November 10, 2025 • 30 mins
Tune in to this engaging episode of the Count Me In Podcast, where we sit down with Rob Stephens, founder of CFO Perspective and an expert who brings a refreshing perspective to the often complex topic of behavioral finance. Rob sheds light on how this field not only intertwines with traditional finance but actually builds upon it, introducing the human elements behind financial decisions. Perfect for CFOs, controllers, and finance teams, Rob shares real-world applications of behavioral finance in corporate settings, from mergers and acquisitions to consumer psychology. Learn about the decision-making processes that can make or break a business and discover practical tools to improve communication and awareness. Whether it's understanding the group dynamics in management or navigating the tricky waters of debt and equity, Rob's insights are invaluable. Don’t miss this episode if you’re looking to enhance your financial decision-making with a touch of human psychology.
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Episode Transcript
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Adam Larson (00:05):
Welcome to Count Me In. I'm Adam Larson, and today's
episode is one you won't wannamiss. We're joined by Rob
Stephens, founder of CFOPerspective and an expert in
behavioral finance to explorehow understanding human behavior
can transform the way weapproach financial decisions.
Rob explains how behavioralfinance started in personal
finance, but its powerfulapplications in corporate
(00:26):
finance, influencing areas likemergers and acquisitions, debt
and equity management, andpricing strategies. As a leader
in the field, Rob walks usthrough the thinking errors,
biases, and heuristics that cancloud judgment and shares
practical strategies like broadframing to enhance decision
making in organizations.
This conversation is packed withinsight to help controllers,
(00:46):
CFOs, and finance leaders betterunderstand themselves, their
teams, and their decisions. Sostick around as we dive into
behavioral finance with RobStevens. Rob, I'm really excited
to have you on the podcasttoday. And today, we're gonna be
talking about behavioralfinance. And so the best first
(01:09):
question would probably be toask you, so what is behavioral
finance, and how does it relateto traditional finance?
Because I'm sure people arewondering, what are we talking
about here?
Rob Stephens (01:17):
Yeah. Yeah. That's a great starting point. And and
the key point to make is it'snot completely different than
traditional finance. It buildson, it informs traditional
finance.
So traditional finance was a avery much a deductive sort of
exercise of saying, you know,what is the correct price? What
people should what should peopledo rationally in this situation
(01:39):
for economics, purchasing, aninvesting decision, corporate
decision, those sorts of things.What behavioral finance did is
it started on the personalfinancial side, and what
researchers were finding wasthat people were doing things
that violated these norms, theseexpected actions in traditional
finance, and and particularly totheir detriment. And so what
(02:02):
behavioral finance startedstudying was, are there patterns
to these? Do people makepatterns of decisions that
causes them to make poorinvestment decisions or poor
decision management in a acorporate setting or poor
decisions in in how they pickretirement plans or health
benefit plans or things likethat?
So I looked and started verymuch in the personal financial
(02:24):
side, but people are people,whether they are making
decisions about their personalfinances or they're making
decisions for their company. Andso that's really been the
fascinating thing for me inparticular, was applying it into
corporate finance. So how doesit impact mergers and
acquisitions? How does it impactdividend policy? How does it
impact the capital stack?
You know, the cap stack of debtversus equity decisions, or how
(02:46):
do we choose projects, and andare there flaws in how we run
the analysis on choosingprojects on pricing and many
other app applications of it.
Adam Larson (02:55):
So what you're saying makes a lot of sense, but
why should controllers or CFOsor your corporate finance app,
why should they really care
Rob Stephens (03:01):
about Yeah. This is this, like I said, I think
there's been so much found inthe personal financial area, and
it's been well explored. And Ithink the next area of great
exploration of this andapplication of this is in
corporate finance. And so Ithink it has a ton of
applicability to FP and A, CFOs,corporate finance staff, things
(03:21):
like that. So what are wetalking about?
Well, one, if you're a companyand you're selling to consumers,
you have to understand consumerpsychology. And that's where a
lot of pricing psychologyhappens and understanding how to
set reference prices anddiscounts to those reference
prices and what how that drivesconsumer behavior. So it has an
(03:42):
application on the sales sideactually there. But also a lot
of times, I know I've been thechair of a pricing committee,
and that impacts the pricingdecision decisions and how to
set pricing for products. Theother is debt and equity, and
that's very much in thewheelhouse of CFOs.
Because overconfidence,excessive optimism, and things
like that can cause companies totake on too much debt, and that
(04:04):
partly comes from the perceptionthat equity in the market's not
being valued correctly. So youdon't wanna issue equity. You
rely too much on debt. Youbecome cash constrained, and
that can make you morevulnerable for bankruptcy. And,
also has major cash flowimplications because, an
overconfident manager may seetoo many opportunities or,
especially, overoptimistic,maybe too many opportunities
(04:26):
that when you run a net presentvalue analysis, you think
there's all these great dealsand you invest, invest.
But at the same time, you don'twanna take on equity to fund
those investments. So on theasset side and on the investment
side, you're overinvesting. Andon the funding side, you're not
bringing enough investment inand relying too much on debt. So
you're really leveraging in avery dangerous way in that
(04:47):
situation. A massive, massivearea is group decision making.
How do we make good decisions asa management team? And this is
really when I started thinkingabout this. I mean, I started
when I was the CFO of banks andthinking, how do I keep my my
head cool? You know, I was theCFO of banks during the Great
Recession. It was a hard time tobe a CFO of a bank.
And so how do I keep my headcool managing the bank and our
(05:10):
investment portfolio and otherthings? And then I started
realizing, wow. These findingsapply so much to how we make
decisions as groups as amanagement team of the banks.
And so there's a lot ofapplication there of what's what
are good decision makingprocesses? How can we improve
how can we improve the decisionmaking process at companies?
(05:30):
And then finally, it's it'sownership too. I've I've worked
for family banks and familyowned businesses. I worked with
small business owners. Andthere's all sorts of wants and
desires outside of just puremoney and how do how do we
balance those things in settingup the company to meet those
needs and not just a a puremonetary risk reward things. But
(05:52):
also too, once again, it getsinto dividend policies and
understanding the psychology ofthe investors on the in the
equity side to understanddividends and and why they're so
valued in in the marketplace.
Adam Larson (06:03):
Mhmm. A lot of times when people talk about
decision making, it's more of,hey, what do the numbers say,
and let's make the best decisionbased on that. But I like that
you're bringing up the wholehuman aspect of decision making,
because it's not just about,Hey, this is what the numbers
say. There's so many otherelements. Are there are there
different things, like factorsthat we should be looking for to
(06:23):
making the right decisions sothat we're not so that we're
maybe I'm not asking thatcorrectly, but what are like,
what are some of the best waysto make good decisions?
Because because it's not justabout the number. Like, we
there's a human aspect based onwhat you're saying.
Rob Stephens (06:39):
Right. There's two aspects to that. One is, like,
when we talk about owners,consumers, those sorts of
things, what do they want? Andand particularly in personal
finance, it had all been boileddown to risk and reward. And
what and I think in the earlydays of behavioral finance, the
thought was, oh, these people,they just don't understand
finance, and they're makingmistakes just because we're
human.
(06:59):
And I think I think MeyerStathmann really advanced the
concepts in behavioral financein behavioral finance two point
o saying, no. We are people, wewant things beyond just money.
