Tag Archives: HEC Montéal

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


Cyert, Robert M. and James G. March
“A Behavioral Theory of the Firm”
Prentice Hall, New Jersey, 1963. Second Edition1992

Topic: An explanation of the theory of the firm from a behavioral perspective.

Summary and citations:

1- Introduction
o “The modern firm has some control over the market; it has discretion within the market; it sees the market through an organization filter” p1

2- Antecedents of the behavioral theory of the firm
o Theory of the firm: “asserts that the objective of the firm is to maximize net revenue in the face of given process and a technologically determined production function” p5; “maximization of profit is accomplished by determining the optimal mix of products (products) and inputs (factors), that is, the equilibrium position.” –p5. “Two major difficulties…1) the motivational and cognitive assumptions of the theory appear unrealistic…2 )has few of the characteristics…of actual business” – p8
o Rothschild: “primary motive of the entrepreneur is long-run survival” p9; Baumol: “the firm seek to maximize sales subject to a profit constraint” –p9
o “information is not given to the firm but must be obtained” –p10
o Papandreou: “views the firm as a cooperative system. The executive tasks are accomplished by a “peak coordinator”. The firm’s has certain goals, and it is a peak coordinator’s job to achieve these by allocating resources rationally” –p11
o In defence of orthodoxy: Friedman: “the function of economic theory is to build propositions with which the world can be analyzed and not to reproduce the world” –p13
o “The organization can be viewed as an information-processing and decision-rendering system” – p21; “in order to develop an alternative theory, we need more satisfactory theories of organizational goals, organizational expectations, organizational choice, and organizational control” – p22

3- Organizational Goals
o The problem of collective goals: “1) People (ie individuals) have goals; collectivities of people do not; 2) to define a theory of organizational decision making, we seem to need something analogous –at the organizational level- to individual goals at the individual level.” –p30
o “Let us view the organization as a coalition…some of them organized into subcoalitions” –p31; “any theory of organizational goals must deal successfully with the obvious potential for internal goal conflict inherent in a coalition of diverse individuals and groups” –p31
o Classic devices for defining organization goals: 1) Goals of the entrepreneur; 2) goal of “public interest” or “social welfare” – p32
o The goal formation process: “1) the bargaining process by which the composition and general terms of the coalition are fixed; 2) the internal organizational process of control by which objectives are stabilized and elaborated; 3) the process of adjustment to experience by which coalition agreements are altered in response to environmental changes” –p33
o Organizational slack: “Because of these frictions in the mutual adjustments of payments and demands, there is ordinarily a disparity between the resources available to the organization and the payments required to maintain the coalition. This difference between total resources and total necessary payments is what we have called organizational slack. Slack consist in payments to members of the coalition in excess of what is required to maintain the organization.” –p42 “when environment becomes less favourable …represents a cushion… slack permits firms to survive in the face of adversity” p43. “Slack operates to stabilize the system in two ways:1) by absorbing excess resources, it retards upward adjustment of aspirations during relatively good times; 2) by providing a pool of emergency resources, it permits aspirations to be maintained (and achieved) during relatively bad times” –p44
o “Finally, we have argued that, because of the form of the goals and the way in which they are established, conflict is never fully resolved within an organization, Rather, the decentralization of decision making (and goal attention), the sequential attention to goals, and the adjustment in organizational slack permit the business firm to make decisions with inconsistent goals, under many (and perhaps most) conditions.

