Monday Mornings with Madison

Thinking Errors and Business: Confirmation Bias, Part 2

Word Count: 1,616
Estimated Read Time: 6 1/2 min.

The Downside of Confirmation Bias

The term Confirmation Bias was first coined by British psychologist Peter Cathcart Wason in 1960 during an experiment he conducted.  The term has since been used and proven countless times.

Confirmation bias is the tendency for people to search for, interpret, favor, and recall information that confirms their own pre-existing beliefs or hypotheses. [1] People also tend to interpret ambiguous evidence as supporting their existing position.

By definition, Confirmation Bias is an error in thinking where we accept or reject information based on whether it fits with what we already believe.  Last week, we talked about how Confirmation Bias works.  As a quick recap, some of the more common types of Confirmation Bias include:

1.  Belief Perseverance – when beliefs persist even after the evidence for them is shown to be false.  Belief Perseverance continues to persist even if the belief costs the person money. [2]

2. Attitude Polarization - when a disagreement becomes more extreme even though the different parties are exposed to the same evidence.  So even when looking at the same evidence or information, opposing sides will not only experience Belief Perseverance, they adopt an even more extreme position.

3.  Irrational Primacy Effect - is when there is a greater reliance on information encountered early (in time) in a series.  Something learned earlier carries more weight than contradictory information learned later.

4.  Illusory Correlation – is when people falsely perceive an association between two events or situations.

The problem with these and all types of Confirmation Bias is that it creates a vicious cycle of acting on information that most likely excludes any data or information that contradicts a pre-existing belief.  It is the ultimate form of closed-mindedness and is responsible for killing companies, ignoring signs of market disruption and causing economic bubbles and downturns.

Let’s briefly look at three examples of how Confirmation Bias has profoundly affected business in the distant and not-so-distant past.

Case Study 1 – The Stock Market Crash of 1929

The U.S. Federal Reserve issued a statement warning investors of the dangers of stock market speculation in early 1929.  Despite that, many ”economic experts” continued to sustain public optimism, including Andrew W. Mellon, the Secretary of the U.S. Treasury at that time.  Mellon proclaimed “There is no cause to worry.  The high tide of prosperity will continue.”  He said this right before the market crashed.  Concerns assuaged by Mellon’s comment, investors continued pouring money into the stock market—with the Dow Jones Industrial Average swelling to a record high in early September 1929.  Then the market collapsed spectacularly within a month causing the worst economic depression in U.S. history.  Many ignored the Federal Reserve’s warnings and embraced Mellon’s sunny outlook because it supported their beliefs.

Case Study 2 – Bernie Madoff and the Ponzi Scheme

The Madoff investment scandal was a case of over $64 Billion in stock and securities fraud discovered in late 2008.  But, evidence shows that Confirmation Bias played a huge role in why such massive fraud was able to continue unchecked for decades.  According to a 2009 internal report by the SEC, there were six distinct complaints about Madoff’s operations filed between 1992 and 2008.  The complaints suggested Madoff was running a Ponzi scheme. The report shows the SEC conducted investigations of Madoff’s investment advisory business yet failed to uncover the fraud.  How is that possible?  Confirmation Bias.

SEC investigators’ Belief Perseverance put more weight on information that confirmed their view and disregarded information that disconfirmed their hypothesis. And, as more information surfaced, they adopted an even stronger position, which demonstrated Attitude polarization The report stated [3]:

The OIG investigation found the SEC conducted two investigations and three examinations related to Madoff’s investment advisory business based upon the detailed and credible complaints that raised the possibility that Madoff was misrepresenting his trading and could have been operating a Ponzi scheme. Yet, at no time did the SEC ever verify Madoff’s trading through an independent third-party, and in fact, never actually conducted a Ponzi scheme examination or investigation of Madoff.

In the examination of Madoff, the SEC did not seek Depository Trust Company (DTC) (an independent third-party) records, but sought copies of such records from Madoff himself. Had they sought records from DTC, there is an excellent chance that they would have uncovered Madoff’s Ponzi scheme in 1992.

. . . The scopes of the examination were in both cases too narrowly focused on the possibility of front-running, with no significant attempts made to analyze the numerous red flags about Madoff’s trading and returns . . .

The investigation that arose from the most detailed complaint provided to the SEC, which explicitly stated it was “highly likely” that “Madoff was operating a Ponzi scheme,” never really investigated the possibility of a Ponzi scheme. The relatively inexperienced Enforcement staff almost immediately expressed skepticism and disbelief. Most of their investigation focused on determining whether Madoff should register as an investment adviser or whether Madoff’s hedge fund investors’ disclosures were adequate.

As with the examinations, the Enforcement staff almost immediately caught Madoff in lies and misrepresentations, but failed to follow up on inconsistencies. They rebuffed offers of additional evidence from the complainant, and were confused about certain critical and fundamental aspects of Madoff’s operations. When Madoff provided evasive or contradictory answers to important questions in testimony, they simply accepted as plausible his explanations.