Like, we buy products because ofwhat they say about us or things
that we believe in, whereinvestors wanna invest in
certain things because it'stheir company, it's their
(07:20):
country, it's a local area orsomething like that. So there's
all sorts of utility, and we getall the way back to the economic
concept of utility, and it's somuch broader than than than pure
money many times. And so, yeah,that's one part of it.
Another part too is even incompanies like I talked about
ownership, there are manythings, particularly when you
(07:40):
work with a family ownedcompany, when you work with just
a few and, a small company withjust a few owners or something
like that. I mean, they madethese companies. I made my
company for reasons far beyondthe numbers. And so you to
understand that and understandall the desires and wants of
those people is the behavioralfinance thing. And that actually
gets into other parts, isfinancial therapy and some other
(08:01):
things like that.
But the other part of that isthe decision making process. So
let's just go back and say,we're just trying to make good
decisions, even if it is even ifit is just about the numbers.
Now what's fascinating is gooddecisions aren't about the
analysis. And one of thegreatest books ever my favorite
book of applying behavioralfinance to a corporate finance
(08:23):
sin situations is OlivierSibonie's book, You're About to
Make a Terrible Mistake. It'sabsolutely incredible and
summarized so much of what'sbeen found in the corporate area
for decision making.
So let's talk about that incorporate decision making with
behavioral finance. The keything for groups is to is to not
to come to agreement too quicklyaround one area, because it's so
(08:45):
easy once a leader, a CEO, orsomething starts to lean a
little bit one way, suddenlyeveryone just falls in line. So
what's really important, andparticularly for the leaders, to
encourage divergent viewpointsand additional options. We
really need to see what are allthe options we have, and we
really need to challenge once westart to lean a certain way. So
there are ways to do that.
(09:06):
One is the premortem, and that'swhere the leader says, okay,
we're leaning towards adecision. Let's do a thought
experiment. Let's say we didthis, and then somewhere down
the road, five, ten years fromnow, three years from now, it
became it was a completedisaster. Why was it a disaster?
So suddenly, instead of thinkingof ways everyone's thinking of
ways to justify and come to aquick conclusion, or or just
(09:27):
naturally your mind starts tofilter out negative thoughts
about it and just starts to,think of positive thoughts of
why you should do something,you're really starting to
stretch yourself and say, am Imissing anything?
And so you're starting to thinkof the other side. If nothing
else, it helps increase your,sensitivity analysis, your risk
mitigation of the situation, andreally rounds out the even if
(09:48):
you rounds out the situation,even if you choose to go a
certain path, you you understandso many more of the
implications. And either youhave alternate plans ready, you
have risk mitigation you putinto place, you have other
things. If you don't do that,another option is a devil's
advocate or red team. A deviladvocate advocate's one person.
A red team's a team whose job isto basically advocate for the
(10:10):
opposite side of where the roomis leading, and they're tasked
with that. So that kinda takesaway some of the office politics
of the naysayer or something isshooting down. You know? It's
there's a lot of pressure to notbe the squeaky wheel. There's a
lot of pressure to not be thenaysayer.
So this is where they're taskedwith literally by the by the
leadership or by the group to,you you know, really, we need to
reintroduce debate and thoughtand stretch ourselves as a room,
(10:34):
and so you have to take theother side. The some other ideas
are when ideas come up for a abudget, you need to put put out
more than just a yes, no option,not just like, here's my up
here's my budget, up or downvote, or here's my plan. And a
great way to do that, zero basedbudgeting and decision packets,
and they do those things topresent multiple options. Or
that when someone presentssomething, they can't just
(10:55):
present an option for an up ordown vote. They have to present
multiple options.
That improves decision making,the decision making process, and
makes it better. Another greatone in decision making too is is
what they call broad framingversus narrow framing. Mhmm. And
that's particularly great forbudgeting and processes too, or
(11:16):
cost estimation and and andproject management. And that's
where you think, okay.
We've got this massive CapExsituation, some big capital
expenditure we wanna do. And sowhat's the probability we're
gonna get it done on time?What's the probability it's
gonna come in on budget? Andwhat we know, like looking at
large construction projects orcorporate projects, is that they
(11:37):
are horrible at coming in ontime and on budget. And why does
that happen?
Well, a lot of times we startwith, what do we think we're
gonna spend on this? When dothink we're gonna finish this?
And a much better way is to lookoutside of that, outside of
yourself, and look at thebroader things either in the
past of the company or outsideof the company and say, how long
has it taken other ourcompetitors to do this? How long
(11:59):
has it taken, how much does itcost others to do this? Is there
any reason that we think we'regonna be so much faster than
them or so much cheaper thanthem to pull this off?
Is and so it's a way to, onceagain, stretch your boundaries
on the possible of the whateverscenario, your your project or
budget you're planning on.
Adam Larson (12:17):
I I think you've given some great examples,
especially when it comes todecision making. What if
somebody's listening to this andthey're and they're reflecting
on what you're saying, andthey're saying, well, we don't
have any decision making, like,don't have any errors in how we
our decision making process. Youknow, lot of times we can be
blind if we're if it's notrevealed to us. How do we how do
we get from being blind to it tokind of being on the path to
having better communication andopenness when we're making these
(12:39):
decisions like you were justdescribing?
Rob Stephens (12:41):
Right. One of my favorite stories comes from,
Subhani's book, and it talksabout, the anti investment wall
or something like that. And it'sa it's a company. It's a a VC
company, I think, that puts upthe list of the investments they
did make that turned out to bewinners. So sometimes it's the
thing you didn't do that goesthe right way.
Now that a company like that canlook at their lost
(13:02):
opportunities. More often thannot, it's it's being humble and
remembering the times you didsomething as a company and it
didn't work. And so a huge, hugepart of this is just humility
and remembering things. And noone wants to bring up the past
or negative things. And and inall honesty, a lot of times
people who have done bad thingsin the past aren't with the
company anymore.
And so there is this kind ofsurvivorship bias that the that
(13:25):
the bad things that happened inthe past get get quietly put
away, aren't talked about. Thosepeople are let go or have to or
lose so much political capital,they have to go away. So the
first thing is is the honestythat we are human, and we've
made mistakes, we will continueto make mistakes, and those
sorts of things. I think thenext step then is because we're
human, that gets into what wetalk about as biases and
(13:47):
heuristics. Now, heuristics arerules of thumb.
They're simple ways of doingthings. A classic is how do we
value things? Like, I worked inbanking, it was one times, one
and a half times book is a goodvalue for a trade for selling
the bank or buying a bank, ortwo times book is a good so it's
geez. Quick rules of thumbs weuse to make quick decisions or
to maybe evaluate quickly thethe potential of a decision or
(14:11):
an opportunity or something likethat. But there are times when
and then biases are patterns ofaction.
Particularly, when we talk inbehavioral finance, they're
patterns of action we take thatare detrimental to us, that we
agree to quickly in decisionsthat we're overconfident, that
we're overly optimistic aboutthe future, that we we are
(14:32):
subject to what's calledconfirmation bias. And I think
this gets directly to your pointtoo, is in confirmation bias, we
subconsciously we're constantly,filtering information, but
subcon but confirmation biastalks specifically that we apply
two different questions whenwe're presented with
information. If it's informationthat we agree with, we
subconsciously ask, can Ibelieve this? It's a fairly low
(14:56):
bar to clear versus the questionwe ask and filter out
information when we don't, whenit challenges what we believe.
