Rational choice theory

Introducton

Decision-making is a critical function of anagement. Managers are required to make decisions such as who
should their suppliers be, what price should they set for their products, and should they invest in
new accounting software. This chapter introduces the ratonal choice theory (RCT) as a basis for
understanding how and why such choices are made in organisations. The chapter proceeds as follows:
the key features of the theory are presented in section two: section three discusses the concept of
'bounded rationality', which was developed in direct response to the narrow view of decision-
making offered by the economic versions of RCT; organisational links to RCT follow in section 4
including descriptions of both vVeber's bureaucracy and Principal-agent theory; the chapter then
introduces RCT's link to accounting and provides a future research agenda in section 5, and concluding
remarks are offered in section 6.
The ratonal decision-making process

The term rational choice theory (RCT) is ofen used interchangeably with 'public choice theory',
'neoclassicism', expected utility theory' (Zey, 1998),'rational actor theory' (Renwick Monroe, 2001; Zey, 1998)
and 'utilitarianism' (Zafirovski, 1999). Derived from economics, RCT is anonnative theory which explains the
purposeful human acton. The key to understanding the rational choice theory lies in 'optimisation'.
Optimisation occurs when actors make decisions and take actions afer assessing the full set of the costs
and benefits of each alternative with the objectve of maximising utility (or minimising disutility)
(Coleman, 1990; Ryan, 1999). When the choice of acton corresponds with the optimal choice, it is deemed to
be rational. FiguJ·e l outlines the typical rational decision process.
The RCT assumes that the decision-making process is underpinned by some simple assumptions
designed to increase its explanatory power and ability to predict decision outcomes. First, the
decision process occurs as a result of a conscious effort by an individual to solve a problem (Renwick
Monroe, 2001). As a consequence, broader social outcomes can be traced to an individual. Second, the
individual possesses complete information and foresight (e.g. demand, supply, prices) which always
enable a rational choice to be made (Kalona, J 964; Renwick Monroe, 200°1 ). Third/the individual is in pursuit
of a set of prespecified goals. Fourth, a set of alternative courses of action to any decision exists and each of
these is mutually exclusive, separate and easily identified. Fifth, these preferences orderings are transitive, in
the sense that an actor will have a Preference of one over the other. An individual's preference orderings
are
determined the alternative that is to maximise benefits and minimise
likel

8 METHODOLOGICAL ISSUES fN ACCOUNTING RESEARCH

Bahan dengan hak cipta

 RATIONAL
CHOICE
THEORY

the costs or maximise utility. Sixth, the individual does not have any
institutional or psychological factors which restrict them or make it
expensive or slow for them to implement the decision (Katona,
1964). Finally, each individual can decide a course of action without
infuence from others (Kalona, ·1964).
Figure 1: A typical rational model of the decision-making process
with feedback control element,

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Source: Hatch, M. J. (1997), Organization Theory: lv1oder11 Syu,bolic and

Postmodern
Perspectives. Oxford University
Press, Oxford, p.273.
RCl' has emerged as a dominant theoretical paradigm in
economic, psychological (Hogarth and Reder, 1986) and political sciences
(Dowding, 1994; Dowding and King, 1995). The critical difference in the
various strands lies in the fact that the psychology and political science
strands concentrate on explaining the process by which choices are
made, whereas the economist versions tend to focus on how the
choice of a particular outcome has produced the intended
consequence.
In the 1950s Simon published two seminal papers in which he outlined
concerns for the simplifying assumptions upon which the economic
RCT was erected (Cyert, Simon and Tow 1956; Simon, 1957). He (Simon,
1957, p.198) argued:
The capacity of the humt1n mind forformulating and solving complex
problems is very
smal! compared unih the size of the problems whose solution is required for
objectively ratonal behaoiour in the real uiorld - or even for a reasonable
approximation to such objectve raiionalitu.

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I·Ie also suggested that individual decision eforts not be always

