Theories of Organization and Decision Theories

Theories of Organization

1. Theories of Organization and Decision Theories Reynaldo C. Castro, PhD College Professor

2. Contents Robert Coase -- The Theory of the Firm Kenneth Arrow – The Limits of the Organization Chester Barnard – Functions of the Executive Neoclassical and Modern Theories Leonard Savage– Subjective Expected Utility Herbert Simon– Bounded Rationality Amos Tversky and Daniel Kahneman – Heuristics

3. The theory of the firm consists of a number of economic theories that describe the nature of the firm, company or corporation including its existence, behavior, structure, and relationship to the market. (Demetri, 2007) Robert Coase – Nobel laureate for economics in 1991

4. In simplified terms, the theory of the firm aims to answer these questions: 1. Existence – why do firms emerge, why are not all transactions in the economy mediated over the market? 2. Boundaries – why is the boundary between firms and the market located exactly there as to size and output variety? Which transactions are performed internally and which are negotiated on the market?

5. 3. Organization – why are firms structured in such a specific way, for example as to hierarchy or decentralization? What is the interplay of formal and informal relationships? 4. Heterogeneity of firm actions/performances – what drives different actions and performances of firms? Firms exist as an alternative system to the market-price mechanism when it is more efficient to produce in a non-market environment. To answer this: transaction cost theory (social contract theory)

6. Kenneth Arrow– Nobel laureate for economics in 1972 In The Limits of Organization , Arrow explains that authority is necessary for organization to exercise power and be effective but responsibility is also necessary to prevent or minimize error. Balance between authority and responsibility

7. Chester Barnard– The Functions of the Executive He looked at organizations as systems of cooperation of human activity and was worried about the fact that they are short lived. Criteria necessary for survival: efficiency and effectivity Reality in formal organization: authority and incentives

8. Neoclassical theories emphasize individual ang group behavior and relationships in achieving success and productivity for the organization. Human relations theory (Elton Mayo). It considered organization as a social process where feelings, sentiments and attitudes were given due importance. Mayo postulated that efficiency and productivity could increase if the attitudes of employees were well regarded. Behavioral science theory (Maslow and McGregor) believes in interpersonal roles and relationships. They emphasized democratic values and human motivation. It also believes that human beings like work but it should not be super imposed and should instead be self-realized.

9. Modern theories based on the concept that organizations are adaptive systems and are connected (have to adjust) to their environment. Systems theory. Contingency theory/situational theory

10. Decision Making Cognitive, also viscerotonic , process of making choices. There are alternative courses of actions and one has to select the appropriate alternative, often under conditions of uncertainty. Why make decisions? Situations call for it (positive and normative principles) Resources are scarce (trade-off, opportunity cost)

11. Subjective Expected Utility (L.J. Savage, 1954) It is an approach to decision making under risk that allows for subjective evaluation of all variables under consideration and the probabilities associated with them. Assumption: People are rational-makers and given the right information, will generally choose the action that is most likely to lead the highest expected value. 1. People have well-specified preferences. Complete: can always decide among 2 alternatives Transitive: if A ≥ B and B ≥ C, then A ≥ C Independent (I): if A ≥ B; then (A+C) ≥ (B+C) Independent (II): if A ≥ B; then A is always ≥ B 2. People choose the option that maximizes their expected utility. Utility: The value associated with an outcome Probability: The likeness of an outcome EU: Probability of an outcome x Utility associated with outcome

12. The value of something, however, might differ from its price-tag. What is the (subjective) value of Php1M to you? What is the (subjective) value of Php1M to Manny Villar? Kahneman and Tversky (1979): Loss Aversion Which one do you prefer? Win Php100 thousand for sure 50/50 chance of winning Php200k or nothing Which one do you prefer? Loss Php100 thousand for sure 50/50 chance of losing Php200k or nothing Php100k for sure is better than Php100k expected : When dealing with gains, we are risk averse -Php100k for sure is worse than -Php100k expected : When dealing with losses, we are risk incline.

13. Bounded Rationality (Herbert Simon, 1957) Herbert Simon is a Nobel Laureate for Economics, 1978

14. Bounded Rationality (Herbert Simon, 1957) Bounded rationality addresses some of the key flaws in the original choice theory by highlighting the limitations of humans’ ability to make decisions. For example, we are ‘bounded’ by limitations such as time constraints, our ability to absorb information or we may be driven to sub-optimal decisions by emotions and our moods, i.e , it is far more likely that someone starts consuming alcohol after a hard and stressful day at the office.

