What is Expectations? And why you should handle with care
Consider the following example
On 31 January 2006, Google announced its financial results for the final quarter of 2005. Revenue: up 97%. Net profit: up 82%. A record-breaking quarter. How did the stock market react to these phenomenal figures? In a matter of seconds, shares tumbled 16%. Trading had to be interrupted. When it resumed, the stock plunged another 15%. Absolute panic. One particularly desperate trader inquired on his blog:
‘What’s the best skyscraper to throw myself off?’
What had gone wrong? Wall Street analysts had anticipated even better results, and when those failed to materialise, $20 billion was slashed from the value of the media giant.
Every investor knows it’s impossible to forecast financial results accurately. The logical response to a poor prediction would be:
‘A bad guess, my mistake.’
But investors don’t react that way.
Here’s another example
In January 2006, when Juniper Networks announced eagerly anticipated earnings per share that were a tenth of a cent lower than analysts’ forecasts, the share price fell 21% and the company’s value plunged $2.5 billion.
When expectations are fuelled in the run-up to an announcement, any disparity gives rise to draconian punishment, regardless of how paltry the gap is.
Many companies bend over backwards to meet analysts’ predictions.
To escape this terror, some began publishing their own estimates, so-called ‘earnings guidance’. Not a smart move. Now, the market heeds only these internal forecasts – and studies them much more closely to boot. CFOs are forced to achieve these targets to the cent, and so must draw on all the accounting artifices available.
An experiment: Expectations can also lead to commendable incentives
In 1965, the American psychologist Robert Rosenthal conducted a noteworthy experiment in various schools.
Teachers were told of a (fake) new test that could identify students who were on the verge of an intellectual spurt – so-called ‘bloomers’.
Twenty percent of students were randomly selected and classified as such. Teachers remained under the impression that these were indeed high-potential students.
After a year, Rosenthal discovered that these students had developed much higher IQs than other children in a control group. This effect became known as the Rosenthal effect (or Pygmalion effect).
Unlike the CEOs and CFOs who consciously tailor their performance to meet expectations, the teachers’ actions were subconscious. Unknowingly, they probably devoted more time to the bloomers, and consequently, the group learned more. The prospect of brilliant students influenced the teachers so much that they ascribed not just better grades but also improved personality traits to the ‘gifted’ students – a tribute to the halo effect.
But how do we react to personal expectations?
This brings us to the placebo effect – pills and therapies that are unlikely to improve health, but do so anyway.
The placebo effect has been registered in one-third of all patients. But how it works is not well understood. All we know is that expectations alter the biochemistry of the brain and thus the whole body.
Accordingly, Alzheimer’s patients cannot benefit from it: their condition impairs the area of the brain that deals with expectations.
Expectations are intangible, but their effect is quite real. They have the power to change reality. Can we deprogramme them? Is it possible to live a life free from expectations? Unfortunately not. But you can deal with them more cautiously. Raise expectations for yourself and for the people you love. This increases motivation.
At the same time, lower expectations for things you cannot control – for example, the stock market. As paradoxical as it sounds, the best way to shield yourself from nasty surprises is to anticipate them.
The above article is from the book The Art of Thinking Clearly by Rolf Dobelli. The article is only for educational and informative purposes to explain and understand cognitive biases. It is a great book, definitely worth a read!