Bounded Rationality

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Description of Bounded Rationality. Explanation.

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Pioneer of Bounded Rationality: Herbert SimonDefinition Bounded Rationality. Description.


"Bounded Rationality" is a term for the phenomenon that cognitive blinders prevent people from seeing, seeking, using, or sharing relevant, accessible, and perceivable information during decision-making. The bounded rationality phenomenon challenges traditional rationalist perspectives and suggests that the rationality of actual human and company behavior is always partial, or ‘bounded’ by human limitations.


This management concept recognizes that decision making takes place within an environment of incomplete information and uncertainty. Herbert Simon (also known for Design Thinking) pointed out that most people are only partly rational, and are in fact emotional and irrational in the remaining part of their actions. They experience limits in formulating and solving complex problems and in processing (receiving, storing, retrieving, transmitting) information.


The point of bounded rationality is not only that people might decide differently if they had more or different information. But is also includes that they can't process all the information even if they had it.



Opportunistic Behavior

One major source of bounded rationality is Opportunistic Behavior by other parties. Opportunism can be defined as: self-interest seeking by an agent (an economic or business party) in a deceptive way (with guile). Or more neutrally as: flexibly adapting to changing circumstances to maximize self-interest. A simple example of opportunistic behavior is a person having a travel insurance who claims sunglasses from his insurer while he didn't lose them at all, suspecting the insurance company is unlikely to investigate relatively small claims.
Opportunistic Behavior: O.E. Williamson

Types of Opportunistic Behavior

We can distinguish a spectrum of opportunism, ranging from very clear forms, such as lying, cheating and stealing, to more subtle forms in which incomplete or (partly) incorrect information is given.


Furthermore, opportunistic behavior can be:

  • Ex ante opportunism / upfront (also called adverse selection): exploiting precontractual information asymmetries.
  • Ex post opportunism / afterwards (also called moral hazard: exploiting information asymmetries by not bearing the full consequences.

Safeguarding against Opportunistic Behavior. Prevention

A pioneer in the field of opportunistic behavior is O.E. Williamson. In The Economic Institutions of Capitalism (1985), Williamson explains that the problem with opportunistic behavior is not that everybody is continually acting in an opportunistic way, but that it is so costly to ascertain the trustworthiness of individuals ex ante.

Laws, contractual arrangements, certain corporate governance instruments, corporate transparency and risk management are amongst the instruments and safeguards to prevent opportunistic behavior.


Consequences of Opportunistic Behavior

A major consequence of opportunistic behavior is that it prevents business parties from relying on each other as much as they should to achieve maximal efficiency.
Opportunism is a main factor behind the prisoner's dilemma and the free rider problem, in which someone consumes a resource without paying for it in any form (or pays less than the full cost of its production).


Bounded Rationality Forum
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Bounded Rationality Special Interest Group


Special Interest Group

 

Best Practices - Bounded Rationality Premium

Expert Tips - Bounded Rationality Premium
 

How to Use Intuition in Decision Making Properly?

Matzler, Uzelac and Bauer (2014) have written a very interesting article on good Managerial decision making and the constraint...
Usage (application): Intuitive Decision Making, Adductive Reasoning, Bounded Rationality, Cognitive Biases, Managerial Decision-making
 
 
 

Do Sad or Happy People Make Better Decisions?

There is a common thought that being in a sad mood will result in a low degree of judgmental biases. For many judgmental biases this reasoning holds. ...
Usage (application): Decision Making, Negotiating
 
 
 

How to Use Counterintuition to Fight 5 Frequent Decision Making Errors

Mauboussin describes five mistakes in decision making that are often made and result in making the wrong decisions. These five mistakes are:
1...
Usage (application): Strategic Decision Making, Dealing with Complexity, Dealing with Uncertainty, Strategy
 
 

Resources - Bounded Rationality Premium

The Influence of Emotions and Moods on Decision-Making and Entrepreneurship

This presentation is about emotions in decision-making, thereby paying specific attention to Emotional Intelligence
1. Key questions
2. Emot...
Usage (application): Decision Making, Emotional Intelligence, Entrepreneurship, Cognitive Bias
 

Overview of Behavioral Economics and Bounded Rationality

This presentation is abut behavioral economics (an area that focuses on the bounds of rationality of economic agents). It is an extensive presentation...
Usage (application): Decision Making, Behavioral Economics, Trainings, Workshops
 

Heuristics as Biases (defects) or Heuristics as Intelligence (beneficial)?

Presentation that mainly is about Heuristics as Biases and Heuristics as Intelligence, including the following sections:
0. Context
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Usage (application): Heuristics, Biases, Framing
 

Full List of Cognitive Biases Classified into Four Different Areas

Presentation that classifies Cognitive Biases into four different areas, by S. Gupta (2011). It includes the following sections:
A. What are Cogn...
Usage (application): Decision Making, Human Behaviour, Management, Leadership, Strategy, etc.
 

Critical Thinking in Decision Making

Presentation about critical thinking for decision making, including the following sections:
1. Failure of Imagination
2. Untested Assumption...
Usage (application): Critical Thinking, Testing Assumptions, Avoiding Fallacies, Avoiding Biases, Dealing with Emotions
 

The Power of Persuasion: 3 Main Principles of Influencing Others

An extensive presentation about persuasion including many types and examples of persuasion experiements. The following sections are included:
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Usage (application): Persuasion Techniques, Managing Behavior, Cognitive Bias, Bounded Rationality, Resistance to Change
 
 

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Compare also: Game Theory  |  Analogical Strategic Reasoning  |  Cognitive Bias  |  Causal Ambiguity  |  Qualitative Investment Analysis  |  Feedback Loops  |  Lateral Thinking  |  TRIZ  |  Synectics  |  Thinker's Keys  |  Abilene Paradox  |  Paralysis by Analysis  |  Tacit Knowledge

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