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Journal of Education for Business
ISSN: 0883-2323 (Print) 1940-3356 (Online) Journal homepage: http://www.tandfonline.com/loi/vjeb20
Bringing Reality to “Real Options”: An Experiential
Exercise
Craig Turner & Kyle Dean Turner
To cite this article: Craig Turner & Kyle Dean Turner (2015) Bringing Reality to “Real Options”: An Experiential Exercise, Journal of Education for Business, 90:3, 164-168, DOI: 10.1080/08832323.2014.988203
To link to this article: http://dx.doi.org/10.1080/08832323.2014.988203
Published online: 22 Dec 2014.
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Bringing Reality to “Real Options”:
An Experiential Exercise
Craig Turner
East Tennessee State University, Johnson City, Tennessee, USA
Kyle Dean Turner
University of Tennessee-Knoxville, Knoxville, Tennessee, USA
Issues surrounding the contextual environment in which strategic decisions are made are difficult concepts to grasp, particularly for undergraduate students with little business experience. They are also problematic for graduate students that have not been called on to make such decisions within their career. The authors propose an exercise that blends many elements of decision making under uncertainty and risk. Students are placed in an environment in which their own choice may differ from that of the team, but in which the team’s performance will have explicit implications on their individual performance and rewards. The exercise incorporates team dynamics and problem-solving capabilities in a temporally and competitively constrained environment.
Keywords: experiential exercise, gain context, loss context, pedagogy, risk
The use and effectiveness of experiential exercises has been addressed in numerous studies since the mid-1970s work of Certo (1975). The overwhelming consensus is that they pro-vide a benefit to the student in solidifying the knowledge and skills they have attained via more traditional methods as well as the instructor by providing illustrations of the material covered in the classroom, particularly those arenas that are best exemplified as configurational in nature. One such arena is that of risk and strategic decisions (Wiseman & Gomez-Mejia, 1998). This is particularly poignant in sit-uations where risk can be mitigated or reduced by individu-als or organizations and these decisions can be enacted to varying degrees based on the perception of the decision maker(s) relative to the future value of the decision (adjusted for risk) and their current state. The study of these “Real Options” (McGrath, 1997) has vast implications across a wide variety of behavioral discourse including the functioning of top management teams, board oversight, and even public policy. Understanding the intricacies of the nature of these decisions is difficult to explain in a class-room setting, but experiential exercises can be designed to
allow students to learn by feeling the pressures of these choices and interactions enhancing their ability to assess and anticipate the behavior of their focal firm and its com-petitors. The design of this exercise fits quite well with the directives prescribed by Aguinis and Bradley (2014) in their experimental vignette methodology (EVM) recom-mendations designed to enhance the validity of such exer-cises. We carefully constructed the scenario to accurately replicate a realistic environment, establish a proper attitude for behavior, and offer teachers and researchers the ability to adapt their independent variables to meet the needs of their students and learning objectives.
THE EXPERIENTIAL EXERCISE
Team Development
This exercise is designed to work best after two examina-tions have been completed in the semester. The instructor should place the students into groups of 3–4 individuals. By establishing groups of this size we enhance the likelihood of building consensus while still maintaining the opportu-nity for discussion and debate.
Correspondence should be addressed to Craig Turner, East Tennessee State University, Department of Management, 115 Sam Wilson Hall, Johnson City, TN 37614–1266, USA. E-mail: [email protected]
ISSN: 0883-2323 print / 1940-3356 online DOI: 10.1080/08832323.2014.988203
Teams should not be artificially developed to create spe-cific contextual environments (such as all high achieving, low achieving, or mix) due to confidentiality issues. They can be randomly assigned, use prior membership, or self-selected.
The Exercise
There are numerous mind teaser games available (we used the “Who Owns the Fish?” exercise, attributed to Albert Einstein [see Appendix A]) for this exercise. It is very important that the challenge has sufficient complexity to convince the students that there is a high likelihood that they may not be able to reach an accurate conclusion on their own. In addition, we altered the exercise to create four possible outcomes of the puzzle, one for which there was no way to solve it definitively. The students are told this upfront so they can accurately assess their potential for suc-cess. Each student his or her own copy of the puzzle.
The risk–reward element is brought in via a competitive environment. The teams are given the following directions:
1. The first team to turn in a correct answer within 25 min will receive five points added to their exami-nation scores. However, if their answer is incorrect, they will have three points deducted from their scores (they may go back and work further). As long as there has not been a correct answer turned in the other teams are still competing under this scenario up to the 25 min.
2. After 25 min and up to 40 min (or after the first cor-rect answer has been received) the reward is reduced to two points added for a correct answer and a loss of one point for an erroneous answer.
3. After 40 min the reward is reduced to one point, but there is no penalty for wrong answers.
4. There must be a signed copy of the team’s solution verifying the vote to submit!
It is very important that this exercise has the ability to have significant impact on the students’ final grade. It is up to the instructor to adjust the previous points to accommo-date this requirement and it is encouraged that they use the EVM guidelines (Aguinis & Bradley, 2014).
