Risk-Taking

The psychology of achievement and risk-taking has been a topic of interest to both experimental psychologists and economists for a very long time. Lola Lopes wrote an interesting article, published in the Journal of Experimental Psychology, which served as a primary reference article for many of the “risky” ideas presented in this column.

The well-known psychologist David McClelland’s ideas on achievement motivation have been common fodder fed to psychology students for over 70 years.

McClelland emphasized the importance of what he called the need to achieve in influencing economic development. For example, he did studies comparing the electric power consumption of different countries, since he figured that the greater amount of electricity used, the higher the achievement need for that particular country. I disagree with that measure since Norway, Canada and Sweden were the top three countries in consumption of electricity. I think they used more electricity to stay warm, not because their need for achievement was higher!

Another psychologist, Atkinson, emphasized the importance of different variables influencing the need for achievement. These included the degree of anxiety about failure, the probability of success or failure and the degree of reward or punishment accompanying success or failure.

Atkinson found that people with high needs for achievement tend to take risks when the probability of success is about 50-50.

However, people with a low need for achievement prefer a much higher probability of successes than 50%. These research subjects traded high rewards for a greater security level. These are probably the people who invest in single digit IRAs, for example. They also prefer explicit risks to risks that are ambiguous. People with a low need for achievement will also prefer risks with a much higher probability of failure. Apparently, when the odds against success are great, the low need for achievement person does not emotionally invest himself or herself, and thus failure is not anxiety producing. Such people can fail at such tasks without experiencing a loss of self-esteem.

A distinction is often made between the definition of risk and of uncertainty in decision-making. Decisions are considered “risky” if the decision maker knows both the possible outcomes and the probability accompanying each outcome. In this case, the risk becomes measurable. But decisions are made under uncertainty if the decision maker knows the outcome but must guess about the probability of each outcome occurring.

Insurance companies stay in business because they deal, in the main, with measurable risks. Insurance companies deal with events that occur in groups large enough and familiar enough that the statistical probability of certain common events occurring can be calculated.

Lloyd’s of London is somewhat exceptional, in that they often have insured people, places, and events for which probabilities are difficult, if not impossible, to calculate. But, a good businessperson can always see the potential gain in a situation, even if, on the surface they risk a huge loss.

For example, in 1971, the Scotch producer Cutty Sark offered five million pounds for the capture of the Loch Ness Monster. Later, the liquor company had second thoughts and asked Lloyd’s for coverage against the monster being caught. For 2500 pounds, Lloyd’s agreed to do so, if (a) the monster was authenticated by the curators of the London Natural History Museum, (b) was at least twenty feet long, (c) was caught between May 1, 1971 and April 30, 1972, and (d) if Lloyd’s could keep the monster. Thus, Lloyd’s devised a scheme whereby they would profit, no matter the outcome.

To summarize, risk-taking entails many factors. These factors include the degree of the risk-taker’s need for achievement, the degree of uncertainty accompanying each outcome, the amount of reward or punishment involved, and the risk-taker’s ability to turn even a loss situation into a profit.