Social Reality, the Boundaries of Self-Fulﬁlling Prophecy, and Economics

OrganizationScience

Vol. 20, No. 3, May–June 2009, pp. 654–668

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1047-7039

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1526-5455

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09

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2003

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0654

informs

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Social Reality, the Boundaries of Self-FulﬁllingProphecy, and Economics

Teppo Felin

Marriott School, Brigham Young University, Provo, Utah 84602, teppo.felin@byu.edu

Nicolai J. Foss

Center for Strategic Management and Globalization, Copenhagen Business School, 2000 Frederiksberg, Denmark, andDepartment of Strategy and Management, Norwegian School of Economics and Business Administration,N-5045 Bergen, Norway, njf.smg@cbs.dk

O

rganizational scholars have recently argued that economic theories and assumptions have adversely shaped manage-ment practice and human behavior, not only leading to the incorporation of trust-eroding market mechanisms intoorganizations, but also unnecessarily creating self-interested behavior. A number of highly inﬂuential papers have arguedthat the

self-fulﬁlling nature

of (even false) theories provides the underlying mechanism through which economics hasadversely shaped not just social science but also management practice and individual behavior. We question these argumentsand argue that there are important boundary conditions to theories falsely fulfilling themselves, boundary conditions thathave hitherto been unexplored in organizational research, and boundary conditions that question the underlying premisesused by organizational scholars and social scientists to attack economics. We specifically build on highly relevant findingsfrom social psychology, philosophy, and organizational economics to show how (1) objective reality and (2) human natureprovide two important boundary conditions for theories (falsely or otherwise) fulfilling themselves. We also defend orga-nizational economics, specifically the use of high-powered incentives in organizations, and argue that self-interest (rightlyunderstood) facilitates in creating beneficial individual and collective and societal outcomes.

Key words

: organization theory and social reality; organizational economics; philosophy of social science

History

: Published online in

Articles in Advance

April 27, 2009.

Introduction

Organizational scholars have recently challenged the ap-plication and use of economics in management researchand practice. For example, in a recent award-winningpaper, Ferraro et al. (2005) argue that the languageand assumptions of economics have adversely influ-enced human behavior, specifically creating more self-interested behavior and also leading to the widespreadacceptance of trust-eroding market mechanisms and badmanagement practices within organizations. Ghoshal andMoran (1996) have made similar points by arguing thatthe prescriptions and assumptions of economic theo-ries have led to increased self-interest and bad manage-ment practice. Organizational scholars have also recentlyargued that there are (both direct and indirect) causallinks not just between the widespread acceptance, teach-ing, and diffusion of economic theories and bad man-agement practice, but also between the teaching of economics in business schools and recent corporateethics scandals (e.g., Adler 2002; Adler and Jermier2005; Ferraro et al. 2005; Ghoshal 2003, 2005; Gintisand Khurana 2007; Harris and Bromiley 2007; Khurana2007; Pfeffer 1997, 2005).Organizational scholars have thus far spoken with aseemingly unified voice in challenging economic theoriesin their role in adversely shaping human behavior andin adversely influencing management practice. Veryfew defenses of economic reasoning have been pub-lished in the organizational literature (see Williamson1996, Zenger and Hesterly 1997), and importantly, themore general logic of the self-fulfilling nature of (falseeconomic) theories has not been questioned or chal-lenged. Unfortunately, scholars directly implicated bythese arguments—namely, scholars in economics andother disciplines such as psychology and philosophy—are unlikely to be aware of these discussions in manage-ment journals; and, even if they are, they may not haveinclinations to write an article providing the other side of the argument.The specific goal of this paper, then, is to provide theother side of the argument, that is, to defend organi-zational economics and to, in part, question the appar-ent consensus regarding economics adversely shapinghuman behavior, management practice, and organiza-tional or social outcomes (e.g., Ferraro et al. 2005,Ghoshal and Moran 1996; cf. Khurana 2007). Note, how-ever, that the goal of this paper is

not

to defend alleconomic assumptions (for example, agent omniscienceor hyperrationality); rather, we focus on those elementsof economic theory that have recently been highlightedby management scholars as having adverse effects. Wespeciﬁcally respond to these extant arguments by care-fully discussing the underlying theoretical and philo-sophical assumptions that organizational scholars have

654

I N F O R M S

h o l d s

c o p y r i g h t

t o t h i s a r t i c l e a n d d i s t r i b u t e d t h i s c o p y a s a c o u r t e s y t o t h e a u t h o r ( s ) . A d d i t i o n a l i n f o r m a t i o n , i n c l u d i n g r i g h t s a n d p e r m i s s i o n p o l i c i e s , i s a v a i l a b l e a t h t t p : / / j o u r n a l s . i n f o r m s . o r g / .

