PhD Literature Review: Behavioural Biases in Risk Perception During Systemic Crises: Lessons Learnt by UK SMEs During COVID-19

1. Behavioural Biases in Risk Perception

Behavioural bias is usually defined as systematic deviations from rationality, where individuals’ decisions, behaviours, and perspectives are affected by predetermined beliefs and mental notions (Parveen et al., 2021; Quddoos et al., 2020; Rehan et al., 2021). They can be further subdivided into unconscious and conscious ones, as well as cognitive and emotional ones. The first type is related to the use of established concepts in decision-making and usually includes status quo bias, confirmation bias, risk-averse bias, bandwagon effect, and similar errors where social trends and habits inform specific irrational behaviours (Benayad & Aasri, 2023). At the same time, emotional bias may be linked with the personal feelings of actors that may be associated with both individual and group behaviours. They usually include loss-aversion bias, endowment bias, overconfidence bias, and other similar errors linked with the fear of loss or excessive confidence leading to sub-optimal decisions (Sathya & Prabhavathi, 2024). In the case of systemic crises, one of the most widespread behavioural biases is bounded rationality, where limited knowledge, time limits, and cognitive capacity create pressure on decision-makers and may convince them to select solutions from a restricted range of bad options without seeing stronger solutions requiring more time or analysis capabilities to find (Compen et al., 2022).

Past studies exploring decision-making in business and investment spheres identified that several bias types were most prominent among company managers (Ahmad, 2020; Benayad & Aasri, 2023; Xu, 2023). Overconfidence was usually manifested as the willingness to use available data without checking its accuracy or entirety. This effect was sometimes called ‘miscalibration’, where the manager did not recognise the limits of their knowledge and believed that they possessed all the information required to make high-quality decisions in a certain situation. In the case of the COVID-19 pandemic, the consequences of these behaviours could be further intensified by the lack of predictability regarding regulatory interventions (Botzen et al., 2022). Another widespread type of bias found in commercial companies as reported by Ahmed et al. (2022) and Islam et al. (2024) was excessive optimism. While overconfidence usually refers to the overestimation of one’s decision-making capabilities and/or information quality and entirety, this issue is often associated with unrealistically positive expectations regarding the company’s performance or environment in general (Abu Hatab et al., 2021).

In the case of COVID-19, excessive optimism was frequently demonstrated by firms expecting a prompt end of the restrictions allowing them to quickly get back to business as usual or overestimating their companies’ resources and resilience (Almansour et al., 2023; Chen et al., 2022; Singh et al., 2023). This bias overlaps with risk-taking behaviours that can manifest themselves as risk aversion, unconscious risk-taking, and anticipation-informed risk-taking, according to the prospect theory. The first option includes the decision to align oneself with past decisions and practices, which could be dangerous in crisis periods where prompt adaptation and adjustment may be necessary (Shukla et al., 2020). Unconscious risk-taking involves the willingness to ignore the possibility of negative outcomes or underestimation of such probabilities. Finally, some SME managers may similarly focus on potential gains as a way of ‘recouping losses’ after a failure (Bihari et al., 2022). This option may be further supported by the aforementioned overconfidence bias, where past successes are associated with skill and knowledge while the role of luck is generally underestimated.

Another type of bias found in SME behaviours includes anchoring heuristic and availability heuristic mental shortcuts (Jain et al., 2023; Kijkasiwat, 2021; Zhang et al., 2022). These phenomena involve intuitive judgements based on a certain earlier reference point considered accurate or prior/recent experiences coming to mind as reliable references for new decisions. In both scenarios, managers and entrepreneurs do not consider all available options in a rational manner due to the willingness to adhere to a more familiar and/or understandable course of action (Adil et al., 2022). While this strategy could be effective in the case of tactical decisions, systemic crises such as COVID-19 may require major changes in business practices, which informs the need for a more thorough and objective analysis (Singh et al., 2023). The situation could be further intensified by psychological pressures and uncertainty, making it difficult to create new ‘reference points’ and avoid falling back to old and well-known scenarios (Mahmood et al., 2024). This poses a serious challenge within the scope of the objectives posed by this thesis, since risk perceptions are largely affected by human emotions and fears.

Additionally, confirmation bias is reported to affect entrepreneurs with limited business expertise (Ababio, 2020; Goswami et al., 2020; Khawaja & Alharbi, 2021). These practitioners frequently lack past failure experiences, which leads to the aforementioned overconfidence and the willingness to seek only the information that supports their judgement (Kartini & Nahda, 2021). As shown by multiple studies, businesses that started their operations right before the COVID-19 period generally demonstrated lower levels of resilience in comparison with their counterparts registered 3-5 years before the pandemic (Mavruk, 2022). While some of this effect was attributed by researchers to resource accumulation and overall business experience, this thesis suggests that such companies could also demonstrate greater levels of confirmation bias in their risk perceptions (Mundi et al., 2022). As a result, they were more willing to take bolder decisions and look for information supporting them instead of avoiding all threats to minimise their exposure. This could lead to the selection of facts confirming a certain scenario selected earlier on the basis of pre-existing beliefs (Stella et al., 2022). As a result, wrong conclusions were drawn about the impact of the systemic crisis on a particular industry since contradictory evidence was not included in the analysis.

