International Journal of Managerial Finance

Risk and decision making by finance executives: a survey study

Les Coleman

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Les Coleman, (2007),"Risk and decision making by finance executives: a survey study", International
Journal of Managerial Finance, Vol. 3 Iss 1 pp. 108 - 124
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Risk and decision making by

finance executives:
a survey study

108

Les Coleman

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Department of Finance, The University of Melbourne,

Parkville, Australia
Abstract
Purpose When finance managers face decisions, they do not always make clinical evaluations
using rational methodology, but systematically depart from utility maximisation. This article
addresses biases that are related to risk propensity, and categorises them under five headings: decision
makers characteristics and perception; reference levels; mental accounting and the assumption of
mean reversion; the longshot bias or overconfidence; and the desire for immediate gratification. The
research reported in the paper seeks to understand the mechanisms of these biases using a study of
decision making by Australian finance executives in a setting that is representative of a typical
business decision.
Design/methodology/approach This paper uses a case study that was designed to identify why
decision makers facing choices will prefer a risky alternative. Data were collected using e-mail contact
and an electronic survey. Respondents (n 67) provided demographic data, and answered questions
that probed their attitudes and decision styles. Risk propensity was quantified by respondents
attitude towards a risky decision, and was explained using independent variables related to decision
maker traits.
Findings Just over half the executives proved willing to take a risk, and almost half the variance in
their risk propensity was explained roughly equally by respondents: endowment, perception of risks
role in decisions, assessment of alternative choices, and expectation of the decisions outcome.
Manipulation of the cases along four dimensions varied the decisions facts, but they proved only
marginally significant to risk taking.
Originality/value The study provides a practical explanation of the risk taking behaviour of
finance executives; confirms that context is more important to decisions than their content; and adds to
the growing body of applied behavioural research in finance.
Keywords Risk management, Managers, Decision making
Paper type Case study

Qualitative aspects of decision making in finance which form part of what is now
termed applied behavioural finance have long been seen as important to the actions
of institutions and individual investors. For instance, Slovic (1972) suggests that:
many aspects of investment analysis are . . . psychological in nature and provides a
catalogue of decision biases. Abundant evidence shows that financial decision makers
do not make clinical calculations using rational methodology, but instead
systematically depart from utility maximisation.
International Journal of Managerial
Finance
Vol. 3 No. 1, 2007
pp. 108-124
q Emerald Group Publishing Limited
1743-9132
DOI 10.1108/17439130710721680

The author is grateful for the advice and suggestions of numerous colleagues, and feedback from
participants at a workshop at University of Melbourne. The comments of three anonymous
reviewers and the Journals editor have significantly improved the paper. Remaining errors and
omissions are the authors responsibility.

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Even though it is important to understand the processes followed by finance

executives when they make decisions in the face of risk, the subject has seen limited
real-world examination. Financial economists have largely modelled asset pricing
without examining how investors make their choices (Barberis and Thaler, 2003), and
this is reflected in finance education. For example, Damodaran (2001, p. vii) begins his
textbook on corporate finance by defining the subject as: encompass[ing] all of a
firms decisions that have financial implications. But, in keeping with most other
treatments, he provides only a normative description of how financial decisions should
be made.
A growing body of behavioural studies has sought more specific explanations for
managerial decision making. Even so, few have used subjects who are experienced
managers; and most of these analyses have employed univariate test statistics focused
on a single aspect of the risk propensity of decision makers. Thus there remain three
significant research gaps. First, relatively little is known about how finance managers
actually make decisions. Second, there is currently only a limited understanding of how
personal attributes and cognitive processes lead to the heuristics that managers
employ. Third, there is no integrated model that incorporates the interaction and
relative importance of many known influences on risk and decision making.
The current study makes two contributions to this literature. First, we examine the
decision processes of practising finance managers using a representative decision.
Second, we use a questionnaire with strong grounding in the behavioural literature and
sufficient granularity to provide reliable measures of respondents characteristics and
decision modes. The questionnaire specifically incorporates risk propensity as a key
feature of decision making and enables us to develop an integrated model of decision
making by finance managers under uncertainty. The results add to the growing body
of work in behavioural finance that seeks to understand the sources and effects of
managers decision biases.
The balance of the paper in organised as follows: section I reviews the literature on
decision making by managers who are facing risk; section II describes the objectives
and design of the empirical research; section III discusses the results, and section IV
discusses the implications of the results for researchers and practitioners.
Review of financial decision making under risk
It has long been recognised that managers may adversely impact firm performance
because they do not unconditionally seek to maximise shareholder value (Jensen and
Meckling, 1976). However, research has largely ignored the importance of recognised,
but more qualitative, biases in managerial decision making such as hubris (Roll, 1986),
and overconfidence (Kahneman and Lovallo, 1993). The contention of this study is that
these attributes are of considerable importance to value maximisation, and hence merit
a more detailed understanding. This section summarises a few of the most important
biases known to affect managerial decision making.
Decision maker characteristics and perception
Several studies have shown that up to a quarter of the variation in risk taking by
individuals is explained by personality factors. For instance, according to Trimpop
(1994), risk takers are psychologically flexible. They are usually better educated,

