You are at the head of an industrial company. You manage 600 employees in 600 plants. Your company faces financial difficulties and you have to take delicate decisions.
After a discussion with your strategic committee, you have two options in two scenarii.
Option 1: You have to fire 400 employees.
Option 2: 33% chance to save all the jobs in the plants and a 66% chance you will have to fire 600 people.
Option 1: 200 plants will be saved.
Option 2: 33% chance that your 600 plants will be saved and a 66% chance that all of them will close.
What do you do in Scenario 1? And in Scenario 2 ?
In terms of risk and expected outcomes, the two scenarii and two options are identical.
Option 1 in both scenarii are certain options, where you lose for sure respectively 400 jobs and 400 plants (and save 200 jobs and plants).
Option 2 in both scenarii are risky options where there is a 33% chance to save all plants and jobs.
However, economic experiments show that most people prefer option 1 in the second scenario and option 2 in the first scenario. Why? Only because of the way the two options are framed in both scenarii.
Two cognitive biases can explain these different investment choices.
The same problem presented in two different ways can lead to contradictory choices.
In the first scenario, the option 1 is presented negatively. This option will destroy 400 jobs. It is not immediately obvious that this option will also preserve 200 jobs.
On the contrary, in the second scenario, the way the option 1 is framed is positive. 200 plants will be saved. It is not immediately obvious that this option also means that 400 plants will have to close. That is why the option 1 is attractive in Scenario 2, and less in Scenario 1.
Most people are loss averse, they are much more sensitive to losses than to gains. The way the second scenario is presented activates emotionally this fear of losing while the first scenario does not.
Thinking Fast and Slow, D.Kahneman