2. SME Behaviours During COVID-19

As noted by multiple studies, UK SMEs were exposed to a number of critical risks related to delayed business reopening, financial constraints, limited state support, logistics disruptions in supply and distribution chains, operational challenges, worker and customer movement restrictions, and the lack of cash buffers (Asriati et al., 2022; Erdiaw-Kwasie et al., 2023; Gur et al., 2023). With that being said, their threat profiles could differ substantially depending on a particular industry. More specifically, firms with business processes compatible with remote or flexible work arrangements could maintain greater sustainability in comparison with fully physical spheres, such as tourism or entertainment (Miocevic, 2023). Additionally, key types of risks these organisations were exposed to primarily included economic, market, financial, and operational risks. According to Hafezalkotob et al. (2023) and Malekinezhad et al. (2024), UK SMEs generally experienced greater threat levels due to several factors. On the one hand, the United Kingdom is physically separated from the continent, which increased the degree to which global transportation disruptions, including air and sea deliveries, affected local businesses. On the other hand, Brexit excluded the UK from the Single EU Market, as well as multiple support programmes realised at the EU level using shared resources of multiple constituent states (Amah, 2023).

These challenges could be seen as largely similar to the risks encountered by SMEs in a number of different contexts (Abdelwahed and Soomro, 2023; Fasth et al., 2023; Mukherjee et al., 2023). According to Abdelwahed and Soomro (2023), key problems with risk perceptions were associated with owners’ identities and propensity to take risks. Low tolerance for ambiguity negatively influenced the ability to adjust to the changing status quo and withstand the increasing psychological pressures. Similarly, Miocevic (2023) noted that the capability to act rationally was largely determined by the predictability of state policies, digital connectivity between different actors within supply and distribution chains, and the degree of collaboration within certain industries. In the UK, job retention schemes were implemented in a somewhat haphazard manner, prioritising short-term survival, as noted by multiple authors (Belghitar et al., 2022). At the same time, the lack of clarity regarding the requirements for receiving such aid and its availability to new companies could inform biased decisions due to high perceived uncertainty.

One of the main problems related to SME behaviours during COVID-19 was associated with the lack of clear risk assessment frameworks (Buganova et al., 2023; Sharma et al., 2020; Wenzel et al., 2020). These instruments can mitigate optimism bias, confirmation bias, and other similar issues by focusing on objective data and appraising its integrity and completeness. Unfortunately, many SMEs lacked such systems prior to the pandemic due to the lack of such challenges and the overall favourable environment reducing the costs of individual mistakes in decision-making (Morgan et al., 2020). This lack of rationality could also explain the diverse effects of open communication and collaboration in some industries (Lim et al., 2020). On the one hand, such relationships could alleviate the pressure by distributing it between multiple actors interested in collective survival. On the other hand, they could support the flow of inaccurate information or wrong estimations leading to sub-optimal decisions made by multiple actors trusting a single source (Greene & Rosiello, 2020).

With that being said, multiple authors noted that SMEs in different industries encountered similar risk types and risk magnitudes during COVID-19 (Cowling et al., 2020; Fasth et al., 2023; Grondys et al., 2021). These threats were mainly related to relationships with customers and suppliers, the inability to cover financial obligations leading to insolvency, the absence of external financing and state support, and excessive costs of operation due to energy prices increase and other similar factors (Belghitar et al., 2022). However, optimal behaviours could be different for micro, small, and medium enterprises according to Grondys et al. (2021), due to the varying nature of their obligations and cost structures. Companies employing 1-10 workers could put usually their business on a standstill for prolonged periods, even with minimum support, due to the limited scope of their obligations. On the contrary, medium-sized companies were paying salaries and generally had indebtedness before their suppliers as well as higher costs of rental space (Miocevic, 2023). These factors required different risk management strategies, since bigger enterprises were exposed to greater threats and were affected by international transportation disruptions to a greater degree.

The analysis of key risk perceptions of German SMEs during the pandemic performed by Glowka et al. (2024) indicated that 40% of firm owners in small firms viewed regulatory and political threats and rapid reduction of profits as two main risk categories. Yet, many of the analysed companies did not have official appraisal strategies to minimise bias in such appraisals or prepare for potential threats in these spheres in advance (Glowka et al., 2024), which was similar to the evidence analysed by Fasth et al. (2023) and Gur et al. (2023). As a result, such firms found it difficult to manage high levels of uncertainty without clearly structured response patterns developed on the basis of thorough advance analysis, rather than immediate reactions to emerging risks (Hafezalkotob et al., 2023). It can also be noted that SME behaviours were informed by both short-term and long-term perceptions of threats. In this aspect, the immediate influence of the pandemic was accompanied by its expected outcomes, such as the decline of offline retail due to e-commerce growth or increasing indebtedness that was difficult to mitigate due to shrinking consumer purchasing capacity (Asriati et al., 2022).

SME behaviours during COVID-19 were also informed by the ideas of resilience and resourcefulness as two partially overlapping concepts (Amah, 2023; Mukherjee et al., 2023; Malekinezhad et al., 2024). The first one included behavioural, social, and financial assets influencing the types of decisions managers could make during the pandemic and their capability to realise the most rational response strategies. These elements primarily defined the short-term state of a particular SME in a cross-sectional manner (Khawaja & Alharbi, 2021). The resilience element involved redundancy, diversity, social capital, transformability, adaptability, and robustness and described firm characteristics and core capabilities that were usually developed over time. As noted by Malekinezhad et al. (2024), both of these dimensions had to be properly appraised in order to ensure firm survival and optimal decision-making. Biased appraisals based on overconfidence and other earlier analysed issues could be highly detrimental and could reduce the outputs these resources could produce (Goswami et al., 2020).

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