The Dan Ariely Series: The Muddy Charles

I’d like to conclude the Dan Ariely Series by thanking both both John Mihaljevic and Dan Ariely for the inspiration to share with you a subject that I truly enjoy. Now back to a couple of experiments conducted by Dan.

First, the Muddy Charles experiment, one of two pubs at MIT, is a famous and a very popular place as I understand it. Here Dan and researchers approach unsuspecting students and ask them to sample two brews: one is known as MIT Brew and the other a commercial brew. The students in a blind taste test are asked which of the two brews they prefer to have a full glass of.

Let me let you in on a secret. The MIT Brew is just commercial beer laced with balsamic vinegar. The other is just a commercial beer.

What are the results? [Drum roll] On average, most participants preferred the MIT Brew to the commercial brew.

So Dan turns the experiment around and now tells the pub-goers beforehand, that here are two brews: One is a commercial brew, and the other is balsamic vinegar-laced commercial beer. Then asks them to taste and choose which one they prefer a full glass of.

Now what do you think happened, Oh wise one? [Another drum roll] on average, most participants preferred the commercial brew and were disgusted with the balsamic vinegar-laced beer.

Our expectations change our decisions. The way we anticipate something changes the way we perceive it and experience it. Our brain works to influence our perception. Our preconceived notions color the world we see around us. Our brain, our mind keeps trying to predict the future. As it tries to predict the future, it changes our physiology. It makes us experience the reality we anticipate. The reality we end up experiencing is partially a function of what we anticipate.

Let me bring this point home as it relates to the world of investing with the wise words of Benjamin Graham. In this video from Columbia’s Heilbrunn Center, Benjamin Graham explains price fluctuations in the stock market:

‘… the explanation cannot be found in any mathematics, but it has to be found in investor psychology. You can have an extraordinary difference in the price level, merely because not only speculators, but investors themselves are looking at the situation from rose-colored glasses rather than dark-blue glasses…’

Here’s Dan talking about the balsamic vinegar experiment and there’s a funny surprise at the end 🙂

The second experiment is about the half-life of Coke. Dan and researchers leave six-pack of Cokes randomly in the common kitchen refrigerators all over campus. They keep a record of how long it takes for the Coke to disappear. It turns out that in a few days, all the Coke was gone.

As you can probably imagine, every one of these common kitchens had a vending machine with Coke ready to be dispensed for a dollar. So Dan takes plates with six one dollar bills and places them in refrigerators across campus. He thought this would make it easy for students wanting Coke to just take a buck, insert into the vending machine and ‘Taste the Feeling’.

It didn’t work! Not a single dollar went missing. It turns out we don’t treat stealing money and stealing ‘tokens’ or ‘widgets’ the same way. Think credit cards, think backdating stock options, think Enron, etc…

Let me conclude with a couple quotes from Dan:

‘One of the challenges of Behavioral Economics is that people behave in all kinds of ways, often in ways that either don’t seem to make sense or don’t seem to be in their long-term best interest… if we can understand  some of the barriers that people have, we can build a mechanism. Much like building a bridge, we need to understand the terrain and what’s going on. We can’t tell people to just go over the cliff, we need to understand exactly what’s missing, and the same goes for changing human behavior.’

and

‘…using these principles [of Behavioral Economics] wisely, we might be able to design a better world’

Thank you!

The Dan Ariely series are inspired by:

John Mihaljevic of the Manual of Ideas. John Mihaljevic, CFA, is author of The Manual of Ideas, the bestselling book on value investing.Manual of Ideas.John is also founder of MOI Global, an invitation-only membership community of intelligent investors. It publishes the Manual of Ideas, “the very best investing newsletter” (Pabrai). John is also a managing director of ValueConferences, the series of fully online investment conferences for sophisticated investors. He has also served as managing partner of investment firm Mihaljevic Capital Management LLC since 2005. He is a member of Value Investors Club, an exclusive community of top money managers, and has won the club’s prize for best investment idea. John is a trained capital allocator, having studied under Yale University chief investment officer David Swensen, and served as research assistant to Nobel Laureate James Tobin. John holds a BA in economics, summa cum laude, from Yale and is a CFA charterholder.
and
Dan Ariely of Duke University. Dan is the James B. Duke Professor of Psychology and Behavioral Economics at Duke and a founding member of the Center for Advanced Hindsight. Dan’s books, Predictably Irrational, The Upside of Irrationality, The Honest Truth About Dishonesty, are NY Times best sellers. Dan also has a podcast “Arming the Donkeys”. A new book by Dan and Jeff Kreisler is expected to go on sale November 11 2017 titled Dollars and Sense.

