Boards of directors generally comprise highly capable people, well aware of the need for careful judgment processes and who know the potential impact that poor decisions can have on the success of the business, shareholder value, and director liability. Notwithstanding this fact, opportunities for improvement in the judgment processes of directors are available. Corporate governance is enhanced when directors improve their ability to exercise an appropriate level of skepticism and actively engage with management. Companies are better served when directors effectively challenge management's judgments, explicitly consider alternative perspectives, and engage management in frank and open discussions.

The above excerpt is from the introduction of a new paper from the Committee of Sponsoring Organizations titled, “Enhancing Board Oversight—Avoiding Judgment Traps and Biases.” It is a call for board members to exercise more care when making decisions and to do more prodding of management's decision-making process.

The bottom line? Even experienced directors can go terribly wrong in decision making. While the paper targets boards of directors, it has some important lessons for C-suite executives who work with or report to the board or its committees. Understanding how boards make critical judgments, and how those judgments can be improved, can make a huge difference in getting to the most desirable, value-added business outcomes.

Common Judgment Traps

The paper points to what it calls one of the most common judgment traps: a tendency to seek to immediately solve a problem, and appear decisive by making a quick judgment. The observation is a good reminder that faster isn't always better. Boards may strive toward early consensus, where ineffective compromises are reached to avoid conflict, rather than engage in healthy consideration of opposing views. I've seen many boards fall into this trap, where current or former CEOs and other accomplished directors pride themselves on the ability to absorb information quickly, analyze issues, and use their insights and finely honed instincts to reach a swift conclusion.

Another common trap resulting in “seriously flawed judgments with calamitous outcomes” stems from “groupthink.” In this situation individuals suppress their own views and assume that group consensus translates into good judgment. Groupthink can result in narrow views, suppression of divergent ideas, and partially considered judgments. Of particular note is that with overly cohesive groups, a quick agreement of like-thinking members can lead to extreme overconfidence in a decision.

Proactive Framing

While groupthink and rash decision making are almost always problematic, the paper also highlights some aspects of judgment that have risk and benefits, such as “judgment framing.” This technique is at the core of a director's ability to raise effective questions, appropriately challenge and evaluate judgments, and help the board and management avoid judgment traps and biases. Judgment framing involves coming at an issue or problem from different perspectives.

I've seen plenty of occasions where senior managements present opportunities to boards that consider only one perspective—a view through rose-colored glasses.

Consider this scenario: A company's CFO presents a plan to acquire another company as “a slam dunk,” thereby suggesting an assuredly positive outcome with little risk, and calls for quick approval. Yet different perspectives need to be considered. Using judgment framing, directors would look, for example, at the objectives of the acquisition, the problem it attempts to solve, and alternative acquisition opportunities that may exist. The paper adds that boards need to take time to identify and consider the implications of alternative or opposing views, including those from “down-the-line employees or outside sources.” After considering these frames, the acquisition may seem less like a slam dunk and more of a long-range three-point shot.

I've seen plenty of occasions where senior managements present opportunities to boards that consider only one perspective, a view through rose-colored glasses. In some instances the board followed along in lock step; in others the board took a more critical view, asking probing questions and challenging unsupported assumptions. In the later cases, the board and management ultimately arrived at significantly better decisions.

Judgment Tendencies and Biases

The paper also explores the notion that directors are regularly charged with making challenging judgments in complex, uncertain, and pressure-filled environments that leave board members vulnerable to systematic and predictable judgment traps and biases. A frequent result is the greater use of “shortcuts” that can be efficient, but can also lead to biased judgments.

To illustrate, the paper points to the example of how the simple decision of when to cross the street can go wrong based on environmental factors. A person crossing a New York City street might look for oncoming traffic, and seeing the coast clear—regardless of traffic lights or “do not walk” signs—proceed to cross. This approach is efficient and can become unconscious and automatic. But using this shortcut strategy in London can prove fatal. I'm not proud to admit this, but on numerous occasions I, a native New Yorker, almost got killed in London despite the multiple signs to “look right!”

The paper points to four common, bias-inducing tendencies that can predictably lead even the brightest people to make sloppy judgments:

Overconfidence. Overestimating your ability to perform tasks or make accurate assessments of risks or other judgments and decisions is a common pitfall. Research, says the COSO paper, shows that many people, including highly experienced professionals, are consistently overconfident when estimating outcomes or likelihoods—and that confidence grows more rapidly with experience than does actual competence. While confidence is an important attribute, overconfidence can lead to poor judgments, resulting in: shutting down potentially useful discussions; reaching ill-considered snap judgments; considering too few alternatives; truncating or skipping an information search; solving the wrong problem; underestimating the likelihood or potential magnitude of risks; ignoring certain stakeholder perspectives; or neglecting to plan for the possibility of events with potentially adverse outcomes.

Confirmation. Decision makers tend to seek information that is consistent with their initial beliefs or preferences and hold it in higher regard. The paper points to how board members may be prone to rely too heavily on management's explanations related to issues or concerns, which can lead to failure to consider information that might suggest alternate explanations.

Anchoring. Another bias trap is the tendency to make assessments by starting from an initial numerical value and then adjusting insufficiently away from it to make a final judgment. The paper highlights the effects of using anchoring in negotiations, when a low or high starting figure is put forth causing judgments to become skewed. Anchoring can be powerful and pervasive and is regularly used by expert negotiators to their advantage.

Availability. Decision makers also have a tendency to consider information that is easily retrievable from memory as being more likely, more relevant, and more important in making a judgment, causing the information to weigh unduly on estimates, probability assessments, and other professional judgments. The information may come from experiences with the company where an issue is being discussed, or even from another board. For example, a director seeing the outcome of another company's acquisition as positive or negative may unknowingly bias his or her thinking on the likely outcome of a proposed acquisition under discussion.

Making the Right Decisions

The traps and biases are there, and we're all likely to trip over them sometime, but the COSO paper gives good tips on mitigating their effects. The most important element is to recognize when we're vulnerable to them and take logical steps to help process information correctly and minimize potential misperceptions.

The paper puts forth a number of techniques, linked to the nature of the tendencies discussed. Actions include: seeking opposing or disconfirming evidence, questioning expert opinions, encouraging opposing points of view, challenging extremely high or low estimates, challenging underlying assumptions, and consulting with others.

Of course no bullet-proof method exists for making great decisions every time, but more awareness of the potential traps and biases can certainly help to improve them. The COSO paper goes a long way toward helping decision makers spot them and is certainly worth a read.