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have a history of successful risk taking, tolerate ambiguity, seek novel experiences,
and respond rapidly to stimuli.
The framing of decisions is also important. Framing involves presenting identical
data with a different emphasis, which shifts a decision makers expectation of the
outcome. Thus a positive frame (e.g. emphasis on expected gains rather than possible
losses) induces greater expectations of a successful outcome (Kuhberger, 1998).
Decision makers also place their own frame on a decision by editing the materials to be
analysed through instinctive perception of the costs and benefits of each outcome, and
by self framing.
Reference levels
An important element of risk-sensitivity is loss aversion. Because losses can have
serious consequences, more weight is given to losses than to gains of equal magnitude,
and the disutility of any loss relative to the utility of a similar gain increases with the
size of the loss. In other words, the pain of loss relative to an equivalent gain is directly
proportional to the amount, and inversely proportional to risk propensity.
The prospect theory of Kahneman and Tversky (1979) proposes domain-sensitive
risk propensity so that decision makers are risk averse above an endowment reference
point and risk embracing below that point. Reference levels can also serve as anchors.
For instance, Lovallo and Kahneman (2003) point out that executives typically begin a
decision with a forecasted outcome, often prepared by a sponsor of the proposal. While
decision makers will adjust the sponsors expectations, this is generally not enough as
the reference anchor continues to influence their assessment of the likely outcome. This
is consistent with studies of decision makers forecasts that show that actual outcomes
frequently fall outside the range of indicated possibilities, even when experts are
involved (Camerer, 1995).
Mental accounting and mean reversion
Thaler (1985) develops a concept of mental accounting in which decision makers
apportion their wealth, knowledge and other resources into discrete and non-fungible
mental accounts. In economic terms, this leads consumers to over-weight sunk costs
and current cash outlays. It also leads to a number of behavioural anomalies.
One particularly relevant feature of mental accounting is called the law of small
numbers. Because it is too demanding for individuals to collect and process a
statistically robust sample, decision makers overgeneralise from small samples and
tend to overweight personal experience and striking observations (e.g. crises, highly
publicised incidents, freakish calamities). In addition, recent experience is used rather
than population-based distributions, and is especially likely to be over-weighted when
it supports a preferred outcome (Zackay, 1984).
The net result is that people place more emphasis on the consequences of decision
outcomes than on their statistical probabilities. Thus, decisions involving risk are
determined by expectations of how alternative outcomes will impact endowment,
rather than on probabilities of the outcomes. This explains why a number of studies
(e.g., Forlani, 2002) find that the facts of a decision are frequently ignored.
Another important decision influence is the assumption by decision makers of mean
reversion. For example, Odean (1998) finds that investors prefer to sell assets that have
risen in value and hold on to those that have made a loss. Further support is found in