STRATEGIC MANAGEMENT THEORETICAL REPRESENTATIONS
Behavioral Agency Model
Recent theoretic development and research into risk and competitive interactions has begun to focus attention on the framing of these decisions by the top management teams (TMT) of organizations (Connolly, 1988; Cyert & March, 1963; Ferrier, 2001; Gilley, Walters, & Olson, 2002;
Wiseman & Gomez-Mejia, 1998). The enhancement of our understanding of how decision makers frame strategic choices, and the effects of that framing on the choices made, particularly in the arena of risk, has become of criti-cal importance to both researchers and practitioners (Bateman & Zeithaml, 1989; Bromiley, 1991; Bromiley, Miller, & Rau, 2001; Fiegenbaum & Thomas, 1986; Finkel-stein & Hambrick, 1996; McNamara & Bromiley, 1999; Pablo, Sitkin, & Jemison, 1996; Turner, Ryman, & Dean, 2008; Wiseman & Gomez-Mejia, 1998). Strategic risk deci-sions are particularly pertinent in this regard. These risk decisions include such choices as the degree of foreign exchange exposure (or other hedging mechanisms; Hammer, 1988; Miller, 1998; Palmer & Wiseman, 1999), the amount of research and development undertaken, the credit risk taken on accounts receivable, and so forth. The better understanding our students have of the organizational mind (Schwenk, 1995), the more capable they will be at predicting their risk behaviors and the outcomes thereof. In the following sections some of the learning opportunities will be discussed. While not an exhaustive list (students often bring up elements that they noted subsequent to the exercise) they give instructors some general ideas of how to incorporate the learning into some of the basic arenas of strategic management.
Gain and Loss Context
Each student has a differing gain–loss context due to their relative positioning, expectations of their relative position-ing (Donaldson, 1999; Fiegenbaum & Thomas, 1988; Kah-neman & Tversky, 1979), prior experience in similar exercises (Bell, 1983), and trend in performance (March, 1988; Wiseman & Gomez-Mejia, 1998). These alter the way the student frames the problem (Nutt, 1998) and estab-lish their aspirations (Greve, 1998). In group decision mak-ing there will be a moderatmak-ing affect of the congruency of aspirations within the decision-making team. The students will learn this as they begin to converge on a solution of which they are not 100% sure is correct. As they discuss their solution they inevitably begin to ascertain the likeli-hood that they are correct, but the differences in the mem-bers’ relative prior performance plays a role in their willingness to present their solution to receive the points (given the risk of loss). In classes where the plus–minus grading scale is not used these differences are quite dra-matic and exemplify Collins and Ruefli’s (1996) ordinal risk perspective in which the likelihood of moving from one position in a rank ordering to another (higher or lower) creates the contextual perception of the decision maker. As a student considers the possibility of moving from an A to a B there is a full point of grade point average reduction ver-sus the change from an A to an A- having a 0.25 affect (dependent on the institution). The more continuous the nature of the perceived effects, the more the curvilinear REALITY TO REAL OPTIONS EXPERIENTIAL EXERCISE 165
behavior found by Bowman (1980, 1982) and Bromiley (1991) will be consistent. There are also relative levels of competency that moderate the relationship. While these skills may represent a competitive advantage (Barney, 1994), the students that have the highest probability of suc-cessfully solving the puzzle independently are also likely to be the higher performers in the class leaving them with a higher loss context and therefore less likely to desire the group to present their solution at the time of maximum loss potential.
Innovation and Intrapreneurship
In the technological innovation literature we often talk about the uncertainty of value and likelihood of acceptance of new innovation (Burgelman & Grove, 1996). The exer-cise mimics this in the early stage while the students are uncertain that a solution truly does exist. As more certainty emerges they move from uncertainty where probabilities are difficult to establish to where they are more readily approximated and therefore fall under the categorization of risk (Knight, 1921). As certainty that a solution exists becomes evident after the first successful solution is ren-dered, the confidence in the risk context is altered and the group then is only assessing whether their answer is correct rather than if an answer exists. This also is useful in discus-sing the returns to innovation in that early entrants may have the potential for higher rewards, but the risk they take may not payoff and therefore they take the losses while later entrants, having waited until more certainty had been established, may have a limited return, but they also did not have to take as high of a risk of loss either. This plays into the concept that sometimes “the second rat gets the cheese!” model of innovation. The game also illustrates this environment by altering the proportional relationship between gain and loss contexts once again based upon the degree of certainty and the lowering of risky entry.
