Cognitive biases and debiasing strategies in governance and auditing

Cognitive Biases: A threat to objectivity

In an increasingly complex world, the demand for high-quality, reliable information has never been greater. However, many of the factors that contribute to this complexity also increase the cognitive biases that affect human decision-making. No information is completely free of bias, whether intentional or unintentional. Cognitive biases can be understood as systematic errors in thinking that unconsciously influence how we interpret information and make judgements.

Cognitive biases pose a significant risk to the objectivity of internal auditors. Auditors need to be aware not only of their own biases, but also of those of the people who create, gather and analyse information for decision making. Board members are not immune to these biases and should develop the skills to identify and mitigate their influence on decision-making and oversight. Researchers have identified more than 200 cognitive biases that can affect governance and oversight.

Objectivity, integrity and ethical standards

Internal auditors are required to comply with the Global Internal Audit Standards, which emphasise principles such as integrity, objectivity, independence and professional scepticism. These standards require auditors to be sceptical when evaluating evidence, making judgements and reaching conclusions. They need to be aware of and vigilant against bias, conflicts of interest and undue influence, all of which can impair objectivity.

Similarly, board members should adhere to ethical guidelines that promote independent thinking and decision-making. As Simeon Wanyama notes in his article "Characteristics of Effective Board Members", board members should be held to professional standards that emphasise integrity, objectivity and due professional care.

Cognitive biases are present throughout the audit process and in business decision-making. They can affect the quality of audit evidence and lead to erroneous business decisions. Conformity bias, authority bias and lack of scepticism have been linked to financial fraud and corporate misconduct. To guard against these risks, both internal auditors and boards need to proactively assess bias-related risks and implement mitigation strategies.

Organisational culture (integrity, ethics...) plays a critical role in mitigating bias. The Global Internal Audit Standards emphasise that internal auditors need to pay close attention to cultural factors and soft controls.

Managing cognitive biases

Cognitive biases and ingrained "instincts" can have a significant impact on the audit process. In “Factfulness”, Hans Rosling outlines ten cognitive instincts that influence how people perceive information. Although he refers to them as instincts, they function similarly to cognitive biases by distorting perception and judgement.

The following is an analysis of how cognitive biases and Rosling's instincts can affect the four main steps of the auditing process: 1 Planning, 2 Execution, 3 Reporting, 4 Follow-up

1. Planning

Activities that are often important parts of the planning phase include task definition, preliminary research, information gathering and understanding the entity better. Biases that can affect this stage include Optimism Bias, Conformity Bias, Authority Bias, Loss Aversion Bias, Framing Bias, Anchoring Bias, Status Quo Bias.

• Optimism bias: There may be a tendency to assume a favourable outcome. One may underestimate risks and overestimate potential positive outcomes.
• Conformity bias: Auditors may align their planning with the prevailing views within the organisation or audit team, potentially overlooking unique risks or opportunities.
• Authority bias: The planning process may be unduly influenced by the opinions or instructions of senior management or other authority figures.
• Loss aversion bias: There may be a tendency to avoid identifying high-risk areas for fear of uncovering significant issues that could lead to negative consequences.
• Framing bias: How the objectives and scope of the audit are framed can influence which areas are prioritised and how issues are perceived.
• Anchoring bias: Initial information or assumptions made during planning can disproportionately influence the focus and direction of the audit. This can lead to tunnel vision and influence final decision making.
• Status-quo bias: Planners may favour existing procedures and avoid proposing changes or new approaches to the audit.

For example, the planning phase could also be influenced by the following common "instincts" discussed by Hans Rosling: The Generalisation Instinct, The Urgency Instinct, The Single Perspective Instinct.

• The Generalisation Instinct: During the planning phase, auditors may make broad generalisations about the scope or focus of the audit, potentially overlooking specific nuances and complexities.
• The Urgency Instinct: The perceived need for quick results could lead to rushed planning, inadequate risk assessment or incomplete understanding of the audit objectives.
• The Single Perspective Instinct: Planners may rely on a single perspective or source of information when defining the scope and objectives of the audit, which can result in a narrow and potentially biased audit plan.