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evidence supporting the gamblers fallacy, which assumes that the recent occurrence of
a particular outcome lowers the probability of re-occurrence of that outcome even in a
statistically independent event (Morrison and Ordeshook, 1975). This assumption of
mean reversion exerts Bayesian influences so that successful decision makers expect a
run of wins to be followed by losses, and in the absence of overconfidence - will tend
to become less risk prone; unsuccessful decision makers expect a turn for the better and
can become more risk prone.
Longshot bias in decision makers
Overconfidence is part of a pattern that psychologists refer to as self-enhancing biases,
and is evidenced when finance managers rely on outcomes that cannot be justified by
their statistical record. For instance, a variety of studies have shown that the average
failure rate for common business strategies lies between 70 and 90 percent[1].
According to one study of managers of US corporations, at least half of all their
decisions fail (Nutt, 1999).
One of the best-known depictions of the longshot bias is Rolls (1986) suggestion
that managers of acquiring firms are overly-optimistic in their valuation of targets and
over-confident of their ability to realize potential merger synergies. Selective analysis
that induces a level of overconfidence bordering on hubris may explain why firms
overpay for acquisitions and through the winners curse suffer poor returns.
Desire for immediate gratification
The final striking feature of risk taking behaviour is the preference of managers for
immediate gratification (Angeletos et al., 2001). Although it is often assumed that
elapsed time is the only difference between an identical decision made now or made in
the future, actual behaviour reflects a bias towards immediate achievement of desirable
outcomes. The practical result of this bias is the use of a higher discount rate for costs
than for benefits (Sagristano et al., 2002), leading to a preference by firms for
investments with high early payouts, and a delay in cost-saving projects including risk
management (which avoids future costs rather than producing an immediate benefit).
The model and research methodology
Decision model
The behavioural and managerial evidence reviewed in section I shows that individual
risk taking is influenced by a combination of personal, environmental, situational, and
definitional aspects of the decision. These can be described by five groups of stimuli
that could be expected to drive the decision of a finance executive who faces a risky
choice. These various factors can be depicted in a decision model as shown in Figure 1.
Three of these stimuli are relatively obvious empirical parameters that can be
reliably measured: the facts of the decision; the population of decision events (which
consists of knowledge about the previous outcomes of similar decisions); and experts
opinions as to the likely outcome.
A fourth and more qualitative group of decision stimuli is the decision makers
paradigm which comprises a pattern of personal features that are relatively stable
across different decision types. These include competencies, personal attributes
(especially demography and personality), endowment, experience in previous decision
making, and future aspirations.

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Figure 1.
Proposed links between
decision components

The fifth group of stimuli, which is more transient, consists of the decision makers
perception or framing of the decision, the institutional setting, and the relevance of the
decision makers skill which indicates how much control they have over the outcome.
The principal objective of this study is to validate this aspect of managerial decision
making.
Survey materials
This research takes the form of a survey of senior finance executives which elicits
sufficient detail to critically examine influences on individuals decision making. The
survey is in the form of a case study involving a decision with two alternative choices,
one of them risky and the other relatively safe. Participants are asked to indicate which
alternative they would recommend and provide personal details by answering a
variety of questions designed to collect demographic information and measure
personality characteristics.
The case study concerns a Grand Prix racing team, Carter Racing, and is loosely
modelled on the events leading up to the 1986 Challenger space shuttle disaster. The
case is designed to evaluate the reasons why experienced decision makers select a
risky alternative (Sitkin and Weingart, 1995). For purposes of this experiment, the case
study was shortened to one page and formatted as a memo describing the experience of
Carter Racing, which had developed a unique engine design and was in its first year of
Grand Prix racing. According to the case facts, the new engine was prone to fail at high
cost, but Carters initial success had attracted attention, and the future success of the
team depended on performing well in its next race. Respondents were given details of
Carters recent performance and some technical information, and were asked if they
would recommend that the team race or not race in the next event. In keeping with the
business style, no irrelevant information was included.
Using an approach that proved successful in past research, the case was internally
manipulated to provide varying levels of risk by incorporating opposing values for
four facts that seem essential to the decision: the teams finishing position in the last
ten races (either one or five top ten finishes); the number of blown engines in the last ten
races (one or five); an expert opinion on the cause of engine failure (either ambient
temperature is or is not the cause of engine failure); and the anticipated consequences