And in those cases, we say, mustI believe this?
This is challenging my belief,and so I'm gonna set the wall
much higher. And what this tendsto do with confirmation bias is
the negative in or the whateverchallenges what we see or want
to believe gets filtered outsubconsciously, and then what we
(15:19):
wanna believe, we just end upfurther entrenching our our
current beliefs. And the problemis is it it leaves us blind to
when there's changes in thebusiness environment or things
like that. So there's all sortsof these biases and heuristics.
I could go on and on, and andbelieve me, my students, they
have to listen to a whole I Icall it the forced march through
(15:39):
the biases and heuristics.
There's dozens of these things.So just becoming aware of all
these common thinking errors ofus as humans is a good starting
point. Then once you're aware ofthem, be aware of the times when
you're most susceptible to them.When are you tired? When are you
hungry?
When are you rushed? When areyou stressed out? When are you
overwhelmed by the options?You're tending to make, your a
(16:00):
more emotional decision, a, adecision that may be based more
on a heuristic or a or morevulnerable to these thinking
errors. And those are the timesthen to slow down.
Slow down the decision makingprocess. Challenge where you're
going. Think about the oppositepotentially. Bring in outside
help. Have other people pointout when you may be in a
(16:21):
cognitive minefield, a dangerousplace where you're subject to
these things.
And that's one reason whycompanies tend to make better
decisions than individuals isbecause they naturally slow down
the decision making process. Buteven then, when you bring in
when you talk in a company,you're subject to groupthink and
all those things, and that'swhere you have to kick in those
other things I just talked abouta little bit ago to improve the
decision making process of agroup. But, yeah, it all starts
(16:43):
with humility and awareness.
Adam Larson (16:45):
Humility and awareness. Yeah. I like that.
Well, in those thinking errorsyou just mentioned, it makes me
go back to what you'reoriginally saying, in one of the
first question we were talkingabout, how, like, debt and
equity can like, our thinkingerrors can affect the amount of
debt we have, the amount ofequity we can make the those
those bad types of decisions.How does that like, how do you
overcome that side of it,especially when you're trying to
(17:07):
make big decisions that affectyour organization?
Rob Stephens (17:10):
Right. And so, I can't remember if I ever
completed the thought that Italked about earlier about
Olivia's and, you're about tomake a terrible mistake, but he
Olivia cites something when hetalks about analysis is just a
small part. I think it was,like, 8% or something of a
decision. And the other twopieces are the decision making
process and things outside ofyour control. Mean, we have to
(17:30):
be honest that we live in anuncertain world that whether you
call it luck or fate or just theway things are or stuff happens,
that just the well, you can makethe greatest decision with the
information you have, with thebest process, and there are
still so many variables outsideof your control that will cause
an outcome to to cause a a bad avery bad outcome to a very good
(17:54):
decision.
So one of the things we have todo too when we look back at our
decisions is look back and say,did we use a good decision
making process? Did we reallythink through the options? Did
we challenge ourselves? Thingslike that. So particularly,
like, with debt and equity, howdo we get into that trouble
there?
That's where you haveoverconfidence is one of the
major drivers of that. Bynature, financial leaders like
(18:15):
CEOs tend to be just very, veryhigh in overconfidence or
overoptimism. Now, a CFO, theycan't be too cocky about that
either, thinking they're notsubject to it, because CFOs are
very much subject tooverconfidence and over
precision in their forecast. Youknow, thinking that there we
tend to not factor in as muchvolatility as there is in real
(18:37):
life. And so we believe ourprojection's a little too much.
And the problem is is when themarket goes against you and
you've got all that debt, you'revery, very exposed to cash flow
issues and liquidity crises, andthen you're talking about
bankruptcy, or you're missingmassive opportunities to
competitors who are cash richand are really getting the deals
in the downturns. So parts ofthe ways you do that, like we
(19:00):
talked about, you think out, youyou bring in conv voices,
opinions, perspectives, thechallenge, the the status quo.
You really that's where you getinto sensitivity analysis and
really pushing the bounds ofsensitivity analysis, what could
happen, in different scenarios.I think, once again, you just
have to be honest and and withyourself and realize the biases
(19:23):
you may have tendencies towards,And so that means you may need
to realize that, you know, wekeep stacking up this debt, and,
we need to balance out ourliquidity. So I come from a
banking background.
I've been the CFO of a few banksor senior vice president of a
few banks. I mean, we are forcedby regulation to do all sorts of
scenario analysis and stresstesting and all sorts of things,
(19:45):
particularly after the greatrecession. And so I think a
corporation has to do the samesort of things. And what's what
will happen is, initially, thoseboundaries will be not far
enough, that the world is a muchmore volatile, dangerous place
than we originally think. And soyou have to start with those
boundaries and then push themout, and then look at those
scenarios, look at those, andstress test your assumptions or
(20:07):
sensitivity to test your yourassumptions to know the key
assumptions to these businessplans, and then dial in and
really see what, you know,what's the spread on this, and
then say, do I need to, youknow, mitigate the plans we're
thinking about?
Do I need to be a little bitmore flexible and change the
plans? Do we need to reallybalance out and maybe, you know,
(20:28):
and not use so much debt?Because it's gonna in certain
scenarios, it causes liquiditycrises for the company that are,
you know, not way way out theretail risks, but, you know, a a
little bit out there, and whatare we gonna do about that? So
it's just looking at abroadening out into a big and
volatile and uncertain world.
Adam Larson (20:46):
There's a lot of things uncertain. And as you're
making these decisions andbecoming better decision makers
in the organization, we mightlook back and see that there's
decisions we made that weren'tso good, and you part of that is
humility and understanding howto adjust that. Why is this so
hard sometimes to remove thosebads, the bad business that we
started or bad investments thatwe did as an organization?
(21:08):
Because sometimes it's hard toto to distance ourselves from
them.
Rob Stephens (21:11):
Yeah. Exactly. So interestingly enough, sometimes
businesses are too conservativewhen they look at a project by
project basis, and so they needto really look at projects on a
portfolio basis, just like aninvestor needs to look at their
portfolio. If we talk modernportfolio theory that you have
to look at, you know, multiplerisky assets can have negative
(21:32):
correlations. Multiple riskrisky assets can have ways to
offset in different economicenvironments that reduces the
overall overall volatility andimproves the overall performance
of the portfolio.
Companies have to think the sameway. And what happens though is,
let's say I'm, you know, atmaybe at a senior level, I do
have a portfolio of projects.But if I'm a mid level manager,
(21:53):
I may only have one of thoseprojects. And when it starts to
go badly, I'm in a a placethat's very dangerous from a
decision making perspectivebecause I have basically two bad
options. One, this project's notgoing well.
It's probably it may not youknow, we may be losing money or
whatever. And for me to end itis a is a loss, and I'm locking
in a loss, and it may be seen asa failure. I may be seen as a
(22:16):
failure. And so and losses aretwice as painful as gains is a
major, major finding ofbehavioral finance. And so I
could do that, or I could let itrun.
