What is Bounded Rationality

1. Bounded Rationality
By Alan Yarborough, Allotrope Sciences Corporation
Bounded Rationality is a term for the
phenomenon that cognitive blinders prevent
people from seeing, seeking, or sharing relevant
information during decision-making. This
phenomenon challenges traditional rationalist
perspectives and suggests that the rationality of
human behavior is often incomplete and
fragmentary or ‘bounded’ by human limitations.
This management concept proposes that decision-
making often takes place within an environment of
incomplete information and uncertainty. Herbert
Simon, known for Design Thinking, pointed out
that most people are only rational to some extent
and are often emotional and irrational even when
making critical decisions. They experience limits in
formulating and solving complex problems while
receiving, processing, storing, retrieving, and
communicating information. The point of
bounded rationality is not only that people might
decide differently if they had more complete or
different information, but that they couldn’t likely
process all the information even if they had it.
Opportunistic Behavior
A major source of bounded rationality is
Opportunistic Behavior. Opportunism in the
context of bounded reality can be defined as: the
taking of opportunities as they arise regardless of
principle, for self-interest in a deceptive way (with
guile). Or flexibly adapting to changing
circumstances to maximize self-interest. A simple
example is a person claiming more mileage or
additional expenses on a travel voucher knowing
that it’s unlikely that it will be questioned.
Another example is withholding information that
would benefit an individual or group out of self-
interest or for competitive reasons. We can
distinguish a range of opportunism, from clear
forms such as lying, cheating and stealing, to more
subtle forms in which incomplete or partially
incorrect information is given. Furthermore,
opportunistic behavior can be: Ex ante
opportunism / upfront, also called adverse
selection, exploiting pre-contractual information
asymmetries. Ex post opportunism / afterward the
fact, called “moral hazard” in economics, is
exploiting information asymmetries and not
bearing the consequences by allowing the other
party to bear most of the risk.
Mitigation
O.E. Williamson is a pioneer in the field of
opportunistic behavior. In The Economic
Institutions of Capitalism (1985), Williamson
explains that the problem with opportunistic
behavior is not that everyone is continually acting
in an opportunistic way, but that it is so costly to
ascertain the trustworthiness of individuals based
on forecast rather than actual results. Laws,
contractual arrangements, corporate governance
instruments, corporate transparency and risk
management are all useful tools to mitigate
opportunistic behavior.
The Impact
A significant consequence of opportunistic
behavior is that it prevents business parties from
relying on and trusting each other as much as they
should to achieve maximal efficiency.