Bounded Rationality By Alan Yarborough, Allotrope Sciences Corporation

Bounded Rationality is a term for the phenomenon that cognitive blinders prevent people from seeing, seeking, or sharing relevant information during decision-making. This phenomenon challenges traditional rationalist perspectives and suggests that the rationality of human behavior is often incomplete and fragmentary or ‘bounded’ by human limitations. This management concept proposes that decision-making often takes place within an environment of incomplete information and uncertainty. Herbert Simon, known for Design Thinking, pointed out that most people are only rational to some extent and are often emotional and irrational even when making critical decisions. They experience limits in formulating and solving complex problems while receiving, processing, storing, retrieving, and communicating information. The point of bounded rationality is not only that people might decide differently if they had more complete or different information, but that they couldn’t likely process all the information even if they had it.

Opportunist ic Behavior

A major source of bounded rationality is Opportunistic Behavior. Opportunism in the context of bounded reality can be defined as: the taking of opportunities as they arise regardless of principle, for self-interest in a deceptive way (with guile). Or flexibly adapting to changing circumstances to maximize self-interest. A simple example is a person claiming more mileage or additional expenses on a travel voucher knowing that it’s unlikely that it will be questioned.

Another example is withholding information that would benefit an individual or group out of self-interest or for competitive reasons. We can distinguish a range of opportunism, from clear forms such as lying, cheating and stealing, to more subtle forms in which incomplete or partially incorrect information is given. Furthermore, opportunistic behavior can be: Ex ante opportunism / upfront, also called adverse selection, exploiting pre-contractual information asymmetries. Ex post opportunism / afterward the fact, called “moral hazard” in economics, is exploiting information asymmetries and not bearing the consequences by allowing the other party to bear most of the risk.

Mitigation

O.E. Williamson is a pioneer in the field of opportunistic behavior. In The Economic Institutions of Capitalism (1985), Williamson explains that the problem with opportunistic behavior is not that everyone is continually acting in an opportunistic way, but that it is so costly to ascertain the trustworthiness of individuals based on forecast rather than actual results. Laws, contractual arrangements, corporate governance instruments, corporate transparency and risk management are all useful tools to mitigate opportunistic behavior.

The Impact

A significant consequence of opportunistic behavior is that it prevents business parties from relying on and trusting each other as much as they should to achieve maximal efficiency.