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Behavioral Theory of the Firm

The behavioral theory of the firm (BTF) is a composition of a number of theories that have emerged within economics, sociology, business, and management studies. These theories have been developed with the intent to deal with the issues of how firms behave in a market-place and what determines the interfirm relationships.

Conceptual Overview

The economic theory of the firm looks at the firm as a black box, as a unit processing inputs into outputs. In contrast, the behavioral theory of the firm attempts to compensate for this narrow view by looking at what happens inside the firm, how the throughput takes place as economic activity, and how decisions are made regarding production, scheduling, and inventory. The BTF is known also as a decision theory, as it explains the circumstances of operational decisions and the outcomes that contribute to value added. Decisions are interpreted as a sequential process, which includes both rational and nonrational aspects and are affected by ownership rights, liabilities, control over resources, and power.

Other core concepts related to the BTF are the notion of firms' competences and capabilities, organizational learning, accumulation of knowledge, cognition and motivation, or how firms learn about their internal and external environment. The BTF advocates for the endogeneity (growing from within) of preferences and expectations as the main source of bounded rationality, or the “irrational” choices made by firm's managers in situations of uncertainty and complexity.

The BTF is a complex agglomeration of business and management theories that contribute to our understanding of the firm. Since its inception, the BTF has dealt with the question of firm boundaries and the related questions of incentives within and outside these boundaries, or opportunities in the environment to capture value and to generate profits and rents. Ultimately the BTF explains strategic decisions made beyond environmental incentives. The BTF is also related to the foundations of the institutional and evolutionary theory of the firm and to various learning and innovation theories.

Critical Commentary and Future Directions

The nature and behavior of firms have been elaborated in a large number of economic, strategic, and managerial theories that contribute to the BTF. Economic theories treat firms as autonomous actors that are engaged in value-creation activities, utilizing various resource inputs and factors of production, where firm behavior is induced by environmental incentives and constraints. The strategic management theory has recognized that behind each firm stands a management team, composed of professionals who are empowered to make decisions regarding strategic alternatives, regarding internal allocation of resources, or giving direction to firm's activities. Strategic behavior of the firm in this context is represented by the strategic choices of managers. Administration and management theories also have contributed to the debate on decision making, power relationships, and structure—or factors that induce firms' behavioral responses. Sociological, anthropological, and organizational behavior theories have explored the behavior of individuals, groups, institutions, and other organized entities, as well as the development and interaction with technologies and sociocultural artifacts.

Different theories refer to different definitions of the firm. Whitley defines firms as centers of economic power that combine allocative decision making with authoritative coordination of economic activities, and as such they add value to human and material resources through collective organization of work. Firms are seen as dominant units of strategic decision making and planned coordination that combine differentiated skills, capabilities, and knowledge, and embody a collective organization that transforms human and material resources into productive services. Attributes of these economic actors are governance structure; separation of ownership from control, and delegation of control; goals and objectives realized within particular profit constraints; diversity of activities and capabilities that are coordinated through authoritative communication; and radical discontinuities in the carried out activities and capabilities.

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