Behavioural and Managerial theory of the firm 2 CONTENT 1. 2. Introduction.………………………………………………………………..2 Behavioural and Managerial theory of the firm: The differences and similarities………………………………………………………………….2 3. 4. Theoretical strengths and weaknesses………………………………….5 Conclusion………………………………………………………………….8 3 Behavioural theory vs. Managerial theory of the firm 1. Introduction Behavioural theories were developed during the early 1950’s of which Herbert Simon played an essential role in advocating the empirical observations of the behaviour of economic decision makers and applied the results to develop the theory. Managerial theory of the firm on the other hand looks at the pivotal role managers plays in companies and firms. In view of the aforementioned, I will point out the differences and similarities between these theories, explains it and identify the different strengths and weaknesses of the theories. 2. Behavioural theory and Managerial theory of the firm: The differences and similarities Cyert and March developed the behavioural theory focussing on the decision-making process of a large multi-product firm under conditions of uncertainty in an imperfect market. This theory is based on a multi-decision making coalition, which differs from the single goal decision unit introduced by the traditional theorists. It can therefore be argued that this model was developed in a duopoly an oligopoly market system. Because of the collusion action of these firms, there is no need to fear competition, as the market exists only of a few firms. Most probably are these firms in the position to control the market through setting prices and determining the output. However, price setting can only be achieved through negotiations amongst the few firms in the market, thus it can be said that price setting occurs in a negotiated environment. Marris (1987: 672) also identified one of the fundamental differences between managerialism and behaviourism to 4 be “the proposition that in the large corporations, owing to inherent difficulties for shareholders in monitoring the performance of managers, there is considerable separation between the vicarious role of stockholders, on the one hand and the control, operating and policy making roles of management on the other”. Goal setting forms one of the vital aspects regarding the behaviour of individuals within the firm, as well as the firm in its entirety (consumers, stakeholders’ etc.). These goals are usually the source of in-house conflict due to the demands set by the respective members. The main factors, attributed to the demands of members, are their aspiration levels, passed achievements of others, levels of expectations and the availability of information. Due to limited resources, the firm would constantly be in a struggle to achieve these goals and demands. Furthermore, it can be argued that the relationship between aspiration levels and past achievements depends on actual and expected changes in the performance of the firm and the environment. In a situation where no growth and changes in the environment occur, aspiration levels and past achievements tends to be equal. Another feature of the behavioural theory is based on the decisionmaking and the determination of goals by the top management. The five main goals are the production goal, inventory goal, sales goal, market share goal and profit goal. When the Law of Diminishing returns are applied to goal setting, it become clear that efficiency in decision-making decreases as the demands of the members of the firm increases. A fundamental difference between a firm within the behavioural theory and that of the neo-classical theory is locked in their respective goals. Under the neo-classical theory the firm set profit-maximisation as the ultimate goal, whilst the behavioural theory assumes that managers seek to satisfy organisational needs (overall 5 performance). The behavioural theory thus postulates the firm to be a satisficing organisation rather than the neo-classical profit-maximising entrepreneur. The behaviour of firms are characterised by Simon as bounded rationality whilst the traditional theory introduced global rationality. The fundamental difference between these two concepts is based on the belief of the traditional theorists that the entrepreneur has unlimited time, costless information and computability. Traditionalists assume computability to mean that projects are decided, after screening the alternatives on the basis of detailed calculations of all direct and indirect benefits and costs. The behavioural theorists on the other hand belief that time, imperfect information and computability restricts the top management decision-making capabilities, thus cannot base decisions on detailed studies and marginalistic rules. According to the traditional theory, a rational firm maximise profits, whilst the behavioural theory postulates satisficing as a goal. Due to the conflicting nature of the demands of the firm, the respective members are in conflict. How does top management resolve the conflict? The traditional theorists believed that money payments are the only way of resolving conflict. However, the behavioural theorists because of their satisficing goal introduced other means such as side payments, slack payments, and sequential attention of demands as well as decentralised decision-making. It should be noted that slack in terms of the behavioural theory is equivalent to the managerial theory’s definition of “economic rent” of factors of production. The neo-classical economists postulate that information search is based on marginalistic rules i.e. marginal cost of information equates marginal benefits. Cyert, March and Simon disagree with this 6 argument and are of the opinion that the search for information is applied at the particular area where the problem appears (problemorientated approach). The traditional theorists therefore treats information search as an investment decision of which costs and returns can be calculated. The traditional theorists when allocating their resources equate marginal revenue with opportunity costs, whilst behavioural theorists assume global rationality. They have perfect knowledge about the alternatives, examining the alternatives and certainty about the future. The traditional theorists treat expectations to be exogenous, whilst the behavioural theorists view it to be endogenously determined by various internal factors. The traditionalists also do not belief in sources of uncertainties, whilst the behavioural theorists identified market and competitor behaviour uncertainties. Because of this difference the traditional theorists postulates long run to be much more important than short-run. Both the traditionalists and behaviouralists use output, price and sale-strategy as decision-making instruments. The difference however lies in the way by which the values of these policy variables are determined. Traditional theorists choose policies based on long-run profit-maximisation and behavioural theorists choose satisficing policies based on sales levels, profit growth etc. 3. Theoretical strengths and weaknesses This part of the essay is merely a continuance of pointing out the differences between the theories. The only difference is that the one theory’s weakness is perceived to be the other theory’s strength. In general it can be argued that the major strength of the behavioural theory is advocated in the fact that it provides a comprehensive look into goal-formation of the firm and the internal allocation of resources. 