https://www.sfu.ca/~wainwrig/Econ400/jensen-meckling.pdf

Theory of the firm: Managerial behavior, agency costs and ownership structure

This paper presents a critique of expected utility theory as a descriptive model of decision making under risk, and develops an alternative model, called prospect theory. Choices among risky prospects exhibit several pervasive effects that are inconsistent with the basic tenets of utility theory. In particular, people underweight outcomes that are merely probable in comparison with outcomes that are obtained with certainty. This tendency, called the certainty effect, contributes to risk aversion in choices involving sure gains and to risk seeking in choices involving sure losses. In addition, people generally discard components that are shared by all prospects under consideration. This tendency, called the isolation effect, leads to inconsistent preferences when the same choice is presented in different forms. An alternative theory of choice is developed, in which value is assigned to gains and losses rather than to final assets and in which probabilities are replaced by decision weights. The value function is normally concave for gains, commonly convex for losses, and is generally steeper for losses than for gains. Decision weights are generally lower than the corresponding probabilities, except in the range of low prob- abilities. Overweighting of low probabilities may contribute to the attractiveness of both insurance and gambling. EXPECTED UTILITY THEORY has dominated the analysis of decision making under risk. It has been generally accepted as a normative model of rational choice (24), and widely applied as a descriptive model of economic behavior, e.g. (15, 4). Thus, it is assumed that all reasonable people would wish to obey the axioms of the theory (47, 36), and that most people actually do, most of the time. The present paper describes several classes of choice problems in which preferences systematically violate the axioms of expected utility theory. In the light of these observations we argue that utility theory, as it is commonly interpreted and applied, is not an adequate descriptive model and we propose an alternative account of choice under risk. 2. CRITIQUE

/pdf/prospect-theory-an-analysis-of-decision-under-risk-4z6oysdahj.pdf

Prospect theory: an analysis of decision under risk

In this paper, we argue that the ability of a firm to recognize the value of new, external information, assimilate it, and apply it to commercial ends is critical to its innovative capabilities. We label this capability a firm's absorptive capacity and suggest that it is largely a function of the firm's level of prior related knowledge. The discussion focuses first on the cognitive basis for an individual's absorptive capacity including, in particular, prior related knowledge and diversity of background. We then characterize the factors that influence absorptive capacity at the organizational level, how an organization's absorptive capacity differs from that of its individual members, and the role of diversity of expertise within an organization. We argue that the development of absorptive capacity, and, in turn, innovative performance are history- or path-dependent and argue how lack of investment in an area of expertise early on may foreclose the future development of a technical capability in that area. We formulate a model of firm investment in research and development (R&D), in which R&D contributes to a firm's absorptive capacity, and test predictions relating a firm's investment in R&D to the knowledge underlying technical change within an industry. Discussion focuses on the implications of absorptive capacity for the analysis of other related innovative activities, including basic research, the adoption and diffusion of innovations, and decisions to participate in cooperative R&D ventures. **

/pdf/absorptive-capacity-a-new-perspective-on-learning-and-1n1c9gg9x0.pdf

Absorptive capacity: a new perspective on learning and innovation

The dynamic capabilities framework analyzes the sources and methods of wealth creation and capture by private enterprise firms operating in environments of rapid technological change. The competitive advantage of firms is seen as resting on distinctive processes (ways of coordinating and combining), shaped by the firm's (specific) asset positions (such as the firm's portfolio of difftcult-to- trade knowledge assets and complementary assets), and the evolution path(s) it has aflopted or inherited. The importance of path dependencies is amplified where conditions of increasing retums exist. Whether and how a firm's competitive advantage is eroded depends on the stability of market demand, and the ease of replicability (expanding intemally) and imitatability (replication by competitors). If correct, the framework suggests that private wealth creation in regimes of rapid technological change depends in large measure on honing intemal technological, organizational, and managerial processes inside the firm. In short, identifying new opportunities and organizing effectively and efficiently to embrace them are generally more fundamental to private wealth creation than is strategizing, if by strategizing one means engaging in business conduct that keeps competitors off balance, raises rival's costs, and excludes new entrants. © 1997 by John Wiley & Sons, Ltd.

