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Bounded Rationality – Why Many Management Decisions are Risky!

March 9, 2014

Herbert A.Simon (1916 – 2001), won many awards in his career including the 1978 Nobel Prize in Economic Science, the A.M. Turing award and the National Medal of Science. The Nobel prize committee awarded him “for his pioneering research into the decision-making process within economic organizations” [1]. Simon’s interest were broad and varied, including computer science, cognitive psychology, administration, sociology, economics and political science. For many years he worked at Carnegie Mellon University, in Pittsburgh, Pennsylvania. I became familiar with his work while working for Carnegie Mellon’s, Software Engineering Institute in Europe. His broad range of interests always remind me of the great thinkers of the enlightenment, a time when it was still theoretically possible to have a grasp of most of human knowledge. Simon’s broad knowledge of, and contribution to science is all the more remarkable as it was achieved in modern times when specialisation drove deep divisions between fields of knowledge.

In the wake of the financial crisis of recent years it has become very fashionable in the media to pour scorn on managers in general and the profession as a whole. Individual managers’ focus on personal gain and corporate cultures that the Vikings would have been proud of have certainly been major contributors to our current economic woes. It is difficult to argue that, in the financial domain,  much of this criticism may not be unwarranted. My experience in the telecommunications and automotive domains and with clients across other industries has however been that most managers are trying to do the best they can for the companies the work for, for their customers and for their staff. That despite their good intentions they sometimes make what later, with hindsight, turn out to be poor decisions may be understood by reference to Herbert Simon’s theory of bounded rationality [2],[3].

Herbert Simon work on bounded rationally offers some insight into the difficulties manager in general face when trying to make decisions. We assume (perhaps influenced by the thought leaders of the aforementioned enlightenment) that rational thought can solve all problems. Simon’s theory of bounded rationality shows that there are limits to the degree of rationality that can be achieved.

Herbert’s bounded rationality describes three limits on rationality in decision making:

Firstly, rational approaches to decision making (except for the most trivial decisions) are limited by the amount of information that can be obtained about the alternative solutions to the problem at hand.

Secondly, individual cognitive capabilities limit the amount of information that can be processed, even if we could have all relevant information.

Thirdly, the amount of time available to make a decision is limited, constraining the time to collect relevant information and process the data, even if we had the cognitive capability.

Simon proposed that decision makers therefore use heuristics (experienced based techniques for problem-solving) rather than relying completely on rational approaches. Such heuristic approaches can be best understood as patterns of problems that experienced managers have come to recognise with associated patterns of solutions. In 1978 Simon wrote “In a world where attention is a major scarce resource, information may be an expensive luxury, for it may turn our attention from what is important to what is unimportant” [4].

So when the media complain about manager salaries maybe we should take a moment to consider that maybe, just maybe, they are paid to take decisions in the context of bounded rationality and are therefore often paid to take a leap of faith into the unknown, based on their past experience and ability to recognise subtle patterns rather than as all-knowing gods.

References

[1] “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1978”. Nobelprize.org.Nobel Media AB 2013. Web. 9 Mar 2014. http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1978/

[2] Simon, Herbert (1957), “A Behavioral Model of Rational Choice”, in Models of Man, Social and Rational: Mathematical Essays on Rational Human Behavior in a Social Setting. New York: Wiley.

[3] Simon, H. (1959) “Theories of decision making in economics and behavioural science” American Economic Review 49.

[4] Simon, H. (1978), “Rationality as a process and product of thought”, American Economic Review, Vol. 68, No. 2, pp. 1–16.

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