Behavioural Theory of Cyert and March

1 year ago

Atiqur Rahman

16 minutes

Introduction

In recent years, behavioural approaches to the theory of the firm have been developed, which also relaxes the assumption of profit maximization. According to the behavioural theory, firms do not tend to maximize either profits, or sales, or utility.

A distinctive feature of the behavioural approach is that it considers how the firms behave or, in other words, how firms take their decisions in the real world. These decisions of the firms are related to the price of their product, level of output, sales strategy, growth maximization etc.

The advocated of the behavioural approach challenges the assumption of profit maximization and also the omission of uncertainty from the conventional theory of the firm. Under conditions of uncertainty about demand and cost conditions, it is impossible to judge whether the profit is maximized or not as the information regarding profits is not there. According to Cohen and Cyert, the two authors of the behavioural theory of the firm.

“In particular, as one looks closely at the behaviour of the actual firms, the justification for the assumption of profit maximization seems to weaken. When one adds uncertainty to the firm’s decision-making process, even defining the meaning of profit maximization becomes difficult to do in an empirically meaningful way. The behavioural theory of the firm takes the position that arguments over motivation are somewhat fruitless. The critical issue is not whether one assumes profit maximizing instead of satisficing behaviour. Instead, it is fruitless to develop an understanding of the process of decision-making within the firm.”

H. A. Simon, one of the advocates of the behavioural approach to the theory of the firm, points out that firms aim at satisficing rather than profit maximization, i.e. firms want to achieve a satisfactory level of profit.

According to him, there is an ‘aspiration level’ that a firm has. An aspiration level of a firm is based on its goal as well as its past experience. If the firm believes that its actual performance is sufficient enough to achieve a given aspiration level, then the aspiration level will be revised upward. On the other hand, if the firm believes that its actual performance is not sufficient enough to achieve a given aspiration level, then the aspiration level will be lowered.

Cyert and March have put forth a full-scale behavioural theory of the firm. In a modem large multiproduct firm, ownership is separate from management. This is basically the principal-agent problem. It explains the relationship between the principal (owner) and the agent (who performs the owner’s work).

The principal-agent shows that whenever the difference between ownership and control exists, then the self-interest of the agent makes profits lower than in a situation where principals act as their own agents. Here the firm is not considered a single entity with a single goal of profit maximization.

According to Cyert and March, a modern business firm is a group of individuals who are engaged in the decision-making process relating to its internal structure. These business firms have multiple goals.

Behavioural Theory of Cyert and March

The behavioural theory of the firm, as developed by Cyert and March, focuses on the decision-making process of the ‘large multiproduct firm under uncertainty in an imperfect market. In a modem large multiproduct firm, ownership is separate from management. This is basically the principal-agent problem. It explains the relationship between the principal (owner) and the agent (who performs the owner’s work).

The principal-agent shows that whenever the difference between ownership and control exists, then the self-interest of the agent makes profits lower than in a situation where principals act as their own agents. Here the firm is not considered as a single entity with a single goal of profit maximization.

According to Cyert and March, a modern business firm are a group of individuals who are engaged in the decision-making process relating to its internal structure and whose interests may conflict with each other. They call this complex organization an organizational coalition. This organizational coalition may include managers, workers, stockholders, customers, etc. These business firms have multiple goals.

Cyert and March deal not only with the internal structure of the firm but also with the problem of uncertainty. They challenge the assumption of profit maximization and also the omission of uncertainty from the conventional theory of the firm. Under conditions of uncertainty about demand and cost conditions, it is impossible to judge whether the profit is maximized or not, as the information regarding profits is not there.

Unlike the conventional traditional theory of the firm, which was based on a single goal of profit maximization, the behavioural theory assumes that an organization has multiple goals to achieve. According to Cyert and March, an organization has five goals which the firms generally possess. These are:

Production goal,
Inventory goal,
Sales goal,
Share-of-the-market goal,
Profit goal.

Five Goals of an Organization

Production Goal:

There are certain goals that are needed to be achieved at the production level. This goal originates from the production department. The production manager’s main objective is to smoothen the production process. This is possible by managers by distributing production evenly over time irrespective of fluctuations in demand that is possible seasonally.

