2. Methodology
2.7 The Behavioural Constructs Examined
This section summarises the bounded rationality constructs that were explored in the thesis.
Two of these have been shown to be specific to climate change response while the rest of the list have been studied and proven in finance, economics and other decision fields.
2.7.1 The ‟No Regret‟ and „Energy Efficiency Gap‟ Paradoxes
‗No regret‘ emission reduction potential, as already explained under the literature review chapter is defined as a situation in which the costs of implementing a measure are more than offset by the direct or indirect benefits (not including climate-related benefits) it generates, based on traditional financial criteria (Huntington et al., 1994). The failure to make ‗no regret‘
choices defies market logic, because overcoming ‗no regret‘ failures is argued to be unequivocally efficient and climate-friendly (IPCC, 2001). According to the normative economic and finance paradigm, if such a profitable potential did exist, economic agents (i.e. optimising machines) would eventually undertake the necessary investments to capture it (Sutherland, 2000). Yet, despite considerable efforts and calls to push for climate-friendly investments, even simple ‗no regrets‘ choices on the energy demand-side management (CDP, 2010), such as reduced energy costs as a result of deployment of energy-efficient technologies, fuel-efficient and economic vehicles, and a change in energy use behaviours and habits (WWF, 2011) etc., have failed to penetrate even a fraction of their potential.
From a market perspective, users of such energy equipment defy the simple logic of preference for cost-effective operations, leading to what has been termed the "efficiency gap" (De Caino, 1998). While some market oriented pundits are baffled by this ―irrationality‖, others have attempted to explain it away using the concept of market failures, citing hidden costs (unprized environmental externalities) and market imperfections such as insufficient investible resources, imperfect information, distortionary taxation or misplaced incentives (Sutherland, 2000).
However, while such costs do indeed exist, bottom-up studies have shown that they do not quite offset the benefits from identified profitable energy-efficient investments (Brown, 2001).
DeCanio (1998) and Shove (2005) showed that there are non-economic barriers that are just as important to bring to the light if decision-makers are to tap into the ‗no regret‘ potential, citing organisational and institutional behaviours as arguments in explaining the efficiency gap in
energy. Schleich and Gruber (2008) concurred that the idea of routinized behaviours is aggregated in groups such as firms and institutions where sources of inertia are multiple. These relate to the irrationality of man commonly referred to as the ―bounded rationality‖ of economic agents (Simon, 1955). In adapting to their limited capabilities, agents adopt decision ―routines‖
to simplify their decision making process and ensure satisfactory results, a phenomenon Simon (1955), termed ―satisficing‖.
2.7.2 Other Irrational Behaviours in Strategic Decision Making
The other irrational behaviours whose influence was examined in the corporate climate change strategy formulation programme are provided in Table 2-1. The researcher looked for predictors or indications of the predictors of each of the irrational behavioural concepts as detailed in the last column of each behavioural concept in the table.
Table 2-1 Behavioural Constructs under Study
Behavioural
Concept Definition and
Descriptors Key Authors Predictors/ behavioural tendencies
Availability
heuristic Rule of thumb or mental shortcut that allows one to estimate the probability of an outcome based on how prevalent or familiar that outcome is.
Tversky &
Kahneman (1973) Gilovich & Griffin (2002)
Irretrievability – ideas that are retrieved most easily also seem to be the most credible.
Categorisation – categorising or summoning information that matches a certain reference.
Narrow range of experience – when a person possesses a too restrictive frame of reference.
Resonance – extent to which a situation resonates with the individual‘s personal situation.
Anchoring and
adjustment
In numerical prediction, when a relevant value (anchor) is available, people make estimates by starting from an initial value (anchor) that is adjusted to yield final value.
Tversky &
Kahneman (1974) Undue emphasis on statistically arbitrary, psychologically determined hurdles rates, prices.
Perceiving new information through a warped lens.
