Management in the movies: three lessons from The Big Short

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This summer, we’re going to the movies! Management experts from McGill University analyze popular films and share the lessons that lie within them.

The Big Short (2015) follows a handful of investors — Dr. Michael Burry (Christian Bale), Mark Baum (Steve Carell), and Jared Vennett (Ryan Gosling) — as they predict the 2008 financial crisis and bet against the US mortgage market to profit from the coming crash.

This is easily one of Levi Olando’s favourite movies. He’s a former fraud investigator and current PhD student in Strategy and Organization at McGill University. In an interview with McGill Delve, he shared what The Big Short teaches us about decision-making, strategy, and morality.

For all of his insights, tune into the McGill Delve podcast on YouTube.

1. Bounded rationality leads to imperfect decisions

While people try to make decisions logically and rationally, their reasoning is actually bounded by the information available to them, said Olando. He calls this “bounded rationality.” The available information will always be imperfect or uncertain to some degree, so decision-making by default also becomes imperfect.

Bounded rationality showed up in the film in the form of a hot-hand fallacy, a cognitive bias that leads an individual to believe success begets success even in two completely independent situations. While the term originated in basketball about an athlete’s ability to make continued successful shots, the banks in the film are equally caught up in their success. They saw a history of on-time mortgage payments and failed to entertain the possibility that people would stop paying in the future. Their reasoning was bounded by their own prior success.

One way to overcome bounded rationality at the individual level, according to Olando, is to embrace counterfactual logic. This means asking “what if” questions or assuming the facts are different when reasoning through a task.

In thinking about the movie, Olando gave this example: “Assuming these loans are AAA in one scenario, well what if they actually aren’t? What does this mean for the market?”

But for that to work, decision-makers must be open to dissenting opinions. When an employee disagrees or sees otherwise in the data, it’s important they feel comfortable voicing those concerns.

“One thing that helps at a collective level is fostering a culture of essentially an obligation to dissent,” said Olando.

In the movie, protagonist Mark Baum does both when raising his concerns about the housing bubble to an S&P agent – an expert tasked with rating the quality of financial products, like mortgage-backed securities. However, Baum’s concerns fell on deaf ears.

This illustrates another complex dimension of organizational decision-making. While Baum was engaging in counterfactual thinking, the people around him weren’t receptive due to their own incentives. This touches on what Olando calls imperfect morality.

2. Perverse incentives make for imperfect morality

We live and work in environments that contain both prosocial and perverse incentives. Prosocial incentives encourage people to engage in socially beneficial behaviours. Perverse incentives promote behaviours that can make the problem worse. Decision-making becomes a question of navigating the dynamics between the two, said Olando.

Many people in the film had perverse incentives – bonuses, commissions, and brokerage fees – to turn a blind eye to the looming housing bubble. They continued profiting from flawed financial products, giving them little reason to question their actions – even as they knowingly misrepresented suboptimal loans.

Olando was quick to point out that even Baum, the so-called hero of the story, has his own perverse incentives. Baum wants to save the world, he wants to improve the market, but he also wants to make a massive profit.

While watching the movie, it’s easy to feel like you’d do the right thing in the character’s place, stand on the right side of history. But the reality is that everyone is subject to balancing these incentives and making decisions despite their tensions.

“We all navigate worlds of cognitive dissonance,” said Olando. “Moral superiority isn’t very beneficial.”

When making decisions, it’s important to reflect on your own incentives and reconcile the prosocial with the perverse. This can be difficult though if you impose moral judgments in the process, labeling yourself as a bad or a good person, said Olando. The un-comfortability of reflecting on your incentives in this way makes people unlikely to do it, hurting their decision-making.

Instead, try a value-neutral approach by evaluating from the third-person perspective.

“Objectively assess your incentives, what the situation is, follow the train of thought as neutrally as you can,” said Olando.

3. Bifocality can address your blind spots

A third lesson from The Big Short is the need for bifocality, in other words, a dual perspective of scale.

“In order for us to understand our settings, it makes sense to have a telescope to see far off, but also a microscope to be close by,” said Olando.

It’s not a case of either/or; it’s a case of both. When applied to the movie, the telescope appears for the investors as intuition, a gut-feeling, hazy logic. The microscope supplements this with evidence-based and data-driven logic. Together, intuition helps guide where to point the microscope and gather data.

For Olando, Dr. Michael Burry, the first investor in the film to predict the collapse, demonstrates the power of both lenses. Burry was a doctor before becoming a hedge fund manager, and by virtue of that had strong analytical skills. While his intuition prompted him to examine the interest rates in the first place, he spent months investigating the mortgage-backed securities to find evidence of the impending collapse.

“Those who were able to make something out of this crisis,” said Olando, “were those that were able to be bifocal.”

This bifocality can translate to other axes as well. The characters in the film were operating under a very powerful financial system that shapes their thinking and in turn their decision making. But according to Olando, this isn’t to say their actions are entirely determined by their environment.

“I think it’s a misnomer and a mischaracterization when you think about just merely person-centric agency and decision making versus environment-centric agency and decision making. It is always a combination of the two,” said Olando.

The skill of bifocality in this sense is to see yourself in the system of your environment but also step outside and observe it for what it is. For more takeaways from The Big Short, listen to the full conversation with Olando on the Delve podcast.