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A situation we know is generally the case.Prospect theory started as a thought experiment which was backed up by substantial testing. Thus its success cannot easily be measured against existing cases. Let’s call this Baumgartner’s Axiom of Innovative Risk!An established business in normal times (i.e., not during an economic recession) usually generates a continuous and most likely slowly increasing income. quality of life or the number of lives that could be lost or saved as a consequence of a policy decision.”“The main properties of the proposed value function for money should apply to other attributes. Established companies do periodically launch innovative new products and services. In order to avoid bankruptcy, and on orders of the President of the United States, both came up with business plans far more innovative than anything either company has done in recent decades.This fits within prospect theory. They sometimes develop innovative new operational processes. Below is an example of some of the questions:– Option A: There is a 50% probability of gaining $1,000 and a 50% probability of gaining zero dollars.– Option B: There is a 100% probability – a certainty – of gaining $500.– Option A: There is a 50% probability of losing $1,000, and a 50% probability of losing nothing.– Option B: There is a 100% probability – a certainty – of losing $500.The vast majority of the participants chose Option B for question 1, and Option A for question 2.

However, if I get a 10% rise and nobody else gets one, I will feel rich – so says prospect theory.Kahneman and Tversky believed that their theory is relevant to many situations in life, and not just monetary ones.Prospect theory could have implications for policymakers when making decisions that could affect the lives of many people.“Although the present paper has been concerned mainly with monetary outcomes, the theory is readily applicable to choices involving other attributes, e.g. Moreover, most people are extremely poor at evaluating risk and especially threats.The implementation of a potentially innovative idea in a business inevitably involves risk. But of course humans are not logical. This is precisely what the managers at the two companies have opted to do.Enron was a highly innovative company in its final years. Faced with losing money (in this case everything) or taking risk in order to reduce that loss (ideally to no loss), the average person will take the second option. But from the moment the start-up begins operations, money is disappearing. They avoid implementing the innovative idea and avoid its potential risk.A typical start-up company, on the other hand, begins its existence losing money. Kahneman and Tversky found that losses had more emotional impact than the equivalent amount of gain for people.For example, in a traditional way of thinking, we should gain the same amount of utility (pleasure, satisfaction) if we received $100, or first received $200 and then lost $100, because the end result would be the same – a $100 net gain.However, this is not how humans see it.

And this is true in my experience, anyway.Likewise, loss making companies such as new start-ups or companies facing economic difficulties are more likely to embrace new product and service ideas as they offer the opportunity to reduce loss. Prospect theory, a theory of decision-making under risk, was first proposed at the end of the 1970s by Daniel Kahneman and Amos Tversky. In particular, it challenges another decision-making theory called the “expected utility theory“. Thus, when faced with diverting resources to implement an innovative idea, the manager is faced with a choice similar to (a) and (b) above. Thus, in an established firm, process efficiency ideas, which reduce costs, are more attractive to the typical human than are product ideas. As a result, the more innovative an idea is, the harder it is to determine the result of its implementation.

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