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Monday, February 18, 2013

Decision making: Likelihood over Rewards



Seeking the best possible outcome.

People make decisions every day of their life. Some of these decisions are rational while others appear to be more irrational. Understanding the evaluative processes of such decision-making helps business leaders better grasp the choices people make between the probability of a positive outcome and higher levels of reward. Research helps show the risk aversive state of normal decision-making as people seek to gain higher likelihood of positive outcome over higher potential rewards.

Decision making can be defined by a number of important key parameters that include probability of an outcome, the size of an outcome, and the variance of an outcome (Christopoulos, et. al., 2009). When making a decision people try and understand the likelihood that they will achieve a certain outcome, the potential value of that outcome and the uncertainty of that outcome. If there is a high likelihood that the object will be obtained, this object is of great value, and there is low variability in the possibility of this outcome then there will be higher levels of motivation to act.

Expected value theory posits that people decide rationally by understanding the objective worth of choices by calculating the expected value of a reward times its probability of its outcome (Milstein & Dorris, 2007). In other words, people will look at the total value of a reward times its likelihood of occurring. An outcome worth a million dollars that has a 50% chance of occurring is worth more than a million dollars with a one in ten chance of occurring.

Prospect theory makes the argument that decisions are made on the basis of perceived value, perceived magnitude, and perceived probability of reward (Kahneman, 1979). This perception changes with the person and the values also change depending on how something is perceived. Each person would evaluate their prospects differently based upon their perceptions of worth. Each person and their potential for rational and irrational decisions are variable and highly subjective

Research conducted by Sharp, Viswanathan, Lanyon and Barton (2012) attempts to evaluate economic decision making under risk and ambiguity. The two theoretical constructs under study focused on decision-making using expected value theory and the other irrational choices under prospect theory. Subjects needed to choose between two prospects varying in size and probability in order to maximize their gains. On each trial the value of the prospects were varied to make a spectrum of choices. Nineteen healthy participants engaged in the study.

Subjects choose between higher probability of gain or higher value obtainment. The results indicate the following:

-Subjects had a preference for higher probability of gain over the value of the gain.

-Subjects had a hard time evaluating small differences in value.

-Subjects were risk aversive.

-Subjects had a tendency to favor higher probability over higher reward.

The research helps highlight the differences of choices subjects make by varying degrees of probability and reward. When confronted between higher levels of probability of a positive outcome or higher rewards, the subjects had a preference for the higher probability of a positive outcome. People naturally chose the safer route than those routes with the highest magnitude but the least chance of a desirable outcome. Understanding these findings can help organizational leaders put within perspective the value of offering higher levels of security over higher rewards in the average adult population.

Christopoulos G., Tobler P., Bossaerts P, Dolan R. & Schultz W (2009) Neural correlates of value, risk, and risk aversion contributing to decision making under risk. J Neurosci 29: 12574–12583.

Kahneman D, Tversky A (1979) Prospect theory: an analysis of decision under risk. conometrica 47: 263–291.

Milstein DM, Dorris MC (2007) The Influence of Expected Value on Saccadic Preparation. J Neurosci 27: 4810–4818.

Sharp ME, Viswanathan J, Lanyon L., Barton J. (2012) Sensitivity and Bias in Decision-Making under Risk: Evaluating the Perception of Reward, Its Probability and Value. PLoS ONE, 7(4)




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