Economic Foundations of Strategy Chapter 1: Behavioral Theory of the Firm

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Economic Foundations of StrategyChapter 1
Behavioral Theory of the Firm

• Joe Mahoney
• University of Illinois at Urbana-Champaign

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Behavioral Theory of the Firm

• Barnard (1938) The Functions of the Executive
• Simon (1947) Administrative Behavior
• March and Simon (1958) Organizations
• Cyert and March (1963) A Behavioral Theory of
  the Firm
• Simon (1982) Models of Bounded Rationality

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Barnard (1938) The
Functions of the Executive

• Barnards purpose is to provide a comprehensive
  theory of cooperating behavior in
  formal organizations.
• Essential features are
• The willingness to cooperate
• The capability to communicate
• The existence and acceptance of purpose

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Barnard (1938) The
Functions of the Executive

• Barnard notes that successful cooperation is the
  abnormal, not the normal condition. What we
  observe from day-to-day are the successful
  survivors among innumerable failures.
• Failure to cooperate and failure of
  organization are characteristic facts
  of human history.

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Barnard (1938) The
Functions of the Executive

• Barnard emphasizes the important role of informal
  organization within formal organizations.
• Informal organization is to be regarded as a
  means of maintaining the personality of the
  individual against certain effects of formal
  organizations, which tend to disintegrate the
  personality.

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Barnard (1938) The
Functions of the Executive

• Barnard maintains that there exists a
  zone of indifference in each individual
  within which orders are acceptable without
  conscious questioning of their authority.
• Barnard submits that he regards
  nothing as more real than
  authority.

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Barnard (1938) The
Functions of the Executive

• Barnard notes that the fine art of executive
  decision-making consists in not deciding
  questions that are not pertinent, in not
  deciding prematurely, in not making a
  decision that cannot be made effective, and in
  not making decisions that others should make.
  Such good judgment by the executive then
  preserves morale, develops competence, and
  preserves authority.

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Barnard (1938) The
Functions of the Executive

• Barnard observes that the executive process
  transcends the capacity of mere intellectual
  methods. The terms pertinent to the executive
  process are
• feeling
• judgment
• sense
• proportion
• balance
• appropriateness

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Barnard (1938)
The Functions of the Executive

• Inducements Contributions Balance
• The effectiveness of an organization depends upon
  what the organization secures and the personnel
  produce (the contributions) and how the
  organization distributes the resources (the
  inducements)
• Inducements include material inducements,
  personal non-material opportunities desirable
  physical conditions ideal benefactions
  associational attractiveness adaptation of
  conditions to habitual methods and attitudes the
  opportunity of enlarged participation and the
  condition of communion (1938 p. 142).

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Barnard (1938) The
Functions of the Executive

• Barnard presents a systems view of the
  organization that contains
• A psychological theory of motivation and
  behavior
• A sociological theory of cooperation and complex
  interdependencies and
• An ideology based on meritocracy.

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Barnard (1938) The
Functions of the Executive

• Barnard concludes that
• expansion of cooperation and the development
  of the individual are mutually dependent
  realities, and that a due proportion or balance
  between them is a necessary condition of human
  welfare.

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Barnard (1938) The
Functions of the Executive

• Barnard maintains that coordination is a creative
  act.
• Barnard also maintains that organizations endure
  in proportion to the breadth of the morality by
  which they are governed.
• Old men and old women
  plant trees.

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Simon (1947)
Administrative Behavior

• Organizations influence individuals habits
• Organizations provide means for
  exercising authority and influence
  over others and
• Organizations influence the flow of
  communications.

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Simon (1947) Administrative
Behavior

• Simon maintains that it is precisely in the realm
  where behavior is intendedly rational, but only
  limitedly so, that there is room for a genuine
  theory of organization.
• Organizational behavior is the theory of intended
  and bounded rationality.

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Simon (1947)
Administrative Behavior

• Organizations enable stable and comprehensible
  expectations among members
• Organizational members satisfice
  and use simple rules of thumb to inform
  decisions and
• Rules of thumb or organizational
  routines are the counterpart of
  individual habits.

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Simon (1947) Administrative
Behavior

• Simon suggests the following mechanisms of
  organizational influence
• Divides work among its members
• Establishes standard operating procedures
• Transmits decisions by authority
• Provides formal and informal channels
  of communication and
• Trains and inculcates its members.

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Simon (1947)
Administrative Behavior

• Zone of Acceptance
• Sales contract versus employment contract
• An incomplete contracting approach
• A real options perspective
• Authority Relationship
• Enforces Responsibility of Individual
• Secures Expertise in Decision Making
  
• Permits Coordination of Activities.

