Fin 393 - Effect of Groupthink on Investing

Kenneth Kiebles

Finance 393

Professor Hocter

21 November 2016

Effect of Groupthink on Investing

        Groupthink is something that influences most things that people do on a daily basis.  People use groupthink every single day to make decisions, to confirm their decisions, or even to compare to the decisions that they have already come to.  Although groupthink has its distinct advantages in certain situations, there are without a doubt situations in which groupthink can be seen as a hindrance.  How companies, and even individuals, invest their money is something that is undoubtedly being affected by groupthink every single day.  Groupthink can give investors an extreme disadvantage and it can be shown by things throughout history.  So, this paper is going to dive into the effects that groupthink has on investors and therefore the effects that it can even have on the economy.

        To understand the effect that groupthink has on investors, and therefore the economy, we must first comprehend what groupthink encompasses.  Groupthink was a term devised in 1972 by psychologist Irving Janis.  According to Janis, groupthink ensues when a group makes flawed choices because group pressures lead to a deterioration of “mental efficiency, reality testing, and oral judgement.”  Essentially what this means is that our decision making can be severely hampered by what the majority of the members of the group may think is the correct way to go about whatever situation may be at hand.  People affected by groupthink will often ignore alternative possibilities and will take illogical paths that dehumanize others.  There are three things that make groups more susceptible to the possibility of groupthink.  Those three things are: when their members are of a similar background, when the group is separated from the opinions of the outside world, and when there are no clear rules stated for the process at hand.

        On top of all of this, when doing his work, Janis documented eight symptoms for groupthink.  The first of the symptoms is the illusion on invulnerability.  This is the creation of an extreme optimism that can lead to taking greater risk than one would normally take while working alone.  Next, we have collective rationalization.  Collective rationalization refers to when group members to not reassess their assumptions and they just ignore the warnings in front of them.  The third symptom that Janis put forth was the belief in inherent morality.  This transpires when team members have the belief in the rightness of what they are working towards and they begin to ignore any moral or ethical issues that may develop from the decisions that they have or may make.  Next, talked about the stereotyped views of groups outside of the group one is in.  When he says this, he is referring to that fact that a group may use the negative views of who they perceive as their enemy as a reason for doing something.  Direct pressure on dissenters is the fifth symptom that Janis discussed.  Essentially, this means that members of a group may be pressured not to express certain opinions that go in contradiction of the unanimity of the group.  Next, we have self-censorship.  Self-censorship, according to Janis, is when deviations or worries from the consensus of the group are not stated.  The seventh symptom that Janis states is the illusion of unanimity.  When Janis talks about this he is referring to the fact the majority view and judgments are assumed to be unanimous by the group even if that may not be the case.  The last of these eight symptoms is what Janis calls self-appointed ‘mindguards’.  ‘Mindguards’ are what he calls the members of the group that “protect” the members and leader of the group from information that may pose to be problematic to the cohesiveness that the group has on its decision making.  According to Janis, when any of these eight different things happen then there is a reasonable chance that groupthink can occur, although it is not a certainty.  The more of these symptoms that are present in a group, the more likely that groupthink will occur.

        Looking through history there are many examples of groupthink that Janis touches on to make his point.  There are five main events that Janis focuses on that have happened to reinforce his position.  Those five events are: the attack on Pearl Harbor, the Bay of Pigs Invasion, the escalation of the Vietnam war, the hostage rescue situation in Iran, and the decision of the US to invade Iraq shortly after 9/11.  Although these are all different events they all have many things in common that groups failed to dive into to make the correct decision. In almost all of these events the illusion of invulnerability, the first symptom Janis gives, is present.  By either over exerting, or not exerting themselves at all, the US and its leaders made decisions that would come back to haunt them in each of these situations.  The second of Janis’ symptoms, collective rationalization, is present in each of these as well.  In all of these situations there are obvious instances where members of the groups did not properly attend to the warnings given to them and just continued to protect the consensus within their group.  I have only even brought up the first two ‘symptoms’ and they both could be easily applied to each of these five situations.  When looking at Janis’ ideas, you only need one of these for the possibility of groupthink to occur.  The more of these ‘symptoms’ that occur the more likely groupthink will happen.