Although the Enforcement staff attempted to seek information from independent third-parties, they failed to follow up on those requests. They reached out to the NASD [now, FINRA, the Financial Industry Regulatory Authority] and asked for information on whether Madoff had options positions on a certain date, but when they received a report that there were, in fact no options positions on that date, they did not take any further steps. An Enforcement staff attorney made several attempts to obtain documentation from European counterparties (another independent third-party), and although a letter was drafted, the Enforcement staff decided not to send it. Had any of these efforts been fully executed, they would have led to Madoff’s Ponzi scheme being uncovered. (pp. 23–25)

Case Study 3 – The Real Estate Crash of 2007-2009

Did Confirmation Bias play a role in the major real estate market meltdown that led to the Great Recession a decade ago?  The evidence says yes.  Financial institutions chose to ignore a wealth of data that indicated there were too many subprime mortgages being made and that there was no way that the price increases could be sustained since general salaries were not increasing in tandem.  And yet, lenders continued to issue loans oblivious to the dangers.  They sought confirming data, suppressed disconfirming information, and took comfort that others were making the same decision.

As J.V. Rizzi concluded in his paper titled “Behavior Basis of the Financial Crisis,”, “Financial institutions suffered large losses following the collapse of the credit markets despite making huge risk management investments.  Major risks are frequently ignored due to behavioral biases resulting in incorrect decisions.” [4] Various forms of Confirmation Bias, including Belief Perseverance and Irrational Primacy Effect played a significant role in banks, lenders and investors all continuing with deeply risky behaviors despite all of the warning signs.

How to Stop Confirmation Bias in Business

So how do we protect leaders from being affected by Confirmation Bias in critically important areas such as business, politics and finance?  How does a business leader stop from falling into the Confirmation Bias trap?   Researchers have spent a lot of time trying to figure this out.  Clifford Mynatt, Michael Doherty, and Ryan Tweney from Bowling Green State University conducted a set of studies [5] to figure out if most commonly accepted strategy for curing Confirmation Bias was effective.  Here’s what they learned was not effective.

  1. Just knowing that the confirmation bias exists doesn’t cure it.  So reading this article and understanding that it exists won’t protect anyone from this bias.
  2. Looking for evidence that an initial hypothesis is wrong isn’t always the safest way to go either. While one would think the antidote to confirmation bias is to search for information that disconfirms information or a belief, since people actively avoid information that refutes their view, Confirmation Bias breeds more Confirmation Bias.
  3. Exposing oneself to situations that will provide a lot of information does not necessarily lead to the right conclusions either.

People who succumb to Confirmation Bias test their hypotheses by searching for information that confirms what they are testing. Lenders did that for years until the credit markets imploded in 2008.  SEC investigators did it between 1992 and 2008 when investigating Madoff until the Recession made the evidence of fraud impossible to ignore.

Here is what does work[6]:

  1. Don’t abandon a first idea completely. Sometimes an initial expectation may be neither 100% right, nor 100% wrong.
  2. Keep an open mind. Ask a lot of questions.  Think of a few far-flung alternatives.  Keep an eye out for evidence that supports any one of them.
  3. Embrace surprises.  When something doesn’t go exactly as expected, consider how things are working and what might need to change.

The only way leaders in business, politics or finance can stop being victim to Confirmation Bias is to assume nothing, follow the numbers and ask lots of questions, reject known falsehoods and confront uncomfortable truths.  It is important to check facts with reliable sources outside one’s existing views/sources and accept that there can be other valid points of view.  Fact-checking is like exposure therapy. Researchers believe there is an effective tipping point when ‘motivated reasoners’ start to accept hard truths after seeing enough claims debunked repeatedly. [7] The goal is to become a motivated reasoner who values truth and facts over being right.

Quote of the Week

“If we hold too rigidly to what we think we know, we ignore or avoid evidence of anything that might change our mind.” Martha Beck

[2] November, 2015, Michael Cipriano and Thomas S Gruca, The Power of Priors: How Confirmation Bias Impacts Market Prices, The Journal of Prediction Markets, DOI: 10.5750/jpm.v8i3.974

[3] January 7, 2016, Hersh Shefrin, How Psychological Pitfalls Generated the Global Financial Crisis (4 of 5), The Financial Professional’s Post, New York Society of Security Analysts,

[4] 2008, J. V. Rizzi, Behavioral Basis of the Financial Crisis, Journal of Applied Finance, Fall/Winter, 2008,

[5] 1977, Mynatt, C., Doherty, M., & Tweney, R., Confirmation bias in a simulated research environment: An experimental study of scientific inference, Quarterly Journal of Experimental Psychology, 29 (1), 85-95

[6] 1978, Mynatt, C., Doherty, M., & Tweney, R., Consequences of confirmation and disconfirmation in a simulated research environment, Quarterly Journal of Experimental Psychology, 30 (3), 395-406

[7] April 9, 2019, Richard Nordquist, Confirmation Bias, Thought Co.


© 2018, Written by Keren Peters-Atkinson, CMO, Madison Commercial Real Estate Services. All rights reserved.

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