Introduction

This chapter investigates alternative approaches for dealing with problems that not only affect individuals but also have important societal consequences. Such problems typically involve a broad spectrum of interests, from consumers and businesses to special interest groups and government agencies. Our particular focus is on low-probability, high-consequence events, as these bring out clearly the importance of understanding decision processes for prescribing public policy. More specifically, biases are known to exist regarding the way different interested parties deal with risks. Society is now struggling with many of these issues, and they will assume even more prominence as technology advances. The problems include such diverse areas as automobile safety, energy, environment, natural and technological hazards, consumer product safety, and occupational risks.

Based on an understanding of the decision processes of the different actors, what type of policy tools should be utilized in allocating resources? Frey and Eichenberger (1989) suggest that private markets may be inefficient when there is uncertainty because of individual limitations in collecting and processing information on the risk. For example, motorists know that their chances of being involved in an accident are low, but few can specify the probabilities of being injured, or whether driving to work is more or less dangerous than a trip on the open highway which takes twice as long. There is a general awareness that protective mechanisms, such as seat belts or air bags, will reduce the impact of an accident, but little thought is generally given to the specific benefits of using these devices.

Introduction

In examining organizational decision making, we shall draw heavily on the earlier chapters dealing with individual and group decisions. After all, organizations do not make decisions, people do. Indeed, it might be argued that understanding how people make decisions and how groups function is sufficient to understand and improve organizational decision making. We take a different view. Although individual and group decision making is nested within organizational decision making, and is indeed important to its understanding, it is not sufficient to describe how organizations arrive at decisions. As foreshadowed in Chapters 1 and 2, an additional set of concepts, principles, and frameworks is needed to understand and improve organizational decisions.

Our focus in this chapter is on decision making by organizations (taking a global and distant perspective), as well as decision making within organizations. The latter perspective examines how the larger organizational context affects people's perceptions of and approaches to decision problems. To address these issues we need to have some understanding of organizations in general. However, the literature on organizations is vast and cannot possibly be reviewed in a few pages. For this reason, we identify in this chapter only the most important concepts and terms needed for our decision process perspective. Multiple perspectives will be offered, including contributions from economics, organization theory, and political science. As before, both descriptive and prescriptive aspects will be addressed.

Introduction

The emerging field of decision sciences is concerned with understanding and improving decision making of individuals, groups, and organizations. At issue is not only how decision makers “solve problems,” but also how they came to identify and accept such problems and learn from the results of their actions.

Decision making may be defined as intentional and reflective choice in response to perceived needs. Anthropologists such as Pierre Teilhard de Chardin (1959) consider this ability to reflect and choose as the fundamental characteristic distinguishing man from lower forms of life. While the recognition of this ability may provide the reader with a momentary feeling of superiority, history is also replete with examples of human limitations in decision making. Our purpose in this book is to provide a basis for understanding these limitations as they relate to individual, organizational, and societal decision processes and to use this basis to provide insights as to how such decision processes might be improved.

The dilemmas of choice in the face of an uncertain and complex world have long been the focus of religion, literature, and philosophy. In Western literature, classical epic poems and tragedies depict the gradual evolution of human choice from a metaphorical extension of the will of gods in Homer's epics to the realm of willful, if not always rational, choice in Euripides' tragedies. Writers such as Friedrich Nietzsche and Julian Jaynes have described this emergence during the first millennium B.C. from ritual and metaphor to willful action and reflective choice as a matter of the utmost importance in Western culture.

Introduction

In this chapter, we approach groups from the perspective of “methodological individualism,” in which groups are viewed primarily from the point of view of the individuals who make up the group. We begin our study with a brief overview of the elements of game theory as a formal representation of certain group choice problems, based on the preferences and beliefs of individuals in the group. We then apply the game theory representation of group choice problems to the problems of cooperation and bargaining. We shall also review the experimental literature on cooperation to explore when cooperation is likely to occur under conditions of conflict.