/pdf/dynamic-capabilities-and-strategic-management-4iyi34iyh6.pdf

Dynamic capabilities and strategic management

Measuring the efficiency of decision making units

We develop a consistent and comprehensive theoretical framework for assessing whether economic growth is compatible with sustaining well-being over time. The framework focuses on whether a comprehensive measure of wealth - one that accounts for natural capital and human capital as well as reproducible capital - is maintained through time. Our framework also integrates population growth, technological change, and changes in health. We apply the framework to five countries that differ significantly in stages of development and resource bases: the United States, China, Brazil, India, and Venezuela. With the exception of Venezuela, significant increases in human capital enable comprehensive wealth to be maintained (and sustainability to be achieved) despite significant reductions in the natural resource base. We find that the value of "health capital" is very large relative to other forms of capital. As a result, its growth rate critically influences the growth rate of per-capita comprehensive wealth.

https://papers.ssrn.com/sol3/Delivery.cfm?abstractid=1723046

Sustainability and the Measurement of Wealth

Political and Economic Evaluation of Social Effects and Externalities

Considers the idea that the uncertainties about economics stem from the need to understand the economics of uncertainty. Also argues that the lack of economic knowledge is largely due to the difficulty in modeling the economic agent's ignorance. The neoclassical model, founded on concepts regarding the individual economic agent and the market, is the starting point for the discussion. It is suggested that a market system is informationally economical and that the individual agent need not know very much about the economic system as a whole because there is far more in it than any one individual can learn. What the individual must know is the motivation and production conditions that define him or her. In addition, the simplification of an individual's decision making processes is possible because the markets have supplied the needed economic information in the form of prices. Also examined is the nonexistence of markets for future goods. This is done by considering the implications for the rest of the system and the reasons for the market's nonexistence. Finally, it is proposed that when uncertainty exists, risk aversion implies that steps will be taken to reduce risks. (SFL)

Limited Knowledge and Economic Analysis

It is a touchstone of accepted economics that all explanations must run in terms of the actions and reactions of individuals. Our behavior in judging economic research, in peer review of papers and research, and in promotions, includes the criterion that in principle the behavior we explain and the policies we propose are explicable in terms of individuals, not of other social categories. I want to argue today that a close examination of even the most standard economic analysis shows that social categories are in fact used in economic analysis all the time and that they appear to be absolute necessities of the analysis, not just figures of speech that can be eliminated if need be. I further argue that the importance of technical information in the economy is an especially

https://www.jstor.org/stable/pdfplus/2117792.pdf

Methodological Individualism and Social Knowledge

This study comes to grips with the industrial outranking problem, one of the major outstanding problems of current operations research and managerial decision-making. The problem, simply stated, is this: given a large but finite set of criteria, and a large but finite number of alternatives, how can the criteria be ranked in priority order, and how should the alternatives be ranked from best to worst consistent with the ordering of criteria that may be conflicting or incommensurable? There have been many proposed solutions to the problem. Numerous empirical recipes—among them the majority method—have been submitted, based in large part on the subjective judgments and biases of various observers. The authors argue that the axiomatic formulation offers the surest path to a solution that is as objective as possible, minimally distorted by the unwitting imposition of personal values. They then develop a system of consistent and appealing axioms, confront the paradoxes that put axiomatic systems in general at risk, and demonstrate the applicability of their system to realistic industrial outranking problems. Even within the axiomatic framework, however, some leeway remains for subjective choice and conscious value decisions. One ad hoc criterion of choice the authors selected was that their method should be neither so flexible and open that personal biases might easily slip in, nor so artificially rigid that the play of intuition and creativity was systematically excluded. The book also takes a hard look at the theoretical and practical defects of the majority method, the favored proposed solution, and at such associated issues as committee decision techniques, strategic majority voting; and restriction conditions.

Kenneth J. Arrow

Papers

Sustainability and the Measurement of Wealth

Political and Economic Evaluation of Social Effects and Externalities

Limited Knowledge and Economic Analysis

Methodological Individualism and Social Knowledge

Social Choice and Multicriterion Decision-Making