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Understanding Risk

Attitude
Chapter
1
Dealing with risk for life and business
Life is full of risks. Every day people make decisions where the outcome
maters but where the conditions surrounding the decision are more or less
uncertain. Faced with these circumstances, most people have developed habits
and strategies that enable their lives to free-fow for much of the time. It is
only in the presence of an unusual risk that people may be conscious of the
need to make a choice.
The management of these uncertain situations that mater, also known as
risk management, is a discipline in its own right. It has an established role
in business, and is applied at a wide range of levels, including management
of strategic risk, corporate governance, operational risk, project risk and
health, safety and the environment (HSE). However, risk management is not
just important for business. There is increasing interest in the application
of efective risk management in society at large. A number of groups across
government and academia have recognized the need for a more considered
and responsible approach to risk, and highlight the urgent need for people to
embrace appropriate risk-taking, both individually and in their working and
social groups, supported by government and wider society.
By defning risk simply as uncertainty that maters, it is clear that
knowing how to take appropriate risks in any particular situation requires an
understanding of two things: the sources and nature of uncertainty, and the
degree to which something maters. It is also clear that diferent things mater
to diferent people to a diferent extent in diferent circumstances. As a result,
a risk perceived by one person or group as requiring urgent atention may be
perceived by others as normal and not worthy of their time. The perception of
risk is not an absolute, either present or absent, but is situational and highly
dependent on a number of contextual factors. It is this situational aspect of
risk that makes the subject of decision-making in uncertain situations both
fascinating and important.
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MANAGING GROUP RISK ATTITUDE
4
Taking appropriate risks requires an underlying understanding of the nature
of the challenge. On the one hand, managing risk can be seen as a rational and
logical process requiring a grasp of factual historical evidence combined with
mathematical assessments of the likelihood of the uncertain event occurring.
It is however equally true that managing risk involves the deepest workings
of the human brain, as the decisions people make are infuenced by a complex
interplay of conscious and subconscious factors. This is why one essential
component of appropriate risk-taking is an understanding of risk atitude as it
applies to individuals and to decision-making groups.
Talking about risk will lead many people to think only about threats, that
is, those uncertainties that should they occur would result in an undesirable
outcome. However, contemporary management thinking and practice treats
risk in a more balanced way. An uncertain set of circumstances could equally
lead to positive outcomes, allowing the defnition of risk to encompass both
opportunities and threats. This double-sided concept of risk is particularly
important in the context of efective decision-making, because most decisions
need to balance the exploitation or enhancement of hoped-for positive outcomes
with the avoidance or mitigation of unwelcome negative ones.
For example, deciding whether to exceed the speed limit when driving a
car will depend on a number of uncertainties, including opportunities such
as geting to the destination more quickly, and threats such as being arrested
or killed during the process. Similarly, deciding whether to seize a business
opportunity to launch a new product on to the market before the competition
needs to be balanced against the threats to the companys reputation if the new
product is not trouble-free. Although each decision is unique, there are no risk-
free options. Moreover, zero risk is not only unachievable, it is also undesirable.
Failing to take risk would stife growth and limit improvement. Appropriate
risk-taking promotes competitive advantage and stimulates innovation and
creativity. Decision-making in a world that is full of uncertainty that maters
needs to fnd an optimal balance of threats and opportunities. The challenge for
fnding an optimal balance are depicted in Figure 1.1; not too safe, or too unsafe
with respect to risks that would mean something bad for objectives, and not too
optimistic, or too pessimistic with respect to risks that could create additional
value.
Achieving the goal of an optimal balance of threats and opportunities
requires a clear understanding of the nature of risk as well as the ability to
determine the infuence of risk atitude on decision-making.
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UNDERSTANDING RISK ATTITUDE 5
Challenges when assessing risk
Risk has two sides: uncertainty, which can be expressed as probability or
likelihood; and how much it maters, expressed as impact or consequence.
Both of these dimensions need to be understood so that good decisions can be
made. If an uncertain event is very unlikely then it might be appropriate to
take no explicit action, even though the consequence of that event on objectives
would be very signifcant should it occur. However, diferent individuals or
groups may perceive both likelihood and consequences diferently, leading to
diferent decisions.