Felin and Foss:

Crossroads

655

made when linking economic theories with the sug-gested adverse effects on human behavior and manage-ment practice. That is, arguments related to theory (andassociated assumptions) shaping or determining humanbehavior in a self-fulfilling fashion (Ferraro et al. 2005,Ghoshal and Moran 1996) directly implicate disciplinessuch as social psychology and philosophy. We thereforecite and build on key theoretical and empirical insightsfrom these disciplines not only to question these argu-ments, but also to highlight rather different conclusions.Importantly, we explicate the boundaries for the self-fulfilling nature of theories and highlight an alterna-tive interpretation for why and how (economic or other)theories influence reality. Key insights from organiza-tional economics also feature prominently in our discus-sion. For example, we discuss the important role thatself-interested behavior—that is, self-interest “rightlyunderstood”—has in creating beneficial collective out-comes. Furthermore, we discuss how self-interestedbehavior scarcely precludes cooperation, trust, or anyother human or organizational virtue. We also high-light the benefits associated with “markets in hierarchy”(Zenger and Hesterly 1997).Note that for purposes of parsimony we will concen-trate largely on the arguments made by Ferraro, Pfeffer,and Sutton (2005)—henceforth referred to as FPS in thisarticle—because this award-winning and already highlycited article is one of the latest, most sophisticated, andtheoretically consistent and strong statements about theself-fulfilling nature of theories, specifically, the caseof economics adversely and “falsely” shaping humanbehavior, management practice, and social outcomes. Wethus recognize and note that there are a host of otherpapers published in a wide variety of management out-lets making broadly related arguments about economicsadversely shaping behavior and more generally about theself-fulfilling nature of (even false) theories (e.g., Adler2002; Adler and Heckscher 2006; Astley 1985;Astleyand Zammutto 1992; Barley and Kunda 1992; Cannellaand Paetzold 1994; Frey and Osterloh 2005; Ghoshaland Moran 1996; Ghoshal 2005; Green 2004; Khurana2007; McKinley et al. 1999; Pfeffer 1997, 2005).

The Relationship Between Theory andSocial Reality: Some Background

The key mechanism that has been proposed as theunderlying driver for the suggested adverse inﬂuencethat economic theories (and associated assumptions andlanguage) have on human behavior, management prac-tice, and organizational outcomes is the

self-fulﬁlling or reﬂexive nature of theories

(FPS, Ghoshal and Moran1996, Pfeffer 1997). That is, whereas theories have tra-ditionally been conceptualized as tools for understand-ing and explaining (a given) reality (Goldman 1999,Nagel 1961, Popper 1972), a relatively recent argumentis that there is a strong reﬂexive nature between theo-ries and reality (Bloor 1991, Knorr-Cetina 1999, Kuhn1970): theories and associated language and assump-tions in effect shape, construct, and determine reality ina self-fulﬁlling fashion rather than merely describing orexplaining reality. In fact—and this will prove critical forour subsequent arguments—the argument is

not just

thattheories influence reality in a self-fulfilling and reflexivefashion (as organizational scholars we all indeed hopethat this is the case), but rather, the “strong form” of theargument is that even

false

theories and associated falsespeciﬁcations of reality in effect evoke behaviors, in aself-fulﬁlling fashion, “which make the originally

false

conception come

true

” (Merton 1948, p. 195, italics inoriginal; FPS, p. 8).It is this very tradition, speciﬁcally its strong formwhere even

false

theories also fulﬁll themselves, thatFPS builds on: the false prediction and assumptionof individual self-interest from economics creates self-interested behavior in a self-fulﬁlling fashion, withthe theory diffusing into management practice via theassumptions and language of economics.

1

Put differ-ently, FPS argue that economic theories do not explainreality (at least initially); rather, the

false

expectationof self-interested behavior by economic theories

cre-ates

self-interested behavior in a self-fulﬁlling fashion.Economics, then, only “explains” reality and behavior

post hoc

, that is, after its assumptions become widelyadopted and subsequently reflected in the behavior of individuals.The idea that theorizing affects the objects of theo-rizing—notions of self-fulfilling prophecy or “reflex-ivity”—has been an important one in sociology sinceThomas (1923) and Merton (1948) (e.g., Giddens 1990,Bourdieu 1992), and has become an anchoring foun-dation in the sociology of knowledge, particularly inthe literature on the social construction of knowledgeand reality, and the problem of “truth” (e.g., Barnesand Bloor 1982, Bloor 1991, Kuhn 1970, Latour 1999).The reflexive and self-fulfilling nature of theories hasalso been a reoccurring theme in economics (in connec-tion with predictions and the modeling of expectations)(Grunberg and Modigliani 1954, Lucas 1977), and it hasbeen treated by philosophers as well (Popper 1957).

