Friday, January 4, 2013

The Bounded Rationality of Stakeholder Theory

Stakeholder Theory is an organizational management perspective that attempts to defined the nature and purpose of firms/corporations within society. According to its founder Milton Friedman, the purpose of a firm is embedded almost exclusively in the production of wealth for shareholders (Friedman, 1970). Since this time, the concept of stakeholder has been expanded to include the idea that other entities have a particular stake, or interest, in the organization and can influence its success or failure.

The theory defines who are the stakeholders in an organization and their rights and obligations to the shareholders as well as society in general. The root of the theory is based off of the premise that its purpose is the, "identification of moral or philosophical guidelines for the operation and management of the corporation" (Donaldson & Preston, 1995). The theory helps to foster the understanding that the needs of the owners should be realized first before other considerations. However, other ethical aspects of managing an organization in society are important considerations of how companies should operate; the definition of stakeholder has been expanded to include them.

This management perspective helps bridge a gap with classical economic theorists who see the system as separate economic components competing against each other while ignoring the perspective of the management of the firm. The classical approach makes the assumption that all participants in the system are rational and independent (unbounded rationality) while management theorists believe that  the imperfect information and lack of participant's mental abilities would bind them together for decision making into firms and organizations (bounded rationality) (Simon, 1955).

Thus the firm became a resource entity where operational abilities and knowledgecan minimize costs and improve upon market influence (Amit and Schoemaker, 1993). It is believed that organizations have the capacity to create market efficiencies through tying together the skills of labor and management into a social function that furthers the interest of its members. In essence, a person joins the firm for resource attainment and hedges their skills which creates more productivity than working alone.

In order for the firm to be effective it must hedge the skills and development of employees to create efficiencies. When these efficiencies are difficult to obtain and employees/managers are capable of a "free ride" the collective benefits will be lessened (Hardin, 1982). The same risks apply when an organization's culture detracts from employee development, unions become obstructionists, or political corruption encourage "free rider" approaches. Adding enough free riders, and inefficient operators to an organization, will detract from the firms missions, purpose, and economic strength.

Coordinators of human capital are combined into what we consider the board of directors. This board should have the skill to develop and create synergy within the organization by hedging human capital to create innovative powers (Mohrman et al., 1995). Thus, the very purpose of the board of directors lies in their ability to increase the efficiency of transactions as well as the innovative potential of the organization.

When a group of skills and abilities come together into an in-group paradigm with productive core values, the stakeholders are able to capitalize on employee's abilities and reap higher market rewards. The firm becomes the psycho-social group with a bundle of rights and obligations (Donaldson and Dunfee, 1999). Each member of the organization must be fully integrated into these groups, rights and obligations if true success of the organization will be found.

Stakeholder theory helps put within perspective the nature and purpose of an organization. At present these two purposes are 1.) shareholder wealth and 2.) other interested parties that have influence over the firm. Even though the theory doesn't specifically state this concept, one could take a very large view that firms are also societal socialization tools and can collectively change the very nature of American values and beliefs. Thus a stakeholder can be any person, group or entity that has a vested interest in the development of the organization and the people that pass through it.

Amit, R. and Schoemaker, P. (1993)Strategic Assets and Organizational Rent. Strategic Management Journal 14, 33–46.

Donaldson, T. & Preston, L. (1995). The Stakeholder Theory of the Corporation: Concepts, Evidence, and Implications. Academy of Management Review 20 (1), 65–91.

Friedman, Milton. "The Social Responsibility of Business Is to Increase Its Profits." New York Times Magazine, 13 September 1970.

Hardin, R. (1995). Efficiency, in R. E. Goodin and P. Pettit (eds.), A Companion to Contemporary Political Philosophy (Blackwell, Oxford), pp. 462–470.

Mohrman, S., Cohen, S. and Mohrman Jr, A. (1995).  Designing Team-Based Organizations: New Forms for Knowledge Work. (Jossey-Bass, San Francisco).

Simon, H. (1955), A Behavioral Model of Rational Choice.  Quarterly Journal of Economics 69, 99–118.

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