4- Organizational Expectations
o Theory of search. “Modern entrepreneurs do not scan all alternatives nor do they have all information about all alternatives. They invest in information only so long as the expected marginal return from the information gained exceeds the expected marginal cost.” –p53
o “We wish to test the proposition the individuals can and do modify their subjective estimates of reality to accommodate their expectations about the kind of payoffs associated with various possible errors” p 80. “cost analysts will tend to overestimate costs and that sales analysts will tend to underestimate sales” –p81
o “The decision making system in the experiment had 4 critical organizational characteristics: 1) subunit interdepence: …the major decision-making units base their actions on estimates formulated at other points in the organization and transmitted to them in the form of communications,. The estimates so received cannot verified directly by the decision-making unit ***; 2) subunits specialization; 3) Subunit discretion; 4) Subunit conflict” –p86
o “An organizational coalition does not require either consistency or completeness in information; “ –p93
o “we do not find anything like a constant level of search” p93
o Resource allocation:
• “decisions considered here arose primarily as responses to “crisis” situations” –p94
• “in every case, once an alternative was evoked, it was accepted if it satisfied the general cost and return constraints…This support in turn came through a rather complex mixture of personal, suborganizational, and general organizational goals.” P94
o Search activity:
• “search became more and more intensive as the decision approached implementation” –p95
• “”search” consists in large part of evoking from various parts of the organization considerations that are important to the individual subunits” –p95
• “search will be much more intensive where organizational slack is small than where it is large” –p95
• Mating theory of search “Not only are organizations looking for alternatives; alternatives are also looking for organizations” –p96
o “Computations of anticipated consequences used by the organizations seem to be quite simple…. awkwardness of developing a single dimension on which all relevant considerations could be measured” –p96
o “Expectations are by no means independent of such things as hopes, wishes, and the internal bargaining needs of subunits in the organization” –p97 “…both conscious and unconscious bias in expectations is introduced” ,-p97 “,…there is some conscious manipulation of expectations” –p97
o “Communication includes considerable biasing, but also considerable bias correction” p97 “…is not passive” p97 “most biases are recognized by other parts of the organization” –p98
5- Organizational Choice
o “1) organizational perceptions are influenced by some characteristics of the organization and its procedures. … 2) Organizations consider only a limited number of decision alternatives. … Finally, organizations vary with respect to the amount of resources they devote to organizational goals on the one hand and suborganizational and individual goals on the other.” P99
o The decision process (p100); 1) forecast competitors’ behaviour; 2) forecast demand; 3) estimate costs; 4) specify objectives; 5) evaluate plan; 6) re-examine costs; 7) re-examine demand; 8) re-examine objectives; 9) select alternative –p102
o The firm as an adaptive institution: “a business form is constrained by the uncertainty of its environment, the problems of maintaining a viable coalition, and the limitations on its capacity as a system for assembling, storing, and utilizing information. … the firm as an adaptively rational system rather than an omnisciently rational system” p117
o “In particular, so long as the environment of the firm is unstable (and predictably unstable), the heart of the theory must be the process of short-run adaptive reactions. The long-run properties o the processes under stable conditions are relevant primarily as indicators of logical properties (and therefore consistency with the general concepts)” p119
o Standard Operating procedures: “we should note that organizations make decisions typically by solving a series of problems” p121 “devote rather little time to long-run planning” –p121. “They move from one crisis to another” p121 “Three basic principles: 1) uncertainty.. 2) maintain the rules… 3) Use simple rules” p121
o Specific standard Operating procedures: 1) task performance rules; 2) Continuing records and reports; 3) Information-handling rules; 4) plans” –p123 “Thus, rules not only transmit past learning: they also control (make predictable) behaviour within the firm” –p124 “good practice … tends to be shared among firms… standardization provides a defense” p125
o Records and reports “two main purposes: control and prediction” p125
o Information handling rules: “there are two aspects to standard operating procedure for information flows. Routing rules and filtering rules” –p129. “The departmental organization defines reasonably well the groups within which sharing of information is needed. Since information needs and task specialization are highly correlated, it is appropriate to process information through the hierarchy defined in terms of task specialization.” –p129
o “Thus, the internal biases in the organization increase the pressure (from external uncertainty) to develop decision methods that do not require reliable information (other than the simplest, most easily checked information). –p130
o “decisions are used as devices for learning about their hidden consequences” –p131
o “The budget in a modem, large-scale corporation plays two basic roles. On the one hand… management control…to check achievement…On the other hand, .. determine feasible programs” –p131
o “1) a plan is a goal,…2) a plan is a schedule,…. 3) a plan is a theory… 4) a plan is a precedent…”p132
o “rules are the focus for control within the form; they are the result of a long-run adaptive process by which the form learns; they are the short-run focus for decision making within the organization” –p134
o “1-Multiple, changing, acceptable-level goals; 2-an approximate sequential consideration of alternatives; 3-the organization seeks to avoid uncertainty by following regular procedures; 4- the organization uses standard operating procedures and rules of thumb to make and implement choices. In the short run these procedures dominate the decision made” –p134

6- A specific price and output model

7- A summary of basic concepts
o “The four major concepts used in the theory are 1) quasi resolution of conflict [goals as independent constraints / local rationality / acceptable-level decision rules / sequential attention to goals]; 2) uncertainty avoidance [feedback-react decision procedures / negotiated environment]; 3) problemistic search [search is motivated / search is simple-minded / search is biased], and 4) organizational learning [adaptation of goals / adaptation in attention rules / adaptation in search rules]” –p164
o “The order in which various alternative solutions to a problem are considered will change as the organization experiences success or failure with alternatives” –p174