The Dan Ariely Series: Huge Cash Bonuses and Motivation

A company has to systematically test its basic assumptions especially when it comes to motivating its employees – rank and file. If we had to invest in a company, wouldn’t you want to know that the employees of that company are highly motivated to produce more widgets for you or to save you more money on purchases or motivated to cut costs?

Although I will not be able to give you the single secret to motivation, I only would like to present you with some experiments that shed some light on what motivates us in an employer/employee relationship through experiments in Behavioral Economics.

For those of us lucky enough to live or have lived in the Northwest and experienced working with or buying from Costco at the Issaquah branch- next to Costco’s HQ – you probably saw first hand the energy and the customer service offered at that branch. Same goes for Microsoft, Nordstrom, Adobe, Amazon, Boeing, PACCAR, Nike, etc…

In Dan Ariely’s book PAYOFF, one of the research papers referenced titled Employee Recognition and Performance by Christiane Bradler, Robert Dur, Susanne Neckermann, and Arjan Non, their experiment shows that unannounced public recognition to employees causes a statistically and economically significant increase in performance.

What do you mean by recognition? Why can’t I just mail ’em a check at the end of the year, wouldn’t that motivate them and it’s so much easier?

One of the books referenced 1001 Ways to Reward Employees. The book confirms what almost every employee already knows:

‘…that recognition for a job well done is the top motivator of employee performance.’

Leadership of a company should understand that people differentiate between Intrinsic vs Extrinsic Motivation.

For example, in a experiment where blood donors were offered $7 every time they donated it actually decreased blood donation. The fact is we DO NOT donate blood for money – I mean some people do – but the overwhelming majority do it for intrinsic reasons. (Mellström, Carl, Magnus Johannesson. 2008).

I get it when you tell me a company’s motto is “Don’t be evil!” or “Do the right thing”. It’s obvious that creative work is not only about the code, it’s what the code does to make our planet better and how it changes people’s lives. How the human potential can be unleashed. Huge cash bonuses and perks for that matter (extrinsic motivation) will not spark the creativity of an engineer or unleash the intelligence of an investment manager – but if you insist, do it with a smile and a firm handshake or public acknowledgement (intrinsic motivation).

Maybe Warren Buffett singing and praising his secretary, Debbie Bosanek, in a ‘My Way’ duet with Paul Ankah will change your mind about intrinsic motivation:

[To the tune of My Way]
The true brain, guts, and glue. Debbie that's you!
You get things done here.
You see, we all agree: she's royalty!
Queen of our palace, heeding each call, Deb does it all!

In an interview with Peter Lynch recently, one of the best investment managers of our time averaging a 29% annual return over 13 years, he was asked by the host why he quit at age 46. Peter said that he had only two gears, OVERDRIVE and OFF. He wanted to spend time with his family, and didn’t want to run the fund at 1/4 or 1/2 gear. What follows is so profound because it shows you the intrinsic motivation of Peter Lynch in running Magellan:

‘…one out of every hundred Americans was in Magellan… it’s a lot of responsibility… if you run a fund at Fidelity it’s the average folks, which is a wonderful feeling when it works.’

Peter Lynch was doing this for his investors and their success was what motivated him.

In an experiment, Dan took 87 participants and promised payment if they performed exceptionally well on an array of tasks that demanded rudimentary cognitive skills.

  • A third were told that they’d be given a small bonus (equivalent to what a participant would receive for a day’s work)
  • A third were told they’d be given a medium bonus (equivalent to what a participant would receive for two weeks work)
  • And a third a high bonus (equivalent to what a participant would receive for five months’ pay)

With hindsight always being 20/20, which of the participants performed the BEST? I can hear you screaming and jumping concluding that of course those that were paid the high bonus performed the BEST!

It turns out that people that were offered medium bonuses performed the same as those offered low bonuses. The ones offered the high bonus did worse than the other two groups. Surprised? Good!

Dan replicated the same study at MIT but this time added another set of participants that were asked to complete mechanical tasks. So you had participants promised to earn $60 (low bonus) and $600 (high bonus) if they completed tasks that required cognitive skills, and another set of participants promised the same amounts but are required to complete mechanical skills. As long as the task involved mechanical skills, the experiment worked as expected. But as soon cognitive skill was required, the higher bonus led to poor performance. The answer lies in a bias referred to as Ego Depletion. I’ll delve deeper into it at a future time.