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of a wrong decision (almost certain bankruptcy or some financial pressure). By

manipulating these four factors, 16 versions of the case study were created, and each
subject was randomly assigned a version of the case.
Each subject was asked to read the case and then complete a questionnaire
consisting of three sections. The first section obtained the dependent variable by
asking the critical question: If you were the owner of Carter Racing, what is the
probability that you would decide to race tomorrow?. The second section contained 18
questions designed to provide information on the underlying reasons for the choice and
incorporated tests of the effects of framing, endowment, expert opinion, and outcome
expectations on the decision.
The third section contained 51 questions. The first 15 questions measured personal
characteristics including education, income, decision experience (years in the
workforce, industry, type of job), age, gender, marital status, and nationality.
The remaining questions were designed to measure personality characteristics such
as locus of control (Levenson, 1974); tolerance of ambiguity (Budner, 1962); sensation
seeking, impulsivity, aggression, and sociability (Zuckerman and Kuhlman, 2000);
egalitarian preferences, extroversion, emotional stability, and conformity to social
norms (Robinson and Shaver, 1973); Type A personality (Williams and Narendran,
1999); autonomy orientation, flexibility and competence, anxiety and susceptibility to
boredom; need for tension, risk, and adventure (Keinan, 1984); lack of inhibition,
feelings of self-efficacy, and self-discipline; worldviews (Slovic, 2000); achievement
motivation (McClelland, 1961); and personal traits (Goldberg, 1990).
To ensure validity and reliability of the questions, the majority were drawn from
studies that had been previously published in peer-reviewed psychology and behavior
journals. Responses were measured on a five-point Likert scale where 1 strongly
agree and 5 strongly disagree. While altering the setting of questions (i.e. their
frame) can elicit different responses, the strategy of using a previously published case
study and questions is intended to facilitate validation of the results[2]. The
questionnaire was made available on a research website and testing showed that it
took an average of 20 minutes to complete.
Survey participants
The survey participants consisted of members of the Finance and Treasury
Association, which is a professional body whose members are active in corporate
finance and typically employed by banks and major companies. In August 2003, an
e-mail was sent to 530 potential participants asking them to participate in the survey.
A follow up request was sent to two weeks later.
Given that target respondents were practicing managers, e-mail was used to solicit
responses as it is a common communication medium for business-to-business contact
and a common mode for business decision making. The e-mail provided a link to the
questionnaire website. The advantages of this approach are that it is inexpensive,
generates quick responses, and is perceived as environmentally friendly. As responses
are received electronically, they can easily be compiled and are obtained anonymously
which promotes completion of sensitive questions[3]. On the downside, e-mail surveys
can produce response rates that are low, or vary widely for no apparent reason (Smee
and Brennan, 2000).

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Limitations of the methodology

Critical assumptions underpinning this research are that: responses to a hypothetical
decision collected by an on-line survey can be generalised to actual finance decision
making; responses are representative of the decision making processes of Australian
finance executives in general; parameters can be quantified without error; and the
absence of real risks does not diminish the validity of the results. Other limitations are
the size of the sample and a practical limit on the number of questions included in the
survey instrument.
As questionnaires can do no more than recognise patterns in subjects reports, they
rely upon the goodwill and accuracy of participants. In a sensitive area such as risk
and decision making, there is no guarantee that responses will reflect true preferences.
These concerns are further complicated by the ethical research requirement for
informed consent since the mere act of describing the research proposal can influence
responses.
Despite these limitations, the research strategy has important strengths, such as
strong grounding in the literature; linkage between questions to ensure internal
consistency of the findings; emphasis on the real world so that decision makers are
operating in a familiar environment; and use of heterogeneous samples of experienced
decision makers. This method allows us to gather evidence relevant to the research
question in a realistic environment, rather than using students in an artificial,
laboratory environment as in most previous studies.
Survey results
Responses and respondents
There were a total of 67 useable responses[4], indicating a response rate of 12.5 percent.
The summary of respondents demographic data in Table I shows that they are not a
random sample of the population at large since they are predominantly male (84
percent), college educated (93 percent), in professional or executive roles (96 percent),
have considerable work experience (67 percent have 16 or more years), and have
relatively high incomes (59 percent earn over $100,000 per year). Conversely, the
sample provides a good variety of ages and some variety in industry, although
naturally there is a heavy concentration in finance.
Given the modest response rate of 12.5 percent, it is important to validate the
representativeness of these responses. The approach suggested by West and Berthon
(1997) is employed and uses a two-tailed t-test to compare the first and last quarters of
responses. The assumption is that late respondents are more similar to the
non-responding group than to the early respondents. Panel A of Table II shows that the
last quarter of respondents proved slightly less likely to race than the early
respondents (55 percent probability of racing versus 61 percent, respectively), but the
difference is not significant ( p . 0.60). This gives some assurance that the survey data
are not biased.
Results
Although the cases were designed to be risk-neutral on average, slightly more than
half (56.7 percent) of the respondents chose the risky alternative of racing. Assuming a
binomial distribution of race-dont race responses, this result is not significantly
different ( p . 0.27) from that expected from a randomly chosen, risk-neutral

