Behavioral Theories of the Firm and Stakeholder Theory

Profit Maximization Assumption Revisited

To begin to examine theories of the firm other than as a production function, we begin with the underlying assumption of the economic perspective - that profit maximization is possible. In the economic argument, as we have seen, profit maximization is assumed, and the firm confronts choices as to which combination of inputs will achieve maximum profits. But, can a firm determine the levels of profits from the available options to combine resources? To do did this the firm must obtain information about costs and about demand to calculate profits. If we assume that the information is freely available, and there is no cost in trying to change the way resources are combined, then a firm can simply move to a level of production to maximize profits. This condition could exist under the economist’s perfect competition and monopoly. A firm in an industry with a static and known demand, might satisfy these conditions for rational decision-making; but, profits will not be predictable if there are other costs incurred in changing how inputs are combined - technology costs, for example.

Under oligopoly the situation is more complex. Here a firm must not only know demand and costs, but know the responses of rivals. This introduces considerable uncertainty to attempts to maximize profits. There are risks in deciding what is the correct level of production and combination of resources ought to be. Firms assess this uncertainty or risk differently. While one firm may be opportunistic and will accept a production decision which if correct maximizes profits, but if wrong leads to bankruptcy. Others will not accept this level of risk, and will opt for production choices that yield less than maximum profits, but minimize the risks of being wrong and inviting retaliation.

Herbert Simon theorized that firms cannot maximize profits because of uncertainty. They can attempt to maximize profits only by manipulation of what they do know - their costs. What firms do is not maximize, at all, they attain satisficing outcomes. This view that economic decisions are not maximum or "best", but only satisfactory or sufficient enough is radical. Remember: the traditional economic view is that profits can be maximized, and the theory requires this assumption for the competitive market to operate, even under oligopolistic assumptions.

Simon argued that decision-makers have an "aspiration" or expectation about outcomes that are acceptable. A limited number of possible outcomes are considered, and an available outcome that meets expectations is accepted. What restricts decision-makers to this satisficing level of outcome, rather than an optimal one, is that human decision-making, unlike economic decision-making models, is limited. We are able to process only information available to us and we process that information rather imprecisely. This is called bounded rationality, which is simply the limits of our own cognitive processes. The reality of bounded rationality is imposed not only by our limits, but by environmental uncertainties. The world is complex - we do not understand all the linkages among variables; the situation and facts under which real decisions are made are dynamic, ever changing; and, our time commitment to gain information, process data, and come to conclusions is constrained by the exigencies to make a decision in a timely fashion.

The classic exposition of this view of the firm as an organization that attempts to attain satisficing outcomes, rather than profit maximization is Cyert and March’s A Behavioral Theory of the Firm (1963). The use of the work "behavioral" as opposed to "economic" here is important. What the authors wished to make clear is that their treatment of the firm as an economic producer is based on observations about how firms really work, especially in deciding what level of production, sales, or profits to attain. Examining the firm as an organization of people making decisions, it is clear that organizations have no objectives, only people can have objectives. Moreover, as we examine how real decisions are made, the evidence is that decision-makers rely more on "general rules" and lessons learned from past experience (heuristics) to make key decisions, rather than employ a rational model that requires information that may not even be available. For the organization, then, how is it that we can talk about purpose, objectives, goals, or missions, much less profit maximization?

For a firm to have an objective, individuals have to impose one on the organization. As we further examine the organization, we find many competing objectives. These are linked with groups of key individuals. For a common organizational objective to arise, there must be a coalition of decision-makers who find common ground. Even though a small group of top executives may make the final decision as to objectives, their decision depends upon information provided them by others in the organization and depends upon others in the organization for implementation. In short, a group within an organization may supply information to top management that is favorable to the group’s interest; also, a group may withhold actions to thwart decisions contrary to its interest.

To illustrate: sales personnel desire lower prices and easier credit which increase sales and increase sales personnel commissions and productivity statistics; finance personnel may set higher price levels and tougher credit requirements to increase profits and reduce accounts receivable; inventory personnel desire high stock levels to guard against stock-outs; to production, high stock levels mean more work, they want a predictable, steady plan for production. What is in each group’s interest, is not reconcilable as a collective and common objective for all. Maximization of one group’s interest does not serve the interest of others. Objectives and goals become constraints or diverse levels of satisfaction. The solution to these conflicts of interest is in a "satisficing" decision through the rise of a dominant coalition. The objectives of an organization shift as the coalition changes, but organizations do have objectives.

Stakeholder Perspective

The behavioral approach is the view commonly presented textbooks on business policy. The perspective has been advanced by an number of contributors as stakeholder theory. This is a political view of the firm in which objectives of the firm are contested and influenced by groups that have an interest in what the business does. Stakeholders are any groups who profess a claim to the operations, value creation or being of the firm. While there is no consistent theory as to which groups are legitimate claimants, at a minimum stakeholders include:

A more developed stakeholder model identifies internal and external coalitions as claimants, as follows:

External Coalitions -

Buyers, who have an interest in the firm’s products or services
Suppliers, who depend upon the firm as a buyer of their goods and services
Employee associations, such as unions and professional associations
Publics, such as community and public interest groups who have a variety of interests including economic development, product and environmental safety, and an interest in a competitive market

Internal Coalitions -

Owners, who hold legal title to the firm, and their Board of Directors who exercise legal control
Chief Executive Officer and Top Management, who have operational responsibilities
Operators, workers who produce the goods and services
Line managers, who supervise the execution of day to day work
Support staff, clerical staff
Sales force

Coalitions compete for influence within an organization, or at least each attempts to exercise influence on decisions and on the allocations of resources - such as the organizational budget. Over time, a coalition or group of coalitions come to dominate the organizations - although this power may continue to be contested by other coalitions. Organizational objectives mirror the concerns and interests of the dominant coalition, or at least represent some compromise among competing coalitions. The mission or purpose of the firm, therefore, is "rationality" in that some interests are attempting to be maximized, but in the stakeholder perspective the organization’s interests are those of the dominant groups. The organizational and decision-making model is political, rather than economic.

Different organizations have different stakeholders. The nature of the organization may invest in more or less power in specific groups and coalitions. A university, for example, can provide a greater claim by faculty over the goals and purposes of the organization, than administrative staff. A hospital may empower doctors and nurses over the claims of patients. An innovative firm dependent upon research and development, may empower engineers and product development groups over managers and production groups. But, even these examples provide a context in which claims can be contentious and different stakeholders compete. Within universities, an interest by alumni and students for greater attention to athletics competes with claims for increased scholarship or faculty salaries. Hospitals that are insensitive to patients’ desires, for example for individual rooms, competes successfully against a nursing interest to facilitate patient care by having patients in a ward. Innovative firms accommodate to the needs of marketing and sales groups to bring a product to market quickly and at a competitive price.