You know? I could let it like alike a rogue trader almost, and
let it run. And and HirschShefrin, he has a great book, on
behavioral corporate finance,and it tackles it more with
studies and from an academic,perspective. There's a ton of
(22:38):
great information. And he asked,though, a very, very difficult
question is, do I care moreabout the project than I care
about the performance of thecompany?
And really what I'm saying Imean, it takes a ton of humility
and honesty to answer thatquestion. And so do you know?
And to realize that whensomeone's in a bad situation
like that, they're gonna makebad decisions. Usually, they're
gonna take on a ton more riskand cause a ton more losses. And
(23:00):
they're looking at the sunkcosts, which we we've we've been
told even before behavioralfinance was all the buzz in
finance, that sunk cost, wecan't consider the pot cost we
made in the past.
We can only do analysis on goingforward. Are the revenues in the
future gonna be better than thegains? And a lot of times,
companies will do that analysisat the beginning of a project,
(23:20):
but not during a project. Maybeat key points, they might some
people use gates and things likethat to analysis. But or even if
someone comes in, you have toask yourself every now and then,
if I were to come into thiscompany, would I have bought
this unit?
Would I have done this project?And really to look forward on
the profitability of thesethings. And once again, we have
to admit there are mistakes inthe past and not allow ourselves
(23:44):
to double down on them and justwaste more and more money after
that and throw more money downthe hole. So those are the
pieces that have to cometogether to to we have all these
things coming together thatwe've talked about. We've got
overconfidence.
We've got the confirmation biaskicking in. We have we're
gamblers in the face of losingchoices or gamblers in the face
(24:05):
of losses, and, got all thesesunk costs that are doing
things, that cause us todistract us from the true
economics of the situation, andand it's just a recipe for
disaster.
Adam Larson (24:18):
It really does sound like a recipe for
disaster, and I I feel likethere's a level of emotional
intelligence that's required toreally be effective in
behavioral finance.
Rob Stephens (24:26):
Yes. There is. And and that's where we have to help
each other out. Once again, thatit's hard for us to see when we
are in these areas that arecausing us a tougher time to
make good decisions. Like Isaid, if I'm if I'm that manager
of a a project you know, a lotof times, projects are picked
off of median expected value orsomething like that.
(24:49):
But, the joke is is you gave mesomething with a p 50, a
probability a 50% probability ofthis sort of outcome, but you
have a p 90 expectation, meaningyou you have this huge
expectation that it's reallygonna come out profitability
wise. But remember, we did allthat analysis to show there
could be all sorts of outcomesto these things, and a lot of
those outcomes have nothing toto do with the decision at the
(25:09):
time. And so one way we can goback is we can say, what did we
know when we make that decision,when we all made that decision?
And that's, know, so many timespeople skip over the assumptions
of an analysis, but that'sreally the the the context with
when that decision was made, andthat's really the context with
which that decision has to beevaluated. Not by the outcomes,
(25:29):
but what did we know at thetime?
Because there's another biascalled hindsight bias or, which
is also called the I knew it allalong bias, which is, you know,
people go look at the outcomesand say, of course, that was a
stupid idea. You know, how couldyou be so stupid? Those sorts of
things. And it's like, we're init together. We were all and
that's where a management teamcan say, hey, we were all in the
room here together, and, we madethis decision.
We have to own it. These werethe assumptions. We're not
(25:51):
clairvoyant. But from apreventative standpoint, you
need that awareness in the roomto say, woah. Woah.
Woah. We need to slow down.Woah. Woah. Woah.
We need to bring in the outsidevoices, conflicting things. And
so, it's that's the awarenesspiece of it too that, like you
said, an emotional intelligencepiece of it. And you could talk
about it in emotionalintelligence, but it's just good
decision making process. It'sjust good decision management,
(26:14):
and it's just pure goodmanagement.
Adam Larson (26:16):
Yeah. It really is. And I like that, the hindsight
bias. It's it's something that Ithink we all struggle with. It's
like, of course, I knew that,but if you asked me at that
time, we didn't know it.
And I that's a that again goesback to the humility of being
able to recognize that big time.
Rob Stephens (26:29):
One of my favorite stories on the hindsight bias
comes from personal financialplanning, actually. And there's
an adviser. And becauseadvisers, doctors, they're much
more prone to the, hindsightbias, anytime you're an agent
for someone. And so, so that'swhy doctors will do tons of
tests and do too many testingsbecause they're trying to
protect themselves from thesenegative outcomes. And, so, you
(26:52):
know, I I well, once again, Iwas a CFO of a medical clinic
system too, and I've auditedinvestment or, insurance
companies.
And so, I guess, another areathat really gets to me is this
waste because of of, trying toprotect yourself from the hines
hindsight bias. But my myfavorite example of how this
adviser protects themselves isat the beginning of the year,
(27:12):
they have the client say, okay.Where do you think the economy
is gonna be? Know, rates or so.You know?
And so instead of the advisersaying, okay. Let's talk about
how your what your allocationsare and your risk levels, and
then a year later, come back,and if things went bad, the
client says, you're such anidiot. Everyone knew. Then the
adviser can pull out and say,well, you know, you thought
that, the world was gonna gothis way and it didn't either.
(27:33):
And so it kind of puts everyoneon the same page of, we, you
know, we can't shoot each otherwhen we we were all at the same
place and at the same time.
And so it's it's a way to tocreate to force that honesty.
Adam Larson (27:46):
Yeah. I like that. That's a that's a really good
example. So, you know, we'vecovered a lot of things today.
You know, if somebody wants togo and more find more
information about behavioralbehavioral finance, Obviously,
they could go see you at yourcollege and and take your class,
but not everybody is able to dothat.
Where where else can they go tokinda find more information? I
know you mentioned a bookearlier,
Rob Stephens (28:08):
a couple of books earlier. Right. I think there
are a few good options. One isanyone can take my course
through IMA. And so, you know,thank you for hosting my
courses, and and I have abehavioral finance course in
IMA.
You know, I was shocked when Ireleased that course to CPE
sites. I I teach it at Gonzaga,and and it's gotten great
reception there, but it gets thegreatest reviews from CPAs who
(28:31):
you would think would be the youknow, who who get a lot of flack
or from CMAs who who get a lotof flack for maybe not being
high on the emotionalintelligence spectrum, but they
love it. They love this topic.It is so applicable. It's so
practical.
So you could do that and takethe course. I mentioned two
books along the way that thatare exceptional and are very,
very accessible. And that's thefirst is Olivier Sibonis' book,
(28:55):
You're About to Make a TerribleMistake. Just an absolutely
great book about applying invery practical ways of
behavioral finance to corporatefinance and corporate decision
making. What I love about thebook is he really respects these
decision makers and understandsthat they're doing the best they
can.
They're not idiots. It's easy tothink, oh, these were just crazy
people making bad decisions inthese companies. No. They're
(29:17):
very smart people, very goodbusiness people, and they're
just human like the rest of us,and that just points that we're
all we're all prone to thesemistakes. The the the third
option would be HirschSheffern's book, Behavioral
Corporate Finance.
That's actually built forteaching the classes. It's a bit
more of an academic, but it'stons of great studies and tons
of great application to businessfinance, and particularly to
(29:38):
corporate finance in the, youknow, like debt and equity
issuance, CapEx sort of things,and lots of great information
there too.
