Behavioral strategy refers to the application of insights from psychology and behavioral economics to the research and practice of strategic management. In one definition of the field, "Behavioral strategy merges cognitive and social psychology with strategic management theory and practice. Behavioral strategy aims to bring realistic assumptions about human cognition, emotions, and social behavior to the strategic management of organizations and, thereby, to enrich strategy theory, empirical research, and real-world practice" [1] (Powell, Lovallo & Fox, 2011: 1371).
More specifically, behavioral strategy is as an approach to core issues in strategic management (e.g., CEO and top management team behaviors, entry decisions, competitive interaction, firm heterogeneity) with the following characteristics:
1) It is microfoundational [2] (Felin, Foss, & Ployhardt, 2015) in the sense that a psychology-based understanding of the actions and interactions of individuals is used to explain strategy phenomena, often on a higher level of analysis;
2) all fields of psychology, as well as relevant parts of behavioral economics and sociology, are seen as potentially applicable to, in principle, any strategic management phenomenon;
3) assumptions about behaviors and interactions are to be based in evidence (e.g., brought about by means of experiments) rather than the extent to which these allow for mathematical tractability, are "elegant" or similar.
In terms of methods, behavioral strategy follows strategy research in general by being pluralist, such that qualitative research, lab and field experiments, and agent based modelling, in addition to conventional quantitative and formal methods are all acceptable. However, because of its heavy psychology-emphasis behavioral strategy research may be more disposed towards experiments than most other streams of strategy research.
Lines of study
Behavioural finance integrates psychological research that describes how people behave in real life and applies it to finance. This research resulted in the formation of two independent study lines:[3]
The first is about how investor behavior may differ from the textbook definition of an efficient rational investor. The other is how investors who aren't completely rational can cause market prices to vary from their underlying values.
The first strand of research examines how investors act in order to determine how investing strategies should meet their desires. The second strand of research examines how investor behavior may influence market functioning; It's used to determine whether active investment managers will find it simpler to outperform (the short answer is "no").
In 2002, a professor of psychology, Daniel Kahneman, was awarded the Nobel Prize in Economics[4] (who won it jointly with Matt Smith) in recognition of the contribution that behavioral analysis is now making in financial economics. This research arose from a series of experiments that yielded significant findings about the biases that influence how people make decisions and create preferences.[5]
Giving investing advice requires a thorough grasp of investor preferences, and understanding investor biases is crucial for predicting how investors will react to specific events or developments. If biases are flaws that could harm an investor's interests, investing advisers should avoid catering to them. This, for example, implies a need for investor education. Investors and their advisers should be aware of these biases because they will influence how they react to various predicted market movements.
Major historical contributions
Herbert Simon's research on cognitive decision making and the concept of bounded rationality contributed to further research in decision making and behavioral strategy. Simon's research also led him to four categoric observations on variations in ability to solve complex problems and make decisions.[6]
Simons Observations:
One key to solving problems lies within adequate representation of the problem. Those who show proficiency in solving problems, also represent the problem accurately, highlighting the nature of the problem and utilizing the most pertinent information necessary for a solution.
Effective problem solvers use patterns. When analyzing problems and their solutions, patterns emerge. These patterns translate to 'if/then' solutions. Porter's five Forces model is an example of 'if/then' solutions with recurring patterns that consistently connect problems with effective solutions. If your supplier has high bargaining power, then seek alternative sources, as an example.
Patterns increase memory encoding and recall.[6] A connection to a memory allows faster recall from long term memory, and patterns increase this connection making memories easier to recall.
Practice increases expertise. Practicing decision making and problem solving correlates to increased skill. Using representation, recognizing and remembering patterns, and recalling these patterns increases one's abilities.
These observations provided early support in the development of research on behavioral strategy.[7]
Development
The use of psychology insights to further research in the behavior and performance of firms has a long history, including research on the behavioral theory of the firm (Cyert & March, 1963; Gavetti, Levinthal, and Ocasio, 2007), aspirations (Greve, 1998), attention (Ocasio, 1997), emotions (Nickerson & Zenger, 2008), goals (Lindenberg & Foss, 2011), cognitive schema, maps, sensemaking, and cognitive rivalry (Porac and Thomas, 1990; Reger and Huff, 1993; Lant and Baum, 1995; Weick, 1995), routines (Cyert & March, 1963), decision theory (Kahneman and Lovallo, 1993), escalation (Staw and Cummings, 1981), motivation, (Foss & Weber, 2016), hubris (Bollaert and Petit, 2010), and top management teams (Hambrick and Mason, 1984), dominant logic (Prahalad & Bettis, 1986), competitive interaction (Chen, Smith & Grimm, 1992), and learning (Levinthal and March, 1993). (The Behavioral Strategy site https://www.behavioralstrategywiki.org/ organizes behavioral strategy papers by juxtaposing concepts (e.g., fairness, emotions, trust, etc.) and phenomena (e.g., global strategy, incentives, CSR, etc.)).
