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Simon subsequently began working on industrial organization and, among the various things he found, was that both the internal organization of firms and the external business decisions of firms seems to conform poorly with the Neoclassical theories of "rational" decision-making. In an avalanche of articles and books since the 1950s, Simon has focused much of his attention on the issue of decision-making - and has come up with a behavioral theory based on "bounded rationality". Agents, he claim, face uncertainty about the future and costs in acquiring information in the present. These two factors, thus, limit the extent to which agents can make a fully rational decision. Thus, Simon claims, they have only "bounded rationality" and are forced to make decisions not by "maximization" by "satisficing", i.e. setting an aspiration level which, if achieved, they will be happy enough with, and if they don't, try to change either their aspiration level or their decision. These "rules of thumb" are the utmost agents can achieve in the "bounded" and uncertain real world.
Simon has backed up much of his work with numerous studies on decision-making in business enterprise. Out of this, the "new" theory of the firm as a "satisficing" as opposed to "maximizing" agent has begun to take hold in industrial organization. In general, Simon's theories of bounded rationality have become an integral part of the so-called "New Institutionalist Economics".
What is Bounded Rationality in risk management and decision making?
Bounded rationality is based on behavioural notions and upon observations of the ways in which decisions are actually taken in practice. Criticism of classical rationality led Nobel laureate Herbert Simon (1972) to propose the notion of bounded rationality. Bounded rationality assumes human rationality has its limits, especially when operating in conditions of considerable uncertainty. Bounded rationality has two interlocking components:
„h Limitations of the human mind. Models of human judgement and decision making have to take into account known limitations about the mind¡¦s capacities. Because of the mind¡¦s limitations, humans "must use approximate methods to handle most tasks" (Simon, 1990: 6). These methods include recognition processes that largely obviate the need for further information search, heuristics (mental shortcuts) that guide search and determine when it should end, and simple decision rules that make use of the information found.
„h Structure within which the mind operates. Environmental structure is of crucial importance because it can explain when and why simple heuristics perform well: if the structure of the heuristic is adapted to that environment. A heuristic is said to be ecologically rational to the degree that it is adapted to the structure of an environment.
The notion of rational, calculating, optimising behaviour. For Professor Simon the notion that companies maximised their profits was absurd, because they could not possibly have the information they would need to do so. What people cannot do, they will not do, was his mantra.
Professor Simon would sometimes use the following powerful analogy. Imagine being told to go to the highest point in [next page]