Adam Larson (29:47):
Alright. Well, look for links to all those in the
show notes for today's show. AndRob, we thank you so much for
coming on the podcast today.Thank you, Adam.
Announcer (29:57):
This has been Count Me In, IMA's podcast, providing
you with the latest perspectivesof thought leaders from the
accounting and financeprofession. If you like what you
heard and you'd like to becounted in for more relevant
accounting and financeeducation, visit IMA's website
at www.imanet.org.
Welcome to Count Me In. I'm Adam Larson, and today's
episode is one you won't wannamiss. We're joined by Rob
Stephens, founder of CFOPerspective and an expert in
behavioral finance to explorehow understanding human behavior
can transform the way weapproach financial decisions.
Rob explains how behavioralfinance started in personal
finance, but its powerfulapplications in corporate
(00:26):
finance, influencing areas likemergers and acquisitions, debt
and equity management, andpricing strategies. As a leader
in the field, Rob walks usthrough the thinking errors,
biases, and heuristics that cancloud judgment and shares
practical strategies like broadframing to enhance decision
making in organizations.
This conversation is packed withinsight to help controllers,
(00:46):
CFOs, and finance leaders betterunderstand themselves, their
teams, and their decisions. Sostick around as we dive into
behavioral finance with RobStevens. Rob, I'm really excited
to have you on the podcasttoday. And today, we're gonna be
talking about behavioralfinance. And so the best first
(01:09):
question would probably be toask you, so what is behavioral
finance, and how does it relateto traditional finance?
Because I'm sure people arewondering, what are we talking
about here?
Rob Stephens (01:17):
Yeah. Yeah. That's a great starting point. And and
the key point to make is it'snot completely different than
traditional finance. It buildson, it informs traditional
finance.
So traditional finance was a avery much a deductive sort of
exercise of saying, you know,what is the correct price? What
people should what should peopledo rationally in this situation
(01:39):
for economics, purchasing, aninvesting decision, corporate
decision, those sorts of things.What behavioral finance did is
it started on the personalfinancial side, and what
researchers were finding wasthat people were doing things
that violated these norms, theseexpected actions in traditional
finance, and and particularly totheir detriment. And so what
(02:02):
behavioral finance startedstudying was, are there patterns
to these? Do people makepatterns of decisions that
causes them to make poorinvestment decisions or poor
decision management in a acorporate setting or poor
decisions in in how they pickretirement plans or health
benefit plans or things likethat?
So I looked and started verymuch in the personal financial
(02:24):
side, but people are people,whether they are making
decisions about their personalfinances or they're making
decisions for their company. Andso that's really been the
fascinating thing for me inparticular, was applying it into
corporate finance. So how doesit impact mergers and
acquisitions? How does it impactdividend policy? How does it
impact the capital stack?
You know, the cap stack of debtversus equity decisions, or how
(02:46):
do we choose projects, and andare there flaws in how we run
the analysis on choosingprojects on pricing and many
other app applications of it.
Adam Larson (02:55):
So what you're saying makes a lot of sense, but
why should controllers or CFOsor your corporate finance app,
why should they really care
Rob Stephens (03:01):
about Yeah. This is this, like I said, I think
there's been so much found inthe personal financial area, and
it's been well explored. And Ithink the next area of great
exploration of this andapplication of this is in
corporate finance. And so Ithink it has a ton of
applicability to FP and A, CFOs,corporate finance staff, things
(03:21):
like that. So what are wetalking about?
Well, one, if you're a companyand you're selling to consumers,
you have to understand consumerpsychology. And that's where a
lot of pricing psychologyhappens and understanding how to
set reference prices anddiscounts to those reference
prices and what how that drivesconsumer behavior. So it has an
(03:42):
application on the sales sideactually there. But also a lot
of times, I know I've been thechair of a pricing committee,
and that impacts the pricingdecision decisions and how to
set pricing for products. Theother is debt and equity, and
that's very much in thewheelhouse of CFOs.
Because overconfidence,excessive optimism, and things
like that can cause companies totake on too much debt, and that
(04:04):
partly comes from the perceptionthat equity in the market's not
being valued correctly. So youdon't wanna issue equity. You
rely too much on debt. Youbecome cash constrained, and
that can make you morevulnerable for bankruptcy. And,
also has major cash flowimplications because, an
overconfident manager may seetoo many opportunities or,
especially, overoptimistic,maybe too many opportunities
(04:26):
that when you run a net presentvalue analysis, you think
there's all these great dealsand you invest, invest.
But at the same time, you don'twanna take on equity to fund
those investments. So on theasset side and on the investment
side, you're overinvesting. Andon the funding side, you're not
bringing enough investment inand relying too much on debt. So
you're really leveraging in avery dangerous way in that
(04:47):
situation. A massive, massivearea is group decision making.
How do we make good decisions asa management team? And this is
really when I started thinkingabout this. I mean, I started
when I was the CFO of banks andthinking, how do I keep my my
head cool? You know, I was theCFO of banks during the Great
Recession. It was a hard time tobe a CFO of a bank.
And so how do I keep my headcool managing the bank and our
(05:10):
investment portfolio and otherthings? And then I started
realizing, wow. These findingsapply so much to how we make
decisions as groups as amanagement team of the banks.
And so there's a lot ofapplication there of what's what
are good decision makingprocesses? How can we improve
how can we improve the decisionmaking process at companies?
(05:30):
And then finally, it's it'sownership too. I've I've worked
for family banks and familyowned businesses. I worked with
small business owners. Andthere's all sorts of wants and
desires outside of just puremoney and how do how do we
balance those things in settingup the company to meet those
needs and not just a a puremonetary risk reward things. But
(05:52):
also too, once again, it getsinto dividend policies and
understanding the psychology ofthe investors on the in the
equity side to understanddividends and and why they're so
valued in in the marketplace.
Adam Larson (06:03):
Mhmm. A lot of times when people talk about
decision making, it's more of,hey, what do the numbers say,
and let's make the best decisionbased on that. But I like that
you're bringing up the wholehuman aspect of decision making,
because it's not just about,Hey, this is what the numbers
say. There's so many otherelements. Are there are there
different things, like factorsthat we should be looking for to
(06:23):
making the right decisions sothat we're not so that we're
maybe I'm not asking thatcorrectly, but what are like,
what are some of the best waysto make good decisions?
Because because it's not justabout the number. Like, we
there's a human aspect based onwhat you're saying.
Rob Stephens (06:39):
Right. There's two aspects to that. One is, like,
when we talk about owners,consumers, those sorts of
things, what do they want? Andand particularly in personal
finance, it had all been boileddown to risk and reward. And
what and I think in the earlydays of behavioral finance, the
thought was, oh, these people,they just don't understand
finance, and they're makingmistakes just because we're
human.
(06:59):
And I think I think MeyerStathmann really advanced the
concepts in behavioral financein behavioral finance two point
o saying, no. We are people, wewant things beyond just money.
Like, we buy products because ofwhat they say about us or things
that we believe in, whereinvestors wanna invest in
certain things because it'stheir company, it's their
(07:20):
country, it's a local area orsomething like that. So there's
all sorts of utility, and we getall the way back to the economic
concept of utility, and it's somuch broader than than than pure
money many times. And so, yeah,that's one part of it.