However, the first explicit use of the term "behavioral strategy" in a journal seems to be in Lovallo and Sibony (2010), which links the term to the behavioral economics literature and the underlying heuristics and biases literature. While Lovallo and Sibony (2010) is a contribution to a practitioner journal, Powell, Lovallo and Fox (2011) edited a special issue on "Psychological Foundations of Strategic Management" of the premier strategy journal, the Strategic Management Journal. Retrospectively, this may be seen as the key event in launching behavioral strategy as a coherent, institutionalized research effort rather than a multitude of relatively unconnected research streams.
In their editorial essay Powell et al. outline three reasons why there is a need for a concerted research effort in behavioral strategy, namely that strategy has been too slow to incorporate relevant results from psychology, lacks adequate psychological grounding (e.g., heterogeneity is assumed and not explained in terms of reasoning and decision-processes), but recent developments (e.g., cognitive neuroscience developments which make it possible to link strategic decision-making and brain activity) have paved the way for a closer and more coherent integration of the cognitive sciences and strategy.
In an article published the year after the Powell et al. article Rindova, Reger, and Dalpiaz (2012) refer to a "'sociocognitive' perspective" in strategy which, "while varied in its theoretical framings, focuses on the roles of managers' and observers' attention; the bounded rationality of their cognitions, intuitions, and emotions; and the use of biases and heuristics to socially construct "perceptual answers" to traditional strategic management questions about how firms obtain and sustain competitive advantage."
Representation in scholarly associations
In terms of institutionalization provided by professional and scholarly associations, behavioral strategy research has historically been represented in context of divisions and interest groups of the Academy of Management such as "Managerial and Organizational Cognition", "Business Policy and Strategy" (now "Strategic Management") and "Technology and Innovation Management" . In 2013, the "Behavioral Strategy Interest Group" was in the context of the Strategic Management Society.
Defining the field of behavioral strategy
The increasing interest in behavioral strategy has motivated a number of recent attempts to define the field (Powell et al., 2011; Rindova et al., 2012; Hambrick and Crossland, 2019) as well as surveys of theorizing that is either part of behavioral or very closely related, such as surveys of the behavioral theory of the firm (Gavetti, Levinthal, Greve, & Ocasio, 2012) or problemistic search (Posen et al., 2018). For example, Hambrick and Crossland adopt an imagery of alternatively sized tents of behavioral strategy. In the small tent conception, behavioral strategy is "a direct transposition of the logic of behavioral economics (and behavioral finance) to the field of strategic management," whereas in the middle-size conception it is "a commitment to understanding the psychology of strategists," and in the large tent conception it behavioral strategy is basically "all forms and styles of research that consider any psychological, social, or political ingredients in strategic management" (Hambrick and Crossland, 2019).
Behavioral strategy has developed gradually into a significant subfield within strategic management. It applies insights from social psychology and cognitive to intensify strategic decision-making by understanding social dynamics and human cognition. Behavioral strategy focuses on top managers’ cognitive processes and emphasizes collaboration and communication patterns. The foundation lies in the behavioral decision theory.
Strategic cognition delves into understanding the cognitive structures within organization and the decision-making processes. Effective and intuitive reasoning plays a significant role in strategy formulation, it comes to influence organizational and managerial cognition.
The field of Behavioral strategy has gained significant attention in academic circles, with issues and volumes dedicated to it in prestigious conferences and publications. The field remains scattered and diverse despite its growth. To address this issue scholars propose integrating theoretical and empirical attention. This integration aims to provide more understanding of how behavior can impact strategic outcomes.[8]
(The study undertakes citation-based systematic literature review to provide a better understanding of behavioral strategy. It addresses the lack of reviews in literature, it aims to illuminate the key sources, contributors, and contribution in the field. Through network analysis and bibliometric, paper maps the network of authors, documents, growth patterns, influential articles, and intellectual structure of behavioral strategy. It identifies and suggests path for future research, it will serve as a valuable resource for researchers that are interested in this area.)
