The Psychology of Regulation Complexity - Corporate Governance and Business Ethics

Introspection and Common Sense

Intuitively starting with introspection in the spirit of James (1890) an increase in complexity increases the costs of individual decision makers. First, a complex problem takes more time to solve. Secondly, there is a psychic disutility to complexity a feeling of stress, powerlessness and anxiety, which will be known to people who try to fill in their tax forms or get computer software to work.

To be sure, there are counterexamples. Some people appear to enjoy working on complex problems in mathematics, Soduku, crosswords or even computer programming. Scientific problems appear to be more attractive to scientists, the more complex they are. In general, however, society would tend to look at complexity lovers as a special kind whose preferences are not widely shared. Furthermore, what is regarded as complex would typically depend on your abilities and what you know? A lawyer would find it impossibly complex to solve an equation while a mathematician might find it difficult to understand tax law.

A similar hypothesis is that complexity is related to learning. A new problem area will seem more complex. What is complex to 6th graders might not be complex to 7th graders. Again, however, people seem to be different. Some appear to like to learn; they are curious and delight in variety and new things to learn. Personality could be a very important determinant of the costs of complexity.

There are several additional elements to the computer and tax frustrations described above.

  • The problems are not voluntary; they are obstacles, which block other more desired activities like going to football match that Sunday afternoon or getting on with your job. Clearly motivation is very important.
  • Moreover, there is a time pressure. It’s late. You become tired and your frustrations increase. You are alone at the office and have no one to ask for help.
  • Third, there is a feeling that the problems are arbitrary and trivial. They could easily have been avoided if the programming had been a little better, or if the explanation in the manual had been a little better. Compare this to a scientific problem, the solution to which could bring you everlasting glory and the joy of understanding something fundamental.
  • In addition, some people get angry at being subjected to authority. This feeling may be worse when filling out your tax forms than in computer frustrations, where you have the feeling that you might choose not to work with this software. This implies that the costs of complexity are higher if you have less control of the situation.
  • The frustration is compounded by your suspicion that learning to solve this problem may not be very useful in the future. The next version of the software or the new tax rules will most likely annihilate the value of your time investment. The costs of complexity are easier to bear if they are believed to be transitory.
  • You feel that you should have been able to solve the problem easily, and the longer you work with it, the more frustrated you get at not be able to find the solution. You are reminded of your own lack of success with similar problems in the past, and your self-confidence drops (“this is typical”). You start to make and recall attributions (I am no good with computers), which makes your feel even worse. Your self-efficacy beliefs suffer.
  • You are bothered by guilt that you did not prepare well enough. Why does it always have to be the last Sunday before the deadline? Why did I not get my papers ready in time? Why did I not read the manual? Irrational behavior of this kind is an example of time inconsistent preferences which make us postpone unpleasant tasks.
  • Many people just give up. After repeated bad experiences and frustrations of not being able to understand, they do not do their tax forms. They are in a condition of learned helplessness which occurs in learning experiments where you punish dogs with random electro shocks. After a while, they give up, loose initiative and become completely passive.
  • Since these problems appear to be generic, one may wonder whether they are completely unintentional. Passivity may be in the interest of tax authorities who then effectively get to fill in the tax forms and get fewer complaints. The status of bureaucrats and computer assistants are heightened by the feeling of inferiority and guilt and the corresponding gratitude at getting help. This seems to fit with sociological theories of bureaucracy.
  • Your irritation will probably be greater if you do not sympathize with the perceived cause of your trouble. For example, you may be extra annoyed at Microsoft if you have leftist sympathies and extra annoyed at your tax accounting if you are conservative and believe that taxes should be cut.
  • Finally, and perhaps most importantly, you make mistakes. You press the wrong button and delete files, you do not get the deductions you are entitled to, or you get fined. These mistakes are costly.

In the following I examine the foundations for these conjectures in psychological science.