Another part too is even incompanies like I talked about
ownership, there are manythings, particularly when you
(07:40):
work with a family ownedcompany, when you work with just
a few and, a small company withjust a few owners or something
like that. I mean, they madethese companies. I made my
company for reasons far beyondthe numbers. And so you to
understand that and understandall the desires and wants of
those people is the behavioralfinance thing. And that actually
gets into other parts, isfinancial therapy and some other
(08:01):
things like that.
But the other part of that isthe decision making process. So
let's just go back and say,we're just trying to make good
decisions, even if it is even ifit is just about the numbers.
Now what's fascinating is gooddecisions aren't about the
analysis. And one of thegreatest books ever my favorite
book of applying behavioralfinance to a corporate finance
(08:23):
sin situations is OlivierSibonie's book, You're About to
Make a Terrible Mistake. It'sabsolutely incredible and
summarized so much of what'sbeen found in the corporate area
for decision making.
So let's talk about that incorporate decision making with
behavioral finance. The keything for groups is to is to not
to come to agreement too quicklyaround one area, because it's so
(08:45):
easy once a leader, a CEO, orsomething starts to lean a
little bit one way, suddenlyeveryone just falls in line. So
what's really important, andparticularly for the leaders, to
encourage divergent viewpointsand additional options. We
really need to see what are allthe options we have, and we
really need to challenge once westart to lean a certain way. So
there are ways to do that.
(09:06):
One is the premortem, and that'swhere the leader says, okay,
we're leaning towards adecision. Let's do a thought
experiment. Let's say we didthis, and then somewhere down
the road, five, ten years fromnow, three years from now, it
became it was a completedisaster. Why was it a disaster?
So suddenly, instead of thinkingof ways everyone's thinking of
ways to justify and come to aquick conclusion, or or just
(09:27):
naturally your mind starts tofilter out negative thoughts
about it and just starts to,think of positive thoughts of
why you should do something,you're really starting to
stretch yourself and say, am Imissing anything?
And so you're starting to thinkof the other side. If nothing
else, it helps increase your,sensitivity analysis, your risk
mitigation of the situation, andreally rounds out the even if
(09:48):
you rounds out the situation,even if you choose to go a
certain path, you you understandso many more of the
implications. And either youhave alternate plans ready, you
have risk mitigation you putinto place, you have other
things. If you don't do that,another option is a devil's
advocate or red team. A deviladvocate advocate's one person.
A red team's a team whose job isto basically advocate for the
(10:10):
opposite side of where the roomis leading, and they're tasked
with that. So that kinda takesaway some of the office politics
of the naysayer or something isshooting down. You know? It's
there's a lot of pressure to notbe the squeaky wheel. There's a
lot of pressure to not be thenaysayer.
So this is where they're taskedwith literally by the by the
leadership or by the group to,you you know, really, we need to
reintroduce debate and thoughtand stretch ourselves as a room,
(10:34):
and so you have to take theother side. The some other ideas
are when ideas come up for a abudget, you need to put put out
more than just a yes, no option,not just like, here's my up
here's my budget, up or downvote, or here's my plan. And a
great way to do that, zero basedbudgeting and decision packets,
and they do those things topresent multiple options. Or
that when someone presentssomething, they can't just
(10:55):
present an option for an up ordown vote. They have to present
multiple options.
That improves decision making,the decision making process, and
makes it better. Another greatone in decision making too is is
what they call broad framingversus narrow framing. Mhmm. And
that's particularly great forbudgeting and processes too, or
(11:16):
cost estimation and and andproject management. And that's
where you think, okay.
We've got this massive CapExsituation, some big capital
expenditure we wanna do. And sowhat's the probability we're
gonna get it done on time?What's the probability it's
gonna come in on budget? Andwhat we know, like looking at
large construction projects orcorporate projects, is that they
(11:37):
are horrible at coming in ontime and on budget. And why does
that happen?
Well, a lot of times we startwith, what do we think we're
gonna spend on this? When dothink we're gonna finish this?
And a much better way is to lookoutside of that, outside of
yourself, and look at thebroader things either in the
past of the company or outsideof the company and say, how long
has it taken other ourcompetitors to do this? How long
(11:59):
has it taken, how much does itcost others to do this? Is there
any reason that we think we'regonna be so much faster than
them or so much cheaper thanthem to pull this off?
Is and so it's a way to, onceagain, stretch your boundaries
on the possible of the whateverscenario, your your project or
budget you're planning on.
Adam Larson (12:17):
I I think you've given some great examples,
especially when it comes todecision making. What if
somebody's listening to this andthey're and they're reflecting
on what you're saying, andthey're saying, well, we don't
have any decision making, like,don't have any errors in how we
our decision making process. Youknow, lot of times we can be
blind if we're if it's notrevealed to us. How do we how do
we get from being blind to it tokind of being on the path to
having better communication andopenness when we're making these
(12:39):
decisions like you were justdescribing?
Rob Stephens (12:41):
Right. One of my favorite stories comes from,
Subhani's book, and it talksabout, the anti investment wall
or something like that. And it'sa it's a company. It's a a VC
company, I think, that puts upthe list of the investments they
did make that turned out to bewinners. So sometimes it's the
thing you didn't do that goesthe right way.
Now that a company like that canlook at their lost
(13:02):
opportunities. More often thannot, it's it's being humble and
remembering the times you didsomething as a company and it
didn't work. And so a huge, hugepart of this is just humility
and remembering things. And noone wants to bring up the past
or negative things. And and inall honesty, a lot of times
people who have done bad thingsin the past aren't with the
company anymore.
And so there is this kind ofsurvivorship bias that the that
(13:25):
the bad things that happened inthe past get get quietly put
away, aren't talked about. Thosepeople are let go or have to or
lose so much political capital,they have to go away. So the
first thing is is the honestythat we are human, and we've
made mistakes, we will continueto make mistakes, and those
sorts of things. I think thenext step then is because we're
human, that gets into what wetalk about as biases and
(13:47):
heuristics. Now, heuristics arerules of thumb.
They're simple ways of doingthings. A classic is how do we
value things? Like, I worked inbanking, it was one times, one
and a half times book is a goodvalue for a trade for selling
the bank or buying a bank, ortwo times book is a good so it's
geez. Quick rules of thumbs weuse to make quick decisions or
to maybe evaluate quickly thethe potential of a decision or
(14:11):
an opportunity or something likethat. But there are times when
and then biases are patterns ofaction.
Particularly, when we talk inbehavioral finance, they're
patterns of action we take thatare detrimental to us, that we
agree to quickly in decisionsthat we're overconfident, that
we're overly optimistic aboutthe future, that we we are
(14:32):
subject to what's calledconfirmation bias. And I think
this gets directly to your pointtoo, is in confirmation bias, we
subconsciously we're constantly,filtering information, but
subcon but confirmation biastalks specifically that we apply
two different questions whenwe're presented with
information. If it's informationthat we agree with, we
subconsciously ask, can Ibelieve this? It's a fairly low
(14:56):
bar to clear versus the questionwe ask and filter out
information when we don't, whenit challenges what we believe.
And in those cases, we say, mustI believe this?