Applying behavioral strategy to extreme circumstances such as Covid 19 and the implications
Behavioral strategy affected decisions made during the COVID-19 disruption. Behavioral strategy provides psychologically based interpretations that can illuminate how individuals and organizations respond to such disruptions. It suggests that strategists may not be good at using formal models, rules, or forecasts because they are not statisticians. There is supporting evidence of this observed during the disruption caused by Covid-19. Some decision-makers treated extreme model projections as deterministic predictions rather than recognizing them as improbable worst-case scenarios. An example of this was the societal lockdown. It was impossible to forecast the economic and social consequences of the lockdown, and its effectiveness, and yet decision-makers decided to implement this worst-case scenario.[9] Another example of worst-case scenario being implemented is when the CDC gave guidance on wearing masks outdoors as this was an example of extreme caution.[10] Decision-makers appeared to overlook the consequences of or misunderstand the lack of error margins around initial forecasts. Also of relevance, decision-makers may rely too much on models, forecasts, and data that are available. When decision-making problems are ill-structured and require quick action, relying solely on formal models and forecasts can be problematic. It becomes necessary to incorporate intuition and soft data into the decision-making process in these cases.[11]
Limitations of behavioral strategy
Strategy making is a deeply social process and strategy research doesn't sufficiently account for this.[12] Different experts' social standards vary, and this will influence what information is collected. COVID-19 highlighted how behavioral strategy frameworks don’t allow dealing with uncertainty beyond standard treatments of risky decision-making.[13] Behavioral strategy is useful in extreme circumstances, however, there is more research to be done on the weaknesses present for disruptions like this.[11]
Market sentiment– General attitude of investors to market price development
Socioeconomics– Social science that studies how economic activity affects and is shaped by social processes
Related Research Articles
Herbert Alexander Simon was an American political scientist whose work also influenced the fields of computer science, economics, and cognitive psychology. His primary research interest was decision-making within organizations and he is best known for the theories of "bounded rationality" and "satisficing". He received the Nobel Memorial Prize in Economic Sciences in 1978 and the Turing Award in computer science in 1975. His research was noted for its interdisciplinary nature, spanning the fields of cognitive science, computer science, public administration, management, and political science. He was at Carnegie Mellon University for most of his career, from 1949 to 2001, where he helped found the Carnegie Mellon School of Computer Science, one of the first such departments in the world.
A cognitive bias is a systematic pattern of deviation from norm or rationality in judgment. Individuals create their own "subjective reality" from their perception of the input. An individual's construction of reality, not the objective input, may dictate their behavior in the world. Thus, cognitive biases may sometimes lead to perceptual distortion, inaccurate judgment, illogical interpretation, and irrationality.
A heuristic (; from Ancient Greek εὑρίσκω 'method of discovery', or heuristic technique is any approach to problem solving that employs a pragmatic method that is not fully optimized, perfected, or rationalized, but is nevertheless "good enough" as an approximation or attribute substitution. Where finding an optimal solution is impossible or impractical, heuristic methods can be used to speed up the process of finding a satisfactory solution. Heuristics can be mental shortcuts that ease the cognitive load of making a decision.
Heuristic reasoning is often based on induction, or on analogy[.] [...] Induction is the process of discovering general laws [...] Induction tries to find regularity and coherence [...] Its most conspicuous instruments are generalization, specialization, analogy. [...] Heuristic discusses human behavior in the face of problems [...that have been] preserved in the wisdom of proverbs.
Bounded rationality is the idea that rationality is limited when individuals make decisions, and under these limitations, rational individuals will select a decision that is satisfactory rather than optimal.
In economics and business decision-making, a sunk cost is a cost that has already been incurred and cannot be recovered. Sunk costs are contrasted with prospective costs, which are future costs that may be avoided if action is taken. In other words, a sunk cost is a sum paid in the past that is no longer relevant to decisions about the future. Even though economists argue that sunk costs are no longer relevant to future rational decision-making, people in everyday life often take previous expenditures in situations, such as repairing a car or house, into their future decisions regarding those properties.
Behavioral economics is the study of the psychological, cognitive, emotional, cultural and social factors involved in the decisions of individuals or institutions, and how these decisions deviate from those implied by classical economic theory.
In psychology, decision-making is regarded as the cognitive process resulting in the selection of a belief or a course of action among several possible alternative options. It could be either rational or irrational. The decision-making process is a reasoning process based on assumptions of values, preferences and beliefs of the decision-maker. Every decision-making process produces a final choice, which may or may not prompt action.
Decision theory is a branch of applied probability theory and analytic philosophy concerned with the theory of making decisions based on assigning probabilities to various factors and assigning numerical consequences to the outcome.
