Bounded Rationality Decision Theory

3.3.1 Background to Bounded Rationality Theory

The human bounded rationality theory has been a discourse since classical times (Simon, 2000). There have been several narratives on the emergence of Bounded Rationality Choice Theory (BRCT). The experimental studies in the 60s and 70s contributed to the understanding of bounded rational decision-making (Reinhard, 1990). Ellison (2006) argued that the distinct emergence of bounded rationality began in the late 70s and early 80s, which marked the revolution in game theory in organisations. Simon’s Bounded Rationality Theory (BRT) which focused on the process of information gathering, human’s limits of rationality, decision under uncertainty, and the consequences of payoff functions, forms the basis for BRT (March, 1978). Simon’s BRT recognised the limitations of Savage’s theory and propounded BRT as a decision scenario where decision-makers have limited information to guide their choice process and are constrained by their cognitive abilities (Phillips-Wren, 2013). However, Simon (2000) acknowledged the introduction of the term ‘utility’, introduced by Mill in 1848, and argued for the inapplicability of the mathematical conceptualisation of utility theory that dominated the economic rationality discipline in the mid-20th _{century. To retain the precise meaning of what}

bounded rationality is, this study presents Simon’s conceptualisation of BRT.

“Bounded rationality is simply the idea that the choices people make are determined not only by some consistent overall goal and the properties of the external world, but also by knowledge that decision- makers do and don’t have of the world, their ability or inability to evoke that knowledge when it is relevant, to work out the consequences of their actions, to conjure up possible courses of action, to cope with uncertainty and to adjudicate among their many competing wants. Rationality is bounded because these abilities are severely limited” (Simon, 2000).

Simon (2000) contended that optimality is attainable through procedural rationality. That is, the process that leads to choices with an emphasis on the phenomenon associated with a limit on rationality. It is arguable that the rationality of decision procedures of humans is subject to the given constraints (March, 1978). From a psychological perspective, rationality is the behavioural style of a decision-maker that is appropriate to the attainment of a given goal in spite of limitations and constraints (Koumakhov, 2009; Simon, 1972). As the BRT evolves, rationality is determined by the decision-maker’s inner environment, memory content and their process, and the outer environment in which they act, and vice versa (Simon, 2000).

A succinct summary of Simon’s definition of BRT was presented in Dequech (2001), where he argued that Simon’s BRT focused strictly on the individual with little consideration to the interactions of a social context and the participation of an institution. Dequech (2001) concluded that BRT has limited applicability in a situation of uncertainty and neglected the innovativeness and creativity of an individual or organisation.

This study focuses on the ‘search’ and ‘satisficing’ as the key concepts of BRT. ‘Search’ is the extensive pursuit of information in a given time frame. Satisficing is attained when a decision- maker achieves satisfactory alternatives which likely might be influenced by the adjustment of the aspiration level (goal) because of the known information about the environment (Tiwana, Wang, Keil & Ahluwalia, 2007). For example, an IT project manager conducts an extensive search of information (about the cost of the project, perceived organisation benefits, business and technical requirements) to guide her decision-making process. In the later stage, she terminates the information searching process to choose without further considerations. The search and satisficing process makes the decision-maker vulnerable to cognitive biases. Satisficing and optimising exist in situations where the complexity of the decision problem and uncertainty makes full rationality impossible. Hence, decision-makers settle for “satisfactory” rather than “best approximate option” (Koumakhov, 2009; Simon, 1972).

In light of the 40 years’ discourse on the clarity of bounded rationality theory, Simon (2000) states that the BRT focuses on procedural rationality – i.e. the quality of the decision process, and substantive rationality – i.e. the quality of the outcome. He emphasised that to understand the procedural rationality one needs to have a theory of psychology of the decision-maker and the theory of goal and external environment to understand the latter.