2. Execution

The execution phase involves evidence gathering, judgement and analysis. Biases that may interfere include: Ambiguity Bias, Action Bias, Authority Bias, False Causality Bias, Conformity Bias

• Ambiguity Bias: Auditors may avoid or overlook ambiguous or complex information, resulting in an incomplete assessment. This bias can have a strong impact on innovation outcomes because an innovation process is risky and unknown.
• Action bias: There may be a preference for taking immediate action or drawing quick conclusions, rather than thoroughly examining all the evidence.
• Authority Bias: Execution may be influenced by the expectations or preferences of authority figures, potentially distorting the investigation. This could mean favouring the ideas of senior team members, even when other ideas and input may be more creative and relevant.
• False Causality Bias: There is a risk of incorrectly linking cause and effect relationships based on incomplete or superficial analysis.
• Conformity bias: execution practices may be too closely aligned with established norms or the approaches of peers, potentially overlooking innovative solutions.

Rosling's instincts that can affect execution: The Availability Instinct, The Negativity Instinct, The Fear Instinct

• The Availability Instinct: Auditors may prioritise easily accessible information and data sources over more relevant but less accessible ones, potentially distorting findings.
• The Negativity Instinct: Auditors may focus more on negative aspects or deficiencies, potentially overlooking positive performance indicators or improvements.
• The fear instinct: fear of uncovering significant issues or challenging entrenched practices could lead to a more cautious and less thorough investigation.

3. Reporting

Biases can affect conclusions, communication and report writing. Biases that can distort audit reports include Framing Bias, Self-Serving Bias, Strategic Misrepresentation, Bandwagon Bias, Feature Positive Effect, Pro-Innovation Bias

• Framing bias: The way findings and recommendations are presented can be influenced by how issues were framed during the audit.
• Self-serving bias: Reports may emphasise findings that reflect positively on the auditors or the organisation, and downplay negative findings.
• Strategic misrepresentation: Information may be selectively presented or distorted to make the report more compelling or to influence stakeholders. It is not uncommon for management to deliberately understate costs and overstate benefits.
• Bandwagon bias: Reports may align with popular opinion or trends within the organisation, rather than presenting an independent analysis.
• Feature Positive Effect: The report may highlight positive findings more than negative ones, potentially misrepresenting the overall situation.? Due to limited resources or time, there is a tendency to focus on the benefits and ignore the negative effects, even if the negative effects are significant.
• Pro-innovation bias: There could be an overemphasis on new or innovative practices, even if traditional methods are more effective.

Rosling's instincts that influence reporting: The Size Instinct, The Gap Instinct, The Blame Instinct

• The Size Instinct: There may be a tendency to emphasise or de-emphasise findings based on their perceived significance without proper context, potentially misrepresenting the overall conclusions of the audit.
• The Gap Instinct: Reports may highlight extremes, such as best and worst practice, and overlook the more common middle ground, leading to a distorted picture of performance.
• The Blame instinct: Auditors may seek to identify specific individuals or departments to blame for problems, rather than considering broader systemic or contextual factors.

4. Follow-up

Biases that can hinder the implementation of audit recommendations include Loss-Aversion Bias, Status Quo Bias, Projection Bias, Authority Bias.

• Loss-Aversion Bias: There may be a reluctance to implement recommendations that involve significant change or perceived risk.
• Status-quo bias: There may be a preference for maintaining existing practices rather than adopting new recommendations. This reduces risk and favours what is familiar or "the way we do things around here".
• Projection bias: Follow-up activities may be influenced by current beliefs and conditions, leading to assumptions that future circumstances will be similar.
• Authority bias: The effectiveness of follow-up can be influenced by the involvement and support of authority figures within the organisation.

Rosling's instincts that can affect Follow-up: The Straight-Line Instinct, The Destiny Instinct

• The Straight-Line Instinct: Follow-up activities may assume that conditions will remain constant, potentially overlooking changes or trends that could affect the audit's findings or recommendations.
• The Destiny Instinct: There may be a belief that certain outcomes are inevitable or unchangeable, leading to a less proactive approach to encouraging and supporting improvements based on audit recommendations.