aimed at providing 'optimal' decisions, but those that arc
satsfactory. To address these criticisms, Simon developed the concept
of 'bounded rationality', which relaxed the assumptions of the
economic ratonal model, combining the economic perspective with the
psychology literature.
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In reality, decision processes are far more complex than described
by RCT. Dowding (1994) for instance, points out that all human
decisions cannot be predicted by identifying the alternative which
maximises utility. Using the Cuban missile crisis as an example,
Dowding shows how particular individuals and their preferences can
shape the decision-making process. He (Dowding, J.994, p.113)
suggests that applying the RCT assumpton of utility maximisation is
too 'crude' and that a fuller explanation of the complexities is
required to understand the process. Also related to this, RCT ignores
the human capacity to make decisions in a rational manner: it ignores
 the fact that emotonal states can affect the degree of rationality of
decision-making. Holsti (1979; as cited in Zey,
1998) for instance suggests that the individual's capacity to make
rational decisions is reduced during periods of high stress. Hechter
and Kanazawa also report this concern, arguing that decisions on
spouses, jobs or children are often emotionally charged and can take an
emotional toll on individuals reducing their ability to choose the most
rational alternative. They (Hcchter and Kanazawa,
1997) also suggest that people often act impulsively and do not
calculate or
appreciate all of the options available (see also Smelser, l992 for some
discussion on this point). In a similar vein, Miller (2000) maintains that
individual actors can have short term horizons making what would
seem to be the rational alternative in the short term irrational in the
long term. Others have also criticised the theory for not acknowledging
possible biased views or opinions (Friedrich and Opp,
2002). RCT is also said to be limited because it neglects to account for
habitual decision-making, much of which occurs in everyday life
(Friedrich and Opp,
2002). It docs not consider for instance, that each decision is not
made afer
completing a full cost benefit of the alternatives. where the decision
mirrors a prior situation, especially where it is a low cost decision, it is
not uncommon the response to imitate a previous response.' By
responding in this manner, organisation's can reduce the amount of
tme needed to make a decision (for a discussion see Zey, '1998).
However, this response also implies that decisions may be made
without full consideration of any of their behavioural
consequences (Friedrich and Opp, 2002).
Apart from these behavioural assumptions, the RCT has been critcised
because it ignores the broader social, economic ,U1d political
context in which organisations operate (Ansari and Euske, 1987;
Burchell, et al., 1980; Chua, 1986; Covaleski and Dirsmith, 1.983; Hopper,
et ai., 1987; Hopwood, 1.983; Ogden and

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Bougen, 1985; Otley, 1984}. Finally, Mouritsen (1994} contends that RCT's
explanatory power is limited since compliance with RCr model
docs not guarantee that the outcome will be rational. Mouritsen, for
instance, suggests that by in.stUling rationality organisational. learning
is reduced. and existing models remain unchallenged.
To cope with this environment, Simon (1957) suggests that individuals
construct a simplifed model of the situaton to enable them to
make rational choices. Prediction of a person's behaviour thus requires
knowledge of his/her psychological attributes.
Extending the theory to modern
organisations
Owing to lirnitations in an individual's computational ability,
comprehension and foresight, organisations become an important
vehicle for the achievement of goals. However, since a group of
individuals is unlikely to hold a statc set of goals and may be poor at
communicating those goals achieving them becomes much more
problematic, When presented with an organisational decision,
disagreements n1ay become commonplace about which goals to pursue
or which problems need solving and which knowledge is relevant to
determine how the organisatonal goals should be achieved. The
complexity of such cases renders the RCT, on its own, uninformative.
Simon (1957) suggests that organisations cope with this
environment, by ad.opting procedures and techniques that
encourage improved decision-making similar to those underpinning
weber's (l952) bureaucracy. Also, the decision-making process has
become i.11cr.easingly complex in the modern business environment, not
least because of the principal• agent relationships that pervade it. This
principal-agent relationship presents a range of problems for agents,
who need to ensure that their objectives remain paramount in the
decision process. To provide more robust explanatons of RCT, some
scholars appeal to principal-agency theory. The next two sections
provide reviews of Weber's theory of bureaucratic rationality and
principal-agent theory, respectively.
Weber's theon; of
bureaucratic
rationalitu
In v\Teber's (1952) terms, bureaucracy is a type of organisational
administrative structure that is characterised by rational-legal
authority. This means that reaching an optmal or rational decision for
the organisaton requires satisfying both the "zioeckraiionliiat', the
values of nu1nagers and owners, and the
'toertrationaliiat', the concerns of other stakeholders. The traits of
bureaucracy
include a hierarchy of authority, an organisation bound by rules,
fixed jurisdictional areas, administrative acts recorded in writing,
subjecting employees to discipline, selecting employees based on their
expertse, and separating the administrative staf from ownership of the
means of production. Weber's theory assumes goals are embedded
within the technical-legal knowledge and thus are not the subject of
debate. The implication of this for

