How we make decisions - internal audit insights from behavioural economics

This thought leadership piece examines the application of behavioural economics to how we examine controls and operate our internal audit activities. Could internal audit be the catalyst to more effective outcomes through application of behavioural nudges? Are we sure that there are no behavioural biases in our work?

What is a behavioural nudge?

In 2002, Daniel Kahneman proposed a new way of understanding why economic theories so often get it wrong and do not result in the changes expected. Sunstein and Thaler popularised this in their book ‘Nudge’, which looked at how we make choices in our lives and how we can practically improve decision-making.

The nudge theory is a concept which proposes positive reinforcement and indirect suggestions as powerful ways to influence the behaviour and decision-making of groups of individuals.

Both Barack Obama and David Cameron utilised the theory in Office.  In the UK the theory was responsible for a raft of policy ‘nudges’ that led to increases in the use of loft insulation, electoral participation rates, payday charitable giving, organ donation pledges and the introduction of pension auto enrolment.

Auditors can learn from this and use nudge theory in control assessment work, how we work with management to raise and ensure issues are closed and in how we work generally.

How does this relate to internal audit?

Economic theory has traditionally been based on three assumptions, all of which have relevance for how we view behaviour in our own organisations. These are that people:

  • act rationally, using all information available to take the ‘right’ decision
  • have unlimited self-control, resisting the temptation to take ‘poor’ choices
  • are selfish, looking to maximise the benefit of actions for their own gain.

Applying this approach to organisational decision-making implies that decisions are taken by carefully weighing up the costs and benefits,…