The maths behind gut decisions

First carefully weigh up the costs and benefits and then make a rational decision. This may be the way we want it to be. But in reality, invisible emotions, experiences, prejudices and even altruisms also influence our decisions.

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In a nutshell

Human decision-making behaviour is far more complex than the traditional economic model of homo economicus, the benefit maximiser, suggests. Who would have thought, for example, that people who are able to determine their own salary do not in fact pay themselves the maximum but a rather moderate amount? That television affects our choice of junior staff or our income and consumption requirements? Or that people with an economic background actually behave differently when making financial decisions? Behavioural economists at the Halle Institute for Economic Research (IWH) are investigating what such irrational factors mean for a society's economic processes, using the (social) psychology toolbox and devising experiments and studies to identify and close the gaps in the homo economicus model.

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The world of work is one area where such deviations from the benefit-maximising ideal image are the rule rather than the exception. Companies need productive staff to be successful. In order to maintain or even improve this productivity, however, it is not enough for a firm to focus solely on the remuneration of its workforce according to the motto: the more, the better. Other factors, such as meaningful work or the feeling of being treated fairly, also affect workforce productivity levels.

For example, if employees learn at a later, that a task they have already performed was meaningless, they will make less of an effort with future work. This means that meaningless work not only evokes negative emotions at the time, such as disappointment and replaceability, but also influences future motivation, as IWH behavioural economist, Sabrina Jeworrek and her co-authors discovered with the help of a large-scale experiment. This discovery should not be confused with another, however: employees also definitely want information about their companies' setbacks. If, for example, a campaign has failed in the past, it makes sense to inform the workforce of this and not to conceal this fact. As employees will not be demotivated by this setback, as you might expect – on the contrary. They will try harder next time if they are able to regard the task as a meaningful challenge.
In another study, Jeworrek discovered that employees are less productive if they believe that their employer is treating their colleagues unfairly – even if they themselves are unaffected by this. For this experiment, 195 test subjects were hired for two assignments in a call centre. A section of the workforce was arbitrarily dismissed on grounds of cost savings. "We wanted the situation to be as anti-social and unfair as possible," says Jeworrek. And not only did productivity fall, the test subjects also took longer breaks and left work earlier.

The self-employed do not have the problem of colleagues being unfairly treated. Nevertheless,their behaviour is also affected by hidden factors. Whether they are gripped by entrepreneurial spirit also depends on which TV programmes they watched in their youth, for example. Or whether they have sufficient financial market knowledge. You see,econometric findings suggest that greater financial literacy leads to increased self-employment. So, if politicians want more entrepreneurial activity in Germany, the prevalence of positive role models, the inclusion of a basic grasp of economics in the curriculum and financial information would be a major starting point. As soon as a person becomes self-employed, their character also changes: if a person is self-employed they are more willing to take risks – and also more likely to remain self-employed.

And even the unemployed are influenced by context: IWH economist Steffen Müller discovered that parental unemployment affects children, for example. What is particularly interesting is that boys and girls react differently to parental unemployment. If their father was unemployed, both sons and daughters are more likely to be unemployed in future, but daughters experience a counter-reaction that sons do not: they invest more in their education.

Regardless of whether a person is employed, self-employed or unemployed, their subjective wellbeing heavily depends on how they perceive their position within their social group. This can also affect basic personal attitudes, for example, towards foreigners: if a person compares their income with that of their friends and feels financially inferior, this will have a negative impact on their sympathy towards foreigners – even if this person is actually a higher-earner.

People do not always act and make decisions rationally; they are fallible. Subconscious factors determine the direction of our decisions, and many of these factors are beyond our control. However, being aware of the mechanisms behind this can help us to understand people and their role in the economy, identifying and promoting their potential.