This is challenging my belief,and so I'm gonna set the wall
much higher. And what this tendsto do with confirmation bias is
the negative in or the whateverchallenges what we see or want
to believe gets filtered outsubconsciously, and then what we
(15:19):
wanna believe, we just end upfurther entrenching our our
current beliefs. And the problemis is it it leaves us blind to
when there's changes in thebusiness environment or things
like that. So there's all sortsof these biases and heuristics.
I could go on and on, and andbelieve me, my students, they
have to listen to a whole I Icall it the forced march through
(15:39):
the biases and heuristics.
There's dozens of these things.So just becoming aware of all
these common thinking errors ofus as humans is a good starting
point. Then once you're aware ofthem, be aware of the times when
you're most susceptible to them.When are you tired? When are you
hungry?
When are you rushed? When areyou stressed out? When are you
overwhelmed by the options?You're tending to make, your a
(16:00):
more emotional decision, a, adecision that may be based more
on a heuristic or a or morevulnerable to these thinking
errors. And those are the timesthen to slow down.
Slow down the decision makingprocess. Challenge where you're
going. Think about the oppositepotentially. Bring in outside
help. Have other people pointout when you may be in a
(16:21):
cognitive minefield, a dangerousplace where you're subject to
these things.
And that's one reason whycompanies tend to make better
decisions than individuals isbecause they naturally slow down
the decision making process. Buteven then, when you bring in
when you talk in a company,you're subject to groupthink and
all those things, and that'swhere you have to kick in those
other things I just talked abouta little bit ago to improve the
decision making process of agroup. But, yeah, it all starts
(16:43):
with humility and awareness.
Adam Larson (16:45):
Humility and awareness. Yeah. I like that.
Well, in those thinking errorsyou just mentioned, it makes me
go back to what you'reoriginally saying, in one of the
first question we were talkingabout, how, like, debt and
equity can like, our thinkingerrors can affect the amount of
debt we have, the amount ofequity we can make the those
those bad types of decisions.How does that like, how do you
overcome that side of it,especially when you're trying to
(17:07):
make big decisions that affectyour organization?
Rob Stephens (17:10):
Right. And so, I can't remember if I ever
completed the thought that Italked about earlier about
Olivia's and, you're about tomake a terrible mistake, but he
Olivia cites something when hetalks about analysis is just a
small part. I think it was,like, 8% or something of a
decision. And the other twopieces are the decision making
process and things outside ofyour control. Mean, we have to
(17:30):
be honest that we live in anuncertain world that whether you
call it luck or fate or just theway things are or stuff happens,
that just the well, you can makethe greatest decision with the
information you have, with thebest process, and there are
still so many variables outsideof your control that will cause
an outcome to to cause a a bad avery bad outcome to a very good
(17:54):
decision.
So one of the things we have todo too when we look back at our
decisions is look back and say,did we use a good decision
making process? Did we reallythink through the options? Did
we challenge ourselves? Thingslike that. So particularly,
like, with debt and equity, howdo we get into that trouble
there?
That's where you haveoverconfidence is one of the
major drivers of that. Bynature, financial leaders like
(18:15):
CEOs tend to be just very, veryhigh in overconfidence or
overoptimism. Now, a CFO, theycan't be too cocky about that
either, thinking they're notsubject to it, because CFOs are
very much subject tooverconfidence and over
precision in their forecast. Youknow, thinking that there we
tend to not factor in as muchvolatility as there is in real
(18:37):
life. And so we believe ourprojection's a little too much.
And the problem is is when themarket goes against you and
you've got all that debt, you'revery, very exposed to cash flow
issues and liquidity crises, andthen you're talking about
bankruptcy, or you're missingmassive opportunities to
competitors who are cash richand are really getting the deals
in the downturns. So parts ofthe ways you do that, like we
(19:00):
talked about, you think out, youyou bring in conv voices,
opinions, perspectives, thechallenge, the the status quo.
You really that's where you getinto sensitivity analysis and
really pushing the bounds ofsensitivity analysis, what could
happen, in different scenarios.I think, once again, you just
have to be honest and and withyourself and realize the biases
(19:23):
you may have tendencies towards,And so that means you may need
to realize that, you know, wekeep stacking up this debt, and,
we need to balance out ourliquidity. So I come from a
banking background.
I've been the CFO of a few banksor senior vice president of a
few banks. I mean, we are forcedby regulation to do all sorts of
scenario analysis and stresstesting and all sorts of things,
(19:45):
particularly after the greatrecession. And so I think a
corporation has to do the samesort of things. And what's what
will happen is, initially, thoseboundaries will be not far
enough, that the world is a muchmore volatile, dangerous place
than we originally think. And soyou have to start with those
boundaries and then push themout, and then look at those
scenarios, look at those, andstress test your assumptions or
(20:07):
sensitivity to test your yourassumptions to know the key
assumptions to these businessplans, and then dial in and
really see what, you know,what's the spread on this, and
then say, do I need to, youknow, mitigate the plans we're
thinking about?
Do I need to be a little bitmore flexible and change the
plans? Do we need to reallybalance out and maybe, you know,
(20:28):
and not use so much debt?Because it's gonna in certain
scenarios, it causes liquiditycrises for the company that are,
you know, not way way out theretail risks, but, you know, a a
little bit out there, and whatare we gonna do about that? So
it's just looking at abroadening out into a big and
volatile and uncertain world.
Adam Larson (20:46):
There's a lot of things uncertain. And as you're
making these decisions andbecoming better decision makers
in the organization, we mightlook back and see that there's
decisions we made that weren'tso good, and you part of that is
humility and understanding howto adjust that. Why is this so
hard sometimes to remove thosebads, the bad business that we
started or bad investments thatwe did as an organization?
(21:08):
Because sometimes it's hard toto to distance ourselves from
them.
Rob Stephens (21:11):
Yeah. Exactly. So interestingly enough, sometimes
businesses are too conservativewhen they look at a project by
project basis, and so they needto really look at projects on a
portfolio basis, just like aninvestor needs to look at their
portfolio. If we talk modernportfolio theory that you have
to look at, you know, multiplerisky assets can have negative
(21:32):
correlations. Multiple riskrisky assets can have ways to
offset in different economicenvironments that reduces the
overall overall volatility andimproves the overall performance
of the portfolio.
Companies have to think the sameway. And what happens though is,
let's say I'm, you know, atmaybe at a senior level, I do
have a portfolio of projects.But if I'm a mid level manager,
(21:53):
I may only have one of thoseprojects. And when it starts to
go badly, I'm in a a placethat's very dangerous from a
decision making perspectivebecause I have basically two bad
options. One, this project's notgoing well.
It's probably it may not youknow, we may be losing money or
whatever. And for me to end itis a is a loss, and I'm locking
in a loss, and it may be seen asa failure. I may be seen as a
(22:16):
failure. And so and losses aretwice as painful as gains is a
major, major finding ofbehavioral finance. And so I
could do that, or I could let itrun.
You know? I could let it like alike a rogue trader almost, and
let it run. And and HirschShefrin, he has a great book, on
behavioral corporate finance,and it tackles it more with
studies and from an academic,perspective. There's a ton of
(22:38):
great information. And he asked,though, a very, very difficult
question is, do I care moreabout the project than I care
about the performance of thecompany?
And really what I'm saying Imean, it takes a ton of humility
and honesty to answer thatquestion. And so do you know?
