US Companies Not Investing Due To Behavioral Bias And Loss Aversion: McKinsey & Co Study

From McKinsey Quarterly, "A bias against investment? Companies should be investing to improve their performance and set the stage for growth. They’re not. A survey of executives suggests behavioral bias is a culprit." by Tim Koller, Dan Lovallo, and Zane Williams, September 2011:

Most executives, the survey found, believe that their companies are too stingy, especially for investments expensed immediately through the income statement and not capitalized over the longer term. Indeed, about two-thirds of the respondents said that their companies underinvest in product development, and more than half that they underinvest in sales and marketing and in financing start-ups for new products or new markets. Bypassed opportunities aren’t just a missed opportunity for individual companies: the investment dearth hurts whole economies and job creation efforts as well.***Executives also reported a high degree of loss aversion in the investment decisions they’d observed. They exhibited the same tendency themselves, even when the value they expected from an investment appeared strongly positive. When asked to assess a hypothetical investment scenario with a possible loss of $100 million and a possible gain of $400 million, for example, most respondents were willing to accept a risk of loss only between 1 and 20 percent, although the net present value would be positive up to a 75 percent risk of loss. Such excessive loss aversion probably explains why many companies fail to pursue profitable investment opportunities.***Executives may be limiting the investments of their companies because of economic fundamentals and policy uncertainties. But their decision making is also tainted by biases and loss aversion that harm performance and cause companies to miss potentially value-creating opportunities. [Emphasis Added].

Read the McKinsey study here.