How a person processes available financial data is subject to behavioral errors based on the context in which the data are presented. For instance, when some expression of judgment makes its way into the presentation of data or information, that judgment influences how others analyze and understand the information.
The process of introducing your own interpretation of a subjective measure or event is called framing. Everything you witness is processed through something of a filter, called a frame, which is composed of everything you’ve learned to assume about the world around you, including the behaviors of people. These frames will cause you to understand and interpret things in a different manner from the people around you and, as a result, alter how you each respond.
Say that the manager of the marketing department sends you a proposal of a project and asks whether the project will fit within the department’s remaining budget. As you research the marketing budget, you discover that the entire budget has been drained because some marketing intern named Jeff (theoretical name has been changed to protect the innocent) spent it all when he purchased a jet ski for “team building.”
You could tell the marketing manager that Jeff embezzled the funds, thus putting it in the manager’s mind to press criminal charges against him, or you could simply say that the project exceeds the remaining budget.
Both cases are likely true, but in the former you assume that Jeff was embezzling, putting an element of personal judgment into the scenario and essentially planting the idea in someone’s head; in the latter scenario, you’re only presenting information likely to be considered out of the ordinary, and Jeff may have actually been told to develop a team-building outing and made a really dumb decision.
In the first scenario, Jeff is going to prison. In the second, the marketing department will likely rework the project for lower costs until the new quarter when its budget is replenished while Jeff simply gets fired for incompetence instead of going to prison. See how the way you present the information greatly influences the way the marketing manager will react to it?
For another example of framing, consider the following two sentences:
The price of XYZ stock has plummeted 75 percent, causing devastating losses.
The price of XYZ stock has plummeted 75 percent, causing it to be a great buy!
In both cases, the price of XYZ stock lost 75 percent of its value, but the action that a person is likely to take in response to this information changes depending on how the information is presented. Even so, what really matters in this situation is whether or not the company is valuable according to the analytics, not how someone explains what happened to the stock price.
Another form of framing is called ethnocentrism, in which you judge the occurrences of one nation by the standards of another.
For example, when an analyst from a nation of people who are culturally more comfortable taking risk analyzes the stock of a company from a nation of people who are culturally averse to risk, the analyst is likely to see the company’s price to earnings as being extremely low for the value of the company.
As a result, the analyst may think the company is undervalued. What’s the problem here? The analyst is judging another nation’s company based on the frame of her own ethnocentrism. Unless that stock cross-lists, the price isn’t likely to increase as the analyst predicts simply because the people of the nation where the stock is from aren’t willing to take the additional risk compared to the company’s future potential earnings.
Framing can influence all sorts of financial decisions. You have to be very careful to apply relevant contextual information along with any analysis you give and ensure that the manner in which you present information remains objective, neutral, and free of judgments that contribute to framing.