Here is a brief excerpt from an article written by Julia Sperling and David Schwartz for the McKinsey Quarterly, published by McKinsey & Company. They interview a Nobel Prize winner and a leading behavioral economist who offer common sense and counterintuitive insights on performance, collaboration, and innovation. To read the complete article, check out other resources, learn more about the firm, obtain subscription information, and register to receive email alerts, please click here.

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The confluence of economics, psychology, game theory, and neuroscience has opened new vistas—not just on how people think and behave, but also on how organizations function.

Over the past two decades, academic insight and real-world experience have demonstrated, beyond much doubt, that when companies channel their competitive and collaborative instincts, embrace diversity, and recognize the needs and emotions of their employees, they can reap dividends in performance.

The pioneering work of Nobel laureate and Harvard professor Eric Maskin in mechanism design theory represents one powerful application. Combining game theory, behavioral economics, and engineering, his ideas help an organization’s leaders choose a desired result and then design game-like rules that can realize it by taking into account how different independently acting, intelligent people will behave. The work of Hebrew University professor Eyal Winter challenges and advances our understanding of what “intelligence” really means. In his latest book, Feeling Smart: Why Our Emotions Are More Rational Than We Think (PublicAffairs, 2014), Winter shows that although emotions are thought to be at odds with rationality, they’re actually a key factor in rational decision making.

In this discussion, led by McKinsey partner Julia Sperling, a medical doctor and neuroscientist by training, and McKinsey Publishing’s David Schwartz, Maskin and Winter explore some of the implications of their work for leaders of all stripes.

Should CEOs feel badly about following their gut or at least listening to their intuition?

Eyal Winter: A CEO should be aware that whenever we make an important decision, we invoke rationality and emotion at the same time. For instance, when we are affected by empathy, we are more capable of recognizing things that are hidden from us than if we try to use pure rationality. And, of course, understanding the motives and the feelings of other parties is crucial to engaging effectively in strategic and interactive situations.

Eric Maskin: I fully agree with Eyal, but I want to introduce a qualification: our emotions can be a powerful guide to decision making, and in fact they evolved for that purpose. But it’s not always the case that the situation that we find ourselves in is well matched to the situation that our emotions have evolved for. For example, we may have a negative emotional reaction on meeting people who, at least superficially, seem very different from us—“fear of the other.” This emotion evolved for a good purpose; in a tribal world, other tribes posed a threat. But that kind of emotion can get in the way of interactions today. It introduces immediate hostility when there shouldn’t be hostility.

That really matters for diversity.

Winter: One of the most important aspects of this interaction is that rationality allows us to analyze our emotions and gives us answers to the question of why we feel a certain way. And it allows us to be critical when we’re judging our own emotions.

People have a perception about decision making, as if we have two boxes in the brain. One is telling the other that it’s irrational, these two boxes are fighting over time, one is prevailing—and then we make decisions based on the prevailing side, or we shut down one of these boxes and make decisions based on the other one only. This is a very wrong way of describing how people make decisions. There is hardly any decision that we take that does not involve the two things together. Actually, there’s a lot of deliberation between rationality and emotion. And we also know that the types of decisions that invoke perhaps the most intensive collaboration between rationality and emotions are ethical or moral considerations. As a neuroscientist, you know that one of the more important pieces of scientific evidence for this is that much of this interaction takes place in the part of the brain called the prefrontal cortex. When we confront people with ethical issues, this part of the brain, the prefrontal cortex, is doing a lot of work.

Yes, and we can track this with imaging techniques. Indeed, neuroscientists keep fighting back when people try too quickly to take insights from their area of science into business, and come up with this idea of a “left-” and “right-brain” person, and exactly the boxes that you are mentioning. Given your earlier comments, do you believe we are capable in a situation where we are emotional, to actually step back, look at ourselves, realize that we are acting in an emotional way—and that this behavior might be either appropriate or not appropriate?

Winter: I think we are capable of doing it, and we are doing it to some extent. Some people do it better, some people have more difficulty. But just imagine what would have happened if we couldn’t have done it? We probably wouldn’t have managed, in terms of evolution. I think that the mere fact that we still exist, you and me, shows that we have some capability of controlling our emotions.

Maskin: In fact, one interesting empirical trend that we observe through the centuries is a decline of violence, or at least violence on a per capita basis. The world is a much less dangerous place now than it was 100 years ago. The contrast is even bigger when we go back longer periods of time. And this is largely because of our ability over time to develop, first, an awareness of our hostile inclinations, but more important to build in mechanisms which protect us from those inclinations.

Can you speak more about mechanism design—how important it is that systems help the individual or groups to act in ways that are desirable?

Maskin: Mechanism design recognizes the fact that there’s often a tension between what is good for the individual, that is, an individual’s objectives, and what is good for society—society’s objectives. And the point of mechanism design is to modify or create institutions that help bring those conflicting objectives into line, even when critical information about the situation is missing.

An example that I like to use is the problem of cutting a cake. A cake is to be divided between two children, Bob and Alice. Bob and Alice’s objectives are each to get as much cake as possible. But you, as the parent—as “society”—are interested in making sure that the division is fair, that Bob thinks his piece is at least as big as Alice’s, and Alice thinks her piece is at least as big as Bob’s. Is there a mechanism, a procedure, you can use that will result in a fair division, even when you have no information about how the children themselves see the cake?

Well, it turns out that there’s a very simple and well-known mechanism to solve this problem, called the “divide and choose” procedure. You let one of the children, say, Bob, do the cutting, but then allow the other, Alice, to choose which piece she takes for herself. The reason why this works is that it exploits Bob’s objective to get as much cake as possible. When he’s cutting the cake, he will make sure that, from his point of view, the two pieces are exactly equal because he knows that if they’re not, Alice will take the bigger one. The mechanism is an example of how you can reconcile two seemingly conflicting objectives even when you have no idea what the participants themselves consider to be equal pieces.

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Here is a direct link to the complete article.

Eric Maskin is a Nobel laureate in economics and the Adams University Professor at Harvard University. Eyal Winter is the Silverzweig Professor of Economics at the Hebrew University of Jerusalem and the author of Feeling Smart: Why Our Emotions Are More Rational Than We Think (PublicAffairs, 2014). This interview was conducted by Julia Sperling, a partner in McKinsey’s Dubai office, and David Schwartz, a member of McKinsey Publishing who is based in the Stamford office.