 One of my favorite business books that I keep close on my shelf is Don Keough’s Ten Commandments of Business Failure. In it he candidly talks about being convinced by experts and consultants to take a serious look at New Coke.

‘After weeks of reviews, debate, and discussion, Roberto and I supported the project. They had convinced us that changing the product would be a brilliant competitive move.’

Imagine a company that really understood what motivated its experts, consultants, and workforce. Imagine also a company that really understood what angered its customers.

It’s a rare person who wants to hear what he doesn’t want to hear” –Dick Cavett

If the leadership of the business you’re investing in understood how to motivate its people and also knew how not to anger its customers, that might be one of the factors for a sustainable competitive advantage.

The Dan Ariely series are inspired by:

John Mihaljevic of the Manual of Ideas. John Mihaljevic, CFA, is author of The Manual of Ideas, the bestselling book on value investing.Manual of Ideas.John is also founder of MOI Global, an invitation-only membership community of intelligent investors. It publishes the Manual of Ideas, “the very best investing newsletter” (Pabrai). John is also a managing director of ValueConferences, the series of fully online investment conferences for sophisticated investors. He has also served as managing partner of investment firm Mihaljevic Capital Management LLC since 2005. He is a member of Value Investors Club, an exclusive community of top money managers, and has won the club’s prize for best investment idea. John is a trained capital allocator, having studied under Yale University chief investment officer David Swensen, and served as research assistant to Nobel Laureate James Tobin. John holds a BA in economics, summa cum laude, from Yale and is a CFA charterholder.
and
Dan Ariely of Duke University. Dan is the James B. Duke Professor of Psychology and Behavioral Economics at Duke and a founding member of the Center for Advanced Hindsight. Dan’s books, Predictably Irrational, The Upside of Irrationality, The Honest Truth About Dishonesty, are NY Times best sellers. Dan also has a podcast “Arming the Donkeys”. A new book by Dan and Jeff Kreisler is expected to go on sale November 11 2017 titled Dollars and Sense.

The Dan Ariely Series: The Die is Cast and the Anchor Set

Colleagues ask how does behavioral economics help investors make money or how does it help investors pick the right stocks or make them better investors? Why can’t we just ignore this discussion about emotional biases and heuristics?

During the Berkshire Hathaway 2017 annual meeting Q&A session, Charlie Munger says:

“I think we have one other advantage. A lot of other people are trying to be brilliant, and we’re trying to stay rational… and… it’s a big advantage!”

Edited image source: Poor Charlie’s Almanac by animoumou.com

Staying rational takes conscience effort and it doesn’t come naturally. Without knowing our biases, we can’t be rational, or as Charlie eloquently puts it:

‘You’re a one-legged man in an ass-kicking contest’

Another investor whom I respect, Allan Mecham of Arlington Value Capital,  in a wonderful interview with the Manual of Ideas talks about using a two-track analysis when looking for investment opportunities:

‘It’s important to keep the litany of subconscious biases in mind when investing. Charlie Munger talks about using a two-track analysis when looking at ideas. I think that’s an extremely valuable concept to implement when looking at investment opportunities. You have to understand the nature and facts governing the business/idea and, equally important, you need to understand the subconscious biases driving your decision making — you need to understand the business, but you also need to understand yourself!’

In an experiment (by Dan Ariely, Drazen  Prelec, and George Lowenstein), college students in a classroom are shown a few random items. A handout with the items listed is given to each student. Students are asked to write their last two digits of their SSN# on top of the page. The random items are: a box of chocolates, a cordless keyboard and mouse, a trackball, a bottle of rare wine, a bottle of average wine, and a design book.

Students are then asked to write their last two digits of their SSN# next to each of the items on the list and add a dollar sign turning it into a price. Then the students are asked to bid for each of the items and write a price they’re willing to pay for each item.

When asked by the researchers, did the last two digits of your SSN# have any effect on the amount you bid? They reply was of course NOT!!

Take a second and think….. What do you think happened?

It turns out that, on average, those with SSN# ending with 80 – 99 bid more for the items, and those SSN# ending  with 01 – 20 bid less for the items. Top 20% avg $56 and bottom 20% avg $16. A 350% difference.

