New Leadership Insights from Behavioral and Causal Economics
Great leaders are constantly on the lookout for new insights that can help them build better organizations and have better impact. Behavioral economics has recently become of priority interest to leaders because it helps explain the often ‘irrational’ behaviors of people that need to be rallied behind a cause. Behavioral economics is a decision making model and research from 2019 in the Harvard Business Review reminds us that decisiveness is the number one factor of great leadership.
Decision making and human psychology have always been central to leadership, but behavioral economics puts some disciplined structure on how leaders can use it. However, behavioral economics in its mainstream form is loose and difficult to consistently apply. That’s because it essentially mashes together a structural analytical framework—cumulative prospect theory—with a separate laundry list of psychological insights. In applying the insights of behavioral economics, leaders generally find themselves applying one-off psychological principles, with no underlying glue to hold them together. Cumulative prospect theory is built on short-term ‘lottery’ type outcomes, which doesn’t even closely resemble the nature of important decisions faced by leaders and their teams. Real decisions require sustained time and effort.
That’s why there’s growing interest among leaders in a particular new stream of behavioral economics, known as causal economics. Causal economics is constructed exactly the way leadership decisions are—deliberate upfront commitment is required in anticipation of expected future results from getting on board with the vision. In causal economics this is formally known as the principle of causal coupling. Significant decisions in life always follow this structure over time—there are no free lunches in the inevitable long-term.
A Simple Framework for Application
Decision making consistent with causal economics can be made using the simple STAR framework (sights, targets, actions and reactions). Every significant decision should be made by defining it in the elements of the STAR framework. Sights are essentially your vision, targets are quantifiable outcomes you’re going after, actions are those you plan and execute and reactions are how you adjust and act in the face inevitable challenges. Causal economics defines decisions as thought (sights and targets) and actions (action and reaction). You can’t have only thought OR action—that’s not a decision. Leaders that understand this appreciate the level of commitment and follow-through that’s expected of them by potential followers.
You’re Not Starting with a Blank Canvas
Your team members are always making the decisions you require within the context of larger decisions they’ve made and reinforced for years—those which define their existing beliefs—about family, health, money etc. These beliefs are usually both rational and irrational. Research in neuroscience demonstrates that 95% of our decisions are actually driven by unconscious emotion. Leaders will be successful when they frame their vision and actions in line with the underlying core belief decisions of their team members and the biases they’ll exhibit on the journey.
It’s hard to rally people into action behind your cause. That’s because so many psychological factors reinforce the current situation, such as cognitive dissonance, status quo bias, recency and selective perception, to name a few. Cognitive dissonance occurs when people face new information that’s inconsistent with their beliefs and the discomfort causes them to attempt to reconcile with existing beliefs. This is undoubtedly a big roadblock to change. The principle of recency reminds us that people remember and give priority to what they have most recently experienced. If you’re not influencing the recency perspective of your team members, then it will just be the status quo. Status quo bias is pretty self-explanatory; people associate discomfort and higher costs with change. With this in mind, selective perception also results in people hand-picking new information to align to their beliefs, including the belief that the status quo is easier than change.
With all of these biases holding people back from joining your exciting vision, what can a leader do? Following your vision requires change—plain and simple—so you have to get your team members to a point where their perceived cost of doing nothing (CODN) is sufficiently higher than their perceived benefit of doing something (BODS) —trying your solution. You have to put this change ratio in your favour versus competing alternatives—based on honest and upfront positioning. Keeping in mind how hard it is to get people to a CODN/BODS level that allows for change, as leaders we have to remember that change takes time. Great leadership requires speed, so it’s a tough balancing act to align that to the patience necessary to support people through change.
One of the most famous insights that behavioral economics brought to the forefront is the explicit difference in perceptions we have of risk versus gain. Behavioral economics shows us that decision makers usually weigh losses twice as much as gains. We are more focused on avoiding loss than we are in obtaining gain. We also tend to pay too much attention to low probability outcomes and too little to high probability ones. Risk aversion is yet another element that makes leadership hard—requiring transparent communication followed by action—talking the talk and walking the talk.
Risk aversion gets all the attention, but just as important are known, upfront and deliberate costs. This insight is added to behavioral economics through causal economics. Based on an endowment effect perspective, cost aversion can result in people avoiding necessary upfront costs, as a result foregoing the potential long-term benefit they are truly after. Endowment effects are the bias that people don’t want to part with anything if they don’t have to. Like risk aversion, cost aversion puts pressure on the brakes of change, so it has to be managed in the same way.
Great decisions from leaders and their followers won’t matter if they fizzle out after an initial run of success. Desired results usually rely on sustainability. Sustainability comes from one thing—when causal coupling occurs across all of your stakeholders. The X (change in benefit / change in cost) of everyone impacted must be greater than or equal to one. That means everyone wins or at least isn’t negatively impacted. This win/win thinking sounds so obvious—how can any leaders not think of it? Well, the reality is that it’s not extremely common for leaders to look deeply into the personal B/C perspectives of their team members—because it’s hard work. If you want your initiatives to be successful, then put in the effort to ensure X ≥ 1 for all involved in your decisions.
Buyers very often place more emphasis on the present relative to the future than would be suggested by fully rational behavior. In psychology this is known as hyperbolic discounting. This bias makes it challenging to keep potential buyers focused on the short-term and long-term relationship, but being aware of it helps the leader try to significantly improve the change in benefit/change in cost ratio for the longer term.
Behavioral economics has made famous the concept of nudging, a principle advanced by Nobel Economist Richard Thaler. To ‘nudge’ the leader applies positive reinforcement and indirect suggestions to influence behavior. This goes beyond just educating with information. It’s action-based. An example of nudging would be placing healthy food options closer than unhealthy ones in the company lunch area to encourage a health and wellness in the workplace.
Transparency, Credibility and Trust
Leadership can only happen when potential followers see the vision and believe the leader is credibly concerned about those that follow. This ‘concern’ has to be proven by walking the talk, taking action first and bearing costs personally. Many of todays ‘leaders’ are really just ‘managers’. Managers talk a great game, as talk is easy, cheap, and can even feel great. Nothing even happens following their empty talk and they aren’t usually held accountable to it anyway. Leaders talk and inspire but quickly move into action and persistent reaction. As a leader you set the pace of decision making in the organization, so make sure you’re explicit about decision making being central in your culture. We all have capabilities, insights and objectives—none of them can be leveraged without a decision—which is purposeful action.
It’s often not appreciated that great leaders also have to be great followers. To earn respect for your decisions as a leader you need to show respect for the decisions of those on your team. There’s also a lot of pressure on leaders to have everything figured out, because others are looking up to them. Don’t give in to this natural pressure—trying to be right all the time will come across as disingenuous and reduce credibility. Be honest, listen and adjust. That will maximize the change in benefit/change in cost perceptions of those on your team.
As a leader, reinforcing the central concept of causal coupling keeps your team focused on constantly breaking down psychological cost barriers and maximizing psychological benefits. It’s vital to stay abreast of the latest relevant thinking in a constantly changing world. Behavioral economics and causal economics definitely fit into that category. Prospective followers of your vision can be lost for many reasons. Don’t let it be the result of a fundamental misunderstanding of the nature of decisions, including bias behaviors that you could better manage through education and attention.
For more insights on causal economics, visit www.causaleconomics.com.