Metacognition is an awareness of one's thought processes and an understanding of the patterns behind them. The term comes from the root word meta, meaning "beyond", or "on top of". Metacognition can take many forms, such as reflecting on one's ways of thinking and knowing when and how oneself and others use particular strategies for problem-solving. There are generally two components of metacognition: (1) cognitive conceptions and (2) cognitive regulation system. Research has shown that both components of metacognition play key roles in metaconceptual knowledge and learning. Metamemory, defined as knowing about memory and mnemonic strategies, is an important aspect of metacognition.
The overconfidence effect is a well-established bias in which a person's subjective confidence in their judgments is reliably greater than the objective accuracy of those judgments, especially when confidence is relatively high. Overconfidence is one example of a miscalibration of subjective probabilities. Throughout the research literature, overconfidence has been defined in three distinct ways: (1) overestimation of one's actual performance; (2) overplacement of one's performance relative to others; and (3) overprecision in expressing unwarranted certainty in the accuracy of one's beliefs.
Computer simulation is a prominent method in organizational studies and strategic management. While there are many uses for computer simulation, most academics in the fields of strategic management and organizational studies have used computer simulation to understand how organizations or firms operate. More recently, however, researchers have also started to apply computer simulation to understand organizational behaviour at a more micro-level, focusing on individual and interpersonal cognition and behavior such as team working.
The following outline is provided as an overview of and topical guide to thought (thinking):
In psychology, the human mind is considered to be a cognitive miser due to the tendency of humans to think and solve problems in simpler and less effortful ways rather than in more sophisticated and effortful ways, regardless of intelligence. Just as a miser seeks to avoid spending money, the human mind often seeks to avoid spending cognitive effort. The cognitive miser theory is an umbrella theory of cognition that brings together previous research on heuristics and attributional biases to explain when and why people are cognitive misers.
The framing effect is a cognitive bias in which people decide between options based on whether the options are presented with positive or negative connotations. Individuals have a tendency to make risk-avoidant choices when options are positively framed, while selecting more loss-avoidant options when presented with a negative frame. In studies of the bias, options are presented in terms of the probability of either losses or gains. While differently expressed, the options described are in effect identical. Gain and loss are defined in the scenario as descriptions of outcomes, for example, lives lost or saved, patients treated or not treated, monetary gains or losses.
Heuristics is the process by which humans use mental shortcuts to arrive at decisions. Heuristics are simple strategies that humans, animals, organizations, and even machines use to quickly form judgments, make decisions, and find solutions to complex problems. Often this involves focusing on the most relevant aspects of a problem or situation to formulate a solution. While heuristic processes are used to find the answers and solutions that are most likely to work or be correct, they are not always right or the most accurate. Judgments and decisions based on heuristics are simply good enough to satisfy a pressing need in situations of uncertainty, where information is incomplete. In that sense they can differ from answers given by logic and probability.
The behavioral theory of the firm first appeared in the 1963 book A Behavioral Theory of the Firm by Richard M. Cyert and James G. March. The work on the behavioral theory started in 1952 when March, a political scientist, joined Carnegie Mellon University, where Cyert was an economist.
Intuition in the context of decision-making is defined as a "non-sequential information-processing mode." It is distinct from insight and can be contrasted with the deliberative style of decision-making. Intuition can influence judgment through either emotion or cognition, and there has been some suggestion that it may be a means of bridging the two. Individuals use intuition and more deliberative decision-making styles interchangeably, but there has been some evidence that people tend to gravitate to one or the other style more naturally. People in a good mood gravitate toward intuitive styles, while people in a bad mood tend to become more deliberative. The specific ways in which intuition actually influences decisions remain poorly understood.
Social heuristics are simple decision making strategies that guide people's behavior and decisions in the social environment when time, information, or cognitive resources are scarce. Social environments tend to be characterised by complexity and uncertainty, and in order to simplify the decision-making process, people may use heuristics, which are decision making strategies that involve ignoring some information or relying on simple rules of thumb.
Henrich R. Greve is a Norwegian organizational theorist, and Professor of Entrepreneurship at INSEAD, and the Rudolf and Valeria Maag Chair in Entrepreneurship. He was the editor of the Administrative Science Quarterly.
Organizational adaptation is a concept in organization theory and strategic management that is used to describe the relationship between an organization and its environment. The conceptual roots of organizational adaptation borrows ideas from organizational ecology, evolutionary economics, industrial and organizational psychology, and sociology. A systematic review of 50 years worth of literature defined organizational adaptation as "intentional decision-making undertaken by organizational members, leading to observable actions that aim to reduce the distance between an organization and its economic and institutional environments".
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