Reinhard (1990) elucidates on the three-level theory of decision-making and identified the routine level, the level of imagination, and the level of reasoning as three mental stages of decision-making. Firstly, the routine level is a situation of making a quick decision with little or no thought process because the decision-maker is time bounded with little or no time for conscious deliberations. Secondly, the decision-maker attempts to picture the actions and consequences of his/her choice on an imagination level. The third level involves the analysis of a decision problem scenario before deciding. To better understand the argument posed by Reinhard (1990), the researcher relates the three level theory with the BRT propositions in (Dequech, 2001):

ii. The alternatives from which to choose to pursue these objectives are not previously given to the decision-maker, who then needs to adopt a process for generating alternatives.

iii. The limits of the decision-maker's mental capacity compared to the complexity of the decision environment are already present at this early stage and usually prevent him/her from considering all the alternatives.

iv. Those limits are also present when the decision-maker has to consider the consequences of the alternatives so that the decision-maker employs some heuristic procedure for that purpose.

v. The decision-maker adopts a "satisficing" rather than an optimising strategy, searching for solutions that are "good enough" or satisfactory, given some aspiration levels. Theories that incorporate the limits of information processing capacity of the decision-maker are theories of bounded rationality (Ellison, 2006; Foss, 2003). Rationality is bounded when: (i) risk and uncertainty are introduced in the decision problem, (ii) the decision-maker has incomplete information about alternatives, and (iii) the existence of environmental constraints makes the computation of the best course of action difficult (Dequech, 2001; Simon, 1972; Tiwana et al., 2007). Simon (1955) disagrees that there is no empirical evidence that computation can be or is performed in any complex human choice situation and puts forward an “approximate” rationality that can be employed by the decision-maker who is processing limited information with limited computation capacity. Koumakhov (2009) appraised Simon’s conventionalism view that, in understanding the problem of coordination, one must take into account individual cognition limits and social representations of reality. Conventionally, the author implies, how common cognition of reality, roles, and group identity operates within a firm, and how these elements interact to inform the decision-maker’s learning process. The assumptions of BRT explicitly depict the decision-making process in SEs when owner-managers make IT investment decisions because decision-makers lack sufficient IT skills, cognitive abilities, and information to decide.

3.3.2 Simon’s Bounded Rationality Theory

Simon discarded the assumption postulated in traditional economic theory that assumes that a decision-maker has absolute knowledge of the environment, has a well organised and stable preference, possesses sufficient computation skills to determine the best alternative action,

and can attain the highest aspirational level (Simon, 1955). People often weigh their current costs and benefits against future ones when making choices. Hence, gratification is delayed when the gratifying object is not visible or imaginable by the decision-maker (Camerer, 1998). Ellison (2006) suggests that Simon’s BRT proposed a global replacement for rationality choice and stressed two significant advantages of bounded rationality choice: a more realistic approach and extensibility of the features of the BRT. In addition, Reinhard (1990) also conceived Simon’s bounded rationality as a more realistic view of dealing with decision processes and believed that choice optimisation of decision-makers exceeds human cognitive abilities. Foss (2003) acknowledged the significant contribution of Herbert Simon towards BRT but argued that the BRT only serves a rhetorical function with less significant impact on utilitarian purpose. It is difficult to describe empirical predictions of bounded rationality theory explicitly.

It has been argued that bounded rationality establishes the knowledge of decision process which helps in predicting the outcome of decision (Simon, 2000). Simon’s BRT focuses too much on satisficing – a choice process where a decision-maker continuously searches for actions until they achieve a payoff that offers at least a minimal aspiration (Ellison, 2006). Thus, the thought of BRT as cognitive-driven theory is dubitable because human capabilities of computation and cogitation are factors that impose limits on rationality (Reinhard, 1990). There is no explicit guide about bounded rationality but, with certainty, bounded rationality is not like any other theory of utility maximisation. It is time to focus on the emprical application of BRT and spend less time debating on the relevance and incompleteness of BRT (Camerer, 1998; Reinhard, 1990).