Perception and Complexity

As emphasized by Kahneman (2003) the borderline between perception and cognition is fuzzy. A substantial body of theory and evidence indicates that people tend to perceive patterns (Bruner and Postman 1949; Gregory 1974; Gibson 1950). Moreover, there is a tendency to prefer certain patterns over others. Gestalt theories (Ehrenfels 1890/1988) came to argue that people prefer relatively simple and symmetrical figures (good gestalts) to more messy and complicated ones. Some of this like the perception of distance, speed and colors appears to genetically hard-wired into human nature. If rules and regulation are not simple, logical and internally consistent, it will be more costly to perceive them correctly. To a very large extent we tend to use cues and distinctive features to fit sense impressions into templates and it may be difficult to perceive impressions which do not match the template (for example to find spelling mistakes in your own manuscripts). It will be more costly for us to correctly perceive information which is not stored in templates for example it difficult to comprehend a random table of allowable tax deductions for depreciation of assets, but it may be easier to perceive a simple rule or formula.

Memory and Complexity

Memory research also stresses the importance of simplicity, coherence and consistency. It is much easier to remember stories or pictures than isolated pieces of information. Isolated bits of information are known to be subject to significant memory loss (Ebbinghaus 1885/1913), while stories and pictures loose details and may be distorted and there is a tendency to fit them into preconceived schemas (Bartlett 1932). As a result, complex regulation runs a greater risk of distortion of meaning and focus, while aspects of it which are difficult to understand will tend to be forgotten.

Cognition and Complexity

Cognitive psychology indicates that complex information will typically be more time consuming and costly to process. Kahneman (2003) describes reason as slow and effortful compared to intuition which is fast and effortless. Moreover, complex information is more likely to give cognitive biases in interpretation (e. g. , Kahneman and Tversky 1979; Rabin 1998). For example, Tversky and Kahneman (1986) document systematic mistakes for a complex decision problem. Cognitive bias includes the tendency to seek confirmation for preconceived ideas, to base interpretation on more or less irrelevant contextual benchmarks (anchoring, framing) and to place too much emphasis on particular cases. For example, the status quo bias would imply that new regulation will be evaluated relative to the present situation, and that any losses will seem large relative to advantages (Kahneman and Tversky 1979).

One reason is that people tend to rely on heuristics as a means to reduce complexity when they are faced with complex problems. While heuristics can be useful they tend to lead to “severe and systematic errors” (Kahneman 2003, p. 1460). Recent research on this question suggests that people tend to focus on a salient attribute of the specific problem and then to substitute that attribute with a heuristic attribute a prototype, which comes readily to mind (Kahneman 2003; Kahneman and Frederick 2002). If nothing else, the heuristic can be affective, so that for example the evaluation of costs is decided intuitively on the basis of like or dislike. Reason may interfere and correct gut feeling, but the cognitive effort commonly spent on ex post rationalization will obviously not improve decision making. Nor is it true that the decision quality will necessarily improve when decisions have significant economic consequences (Camerer and Hogarth 1999).

Finally, decision quality and the cost of complexity will be lower under time pressure and when people are involved in other cognitive tasks (Kahneman and Frederick 2002). This may also apply when business companies in intense competition are subjected to complex regulatory shocks.

Personality and Complexity

The definition of complexity will depend on personality. Gardner (1983) proposed that there are multiple types of intelligence. Depending on the type of regulation in question the level of complexity can seem greater to less linguistically or mathematically intelligent people, although they may be intelligent in other ways (interpersonal or emotional intelligence). There is a fit here with Carl Jung’s theory of rational versus emotional personalities. Related research would tend to indicate that the costs of handling complexity are higher among authoritarian personalities (Adorno et al. 1950) and stressed people (Friedman and Rosenman 1959).

