Craig Fox

December 16, 2009

MBA Students Encounter Behavioral Decision Theory in Many Disciplines at UCLA Anderson

Craig Fox explains how it is applied in business

Behavioral decision theory has evolved rapidly over the past 50 years and now impacts nearly every discipline in UCLA Anderson's MBA curriculum. Students will encounter behavioral decision theory in their marketing and organizational behavior classes and sometimes in finance classes. UCLA Anderson Professor Craig Fox explains that it provides a new perspective on human behavior.

"In traditional economic thinking," according to Fox, "people are assumed to be rational agents, processing information in a thorough and evenhanded manner, and maximizing their self-interest. However a number of studies in recent decades have found that very often people fall short of this Olympian standard of rationality, and they do so in systematic and predictable ways. Behavioral decision research attempts to more accurately characterize how people make decisions."

"Rational choice theory is an important assumption for building powerful models in a variety of business disciplines," said Fox. "Beginning in the 1950s, however, its limitations became increasingly apparent. People are not perfectly rational. At best they may sometimes be rational subject to the limitations of their memory and attention-that is, they may be ‘boundedly rational.'"

In the 1970's, researchers began to build behavioral models that characterize people's judgments and choices in a more psychologically valid and descriptively accurate way. As rational models struggled to explain market irregularities, behavioral models became increasingly popular.

"I think the watershed moment came in 2002 when Daniel Kahneman was awarded the Nobel Prize in Economics for his work in behavioral decision making," said Fox. "From that moment on, I think it has been acknowledged as a mainstream discipline in economics and it has had an increasing influence on business school education and research."

Behavioral decision making is widely studied in business schools. "The largest contingent," Fox said, "is in marketing departments where researchers study how consumers make decisions such as which computer to purchase or how to invest one's savings. If your goal is to predict how consumers will actually behave, rather than how they ought to serve their rational self-interest, then you will typically want to draw on behavioral decision research."

"We have a Behavioral Finance elective," said Fox. "In addition, Shlomo Benartzi teaches a class in Household Behavioral Finance and I teach a course in Managerial Decision Making. It's increasingly influencing what we teach in both core and elective courses, and I think the same is happening in leading institutions across the country."

According to Fox, behavioral decision theory is used in Organizational Behavior courses to understand biases in decisions of managers and employees. In Behavioral Finance, it is used to help explain anomalies in market prices and investor behavior.

"We're also beginning to see the development of Behavioral Strategy," continued Fox. "Strategy researchers are applying models from behavioral decision theory to better understand decisions made by firms in competitive environments. There is also a movement to study Behavioral Operations Research. For instance people are trying to understand how psychology influences supply chain management. There is even work on Behavioral Accounting. Almost every discipline of management science is starting to see the influence of behavioral decision research."

Fox explained that behavioral decision theory can be leveraged to help managers make better decisions. "Even when managers aspire to make rational decisions using the tools of decision analysis such as decision trees," he said, "you use these tools more effectively if you can anticipate biases in expert judgment and take steps to prevent them." For instance, research by Fox and his colleague Robert Clemen from Duke University showed that expert decision analysts who assessed the probabilities of future events were biased toward assigning equal probabilities to all of the events that they had identified as possibilities.

One prominent example of how behavioral decision theory is used in the workplace is the Save More Tomorrow (SMarT) Plan. Developed by Shlomo Benartzi and his colleague Dick Thaler from the University of Chicago, the plan encourages employees to invest more of their income into 401k plans and leverages three behavioral principles. First, the plan includes automatic enrollment, as behavioral studies have found that people are much more likely to remain in an opt-out plan than opt in. Second, it pre-commits participants to increase their savings in the future, since behavioral studies have found that people tend to discount events that happen in future time periods. And third, the plan matches increases in savings with raises in salary, as behavioral studies have found that people are much less sensitive to foregone gains than they are to out-of-pocket losses. The SMarT Plan has dramatically increased savings rates in companies where it is implemented.

In 2003, Fox and Benartzi founded the Interdisciplinary Group in Behavioral Decision Making (IDGBDM) at UCLA Anderson The IDGBDM conducts bi-weekly seminars on behavioral decision theory. "Prior to that time," said Fox, "there wasn't a coherent behavioral decision making presence at UCLA and only a few people here did behavioral research. In the last six years, we've assembled quite a community across campus and hired several new behavioral research faculty in various departments at UCLA Anderson."

The IDGBDM roster includes 17 faculty from UCLA Anderson, ten from UCLA, three from USC, and one from Caltech. The goal of the organization is to understand decision making behavior.

IDGBDM research seminars continue to be well-attended and the group is gaining recognition outside of UCLA. In addition, several participants attend weekly meetings in which faculty and doctoral students discuss current research in progress. The group has also sponsored two international conferences since 2006.

Fox noted that seminars attract participants from departments such as psychology, economics, political science, anthropology, communications, and the law and medical schools, and as a result, have spawned several interdisciplinary collaborations. "I've been doing some work in neuroeconomics with Russell Poldrack from the psychology department," said Fox. "We are trying to understand the neuro-physiological correlates of risk taking using brain imaging technology. And that's just one instance of a collaboration fostered by this community. It's exciting to see this happen."

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Media Relations, (310) 206-7707, media.relations@anderson.ucla.edu

Media Relations