Organizational risk taking: adaptation versus variable risk preferences

The observed association between performance and organizational risk taking has usually been attributed to the influence of performance on risk preferences. Here I show how a simple model of adaptation, which only assumes that organizations avoid activities with poor past performance, can explain the empirically observed U-shaped association between risk and return. The model also makes novel predictions, which are shown to be consistent with the data. The findings suggest that risk taking may be a by-product of adaptation rather than a deliberate choice motivated by variable risk preferences.

[1]  Henrich R. Greve,et al.  Organizational Learning from Performance Feedback: A Behavioral Perspective on Innovation and Change , 2003 .

[2]  Gloria J. Hurdle,et al.  Leverage, Risk, Market Structure and Profitability , 1974 .

[3]  David B. Jemison.  Risk and the relationship among strategy organizational processes, and performance , 1987 .

[4]  E. Weber,et al.  Cross‐Cultural Differences in Risk Perception: A Model‐Based Approach , 1997 .

[5]  Jeffrey M. Wooldridge,et al.  Solutions Manual and Supplementary Materials for Econometric Analysis of Cross Section and Panel Data , 2003 .

[6]  Glenn R. Carroll,et al.  The Fog of Change: Opacity and Asperity in Organizations , 2003 .

[7]  Philip Bromiley.  Paradox or At Least Variance Found: A Comment on Mean-Variance Approaches to Risk-Return Relationships in Strategy: Paradox Lost , 1991 .

[8]  Howard Thomas,et al.  Dynamic and risk measurement perspectives on bowman's risk‐return paradox for strategic management: An empirical study , 1986 .

[9]  George Foster,et al.  Financial Statement Analysis. , 1980 .

[10]  David A. Baucus,et al.  Estimating risk‐return relationships: An analysis of measures , 1993 .

[11]  Jerker Denrell.  Adaptive learning and risk taking. , 2007, Psychological review.

[12]  Allan Gut,et al.  An intermediate course in probability , 1995 .

[13]  Michael X Cohen,et al.  A Garbage Can Model of Organizational Choice. , 1972 .

[14]  Kenneth R. MacCrimmon,et al.  Taking Risks, the Management of Uncertainty , 1987 .

[15]  Henrich R. Greve,et al.  The Effect of Core Change on Performance: Inertia and Regression toward the Mean , 1999 .

[16]  M. Shubik,et al.  A Behavioral Theory of the Firm. , 1964 .

[17]  Amy L. Pablo,et al.  Reconceptualizing the Determinants of Risk Behavior , 1992 .

[18]  Christian Czernich.  When ideas meet organizations : the survival of entrepreneurial ventures inside the established firm , 2004 .

[19]  I. Erev,et al.  On adaptation, maximization, and reinforcement learning among cognitive strategies. , 2005, Psychological review.

[20]  Don Y. Lee.  The Impact of Poor Performance on Risk‐Taking Attitudes: A Longitudinal Study with a PLS Causal Modeling Approach , 1997 .

[21]  R. Hertwig,et al.  Decisions from Experience and the Effect of Rare Events in Risky Choice , 2004, Psychological science.

[22]  Tapen Sinha.  Prospect theory and the risk return association: Another look , 1994 .

[23]  Timothy W. Ruefli,et al.  When Mean Square Error Becomes Variance: A Comment on Business Risk and Return: A Test of Simultaneous Relationships , 1994 .

[24]  Jesper B. Sørensen.  The Strength of Corporate Culture and the Reliability of Firm Performance , 2002 .

[25]  Karel Cool,et al.  Business strategy, market structure and risk-return relationships: a structural approach , 1989 .

[26]  J. Heckman.  Sample selection bias as a specification error , 1979 .

[27]  J. March.  Exploration and exploitation in organizational learning , 1991, STUDI ORGANIZZATIVI.

[28]  Jerker Denrell.  Vicarious Learning, Undersampling of Failure, and the Myths of Management , 2003, Organ. Sci..

[29]  M. C. Jensen,et al.  Harvard Business School; SSRN; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Harvard University - Accounting & Control Unit , 1976 .

[30]  W. P. Barnett,et al.  MODELING INTERNAL ORGANIZATIONAL CHANGE , 1995 .

[31]  Kent D. Miller,et al.  Variable Organizational Risk Preferences: Tests of the March-Shapira Model , 2004 .

[32]  S. Athey.  Monotone Comparative Statics under Uncertainty , 2002 .

[33]  Eldad Yechiam,et al.  Comparison of basic assumptions embedded in learning models for experience-based decision making , 2005, Psychonomic bulletin & review.

[34]  J. Henkel.  The Risk-Return Paradox for Strategic Management: Disentangling True and Spurious Effects , 2008 .

[35]  Jerker Denrell.  RISK TAKING AND ASPIRATION LEVELS: TWO ALTERNATIVE NULL-MODELS. , 2004 .

