Imperfect decisions in organizations: Toward a theory of internal structure

Abstract I argue that an organization's internal structure systematically depends on how its members use information imperfectly, as distinct from their information also being imperfect. Certain reliability principles are developed to analyze the effects of decision errors: involving the probability of failing to select actions when they are superior to others based on observed information, and the probability of still selecting actions when they are inferior to others based on observed information. A two-stage reliability model is also developed in order to explicitly distinguish between imperfect information and imperfect decisions. The above results imply the need to use rules and procedures to constrain individual decision and information spaces within an organization, and the dynamic flow of information between them, thereby explaining why organizations evolve an internal decision structure in the first place. The analysis is also briefly compared with organization models that incorporate only imperfect information; such as ‘architecture’ theory by Sah and Stiglitz and ‘team’ theory models by Marschak, Radner and Arrow.