Enhancing Board Oversight by Challenging Traps and Biases in Professional Judgment - Part 3 of 3

As previously mentioned (see Part 1 and Part 2), the Committee of Sponsoring Organizations of the Treadway Commission (COSO) has released a thought paper called Enhancing Board Oversight: Avoiding Judgment Traps and Biases. COSO recognizes the vital role of consistent, high-quality professional judgment as management and boards of directors execute and oversee an entity’s enterprise risk management, internal control and fraud deterrence efforts.

COSO stresses that “Professional judgment is increasingly important as board members fulfill their responsibilities related to effective oversight of management’s strategic planning, execution, fraud prevention and risk management processes. Even seasoned board members can improve the consistency and soundness of their judgment by being aware of common judgment traps and by following a good judgment process.” Such a process can help avoid threats to good judgment and mitigate the biases associated with common judgment tendencies (see Exhibit 3 below, drawn from page 16 of the COSO Paper).

Exhibit 2 (on page 14 of the Paper) summarizes the traps and tendencies. Exhibit 4 (on page 18 of the Paper) outlines actions that boards can consider at each of the five steps of the judgment process presented in Exhibit 1 (see Part 2).

Many board-level judgments are made in group settings and, although group judgments are often better than individual judgment, group judgments can fall victim to narrow thinking; suppression of divergent views; and, consequently, shallow judgment processes. Some common tendencies in individual judgment that can lead to bias in board-level decisions are the overconfidence tendency, the confirmation tendency, the anchoring tendency and the availability tendency.

Awareness of the common threats to good judgment is the key initial step in improving judgment. Board members can use the insights summarized in this thought paper to test and improve the consistency and quality of management’s judgment processes and outcomes by rigorously challenging perspectives and assumptions via open and frank discussions. Such discussions can include consideration of judgment traps, simplifying tendencies and alternative viewpoints. Board members who are aware of traps and tendencies that limit the quality of judgment can use these insights to challenge management’s judgments and more effectively fulfill their oversight role.

Enhancing Board Oversight by Challenging Traps and Biases in Professional Judgment - Part 2 of 3

As previously mentioned (see Part 1), COSO has released a thought paper called Enhancing Board Oversight: Avoiding Judgment Traps and Biases. According to this thought paper, “judgment is the process of reaching a decision or drawing a conclusion when there are a number of possible alternative solutions. An effective judgment process will be logical, flexible, unbiased, objective and consistent. It will utilize an appropriate amount of relevant information, and it will properly balance experience, knowledge, intuition and emotion.”

The paper notes that: “we often do not follow a sound process due to common judgment traps and tendencies that can lead to bias. Some of these tendencies are judgment shortcuts that help simplify a complex world and facilitate more efficient judgments. However, these shortcuts sometimes can lead to suboptimal judgments. The judgment traps and tendencies are systematic—in other words, they are common to most people, and they are predictable.”

It also points out that: “By consistently following a sound judgment process, understanding where directors and management are vulnerable to predictable traps, and appropriately challenging their own judgments and the judgments of those they are charged with overseeing, directors can improve their oversight and monitoring of the organization’s strategies and risks, including the risk of fraud. Following a better judgment process translates to improved risk management and better business outcomes.”

Exhibit 1 (on page 3 of the Paper) illustrates a model of a good judgment process. The steps in this process are simple to understand. Although the steps are a representation of the process to follow, the Exhibit does not depict how people actually make judgments. It provides a helpful context to illustrate where judgments can go wrong. The reality is that in a world of high-stake decisions, deadlines and limited capacity, the judgments of even highly educated, capable people are vulnerable to common, systematic traps and predictable biases.

This thought paper highlights some of the common pitfalls and biases in judgments to which decision makers are vulnerable and provides an overview of actions and steps that boards can take to avoid falling prey to them. For additional insight, read the COSO Paper and the article “COSO explores common judgement traps, lays out five-step decision-making process”at CGMA Magazine online.

Enhancing Board Oversight by Challenging Traps and Biases in Professional Judgment - Part 1 of 3

Recently, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) commissioned a paper on Enhancing Board Oversight: Avoiding Judgment Traps and Biases. Originally formed in 1985, COSO is a joint initiative of five private sector organizations and is dedicated to providing thought leadership through the development of frameworks and guidance on enterprise risk management (ERM), internal control and fraud deterrence. COSO’s supporting organizations are the Institute of Internal Auditors (IIA), the American Accounting Association (AAA), the American Institute of Certified Public Accountants (AICPA), Financial Executives International (FEI) and the Institute of Management Accountants (IMA).

The paper was authored by Steven M. Glover, CPA, Ph.D., and Douglas F. Prawitt, CPA, Ph.D., as well as contributing authors from KPMG LLP including Sam Ranzilla, National Managing Partner, Audit Quality and Professional Practice; George Herrmann, National Office Partner; and Rob Chevalier, National Office Partner. It provides a five-step judgment process that board members and others can use to overcome common pitfalls and mitigate the effects of judgment bias. The judgment process is based on KPMG’s Professional Judgment Framework, which enables individuals to identify where and when the quality of judgments tends to be threatened by predictable, systematic judgment traps and biases.

The authors note that: “Consistently making high-quality professional judgments in a constantly changing environment has never been more important or challenging. The growing complexities of the global business environment and demands for effective corporate governance and oversight have placed a premium on sound judgment and decision making by all key players in the marketplace: management, boards of directors, auditors, and others. Our hope is that this collaboration—incorporating insights from academic research and reflecting KPMG’s commitment to consistent and incisive professional judgment in all aspects of its work—will be useful to board members in appropriately evaluating and challenging judgments and in encouraging sound decision making and solid performance.”

To learn more, view the COSO press release “COSO Releases Thought Paper on Enhancing Board Oversight by Avoiding and Challenging Traps and Biases in Professional Judgment” and read the paper Enhancing Board Oversight: Avoiding Judgment Traps and Biases.