‘Five challenges’ podcast series – Episode 5 – ‘Bounded rationality’ and entrepreneurial decision-making.
Welcome back to the last in this ‘five challenges’ podcast series. I’m Katherine Parsons, doctoral researcher at Cardiff Business School.
Each episode I have been addressing challenges set by Alacrity CEO Wil Williams in response to my recent research project on identity negotiation during the entrepreneurial process. In previous episodes I have addressed challenges set by Wil such as; how to manage and balance our multiple ‘selves’ at home and at work, how to embrace distinctiveness whist maximising efficiency on a start-up development programme such as Alacrity UK and how values shape an entrepreneur’s sense of who they are and are becoming.
This week, in the final of this current ‘five challenges’ podcast series I address Wil’s last challenge arising from my recent study. Wil asks; how do entrepreneurs overcome ‘bounded rationality’ and cope in a world with imperfect information on the markets in which they operate?
‘Bounded rationality’ a term coined by Simon in 1947 is used to describe the limited resources or cognitive capability one has with which to process information and make decisions. Simon’s theory of bounded rationality (1947) dictates that we make ‘satisycing’ as opposed to ‘optimal’ decisions (Cristofaro, 2017, pg.3) due to the limited information and resources available to us and are therefore impacted by the social and cognitive ‘reality’ and constraints as perceived by the individual, requiring them to construct a ‘simplified model’ as Simon (1957) calls it based on their cognitive and social perception of reality. It is, therefore, the “decision-maker’s simplified model of the world” Koumackhov (2009: 297) according to Simon (1957) that guides their decision-making. Decision-making, resultingly, is ‘bounded’ by this imperfect information and knowledge, leading Wil to ask – how do entrepreneurs overcome this bounded rationality in their decision making? How do they make decisions based on imperfect or incomplete information?
Bounded rationality assumes, however, as scholars observe (Brouwer, 2002) that all “costs and benefits can be calculated accurately” (pg. 91). This is problematic, however, if we understand that the costs and benefits are perceived in relation to the decision-maker’s simplified model of the world – how they perceive and interpret the information and resources they have available to them in making that calculation.
My study challenges a dominant assumption in the entrepreneur identity literature which polarises the values that lie beneath an entrepreneur’s decision making. Values driving entrepreneurial decision making and behaviour have been over simplified, categorised into ‘economic’ or ‘social’ based values, ignoring the myriad of other social and personal influences on their behaviours. My study applies rationality theory to identity management so as to understand what perceptions of reality are guiding the forms of rationality nascent entrepreneurs apply when negotiating who they are or are not and who they are in the process of becoming.
Looking to alternative rationality theories such as Weber’s ‘substantive’ and ‘instrumental’ rationality (1978), presented the opportunity to consider a range of values-based forms of rationality guiding entrepreneurial behaviour, for example, ethical, moral and equality-based judgements. Within my study, I adopt Biggart and Delbridge’s Systems of Exchange (SoE) Typology (2004) which is a response to the dominant rational-economic world view.
Specifically, it takes Weber’s (1978) Instrumental and Substantive rationality and Parsons’ (1968) Universalistic and Particularistic social relations to provide an analytical framework through which to understand how the economy and society are connected through the classification of four ways of ordering economic exchange other than the espoused ‘free market’. These are; Price, Associative, Moral and Communal exchanges, recognising “that individuals may be influenced by their social relations and that rationality comes in different forms” (Biggart and Delbridge, 2005).
Applying Biggart and Delbridge’s Systems of Exchange (SoE) typology (2004) to understand the ‘end goals’ the participants of my 2018/2019 study referred to within the narratives they told, illuminated a range of values-based forms of rationality guiding the nascent entrepreneurs’ identity work in managing and negotiating their identity construction throughout the entrepreneurial process.
Applying the SoE typology, it could be seen that ‘price system’ logics were guiding a number of the participants’ actions which were inherently driven by self-interests and personal beliefs. Others, however, could be seen to be driven primarily by the associative system, whereby, the team was the collective focus and where reciprocity and mutual support guided their actions. Yet for others, a ‘moral code’ of what’s ‘right’ guided their identity work as they wanted to be seen as someone who does ‘the right thing’. Finally, for some, a communal system could be seen to be guiding their behaviour as they developed a shared bond of professional norms and sought to follow the protocols and esteemed business models within the programme.
