Carmichael Corporate Services

Better Board decision-making: The case for encouraging diversity over collegiality

Smart people can still make poor decisions. Whether in public, business or personal life, we can all recall our own brain fades or those of people we admire for their intellectual capabilities. Collective decision-making, such decision-making that occurs on Boards, is often seen as a check to an individual’s blind spot, but often group dynamics can amplify a poor decision-making process rather than correct it. In the following article our Principal Governance Consultant, David Mahon, discusses how the phenomenon of Groupthink and dominant cognitive frames impact Board decision-making and how harnessing dissent is an integral part of achieving better outcomes.


CCS Article 3 Thumbnail.jpg

Smart people can still make poor decisions: it’s the Achilles heel of a meritocratic approach to organising society. Whether in public, business or personal life, we can all recall our own brain fades or those of people we admire for their intellectual capabilities. Whether it’s bad investment decisions, inability to manage relationships or detonating the world economy with collateralised debt obligations, IQ is no defence against undertaking actions that are blatantly the wrong course to take. Collective decision-making, such as decision-making that occurs on Boards, is often seen as a check to an individual’s blind spot, but often group dynamics can amplify a poor decision-making process rather than correct it.

Groupthink – when cohesion trumps doubt

In 1971 psychologist Irving Janis coined the phrase “Groupthink” in a paper published in Psychology Today. Janis set out to identify a psychological mechanism that could help explain how, 10 years before, a team of 40 of the brightest minds and intellectual talents in the United States of America planned and approved one of the most disastrous (at that time) foreign policy decisions in US history – the invasion of Cuba at the Bay of Pigs. Janis posited that when groups come together to make decisions under pressure, they suffer from a process problem that distorts their perception of reality, which can lead to solutions that make internal sense, but are fatally flawed in their real world application.

Janis had studied group cohesion during and immediately after World War II, and observed the importance of the human bonds formed under extreme stress in helping combat soldiers, medical staff and civilians to endure almost unendurable circumstances. Sticking together, creating loyalty among the group, reducing behaviour that caused friction: all of these factors were observable in the way that humans survived and coped with stress as groups in these conditions.

If this approach worked in extreme circumstances, conventional wisdom had it then, that promoting a congenial, task-orientated atmosphere among colleagues on Boards and committees would make for better group discussion in normal conditions, and this is what occurred in many organisations in the UK, US and other western democracies in the post-war decades.

What Janis recognised was that there were fundamental differences in the group decision-making process compared to survival in combat conditions, which meant that group cohesion in peace time was unproductive and possibly dangerous.

Janis felt that this collegiate approach created a situation where the unstated goal of group discussions in government cabinets, company boardrooms and back room committees became getting to a quick and painless position of unanimity. Individuals self-censored their inner doubts, stifled dissenters and tried their best to reflect their leaders’ opinions. The natural human instinct to belong meant that being part of the inner circle became more important than making the right decision.

Cognitive framing

Most decision-making processes require groups to work with incomplete information; there are nearly always, to paraphrase Donald Rumsfeld, known-knowns, known-unknowns and unknown-unknowns. Human psychology will try to impose structure on information to fill in the gaps in a process known as cognitive framing. What Janis recognised was that when you have an unchallenged dominant cognitive frame for dealing with incomplete data within a group it will promote a particular set of problem definitions, causal relationships, normative evaluations and recommended actions that are shaped by the social ideology, organisational culture and professional education of the dominant group members. This leads to unconscious bias and conformity of assumptions in decision-making.


Collateralised Debt Obligations (CDO) – how dominant cognitive frames created a financial crisis

CDOs were supposed to distribute the risk of under-performing, low-grade mortgage loans by bundling them up with higher rated mortgages. The dominant cognitive frame accepted by the world’s financial markets in assessing the risk of these instruments made four assumptions:

  • the US housing market would never fail;

  • ratings agencies were not flawed;

  • self-preservation would prevent financial institutions over-committing themselves to exposure to CDOs; and

  • the ability to back out the risk by buying or selling CDO derivatives would manage the risk of over-exposure by distributing the risk across the market participants.

This cognitive frame allowed the money managers to justify investing hundreds of billions of dollars in complex instruments that were in many instances too opaque to be fully understood by those trading in these instruments, or incorrectly rated as investment-grade. As it turned out, the first three assumptions of the dominant cognitive frame around CDOs all turned out to be incorrect; and the fourth, the distributed nature of the products, became the main problem when the US sub-prime mortgage market crashed. As some of the oldest and most venerated institutions shook and even fell under the shock, no one was certain of their counterparties’ exposure to CDOs and institutions were too afraid to lend to each other, freezing up capital markets as the contagion of the unravelling of the CDO derivatives spread throughout the world’s financial institutions.