Take the example of deciding whether to invest time and money in a new
business venture, providing cofee for business rail commuters. Of course
consumer habits could change for any number of reasons, with a signifcant
benefcial or detrimental efect on cofee sales. However, assessment of the
likelihood, nature and scale of any change is largely a mater of perception.
Appropriate risk-taking means that people take chances. The degree of
efectiveness of that risk-taking depends on how well people understand the
chances that they take, and whether they embrace the consequences should the
situation turn out diferently from their expectations.
If a number of people were faced with the same decision about whether
to invest in the business commuters cofee venture, diferent choices would
inevitably be made, driven by the perception by each individual of the
underlying risks and the degree to which they matered. Some people might
be highly uncomfortable with the perceived uncertainties and be atcrsc to an
Too safe
Upside impact
opportunities
Downside impact
threats
Too far
Not feasible
Just right
Value missed
Just right
Figure 1.1 Appropriate risk-taking requires optimization of opportunities
and threats
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MANAGING GROUP RISK ATTITUDE
6
uncertain outcome; this might lead them to seek certainty even if that meant
not pursuing the venture. Others could be quite comfortable with their
perception of the uncertainties and scck to pursue the venture and take their
chances along the way. Another group might be more ic|crani of the underlying
uncertainties, with less strong feelings of comfort or discomfort. Still others
could be uncomfortable with ambiguity in the long term so would be prepared
to take whatever short-term actions were necessary to deliver a certain long-
term outcome: a ncuira| position.
The words averse, seeking, tolerant or neutral represent a chosen
response to uncertainty that maters, driven by perception. This phrase forms a
working defnition of risk atitude, which is a choice made by a given individual
or group in the face of a particular risky situation, and which is afected by a
range of perceptual factors (these are discussed below).
Labels like risk averse, risk seeking, risk tolerant and risk neutral are useful
headlines to describe alternative positions adopted by people when faced with
uncertainty. Although labels provide valuable shorthand, their use should not
hide the fact that risk atitude exists on a continuous spectrum, as illustrated in
Figure 1.2. There are an infnite variety of possible responses to risk which can
be displayed by a particular individual or group, but the four basic positions
ZERO
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HIGH
EXTREME
EXTREME
HIGH
LOW
ZERO
Risk
Averse
Risk
Tolerant
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Seeking
Level of
discomfort
to risk
Level of
comfort
to risk
Risk
Neutral
(Short term) (Long term)
Figure 1.2 Risk atitude spectrum
(adapted from Hillson and Murray-Webster, 2007)
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UNDERSTANDING RISK ATTITUDE 7
allow a generalized discussion of the topic. These four fundamental risk
atitudes are summarized in Table 1.1.
We have explored in other published work how risk atitudes are formed,
and concluded that they are usually adopted subconsciously, except when a
person or group consciously decides to override their automatic response in
order to make a more appropriate choice. Our previous work revealed that
the perceptions driving risk atitude are infuenced by many factors. These can
be grouped under three headings: conscious assessments which are largely
rational; subconscious factors including heuristics or mental short-cuts and
other sources of cognitive bias; and gut-level afective factors, including feelings
and emotions. Table 1.2 provides a composite list of the factors covered by each
heading, drawing on the work of various authors, some of whom use diferent
terms to describe the same factor.
Although the various factors afecting perception of risk can be detailed
separately under the three headings of conscious, subconscious and afective
factors, they do not exist or operate in isolation. They form a triple strand of
infuence, combining to afect how an individual or a group responds in any
given situation, as illustrated in Figure 1.3.
The following paragraphs describe each of three strands in turn. However,
while each strand can be teased out separately to aid understanding and
explanation, in reality the three are intertwined and each afects the others.
There are many cross-links between the diferent infuences on perception,
forming a complex web whose efect can be hard to predict.
Term Defnition
Risk averse Uncomfortable with uncertainty, desire to avoid or reduce threats and exploit
opportunities to remove uncertainty. Would be unhappy with an uncertain
outcome.
Risk seeking Comfortable with uncertainty, no desire to avoid or reduce threats or
to exploit opportunities to remove uncertainty. Would be happy with an
uncertain outcome.
Risk tolerant Tolerant of uncertainty, no strong desire to respond to threats or
opportunities in any way. Could tolerate an uncertain outcome if necessary.
