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The Determinants ofThe Determinants ofManagerial Decisions Under RiskManagerial Decisions Under Risk

Martin G. KocherUniversity of Innsbruck

Ganna PogrebnaColumbia University

Matthias SutterUniversity of Innsbruck

Roma, 30 June 2007

30.06.2007, Roma

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Introduction

• In hierarchical organizations the role of a team leader often requires making decisions, which do not necessarily coincide with the majority opinion of the team. However, these decisions are final and binding for all team members.

• We are especially interested in decisions on projects with a stochastic outcome, i.e., risky decisions.

• While business practices provide substantial evidence that leaders make managerial decisions (e.g. Lieberman et al., 1990, or Knott, 2001), the question which factors motivate such decisions remains largely unanswered.

• We study managerial decision making in a controlled laboratory experiment; we identify the conditions and reasons why team leaders may overrule the majority opinion of their team.

Introduction Design Theory Results Conclusion

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Related literature

• Economic research has largely concentrated so far on one particular type of leadership, i.e. leading by example.

• Theoretical basis for research on leadership with different information structures: e.g. Hermalin, 1998; Rotemberg and Saloner, 1993 and 2000; Kobayashi and Suchiro, 2005; Komai et al., 2007.

• Experimental studies have confirmed the efficiency-increasing impact of leading by example, e.g., in public goods games (e.g. Vesterlund, 2003; Potters et al., 2005, 2007; Andreoni, 2006; Güth et al., 2007).

• But we are not aware of any paper that studies managerial decisions for choices under risk.

Introduction Design Theory Results Conclusion

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Basic experimental design I

• The experiment consists of two stages: an individual stage and a team stage (design balanced for order effects).

• We design 17 (34) pairs of lotteries with different payoff scheme and risk coefficients σ for leaders and ordinary team members. In the individual stage, we elicit individual preferences of participants over these pairs of lotteries (lotteries are in random order). Subjects are also exposed to a risk test (Holt and Laury, 2002).

• In the team stage subjects are randomly assigned to teams of three people. Members of a team are asked to elect a leader (through self-proposals). Team members can communicate using an interactive chat (z-tree). Every team has three chat periods for discussion. Each chat period lasts three minutes, after which team members have to cast their votes. If a simple majority is not reached, the team proceeds to the next chat period (3 times and, then, leader at random).

Introduction Design Theory Results Conclusion

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Basic experimental design II

• After the election of the leader, teams receive 17 decision problems. In each problem they have to choose between paired lotteries. Although these decision problems are identical to the problems used in the individual stage, they are shown in a different order and framed differently.

• For each decision problem, all three team members, including the leader, are requested to cast a vote for one of the lotteries in a lottery pair.

• The team leader is informed about the lottery, chosen by at least two team members, and, then, has an option to either confirm the majority decision or to pick an alternative lottery. This decision is final and determines the payoff of the entire team.

Introduction Design Theory Results Conclusion

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Risk attitude and leader selection

• We consider the choices of 92 out of 108 participants, who have made their decisions consistently in the Holt-Laury procedure. These subjects have switched from the safe choice to the risky choice at most one time. Overall, consistent subjects made 5.64 safe choices, indicating a slight degree of risk aversion in the aggregate.

• Leaders were significantly less risk averse than ordinary team members (p-value = 0.05; Mann-Whitney-U-test).

• There were 31 out of 36 teams that were successful in electing a leader. Out of them 25 (81%) chose the leader in the first vote (by simple majority voting), 5 (16%) needed two voting rounds, and 1 team (3%) agreed on a leader only in the third voting round. 5 teams could not agree on a team leader.

Introduction Design Theory Results Conclusion

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Managerial decisions I

• In 35.3% of cases leaders overrule the majority vote in their team. We use logit regression analysis to determine the impact of different explanatory variables on the likelihood of a team leader making such managerial decisions.

• More than 70% of the variability in the data can be explained by decision contradiction (whether the leader has voted for a different lottery than the two other members in the team during the team stage of the experiment). The variable preference contradiction is also significant (if the two ordinary team members vote for a different lottery than the leader has chosen in the individual stage).

• Risk seeking leaders are more likely to resort to managerial decisions that overrule the other team members. We also find that two personal characteristics – gender and age – are significant.

Introduction Design Theory Results Conclusion

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Managerial decisions II

Introduction Design Theory Results Conclusion

Explanatory variable

Description Coefficient (standard

error)

Coefficient (standard

error)

Constant Constant 2.5313

(2.0654) -3.2959***

(0.294) Decision

contradiction (X1)

1 – decision of the group is different from leader’s decision in the group

vote; 0 – otherwise.

4.0293*** (0.3487)

4.3373*** (0.3244)

Preference contradiction

(X2)

1 – decision of the group is different from leader’s decision in the

individual stage; 0 – otherwise.

1.4017*** (0.3542)

Gender dummy (X3)

1- female; 0 – male. -0.4755* (0.2805)

Age (X4) Self-reported age of subjects. -0.2314** (0.0823)

Risk attitudes rank dummy

(X5)

A scale from 0 – risk seeking to 9 – risk averse

-0.2129** (0.0909)

Sequence dummy (X6)

0 – first sequence, 1 – second sequence

-0.0586 (0.2912)

Log-likelihood -194.8753 -210.1838 McFadden’s likelihood ratio index 0.5406 0.504524

Veall and Zimmermann R2 0.7374 0.708444 * Significant at 0.05 significance level ** Significant at 0.01 significance level *** Significant at 0.001 significance level

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Brief conclusion

• The main contribution of this paper is twofold:• First, we analyze leadership in a risky environment, which is one of

the key elements of managerial decision making.• Second, we consider leadership as a formal authority where the

leader makes the ultimate decision for his group.• These two important aspects of leadership have been largely

understated in the previous research.• Our design is extendable in several dimensions.

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Thank you!