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decision-making is that the goals of those employed in the

organisation are consistent with those of the organisation. For Weber,
bureaucracy represents the most rational form of the organisation
since it offers the possibility of logical outcomes (Ryan, 1999). ln his
wor:ds (1968, p.987):
Bureaucracy is the means of transjorming social action into ratonally organised
action. Therefore, bureaucracy is a11 instrument of potoer for one who controls the
bureaucratic apparat us.
Through this device, organisational decisions may be made and
resources mobilised. Advocates of this theory argue that this type of
structure is necessary to carry out the administration of the
increasingly complex business environment and that if these
bureaucratic forms did not exist, society would be chaotic, and
organisations would function in an inefficient and wasteful
manner. \.'Vhile
bureaucratic forms of administration increase the efectveness of an
mav,
organisation, this type of structure is also acknowledged to limit
freedom, and provide structures of domination.
Weber distinguished between two types of ratonality in his
analysis of organisations: formal and substantive. Formal rationality
is concerned with the techniques of calculation. Substantive
rationality, in comparison, refers to a decision which is subject lo
values and ethical norms. It is the substantive rationality that gives
meaning to the outcome of the formal rationality.
To date, much of the criticism surrounding Weber's theory sterns from
its dehumanising nature, in particular, its attention to conflict and
evasion of rules and the chain of command (sec, for instance,
Couldncr, 1954; Parsons, 1956; Selznick, 1957, 1966). In reality,
decision-making is far more problematc because of a separation of
principal and agent fostering a debate over what the
organisational goals are and how they can best be achieved. The
principal-agent model (also known as agency theory) provides some
insight into this process.
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The complexity of modern day organisations where it is common for
an agent to work on behalf of a principal in an organisation
presents a challenge to RCT which was designed to provide insight
into individual decision-making.
A common criticism of RCT is that individuals will strive to maximise
the profits of organisations, with little regard to the multiplicity of
non-pecuniary motives which n1ay infuence that individual in
making a choice. For example, in an outsourcing decision, a CEO
1nay choose to purchase from a former colleague, rather than from
the lowest bidder. Alternatvely, a choice may be made by a CEO
based on its ability to legitimise or reinforce power relations in
the orga nisa ton.
Principals face two problems in hiring agents to undertake a task: (1)
the agent's and the principal's goals are incompatible, and (2)
there is an asymmetric
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information problem, whereby the principal does not have full knowledge
of the agent's abilities, skills and expertise, or integrity (Zcy. 1998). To
complicate the situation further, these goals change over tune. To
address these asymmetries, the principal. must determine what
governance structures (informaton systems, monitoring, incentives) are
needed to ensure that the agent fulfls the principal's wishes and act in
their best interest. A11 in-depth review· of this theory is provided in
Chapter 5.
Management
accounting and
RCT
Accountng practces provide calculative techniques for optimal
decision• making. In addition, accounting provides a basis for decision
alternatives to be compared (Carruthers and Espeland, 1991). It also
provides a record of the organisational choices which can help to
rationalise or: justi (y actons that have already been carried out (Burchell,
et at., 1980). In this sense, it could be argued that RCT pervades much o(
what is written about accounting; texts are written to describe
accounting techniques that are an integral part of organisational
decision-making. In true Weberia.n form, Dillard and Ruchala (2005) also
suggest Lhat accounting systems foster 'administrative evil' in
organisations since they have a tendency to divorce acton from moral
context.
So if accounting systems are considered rational, why do they change?
The sunple answer to this is because concepti.ons of. what is rational
changes over tme; RCf assumes that it is always possible to improve
accounting information through the introduction of new technical
developments. This suggests that personal conceptions of what is
rational n,ay be challenged when new information or techniques are
presented or when the existing systems fail to provide the requisite
information.
Management accounting research explicitly Informed by RCT is relatively
rare, with the exception of a few studies that explain the form in
which the management control system or elements of the management
control system exist (Burchell et ai., 1980). In this section, we review briefly
several of these studies to indicate how it has been used in the discipline.
Ansari and Euske (1987) arc perhaps most commonly cited for their use
of RCT. In this study, the authors utilised three theories, socio-political,
institutional and the technical rational perspective to understand how
military repair facilities introduced the depot cost and production
reporting system and how this system conformed to the objectives of the
system.
Carruthers and Espeland (1991) used the RCT to explain why double
entry bookkeeping emerged as a dominant form of accounting. They
suggest that there has been a widespread adoption of double entry
bookkeeping because of its technical superiority for providing accurate
and relevant information for decision-making.

