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Theories of Decision Making

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Theories of Decision Making

 

 

Decision – making occurs at every level within an orgnisation. From the CEO down to the junior assistant, daily decisions ultimately impact on whether an organisation will be profitable or not.

 

So what determinants are involved in making a decision?

 

Is it a decision based on rationality whereby information is sort through the acquisition of knowledge and analytical thought (Sadler - Smith and Shefy, p77) or does it include intuitive awareness, or feelings, developed from extensive experience (Sadler-Smith and Shefy, p77)? Are decisions purely objective or are their factors that need to be considered that could influence or bias the decision making process. This paper will analyse, and compare and contrast the different theories of decision making in an organisation.

 

Rationality theory is the process of acquiring knowledge and information through strategic thinking as well as quantitative gathering of techniques, which are void of feelings and emotions (Sadler- Smith and Shefy, 2004). Rationality provides certainty by identifying and filling the gaps to reduce the uncertainty that may exist when making a decision. Managers in large organisations have been identified in Busenitz and Banreys paper (1997) as people who have the time and money to implement rationality in their decision making process. They tend to have elaborate policies and procedures as well as the ‘routines’ to aid their managers in the decision making process. Rational decision- making though is only as good as the information gathered for the decision. Weinberger in his article ‘Garbage In, Great Stuff Out’ identifies the importance of gathering the right types of information before a decision is made. He emphasises that making an informed decision means not just saying yea or nay but evaluating all sources and deciding which types of information to trust.

 

Haley and Stumpf (1989 cited in Busenitz & Barney, 1997) argue that it is not always feasible to evaluate all sources of information before a decision is made. They outlined several factors that prevent purely rational decision- making: These include:

  • High costs involved in implementing rationality in decision making
  • Information processing limits of decision making
  • Differences in the values of decision makers.

Busenitz and Barney (1997) support these factors by identifying two important theories that deviate from rational decision making which are biases and heuristics. “Biases and heuristic’s are decision rules, cognitive mechanisms and subjective opinions people use to assist in making decisions” (Busenitz, Barney, 1997, p12). These two theories have been shown to work effectively under conditions of environmental uncertainty and complexity, similar to what entrepreneurs’ face on a day - to- day basis. Pitz and Sach (1984 cited in Busenitz and Barney, 1997) note that under these circumstances, rational decision making for entrepreneurs is not possible, and as a result biases and heuristics may provide an effective way to approximate decisions. Hambrick and Crozier (1985 cited in Busenitz and Barney, 1997) make the point that managers in large organisations usually have access to rational decision making tools like historical trends and past performance information, which could lift the uncertainty faced in an organisation. Entrepreneurs on the other hand, tend not to have access to this information and thus must base a lot of their decisions on Biases and Heuristic’s.

 

One particular Bias/Heuristic identified in Busenitz and Barneys work is Overconfidence. Overconfidence exists when decision - makers are overly optimistic in their initial assessment. Overconfidence enables entrepreneurs (more so then managers of large organisations) to proceed with an idea before all steps are fully known. “Put differently, if entrepreneurs wait until all the ‘facts’ are in to start convincing others that their venture is indeed legitimate, the opportunity they are seeking to exploit will most likely be gone by the time more complete data becomes available (Busenitz, Barney, 1997, p15).

Lovallo and Kahneman (2003) identify overconfidence (or overly optimistic) as the pre-cursor to flawed decision making. They state that when forecasting the outcomes of risky projects, executives/entrepreneurs all too easily succumb to what psychologists call the planning fallacy. This is when decisions are made based on delusional optimism rather than on rational weighting of gains, losses and probabilities. Lovallo and Kahneman (2003) continue by stating that mistakes and miscalculations are often overlooked because scenarios of success are being spun. As a result of this budgets never come in on time or truly deliver the expected returns. Messick and Bazerman (1996, p19) support Lovallo and Kahneman point of view, identifying the dangers of overconfidence stating:

“That policies based on erroneous information may fail and harm others as well as the executive who established the policy. Overconfidence, poses serious threat to rational and ethical decision making”.

 

Perception decision - making is another subjective theory used by managers.

“Perception is the act of receiving external images, impressions or sensations through one of the senses” (Santos, M & Garcia, T, 2006, p753).

Managers constantly receive information signals from competitors, stakeholders and within their firm. Information doesn’t though reach the manager in its purest form, but rather through the filter of their perception. Thus, it can be argued that the raw material of business decisions is no longer real but rather a managerial perspective.