In a 2012 article in the Review of Economic Studies, Roland Benabou described this mutual agreement among financial, regulatory and economic leaders to not question the dominant cognitive frame in relation to CDOs as creating levels of collective denial and wilful ignorance so high that they distorted perceptions of reality. This denial was contagious and created a state of “mutual assured delusion” among decisions makers who became “colour-blind in a sea of red flags.”

Tackling Groupthink – Diversity will check complacency

In his recent paper on diversity and Groupthink, Khalil Smith, Head of Diversity and Inclusion at the NeuroLeadership Institute, sets out a number of tactics and approaches centred around allowing diversity of experience, education, culture, age and sex to have a voice in group decision-making forums such as Boards and committees.

One interesting and telling observation he makes is that culturally diverse teams scrutinise each other’s assumptions and decisions more closely than homogenous teams, which creates more friction and conflict in the decision-making process, but ultimately leads to better outcomes. In studies cited by Smith, diversity is shown to increase critical thinking, contribute to better error detection and produce “cognitive friction that enhance(s) deliberation”.

While the benefits of cognitive friction in decision-making are evident in the examples cited by Smith, encouraging dissent is uncomfortable for participants, so the group leadership must create a social context in which opposing viewpoints are welcomed and rewarded, and dissent is recognised as bringing the group closer to achieving a common purpose.

As well as adding people of diverse backgrounds into the boardroom, Smith encourages organisations to also consider what mechanisms they can use to provoke the people already in the room into thinking more critically.

Chairs to direct rather than lead discussion

Like orchestral conductors, Board chairs should seek to bring all of the voices to be heard in a discussion, not just the virtuoso violinist or booming brass. This encourages those whose natural reticence may cause them to keep their doubts and reservations to themselves to be amplified, so the meeting becomes more than a one note performance. Chairs, because of the deference afforded to their position, are also often in a position to provide their opinion on a matter at the beginning of discussions, which also may bias the discussion because of their influence. Chairs should consider holding back their comments.

Zeus’ Gadfly and Socratic questioning

Socrates’ habit of questioning even the most basic assumptions of his students earned him the nickname of Zeus’ Gadfly, a gnat that buzzed the Gods with an incessant demand for answers. The role of the ignorant questioner on Boards and committees adds an important dimension to discussions where no counter-point is forthcoming from other members to create cognitive friction. Often this role is assumed by the same person in each discussion, but it is important that each member of the Board can employ Socratic questioning techniques and the role is shared so that no one person becomes marginalised as the annoying Gadfly.

Change the time horizon – how will this look in three years instead of three months?

Another way to combat conformity of thinking is to shift the time perspective of the matters that Boards are considering: run scenarios that project possible outcomes into the future and consider risks, consequences and opportunities. This technique can counter misplaced optimism or pessimism that may be a Board’s default position on certain matters.

Carmichael Corporate Services Pty Limited (CCS), a division of DJ Carmichael Pty Limited, focuses on delivering expertise in corporate compliance, enterprise risk and effective governance to SMEs. CCS provides clients with these essential corporate skills in a bespoke fixed-price service package, “Board Room Solutions”, that can provide assurance and support for growing companies without the overheads of permanent staff.

David Mahon
FGIA FCIS
Principal Consultant – Governance and Company Secretarial

T: +61 (0)8 9263 5232
M: +61 (0)431 399 230
E:
dmahon@djcarmichael.com.au

David Mahon

Principal Consultant - Governance and Company Secretarial

David has over twenty years experience in governance, risk management and compliance, working for fund managers and corporate advisory firms in London, Perth and Sydney.

In 2010, he established Mahon Consulting which provided company secretarial and corporate compliance requirements to a number of companies across the spectrum, including mining and resources, healthcare, ICT, primary industries, real estate, financial services and infrastructure. In 2013, he co-created a joint venture to establish pooled investment vehicles (Australian and Overseas) targeting pre-IPO and high growth Australian companies.

Prior to joining DJ Carmichael, David was the WA State Manager and senior governance consultant for a national corporate services firm, focusing on delivering tailored governance and risk systems to commercial organisations, listed entities and fund managers.

David is a Chartered Company Secretary, a Fellow and graduate of the Governance Institute of Australia and a Fellow of the Institute of Chartered Secretaries and Administrators. He holds post graduate qualifications in risk and compliance from Charles Sturt University, NSW.