Controlling and Mitigating Cognitive Biases

A survey of German companies found that fewer than 40% of managers were aware of cognitive biases and debiasing techniques, while 75% had no institutionalized debiasing processes.

To mitigate cognitive biases, organizations should:

• Foster a culture where employees feel encouraged to voice diverse opinions.
• Reinforce ethical guidelines emphasizing objectivity and independent thinking.
• Train auditors and board members to recognize and counteract cognitive biases.

Research into cognitive biases has found that awareness and training may help to mitigate bias. The scientific work of Dr. Kucera suggests that training people to recognize and avoid cognitive biases can be very effective. His work has showed that only a 5-minute-long video containing an information on confirmation bias among participants is a good recipe for avoiding a biased decision.

The debiasing techniques mostly used and recommendable by practitioners are according to Dr. Christian Muntwiler the following:

• Put yourself in the shoes of- Encourage decision-makers to consider alternative points of view.
• Clarify problem statements - Ensure issues are clearly and unbiasedly framed.
• Use multiple experts - seek diverse input to counter individual biases.
• Devil's advocate approach - appoint a team member to challenge assumptions.
• Checklists and structured analysis - reduce reliance on intuition.
• Analogical reasoning - comparing cases to uncover hidden biases.
• Group decision making - encourage open discussion with multiple people
• Problem decomposition - improving understanding of a problem

The use of creative problem-solving techniques (brainstorming, six thinking hats, opposite thinking...) and anonymous voting to encourage open discussion and reduce biases (e.g. confirmation bias, groupthink, bandwagon bias, authority bias) has also been found effective by several scientists.

Auditors and managers often significantly overestimate their understanding of complex causal patterns, creating a "positive illusion" about their own knowledge. This can lead to flawed decision making in the audit and/or strategy process. In his well-researched dissertation on “Cognitive Biases and Debiasing in Strategic Decision Making” from 2023, Dr. Muntwiler also looked closely at managers' overestimation of their understanding of digital technologies. He found that visualization techniques such as visual self-drawn explanations can lead to a more accurate calibration of knowledge and to a reduction of overestimation.

Below is an overview of some of the possible debiasing techniques found in the literature.

?Conclusion

Cognitive biases impact every stage of the audit and decision-making process. Awareness and active mitigation strategies are essential to maintaining objectivity, accuracy, and professional scepticism. By implementing debiasing techniques, internal auditors and board members can enhance the integrity and effectiveness of governance and auditing practices.

References

• The Association of Chartered Certified Accountants, Banishing bias? Audit, objectivity and the value of professional scepticism, March 2017
• Sarah Behimehr, Hamid R. Jamali, Cognitive Biases and Their Effects on Information Behaviour of Graduate Students in: Their Research Projects (2020), in: JISTaP (www.jistap.org)
• www.boardofinnovation.com/blog/16-cognitive-biases-that-kill-innovative-thinking/
• Angelina K.Y. Chin, Recognizing and Mitigating Cognitive Biases: A Threat to Objectivity. Internal Audit Foundation, 03/2022
• Global Internal Audit Standards, The Institute of Internal Auditors, 09/2024
• Peter Yao Lartey, Isaac Gumah Akolgo, Santosh Rupa Jaladi, Selorm Ayeduvor, Stephen Owusu Afriyie, Recent advances in internal control: Soft control overcoming the limits of hard control Front Manage Bus, 2023, 4(1): 289-302, DOI: 10.25082/FMB.2023.01.00
• Tomas Kucera, Cognitive Bias Mitigation: How to make decision-making more rational? 2017
• Christian Muntwiler, Cognitive Biases and Debiasing in Strategic Decision Making, Dissertation University of St.Gallen, 2023
• Hans Rosling, Factfulness: ten reasons we’re wrong about the world – and why things are better than you think, 2018
• Simeon Wanyama, Characteristics of Effective Board Members, 2016, (www.researchgate.net/publication/312538223)

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