Other Theories of the firm

Behavioural Theory

Central to the theory of behaviourism is a critique of the assumption rationality that underlines the neoclassical view. It introduces the idea of bounded rationality which accepts that firms cannot have perfect knowledge. Thus a decisions with bounded rationality arrives at an option that satisfies knowable criteria.

This is similar to Simon’s theory of satisficing, which states that people make decisions which are satisfactory due to their consistency with norms or ‘rules of thumb’.

Behavioural theory is similar to managerial theory in that the both believe the firm has multiple objectives driven by different factors. The Behavioural Theory views the firm as a coalition, made of members who have different or even competing interests. For the coalition to survive, compromise must be reached through a bargaining process, which is the heart of the decision making of the firm.

The choice of options, for survival of the coalition must be based as much as possible on achieving the range of satisfactory outcomes defined by the different members. Maximisation does not enter the picture. Each of these objectives might only be achieved at the expense of another.

The theory suggests that organisational slack is necessary to solve that conflicts that arise form competing objectives. While organisational slack may seem like inefficiency, it may be required to achieve multiple objectives.

That this slack exists is clear, although what is less apparent is that it works in the way behavioural theory suggests. The impact of behavioural theory has been modest due to its failure to generate clear cut predictions and prescriptions, and it does not lend itself to mathematics.

Stakeholder Theory

Stakeholder theory is similar to behaviourism in that in focuses on the interests of all the participants in the firm. It differs in that it does not adopt concepts such as bounded rationality and is instead more about politics and ethics.

It argues that a firm will perform better by being concerned with the interests of all its stakeholders, rather than just its shareholders. Stakeholders include all those working in the firm and others such as suppliers, customers, creditors, government, local community and shareholders.

Because stakeholders see themselves as part of a team their closer association with the firm results in more personal benefit for the performance of the firm and will so put in more effort. They will also be reluctant to let down other members of the team.

A major difficulty that arises in testing this theory is that it is difficult to determine what constitutes a stakeholder firm.  For example, a shareholder firm considers all the interests of the stakeholders, but only as a means to an end of maximising profit. Moschandreas states that stakeholding behaviour is expected to lead to enhanced competitive advantage through behaviour which is inclusive and socially efficient. This leads to the short-term objective of maximisation of profit and its fair distribution among stakeholders and the long-term objective of stability and corporate viability. Blair argues that institutional reforms are necessary for stakeholders to invest in firm specific assets.

A critique of this view rests on what is meant by fair distribution of surplus. What is missing from the Stakeholder view, according to O’Sullivan is the relationship between firm specificity and innovation.

Whether stakeholding should be left to the market or regulated by the government is unclear. With the increase in globalisation and thus the fragmentation of stakeholding groups, it is unlikely that firms will adopt this practice on a voluntary basis. Thus it is up to the government to impose it upon them, should they feel it necessary.

Co-operative Game Theory

A firm can serve as a nexus for co-operative relationships between the employees and the shareholders which makes possible the optimal redistribution of risk as well as the efficient collective use of skills, knowledge and funds.

The behaviour of the firm on the market emerges from this nexus; this behaviour is a co-operative game solution called the organizational equilibrium. This coalition view disregards other potential players unless they can be influential. Co-operating firms can stand to gain much more from each other as this theory does not believe firms operate in a zero sum world.

This theory is particularly useful for analysing potential partners prior to entering negotiations and for obtaining a stable and reasonable share of the intended partnership.

Transaction Cost Theory

This theory states that firms exist to minimize transaction costs. Transaction costs are those incurred in enforcing property rights, locating trading partners and actually carrying out a transaction. If property rights over a good cannot be established, then this theory is not appropriate.

While originally a rather minor field of Industrial economics, in recent times it has become considerably important, mainly due to the work of Coase who criticised the tendency of economists to ignore the institutional arrangements which govern the process of exchange.

Where transactions between individuals would be too difficult, firms emerge to perform this co-ordination and thus obviate these transaction costs by internalising them.

Williamson focuses on bounded rationality and opportunism. Opportunism relates to how people will respond to conflicts, given the existence of bounded rationality. They will behave opportunistically if they act in their self interests. Bounded rationality is a cognitive condition while opportunism is a behavioural condition. Without opportunism, the transaction would not take place on the market. But bounded rationality is a precondition to opportunism and so both are likely to give rise to internalisation.

He also referenced asset specificity which refers to assets specific to particular transactions. This is the critical condition which favours hierarchies over markets. For asset specification, assets involved in the transaction are not freely available for other use.  This results in a need for continuity, which only increases as the asset gets more specific and makes it more likely that internal governance will replace market governance.

There is criticism of the transaction cost theory due to its neglect of the use of knowledge. Many have called the theory that of the adaptive firm, not of the innovative firm.

Evolutionary Theory of the Firm

For evolutionary theorists, the basic unit of analysis is the firm itself and its specific physical and human assets. The features of the firm they focus on are strategy, structure and organisational capabilities, which refer to a firms spare managerial capacity arising from indivisibilities or different rates of growth of the various aspects of the firm.

Organisational routines are the building blocks of these capabilities. There are learned routines in each of the various functional areas of the organisation and even more importantly, in the co-ordination of these functions. Organisational theory sees routine as the genetic code of the firm.