What Is Anchoring and Adjustment?
Anchoring and adjustment is a phenomenon wherein an individual bases their initial ideas and responses on one point of information and makes changes driven by that starting point. The anchoring and adjustment heuristic describes cases in which a person uses a specific target number or value as a starting point, known as an anchor, and subsequently adjusts that information until an acceptable value is reached over time. Often, those adjustments are inadequate and remain too close to the original anchor, which is a problem when the anchor is very different from the true answer.
Key Takeaways
- Anchoring and adjustment is a cognitive heuristic where a person starts off with an initial idea and adjusts their beliefs based on this starting point.
- Anchoring and adjustment have been shown to produce erroneous results when the initial anchor deviates from the true value.
- Awareness of anchoring, monetary incentives, giving careful consideration to a range of possible ideas, expertise, experience, personality, and mood can all modify the effects of anchoring.
- Anchoring can be used to advantage in sales and price negotiations where setting an initial anchor can influence subsequent negotiations in your favor.
Understanding Anchoring and Adjustment
Anchoring is a cognitive bias described by behavioral finance in which individuals fixate on a target number or value—usually, the first one they get, such as an expected price or economic forecast. Unlike the conservatism bias, which has similar effects but is based on how investors relate new information to old information, anchoring occurs when an individual makes new decisions based on the old, anchor number. Giving new information thorough consideration to determine its impact on the original forecast or opinion might help mitigate the effects of anchoring and adjustment, but the characteristics of the decision-maker are as important as conscious consideration.
The problem with anchoring and adjustment is that if the value of the initial anchor is not the true value, then all subsequent adjustments will be systematically biased toward the anchor and away from the true value. However, if the anchor is close to the true value then there is essentially no problem.
One of the issues with adjustments is that they may be influenced by irrelevant information that the individual may be thinking about and drawing unfounded connections to the actual target value. For instance, suppose an individual is shown a random number, then asked an unrelated question that seeks an answer in the form of an estimated value or requires a mathematical equation to be performed quickly. Even though the random number they were shown has nothing to do with the answer sought, it might be taken as a visual cue and become an anchor for their responses. Anchor values can be self-generated, be the output of a pricing model or forecasting tool, or be suggested by an outside individual.
Studies have shown that some factors can influence anchoring, but it is difficult to avoid, even when people are made aware of it and deliberately try to avoid it. In experimental studies, telling people about anchoring, cautioning them that it can bias their judgment, and even offering them monetary incentives to avoid anchoring can reduce, but not eliminate, the effect of anchoring.
Higher levels of experience and skill in a specific field can help reduce the impact of anchoring in that subject area, and higher general cognitive ability may reduce anchoring effects in general. Personality and emotioncan also play a role. A depressed mood increases anchoring, as do the personality traits of agreeableness, conscientiousness, introversion, and openness.
Anchoring and Adjustment in Business and Finance
In sales, price, and wage negotiations, anchoring and adjustment can be a powerful tool. Studies have shown that setting an anchor at the outset of a negotiation can have more effect on the final outcome than the intervening negotiation process. Setting a deliberate starting point can affect the range of all subsequent counteroffers.
For example, a used car salesman (or any salesman) can offer a very high price to start negotiations that are arguably well above the fair value. Because the high price is an anchor, the final price will tend to be higher than if the car salesman had offered a fair or low price to start. A similar technique may be applied in hiring negotiations when a hiring manager or prospective hire proposes an initial salary. Either party may then push the discussion to that starting point, hoping to reach an agreeable amount that was derived from the anchor.
In finance, the output of a pricing model or from an economic forecasting tool may become the anchor for an analyst. One possible way to counteract this is to look at multiple, diverse models or strands of evidence. Social psychology researcher Phillip Tetlock has found that forecasters who make predictions based on many different ideas or perspectives ("foxes") tend to make better forecasts than those who focus on only a single model or a few big ideas ("hedgehogs"). Considering several different models and a range of different forecasts may make an analyst’s work less vulnerable to anchoring effects.
FAQs
Anchoring and adjustment refers to a cognitive heuristic that influences how people assess probabilities in an intuitive manner. According to the anchoring and adjustment heuristic, people employ a certain starting point (“the anchor”) and make adjustments until they reach an acceptable value over time.
