How do financial firms’ efforts to stockpile expertise affect trading conditions — particularly when the market becomes more volatile? Can a simple prompt to make a plan of action help people overcome forgetfulness that might be impeding their best intentions? Are people passing up once-in-a-lifetime opportunities out of a need to complicate what should be easy decisions? Wharton professors Vincent Glode, Katherine Milkman and Rom Schrift, respectively, examined these issues — and what they mean for business — in recent research papers.
When Being Good Is Bad
Even at the best of times, running a financal services company on Wall Street can resemble warfare. But it gets worse when trading conditions get volatile and pricing assets becomes trickier. That’s when financial experts might feel nothing short of all the fear, mistrust and uncertainty of a high-stakes arms race, according to a paper forthcoming at the Journal of Finance and co-written by Wharton finance professor Vincent Glode.
Using game theory concepts, the paper — titled “Financial Expertise as an Arms Race” — explores what happens when financial firms compete to accumulate human capital, data and technology that will allow them to acquire better information about the assets they’re trading. The idea for the paper came to Glode and his co-authors — Richard C. Green from Carnegie Mellon University’s Tepper School of Business and Richard Lowery from McCombs School of Business at the University of Texas at Austin — when they observed an escalating level of expertise on Wall Street before the market turbulence of 2008. According to Glode, Wall Street has always attracted highly qualified workers, “but recently they have been hiring more and more guys with Ph.D.s in math, physics or finance.”
In many respects, that’s been a good thing for financial intermediaries. Among other things, notes the paper, growing expertise has helped improve risk sharing and risk management; increased trading efficiency and developed securities that make the capital markets accessible to more people. But Glode suggests that the events of 2008 show how overinvesting in expertise can also be destabilizing.
In the model’s best-case scenario, any advantage of having a bigger pool of expertise at one firm is offset by the fact that its trading counterparties are doing the same.In the worst-case scenario, however, trading is disrupted because one firm fears its expertise isn’t as good as its counterparty’s and that it is at risk of losing large sums of money, so it refuses to participate in some trades. “When someone is really good at valuing a security and he tells you, ‘I need to sell this asset because I need liquidity,’ it is more difficult to trust his motives because he might be trying to sell you an asset using information that you don’t have,” says Glode.
In some ways, it’s a similar dilemma to that faced by countries in a nuclear arms build-up, the researchers contend. In an arms race, Glode notes, “the best thing is to have no country investing in nuclear weapons to make sure you will never have a war. But it’s always optimal for one country to get some weapons in case the other country acquires weapons, too. In the end, both countries end up acquiring weapons, and you just hope they won’t acquire too much or that they will not pull the trigger.”
In the case of financial firms, “even though acquiring expertise might make it difficult for you to sell or buy securities in the future,” Glode says, companies can’t pledge not to invest in it because they always want to be just a little bit better than an opponent at valuing securities. And deciding how much expertise to acquire often depends on what companies expect others will do.
“We highlight the trade-off that a firm has when it decides on its expertise levels — between becoming better at valuing financial assets and making more money when trade takes place, and minimizing the probability that the counterparty refuses to trade out of fear of being taken advantage of,” Glode notes.
The crunch time happens during periods of greater market uncertainty. “There is a cost to becoming more knowledgeable as a financial intermediary and this cost has to do with your reduced ability to trade in situations where you might want to trade most,” Glode says.
The study highlights another, broader point. “It’s easy to think the financial sector is just another sector. But in terms of competition, it is not,” according to Glode. So, say, Adidas were to think Nike “was too good” at producing shoes; it’s likely that Adidas would reduce its investments in the sector or stop making shoes altogether and move to another sector. “For Nike to do business, it doesn’t need Adidas to be there,” Glode points out. “Whereas in finance, if one of my clients says, ‘Find me a buyer for this credit default swap,’ I often need to find another financial firm that will be willing to buy it from me. What makes the financial intermediation sector special is that your competitors are also your partners.”
The big conundrum during volatile times for a financial intermediary sitting on a lot of expertise is what to do with it. Reacting quickly by cutting staff or dumping data isn’t necessarily a solution, especially if a counterparty doesn’t believe the intermediary’s claims that it has indeed reduced its arsenal of knowledge. “One of the contributions of our paper is that it shows how you become a victim of your own success in high uncertainty periods,” Glode says. “This is when your expertise becomes, in a way, your liability.”