He is also avoiding excess capacity, laying off workers at some periods, overworking the plant and resorting to rush recruitment of workers at other times because of consequences of higher costs, excess capacity, dismissal payments or too frequent breakdowns of machinery and wastes of raw materials in the period of ‘rush’ production. This goal is related to output decisions.

Inventory Goal:

The inventory goal originates mainly from the inventory department, if such a department exists, or from the sales and production departments. This goal represents the demands of coalition members who are well-connected with the inventory. It is affected by pressures on the inventory from customers and salesmen. This goal is related to decisions in output and sales areas.

Sales Goal:

The sales goal aims at meeting the demand of coalition members connected with sales, who regard sales as necessary for the stability of the organization. The sales department wants an adequate stock of output for the customers. The sales goal originates from the sales department.

The market-share goal is an alternative to the sales goal. It is related to the demands of sales management of the coalition who are primarily interested in the comparative success of the organization and its growth. Like the sales goal, the market-share goal is related to sales decisions. The same department will also normally set the ‘sales strategy,’ that is, decide on the advertising campaigns, the market research programs, and so on.

Profit Goal:

The profit goal is set by the top management so as to satisfy the demands of shareholders and the expectations of bankers and other financial institutions; and also to create funds with which they can accomplish their own goals and projects or satisfy the other goals of the firm.

We have seen above the five goals that an organization should possess. The number of goals can be increased, but this addition of new goals would result in the complexity of the decision-making process. There exists a negative relationship between the efficiency of decision-making and the number of goals. The efficiency of decision-making decreases as the number of goals increases and vice versa.

The goals of the firm are decided by the top management. This is done through continuous bargaining between the groups of the coalition. The firms, while forming goals attempts to satisfy as many demands as it is confronted by various members of the coalition.

Some of the goals that we have studied above may be desirable to all members of the coalition. For example, the sales goal is directly desirable to the sales manager and his department, to the top management and most probably to the shareholders. But it is also indirectly desirable to all the other members of the coalition as all the members of the coalition know that unless the firm sells whatever it produces, no one will be able to attain his own individual goals.

But except for this goal, there are other goals that are desirable for only too few members of the groups. For example, the profits goal is directly desirable to the shareholders and the top management, but not to the employees in lower administrative levels or of the workers ‘on the floor.’ The goals of the firm, like the goals of the individual members or groups of the coalition, take the form of aspiration levels rather than strict maximizing constraints.

The firm in the behavioural theories seeks to satisfice, that is, to attain a ‘satisfactory’ overall performance, as defined by the set aspiration goals, rather than maximize profits, sales or other magnitudes. The firm is a satisficing organization rather than a maximizing entrepreneur.

Conflicting Goals:

The goals of the firm, like the goals of the individual members or groups of the coalition, take the form of aspiration levels rather than strict maximizing constraints. The factor that determines these goals within the firm is the aspiration level of the individuals. This aspiration level changes over time as a result of organizational learning. In the organizational coalition, these goals are regarded as the product of a bargaining-learning process.

But it is not necessary that different goals get resolved cordially. There may exist conflicts among goals. The organizational coalition is thus a coalition of conflicting interests. These conflicting interests can be reconciled by the distribution of ‘side payments’ among coalition members. The actual amount of the side payment that needs to be distributed is not fixed for the coalition. That actual amount basically depends on the form of the coalition and the demand of coalition members.

In the long run, the demand for coalition members is equal to the side payments. The behavioural theory focuses on the short-run relation between side payments and demands. These side payments can be in the form of cash or in kind. The side payment in kind is mostly in the form of ‘policy’, which is the right to take part in the policy decisions of the organization.

In the short run, new demands are being constantly generated and the goals of the organization are continuously adapted to take account of these increased demands. The demand for the coalition members in the organization need not be mutually consistent. All this increased demand is not made simultaneously.

The organization that is meeting the demand can remain viable by attending to the demand in sequence. But the problem can still arise when the organization is not able to accommodate the demand of its coalition member even sequentially. This happens due to a lack of resources.

Satisficing Behavior:

We have seen above that the conflicting goals of the organization can be reconciled by the distribution of ‘side payments’ among coalition members. Besides the distribution of side payments, the conflicting goals of the organization are resolved by subjecting them to constant review. This constant review is required because the aspiration levels of coalition members change with experience. The aspiration levels change with the process of satisficing.