We use this same formal and individualistic methodology to consider certain collective choice problems such as choosing a president for a country or a location for a hazardous facility that must serve several communities in a region. Finally, we introduce the principal–agent paradigm, which has become important in economics and finance for understanding contractual relations between two or more parties.

Introduction to game theory

The theory of games is concerned with formal models of groups of selfinterest- seeking individuals engaged in a common endeavor, but whose members may have different preferences and beliefs about what the group should do. As such, game theory is a formal framework for understanding conflict and conflict resolution. As we shall discuss, game theory can be viewed as either a normative or as a descriptive theory, and it enjoys a rich literature in both theory as well as experimental and field studies.

In this appendix we prove two key theorems of the von Neumann–Morgenstern (NM) utility theory, using a numerical example along with the general case. Thereafter various illustrations are offered of how to apply expected utility (EU) theory.

EU axioms and theorems

This subsection states the von Neumann–Morgenstern (1947) axioms and proves that they imply expected utility maximization as the appropriate choice rule. Our approach follows that of Baumol (1977). Lotteries will be denoted as [p: A, B], meaning a p chance of getting A and a (1 - p) chance of getting B. The NM axioms are as follows:

1. Transitivity: If A > B and B > C then A > C, where > denotes “at least as preferred as.”

2. Continuity: For any three ordered outcomes A, B, and C, there exists a probability p such that B ∼ [p: A, C], where ∼ denotes indifference.

3. Independence: For any four outcomes A, B, C, and D, if A ∼ B and C ∼ D then [p: A, C] ∼ [p: B, D] for any p.

4. Stochastic Dominance: If A > B, then [r: A, B] > [r′: A, B] whenever r > r′.

5. Reduction: For any alternatives A and B and probabilities p, p1 and p2 [p: [Pl: A, B], [p2: A, B]] ∼ [r: A, B] where r = pp1] + (1 - p)p2.

Introduction

The previous three chapters have described how problems are identified and evaluated. We have discussed several different types of theories concerned with how decision makers perform these activities:

The dominant features of the descriptive theory we have presented are the limitations in cognitive abilities of decision makers, leading to systematic biases in choice behavior when compared with normative benchmarks such as expected utility theory and statistically based inference and prediction procedures. We have also indicated some prescriptive approaches, such as bootstrapping, to improve (although not necessarily optimize) decision making.

In discussing these descriptive, normative, and prescriptive theories, we have considered problem finding and problem solving as an ordered, interconnected set of phases: identification, representation, acceptance, alternative generation, evaluation, and choice. We now consider several holistic approaches to problem solving, with a view to providing a synthesis of the descriptive, normative, and prescriptive theories previously discussed. These holistic approaches may be viewed as competing prescriptive theories for accomplishing and piecing together the problem-solving phases mentioned previously.

Nature of problem finding

Most research on decision making focuses on how problems are solved. In this chapter, we consider the question of which problems are solved and how alternatives are generated for problem solving. These are fundamental activities underlying effective problem solving and decision making. Clearly, if we spend our time solving the wrong problems, or if we restrict attention to an inferior set of alternative solutions, then no matter how effective our problem-solving procedures may be, the outcome will be poor.

Figure 2.1 reproduces the problem context and problem-finding aspects of Figure 1.2, together with some typical examples of problem finding at various social levels. We note the following descriptive and prescriptive aspects of problem finding of interest:

1. Problem identification: the process by which a decision maker recognizes that a problem or decision-making opportunity exists.

2. Problem acceptance: the decision maker focuses attention on the problem as something worth considering further (as opposed to ignoring it).

3. Problem representation: the problem or decision situation is linked to potential improvements that may be achievable and perhaps some alternatives for problem solving are considered.

From a prescriptive viewpoint, we will be concerned with procedures to improve recognition and acceptance of problem situations. This leads to procedures for clarifying the objectives to be satisfied by problemsolving activity and for improving the management of time and attention so that important problems are dealt with first.