Behavioural Theories of the Firm

Definition of Behavioural Theories of the Firm: An examination of the inner motives and direction of firms, using a range of models and different assumptions about those who work in a firm.

In classical economics, the theory of firms is based on the assumption that they will seek profit maximisation. However, in the real world managers and owners may behave quite differently. Behavioural Theories of the Firm include:

  • Size of a firm/prestige. Some managers may simply aim for working in a big and seemingly successful firm which gives more prestige and honour. Managers may be motivated to prove their projects are successful. This can cause firms to pursue goals which have a high profile. It may explain why firms persist with projects which may not be desirable. There is a cost to letting go of past decisions.
  • Profit satisficing. Based on the problem of asymmetric information. Owners wish to maximise profits, but, workers don’t. Because owners don’t have perfect information, workers and managers are able to get away with decisions that don’t maximise profits.
  • Co-operative/ethical concerns. Some firms may be set up with very different objectives to the traditional model of profit maximisation. In co-operative firms, the goal is to maximise the welfare of all stakeholders. In this model, ideas of altruism, concern for the environment and workers welfare may explain many decisions. The firm may also be set up with specific charitable aims.
  • Human emotion/bias. The economic model of a rational economic man assumes that individuals seek to maximise their economic welfare with rational choice. However, in the real world, we are influenced by human emotion. This could be discrimination based on bias and prejudice. Or it could be irrational exuberance and the perceived wisdom of following the crowd. For example, in asset bubbles, mortgage companies can get caught up in relaxing their lending criteria and lending mortgages to those at risk of default.

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