And to realize that whensomeone's in a bad situation
like that, they're gonna makebad decisions. Usually, they're
gonna take on a ton more riskand cause a ton more losses. And
(23:00):
they're looking at the sunkcosts, which we we've we've been
told even before behavioralfinance was all the buzz in
finance, that sunk cost, wecan't consider the pot cost we
made in the past.
We can only do analysis on goingforward. Are the revenues in the
future gonna be better than thegains? And a lot of times,
companies will do that analysisat the beginning of a project,
(23:20):
but not during a project. Maybeat key points, they might some
people use gates and things likethat to analysis. But or even if
someone comes in, you have toask yourself every now and then,
if I were to come into thiscompany, would I have bought
this unit?
Would I have done this project?And really to look forward on
the profitability of thesethings. And once again, we have
to admit there are mistakes inthe past and not allow ourselves
(23:44):
to double down on them and justwaste more and more money after
that and throw more money downthe hole. So those are the
pieces that have to cometogether to to we have all these
things coming together thatwe've talked about. We've got
overconfidence.
We've got the confirmation biaskicking in. We have we're
gamblers in the face of losingchoices or gamblers in the face
(24:05):
of losses, and, got all thesesunk costs that are doing
things, that cause us todistract us from the true
economics of the situation, andand it's just a recipe for
disaster.
Adam Larson (24:18):
It really does sound like a recipe for
disaster, and I I feel likethere's a level of emotional
intelligence that's required toreally be effective in
behavioral finance.
Rob Stephens (24:26):
Yes. There is. And and that's where we have to help
each other out. Once again, thatit's hard for us to see when we
are in these areas that arecausing us a tougher time to
make good decisions. Like Isaid, if I'm if I'm that manager
of a a project you know, a lotof times, projects are picked
off of median expected value orsomething like that.
(24:49):
But, the joke is is you gave mesomething with a p 50, a
probability a 50% probability ofthis sort of outcome, but you
have a p 90 expectation, meaningyou you have this huge
expectation that it's reallygonna come out profitability
wise. But remember, we did allthat analysis to show there
could be all sorts of outcomesto these things, and a lot of
those outcomes have nothing toto do with the decision at the
(25:09):
time. And so one way we can goback is we can say, what did we
know when we make that decision,when we all made that decision?
And that's, know, so many timespeople skip over the assumptions
of an analysis, but that'sreally the the the context with
when that decision was made, andthat's really the context with
which that decision has to beevaluated. Not by the outcomes,
(25:29):
but what did we know at thetime?
Because there's another biascalled hindsight bias or, which
is also called the I knew it allalong bias, which is, you know,
people go look at the outcomesand say, of course, that was a
stupid idea. You know, how couldyou be so stupid? Those sorts of
things. And it's like, we're init together. We were all and
that's where a management teamcan say, hey, we were all in the
room here together, and, we madethis decision.
We have to own it. These werethe assumptions. We're not
(25:51):
clairvoyant. But from apreventative standpoint, you
need that awareness in the roomto say, woah. Woah.
Woah. We need to slow down.Woah. Woah. Woah.
We need to bring in the outsidevoices, conflicting things. And
so, it's that's the awarenesspiece of it too that, like you
said, an emotional intelligencepiece of it. And you could talk
about it in emotionalintelligence, but it's just good
decision making process. It'sjust good decision management,
(26:14):
and it's just pure goodmanagement.
Adam Larson (26:16):
Yeah. It really is. And I like that, the hindsight
bias. It's it's something that Ithink we all struggle with. It's
like, of course, I knew that,but if you asked me at that
time, we didn't know it.
And I that's a that again goesback to the humility of being
able to recognize that big time.
Rob Stephens (26:29):
One of my favorite stories on the hindsight bias
comes from personal financialplanning, actually. And there's
an adviser. And becauseadvisers, doctors, they're much
more prone to the, hindsightbias, anytime you're an agent
for someone. And so, so that'swhy doctors will do tons of
tests and do too many testingsbecause they're trying to
protect themselves from thesenegative outcomes. And, so, you
(26:52):
know, I I well, once again, Iwas a CFO of a medical clinic
system too, and I've auditedinvestment or, insurance
companies.
And so, I guess, another areathat really gets to me is this
waste because of of, trying toprotect yourself from the hines
hindsight bias. But my myfavorite example of how this
adviser protects themselves isat the beginning of the year,
(27:12):
they have the client say, okay.Where do you think the economy
is gonna be? Know, rates or so.You know?
And so instead of the advisersaying, okay. Let's talk about
how your what your allocationsare and your risk levels, and
then a year later, come back,and if things went bad, the
client says, you're such anidiot. Everyone knew. Then the
adviser can pull out and say,well, you know, you thought
that, the world was gonna gothis way and it didn't either.
(27:33):
And so it kind of puts everyoneon the same page of, we, you
know, we can't shoot each otherwhen we we were all at the same
place and at the same time.
And so it's it's a way to tocreate to force that honesty.
Adam Larson (27:46):
Yeah. I like that. That's a that's a really good
example. So, you know, we'vecovered a lot of things today.
You know, if somebody wants togo and more find more
information about behavioralbehavioral finance, Obviously,
they could go see you at yourcollege and and take your class,
but not everybody is able to dothat.
Where where else can they go tokinda find more information? I
know you mentioned a bookearlier,
Rob Stephens (28:08):
a couple of books earlier. Right. I think there
are a few good options. One isanyone can take my course
through IMA. And so, you know,thank you for hosting my
courses, and and I have abehavioral finance course in
IMA.
You know, I was shocked when Ireleased that course to CPE
sites. I I teach it at Gonzaga,and and it's gotten great
reception there, but it gets thegreatest reviews from CPAs who
(28:31):
you would think would be the youknow, who who get a lot of flack
or from CMAs who who get a lotof flack for maybe not being
high on the emotionalintelligence spectrum, but they
love it. They love this topic.It is so applicable. It's so
practical.
So you could do that and takethe course. I mentioned two
books along the way that thatare exceptional and are very,
very accessible. And that's thefirst is Olivier Sibonis' book,
(28:55):
You're About to Make a TerribleMistake. Just an absolutely
great book about applying invery practical ways of
behavioral finance to corporatefinance and corporate decision
making. What I love about thebook is he really respects these
decision makers and understandsthat they're doing the best they
can.
They're not idiots. It's easy tothink, oh, these were just crazy
people making bad decisions inthese companies. No. They're
(29:17):
very smart people, very goodbusiness people, and they're
just human like the rest of us,and that just points that we're
all we're all prone to thesemistakes. The the the third
option would be HirschSheffern's book, Behavioral
Corporate Finance.
That's actually built forteaching the classes. It's a bit
more of an academic, but it'stons of great studies and tons
of great application to businessfinance, and particularly to
(29:38):
corporate finance in the, youknow, like debt and equity
issuance, CapEx sort of things,and lots of great information
there too.
Adam Larson (29:47):
Alright. Well, look for links to all those in the
show notes for today's show. AndRob, we thank you so much for
coming on the podcast today.Thank you, Adam.
Announcer (29:57):
This has been Count Me In, IMA's podcast, providing
you with the latest perspectivesof thought leaders from the
accounting and financeprofession. If you like what you
heard and you'd like to becounted in for more relevant
accounting and financeeducation, visit IMA's website
at www.imanet.org.
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