Advice for CFOs: Don’t Think Fast; When chief financial officers think too fast, they can get the company into a lot of trouble. Here’s how to slow down and avoid such problems, based on insights from Nobel laureate Daniel Kahneman

July 21, 2013, 4:01 p.m. ET

When CFOs Think Fast…

…They may get the company into a lot of trouble. Here’s where they go astray—and how to avoid it.

HERSH SHEFRIN

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Daniel Kahneman, in his best-selling book, “Thinking, Fast and Slow,” says there are basically two modes of thinking. Fast and slow. Fast thinking is intuitive, he says. It arises from experience and broad unconscious associations between ideas. Slow thinking, in contrast, relies on reason, analysis and deliberation. Both have their time and place. But the psychology professor and Nobel laureate in economics warns about the risks of too much fast thinking when thinking slowly would lead us to better decisions. Chief financial officers would do well to heed that advice. Too often, they take mental shortcuts, trusting their instincts instead of doing the math. And the results can be damaging to their companies’ shareholders, employees and customers. Here are some of the ways fast thinking leads CFOs astray, and a few suggestions as to how such problems can be avoided.Everything Is Rosy

 

Everybody wants to be right. CFOs are no exception.

The problem is known as “confirmation bias,” in which decision makers place far too much weight on information that supports what they already believe. It can reinforce, if not lead to, excessive optimism and overconfidence—and stems from a CFO following a self-serving impulse to trust his or her gut, rather than engage in careful analysis.

In any industry, the risk is higher when the CFO feels directly responsible for a project’s success or failure. A CFO who is emotionally invested in a product launch might ignore warnings about production problems or react aggressively to legitimate questions about cost and marketing assumptions.

Rules of Thumb

A different kind of bias creeps in when CFOs resort to rules of thumb and snap judgments. Often they are again trusting their instincts, typically by relying on stereotypes.

Some of the worst corporate-acquisition decisions have resulted because CFOs relied on fast thinking to assess the value of their deals. Indeed, when a CFO says, “Doing a deal with X would be a smart deal for our company because X fits with our strategy,” it may reflect no more careful analysis than “X is a round peg that should fit into our company’s round hole.”

Such thinking often leads companies to overpay for acquisitions.

Framing Effects

CFOs sometimes neglect to see how their thinking and decisions can be shaped by the way a situation is described, or “framed.” For example, despite what they’re taught in business school, some CFOs, when their company is facing losses, will focus on the sunk costs instead of ignoring those costs and creating as much incremental value as they can. A kind of crisis mode develops, aggravated by CFOs “framing” their situations in terms of losses. Doing so leads them to pressure themselves to stop the losses by resorting to quick fixes—and sometimes unwise risks.

What to Do

How can chief financial officers avoid these psychological pitfalls and get their planning and forecasting on firmer footing?

Having well-defined procedures is a start. For everything from acquisitions to annual budgets, when CFOs and management teams follow well-structured processes, more careful analysis takes place. Checks and balances kick in that can curb impulses and other destructive forms of fast thinking.

Slowing things down can lead CFOs and their teams to set more realistic goals, to engage in more effective information sharing and to reap financial rewards based on actual performance.

Another technique calls for a shift in perspective: from an “inside view” to an “outside view.” The former is what detail-oriented CFOs tend to do well: estimating the required resources and future rewards of a given project.

The outside view imagines what that same project would look like to peers from outside the company. Using detailed data, it makes comparisons with similar past projects attempted both within the company and elsewhere, looking at the track records of those projects and of the people involved.

Taking the outside view requires doing more analysis, and crunching more numbers. In other words, it requires thinking more slowly.

Mr. Shefrin is the Mario Belotti professor of finance at Santa Clara University’s Leavey School of Business and the author of “Behavioral Corporate Finance.” He can be reached at reports@wsj.com.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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