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Gender
Male
Female
Age (years)
# 25
26-35
36-45
46-55
55-65
Marital status
Never married
Married
Separated
Divorced
Education level
Diploma
Bachelor degree
Postgraduate degree
Work experience (years)
,5
5-10
11-15
16-20
. 20
Industry
Manufacturing
Wholesale or retail trade
Agriculture or resources
Finance
Services
Government
Occupation
Clerical
Professional
Executive
Student
Income ($K PA)
, 25
25-50
50-75
75-100
100-150
. 150
Investments ($K)
, 25
25-100
100-250
250-500
500-999
. $1 mill
Note: Figures are percentages

84
16
6
24
33
32
5

115

18
76
3
3
7
35
58
3
15
15
19
48
8
7
3
48
26
8
2
57
39
2
4
2
11
24
22
37
17
15
15
29
20
4

Table I.
Distribution of
respondents (percent)

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Sample 1
Mean

Std dev n

Panel A: test of respondent bias

First and last quarters of responses

61.3

30.7

16 55.0

41.6

16 0.5

50.4

38.0

24 60.9

34.8

34 2 1.1

58.6

35.4

28 54.7

37.5

30 0.4

61.4

35.8

36 48.6

36.3

22 1.3

49.6

38.5

26 62.2

33.8

32 -1.3

82.6

21.6

19 36.3

32.2

30 6.0 * * *

65.1
80.6

33.8
24.8

43 34.0
18 35.6

29.9
35.7

10 2.9 * * *
25 4.9 * * *

65.0

35.0

14 33.8

37.8

13 2.2 * *

78.8

21.5

17 54.8

35.0

23 2.7 * * *

42.5

38.1

20 82.5

21.4

12 2 3.8 * * *

79.0

26.5

20 26.7

28.9

18 5.8 * * *

64.5
60.4
67.8
73.3
70.5

34.2
35.3
28.8
27.7
28.6

33
47
18
12
20

38.3
30.5
38.3
37.1
37.9

11
7
40
46
38

Panel B: internally manipulated facts of

the case
Recent results: zero or five top five
finishes in last ten races
Recent vehicle performance: one or five
blown engines in last ten races
Experts opinion: knows cause and does
not know
Outcome of racing: almost certain
bankruptcy or some financial pressures
Panel C: respondent perception of
decision (strongly agree & agree versus
strongly disagree & disagree)
If this opportunity is passed up, there
will never be another as good
The situation faced by Carter has large
potential for gain
Carter Racing can tolerate large risks
Carter has a record of making the right
decisions
Although GP racing is risky, Carter
Racing can expect safe operation
The average person would make the
same decision as me
Carter Racing is likely to succeed
tomorrow
Panel D: respondent trait or response
(strongly agree & agree versus strongly
disagree & disagree)
I am calm and relaxed when
participating in group discussions
I regularly set deadlines for myself
Age (35 or less, . 35 years)
Income (, $100K PA, . $100K PA)
Investments (, $100K, . $100K)

Table II.
Analysis of decisions to
take a risk (probability of
racing (i.e. risk
propensity) by decision
maker feature)

Sample 2

Independent variable Sample 1 and

Sample 2

Mean

33.6
25.7
51.5
52.2
49.2

Std dev n

2.4 * *
2.8 * * *
1.8 *
2.2 * *
2.4 * *

Notes: The characteristics of respondents are compared by dividing them into two samples according
to the Independent Variable and using t-tests to compare the mean risk propensity (the probability of
choosing to race) of the samples. Significance at the 10, 5 and 1 percent levels are denoted by *, * * and
* * *, respectively. Panel A compares the first and last quarter of responses that were received. Panel B
reports results after partitioning respondents based on variation in the case facts provided to them.
Panel C classifies respondents by their perceptions of the decision and its frame. Panel D classifies
respondents by their demographic or personality traits. Only statistically significant relationships ( p
, 0.10) are reported in panels C and D