Publications on "Behaviour"

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Paid Vacation Use: The Role of Works Councils

Laszlo Goerke Sabrina Jeworrek

in: Economic and Industrial Democracy, forthcoming

Abstract

The article investigates the relationship between codetermination at the plant level and paid vacation in Germany. From a legal perspective, works councils have no impact on vacation entitlements, but they can affect their use. Employing data from the German Socio-Economic Panel (SOEP), the study finds that male employees who work in an establishment, in which a works council exists, take almost two additional days of paid vacation annually, relative to employees in an establishment without such institution. The effect for females is much smaller, if discernible at all. The data suggest that this gender gap might be due to the fact that women exploit vacation entitlements more comprehensively than men already in the absence of a works council.

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Equity Crowdfunding: High-quality or Low-quality Entrepreneurs?

Daniel Blaseg Douglas Cumming Michael Koetter

in: Entrepreneurship, Theory and Practice, forthcoming

Abstract

Equity crowdfunding (ECF) has potential benefits that might be attractive to high-quality entrepreneurs, including fast access to a large pool of investors and obtaining feedback from the market. However, there are potential costs associated with ECF due to early public disclosure of entrepreneurial activities, communication costs with large pools of investors, and equity dilution that could discourage future equity investors; these costs suggest that ECF attracts low-quality entrepreneurs. In this paper, we hypothesize that entrepreneurs tied to more risky banks are more likely to be low-quality entrepreneurs and thus are more likely to use ECF. A large sample of ECF campaigns in Germany shows strong evidence that connections to distressed banks push entrepreneurs to use ECF. We find some evidence, albeit less robust, that entrepreneurs who can access other forms of equity are less likely to use ECF. Finally, the data indicate that entrepreneurs who access ECF are more likely to fail.

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Do Activist Hedge Funds Target Female CEOs? The Role of CEO Gender in Hedge Fund Activism

Bill Francis Iftekhar Hasan Yinjie (Victor) Shen Qiang Wu

in: Journal of Financial Economics, forthcoming

Abstract

Using a comprehensive US hedge fund activism dataset from 2003 to 2018, we find that activist hedge funds are about 52% more likely to target firms with female CEOs compared to firms with male CEOs. We find that firm fundamentals, the existence of a “glass cliff,” gender discrimination bias, and hedge fund activists’ inherent characteristics do not explain the observed gender effect. We also find that the transformational leadership style of female CEOs is a plausible explanation for this gender effect: instead of being self-defensive, female CEOs are more likely to communicate and cooperate with hedge fund activists to achieve intervention goals. Finally, we find that female-led targets experience greater increases in market and operational performance subsequent to hedge fund targeting.

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Do Banks Value Borrowers' Environmental Record? Evidence from Financial Contracts

I-Ju Chen Iftekhar Hasan Chih-Yung Lin Tra Ngoc Vy Nguyen

in: Journal of Business Ethics, forthcoming

Abstract

Banks play a unique role in society. They not only maximize profits but also consider the interests of stakeholders. We investigate whether banks consider firms’ pollution records in their lending decisions. The evidence shows that banks offer significantly higher loan spreads, higher total borrowing costs, shorter loan maturities, and greater collateral to firms with higher levels of chemical pollution. The costly effects are stronger for borrowers with greater risk and weaker corporate governance. Further, the results show that banks with higher social responsibility account for their borrowers’ environmental performance and charge higher loan spreads to those with poor performance. These results support the idea that banks with higher social responsibility can promote the practice of business ethics in firms.

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Firm Social Networks, Trust, and Security Issuances

Ming Fang Iftekhar Hasan Zenu Sharma An Yan

in: European Journal of Finance, forthcoming

Abstract

We observe that public firms are more likely to issue seasoned stocks rather than bonds when theirs boards are more socially-connected. These connected issuers experience better announcement-period stock returns and attract more institutional investors. This social-connection effect is stronger for firms with severe information asymmetry, higher risk of being undersubscribed, and more visible to investors. Our conjecture is this social-network effect is driven by trust in issuing firms. Given stocks are more sensitive to trust, these trusted firms are more likely to issue stocks than bonds. Trustworthiness plays an important role in firms’ security issuances in capital markets.

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