This suggests the possibility of a division of labor in which complexity seekers (or alternatively people less adverse to complexity) offer their services to the rest of the population as specialists (tax consultants, computer assistants, lawyers, accountants and mathematicians). However, if the decision problems are complex (and predictability is low), even highly educated experts will continue to make mistakes and may even make more mistakes because of overconfidence (Rabin 1998). Nevertheless, people’s approach to complexity is probably to some extent changeable. For example, the original definition of intelligence was to regard intelligence as sensitive to schooling (Binet and Simon 1904). Moreover, the capacity to handle complex problem will to some extent depend on other personality factors like self confidence (self efficacy beliefs) which can be influenced by social learning (Bandura 1977). The ability to learn indicates that the costs of complex would be higher in the short run than in the long run (see below), but as it turns out, effective learning is less likely if the decision problem is highly complex.

Emotions and Complexity

Emotions probably matter a great deal to the psychic costs of complexity, which can give rise to stress, anger and anxiety. The costs of voluntary complexity as in chess games played voluntarily are far lower than costs of complexity imposed from the outside. In work situations people with an internal locus of control (who feel that they are in control of the situation) are less likely to become stressed (Rotter 1966). The reaction to complexity also appears to be sensitive to attributions, i. e. how people assign causality to the difficulties encountered (Abramson et al. 1978). If they believe that the situation is permanent and attributable to their own incapacity, they will become more stressed, than if the problems are seen as transitory. It is also possible that complexity can trigger more irrational reactions like denial (Freud 1937).

Motivation and Complexity

Unsurprisingly, motivated individuals appear to handle complexity better (Bandura 1977) If the problems become too complex and if the sanctions are very severe so that that people perceive them as random, they may learn passivity (learned helplessness) like dogs when subjected to random electroshocks (Seligman and Maier 1967) or college students who were “taught” to be less good puzzles solvers if asked to solve unsolvable puzzles. Subsequent research indicates that this de-motivation effect is highly contingent on attributions (Abramson et al. 1978). People with high self-efficacy beliefs tend to have higher ambition levels, to be more persistent in problem solving, to feel more in control and to be less stressed by complex decision problems.

Social Effects and Complexity

More generally, the psychic costs of complexity will be sensitive to social interpretation effects (Moscovici 1984). If a new piece of legislation is regarded as having a good purpose and is well received by opinion leaders or peer groups, individuals may react less negatively to it. This may for example be the case if new environmental standards are believed to have a positive effect on the environment. But herd behavior may also lead to inadequate or dysfunctional responses to new challenges (Trotter 1919). Festinger (1957) argues that people prefer to have similar attitudes to a subject and to reduce the cognitive dissonance of unbalanced attitudes. In more extreme instances business elites can become subject to groupthink, where information from the outside world is systematically discarded (Janis 1972). This is a big risk for regulation which aims to change decision processes, but may be received cynically and adopted as a legal formality only.

Learning to Deal with Complexity

It seems plausible that that complexity costs can be reduced over time by learning. However, learning complex behavior by positive reinforcement (Watson 1903; Skinner 1938) will take more time. The seemingly uncertain rewards involved will create anxiety, and negative rewards (punishment) work badly because the behavior desired by regulators comes to be associated with negative emotions. Moreover, learning tends to be more effective if you are interested in learning (getting to know your computer) than if you are only interested in performance (Ames 1992), which is unfortunately more realistic for coping with complex legislation. And what you learn is influenced by social mechanisms for example by imitation of role models (Bandura and Walters 1963), which may or may not be in accordance with the intentions of the regulators. Moreover, as people who experience the same frustrations at filling out the tax forms year after year will testify, some people never learn. Psychological research indicates that people continue to make mistakes, and for very complex problems experts may learn slower because they are overly self confident (cf. Rabin 1998). In fact, when people are misled by stochastic feedback, misunderstandings and spurious correlations may reinforce superstition rather than learning so that “superstitious learning” takes place (Skinner 1938). Levinthal and March (1993) emphasize some limitations of organizational learning.


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