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The gamble
Richard Thaler, the Nobel Prize-winning behavioral economist and author of Nudge, put that question to a board of about ten people at a very large company. He asked the heads of its eight largest divisions all at once. He then pointed out that for anyone good at math the odds were highly favorable, and asked why they had declined.
Six of the eight gave the same answer: 20% of the time, or 30% of the time, they would lose their jobs.
What the CEO wanted
The chief executive, sitting at the end of the table, looked aghast. He had wanted all of them to take those odds, because across the company they would almost certainly end up massively better off. One division might have a slightly disappointing year while four performed spectacularly.
Risk further down
As responsibility and accountability are pushed further down an organization, people become more risk averse and more uncertainty averse. They prefer a definite 5 to 10% to a 50% chance of 50%. Innovation and marketing are fat-tailed activities, where perhaps 10% of what a company does is worth more than everything else, and nobody can tell in advance which 10%.
Why do losses feel bigger than gains?
Daniel Kahneman and Amos Tversky described this in their 1979 paper on prospect theory, which showed that people weigh a loss more heavily than a gain of the same size. In many experiments the loss counts for roughly twice as much. It is called loss aversion, and it helps explain why a bet with good odds can still feel unattractive.
Why do managers avoid risks that help the company?
Shareholders can spread their money across many companies, but a manager holds a single career. The company gains from the upside of many bets, while the manager personally bears the downside of any one that fails. Economists call this mismatch of interests a principal-agent problem.
How does combining many bets reduce risk?
When bets are independent, wins and losses partly cancel, so the total result varies far less than any single bet does. The economist Paul Samuelson reported in 1963 that a colleague refused a single coin toss to win $200 or lose $100, yet said he would accept a hundred of them. Across a hundred such tosses, the chance of finishing behind is under one in a thousand.
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