

Simonson & Tversky (1992): Choice in Context

Short Writing Assignment 3

Try to find a real world example of the compromise or attraction effect and present this as a written assignment. Try to explain the firm's intent, and why it will or will not work, in your judgment, using the principles in reading and lecture. Attach a copy of the ad.

SESSION 5B: MAR 2,10:15-11:35

Roundtable: "The Psychology of Technology Investing"

Guests:

Bernard Goldstein served as Managing Director of Broadview International, LLC, a boutique investment bank serving the IT industry, from 1979 to 1996. Before co-founding Broadview, Mr. Goldstein had extensive operational experience at various technology companies, including serving as Chairman of National CSS and founding Computech and United Data Centers.

Mr. Goldstein has served on the Boards of Directors of Apple Computer Inc., Sungard Data Systems Inc., Enterprise Systems Inc., SPSS Inc.

Allscripts Healthcare Solutions Inc., Thrupoint Inc., Rasmussen College, Inc. (formerly, Deltak Edu, Inc.), Collegis Inc., Franklin Electronic Publishers, Inc., GIGA Information Group, Inc., and several privately held companies, as well as President of the Information Technology Association of America. He is a graduate of both the Wharton School of the University of Pennsylvania and the Columbia University Graduate School of Business.

Ira D. Cohen is a Managing Director and Head of Technology Advisory Services at Signal Hill, a leading investment bank. Previously, Mr. Cohen was Managing Partner, Co-Founder and President of Up data Advisors, Inc., a leading IT boutique investment banking firm, as well as a founder and Venture Partner of Up data Partners, a series of venture and private equity funds. Prior to the founding of Up data Advisors, Mr. Cohen served as CFO ofCGA Computer, Inc.,Tridex Corporation and Computer Magnetics, Inc.

Mr. Cohen has served on the Boards of Directors of Alphanet Solutions, Inc., Computer Learning Centers, Inc. and Datastream Systems, Inc, Spectrum K12 School Solutions, Inc., Jobs2Web, Inc. and Merlin Technology, Inc. He is also an advisor and has served on the boards of a number of other privately held companies, non-profits and social organizations. He has a B.S. in Accounting from the City University of New York - Herbert H. Lehman College and a M.S. in Banking and Financial Services from Boston University. In 2005, he attended the Harvard Business School Executive Education Program for publicly traded company Audit Commi ttee Chairs.

SESSION 6A: MAR 3, 3:40-5:00

Mindless decision making vs. statistical models

Applications: Persuasion, branding, and model building

Readings

Cialdini (2001): Harnessing the science of persuasion

Surowiecki (2010): Branded a Cheat

Camerer and Johnson: The process-performance paradox in expert judgment: How can experts know so much and predict so badly?

Short Writing Assignment 4: choose ONE of the following:

3b. Imagine that you have just taken the job of running the Columbia Business School admissions office. One of the statistics professors has come to you to suggest that you could do a better job of picking students for the school if the admissions office had less discretion in the selection process. Instead, you could commission the statistics department to fit a model to predict success (somehow defined) and then just pick the students that score highest on this model. What do you think of this plan? What problems to you anticipate? How would you solve them? Is it "fair" (whatever that means)? If you decided to implement this plan, would you make it public? What role would you assign to interviews?

3c. Can you think of how you would apply the idea of a linear model, proper or improper to improve business decisions in your business? What are the barriers to doing so? Why do you think it would or would not work?

SESSION 6B: MAR 3,5:10-6:30

Roundtable: "The Psychology of Non-profits"

Guest:

Pierre Ferrari is the CEO of Heifer International, a not-for-profit organization which uses gifts of livestock and training to help end hunger and poverty throughout the world. Before joining Heifer in November of 2010, Mr. Ferrari had an extensive career that spanned marketing, investing, and entrepreneurship. Ferrari served as the Senior Vice President for Marketing at Coca-Cola, USA, where he was responsible for a $500 million budget and managed more than 200 professionals. After leaving Coca-Cola, Ferrari was the international president of the sports marketing firm Lang and Associates. Ferrarri also founded Tula Communications, a boutique­marketing firm specializing in strategy and immersive brand experiences.

Ferrari's board memberships include the Small Enterprise Assistance Fund, the Emory University Center for Ethics, and Ben & Jerry's Homemade Ice Cream. He serves as the President of the Hot Fudge Social Venture Fund

and as a director of Guayaki SRP, a sustainable beverage business whose business model was featured at the 2010 Clinton Global Initiative Conference. Ferrari received his MA in Economics from the University of Cambridge and an MBA from Harvard Business School.

SESSION 7: MAR 24,8:45-11:35

Risk and decision making in a real world setting: Into Thin Air Case

Applications: organizational dynamics

Readings:

Heath, Larrick, and Klayman (1998): "Cognitive Repairs"

Krakauer (1996 ): "Into Thin Air"

NB this is NOT a written assignment, but please prepare for class discussion by considering the following questions:

- Why are the climbers up there? Consider the motivation and incentives facing each participant. What are the implications for potential decisions biases and corrective measures?

- What are the defining characteristics of the decision-making environment on Mt. Everest? Setting aside the extreme physiological conditions, what are the biggest challenges for good decision making?

- Describe the decision process used by Hall and Fischer. What mistakes did the guides or members of the climbing teams make during the climb to the summit? Why were these mistakes made? How do these mistakes relate to concepts we have discussed in the course?

- If you were advising a friend interested in organizing an expedition to the top of Everest (or some other large but potentially dangerous mountain), what advice would you give him or her based on the concepts of this course?

Short Writing Assignment 5

The insurance industry is one that specializes in taking the "outside" view. Imagine that you work for an insurance company approached by Doug Hansen in spring 1996, who wants to buy $1 million in life insurance in case of his death on Everest. Calculate how much the company should charge him for this policy. Would you suggest a different price if Rob Hall also wanted to buy a policy?

SESSION 8: APR 13, 8:45-11:35

Strategic interaction: Behavioral Game Theory

Applications: Bargaining and negotiations

Readings

Camerer (1997): Progress in Behavioral Game Theory

Thaler and Dawes (1992): Cooperation

SESSION 9: APR 27,2:00-4:00

Financial Markets: how does individual investor behavior aggregate?

Applications: Personal investing and financial services firms

Readings

De Bondt and Thaler (1995): Financial Decision Making in Markets and Firms: A Behavioral Perspective

Keynes (1936): Chapter 12 from The General Theory of Employment

Short Writing Assignment 6

Make a copy of a regular statement (or web interface) you or someone you know receives from a financial services company such as Fidelity or Vanguard. Do whatever is necessary to make the statement confidential

(black out names and/or amounts) and then attach the relevant parts to this paper. Now, based on what we've learned in the course thus far, make some suggestions for how this statement could be improved. Be sure to say explicitly what you are trying to improve.

SESSION 10: APR 27, 4:30-6:30

Student Presentations

Concluding lecture: Happiness and decision making: why do we decide?

REQUIRED Assignment (due no later than 10 pm April 27):

Submit 2 exam questions suitable for use in an essay exam.

SESSION 11: MAY 4,9:00-12:00

In-class final exam