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Ansari and Bell (1991) employed the RCT to provide a partial

explanation of the role accountng played in control in International
Foods, a holding corporation for a group of companies located
in Pakistan. Covaleski, Dirsmith, and Michelman (1993) combined
institutional and RCT theories to explain the use of case-mix
accounting systems in health care organisations. From an RCT
perspectve, they argue t:hal the use of case mix accounting systems
can lead to optimal efficiency and efectiveness by allowing for
product lines to be monitored.
Jones and Dugdale (1994) drew on the RCT to explain investment
decision• making practices. Their study investigated the
investment appraisal decision processes within the wider
investment decision processes and context to understand the
diferent reasons for the choice of a particular method to make
investment decisions. In the case of Hoque and Hopper (1994), RCT
provided a partial explanation for how and why the control system
was fashioned in a large nationalised jute mill in Bangladesh. More
recently, Vamosi (2000) used a combination of institutional theory
and RCT to explain how the concepts of market and market
economy are adapted to the management accountng system in a
Hungarian company.
Rahaman and Lawrence (2001) combined RCT with the socio-
historical perspectve and the socio-economic perspectve to analyse
the nature and effectiveness of accounting and financial n1anagen1ent
systems operating in the Volta River Authority in Ghana to
determine the extent to which the accounting and financial systems
were 'defcient'.
Utilising RCT in
accounting
research
The limited use of RCT to inform our understanding of management
accounting research suggests that there is still much to be
learned about the role(s) that accounting plays in constructng and
making sense of everyday organisational life. How, for example, do
organisations explain poor performance when accounting tools
have been used to inform their decisions? Under what
circumstances does accounting information dominate the decision
process? vVhat are the unintentional outcomes that can arise
with using the information provided by a particular accounting
technique? And, why do organisations prefer certain techniques
over others, when their technical superiority is well noted in the
texts? Such studies arc also likely to contribute to the broader RCT
literature, which has tended to focus on the economic 'outcome'
rather than the psychology processes underpinning decisions.
The simple nature of RCT acts as both its strength and weakness. It
means that it is relevant to a range of decision situations from
new technologies, new products, mergers and acquisitions,
discontinuation of products, to pricing, and product mix. Also, it is
robust regarding its applicability to both individual and
organisational decision making (Hannan, 1992; Zev, 1998).
Traditionally, scholars

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focused on the individual (i.e. the manager or the employee) as a

basis for understanding organisational choice with the assumption
that the analysis of individual actons would provide insight into
broader social outcomes. In this regard, individual action is believed to
be supportive of those outcomes that are beneficial to the organisation.
Recently, however, scholars have directed their attention
towards the organisaton as the unit of analysis. This change in focus
follows from a view that organisatons are not passive recipients of
the choices of its members or institutional rules, and that they
can play a fundamental role in setting the direction or timing of
the change in the social system (e.g. Coleman 1990; Hannan, 1992).
Advocates of this view challenge whether social systems can be
explained by the aggregate individual action. If, for example,
individuals are rational decision makers, does this also imply that the
collective organisational outcome will also be rational? According
to these scholars, irrational organisational choice represents
deviations in the behaviour of employees, in particular, those who
have little or no incentive to comply with the chosen course of acton
(Hechter and Kanazawa, 1997).
However, the simplified nature of RCT comes at a cost such as its
ability to provide in-depth analysis of decision situations. (ts ability
to provide insight when the decision situation features multiple
individuals, each able to mobilise diferent resources and each having
diferent goals, priorities and assumptions about how the
organisational goals should be atained is limited. RCT is incapable
of explaining such social relationships since it overlooks any data that
docs not fit within its assumptions (Zey, 1998). Furthermore,
despite its normative focus, RCT does not atten1pt to explain what the
organisational aims ought to be. To make sense of the decision
process and why it considers a particular action to be rational
also requires knowledge of individual preferences, how they axe
formed and why partcular meanings get attached to a situation. If such
questons are the focus of study, they point to the need for RCT to be
complemented with other sociological theories such as an
institutional theory or symbolic interactonism.
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This chapter has described RCT as a theory of decision-making.
RCT is purposively simple, ignoring social norms and values,
historical forces and painting the decision maker to be one whose
actions are unaffected by emotion or habit. Typically, the perspective is
used to understand how the incentves of a given decision imply a
particular behavioural response, one that is dictated by a desire to
echieve maximum utility. Discussions of the concept of bounded
rationality and models of bureaucracy and principal-agent
followed. These discussions show the complexity of decision processes
across time and in tum point to the limitations of RCT. Owing to their
ability to shed light on what is

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understood as being 'rational', other sociological theories such as

institutional theory may need to be used alongside RCT to deepen our
understanding of an organisational decision-making. Anyone wishing to
further their knowledge of RCT should refer to the early chapters in
Coleman's (1990) Foundatons of Social Theory, Zey's (1998) Rational Choice
Theory and Organizational Theory: A Critique, and Abell's (J.991) Rational
Choice Theory.