[36]  Johannes M. Lehner.  Shifts of Reference Points for Framing of Strategic Decisions and Changing Risk-Return Associations , 2000 .

[37]  I. Erev,et al.  Small feedback‐based decisions and their limited correspondence to description‐based decisions , 2003 .

[38]  Sandra L. Schneider,et al.  Reflection in preferences under risk: Who and when may suggest why , 1986 .

[39]  H. Simon,et al.  A Behavioral Model of Rational Choice , 1955 .

[40]  M. Degroot.  Optimal Statistical Decisions , 1970 .

[41]  James G. March,et al.  Organizational decision making: Understanding how decisions happen in organizations , 1996 .

[42]  Richard A. Bettis,et al.  Risk Considerations in Modeling Corporate Strategy. , 1982 .

[43]  M. Jegers.  Prospect Theory and The Risk-Return Relation: Some Belgian Evidence , 1991 .

[44]  Paul R. Milgrom,et al.  Good News and Bad News: Representation Theorems and Applications , 1981 .

[45]  Jitendra V. Singh.  Performance, Slack, and Risk Taking in Organizational Decision Making , 1986 .

[46]  J. March.  Learning to be risk averse. , 1996 .

[47]  Reply to Bromiley's comment and further results: paradox lost becomes dilemma found , 1991 .

[48]  Jerker Denrell,et al.  Strategic responsiveness and Bowman's risk–return paradox , 2007 .

[49]  Jerker Denrell,et al.  Why most people disapprove of me: experience sampling in impression formation. , 2005, Psychological review.

[50]  Raphael Amit,et al.  Diversification and the Risk-Return Trade-off , 1988 .

[51]  H. Greve.  Performance, Aspirations, and Risky Organizational Change , 1998 .

[52]  J. March,et al.  Adaptation as Information Restriction: The Hot Stove Effect , 2001 .

[53]  S. Karlin,et al.  Classes of orderings of measures and related correlation inequalities. I. Multivariate totally positive distributions , 1980 .

[54]  H. Thomas,et al.  Attitudes Toward Risk and The Risk–Return Paradox: Prospect Theory Explanations , 1988 .

[55]  P. Schoemaker.  The Expected Utility Model: Its Variants, Purposes, Evidence and Limitations , 1982 .

[56]  Benjamin M. Oviatt,et al.  Business risk and return: a test of simultaneous relationships , 1991 .

[57]  James G. March,et al.  Variable risk preferences and adaptive aspirations , 1988 .

[58]  Philip Bromiley,et al.  Risk-Return Associations: Paradox or Artifact? An Empirically Tested Explanation , 1991 .

[59]  Stanley Lieberson,et al.  Making It Count: The Improvement of Social Research and Theory. , 1987 .

[60]  Kent D. Miller,et al.  Risk and Firms' Costs , 2003 .

[61]  Manuel Núñez Nickel,et al.  A review of research on the negative accounting relationship between risk and return: Bowman's paradox , 2002 .

[62]  V. Mahajan,et al.  Risk/Return Performance of Diversified Firms , 1985 .

[63]  E. Weber,et al.  Perceived risk attitudes: relating risk perception to risky choice , 1997 .

[64]  Cristiano Antonelli,et al.  A failure-inducement model of research and development expenditure: Italian evidence from the early 1980s , 1989 .

[65]  Philip Bromiley,et al.  Risk and Return in Organizational Decision Making , 1999 .

[66]  J. March.  Bounded rationality, ambiguity, and the engineering of choice , 1978 .

[67]  Samuel Karlin,et al.  A First Course on Stochastic Processes , 1968 .

[68]  John J. McGowan,et al.  On the Misuse of Accounting Rates of Return to Infer Monopoly Profits , 1983 .

[69]  Z. Shapira.  Risk Taking: A Managerial Perspective , 1995 .

[70]  Johan P. Olsen,et al.  Ambiguity and choice in organizations , 1976 .

[71]  A. Kühberger,et al.  The Influence of Framing on Risky Decisions: A Meta-analysis. , 1998, Organizational behavior and human decision processes.

[72]  M. Hannan,et al.  Structural Inertia and Organizational Change , 1984 .

[73]  Andrew D. Henderson,et al.  Firm Strategy and Age Dependence: A Contingent View of the Liabilities of Newness, Adolescence, and Obsolescence , 1999 .

[74]  Peter Hwang,et al.  MULTINATIONALS' DIVERSIFICATION AND THE RISK-RETURN TRADE-OFF , 1993 .

[75]  J. March,et al.  Variable risk preferences and the focus of attention , 1992 .

[76]  Damon J. Phillips,et al.  Middle‐Status Conformity: Theoretical Restatement and Empirical Demonstration in Two Markets1 , 2001, American Journal of Sociology.

[77]  A. Tversky,et al.  Prospect Theory : An Analysis of Decision under Risk Author ( s ) : , 2007 .