Business Strategy Perspectives and Economic Theory: A Proposed Integration

Article excerpt

ABSTRACT

Prospect theory as developed in psychology and applied to economic behavior by Daniel Kahneman and others claims that an individual's personal position relative to a good or service will determine the value of that good or service to the person in addition to the individual's position relative to the general market for the good or service. Similar ideas have been discussed as "fuzzy-set" social science. In the related field of organizational theory the argument is being made that rational choice theory is inadequate as a basis for describing and explaining reality and an historical political economy contingency perspective is being offered as an improvement. Similar themes appear in the business organization strategy work of Raymond Miles and Charles Snow who discuss the "prospecting strategy." In this paper, the conceptual relationships between these prospect theories are developed and discussed. A comparative assessment reveals that the perspectives have three very similar theoretical underpinnings and that future empirical and macro theoretical integrative work is necessary. The paper concludes with a case illustration.

INTRODUCTION

The assumption of rationality in economics has been challenged most recently by prospect theory. Prospect theory has claims that an individual's personal position relative to a good or service will determine the value of that good to the person in addition to the individual's position relative to the general market for the good (cf. Kahneman, 1999; List, 2003a; List, 2003b; Thaler, 1980). Similar ideas have been discussed as "fuzzy-set social science" (Ragin, 2000; Sen, 2002; Baliamoune, 2003). In the related field of organizational theory, Zey (1998) has argued that rational choice theory is inadequate as a basis for describing and explaining reality; she argues for an historical political economy contingency perspective. The same underlying conceptual themes appear in the work of Miles and Snow (1994) who discuss the "prospecting" strategy.

In this paper, the conceptual relationships between prospect theory as developed and applied to the field of economics by Kahneman and Tversky (2000a, 2000b), Kahneman and Lo vallo (1994) and Tversky and Kahneman (2000, 1981) and prospect theory as developed and applied by Miles and Snow (1994, 1978) are discussed. The paper concludes that there is a clear convergence of these theoretical perspectives and that future empirical and macro theoretical integrative work is necessary.

TWO PROSPECT THEORIES

In this section, two theoretical statements will be described, their similarities will be presented and the argument will be presented that because of these similarities, "prospect theory" has far greater applications than envisioned by their respective proponents. The first of these theories is the "prospect theory" developed by economist Daniel Kahneman and various collaborators and stands in contradiction to standard expected utility theory. Expected utility theory underlies much of the reasoning of contemporary economic theory. The second is the "prospect theory" developed by the organization management theorists Raymond Miles and Charles Snow and various collaborators and stands in contradiction to standard rational contingency theory. Rational contingency theory underlies much of the reasoning of contemporary organizational theory.

Economic Prospect Theory

Economic prospect theory was created, essentially, because of apparent weaknesses in the conventional wisdom of classical economic theory. As Edwards (1996) describes:

Prospect theory was formulated ... as an alternative method of explaining choices made by individuals under conditions of risk. It was designed, in essence, as a substitute for expected utility theory [because the] expected utility theory model did not fully describe the manner in which individuals make decisions in risky situations and that therefore, there were instances in which a decision-maker's choice could not be predicted. …

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