In work, as well as in life, forgetfulness often impedes our best intentions. And in both settings, a failure to remember can have significant implications.
Forgetting to schedule an annual check-up at the doctor’s office could lead to a serious medical problem going undiscovered. The cost of neglecting regular meetings with a mentor could lead to the loss of a valuable contact. And a missed deadline on one component of a project can upend the schedule of the entire enterprise.
Is there any way to get past what would appear to be a common human foible? In a recent paper, “Using Implementation Intentions Prompts to Enhance Influenza Vaccination Rates,” Wharton operations and information management professor Katherine Milkman argues that in some situations, the solution is as simple as a design change to form letter reminders.
Milkman and co-authors John Beshears of Stanford University, James J. Choi of Yale University and David Laibson and Brigitte C. Madrian of Harvard University found that participation in workplace flu vaccination clinics went up among employees who were sent a flier that prompted them to fill in blank spaces on the handout with a specific date and time when they planned to come in to get a shot.
“Forgetfulness is a big part of why people don’t take preventative health actions; they mean to, but when it comes down to it, they don’t remember,” Milkman says. “One solution is to help people make a concrete plan.”
What is unusual in this case was that the employees weren’t being held to that plan by a doctor or a boss. According to Milkman, past research shows that people like to be thought of as dependable, and keeping commitments is part of that. “But most of the time, when you make a commitment, it isn’t invisible; you make a commitment to someone,” she notes. “It’s unusual to make a commitment to no one, but our study shows that even making a plan that only you see is tremendously effective.”
The researchers partnered with Evive — a health care communications company that contracts with businesses to provide wellness tips and information to employees — to test the power of different styles of reminders to attend flu vaccination clinics at a large Midwestern utility firm with multiple work sites.
Employees at the firm were assigned to receive one of three mailings about the upcoming vaccination clinics, which were free and conducted on-site. The control group received a flier that simply listed the dates and times when the shots would be available. A second group received a sheet that listed the dates and times, but also prompted each employee to privately write down the day he or she planned to get the shot. Mailings for a third group asked workers to privately write down a specific day and time for visiting the clinic.
In the end, employees in the third group who received the date and time prompts had a 37.3% participation rate in the vaccination clinics — 4.2% more than the control group. Those in group two who received date prompts also had a higher participation rate than the control group, but the increase was not statistically significant. “In most models where individuals fail to take an action that is in their long-run best interest, the mechanism that causes the failure is an overweighting of the immediate costs of the action or a lack of relevant information,” the authors write. “This study suggests that the lack of a concrete plan for implementing a desired action can also contribute to gaps between an individual’s intentions and actions.”
The positive effect of the prompt to make a concrete plan of action was particularly noticeable at work sites where the vaccination clinic was only scheduled for one day — where it was arguably more critical not to forget. At those locations, participation rates were 7.9% to 9.5% higher among employees who received planning prompts as opposed to fliers simply listing the dates and times of clinics. “We think this is a really powerful tool for helping people remember to avail themselves of preventative health services, including colonoscopies, mammograms and primary care visits,” says Milkman, noting that Evive is already implementing this insight into its new mailings.
According to Milkman, the paper is part of a growing field of research into the power of “nudges” in spurring people to take a particular action. Traditionally, companies and other entities try to change behavior by fining, taxing or otherwise punishing those who fail to do something or rewarding those who do it. But that approach may be viewed as draconian by employees, and it pulls in both workers who never intended to complete a particular task, and those with good intentions and poor follow-through. “Our nudge only helped the people who wanted a flu shot in the first place,” Milkman points out. “We were not coercing people into anything.”
Beyond public health, Milkman says the study has implications for any task where forgetfulness often interferes with completion rates. “There are an enormous number of tasks in organizations that employees frequently forget to do, even though they mean to get to them and know they are important.”
When Too Good to Be True Might Just Be True
From the time many of us are very young, we are taught that good things come to those who work hard.
