The behavioural theory differs in almost all its aspects from the traditional theory of the firm. The firm in the behavioural theory is conceived as a coalition of groups with largely conflicting interests.
There is a dichotomy between ownership and management. There is also a dichotomy between individual members and the firm-organisation.
The consequence of these dichotomies is conflict between the different members of the coalition.
The traditional theory conceives the firm as synonymous with the entrepreneur. The owner-businessman is at the same time the manager of the firm. The ‘members’ of the firm are the entrepreneur and the owners of the factors of production, whose demands are satisfied via money payments. Consequently there is no conflict since the entrepreneur pays to the factors of production in his employment their market prices (opportunity cost).
The firm of the traditional theory has a single goal, that of profit maximisation. The behavioural theory recognizes that the modern corporate business has a multiplicity of goals. The goals are ultimately set by the top management through a continuous process of bargaining. These goals take the form of aspiration levels rather than strict maximising constraints. Attainment of the aspiration level ‘satisfices’ the firm: the contemporary firm’s behaviour is satisficing rather than maximising. The firm seeks levels of profits, sales, rate of growth (and similar magnitudes) that are ‘satisfactory’, not maxima.
The behavioural theory is the only theory that postulates satisficing behaviour as opposed to the maximising behaviour of other theories. Satisficing is considered as rational, given the limited information, time, and computational abilities of the top management. Thus the behavioural theory redefines rationality: it introduces the concept of ‘bounded’ or ‘limited’ rationality, as opposed to the ‘global’ rationality of the-traditional theory of the firm.
The traditional theory of the firm initially assumed that in deciding the allocation of resources (within the firm) the entrepreneur equates marginal revenue to opportunity cost. This behaviour implicitly assumes global rationality, that is, perfect knowledge of all alternatives, examination of all possible alternatives and certainty about future returns. Later theorists recognized uncertainty as a fact of the real business world and introduced a probabilistic approach to the above decision rule for the allocation of internal resources.
The entrepreneur was assumed to be able to assign definite probabilities to future returns and he equated expected returns with opportunity costs. Furthermore, later theorists recognised the fact that the entrepreneur has limited knowledge, limited information, which is not costless, but is acquired at a cost.
The allocation of resources to search activity (activity aiming at acquisition of information) was assumed to be decided by comparing expected profitability of the information with its cost. That is, search activity was treated by the traditional theory as an activity, like all the other activities of the firm, which absorbs resources and hence must be judged on marginalistic rules like the other activities.
In general, traditional theory postulated that the decisions about resource allocation are taken by comparing marginal (expected) return to marginal cost. The probabilistic approach was attacked and other theories were developed to cope with uncertainty. The most important of these theories is the theory of games, which, however, has not as yet been generally accepted.
Cyert and March criticized the probabilistic-marginalistic behaviour of the traditional theory on the following grounds:
Firstly, the traditional theory assumed continuous competition among all alternative resource uses. In the actual world we observe local problem-solving rather than general planning for all activities of the firm simultaneously.
Secondly, the traditional theory treats ‘search’ as another investment decision, that is, in terms of calculable returns and costs. In reality, it has been observed that search is problem-oriented and is not decided on marginalistic rules.
Thirdly, traditional theory assumes substantial computational ability of the firm projects are decided after screening of all alternatives on the basis of detailed calculations of all direct and indirect benefits and costs. Reality suggests that firms are of limited computational ability and do not make decisions on the basis of detailed studies or marginalistic rules.
Fourthly, the traditional theory treats expectations as exogenously determined. In reality expectations are to a large extent endogenous, being affected by various internal factors, for example, the desires-aspirations of various groups, the information available and its flow through the various sections of the firm, and from past attainments of the various groups and of the firm-organisation as a whole.
In the traditional theory there is no conflict of goals between the organisation and its individual members. In the behavioural theory conflict among the various members of the coalition is inevitable. It is never fully resolved at any one time. There is rather a continuous process of bargaining between members and the organisation, and the conflict is quasi-resolved in any one period by money payments, slack adjustment, policy commitments, delegation of authority (decentralisation of the decision-making activity), and by sequential attention to the conflicting demands. Such means permit the firm to make decisions with inconsistent goals, and within a continuously changing internal and external environment.
Unlike the traditional theory, Cyert and March distinguish two sources of uncertainty uncertainty arising from changes in market conditions (tastes, products and methods of production), and uncertainty arising from competitors’ behaviour. Market-originated uncertainty is avoided, according to the behavioural school, partly by search activity, partly by maintaining R&D departments, and partly by concentrating on short-term planning. Contrary to the traditional theory, Cyert and March postulate that the short run is much more important than the long run.
In particular, so long as the environment of the firm is unstable (and unpredictably unstable) the heart of the theory must be the process of short-run, adaptive reactions. It seems to us, however, that unless the long-run goals are defined, any short-run description of the behaviour of the firm cannot attain the degree of generality expected from a theory of the firm. Regarding the competitor-originated uncertainty, Cyert and March accept that firms act within a ‘negotiated environment’, that is, firms adopt business practices of a collusive nature. Thus, the behavioural theory is not applicable to non-collusive oligopolistic markets.
In the behavioural theory the instruments which the firm uses in the decision-making process are the same as those of the traditional theory: output, price, and sales strategy (the latter including all activities of non-price competition, such as advertising, salesmanship, service, quality). The difference lies in the way by which the values of these policy variables are determined. In the traditional theory the firm chooses such values of the policy variables which will result in the maximisation of the long-run profits. In the behavioural theory the policies adopted should lead to the ‘satisficing’ level of sales, profits, growth and so on.
Cyert and March postulate that the firm is an adaptive organisation: it learns from its experience. It is not from the beginning a rational institution in the traditional sense of ‘global’ rationality. In the long run the firm may tend towards the ‘omniscient rationality’ of profit maximisation, but in the short run there is an adaptive process of learning there are mistakes, trials and errors. The firm has a memory and learns through its past experience.
It seems strange to us that despite this ‘adaptive learning process’ the firm does not ever seem to acquire the ability for long-run planning. The behavioural theory is basically a short-run theory. The determination of the values of the instrumental variables (output, price, sales strategy) does not adequately take into account the environment past performance and past conditions of the environment are crudely extrapolated into the future.