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sample[5]. Thus these responses are consistent with the notion that executives are risk
neutral or slightly risk-prone on average.
A simple univariate analytical strategy was chosen to identify which effects on
decision making were most significant. Only respondents who gave a clear decision to
race or not to race (i.e. percentage probability of racing . 60 or , 40, respectively) were
included in the subsequent tests, reducing the sample size from 67 to 58 in the
remainder of the paper. For each of the 69 questions, responses were divided into two
groups, a group that strongly agreed or agreed with the particular statement and
another group that disagreed or strongly disagreed with the statement. The sample
means of each of the 69 paired groups were compared and significant differences are
reported in Panels B, C, and D of Table II.
Panel B examines risk propensity in light of the four manipulated facts of the case,
and shows that none of the four facts is related at a statistically meaningful level to the
decision made.
The next step was to identify influences on risk propensity from respondents
perception of the decision and their personal traits. The results in panel C show
statistically significant support for a longshot bias as the probability of racing is
higher for respondents who foresee a large potential for gain and for those who believe
that racing is too good an opportunity to pass up. The results also suggest that
respondents self-framed their decisions so that even though virtually all saw the
decision to race as a risky one those who took the risk believed that Carters risk was
low and that racing was likely to prove successful.
The pattern of answers to questions in Panel D shows that respondents are more
likely to take risks if they are calm and relaxed in group settings and able to set deadlines
for themselves (i.e. Type A personalities), young, and have less wealth and income.
The factors that are not significant in decision making are also of interest because
they too have important implications for the literature on managerial decision making.
For instance, despite extant studies to the contrary, gender, locus of control, and the
respondents self-assessment of their risk propensity did not prove to be important
determinants of risk propensity in this study.
Another important result of this study is the finding that executives do not have
stable risk propensity that can be generalized across different settings. Respondents
were asked about their tendency to take risks in their personal life, personal investment
strategy, and in working for clients or employers. Only one of the three paired
combinations is statistically significant: the link between risk propensity in personal
finances and business. Moreover, none of these self-reported risk propensity factors are
significantly related to decision making.
A key research objective is to identify which personality traits influence risk taking
in finance. The analysis above is extended by use of bivariate correlations between the
probability of racing and self-reported agreement with 51 personal and psychological
measures. The statistically significant ( p , 0.05) relationships are reported in Table III,
and demonstrate strong support for previously published studies. No significant
relationship found in this study contradicts the relationship between personal
attributes and risk propensity established in prior studies.
The results in Table III characterise risk-seeking finance managers as confident and
sociable and calm and relaxed, but also as hard driving. They believe that risk is
required to get ahead, and that risk taking contributes to success. An interesting

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Table III.
Personality and risk
propensity (personality
links to risk propensity)

Measure of risk propensity

Austin et al. (2001) Successful people take risks

Locus of control: when I get what I want,
Levenson (1974)
its usually because Im lucky
I am calm and relaxed when participating
in group discussions
Robinson et al.
In general I am very confident of my ability
(1991)
Ive not much sympathy for adventurous
Rohrmann (1997) decisions
Williams and
Narendran (1999) Type A: I regularly set deadlines for myself
Zaleskiewicz
To achieve something in life, one has to
(2001)
take risks
Zuckerman and
Kuhlman (2000)
My behaviour can be described as sociable

Sign of
relationship
Original study

Current study

( * *)
( * *)

( * *)

( *)

