In 2008 the Queen famously asked a group of academics at the London School of Economics why no one had seen the financial crisis coming.
Equally famously, no one was really able to give her a satisfactory answer. And they still haven’t, although explanations such as Professor Luis Garicano’s – ‘At every stage, someone was relying on somebody else and everyone thought they were doing the right thing’ – certainly covered part of it.
My recent research with my Oxford Saïd colleague Nir Vulkan may indicate another aspect of the problem, as well as providing future food for thought for recruiters in the financial services industry and other sectors. We looked at the role of personality in group financial decision-making.
Neoclassical economists usually work on the assumption that decision-making is rational. People are expected to make logical decisions that are in their highest self-interest or ‘utility’ – which means that incentives can play a part. However, as the behavioural economists show us, those rational choices can be distorted by cognitive biases: people can’t see past optimistic ‘framing’ of the financial environment, for example, or they follow rules of thumb such as ‘you can’t go wrong investing in property’ or ‘private equities beat the stock market’.
But there is another factor that can affect financial decisions, especially institutional investment decisions. That is that they are almost always made collectively in a group context. So the social dynamics of these groups – the personalities of the individuals involved and how they relate to each other – may also have an impact.
Our study looked at how a single personality trait, aggressiveness, affects how fund managers make investment decisions in a group setting. Aggressiveness as a personality trait is linked with behaviours such as a desire to dominate and command others (it’s nothing to do with picking fights in bars!). We wanted to find out if it could account for excessive risk-taking even in the absence of contractual incentives, cognitive biases, or risk-loving preferences.
We conducted a series of laboratory experiments with groups of seasoned financial professionals, whose aggressiveness had been measured in standard psychology tests. The experiments involved placing them in a variety of different scenarios and asking them to make portfolio allocation decisions.
In each scenario, the subjects were confronted with a choice between investing in a safe asset or a risky asset. The information they were given at the start of each scenario meant that most risk-neutral or risk-averse investors would choose to invest in the safe asset. However, we then gave each participant a personalised ‘rumour’ that signalled the returns on the risky asset, and in most scenarios they were also able to see the rumours that were being sent to the other members of the group.
What we found was that highly aggressive participants were much more likely to recommend risky investment strategies consistent with their own personal information, regardless of the information received by other group members. Their aggressiveness meant that they sought to dominate group decisions at any cost: it did not matter to them whether the group reached the right decision, so long as it was their decision. In fact, a one standard deviation increase in aggressiveness approximately doubled the estimated probability of a subject recommending the risky asset.
Given the amount of harm that has already resulted from risk-taking by financial institutions, this is an important finding. Yes, there is room for more research, looking at, for example, the interplay in decision-making between personality and preferences, information, and incentives, or the effects of other personality traits, such as extroversion. But if, as we have identified, aggressiveness has a first-order effect on risk-taking, there are actions that firms and regulators can take now to control the average aggressiveness of money managers – and therefore potentially to reduce risk-taking in the financial system. Personality screening and training are relatively low-cost and easy to implement but could have a big impact on the effectiveness and prudence of group financial decision-making.