Comparing apples to cash flows: Structural alignment in financial decision making

AbstractBusiness executives often have to allocate resources across very dissimilar projects. They use financial measures, such as Net Present Value (NPV), that simplify this difficult comparison because they aim to be equally applicable to any kind of project, but these measures vary in their reliability. Psychological research suggests that comparing alignable objects (apples to apples) will be easier than comparing non- alignable objects (apples to oranges; Markman & Gentner, 1993; Markman & Medin, 1995). Experiment 1a shows that naïve participants’ forecasts of future returns are more variable for non-alignable projects. Experiment 1b shows that these participants accommodate their use of a financial measure (NPV) based on its reliability (as explicitly described in the introduction to the task) when allocating resources to a set of alignable projects, but use it regardless of reliability when allocating to a set of non-alignable projects. Experiment 2 shows that participants with more business experience similarly rely more on NPV for non-alignable projects. However, they do not use information about the variance underlying NPV (which was shown in financial data they were instructed to attend to, but not explicitly labelled as reliable as with the naïve participants). Theoretical and practical implications will be discussed.

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