ISSUE 15: They Who Dance Are Thought Mad by Those Who Hear Not the Music
On Preference Reversal and the Role of Context
Good evening.
1.
Every decision is a prediction. We predict how events will turn out, then choose an action most likely to give us the advantage. But predictions are hard, especially about the future, so quipped a Yankees hall-of-famer. Moreover, just as elusive is selecting the correct action, even when predictions are straight-forward, or at least so they seem.
With a title to dispatch many an economics nerd into a chortle, behavioral scientist Cass Sunstein examines such elusiveness in his paper On Preferring A to B, While Also Preferring B to A. Sunstein opens the paper with a 1996 research conducted by Christopher Hsee of the University of Chicago, where participants were asked to assess their preference for:
Dictionary A: 20,000 entries, torn cover but otherwise like new
Dictionary B: 10,000 entries, like new
When people assessed the options separately, they were willing to pay more for B. When assessed jointly, A was priced higher.
How can this be? Sunstein explores:
A prominent explanation for such preference reversals points to “evaluability”. In separate evaluation, it is difficult for most people to know how many words a dictionary should have, or whether 10,000 is a lot or a little. For that reason, 10,000 and 20,000 might be taken to be indistinguishable in separate evaluation, and hence produce essentially the same willingness to pay. The numbers do not and indeed cannot matter, to the extent that people do not know what they mean. By contrast, “torn cover” is clearly a negative and “like new” is clearly a positive in separate evaluation. That characteristic looms large. Who wants a dictionary with a torn cover?
On this point, negotiation experts will recognize a related though different concept: anchoring. When price-haggling at the night market in Tiong Bahru, for example, offer $10 for a souvenir if you were actually willing to pay $20. What makes preference reversal and anchoring different, though, is anchoring typically stakes out a far point along the spectrum of the same consideration factor (e.g., price), while preference reversals as illustrated above happen when even which factor matters is altered, especially implicitly.
So which method is better aligned with the interest of the decision-maker, joint or separate? An intuitive answer is neither. An evaluation of all options, or a global evaluation, is always best, at least in theory. Strategists call this widening the aperture.
What happens in practice is a little different. Sunstein observes:
The problem of evaluability…points to a lack of adequate information, which can be costly to obtain, and which people might not seek out even if obtaining it is not costly. In separate evaluation, insufficient information is a pervasive problem. (Whether it is rational to try to obtain it is a separate question, which depends on the costs and benefits of the effort. As we shall see, people sometimes do not put themselves in a position to make comparative judgments even when the benefits of doing so justify the costs.)
In other words, even when decision-makers know it’s better to evaluate more options than what are readily available, they may forgo such exercise unless extraordinarily motivated.
2.
Preference reversals between joint and separate evaluations may help provide some context to several recent news items.
First, the sudden and total collapse of FTX has led investors, customers, and crypto peers examine what went wrong. Financial and technical details aside, it certainly seems Sam Bankman-Fried, FTX’s charismatic founder, benefited from joint evaluation by his fans. Faced with a generally libertarian-leaning crypto community, Bankman-Fried’s philanthropic engagements were better tuned into matters such as climate, food, and poverty that are closer to the hearts of his supporters. As Sunstein notes in his paper:
…in joint evaluation, certain characteristics of options may receive excessive weight, because they do not much affect people's actual experience or because the particular contrast between joint options distorts people’s judgments.
Second, on the other coast of the country, news of Bob Iger returning as Disney’s CEO shook up the investor and analyst community as questions immediately emerged whether Iger’s return was the best alternative to the outgoing CEO, Bob Chapek. Representative is analyst Ben Thompson on his much-read blog Stratechery:
First, all of the decisions that Chapek was making that Iger hated were, in my estimation, downstream of the strategy Iger himself laid down for the company. That means that to the extent Chapek’s big changes were wrong, so was Iger’s strategy…To put all of this a different way, if Iger is coming back because he disagrees with Chapek’s tactics, well, that strikes me as a bad idea: Chapek played the hand that was dealt him by Bob Iger. On the other hand, perhaps Iger has come to realize that the all-in bet on Disney+ was itself the problem: in other words, he is coming back not to fix Chapek’s mess, but to fix his own…This, though, isn’t great news either: the entire reason why Iger went all-in on streaming is because the cable bundle, Disney’s real money-maker for most of Iger’s tenure, was starting to falter; that faltering is coming perilously close to being a full-blown engine failure. That means simply going back to the old strategy isn’t an option either.
Whether the reader agrees or not with Thompson’s premise, that Iger’s strategy for Disney may have proven incorrect should not automatically disqualify him from returning to right the ship. A different, more direct concern may be that for all the reasons Disney’s board judged Iger to be the best candidate, such “proof of work” wasn’t provided to investors and analysts, many of whom are sophisticated decision-makers expecting a global evaluation among at least a few viable candidates, rather than a joint evaluation only between Iger and Chapek. Short of such proof of work, stakeholders are left with speculation. Here is Thompson again from the same post:
[T]he more optimistic take as to why Iger would change his mind is that he still believes the strategy can work, but precisely because the tactics necessary are very difficult, Disney simply couldn’t afford the more basic CEO errors I opened with, and that both investors and customers needed someone they trusted to support Disney through this transition. If that ends up being the case, well, that’s a pretty good reason to come back: it wouldn’t simply be that Disney needed Iger, but that Iger’s own strategic legacy needed Iger’s touch with tactics.
3.
Context matters, so caution the wise in scholarship and investing. But context exists in our minds, whether we are aware of it or not. As illustrated in the preference reversal phenomenon between separate and joint evaluations, the more actionable advice may be to be vigilant of our subconscious context, probe for evaluability bias, opt for global evaluation whenever possible, and make a conscious trade-off when to stop exploring further options.
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