Does this sound rational to you? Do you think you or I are immune?

In this experiment, the SSN# was the anchor. Had the researchers used the students’ shoe size or the current temperature, the results would vary accordingly. Beware of anchoring or – as it’s known by behavioral economists – Arbitrary Coherence.

Could it be that the intricate lives we have carefully crafted are largely a product of arbitrary coherence?

The Dan Ariely series are inspired by:

John Mihaljevic of the Manual of Ideas. John Mihaljevic, CFA, is author of The Manual of Ideas, the bestselling book on value investing.Manual of Ideas.John is also founder of MOI Global, an invitation-only membership community of intelligent investors. It publishes the Manual of Ideas, “the very best investing newsletter” (Pabrai). John is also a managing director of ValueConferences, the series of fully online investment conferences for sophisticated investors. He has also served as managing partner of investment firm Mihaljevic Capital Management LLC since 2005. He is a member of Value Investors Club, an exclusive community of top money managers, and has won the club’s prize for best investment idea. John is a trained capital allocator, having studied under Yale University chief investment officer David Swensen, and served as research assistant to Nobel Laureate James Tobin. John holds a BA in economics, summa cum laude, from Yale and is a CFA charterholder.
and
Dan Ariely of Duke University. Dan is the James B. Duke Professor of Psychology and Behavioral Economics at Duke and a founding member of the Center for Advanced Hindsight. Dan’s books, Predictably Irrational, The Upside of Irrationality, The Honest Truth About Dishonesty, are NY Times best sellers. Dan also has a podcast “Arming the Donkeys”. A new book by Dan and Jeff Kreisler is expected to go on sale November 11 2017 titled Dollars and Sense.

 

 

The Dan Ariely Series: Power of Price

In Dan Ariely’s book Predictably Irrational, the famous Veladone RX experiments conducted on a college campus vividly exposes our bias to the power of price when participants of the experiment were able to withstand more pain from electric shocks taking the full-priced painkiller than those that took the discounted cheap painkiller pill.

Although we later learn that both painkillers were placebos (vitamin C), we wanted to dive into the power of price and how that affects our social decisions when making purchases that have to do with health.

In Ghana, it is not uncommon that a member of my family has malaria from time to time. A friend of mine,

Artefan 20 / 120

Basha the pharmacist, tells me there’s an alternative to the more expensive anti-malarial Coartem 3-day course by Novartis which generally costs anywhere from Ghc35 – Ghc39 equiv. $8-$9. The alternative referred to as ACT Artefan is subsidized and costs roughly $1 or Ghc5.

My understanding from Bendi, another pharmacist friend, is that pharmacies only pay the shipping of the product and Bill Gates pays the rest. Regardless what the truth behind the subsidizing authority or body, there’s an 8x price difference.

The BIG Question is: Which anti-malarial  will you buy for your sick daughter or son or spouse? Not only are they weak in bed shivering from fever with sweat dripping from their forehead, but also too weak to move or eat or drink.

Will you go for the discounted ACT or will you ask for the original fully-priced 3-day course and more expensive drug? Even though we know they’re the same, many of us go for the expensive option.

The Dan Ariely series are inspired by:

John Mihaljevic of the Manual of Ideas. John Mihaljevic, CFA, is author of The Manual of Ideas, the bestselling book on value investing.Manual of Ideas.John is also founder of MOI Global, an invitation-only membership community of intelligent investors. It publishes the Manual of Ideas, “the very best investing newsletter” (Pabrai). John is also a managing director of ValueConferences, the series of fully online investment conferences for sophisticated investors. He has also served as managing partner of investment firm Mihaljevic Capital Management LLC since 2005. He is a member of Value Investors Club, an exclusive community of top money managers, and has won the club’s prize for best investment idea. John is a trained capital allocator, having studied under Yale University chief investment officer David Swensen, and served as research assistant to Nobel Laureate James Tobin. John holds a BA in economics, summa cum laude, from Yale and is a CFA charterholder.
and
Dan Ariely of Duke University. Dan is the James B. Duke Professor of Psychology and Behavioral Economics at Duke and a founding member of the Center for Advanced Hindsight. Dan’s books, Predictably Irrational, The Upside of Irrationality, The Honest Truth About Dishonesty, are NY Times best sellers. Dan also has a podcast “Arming the Donkeys”. A new book by Dan and Jeff Kreisler is expected to go on sale November 11 2017 titled Dollars and Sense.