Each person in the organization has a satisficing level for each of his goals. If this desired level is achieved, then they will not seek more. But if this desired level is not achieved, the aspiration levels are revised downwards. If they are exceeding the desired amount, the aspiration levels are raised upwards. In both situations, the satisfactory levels of performance are changed accordingly.

Organizational Slack:

A coalition is sound and workable if payments made to various members of the coalition are adequate. In order to have a workable coalition, enough resources are needed to meet all the demands of members of the coalition in an organization. This is generally not possible because there exists a disparity between the total resources available to the organization and the total payments required to maintain the coalition.

According to Cyert and March, the difference between the total resources available and total necessary payments is called organizational slack. The organizational slack arises in payments to coalition members in the organization that is in excess of what is required to maintain the organization.

There are other forms of slack that exist when the organization operates under market conditions that are not perfect. There is a possibility that the shareholders may be paid dividends in excess of what is required to keep them in the organization, or the customers may be charged lower prices so that they may stick to the products of the firm.

The workers may be paid wages in excess of what is needed to keep them in the firm. The executives may be provided with services and personal luxuries more than what is required to keep them. All such expenses in the form of excess payments are slack expenditures for the firm, which every member of the coalition obtains from time to time.

According to Cyert and March, organizational slack is typically not zero. But it is positive. It is possible that some members of the coalition in general obtain a greater share of the slack than others. In general, those members of the coalition who are full-time tend to get more payments than the other members of the coalition. This organizational slack is very important for the existence of a coalition.

Organizational slack plays a productive role by enabling the firm to maintain itself under a crisis-type situation. It also enables the firm to adjust itself to changes in the external environment. It serves as a cushion to absorb abnormal shocks. These payments increase during boom periods and decrease during bad phases of business. Thus, organizational slack plays both a stabilizing and an adaptive role.

Decision-Making Process:

The important parameter that needs to be discussed is the decision-making process. In the Cyert-March model, the decision-making rests with the top management and with the lower levels of administration. It is the top management that sets the organizational goals and allocates the given resources to the various departments. This allocation of resources is based on their share of the total budget of the firm.

The share in the budget depends upon the bargaining power and the skill of each manager. This bargaining power is determined by the past performance of each department and their hard work. In this process of allocation, the top management retains some funds to be allocated at its discretion at any time to any department.

The decision-making process at the lower levels provides various degrees of freedom of action to the administration. The budget is allocated to each department. Once the share is distributed from the budget, each manager has considerable discretion in spending the funds at his disposal. All the decisions that are taken by the managers are implemented by the lower-level staff based on their experiences and the “blueprint” rules laid down earlier.

Another factor that determines the decision-making process is information and expectations formed within the organization. Information plays an important role in the decision-making process as it is required to facilitate the decision-maker.

Seeking information is not costless, and it is required at each and every step. Search activity is started whenever the problem persists as the search helps to locate and collect information. This information determines the aspirations of each department, which, in turn, helps the top management in setting goals.

On the other hand, expectations also play an important role in the decision-making process, as organizational expectations are related to the hopes and wishes of the decision-maker.

Given these two parameters that affect the decision-making process, the top management examines and decides upon the projects presented by the managers. The top management evaluates the projects presented by the managers on the basis of two grounds.

First, Budget constraint which emphasizes on the availability of funds for the project. And Second, Improvement criteria which focus on whether the project is better than the existing one?

In making decisions, the top management follows the rule that leads to a better state in the future than it was in the past. Thus, the Cyert-March model of behaviourism is thus an adaptive rational system.

Behavioural Theory of Cyert and March

Introduction

Behavioural Theory of Cyert and March

Five Goals of an Organization

Production Goal:

Inventory Goal:

Sales Goal:

Profit Goal:

Conflicting Goals:

Satisficing Behavior:

Organizational Slack:

Decision-Making Process:

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Introduction

Behavioural Theory of Cyert and March

Five Goals of an Organization

Production Goal:

Inventory Goal:

Sales Goal:

Share-of-the-Market Goal:

Profit Goal:

Conflicting Goals:

Satisficing Behavior:

Organizational Slack:

Decision-Making Process:

Read More- Microeconomics

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