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Forecasting, Risk Management, and Decision-Making
Introduction
Risk is a situation that exposes one to danger. It involves exposing a person to something that is valued to danger, loss or harm. Risk is, therefore, a threat or probability of injury, liability, damage or another negative occurrence. It is the possibility of incurring a loss or misfortune, for example, in a business or insurance company (Tversky & Kahneman, 1973, p. 220). Business risk is the probability of danger or loss in the operation of an organization and environment such as adverse economic conditions and competition.
The loss can impair the ability of the organization to provide returns on investment (Nisibet & Ross, 1980, p. 116). There is a risk that organizations may experience a hard period of poor earnings, mainly due to competition or adverse economic conditions. Business risk is common in relatively new businesses and cyclical firms. Business risk affects all the stakeholders of a business, from the holders of stocks and bonds to the cleaners (Schwarz, 1991). It can be a risk if a company goes bankrupt or the sale of a particular product decreases due to competition. It is a norm for every company to carry a business risk that it may have trouble in the cash flow to maintain operations (Waenke, Schwarz, & Bless, 1995, p.110).
There are various sources of business risk. Some sources are systematic while others are unsystematic. There are some components of business risk, which have a greater impact than others. Every company takes the risk that the broader economy may perform poorly, therefore, affecting its sales. Also, customers may dislike the companys products. The business risk could arise due to external factors that the company can do nothing about, or its problems.
The company has no control over external factors. Examples of external factors are declining economy, changes in regulations affecting the industry, and a decreased demand for services or products. Internal factors are easily controllable since they arise from within. Internal factors of business risks are problems within a company. Some of the internal factors of business risk include the company initiatives, overhead costs, and the companys budget (Dawes et al, 1993).
There are three major factors that should be considered in business, when evaluating the possibility of investing in a company. They include external factors in the business marketplace, easily fixable internal factors, and the state of the organizations assets and securities. The risk factor affects the companys pricing securities and stock. The decline of security in a company shows an increased risk of investing in that organization. When the price of securities goes up, the organization is safe for investment (Waenke, Schwarz, & Bless, 1995, p. 131).
Impact of decision-making heuristics, bias and risk preference
Various factors affect decision-making. These factors include cognitive biases, belief in personal relevance, escalating commitment, past experience, age, and personal differences. A heuristic is a shortcut that allows people to make judgments fast, effectively and efficiently to solve problems. These rules of decision-making strategies shorten the time used in making decisions and allow people to work without having to think about the next course of action. This is a trial and error method of solving problems through exploration. There is no guarantee that the problem will be solved (Nisibet & Ross, 1980, p. 116).
Heuristics are very helpful on many occasions, but also lead to biases. Since heuristics involves the use of prior experience and available information, bias can be easily manifested in the process. Whether conscious or unconscious, heuristics ignores some of the information. Heuristics leads to biases and risk preferences, which sometimes lead to high-perceived risk and low perceived expected returns. The perceptions may lead to unnecessary depression in cost. However, after the disappearance of unnecessary depression, excessive returns will be realized (Waenke, Schwarz, & Bless, 1995, p. 135).
Drug abuse is a common problem affecting many workplaces. Some workers abuse drugs, which affect their productivity for the company. This could lead to a reduction in the production of the whole company. This could also put the drug abuser and his fellow workmates at risk, especially if it is a production industry, which involves the use of machines (Bar-Hillel & Neter, 1986, p. 1120).
Decision-making heuristics
There are three major decision-making heuristics. These are representativeness heuristic, availability heuristic and anchoring and adjustment (Folke, 1988, p. 265). Representativeness is a situation where the possibility of a hypothesis is described by finding out the resemblance between the available and the existing data. It is a cognitive bias where people categorize a particular situation based on a pattern of previous experiences and beliefs about the situation (Tversky & Kahneman, 1983, p. 300).
Availability heuristic assesses the possibility or occurrence of an incident, based on the way relationships take place. In availability heuristic, decision-making relies on the readily available knowledge rather than an examination of other procedures or alternatives. People judge the probability of events by the ease with which it occurs. Therefore, incidences in availability heuristic have higher chances of occurring if similar occurrences are considered. Decisions making is based on what can be remembered rather than the complete data (Kehneman, Tversky & Slovic, 1982, p. iv).
Adjustment and anchoring heuristics are about making decisions under circumstances of uncertainty. To reach a conclusion, the anchor is established and then changed inadequately. For example, a persons productivity can be measured by making your productivity as the anchor or reference point (Folke, 1988, p. 282). The productivity of the person in comparison is then rated depending on the level of productivity. There is a tendency of making judgments by starting with a reference point or an anchor and then adjusting the estimate to reach a conclusion (Waenke, Schwarz, & Bless, 1995). From the above three decision-making heuristics, anchoring and adjustment best fit the method to be used in a company to determine the level of drug abuse by different employees (Tversky & Kahneman, 1973, p. 185).
Decision-making biases
The following are some of the common cognitive biases that influence or affect peoples decisions. The confirmation bias is where people readily collect information that regards certain judgments while overlooking other information that supports alternative judgments. On the other hand, a situation where people do not readily change their prior thinking in regard to new circumstances is referred to as inertia bias. In selective perception, information that is thought to be unimportant is screened out. Repetition bias is the unwillingness to believe or trust what has been said most often, and by the highest number of various sources (Lynch, 2008).