Competitive Interactions
During the exercise the groups are seated close enough to be aware of changes in behavior of the opposing teams, but not close enough to hear their detailed discussions. This awareness simulates the degree of competitive intelligence in technological environments in that they are cognizant that the other firm, or firms, are getting close to a response (therefore close to making the larger point gain) and tend to ramp up their efforts to beat them, or become more focused on finding out if the competitor truly has the answer than working on their own. If it becomes a race, the group dynamics are altered as reluctant members are pushed to make a move before the gain context is reduced. If the first team to turn in a response turns in a wrong answer, even teams that believe they have a correct answer begin to go back to earlier stages of their analysis to verify.
Intraorganizational Decision Making
Understanding the complexity of decision making within organizations is difficult for many students. This exercise allows for discussions related to individual risk preferences, how those are affected by the gain and loss context, and how that alters the teams decision making process and out-come. Teams use several methods to solve the puzzles, but they can generally be categorized in two ways: (a) each individual attempts to solve the puzzle and then the team looks for consensus of solution and (b) the team works from one template and team members feed their informa-tion and observainforma-tions into the common template. These dynamics are affected by the level of trust students have in their teammates which is often derived from prior work with each other, or knowledge of the cognitive capabilities of the teammates. This also provides a solid opportunity for discussion of team related issues as they relate to the behav-ioral agency model. Finally, students gain the experience of feeling peer pressure to either taking the risk, or avoiding it as they find themselves drawn toward a position that they may be less then comfortable with accepting.
OBSERVATION AND DISCUSSION
The true value of experiential exercises is their ability to demonstrate theory in a way that students find appealing which leads to better retention of knowledge gained (Gosen & Washbush, 2004). This exercise meets that objective and gives students a vision of the complexity and contexts that can affect the decisions of a team and their own choices. One key indicator this is occurring with this exercise is the percentage of students that used one or more elements of the exercise in their discussions on essay questions in their final exam. The primary question via which this is addressed asks the student about the traditional risk/return relationship and how context affects this relationship. In the 12 classes that this tool has been used 79% of the stu-dents used the experiential exercise to describe the theoreti-cal concept being addressed. Of those students that cited the tool in their exam, 88% used it multiple times on their exam. These students performed significantly better on all aspects of their exam (p<.01). Finally, student evaluations
have been overwhelmingly positive towards the exercise, indeed there have been no derogatory remarks relative to the exercise and that includes those that chose not to take the risk. Of the students that responded to the additional comments request, 52% referred to the exercise and of those 95% were positive in their feedback. The students that had ambivalent comments (there were no negative comments) merely made statements such as that it created a “decision that was interesting, but difficult for me individu-ally”; “fun, but would have preferred it to be an individual choice”; and “would like to try it again with another
group.” The reliability of these findings is somewhat pro-tected in that these feedback loops are not completed until long after the students’ grades have been assigned. The stu-dents are aware of this before they fill out their evaluations.
We have also begun to collect survey data from students related to their observations of their own and their team-mate’s behaviors during the exercise. This data will be used to test theories of individual and group decision making. While student data has its limitations in research, we believe that the context of this exercise creates a realistic environment from which to assess the behavioral compo-nents of decision making models.
As mentioned earlier, this exercise has applicability at multiple levels of education, but it also has potential in sev-eral different courses as well. Some of the courses that it has already been used in include strategic management of innovation and technology, strategic processes, strategic policy, strategic leadership, and entrepreneurial finance. It is quite feasible that the tool can be adapted to include such courses as organizational behavior and entrepreneurship courses.
It is our hope that we will continue to hear from instruc-tors about new and unique ways to further develop, facili-tate, and evaluate this experiential exercise.
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REALITY TO REAL OPTIONS EXPERIENTIAL EXERCISE 167
APPENDIX A
The “Who Owns the Fish” Exercise With the Traditional Solution
Who Owns the Fish???
There are 5 Houses of Different Colors
There is a Person of a Different Nationality in Each House The 5 Owners
BDrink a certain drink
BSmoke a Certain Type of Cigarette BHave a Certain Pet
BNone are Replicated WHO OWNS THE FISH???
Clues
1. The British Man Lives in the Red House 2. The Swedish Man Has a Dog for a Pet 3. The Danish Man Drinks Tea
4. The Green House is to the Left of the White House
5. The Owner of the Green House Drinks Coffee 6. The Person That Smokes Pall Mall has a Bird 7. The Owner of the Yellow House Smokes Dunhill 8. The Person That Lives in the Middle House Drinks Milk 9. The Norwegian Lives in the First House
10. The Person That Smokes Blend Lives Next to the One That Has a Cat
11. The Person That has a Horse Lives Next to the One That Smokes Dunhill
12. The One That Smokes Bluemaster Drinks Beer 13. The German Smokes Prince
14. The Norwegian Lives Next to a Blue House
15. The Person That Smokes Blend has a Neighbor That Drinks Water
Solution
Color of House Yellow Blue Red Green White Nationality Norwegian Dane Brit German Swede Drink Water Tea Milk Coffee Beer
Pet Cat Horse Bird Fish Dog
