Behavioural theory of the firm

3 key takeaways

• The theory focuses on the decision-making processes within firms, highlighting the role of internal politics, satisficing, and bounded rationality.
• It suggests that firms aim for satisfactory rather than optimal outcomes.
• Organizational routines and standard operating procedures significantly influence firm behavior and decisions.

What is the behavioural theory of the firm?

The behavioural theory of the firm, developed by Richard Cyert and James March in 1963, challenges the traditional economic view that firms always aim to maximize profits. Instead, it posits that firms are complex coalitions of individuals with diverse goals and limited information. Decision-making within firms is influenced by various internal and external factors, including organizational culture, power dynamics, and individual behaviours.

In this theory, firms are seen as satisficers rather than optimizers. This means they aim for satisfactory outcomes that meet acceptable criteria rather than seeking the absolute best or optimal results. This approach accounts for the reality of limited information and cognitive constraints faced by decision-makers.

Key concepts of the behavioural theory

• Bounded Rationality: This concept suggests that individuals within a firm make decisions based on limited information and cognitive capabilities. They use heuristics or rules of thumb to simplify decision-making processes.
• Satisficing: Instead of optimizing, firms often settle for satisfactory solutions that meet minimum acceptable criteria. This approach reflects the practical limitations faced by decision-makers.
• Organizational Routines: Standard operating procedures and routines guide much of the behavior within firms. These routines help manage complexity and ensure consistency but can also lead to resistance to change.
• Internal Politics: Decision-making within firms is influenced by the power dynamics and politics among various stakeholders, including managers, employees, and shareholders. These interactions shape the firm’s strategies and actions.

Real world application

The behavioural theory of the firm can be seen in many real-world business scenarios. For example, a company may choose to continue producing a product line that meets minimum profitability criteria rather than shifting resources to a potentially more profitable but riskier venture. This decision might be driven by established routines, the desire to avoid conflict among managers, and the use of bounded rationality in decision-making processes.

Another example is the development of new products. Instead of aiming to create the best possible product, companies might focus on creating products that are good enough to meet market needs and customer expectations. This satisficing behavior allows firms to manage resources more effectively and respond to market changes without overextending themselves.

Related topics

If you are interested in exploring more about organizational behavior and economic theories, consider reading about:

• Bounded Rationality: Understanding the limits of decision-making processes within organizations.
• Satisficing: Exploring the concept of settling for satisfactory outcomes instead of optimal ones.
• Organizational Culture: How the shared values, beliefs, and norms within an organization influence behavior.
• Decision-Making Processes: Various models and theories explaining how decisions are made within firms.

These topics provide further insights into the complex and multifaceted nature of organizational behavior and decision-making, helping you appreciate the various factors influencing business strategies and actions.