Blind Spots in Risk Identification Can Be Driven by Recency

As humans, we exhibit a number of cognitive biases and tend to think in certain ways that can cause us to wander from the path of rationality or good judgment from time to time.

One such bias involves the phenomenon of most easily remembering those things that have happened recently, compared to remembering something that may have occurred a while back. For example, talent managers express concern that employee performance reviews often reflect what an individual’s performance has been lately instead of their true performance throughout the evaluation period.

Thinking Differently

This “recency effect” principle is described by psychologists as a belief that recent experiences will continue on as they have. So we tend to think that what is happening around us today will continue for the foreseeable future. In business, this can be a real source of unanticipated disruption to the company, the stockholders, and the board.

For example, top executives don’t believe that the quality of their products could degrade suddenly and lead to customer injuries, or may not see an emerging competitor with superior technology coming to take their best customers this year. And because they believe their company employs only the best people, leaders and board members may not foresee a scenario where the CEO could divert significant capital into a poor acquisition, or one that is rife with fraud — with either result significantly impacting the acquiring company’s reputation and results.

So recency bias impacts how we think about risk events. When we consider risk to our strategic goals and objectives, it causes us to sometimes discount the likelihood of unexpected events occurring, and instead assume that people, markets, and customers will continue to behave in much the same way as they have previously. If we don’t at least play out the possibility that changes may be occurring – in other words, evaluate options not on the current path — we won’t be prepared to handle any resulting impact. As a result, discounting or ignoring unobvious options precludes planning with appropriate responses that would enable us to recover quickly – the “resiliency” needed to survive and thrive.

Closer to Home

Beyond business survival, having a recency bias can also affect our personal lives – perhaps even impacting the safety of our families. We have to be continually looking beyond today’s observations of the world and consider what may happen in the future – given that various cycles exist in the world, and things that have occurred previously can occur again. Economic cycles, cycles of war, and even the rise of political protest and societal instability will appear regularly in the ebb and flow of events over time.

Our weather here in Michigan is a great example. History shows us that within the space of a few days, the weather can go from one extreme to another and catch many people unprepared.

Over the past few weeks we have enjoyed temperatures in the 40s and 50s, hitting 57 degrees in Detroit on January 12th and 56 degrees in Lansing on January 21st. As a result, many expect the winter to continue to be mild. However, these extremely mild weather patterns have occurred in the past – and in some cases, foretold the arrival of massive snow storms. Two such storms occurred in the final days of January in two different years following unusually warm temperatures and rain.

The storm of January 27-28, 1967 resulted in the shutdown of Chicago, Detroit and much of Michigan for several days, leaving thousands of vehicles and travelers trapped in driveways, streets, parking lots and on highways due to massive snow drifts many feet high. The Governor of Michigan declared a State of Emergency as people were trapped in their homes and trucks were unable to transport goods of any kind across the State. Those with emergency food and fuel were able to adapt to the changing weather and “ride out the storm” more easily, but over 20 people lost their lives — primarily due to the exertion required to dig out of the snow.

Then exactly 11 years later on January 27, 1978 another massive storm — later deemed to be worse than the earlier one — blanketed most of Michigan and again halted commerce. But with this storm, below-zero temperatures, combined with winds gusting over 50 mph, produced wind chills down to negative-50 degrees for the next month. Business and individual resilience was again tested, but to a much greater degree given the extended period of frigid conditions.

Enhancing Risk Intelligence

Identifying potential sources of business risk takes effort. While weather change may be an easily foreseeable event, our failure to take action and prepare for a crisis may come from the human bias toward normalcy surrounding recent conditions. Likewise in business we may dismiss outright or give only passing consideration to events that could occur but have not been observed lately.

Properly managing your risk, whether at home or in your organization, requires a disciplined process for identifying and evaluating events and other factors that could derail achievement of your objectives. This should include unlikely changes in the business, economic, political and other environments.

To improve our chances for success, we must be aware that bias may exist as we complete our assessment. In addition, we must evaluate both the range of potential outcomes and how quickly things can change – the velocity – in addition to the impact on the organization. Techniques to assess both the upside and downside impact on our objectives could include business plan scenario analysis, war gaming, and even conducting game theory workshops in situations where external player actions will impact our decisions and plans. Where signals or mechanisms do not exist to provide sufficient early warning for the approach of adverse events, we must develop more robust response plans to minimize the impact on our organization, its employees and customers.

About the Author: Jay R. Taylor is CEO of EagleNext Advisors in Detroit, Michigan after having led Strategic Risk Management and serving in various global executive internal audit roles for General Motors Company. Jay focuses on enabling business growth and opportunity through risk-enabled decision making and better board governance. He is a Founding Member of the Private Directors Association Detroit Chapter and in 2016 became a National Association of Corporate Director’s Governance Fellow. Jay can be reached at jay.r.taylor@comcast.net.
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