Mental
accounting Tendency to code, categorise and evaluate economic outcomes by grouping assets into any number of non- interchangeable mental
Thaler (1985) Thaler (1999) Barberis & Huang (2001)
Placement of investment assets into discrete ―buckets‖
according to asset type without regard for potential correlations connecting investments across
accounts.
Two values are attached to any transaction - acquisition value and transaction value.
Acquisition value is the money that one is ready to part with for physically acquiring some good.
Transaction value is the value one attaches to having a good deal. If the price that one is paying is equal to the mental reference price for the good, the transaction value is zero. If the price is lower than the reference price, the transaction utility is positive.
categories.
Layered investment portfolios with each tier addressing certain investment goals independent of any additional goals.
Increased or reduced risk taking behaviour on investments depending on the capital classification, e.g. Money you can afford to lose (risk money, risk capital); Money you need (safety capital).
Status quo
bias Tendency to want things to
stay relatively the same. Samuelson &
Zeckhauser (1988) Kahneman, Kentsch
& Thaler (1991) Fernandez & Rodrik (1991)
Inertia, usually because of an emotional attachment or lack of knowledge of the alternatives.
Finding that an option is more desirable if it is designated as the ―status quo‖ than when it is not
Holding inappropriate assets.
Loss aversion and Myopic loss aversion
Losses and disadvantages have greater impact on preferences than gains and advantages.
Approximately risk neutral when stakes are small.
Stronger impulse to avoid losses than to acquire gains.
Kahneman, Kentsch
& Thaler (1990) Kahneman, Kentsch
& Thaler (1991) Kahneman &
Tversky (1991) Benartzi & Thaler (1995)
Consistent one-sided deviations of subjects‘ choices from the predictions of risk neutrality causing decision makers to hold on to a more risky portfolio instead of divesting from some investment, or not taking up certain investment resulting in unbalanced portfolios.
Endowment
effect People often demand much more to give up an object than they would be willing to pay to acquire it.
A differential weight is placed on the value of an object.
Kahneman, Kentsch
& Thaler (1990) Kahneman, Kentsch
& Thaler (1991)
Bargaining habits (willingness to pay WTP, or willingness to accept, WTA).
Resistance to offload certain assets in ownership due to fear of unknown assets, or attachments to legacy.
Familiarity is treated as having value.
Hyperbolic Discounting (short vs. long horizons)
Tendency for people to have a stronger preference for more immediate payoffs relative to later payoffs, where the tendency increases the closer to the present both payoffs are.
Poterba & Summers (1988)
Lee & Swaminathan (2000)
Positive autocorrelation in returns over short horizons and negative autocorrelation over long horizons.
From a distant perspective we see the forest, but from a proximal perspective, we see trees.
Herding Social influences such as
"emulation," where some members of a group mimic other members of higher status.
Tendency towards mass or copied behaviour (group think),
Choosing the socially desirable option.
Information
aggregation/cascade in market contexts.
Banerjee (1992) Grinblatt, Titman &
Wermers (1995) Wermers (1999) Nofsinger & Sias (1999)
Diffusion processes whereby organisations adopt an innovation, not because of their individual assessments of the action's efficiency or returns, but because of a bandwagon pressure caused by the sheer number of organisations that have already participated in this action.
Affect heuristics (anchoring and
adjustment)
Deriving both risk and benefit evaluations from a common source.
Basing a decision on an emotional reaction rather than a calculation of risks and benefits.
Finuacane et al. (2000)
Slovic, et al. (2002) Gilovich & Griffin (2002)
Rule of thumb decisions.
Experienced as a feeling state with or without consciousness.
Relying more on experiential systems for decision making.
The behavioural perspectives presented in this section will be applied to the domain of climate change response investments. To this end, a framework that examines the relationship between these behaviours and companies‘ responses to climate change will be developed.
The next section describes in detail the operationalization of the multi-criterion nature of the climate change challenge for organisations using the analytical hierarchy process (AHP) as the chosen multi-objective decision aid tool.