Overcoming a bias against risk

The right level of risk aversion depends on the size of the investment. CEOs making decisions about large, unique investments are typically more risk averse than overconfident—and they should be, since failure would cause financial distress for the company.

In contrast, midlevel executives making repeated decisions about the many smaller investments that a company might make during the course of a year—expanding a sales force at a consumer-goods company into a new geography, for example, or introducing a product-line extension at an electronics firm—should be risk neutral. That is, they should not overweight negative or positive outcomes relative to their actual likelihood of occurrence. Decisions about projects of this size don’t carry the risk of causing financial distress—and aversion to risk at this level stifles growth and innovation. Risk aversion is also unnecessary because statistically, a large number of projects are extremely unlikely all to fail (unless they are highly correlated to the same risks). Yet many managers at this level—who make many such investments over a career—exhibit an unwarranted aversion to risk.