Notes: This table compares the influences of personality on risk propensity as identified in this study
with the results from the earlier study from which the question was sourced; relationships are shown
where significance in this study exceeds 20 percent; relationships that are significant at the ten and
five percent levels are denoted by * and * *, respectively; positive correlations mean that risk prone
decision makers agree that the phrase describes their behaviour or beliefs

finding is that risk-seeking executives believe that luck plays an important role in their
success, which implies that they consider outcomes of risky actions to be at least partly
beyond their control.
The next step was to more comprehensively test respondents risk propensity by
using multiple regression to derive an expression that is parsimonious and logical. It is
also desirable to show the extent to which subjects decision making matches, or fails
to match, the processes in the proposed decision making model. The results are shown
in Table IV using a layout proposed by Hair, Anderson, Tatham, and Black (1998: 212).
Not surprisingly, the probability of racing increases when the subject agrees with the
following statements:If this opportunity is passed up, there will never be another as
goodCarter Racing is likely to succeed tomorrowThe probability of racing decreases
when the subject believes that:Risk is higher when facing situations we do not
understand.The probability of racing also decreases in proportion to the respondents
wealth as measured by the value of his/her investments.
These explanatory variables reflect a persons innate traits, propensity to select a
risky alternative when making a decision, and decision making style.
These results can then be used to identify which of the proposed relationships set
out in Figure 1 are important. As shown in Figure 2, it is possible to describe
executives who take risks along four dimensions[6].
The first dimension is personal attributes: risk propensity is higher for those with a
lower value of investments, which is correlated to lower income, fewer years of
employment, and younger age. A second dimension is decision making style which
assumes that risk is not higher when facing decisions that we do not understand.
These risk takers describe themselves as controlled and believe they have received

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Term
Variables in the equation
Intercept
Endowment: value of investments,
excluding principal residence
Perception of risk: risk is higher
when facing situations we do not
understand
Assessment of alternatives: if this
opportunity [for Carter to race] is
passed up, there will never be
another as good
Expectation of success: Carter
Racing is likely to succeed tomorrow
Summary of model
R squared
Adjusted R squared
Standard error ogf estimate
Observations

Standardised
regression
coefficient
Standard
(beta)
Coefficient
error

Risk and
decision making
t value

Significance

10.61

0.00

8.125

0.766

20.240

0.103

20.214

22.338

0.023

20.439

0.186

20.219

22.367

0.021

0.492

0.149

0.328

3.309

0.002

0.687

0.175

0.387

3.926

0.000

0.494
0.462
1.344
67

Notes: This table reports the results of multivariate regression of the dependent variable Probability
of Racing (which is a proxy for risk propensity) against 65 independent variables related to
respondents perception of the decision and personal characteristics. The dependent variables were
measured using Likert scales and are reported so that a positive co-efficient means agreement with the
statement

more breaks in life than most. The third dimension is an assessment of the situation
which leads to the belief that there is no alternative to taking the risk, and an
expectation that taking the risk will bring substantial benefits. The final decision
dimension is a judgement that risk will bring success. These people describe
themselves as more willing to take risks than their colleagues and as confident.
Table IV and Figure 2 indicate that almost half the variability in risk propensity
between finance managers can be explained by four measurable parameters. However,
the most interesting aspect of this finding is that none of the quantitative measures
that were proposed in Figure 1 as influences on decision making experts opinion,
decision facts and features and previous outcomes had any significant influence on
the decision. In fact, the explanatory variables that influenced decision making were all
qualitative. This is particularly important given the relative neglect of these
parameters in most previous studies.
Discussion and implications
This study examines the reasons why finance executives choose a risky alternative
when making decisions. Although the study does not consider the effectiveness of
these decisions, it leads to four particularly significant conclusions.

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Table IV.
Multivariate regression of
impacts on risk
propensity (statistics
associated with
probability of racing)

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Figure 2.
Determinants of risky
decision making

Just over half the executives surveyed proved willing to take the risk of racing. The
first conclusion is that finance executives are risk neutral or slightly risk prone on
average, which contradicts the standard assumption of risk aversion so often invoked
in finance. However, it is consistent with previous studies of managers such as those
by MacCrimmon and Wehrung (1984) and Williams and Narendran (1999).
The second conclusion is that relatively stable, personal characteristics explain
around a quarter of the variation in risk propensity among executives. In this
study, risk prone executives tend to be younger and have lower incomes and
lower wealth. They are Type-A personalities, sociable, confident, and calm, and
believe they need to take risks to be successful. The decision making style of risk
takers is driven by a belief that they are luckier and more capable than their
peers.

