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.
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.
Our expert for this issue
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"
Benchmark on Themselves: CEO-directors’ Influence on the CEO Compensation
in: Managerial Finance, forthcoming
The purpose of this paper is to examine whether or not the chief executive officers’ (CEO) compensation is affected by the compensation of the outside directors sitting on their board, who are also CEOs of other firms.
Financial Literacy and Self-employment
in: The Journal of Consumer Affairs, forthcoming
In this paper, we study the relationship between financial literacy and self‐employment. We use established financial literacy questions to measure literacy levels. The analysis shows a highly significant and positive correlation between the index and self‐employment. We address the direction of causality by applying instrumental variable techniques based on information about maternal education. We also exploit information on financial support and family background to account for concerns about the exclusion restriction. The results provide support for a positive effect of financial literacy on the probability of being self‐employed. As financial literacy is acquirable, the findings suggest that entrepreneurial activities might be increased by enhancing financial literacy.
On the Effect of Business and Economic University Education on Political Ideology: An Empirical Note
in: Journal of Business Ethics, forthcoming
We empirically test the hypothesis that a major in economics, management, business administration or accounting (for simplicity referred to as Business/Economics) leads to more-conservative (right-wing) political views. We use a panel dataset of individuals (repeated observations for the same individuals over time) living in the Netherlands, drawing data from the Longitudinal Internet Studies for the Social Sciences from 2008 through 2013. Our results show that when using a simple fixed effects model, which fully controls for individuals’ time-invariant traits, any statistically and quantitatively significant effect of a major in Business/Economics on the Political Ideology of these individuals disappears. We posit that, at least in our sample, there is no evidence for a causal effect of a major in Business/Economics on individuals’ Political Ideology.
Paid Vacation Use: The Role of Works Councils
in: Economic and Industrial Democracy, forthcoming
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.
Financial Incentives and Loan Officer Behavior: Multitasking and Allocation of Effort under an Incomplete Contract
in: Journal of Financial and Quantitative Analysis, forthcoming
In this paper we investigate the implications of providing loan officers with a compensation structure that rewards loan volume and penalizes poor performance versus a fixed wage unrelated to performance. We study detailed transaction information for more than 45,000 loans issued by 240 loan officers of a large commercial bank in Europe. We examine the three main activities that loan officers perform: monitoring, originating, and screening. We find that when the performance of their portfolio deteriorates, loan officers increase their effort to monitor existing borrowers, reduce loan origination, and approve a higher fraction of loan applications. These loans, however, are of above-average quality. Consistent with the theoretical literature on multitasking in incomplete contracts, we show that loan officers neglect activities that are not directly rewarded under the contract, but are in the interest of the bank. In addition, while the response by loan officers constitutes a rational response to a time allocation problem, their reaction to incentives appears myopic in other dimensions.