So, to sum up; in response to Wil’s question, my 2018/2019 study found that the entrepreneurs participating in my study ‘overcame’ bounded rationality and imperfect market information through their own ‘simplified model’ of the world. It found that for those guided by price logic and economic values drivers, economic indicators and measurements play a larger part in their ‘simplified model’ of the world, and economic forms of rationality will prevail in their decision-making. For those guided by the associative system, people related forms of logic are more likely to guide their decision-making and information which relates to how a cohesive, effective and sustainable team can be built and grown are likely to be given greater attention through their ‘simplified model’ of the world. Those guided by a ‘moral code’ will be ‘bound’ by morals and ethics guidelines and information whereas those guided by an associative system will be led by logics relating to developing and following professional norms and protocols for their industry, prioritising information in this regard within their ‘simplified world model’. This categorisation of types of behaviour also over-simplifies entrepreneurial behaviour and decision-making but it does illustrate the point that entrepreneurs and all individuals more generally will see the world and ‘facts’ in slightly different ways and will, therefore seek, interpret and understand information differently when making decisions and taking action. Entrepreneurs ‘rationales’ for thinking and decision-making will be driven by underlying values as to what is important and as long as their ‘rationales’ are commensurate with their ideals, values and identity, then the rationale is sound – for them.
An acceptance that we all see and hear things differently perhaps eradicates the notion of an ‘imperfect market’ and ‘imperfect information’ for what is ‘perfect’ and according to whom? My research found support for the scholarly view (Mody et al, 2014) of a ‘dynamic interplay’ of different forms of rationality guiding entrepreneurial decision-making and behaviour as they work through ‘whom am I?’ and ‘who or what do I want to become’? My research argues that as entrepreneurs navigate the market and environment around them and process the information available to them, they do so guided by their own values and identity. How they ‘cope’ with the imperfect information and markets surrounding them is dependent on how aligned their values are with the behaviours and actions they find themselves displaying. Where values are aligned with behaviours, identity congruence reigns, where there is mis-alignment between values and behaviour, identity conflict may ensue.
Throughout this podcast series I have addressed five challenges set by Alacrity UK CEO Wil Williams with relation to my 2018/ 2019 study on identity negotiation during the entrepreneurial process. Theoretical principles and frameworks helpful for increasing our understanding of how entrepreneurs develop and change during the entrepreneurial process have been discussed with relation to identity conflict, optimal distinctiveness and rationality. Practical implications for start-up skills and development programmes such as Alacrity UK have also been highlighted as they seek to nurture and support nascent entrepreneurs throughout the process of starting their own business. My current research project turns attention towards the start-up team – how viable and desirable entrepreneurial opportunities are identified and a collective organisational identity constructed within a start-up team context. The aim of the study is to shine a light on how more cohesive and sustainable start-up teams can be built, grown and developed to bring business solutions to some of society’s greatest challenges.
I do hope you will join me for my future Vlog series when I will be sharing my research ideas and early findings during this project.
Until then, please do check out the rest of this podcast series and connect with me via my social media (details on the Alacrity blog site) if you would like to connect and keep going the conversations started during this podcast series. Until then….
To connect with me about my research;
Biggart. N and Delbridge. R. 2004. Systems of Exchange. Academy of Management Review. 29 (1). pp:28-49.
Brouwer. M. 2002. Weber, Schumpeter and Knight on entrepreneurship and economic development. Journal of evolutionary economics. 12 (1-2). pp:83105.
Cristofaro. M. 2017.Herbert Simon’s bounded rationality: Its historical evolution in management and cross-fertilizing contribution. Journal of management history. 23(2):170-190. pp: doi:/10.1108/JMH-11-2016-0060
Koucmakhov. R. 2009. Conventions in Herbert Simon’s theory of bounded rationality. Journal of economic psychology. 30. pp:293-306. doi:10.1016/j.joep.2009.03.001
Mody. M, Day. J, Sydnor. S and Jaffe. W. 2014. Examining the motivations for social entrepreneurship using Max Weber’s typology of rationality. International Journal of Contemporary Hospitality Management. 28 (6). pp.1094-1114 DOI 10.1108/IJCHM-05-2014-0238
Parsons. T. 1968. The Structure of Social Action Volume II: Weber. New York: Free Press.
Simon. H. 1947. Administrative behaviour. New York: Free press.
Weber. M. 1978. Economy and Society. Berkeley: University of California Press.
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