The new behavioral science of risk taking in business

The new behavioral science of risk taking in business

There’s something of a bull market in understanding attitudes toward risk. Last decade’s financial crisis spawned a slew of platforms — Riskalyze, FinaMetrica, Tolerisk, and a rapidly growing list of competitors — that seek to understand people’s tolerance for financial risk. It is now common for financial advisors to ask clients a set of questions about how much money they’re willing to lose in exchange for the chance to make more. The advisors then use the answers to assign clients a risk number and match them to appropriate portfolios. The practice represents an important step in the evolution of thinking about risk. In the wealth management industry, it’s become a given that it is not enough to analyze just risks themselves, but also how different people respond to them.

Now there are signs that all kinds of companies are delving more deeply into peoples’ attitudes toward risk as a way to improve operations and build more effective teams. Firms are using increasingly sophisticated behavioral science and personality profiling tools to better understand how their people think and feel about risk, so that they can tap into employees’ strengths and improve teamwork and decision making. By taking this more comprehensive approach, companies can reduce the risk that the threats they face on a daily basis might spiral into crises.

“Personality profiling is relatively new, but there is rising interest in risk management circles and in business more generally,” said Julia Graham, deputy CEO and technical director of Airmic, the London-based risk management and insurance trade association. Risk personality assessments have taken particular hold in industries in which people factors can have a profound impact on risk decisions and behaviors: pharmaceuticals, energy, and transportation. “Specifically, profiling can assist in the space of crisis management and in the design and selection of teams — those who respond effectively when ‘business as usual’ might not be quite so effective, [and] when different personality profiles may come to the fore,” she said.

Financial regulators began encouraging advisors to assess their clients’ risk tolerance in the 1980s and early 1990s. That directive led the U.K.-based Psychological Consultancy to develop the Risk Type Compass. The tool evolved out of the Hogan methodology for personality assessments, which is itself based on the so-called big five personality factors that are the foundation of many psychometric tests: extraversion, agreeableness, conscientiousness, neuroticism, and openness to experience.

Psychological Consultancy founder Geoff Trickey is an English psychologist whose passion for studying risk is contagious. Years after he and his team grouped together risk-related questions to develop the Compass, he’s still visibly excited over how the analysis yielded a tool that, like its namesake, is built around two axes.

One axis measures how calm or anxious people are. The other assesses how impulsively or methodically they manage risks in different areas: financial, career, ethical, social, and health. Unlike tests that pigeonhole people into absolute categories, Trickey’s assessment also measures how closely people adhere to one of the eight personality types around the Compass: wary, prudent, intense, excitable, deliberate, adventurous, carefree, and composed.

(Other assessment tools, such as the Cambridge Code, examine personalities more broadly but break out risk so that teams can look in more depth at that particular trait.)

Within the Risk Type Compass, wary types are shrewd, vigilant, and controlling, as police officers and lawyers tend to be. Their polar opposites, the adventurous, are fearless, undaunted, and entrepreneurial.

Intense personalities are apprehensive, risk aware, and ardent: They go all in but don’t make the same mistake twice. On the other side are composed types: calm, resilient, optimistic — unflappable.

Deliberate risk takers tend to appear among engineers and bankers: analytical, investigative, calm, business-like. Their counterparts, the excitables, are enthusiastic but anxious, with these two traits combining to create strong commitment.

Prudent risk takers are systematic, orthodox, and detailed, seeking to eliminate ambiguity. And carefree types are likely to see risks as opportunities instead of dangers and tend toward the unconventional.

People who share characteristics of multiple types are called axials. They have a powerful capacity to empathize with peers of just about any kind of profile, and to mediate among them, as well. That’s a soft skill that is often overlooked, until companies realize that different combinations of risk personalities can cause conflicts — and understanding those personalities can help to resolve previously intractable problems. It’s an invaluable aptitude, especially as companies embrace research that shows diverse groups make better decisions.

By looking at a scatter graph of risk types, managers can see whether their team members tend to build factions, or if certain viewpoints are overrepresented or missing. This analysis can provide valuable information about how working relationships play out, how to avoid misunderstandings, and how to keep fault lines from becoming fatal to the team.

Employees are sometimes initially surprised by their types. But in the diagnostic process, they also learn about their hidden strengths. Trickey cited the example of one woman who took the test just as Europe’s General Data Protection Regulation (GDPR) was coming into effect in 2018. “Her lively, talkative team was dominated by excitable and carefree risk types, and she was miffed to be assessed as prudent. She hoped she might be something more interesting,” Trickey told me with a wry smile. “But when she recalled being the only one who had worried about GDPR regulation, it all fell into place. She had faced an uphill battle urging others on to meet deadlines. Nobody else was showing any urgency. In the end, she had done it all herself, and she was quite proud of that.”

Traders have used the tool to identify their own capabilities and blind spots, and to then develop strategies that play to their strengths and shore them up against their weaknesses. One trader, for example, was surprised to learn that his type was wary — not exactly what you might expect in his field. But his analytical, systematic approach minimized excessive market risk and perfectly complemented the style of a highly adventurous trader with whom he worked. Their opposing personalities combined to make the team top performers. Understanding their personalities solidified that collaboration.

European and Australian companies are farther ahead in taking up risk personality assessments than are firms based in the Western hemisphere are. And together with financial-services companies and traders, heavy industries and other safety-conscious firms have also led the way.

Though many in the United States may associate psychometric testing with recruiting and human resources applications, risk assessments are most likely to be used when teams are already in place. They are a tool to harmonize existing processes, rather than to select hires based on certain traits.

Risk-related behavioral tools serve another important function. By helping team members understand their preferences, the assessments confer a sense of control (even if it the feeling is sometimes illusory) that can make them more comfortable with whatever level of risk they assume. And in thinking ahead about how their own attitudes play into risk preparedness, people increase their ability to manage the challenges that come their way.

Published at Wed, 09 Oct 2019 05:00:00 +0000