Risk neutral Uncomfortable with uncertainty in the long term so prepared to take
whatever short-term actions are necessary to deliver a certain long-term
outcome.
Table 1.1 Defnition of basic risk atitudes
Hillson Book.indb 7 20/03/2008 12:46:18
MANAGING GROUP RISK ATTITUDE
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Hillson Book.indb 8 20/03/2008 12:46:18
UNDERSTANDING RISK ATTITUDE 9
Ccnscicus: These factors are based on the visible and measurable
characteristics of the situation within which the decision is being made.
(Typical conscious factors are listed in Table 1.2.) Such factors are known to
bias perceptions of risk for individuals and within groups. They operate in
a systematic way, allowing corrections to be made where their infuences are
exposed. Situational assessments are the most rational part of the triple strand
of infuences as they tend to be explicit and based on conscious thought.
Subconscious: These factors include mental short-cuts made to facilitate
decision-making (heuristics) and other sources of cognitive bias. Heuristics
operate at both individual and group levels, and provide mechanisms for
making sense of complex or uncertain situations. Based on previous experience,
many of these heuristics are useful because they allow rapid fltering of data
to determine the most important elements, easing the decision-making task.
Unfortunately the fact that heuristics operate subconsciously means that their
infuence is ofen hidden, and they can introduce signifcant bias into decisions.
Whereas heuristics can have a positive infuence, cognitive biases do not. The
efect is to skew perception and decision-making in a way that is not real nor
benefcial. Table 1.2 contains common heuristics and sources of cognitive bias
that afect both individuals and groups.
Afective: These visceral gut-level responses are based on instinctive emotion
or deep underlying feelings rather than rational assessments. All human beings
store emotion-charged memories in the limbic system within the brain, and
Conscious
factors
(rational

assessments)
Affective
factors
(feelings
and emotions)
together influence
perception and risk attitude
Subconscious
factors
(heuristics and
cognitive bias)
Figure 1.3 The triple strand of infuences on perception and risk atitude
Hillson Book.indb 9 20/03/2008 12:46:21
MANAGING GROUP RISK ATTITUDE
10
these emotions are automatically triggered in situations perceived to be similar
to the stored memory. A wide range of emotions or afective states could
infuence decision-making (as listed in Table 1.2), although some researchers
suggest that the primary infuence for any human being is to seek pleasure or
to avoid pain.
The triple strand. The three sets of infuences which form the triple strand
are each important in the context of decision-making, as they each infuence
perception. Perception drives risk atitude, which in turn afects the quality
of decisions made under conditions of uncertainty. It is possible to adopt a
reductionist approach when considering these factors, examining the infuence
of each one in turn. However, the triple strand model has a more important
message. The strands do not exist or operate in isolation, but are interwoven to
form a complex set of infuences. An individual in a decision-making group may
have made an apparently rational assessment of the situation and decided on a
particular approach, but this assessment will have been shaped by the operation
of subconscious heuristics, and coloured by the persons underlying emotions. For
example, a person has an opportunity to perform a parachute jump for charity.
The person in question thinks that taking part would normally be too risky for
them, explaining their decision in terms of a conscious rational assessment of
the mathematical probability of injury. They also remember a recent news story
where an experienced skydiver died due to a faulty parachute, and this makes
them more risk averse, due to the subconscious operation of the availability
heuristic. The very thought of jumping out of an aeroplane is enough to make the
persons palms sweaty, a sure physiological sign to back up the feeling of dread in
their stomach. Its for a good cause (but money could be donated anyway without
doing the jump so that could be avoided). The real driving emotion for the person,
however, is to avoid being embarrassed (in front of instructors and friends) if they
were to chicken out from a jump at the last moment. This adds further emotional
weight to the conscious and subconscious perception of the risk. This perception
drives their risk atitude (risk averse to the parachute jump) and their ultimate
choice not to do it. This assessment is complex enough at an individual level, but
would have been more so had there been the infuence of a social or work group.
Risk in groups
All of the factors within the triple strand afect the perceptions, risk atitudes
and decision-making abilities of both individuals and groups. However, the
situation is considerably more complex than simply combining the individual
infuences to determine their overall efect on the group.
