Reexamining the Relationship between Action Preferences and Managerial Risk Behaviors

Abstract

The assessment of risk and its relationship with expected returns is a central concern of strategic management and has been extensively researched (McNamara and Bromiley, 1999; Sitkin and Pablo, 1992). There has been increasing recognition that the subject of risk is inherently more complex than previously thought, incorporating literature from seemingly disparate fields. The streams we examine in this article to reconstruct the determinants of risk-taking are theory (Kahneman and Tversky, 1979; Tversky and Kahneman, 1981, 1986), behavioral theory (Cyert and March, 1963; March, 1994), and theories of social cognition (Lewicka, 1997). In the next few paragraphs, we briefly examine theory and behavioral The theories of social cognition are discussed in more detail in a later part of the article. Prospect Theory Our first approach to understanding managerial risk-taking is the perspective provided by theory which is in sharp contrast to the position taken by agency Agency theory, rooted in financial economics, is based on assumptions of rational behavior and economic utilitarianism (Ross, 1973), and posits a linear positive relationship between risk and return. The work of Kahneman and Tversky (1979), however, presented a nonlinear and, in part, negative relationship between risk and return. Kahneman and Tversky (1979) showed that people's understanding of and relationship with risk could be better explained by prospect theory. This theory suggests that the way a situation is framed will determine individual risk perception and risk behavior. Prospect theory suggests that in the case of gains people outweigh outcomes that are certain compared to outcomes that are probable. However, in the case of losses, people outweigh outcomes that are probable compared to Outcomes that are certain. In other word s, people prefer sure gains to likely gains, and they also prefer likely losses to sure losses. Prospect theory suggests that individuals prefer to protect prior gains and are, consequently, risk-averse. This is in contrast to failures, when past failures tend to make individuals risk-seeking. It should be noted, however, that there are some theoretical approaches and empirical findings that are at variance with theory in that past success increases the willingness to take risks (Osborn and Jackson, 1988; Thaler and Johnson, 1990), or that past failures lead to rigidity and risk-averse behavior (Staw et al., 1981). The framing of problems, a central finding in the area of managerial cognition and decision making (Kahneman and Tversky, 1979; Williams and Voon, 1999), in turn, leads to a variety of risk-related behaviors by managers and should be contrasted by the outcomes provided in agency Agency theory makes normative assumptions about agents' choice of behavior, which are based on rational expectations and utility maximization. In short, agency theory assumes consistent choice behavior across a variety of differently framed problems, and does not consider the important role of problem framing. However, theory predicts that individuals exhibit risk-averse preferences when selecting from positively framed prospects, and they exhibit risk- seeking preferences when selecting from negatively framed prospects (Kahneman and Tversky, 1979; Wiseman and Gomez-Mejia, 1998). Behavioral Theory Wiseman and Bromiley (1996), in examining the behavioral theory of the firm (Cyert and March, 1963; March, 1994), suggest that a number of contextual variables are integral to the decision-making process. These contextual variables include (1) performance (or indicators of internal and comparative performance), (2) organizational resources (or slack, measured as the difference between the minimum resources required to produce a given level of output and some higher level actually observed), (3) aspirations and expectations (hoped-for and actual levels of accomplishment), (4) income stream variability or risk, and (5) organizational size. …

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