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Simon (1947)
Administrative Behavior

• The Brain as Scarce Resource
• The information-processing systems of modern
  civilization swim in an exceedingly rich soup of
  information. In a world of this kind, the scarce
  resource is not information it is processing
  capacity to attend to information.

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Simon (1947)
Administrative Behavior

• The Brain as Scarce Resource
• Attention is the chief bottleneck in
  organizational activity, and the
  bottleneck becomes narrower
  and narrower as we move to the
  
  tops of the organizations.

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March and Simon (1958) Organizations

• Managers must continually search for
  complementarities to inform their
  task allocations
• An organizational model that neglects economic
  incentives will be, for most humans, a poor
  predictive model and
• Organization behavior can often be predicted by
  knowing past behavior and routines.

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March and Simon (1958) Organizations

• Features of their model of organization
  structure
• Optimizing is replaced by satisficing
• Alternatives of action and consequences of action
  are discovered sequentially through search
  processes and
• Each specific action deals with a restricted
  range of situations and a restricted range of
  consequences.

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March and Simon (1958) Organizations

• Search is partly random, but in effective problem
  solving search is not blind.
• The design of the search process is itself often
  an object of rational decision.
• Optimizing models
• Satisficing models

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Cyert and March (1963)
A Behavioral Theory of the Firm

• Four research commitments
• Focus on a small number of key
  economic decisions made by the
  firm
• Develop process-oriented models of the firm
• Link models of the firm as closely as possible to
  empirical observations and
• Develop theory with generality beyond the
  specific firms studies.

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Cyert and March (1963) A
Behavioral Theory of the Firm

• Organizations are viewed as consisting of a
  number of coalitions and the role of management
  is to achieve a Quasi-Resolution of Conflict and
  Uncertainty Avoidance.
• Problemistic Search that is stimulated by a
  problem with (or lack of) an existing
  routine is assumed to be motivated,
  simple-minded, and biased
  (reflecting unresolved
  conflicts
  within the organization).

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Simon (1982)
Models of Bounded Rationality

• To encompass goal conflict and uncertainty we
  need to know something about perceptual and
  cognitive processes in order to predict
  short-term behavior.
• Filtering of information is not a passive process
  but an active process involving attention, which
  is influenced by hopes and wishes.

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Simon (1982)
Models of Bounded Rationality

• A rabbit-rich world is a lettuce-poor world, and
  vice versa. Similarly, in an information-rich
  world, an abundance of information means a dearth
  of something else a scarcity of whatever
  information consumes. Information consumes the
  attention of its recipients.
• Information systems need to listen and think more
  than they speak. Stating the organization
  problem in this way leads to a very different
  system design (that deals with information
  overload).

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Simon (1982)
Models of Bounded Rationality

• Substantive Rationality
• Behavior appropriate to the achievement of given
  goals within the limits imposed by given
  constraints.
• In this economics view, given the goals, rational
  behavior is determined entirely by the
  characteristics of the environment in
  which such behavior takes place.

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Simon (1982)
Models of Bounded Rationality

• Procedural Rationality
• The traveling-salesman problem in operations
  research is a theory of efficient computational
  procedures to find good solutions --- a theory of
  procedural rationality.
• It is a search for better heuristics --- which
  Simon regards as the heart of intelligence.

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Simon (1982)
Models of Bounded Rationality

• Procedural Rationality
• Organizational economics is a description and
  explanation of human institutions, whose theory
  is no more likely to remain invariant over time
  than the theory of bridge design. Decision
  processes, like all other aspects of economic
  institutions, exist inside human heads.
  Decision processes are subject to change with
  every change in what humans know, and with every
  change in their means of calculation.
• A business firm equipped with the tools of
  operations research does not make the same
  decisions, for example, concerning inventory
  management, as it did before it possessed such
  tools.

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Simon (1982)
Models of Bounded Rationality

• Procedural Rationality
• The shift from theories of substantive
  rationality to theories of procedural rationality
  requires a basic shift in scientific style, from
  an emphasis on deductive reasoning within a tight
  system of axioms to an emphasis on detailed
  empirical exploration of complex algorithms of
  thought.

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Simon (1982)
Models of Bounded Rationality

• Procedural Rationality
• Complexity is deep in the nature of things, and
  discovering tolerable approximation procedures
  and heuristics that permit huge spaces to be
  searched selectively is at the heart of
  intelligence, whether human or artificial.