The Need to Specify Boundaries forthe Self-Fulﬁlling Nature of Theories

The strong forms of the self-fulfilling nature of theoriesand language are sobering because, if true, they threatenthe fundamental definition of science and theory as anattempt to understand and predict objective reality (seeGoldman 1999, Popper 1972, Psillos 1999). Specifically,the self-fulfilling nature of even false theories makesdeeply problematic such traditional scientific notionsas explanation, prediction, description, understanding,and control. To illustrate, the theoretically all-important

Felin and Foss:

Crossroads

656

“why” question (Popper 1972, cf. Nagel 1961)—forexample, why someone behaved or acted in a certainway—in a rather sobering twist, gets explained by the-ories and associated language itself rather than beingbased on any underlying realities or human universalsthat might explain that behavior (cf. Brown 1991). Thestrong form of the argument is also sobering becauseit makes scientists and scholars themselves (in somepart) directly responsible for how individuals behave—this indeed is the explicit argument by FPS with regardto the false assumptions of economics and the resultant,self-fulfilling self-interested behavior (FPS, p. 15; seealso Adler 2002, Ghoshal 2005, Pfeffer 2005).However, a key problem in citing or evoking the self-fulfilling nature of theories and language is the lack of boundaries in making these arguments, that is, schol-ars have not been clear about the “conditions that limitprophecy fulfillment” (Jussim 1986, p. 429; cf. Henshel1982). It is not clear when exactly theories and asso-ciated language are self-fulfilling, and whether theoriesand associated language

in all

situations—again, evenwhen based on

false

premises, as is explicitly arguedby FPS in terms of economics—create and construct thevery reality that the theory seeks to explain. A natu-ral extension of FPS, and related strong forms of theargument is that

any

(even false) reality can be cre-ated through theory, language, and prophecy, which sub-sequently fulﬁlls itself. Clearly, this does not soundplausible. Thus, an examination of the boundaries forself-fulﬁlling prophecy is needed.

Boundaries for the Self-Fulﬁlling Natureof Theories: Objective Reality andHuman Nature

We discuss two important boundary conditions delimit-ing the extent to which theories, particularly false ones,are self-fulfilling: (1) objective reality and (2) humannature. We highlight theoretical, logical, and empiri-cal evidence, which shows that objective reality andhuman nature provide important boundaries for self-fulfilling prophecy, boundaries that have yet to be articu-lated in management research, and boundaries that makethe strong forms of self-fulfilling prophecy tenuous toaccept. We specifically utilize many of the same exam-ples as FPS (from economics and social psychology)and explain how sensitivity to these boundary conditionsfundamentally changes their underlying conclusions.

The Boundary of Objective Reality

An important boundary of self-fulfilling prophecy, withmomentous consequences for FPS’s argument, is objec-tive reality. In discussing objective reality as the bound-ary for self-fulfilling prophecy, we adopt the positionof “scientific realism,” that is, the argument that thereare objective facts and truths in the social world (inde-pendent of our theories about them), and that sci-ence, including organization and management science,is fundamentally about explanation and understanding(Goldman 1999, Popper 1972, Psillos 1999).

2

Note thatthis realist perspective scarcely precludes the fact thattheories can and do shape social reality and behavior.We will in fact delineate the reasons why and how

true

theories indeed affect the objects that they theo-rize about, and discuss why and how theories inﬂuencehuman behavior and management practice more gener-ally. However, our reasons for why and when theoriesshape social reality will be fundamentally different fromthe ones articulated by FPS (pp. 10–17).To highlight how objective reality provides an impor-tant boundary for the self-fulﬁlling nature of theories,we discuss two key subpoints: (a) why and how theoriesaffect reality, and (b) objective reality and assumptionsabout rationality.

Why and How Do Theories Affect and Shape Reality?

Although this may seem simplistic and naive, we arguethat theories affect reality when they are true (seeBonjour 1998, Goldman 1999, Popper 1972). Or putdifferently, self-fulﬁlling prophecies based on

true

pre-dictions, rather than false ones, affect reality. (We willalso concurrently explicate how false theories

may

shapereality in the

short term

.) Theories then affect realitybecause they capture and explain underlying objectiverealities better than alternative conceptualizations of thatreality (Psillos 1999).To illustrate our point, consider the Chicago Board of Exchange (CBE) and the influence that the Black-Scholesmodel had on its operations. We specifically use CBEand the Black-Scholes model as an example because FPS(pp. 12–13; Fourcade 2007a, p. 1025) argue that thereis “no clearer demonstration” of the self-fulfilling natureof economic theories (see also MacKenzie and Millo2003, MacKenzie 2006). In short, FPS’s argument is thatrather than merely explaining the market or helping usunderstand markets and options prices, the Black-Scholesmodel corrected and constructed new market dynam-ics at CBE, specifically where, within days, the pricesof options reflected the reality and assumptions of theBlack-Scholes model itself. The argument, then, is thatfinancial models in effect cause or construct markets ina “performative” fashion (see Callon 1998, MacKenzie2006, MacKenzie and Millo 2003), rather than merelyhelping us explain or understand them.We agree that the Black-Scholes model affected reality,specifically, option prices. But, the key question is, why?It is critical to note that the reason the Black-Scholesmodel affected reality was because the model helped bet-ter explain—though not perfectly—the underlying real-ities about a “truer” value of option prices that existed(Black and Scholes 1973). Thus, not just any (false or