Adjustment and anchoring provide that decision making is affected by the original information, which impacts on the direction of the succeeding information. Group thinking takes place where peers influence each other, hence, forcing others to adopt their ideas and opinions. In regency, people tend to take seriously recent information more than distant or old information. In source credibility bias, people tend to reject things or information if they have a bias towards the reporter. People have a tendency to receive, accept and reciprocate information from reporters they like (Folke, 1988, p. 255).
Role fulfillment bias explains the tendency of people to conform to the decision-making expectations of someone in their position (Waenke, Schwarz, & Bless, 1995, p. 131). Underestimating uncertainty and the illusion of control also shows the tendency of people to believe that they can controllably eliminate potential problems in their decisions.
Incremental decision-making and escalating commitment-decision is looked at as a small step in a big process, perpetuates a series of same decisions (Pearl & Judea, 1983). Usually, untimely end of search by evidence people take the first choice that appears to work. Wishful thinking or optimism bias people tend to alter their attitude and judgment because of their relentless effort of getting positive results. Choice-supportive bias peoples minds or memories are distorted on chosen and rejected options in making their chosen options (Kehneman, Tversky & Slovic, 1982, p. iii).
The three biases that apply to the problem of drug abusiveness by employees are anchoring and adjustment, incremental decision making, and escalating commitment, and role fulfillment. Initial information about the abuse of drugs will help the employer to decide on the kind of decision to make. The expectations of people in the position one are holding play part in the kind of decision one makes (Kehneman, Tversky & Slovic, 1982, p. iv).
Risk implication
The implications of the problem could be devastating to a company or organization. Some workers abuse drugs, which affects their productivity for the company. This could lead to a breakdown or reduction of the production of the whole company. This could also put the drug abuser and his fellow workmates at risk especially if it is a production industry (Carroll, 1978, p. 65).
Risk management process
Risk management involves five stages, which go simultaneously. The first stage involves risk identification. It is the most vital step since nothing can be done until a problem is identified. The identification of the risk starts at its origin. The origin of drug abuse is identified first before the next procedure is done. In risk analysis, the analysis of the risk is done and its vulnerability or impact measured (Waenke, Schwarz, & Bless, 1995, p. 131). The frequency and severity of the problem or risk are also measured. Risk control involves making decisions on how to control the risk. If the risk cannot be controlled, then it should be transferred. For example, if the employees have indulged themselves so much on drug abuse that they cannot stop it, the best way to solve the problem is to fire them (Tversky & Kahneman, 1974, p. 214).
Risk transfer comes in when the risk is not manageable. It is transferred to the third party. Insurance comes into action in this stage (Folke, 1988). Risk review involves evaluating all the above procedures. A review of the risk management steps should be done regularly since the conditions and circumstances of organizations change continuously (Kehneman, Tversky & Slovic, 1982, p. ii).
References
Bar-Hillel, M., & Neter, E. (1986). How alike is it? Versus how likely is it? A disjunction fallacy in probability judgments, Journal of Personality and Social Psychology. 65, 1119-1131.
Carroll, S. (1978). An event on expectations for the event: An interpretation in terms of the availability heuristic. Journal of Experimental Social Psychology, 26,100-195.
Dawes K., Mirels, Q., Gold, P., & Donahue, P. (1993). Equating inverse probabilities in implicit personality judgments. Psychological Science, 4, 6, 396-400.
Folke, V., (1988). The Availability Heuristic and Perceived Risk. Journal of Consumer Research, 8, 254-300.
Kehneman, D., Tversky, A., & Slovic, P., (1982). Judgment under Uncertainty: Heuristics & Biases. Cambridge: Cambridge University Press.
Lynch, G. (2008). At your own risk: How the risk conscious culture meets the challenge of business change. New Jersey: John Wiley and Sons Inc.
Nisibet, D., & Ross, L., (1980). Human Inference: Strategies and Shortcomings of Social Judgment. Prentice Hall: Englewood Cliffs NJ.
Pearl, G., & Judea, H. (1983). Heuristics: Intelligent Search Strategies for Computer Problem Solving. New York: Addison-Wesley.
Schwarz, N. (1991). Ease of retrieval as information: Another look at the availability heuristic. Journal of Personality and Social Psychology, 50, 65-100.
Tversky, A., & Kahneman, D. (1974). Judgment under Uncertainty: Heuristics and Biases. Science, New Series, 185(4157), 5-8.
Tversky, A., & Kahneman, D., (1973). Availability: A heuristic for judging frequency and probability. Cognitive Psychology, 5, 207-232.
Tversky, A., & Kahneman, D., (1983). Extensional versus intuitive reasoning: The conjunction fallacy in probability judgments. Psychological Review, 90(293), 1124-1131.
Waenke, M., Schwarz, N. & Bless, H., (1995). The availability heuristic revisited: Experienced ease of retrieval in mundane frequency estimates. Acta Psychologica, 55, 98-130.
Do you need this or any other assignment done for you from scratch?
We assure you a quality paper that is 100% free from plagiarism and AI.
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NB: We do not resell your papers. Upon ordering, we do an original paper exclusively for you.
NB: All your data is kept safe from the public.