15. Bounded Rationality (Herbert Simon, 1957) Imperfect Information US Secretary of Defense Donald Rumsfeld once said: There are known knowns, known unknowns, unknown knowns, and unknown unknowns. 2. Cognitive Limitations Refers to our inability as humans to process information in. an optimal manner. In other words, we are unable to consider all available factors in our decision making. 3. Time Constraints It constrict our ability to process and analyze a situation and come to an optimal decision. Decisions are made by luck rather than good judgment.

16. Heuristics (Amos Tversky and Daniel Kahneman, 1983) Heuristics are best described as mental shortcuts or rule of thumb for decision-making to help people make a quick, satisfactory, but perhaps not perfect, answer to complex situation. It’s not about making perfect decisions or judgments, just about making one quickly. Optimal behavior is not the same as maximizing behavior Daniel Kahneman, Israeli-American psychologist and economics Nobel Laureate in Economics, 2002

17. Availability Heuristic 1. How frequent is L? 2. How easily does L came to mind? Easy = frequent Hard = not frequent Riding the plane vs riding the car

18. Representativeness Heuristics 1. The Rule: If it seems like “X”, then it must be “X”. “If it looks like a duck and quacks like a duck, then it’s probably a duck. 2. The Problem: We ignore how often “X” actually occurs (i.e., the base rate)

19. Representativeness Heuristic Skerry J. is of high IQ, although lacking in true creativity. He has a need for order and clarity, and for neat and tidy systems in which every detail finds its appropriate place. His writing is rather dull and mechanical, occasionally enlivened by somewhat corny puns and by flashes of imagination of the sci-fi type. He has a strong drive for competence. At his school, 5% of students are engineering majors and 70% are English majors.

20. Anchoring Heuristic ( Focalism ) People tend to focus on the single, initial piece of information, which influences how they estimate value and make subsequent decisions. Suppose a person walks into a showroom with a budget of $1000 to buy an item of antique furniture. The person finds a unique piece of furniture whose value is hard to determine. The salesperson mentions its rate as $1500 and offers to give a discount on it. It creates the impression that any deal below $1500 is reasonable. (Adopted from WallStreet Mojo)

21. Anchoring Heuristic ( Focalism ) Let’s assume investor A decides to buy the shares of Amazon after looking at its splendid performance in the stock market   in the year 2021. In July 2021, Amazon stock reached the pinnacle of $3,731. This price acted as a mental anchor for his decisions. So, on January 26, 2022, he bought the 1000 shares of Amazon at $2,777. He waited for the stock prices to go up. As expected, within a month, the stock prices rose and reached $3,308. However, since his mental anchor was set at $3,700, he didn’t sell the stock and waited for the price to touch the anchor. Unfortunately, the Amazon stock prices took a deep dive. Thus, due to anchoring bias, A couldn’t sell the stock at any value below the anchor price. This resulted in a substantial loss for A. (Adopted from WallStreet Mojo)

22. Topics for Presentation: 1. Leadership and Governance

23. Topics for presentation

24. Topics for presentation

25. * Structuring a Critical Analysis Paper Introduction a. Identify the article/work being analyzed. Cite similar materials (authors, articles) that support the main topic. b. Present thesis – argument about the work c. Preview your argument – what steps and area you will take and focus to prove your work 2. Short summary of the work a. Does not need to be comprehensive – present only what the reader needs to know and understand your argument * Adopted from University of Washington

26. Structuring a Critical Analysis Paper 3. Your argument a. Your argument will likely involve a number of sub-arguments – mini-theses you prove to prove your larger arguments are true. For example, if your thesis was that the author’s presumption that the world will soon face a ‘clash of civilizations’ is flawed because inadequately specifies his key concept , civilizations, you might prove this by: i . Noting competing concepts and definitions of civilizations (Cite authors and articles) ii. Identifying how his examples do not meet the example of civilizations iii. Argue that civilization is so broad and non-specific that is not useful Note, however, that your discussion varies depending upon the issue or topic. b. This should be the bulk of the paper – I am interested to read how you argue and relate the topic to existing business conditions, not a summary.

27. Structuring a Critical Analysis Paper 3. Conclusion (Recommendation for Research and Policy Analysis) a. Reflect on how you have proven your argument. b. Point out the importance of your argument c. Note potential avenues for additional research or analysis A4-sized paper, double-spaced, font 12, not less than 4 pages.

28. Thank you…