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

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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. **

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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.

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Dynamic capabilities and strategic management

Measuring the efficiency of decision making units

24 December 1996EMF-RFF Conferenceon DiscountingDISCOUNTING, MORALITY, AND GAMING Kenneth J. Arrow1. IntroductionI take the problem of discounting for projects with payoffs inthe far future (climate change, nuclear waste disposal) to belargely ethical (Schelling 1995). There is an apparent conflict inour moral intuitions, already apparent in Ramsey's work (1928).On the one hand, moral considerations are based onuniversalizability, in which case we should treat future generationsas we would ourselves, so that the pure rate of pure timepreference should be zero. But with zero time preference and along horizon, the savings rates become inordinately high, possiblyapproaching one as the horizon goes to infinity (Koopmans 1960).A reconciliation must be based on the notion that individuals arenot morally required to subscribe fully to morality at any cost tothemselves. There are both empirical evidence and theoreticalarguments that individuals recognize moral arguments for the farfuture but treat themselves and the near future better (Cropper,Aydede, and Portney 1994; Chichilnisky 1996). This approachleads to a non-cooperative game, in which each generation issomewhat selfish (compared with perfect morality) and recognizesthat future generations will be similarly selfish. I thus come back

Discounting, Morality, and Gaming

Rawls's Principle of Just Saving

Utilities, Attitudes, Choices: A Review Note

Merit and Justice

Insurance is an item of considerable importance in the economies of advanced nations, yet it is fair to say that economic theorists have had little to say about it, and insurance theory has developed with virtually no reference to the basic economic concepts of utility and productivity. Insurance is not a material good; although it is usually classified as a service, its value to the buyer is clearly different in kind from the satisfaction of consumers’ desires for medical treatment or transportation. Indeed, unlike goods and services, transactions involving insurance are an exchange of money for money, not money for something which directly meets needs. The closest analog in ordinary economic theory to an insurance policy is a bond or note, an exchange of money now for money later. But an insurance is a more subtle kind of contract; it is an exchange of money now for money payable contingent on the occurrence of certain events.

Kenneth J. Arrow

Papers

Discounting, Morality, and Gaming

Rawls's Principle of Just Saving

Utilities, Attitudes, Choices: A Review Note

Merit and Justice

Insurance, Risk and Resource Allocation