What is anchoring and adjustment in finance? ›
Anchoring and adjustment is a phenomenon wherein an individual bases their initial ideas and responses on one point of information and makes changes driven by that starting point.
What does anchoring mean in business? ›
What Is Anchoring? Anchoring is a heuristic in behavioral finance that describes the subconscious use of irrelevant information, such as the purchase price of a security, as a fixed reference point (or anchor) for making subsequent decisions about that security.
What is anchoring and adjustment in negotiation? ›
A well-known cognitive bias in negotiation and in other contexts, the anchoring bias describes the common tendency to give too much weight to the first number put forth in a discussion and then inadequately adjust from that starting point, or the “anchor.” We even fixate on anchors when we know they are irrelevant to ...
What is anchoring in accounting? ›
Anchoring is the utilisation of irrelevant information as a basis for measuring or calculating the uncertain value of a financial instrument, such as the purchase cost of security.
What is an example of anchoring and adjustment? ›
For example, when we are trying to estimate how long it will take us to write a paper. In this case, we start with an initial anchor value that seems reasonable and then adjust until an acceptable answer is found.
What is an example of anchoring in finance? ›
Anchoring Bias Example in Finance
Many people would first say, “o*kay, where's the stock today?” Then, based on where the stock is today, they will make an assumption about where it's going to be in three months. That's a form of anchoring bias.
What is anchoring in simple words? ›
to make something or someone stay in one position by fastening him, her, or it firmly: We anchored ourselves to the rocks with a rope.
What are the 4 stages of anchoring? ›
The 4 stages of anchoring are selection, plotting, execution, and post-anchoring considerations. Key terms are defined, such as head bearing, letting-go circle, and letting-go bearing.
What is an anchor in banking? ›
Anchor Banks are public sector banks that will drive the consolidation process among the state owned banks. There are 22 public sector banks in the country apart from five associate banks of State Bank of India. Consolidation among public sector banks has been under discussion for about a decade now.
How do you prevent anchoring bias?
- Identify the anchor.
- Seek alternative perspectives. Be the first to add your personal experience.
- Adjust your thinking. Be the first to add your personal experience.
- Test your solutions. ...
- Reflect on your process. ...
- Practice regularly. ...
- Here's what else to consider.
Examples of anchoring bias in the hiring process
For example, if the job description requires a specific degree or certification, hiring managers become anchored on these requirements and overlook other qualities that could make a candidate a good fit for the role.
What is an anchoring strategy? ›
Anchoring is a cognitive bias that affects how people perceive and evaluate information. It happens when people rely too much on the first piece of information they receive, and use it as a benchmark or anchor for making subsequent judgments or decisions.
What is anchoring in business? ›
Imagine you're buying a new product. The first price you see is like an anchor; it sticks in your mind. If the product was really expensive at first, even a lower price later seems like a good deal. This is called anchoring, and stores use it to make you think you're getting a bargain.
How to avoid anchoring bias in finance? ›
To combat anchoring bias, reassess investments objectively: Avoid fixating on your original purchase price:. Let your goals, fundamentals, situation, and alternatives guide your decision. Analyze current conditions and future prospects rather than relying solely on past performance.
What is the meaning of anchor in corporate business? ›
Anchor company means a qualified high-technology business that is an integral part of a high-technology activity and that has the ability or potential ability to influence business decisions and site location of qualified suppliers and customers.
What does adjustment mean in financial statements? ›
Adjustments are made at the close of an accounting period to rectify errors, record unaccounted income or expenses, and maintain the integrity of financial records to prepare comprehensive financial statements. This ensures financial data accurately reflects the financial position and performance of a business.
What are the four types of adjustments? ›
There are four types of account adjustments found in the accounting industry. They are accrued revenues, accrued expenses, deferred revenues and deferred expenses.
What is adjustment for financial services? ›
Adjustment refers to those changes in expenditure, saving, and production that are needed to produce a sustainable balance of payments situation, namely, one where any deficit on current account can be financed by normal capital inflows.
What does adjust mean in finance? ›
What Is Adjustment? An adjustment is the use of mechanisms by a central bank to influence a home currency's exchange rate. An adjustment is specifically made if the exchange rate is not pegged to another currency, meaning that the currency is valued according to a floating exchange rate.
