Strategy & Corporate Finance Practice

What I learned from

Daniel Kahneman
Daniel Kahneman, the psychologist whose findings helped launch
behavioral economics, passed away this March. The encouraging
words he shared with me offer good news for organizations.
by Tim Koller

October 2024
One night, over dinner, Daniel Kahneman1 changed These businesses should receive fewer
my perspective on value creation. Why do so many resources—or none at all.
people, including leaders of large corporations,
draw back from acting more boldly, even when Yet even when the data and conclusions are
taking incremental risks can create much greater indisputable and highly capable CEOs and CFOs
returns? And perhaps more important: Can anything recognize what needs to be done, their companies
be done about it? often still fail to allocate resources as they should.
Instead, managers and their teams fall back to the
Kahneman explained to me that while it’s hard to same ways of doing things. The companies don’t
change human nature, it’s much easier for maximize value. Or worse, they watch upstarts and
organizations to take practical steps to overcome competitors disrupt their businesses. It doesn’t
human decision biases. By understanding the seem rational.
inherent irrationality of how people make
decisions—including a strong tendency toward loss But it’s human. Thanks to Daniel Kahneman, we
aversion—companies can successfully encourage now understand human nature—and all of its
managers to allocate more resources for more apparent irrationality—much more clearly.
value-creating projects. Kahneman and his research partner, psychologist
Amos Tversky, found that people didn’t make
His insights were a revelation to me. I’ve been a decisions in the ways that economists had
consultant for more than 40 years, nearly all of that traditionally assumed. Harvard University
span at McKinsey. Over those decades, I’ve been psychologist and author Steven Pinker said of
blessed to work with not only brilliant colleagues Kahneman: “His central message could not be more
but also many of the most effective business important, namely, that human reason left to its own
leaders in the world. From the very start, I sought to devices is apt to engage in a number of fallacies
understand and explain how companies could and systematic errors, so if we want to make better
allocate their resources to maximize value over the decisions in our personal lives and as a society, we
long term. With that mission in mind, my coauthors ought to be aware of these biases and seek
and I wrote what turned out to be a best-selling workarounds. That’s a powerful and important
book on corporate valuation, Valuation: Measuring discovery.”3
and Managing the Value of Companies; next year
will mark its eighth edition.2 Kahneman’s published work was primarily about
individual decision making. I, along with my
Yet from the time I began analyzing companies collaborator Dan Lovallo, had the opportunity to
(this, even before I was a consultant), and for years work with Kahneman on how organizations might
afterward, I was puzzled: Why don’t companies take improve their decision making. It was while we were
obvious, rational actions to maximize long-term having dinner that I asked him straight out, “If
value? It’s up to senior leaders to allocate resources people don’t behave in an economically rational
to the projects that create the largest cash flows way, is there any hope for organizations?”
over time. Some projects deliver outsize,
sustainable returns; it’s clear that these initiatives Yes, Kahneman assured me. “I’m much more
should receive more company resources. Other optimistic about organizations than individuals,” he
investments deliver lower or even negative returns. said. “Organizations can put systems in place to

1
Dr. Kahneman died in March 2024 at age 90. He won the Nobel Prize in economics, although he was a psychologist. That’s a testament to the
impact of his insights, along with those of his collaborator, Amos Tversky, who died in 1996. Their work laid the foundation for what we now call
“behavioral economics” and “behavioral finance.”
2
Tim Koller, Marc Goedhart, David Wessels, Valuation: Measuring and Managing the Value of Companies, seventh edition, New York, NY: John
Wiley & Sons, 2020.
3
Robert D. Hershey Jr., “Daniel Kahneman, who plumbed the psychology of economics, dies at 90,” New York Times, March 27, 2024.

What I learned from Daniel Kahneman 2

Managers can develop rules and
processes that help overcome inherent
decision-making biases.

help them.” Managers can develop rules and subject matter experts (not just the top
processes that help overcome inherent decision- management team), and, for really big decisions,
making biases. putting in place a red and blue team approach in
which two teams are assigned to take opposite
Drawing on Kahneman’s insights, my colleagues points of view.
and I have proposed (or adopted from others)
several techniques to help organizations Loss aversion is the idea that human beings weight
understand and improve their decision making in losses more than they do gains and, therefore, pass
resource allocation. In particular, our research finds up promising investment opportunities. Dan and I
that large organizations often suffer from four cowrote with Kahneman the Harvard Business
decision-making biases that Kahneman’s work Review article, “Your company is too risk-averse.”4
helps solve: groupthink, loss aversion, confirmation We showed that what mattered was not the
bias, and anchoring. riskiness of an individual project but how that
project contributed to the overall risk of the
Groupthink and its sibling concept “sunflower company’s portfolio of projects. We found that, too
management” lead to a lack of debate about often, companies pass up attractive projects and
important decisions. In groupthink, individuals are focus on the risk of each one. But when companies
reluctant to raise ideas that might be different from aggregate projects, they achieve a natural
what they perceive as the emerging consensus. diversification effect and can realize a better
With sunflower management, executives try to financial result without taking on much, if any,
guess what the most senior person wants to hear additional risk.
rather than expressing their own points of view and
then bend their own views accordingly. While the Confirmation bias is the tendency to search only for
best solution is a culture of debate, fostering a data or evidence that supports a hypothesis. For
strong obligation-to-debate culture can take years example, a management team might develop a
to develop (and unfortunately, much less time to hypothesis about a strategic direction for a
destroy). Short-term techniques to ensure that business and, consciously or otherwise, highlight
valuable insights are heard can include assigning only confirming data. As a result, they will miss
someone to be a devil’s advocate, insisting that the information that might send them in a different
most senior people don’t express their views until direction. Overcoming confirmation bias is relatively
everyone has had a chance for input, bringing in simple, so long as organizations follow Kahneman’s

4
Dan Lovallo, Tim Koller, Robert Uhlaner, and Daniel Kahneman, “Your company is too risk-averse,” Harvard Business Review, March–April 2020.

What I learned from Daniel Kahneman 3

Our research finds that large
organizations often suffer from four
decision-making biases that
Kahneman’s work helps solve:
groupthink, loss aversion, confirmation
bias, and anchoring.

counsel to put rules in place that must be followed. bias. For example, an organization might create a
All it takes is discipline and enforcement by top rule that every strategic initiative in the budget
management to insist on asking the right questions. must be fully funded.

Anchoring is the tendency to make decisions based These rules may feel unnatural, and indeed they
on past (or even irrelevant) information. Large often go against human nature. But while you can’t
organizations tend to anchor their budgets and change human nature, thanks to Kahneman, I’ve
resource allocation decisions based on what they learned that you can change how organizations
did last year, with only minor deviations. As a result, approach resource allocation. Debiasing decision
their budgets won’t be aligned with any potential making helps companies achieve value-creation
strategic shifts that top management may want to opportunities that were there all along.
make. Once again, putting in place rules that
Kahneman recommended can overcome significant

Tim Koller is a partner in McKinsey’s Denver office.

This article was edited by David Schwartz, an executive editor in the Tel Aviv office.

Copyright © 2024 McKinsey & Company. All rights reserved.

What I learned from Daniel Kahneman 4