Question

When a manager is forecasting cash flows for a potential project, do you think the forecasts are biased in any way? If so, how can you mitigate this bias? explain

Answer 1

When a manager is forecasting cash flows for a potential project, the forecasts could have the following bias :

• Selective perception and confirmation bias - information that supports the manager's pre-conceived notions could be given more importance. All the available information is not neutrally considered. Rather, that portion of information that inclines with the manager's knowledge, interests, or subconscious decisions is given selective preference. If the manager is intuitively convinced that the project is unprofitable, any information to the contrary could be filtered and any information that supports this view could be given more importance than due.
• Recency bias - This is a type of bias where recent events are given more weightage. If the manager had an extremely profitable or extremely poor project recently, the learning from that project could have an overbearing influence on the current project
• Overconfidence bias - This is a type of bias where the manager has too much confidence in their analysis decisions. This could lead to overstating cashflows or even understating them. The underlying problem is that indepenence of judgement is compromised
• Anchoring bias - This is where the initial information flow is given overdue importance. In this type of bias, too much weightage is given to one piece of information. Managers with this bias tend to make decisions too early.

These are a few important biases in managerial decision making.

To mitigate this bias, the manager could :

• Constantly challenge their own viewpoint. Do not assume anything. Always question the basic assumptions in any analysis.
• Discuss thoughts with others to understand multiple perspectives. Play the devil's advocate
• Avoid making decisions under pressure. A slower but well-thought decision is better than a hasty but wrong decision
• Analyse the decision making process to delete any subjective decisions. All decisions must be analytical and fact-based
• Review the information sources to make sure they are accurate