Hillson Book.indb 10 20/03/2008 12:46:21
UNDERSTANDING RISK ATTITUDE 11
First, individuals are members of multiple groups, as illustrated in Figure
1.4. Every person belongs to a family, though the strength and infuence of
the family relationship may vary widely. Many individuals have jobs which
involve membership of an organization as well as smaller work groups. Most
people belong to a local community which in turn exists within a wider national
context. Some individuals with the opportunity to travel may even consider
themselves to be world citizens.
Each of these levels of membership infuences the individual to a greater or
lesser extent, and the various groupings also interact. Risk also exists at every
level, with interactions between diferent types of risk.
When applied in the decision-making context, the multiple infuences at
various group and individual levels present a complex web whose precise
efect is hard to determine. It is difcult to rate the relative importance of
individual conscious assessments, subconscious heuristics or afective emotions,
compared to group dynamics, or societal, organizational and national norms
and expectations. These bring a range of infuences to bear on individuals,
potentially changing their perspectives and risk atitude in a given situation.
It is clear therefore that any complete and meaningful consideration of
decision-making in risky situations must address both individuals and groups,
and evaluate the efect of this wide range of infuences on risk atitudes.
World
Nation
Work
Organization
Local
Community
F a m i l y
Work
Group
I N D I V I D U A L
Figure 1.4 Hierarchies of membership and infuence (not to scale)
(from Hillson and Murray-Webster. 2007)
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MANAGING GROUP RISK ATTITUDE
12
Why does understanding risk attitude matter?
No-one would get out of bed in the morning if they had to consciously make
a decision about every action to take, so people develop habits and routines
that allow their lives to free-fow unless there is an unusual situation to be
addressed. The free-fow of individuals and groups is infuenced by past
experiences and expectations for the future. The perception of uncertainty and
the resulting response to out of the ordinary situations is biased by a complex
triple strand of intertwined factors including conscious rational assessments,
subconscious heuristics and cognitive biases, and gut-level emotions. Each of
these three afects both individuals and groups in diferent ways. The situation
is further complicated by various organizational, national or societal infuences
which impose norms and expectations on individuals and groups.
When decisions have to be made under conditions of uncertainty, each
of these infuences is important, because they drive the perception of risk.
Risk atitude is the chosen response of an individual or group to uncertainty
that maters, driven by perception. As a result, the ability to understand risk
atitude ofers a key to unlock the mysteries of efective decision-making where
risk is involved. Understanding risk atitude is a critical success factor which
promotes efective decision-making in risky situations, as shown in Figure 1.5.
Figure 1.5 Risk atitude as a CSF for efective risk management
Risk
Attitude
Understood
and managed
Ignored
and unmanaged
C S F
Critical
Success
Factor
Critical
Source of
Failure
Risk management effectiveness LOW HIGH
Hillson Book.indb 12 20/03/2008 12:46:22
UNDERSTANDING RISK ATTITUDE 13
However, the absence of this understanding is not neutral, but presents a critical
source of failure, leading to reduced efectiveness.
Our previous work (Hillson and Murray-Webster, 2007) presents a
thorough analysis of risk atitudes at both individual and group levels. This
is recommended for those with a deeper interest in the subject or who need to
explore the background concepts in more detail.
Understanding risk atitude is a critical point of departure for efective
decision-making, but it is not sufcient; two other parts of the jigsaw need to be
put in place. In Chapter 2 we explore the frst of these missing pieces, namely
to defne the notion of a good decision. We summarize the literature on the
subject to make the link between risk atitude and decision-making robust.
Second, in order to make a good decision, sometimes risk atitude
needs to be intentionally managed to override habitual/normalized paterns
of behaviour or to change perspectives that have been biased by erroneous
conscious or subconscious infuences. Chapter 3 outlines our starting premises
about managing risk atitude, particularly to summarize our existing work on
individuals and groups, but the story is not complete. The summary in Chapter
3 leads into Part II, where we outline our work to complete the story about
understanding and managing risk atitudes for both individuals and for groups
in pursuit of appropriate risk-taking and optimal decision-making.
Hillson Book.indb 13 20/03/2008 12:46:22
Hillson Book.indb 14 20/03/2008 12:46:22