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The third conclusion is that actual facts in the case had a limited impact on the
decision. The most important transient influences on decision making are judgements
about the outcome. The findings of this study contradict the normative assumption
that decisions are determined largely by the relevant facts. Overall, executives tend to
place much less weight on the quantitative content of a risky decision than they do on
its qualitative aspects. Risk-seeking respondents do not see a viable alternative to
taking the risk, and are confident of a successful outcome. Respondents conform to the
conclusion of West and Berthon (1997, p. 30) that successful risk taking individuals
are likely to believe that they can beat the odds, that nature is good to them, and that
they have special abilities. Using their own unique perspective of the decision context,
executives make risky choices by looking to the future, virtually independently of
seemingly relevant facts.
Managers with lower endowments proved to be more risk seeking. This fourth
conclusion supports Kahneman and Tverskys prospect theory. Respondents with low
incomes and less wealth have higher risk propensity. This is consistent with an inverse
relationship between risk propensity and endowment.
These results have significant implications for finance management, particularly
investment decisions and agency theory. The finding that at least half the sampled
finance managers are prepared to make a risky choice is clearly important based on the
model developed by Parrino et al. (2005). They reach the intuitively obvious conclusion
that manager risk propensity is critical to selection of investments: managers who are
risk-averse will reject attractive, but risky, investments; whereas risk-neutral decision
makers find risky projects more attractive. Thus the assumption in many models of
myopic risk aversion will misrepresent decisions by managers and investors.
The basis for the longshot bias in managerial decision making is apparent in the
result that the variables with the strongest links to risk propensity were belief that the
situation has large potential for gain and confidence in a successful outcome. This
points to one possible explanation for high risk strategies, which is that managers
recognise the skewness in returns and prefer the small chance of a high payout despite
their low expected return (Golec and Tamarkin, 1998). The temptation to gamble may
be fostered by executives belief in their luck, and confidence that their skill can
increase the probability of success.
The studys results also provide insights into the factors most likely to increase
agency problems. Much of the variance in executives risk propensity arises from
personal traits and expectations about the outcome. Thus, simply increasing the
amount of data and analysis will not change decisions. Managers decide to take a risky
alternative because of their innate personal characteristics, learned decision making
style, and expectations of a successful outcome. This means that a significant change
in firm risk propensity requires a change in its managers, not just their compensation
or the organisations structure. This explains why so many organisations make major
changes to their senior staff, despite the costs, disruption, and loss of corporate
memory inherent in such changes.
The executives surveyed here are risk prone, although far from homogenous in their
risk propensity; and they do not rely solely on facts when taking risks. This, too, has
important implications for modern finance theory, which assumes financial decision
makers are rational, homogenous, and risk averse, with diminishing marginal utility of
wealth.

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Finally, this studys results point to two gaps in the finance research agenda. The
first is the need to examine decisions (and, by implication, other finance practices) in a
real-world context where subjects follow their natural decision styles, rather than
conforming to norms imposed by experimental settings. Given that risk propensity can
explain half the variance in executives decision making, a further area for research is
the impact of risk on firm performance.

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122
Notes
1. Examples include acquisitions (Rau and Vermaelen, 1998), research and development
projects (Palmer and Wiseman, 1999), company formation (Camerer and Lovallo, 1999),
mineral exploration (Mackenzie and Doggett, 1992), and new product launches (Roskelly,
2002).
2. Copies of the case study and questionnaire are available upon request from the author.
3. Although the Perseus software that was used for the questionnaires provides the ability to
surreptitiously record details of respondents servers, this was not done as respondents had
been assured of anonymity.
4. Although a larger sample may be desirable, a wide variety of well-accepted studies have
used much smaller samples of homogeneous students. Examples include Bleichrodt (2001),
Fox and Tversky (1998) and Sitkin and Weingart (1995).
5. Assume for simplicity a binomial
p distribution of race-dont race responses, with a mean of
0.5 and standard deviation of [ (0.5 *0.5)/67 ) 0.061. The observed pattern would occur by
chance in 27.0 percent of equivalent random samples.
6. Unfortunately the sample size is too small to permit structural equation modelling; however,
the dimensions above could be extended using basic path analysis to propose a more
integrated model of risk taking.
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Corresponding author
Les Coleman can be contacted at: les.coleman@unimelb.edu.au

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