While that is true in many cases, Wharton marketing professor Rom Schrift argues that this thinking may be standing in the way of making decisions that could positively affect our lives and careers.
In a new paper, “Complicating Choice,” Schrift and co-authors Oded Netzer and Ran Kivetz of Columbia University note that consumers enter into a decision-making process with a preconceived notion of how much effort will be reasonable to exert. Through a series of experiments, they find that when a decision seems more difficult than expected, people will artificially simplify it. But when making a choice is easier than anticipated, they will find ways to complicate it, in some cases, leading to a different — and possibly less advantageous — final determination.
People generally believe that the way to get good outcomes in life is to “exert a certain amount of effort, that effortful decisions and actions will produce good outcomes,” Schrift says. “That may be true in a lot of situations, but sometimes this belief can actually make us complicate a decision. We think that if we don’t deliberate enough, we will get a bad outcome.”
The study was inspired by an experience Schrift and his wife had while apartment hunting. They found the ideal digs on their first showing — but hesitated to immediately sign on the dotted line. “We had to over-think it; we had to complicate the decision by checking on all these unimportant things because [we couldn't believe] that such an important decision could be made so easily without conducting due diligence.”
Although Schrift and his wife ultimately got the apartment they wanted, he notes that for many of life’s decisions — whether it is buying a house, mulling a job offer or finding the ideal future spouse — too much time spent deliberating can actually cause someone to miss out on a good opportunity. In other words, sometimes an offer that appears “too good to be true” is, in fact, entirely legitimate. “You could meet the man or woman of your dreams,” Schrift notes.
As part of the research, Schrift and his co-authors found three key mechanisms that consumers used to complicate decisions they felt were “too easy.” The first was making the unimportant important. The researchers asked participants to choose between the services of two physicians, one of whom was made to appear much more attractive than the other — for example, the “better” doctor offered more flexible office hours and quicker wait times for scheduling an appointment. But the other physician had one attribute that the other did not — he or she made house calls. Even though respondents had previously said house calls were not an important factor for making the decision, when faced with this relatively easy decision, they began placing greater weight on this service. Doing so made the decision more effortful.
A second means of artificially complicating a decision was making two alternatives appear more equal than they actually were. In this experiment, the researchers asked participants to rate a dozen famous paintings. At a later stage of the test, respondents were shown two of the paintings from the list at random. They were once again asked to assign each one a rating, and then to choose which painting they ultimately preferred. “If people needed to make a choice between one painting that they had previously rated very high and one that they had rated very low, that should be a very easy decision,” Schrift points out. Instead, participants assigned a lower rating to the painting they initially liked better and a higher one to the painting that was initially scored lower. “They were essentially bringing these two paintings closer together, which made the decision harder.”
Finally, a third study showed that people would change their preference about a particular aspect of an option in order to make their decision harder. The authors asked a group of participants to pick among different job offers. Again, one job was by far the most attractive — it paid more and required a shorter commute. Each job was assigned a third, relatively ambiguous attribute — working with either three or six team members. “Whether the attractive job opportunity offered three or six team members, [respondents] always tended to prefer the other option just because they wanted to feel that there was something to think about,” according to Schrift.
In the job opportunities experiment, the co-authors even observed scenarios where complicating behavior led participants to change the alternative they ultimately chose. “Once we begin complicating our choice, we distort our preferences. At times, such distortions may lead us to choose an alternative that merely appears to be better for us just because we went through this process of choice-complication,” Schrift says.
Marketers must find a way to anticipate this tendency when coming up with a sales plan, Schrift argues. For example, a realtor could help potential buyers feel like they have done their due diligence by ordering the sequence of housing options in a manner that will facilitate a proper level of conflict in choice.
In future papers, Schrift and his co-authors plan to look at ways consumers can cope with the need to second-guess themselves. He suggests that preparing a list of priorities in advance of a decision-making process might make it easier to objectively weigh attributes before worries about not putting enough effort into the choice get in the way.
Another idea would be to create a psychological distance from the decision — or to bring a friend along. “If I’m helping a friend decide something, suddenly the decision doesn’t need to be so complicated,” Schrift notes. “It’s very easy to watch someone else and say they are over-thinking. But when we are making the decision for ourselves, we often do just that.”