8- Some implications
o Descriptive analysis: the firm :
• 1) Price and output determination (excess resources, organizational slack, decentralising, reduce uncertainties using standards)
• 2) Internal resource allocation quasi resolution of organizational conflict, search behaviour, uncertainty avoidance, organizational learning): “In general, for an alternative investment opportunity to have a significant chance of being introduced in the system, two conditions have to be met. A problem must be perceived by the organization, and the investment must be visible to that part of the organization in which search is stimulated by the problem” p180
• 3) Innovations (“failure induces search and search ordinarily results in solutions” p188: “firms that have made specific significant technological improvements, we find that they were made by firms with substantial slack (and thus mostly successful firms).” –p189
o Descriptive analysis: non-business organizations: “the behavioural theory of the firm is one the important potential sources of evidence about the validity of this structure and there mechanisms” –p196
o “These implications for descriptive economics, for studies of non-economic organizations, and for normative analysis are not always easy to see at this stage. They are even harder to validate” – p211

9- An Epilogue
o Three related but largely independent ideas:
1. Bounded rationality: “rational actors are significantly constrained by limitations of information and calculation” –p214. “They set targets and look for alternatives…rather than try to find the best imaginable solution; they allocate attention by monitoring performance with respect to targets. They attend to goals sequentially, rather than simultaneously. They follow rules-of-thumb and standard operating procedures.” –p214
2. Imperfect environmental matching: “behavioural theories emphasize the inefficiencies of history” –p215
3. Unresolved conflict: “multiple actors with conflicting interests not entirely resolved by the employment contract” –p215
o Developments in economic theories of the firm:
• Theory of teams
• Control theories of the firm
• Transaction costs economics: “two behavioural assumptions about “contracting”, as opposed to “maximizing”. The first assumption is bounded rationality…. The second, assumption is opportunism, the notion that there is conflict of interest within, as well as between, organizations, that participants in an organization will lie, cheat, and steal in their own self-interest if they can” *** p220; “,…when asset specificity is low, debt financing is likely…where asset specificity is high, costs of debt will have to grow to cover the risk” -p221; “the flexibility of the definition of transaction costs tends to make the concept amore powerful tool for interpreting historical outcomes than for predicting future ones” -p221
• Agency theory: “…bounded rationality has tended to fade into the background, and attention to conflict of interest has become paramount” p222; “In practice, the theory is written from the point of view of one side of the contract. From this perspective, there is a cascade of principal-agent relations” –p222
• Evolutionary theories: “they see firms as being selected upon by virtue of their fit to the environment” –p224
o Developments in behavioural studies of organizational decision making:
Four interrelated visions: (p225)
1. Decisions resulting from intentional, consequential action
2. Decisions by a logic of appropriateness implemented through a structure of organizational rules, roles, and practices
3. Decisions influenced by the interactive ecological character of decision making (“hierarchies but they tend to function as less hierarchical networks of relations” p233: “this ability to learn from others is one of the most powerful of adaptive tools available to individuals and economic organizations. It depends, however, on a structure of linkages among forms… and… capability of learning the lessons” p234
4. Decisions as artifactual rather than as central to understanding decision making. “Individuals fight for the right to participate in decision processes, but then do not exercise the right.” –p236; “very little time spent in making decisions…managers seem to spend time meeting people and executing managerial performances” p236; “choices as artifacts… the focus has shifted from the “substantive” to the “symbolic” components of decisions” p236; “On the one hand, the processes of choice reassure those involved that the choice has been made intelligently, that it reflects planning, thinking, analysis, and the systematic us of information: and that the choice is sensitive to the concerns of relevant people, that the right people are involved.” -p237. Symbolic action: “It is the process that gives meaning to life, and meaning is the core of life” –p237

Personal comments, interesting issues and findings:
• I think the notion of slack is real: salaries and policies are revised in periods of difficulties. This means that there was a cushion to cost reduction. This is also true that negotiation can be more flexible in the presence of evidence of bad times. I.e. a worker would not accept a wage reduction if the bad conditions cannot justify it.
• The influence and applicability of the theory of Cyert & March is very wide. For instance, in International Studies (that I study in Dr Farashahi’s course), the main two streams are OLI theory (based on Transaction cost theory) and Organizational Capabilities theory. Both can be explained using the behavioural theory of the firm.
• The behavioural theory of the firm tries to reflect better the firm’s reality. Let me do an analogy: If the firm is the territory, the classical theory of the firm is the map and the behavioural theory of the firm is a photo from an airplane (with an inclination to see land’s imperfections).
• The behavioural theory of the firm is based on highlighting all firms’ imperfections and explaining how they are faced to coexist with them.