 

Intuition offers another decision-making theory when deliberative rational thought is not achievable or desirable. Intuition can be defined as the skill of focusing on those potentially important but at times faint signals that fuel imagination, creativity and innovation’ (Sadler- Smith and Shefy, 2004, p76). Intuition follows a similar approach to bias, heuristics and perception theory in that it is subjective in nature. Isenberg (1984, cited in Sadler- Smith and Shefy, 2004) outlines the different ways in which intuition is used in the decision making process; these include sensing a problem; performing pre-programmed behavioural patterns and producing an integrated picture. Isenberg argues, that becoming an effective decision maker is about learning to make sense of intuition, judging when to trust it and feeling confident enough to use it (Sadler - Smith and Shefy, 2004, p79). Hayashi supports Isenberg thoughts of intuition stating that intuition becomes of great importance as people climb up the corporate ladder. This is due to the level of job responsibilities and complexity placed on a more senior position.

 

Messick and Bazerman (1996, p10) are critical of intuition as a decision making tool. They provide 3 theories as to why the decision making process is incorrect when making complex choices. They suggest that in making complex choices, senior people make poor ethical decisions based on theories about the world, theories about people and theories about themselves. Theories about the world refer to the beliefs one holds about how the world works, and the ways in which our decisions impact on the world. Theories about people look at the organised beliefs that differentiate ‘them’ and ‘us’ and 'theories about ourselves’ focuses on the negative side of the belief that all ‘individuals are unique’. More specifically theories about ourselves, lead senior people to take more than there fair share of credit for success, or be too confident that there theory of the world is the correct one (Messick and Bazerman, 1996). All of the three theories outlined by Messick and Bazerman (1996, p20), hold the general principle that poor ethical decisions are made when decisions are intuitive, impulsive or subjective. They support the rational theory of decision- making stating decisions should be based on data not on hunches. They identify that there are times when executives cannot escape making decisions and judgements that are subjective or intuitive based, but they strongly believe that steps can be taken to prevent biases caused by intuition or subjective judgement. They continue by stating that in uncertain situations, the best guide comes from close attention to the real world (e.g. rational data analysis).

 

Niklas Luhman’s theory of organised social systems takes a completely different perspective (not pure rationalism or subjective) to decision making (Nassehi, A. 2005). His sociological viewpoint identifies decision making as an interconnected organisational system consisting of interactions that has evolved over many generations. He states that people within the organisation don’t make choices. Instead systems within the organisation cope with the problem of decision making by using the systems created to give security and reasoning to individuals (Nassehi, A 2005).

 

It is identifiable from this analysis that decision - making has many different lines of thought. On the one hand, rational decision -making argues that decisions should only be made once all the facts, data and quantitative data has been gathered. Biases and Heuristics theory notes that this is not always feasible as rational data is not always available and economical. Due to a lack of rational information, Biases and Heuristics theory use limited information to make decisions. Intuitive theory bases its decisions on faint signals that fuel imagination, creativity and innovation. Luhman’s sociological theory focuses on systems within organisations to cope with the problem of decision - making.

 

I would conclude that all of the theories identified are useful and applicable in the right situations. For example, rational decision -making may be the theory of choice in the military, but not for an entrepreneur with limited access to raw data. It ultimately comes down to the type of organisational culture, the line of work, or the environment where the decision is to be made that influences which decision - making theory should be used.

 

 

 

References

 

Busenitz, L. & Barney, J. (1997) Differences between Entrepreneurs and managers in large organisations: Biases and Heuristics in Strategic Decision Making. New York: Journal of Business Venturing Vol 12. Pp 9-30: Elsevier Science Inc. 

Lovallo, D & Kahneman, D. (2003) Delusions of Success: How Optimism undermines Executives Decisions. Harvard Business Review.

 

Messick, D. & Bazerman, M. (1996) Ethical Leadership and the Psychology of Decision Making. Sloan Management Review/Winter: Vol 37. No 2.

Nassehi, A. (2005) Organisations as decision makers: Niklas Luhmann’s theory of organised social systems. Oxford: Blackwell Publishing Ltd.

Sadler – Smith, E. & Shefy, E. (2004) The intuitive excutive: Understanding and applying ‘gut feel’ in decision making. Academy of Management Executive: Vol 18. No 4. 

Santos, M & Garcia, M. (2006) Managers’ opinions: reality or fiction. Management Decision: Vol 44. No 6: Emerald Group Publishing.

 

Weinberger, D. Garbage In, Great Stuff Out. Harvard Business Review.

 

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