Theories of business decision making generally assume that estimates of cost and return in some form are made by the firm and that decision behavior depends heavily on such estimates. For example, the standard theory of price treats investment and internal resource allocation as problems in maximization. The firm invests in each available alternative to the extent that the marginal return from each alternative will equal the opportunity costs. Except insofar as sunk costs are involved, the firm makes no fundamental distinction between internal and external investment; that is, all marginal returns are equal to the best alternative return available. Under these conditions, “efficiency” — the ratio of obtained to potential return — is equal to one.
What conception of organizational decision making is implicit in such theories? They assume that the organization scans all alternatives continuously and just as continuously adjusts its portfolio of investments to changes in the pattern of alternatives available. They assume that firms have accurate information on the costs to be incurred and returns to be received from alternatives and that decisions are made on the basis of this information. These assumptions have been attacked by both economists and organization theorists.
Attempts to revise the standard theories have been designed primarily to modify the assumptions through the introduction of probability distributions and the substitution of expected profit (or utility) for the profit (or utility) originally specified. The “modern entrepreneur” is probabilistically omniscient. He knows the probability distribution of outcomes from all alternatives. He can, therefore, compute the expected value of any particular alternative and equate expected marginal return with expected marginal cost.
At the same time, the assumption of infinite search has been replaced by a theory of search that recognizes certain costs to search and thus makes the allocation of resources for securing information one of the investment decisions to be made. The modern entrepreneur does not scan all alternatives nor does he have all information about all alternatives. He invests in information only so long as the expected marginal return from the information gained exceeds the expected marginal cost.
There is general consensus that these theories, specifically their economic versions, have been valuable in both normative and empirical analyses of aggregate behavior. Since this has been the major traditional interest of economic analysis, macroeconomists have found no pressing reasons for re-examining the assumptions of the standard theories.
On the other hand, economists and others interested in the behavior of the individual firm have not been entirely satisfied with the classic assumptions. As normative theory, the theories have been challenged for accepting too easily Bernoullian expected utility. Alternative formulations, arising primarily from game theory considerations, are preferred by a vocal, but apparently minority, group. The normative uses of the theories, however, are tangential to our main interest here. We are more concerned with the challenges to these theories as explanations of business behavior.
Because we wish to consider some empirical studies of business decision making, we will elaborate upon these challenges.There have been four major objections to the more or less “pure” theory of expectations insofar as it has been applied to the behavior of individual firms.
- The theories assume continuous competition among all alternatives for all As Coase has pointed out, the perfectly competitive market for internal resources is a major implicit assumption of the standard theory of the firm. Such a description of organizational behavior is distinctly different from that implicit in many treatments of other organizations. For example, some public administration models seem to emphasize local adaptation to specific problems; they stress problem solving much more than planning.
- The theories make search activity (and thus information) simply one of the several claimants for resources to be evaluated in terms of calculable costs and expected returns. Simon and others have questioned this treatment of search. They have placed considerable emphasis on dissatisfaction as a stimulant to search, on the “conspicuousness” of alternatives as a factor in their consideration, on the external effects on the generation of information, and on the sequential characteristics of alternative evaluation.
- The theories require substantial computational activity on the part of the Shackle and others have argued that the theory grossly exaggerates both the computational ability and, more important, the usual computational precision of human beings. There have been a number of suggestions for constraining the amount of information that must be digested. For example, the heart of Shackle’s theory (still completely untested) lies in the Φ-functions by which the attention value of a particular outcome is determined.
- The theory treats expectations as exogenous variables; they are given, not But such an eminently logical extension of certainty theory to the treatment of uncertainty ignores a number of important (or potentially important) phenomena. On the one hand, it sidesteps a major aspect of uncertain situations, the interaction of expectation and desire. On the other hand, it ignores the ways in which information is obtained and processed through the organization. For example, pricing decisions are assumed to be based on expectations concerning future sales, costs, and competitors’ behavior. The firm is organized to provide information on which such expectations can be based, and it seems at least plausible that some features of the communication system in the firm will affect the kinds of information made available.
To examine the ways in which information about the external environment is obtained and processed by an organization, we consider two sets of recent observations on organizational expectations. First, case studies of four major decisions in three business firms and, second, two experimental studies of organizational communication are discussed. From an analysis of these studies we arrive at some tentative reformulations of the role of expectations in business decision making.
Source: Skyttner Lars (2006), General Systems Theory: Problems, Perspectives, Practice, Wspc, 2nd Edition.