In our previous newsletter, we dwelled deeper into what cognitive biases are, the causes and implications they can have on the decisions made by investors, and how their impact can be reduced. We further look to explore what emotional biases are, the causes and implications they can have on the decisions made by investors, and how their impact can be reduced.
Emotional bias happens when our emotions cloud our ability to make decisions, reason, and decode information. Emotional bias causes us to make rash conclusions and judgments that are not supported by facts, evidence, logic, or study. Since they are unintentional, emotional biases cannot be mitigated, and they have to be adapted to. Before we dive into how to adapt and navigate through emotional biases, let’s understand a few key types of.
1. Overconfidence: This leads to an individual to overestimate their intelligence and decision-making ability, while ignoring advice or evidence pointing to the contrary. From an entrepreneurial perspective, this can lead to tunnel vision, making it difficult for entrepreneurs to adjust their plans in reaction to new facts, or stick to the same decision-making frameworks that result in them not being able to transform.
2. Self attribution: This refers to attributing all wins and positive outcomes to one’s own abilities and actions while all losses and negative outcomes to external factors. While self-assurance is a key attribute for entrepreneurs, recognizing actions that led to losses can help with their personal growth, companies growth and ability to learn from failures.
3. Gambler’s fallacy: This refers to the individual expecting outcomes to favor them after they have been adverse for over a period of time. This misunderstanding has an impact on strategic decisions including investments, product development, and market entry. An entrepreneur must recognize the cause of a negative outcome and take appropriate measures to mitigate the situation.
4. Loss aversion: Entrepreneurs may be more sensitive to prospective losses than potential rewards, resulting in risk-averse behavior or continue to make the same bad decisions to avoid realizing losses. While careful risk management is crucial, an entrepreneur's inability to take critical risks may hamper the innovation and growth of the company.
5. Regret aversion: Entrepreneurs may take actions in order to avoid future regret rather than maximize future gains. This tendency can lead to a conservative decision-making style in which entrepreneurs choose safer, if less inventive, paths.
6. Status quo bias: This refers to the tendency of preferring the current paradigm over changing or evolving. Entrepreneurs often feel too comfortable with the positioning and brand image of the company that they decide against evolving or diversifying, hampering potential growth and success of the company.
Emotional biases influence the decision-making processes and actions of entrepreneurs and founders. These biases are rooted in the complicated realm of human emotions and psychology, and they can have an impact on both positive and negative entrepreneurial initiatives. Understanding these emotional biases is critical for making sound business judgments.