Business System Analysis _ Decision Making

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```					Business System Analysis &
Decision Making
- Lecture 7

Zhangxi Lin
ISQS 5340
July 2006

1
Chapter 5: The Nonrational Escalation
of Commitment
 Why Does Escalation Occur?
 Integration

2
Situations
 You bought a mutual fund two years ago. Your financial advisor
told you that this is a safe mutual fund with good potentials. In
last year it grew 2% and this year it remains almost the same
level even other alternative choices of mutual funds have grown
more than 10% in the last year. Are you going to keep it
because it may be time for this fund to grow, or you are to sell
it?
 You have been sitting in front of a slot machine for an hour and
you have plus in two \$20 bills, and now the balance is less than
\$2. This was a good machine as you played last time. You know
slot machines are sometimes making gamblers happy though
most time do not. Now it could be the hunch time or it will
continue to devour another \$40. Are you going to change a new
machine?

3
 The mechanism underlying escalation is self-
justification.
 Groups are less likely than individuals to escalate
commitment.. However, it a group does, it tends to do
so to a greater degree.
 It is difficult to separate initial decision from related
future decisions. Our decisions tend to be biased by
our past actions. There is a natural tendency to
escalate commitment, particularly after receiving
negative feedback.

4
– Company Acquisition
 The case of company acquiring
 Company C worth of \$1.2billion to A or B
 If A acquires C, B will lose \$0.5 billion, and vise versa.
 If A and B compete, both will lose \$0.5 billion

A              B             A                            A
\$1.1b         \$1.2b           \$1.3b   \$1.6b             \$1.7b
(-0.5, -0.5)
No             No            No                           No

(0, 0)       (0.1, -0.5)   (-0.5, 0)                   (-0.5, -0.4)

5
 The difference between the cases of competition
escalation and unilateral escalation
   Using a game theoretic model we can study the final
outcome with certainty for the competition escalation
case. We fall under the escalation because of bounded
rationality. In the case of USAir acquisition case, AA
and United did a good job by not taking any action to
the offer.
   There is some uncertainty in the unilateral escalation
case.


6
Why Does Escalation Occur?
 Perceptual biases
We pay more attention to confirming that disconfirming information.
 We need to search for more disconfirming information to make right
decisions.
 Establish monitoring system
 Judgmental biases
 Risk averse to positively framed problems and risk seeking for
negatively framed problems
 Need to access the new decision from a neutral reference point
 Impression Management
 We tend to provide confirming information to others and try to
appear consistent to others.
 Competitive Irrationality
 If the final outcome is certain, check it before do it.

7
Chapter 6: Fairness in Decision
Making
 Two cases
   Salary of an MBA graduate
   Building material price raise after a hurricane
 Outline of the chapter
   When do we accept the role of supply and
demand?
   The influence of ultimatums
   Concern for the outcomes of others

8
When do we accept the role of supply
and demand?
 Case 1: Salary cut/increase
 Case 2: Raising price for the popular model of car
 The problem of the perception of unfairness of the
price: negative effect on future business
 Individuals are very concerned with departure from
the status quo – fairness judgments affect the
behavior of others

9
The influence of ultimatums
 Case: splitting \$5,000 between Mark and you
   Mark makes the offer
   You make the offer
   How to forecast the outcome in order to make a feasible offer?
 A smaller share of a larger pie vs. a larger share of a much smaller pie
 For Discussion
   You got an excellent business idea and invite your friend Mark to be
the partner. Mark is an IT guru and should be qualified as a CTO. This
will complement your knowledge as you are only good in marketing and
creating new ideas. Since Mark has been layoff for three months you
believe this will be a good opportunity to Mark. Regarding the shares of
the company ownership, you believe you hold 80% of the share and
Mark will take 20% because 1) you created this opportunity, 2) you will
do a lot managerial work and take more risk, and 3) Mark will be better
off than his current status.
   How will Mark consider this opportunity? What will be his judgment of
fairness?

10
How to share the award among your
team members?
 Your team has been awarded \$20,000 for the excellent
performance in last year in conducting an important project for
your company. The project will last for another two years. You
you split it? Evenly or not evenly? You, as the team leader, has
contributed a lot to the success of the project. Should you
allocate more to yourself?
 You got 3 coupons for a one-week vacation in Hawaii. While
there are 5 members in your team, how will you handle this?
 Texas Tech University allocated 2% salary raise for BA faculties
in 2007 academic year. How should this be allocated further too
80 faculty members?
 See Ocean’s Eleven

11
Concern for the outcomes of others
 People make comparisons of salary within a firm and to other
firms in the industry, not across industry.
 A common question: Who is happier, a person living in a
wealthy country with more inequality and a person living in a
poor country with much better equality?
 Kathy is a PhD student in a Finnish university. She is from
China. She is in the market now. She is facing two choices:
 Stay in Finland with a teaching job paid 50,000 euro/year.
This is the market salary level in Finland.
 Work for Nokia Beijing with a salary of 55,000 euro/year,
while her peer Finnish colleagues make 80,000 euro/year,
the latter taking into the account of compensation working
abroad. The Nokia HR manager told her since she is a
Chinese and she may not get the extra compensation. Also
living cost in Beijing is much lower than that in Finland.
 Which choice should she take?

12

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