7 A look at resource allocation will reveal that the behavioural theory concentrates only on internal resource allocations, whilst the managerial theory stresses the importance of market mechanism between the various sectors of the economy. Therefore, as a weakness it can be observed that the theory neglects to explain the interdependence of other firms as well as the way interrelationship amongst firms leads to price and output equilibrium at industry level. It therefore does not deal with industry equilibrium that is in contrast to managerial theory. Strength of the behavioural theory is the systematic analysis of the stabilising role of slack. The firm is exposed to an ever-changing economic environment, and slack will provide stability in the sense that it can ignore the environment in “bad times” because it can cut costs by reducing slack payments. The behavioural theory provides a simulation approach to the complexity of the mechanisms of a multi-goal corporation and can be viewed as a predictive technique. It predicts the behaviour of the firm without explaining other particular actions of the firm. It is also notable that no exact prediction can be derived from the postulates of the behavioural theory, because satisficing reduce the theory into a tautology. The theory does not look at the effects and the role that potential market entrants have on established firms. Long run activities such as innovation and invention are neglected, because the behavioural theorists postulates short run to be more important than long run. The evaluation of satisficing performance become complex, because as the targets of the firm are not attained, the aspiration levels are readjusted downwards, thus no objective criteria can be formulated. The satisficing goal of the theory makes it difficult to make exact predictions. The theory is also short-sighted when decision regarding 8 environment is required. Oligopolistic interdependence is solved through tacit collusion, but become non-existent when market entry takes place. Another way of looking at behaviour of the members within the firm is through the argument that in “realism”, members do not always behave in a manner that is conducive for profit-maximisation. The traditional theorists are therefore seen to neglect to consider the following issues: Entrepreneurs and managers sacrifice some income for the sake of more leisure; Managers attempts to avoid resentment from colleagues, thus not to strict on enforcing orders to maximise profits; Subordinates do not disturb superior’s routine, thus abstaining from making proposals that could maximise profits; Managers are more interested in their own remuneration than profit-maximisation; The different level of management tends to bias or selective towards information, which might lead to misinformation, thus hampering profit-maximisation; The existing group of managers is reluctant to abdicate control, holding on at all costs; Security preferences cause managers to eschew increasing profits by hanging on to conservative ways; The social responsibility of a firm may be of such nature that profitability policies become constrained. Workmanship, professional excellence etc. of members may be in conflict with profit-maximisation goals, and Compromises amongst different goals of executives with different interests may compromise profits. 9 The classical theory postulates that the consumer maximises utility. To be able to determine how consumers will behave, it is imperative to determine their utility functions. Consumer behaviour postulates that the consumer attempts to maximise his/her satisfaction. As the behavioural theorists believe in satisficing, it can be argued that the traditional theorists agree with this postulate. An experimenter who wants to measure utility is faced with extreme difficulties. In real life these difficulties multiply. It is not clear whether the consumer behave in accordance with the utility axioms. When a situation is simple and transparent, consumers can be viewed as consistent in their choice and as utility maximisers. However, as choices become more complicated, the consumer becomes less consistent in choice. It can therefore be argued that consumers want to maximise utility when choices are clear and simple. However, in the real world, utility maximisation is viewed to be of small significance, if not irrelevant. Simon (1959) also pointed out a few weaknesses in the managerial theory that can be summarised as follows Consumer utility maximisation forms an integral part of classical theory. He specifically criticise the managerial theory for choosing amongst fixed and known alternatives, because in the real world alternatives are not always known; The growing gap between ownership and management has directed attention to the motivation of managers to strive towards profit-maximisation. He introduced the concept of satisfactory profits and satisfied managers (overall satisficing); The extension of the managerial theory when perfect competition is removed will make the rationality concept ambiguous; 10 If the assumption of perfect foresight is removed from the theory, the definition for rationality is forced to account for prediction and formation of expectations; The addition of goal conflict and uncertainty to the definition of rationality will make it difficult not to distinguish between the objective environment and the subjective environment of the economic actor. The behaviour of the economic actor can no more be predicted only to be rational without making the distinction between these environments. 4. Conclusion The traditional theory and the behavioural theory with regards to the firm have shown fundamental differences. Profit-maximisation in respect of the traditional theory was contrasted with the satisficing goal of the behavioural theory. However, when looked at from a consumer behaviour point of view, it was found that behavioural theory postulates satisficing in the case of both consumers and firms, whilst managerial theory assumes utility maximisation. The behavioural theory also treats goal formation as an essential component of behaviour of the firm. It is notable that the behavioural theory postulates divorce between ownership and management, whilst managerial theory postulates single-ownership entrepreneur. The essay pointed out the differences, similarities, strengths and weaknesses of each theory, opening new avenues to explore and theories to develop or improve. 11 BIBLIOGRAPHY Hughes A, 1987. Managerial capitalism, The New Palgrave- A Dictionary of Economics 3: 56-59. Reprinted in Microeconomics- selected readings: Reader for MICECH-V. Pretoria: Unisa, 1999 Koutsoyiannis A, 1979. The behavioural model of Cyert and March, 386-401. Modern Economics. London: The Macmillan Press Ltd. Machlup F, 1967. Theories of the firm: marginalist, behavioural, managerial, The American Economic Review, 57(1), March: 1-33 Marris RL, 1987. Corporate economy, The New Palgrave- A Dictionary of Economics 1: 149-153. Reprinted in Microeconomics- selected readings: Reader for MICECH-V. Pretoria: Unisa, 1999 Simon HA, 1959. Theories of decision-making in economics and behavioural science, The American Economic Review, 69(3), June: 253-283 Simon HA, 1987. Behavioural Economics, The New Palgrave- A Dictionary of Economics 1: 221-225. Reprinted in Microeconomics- selected readings: Reader for MICECH-V. Pretoria: Unisa, 1999
"Behavioural and Marginal theory"