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Newell, A. and H.A. Simon: 1972, Human Problem Solving (Englewood Cliffs: Prentice-Hall).
Rabin, M.: 1998, “Psychology and Economics”, Journal of Economic Literature 36: 11–46.
Schütz, A.: 1932, The Phenomenology of the Social World, 1972 edn. (London: Heinemann).
Simon, H.A.: 1948/1976, Administrative Behavior (New York: Free Press).
Simon, H.A.: 1951, “A Formal Theory of the Employment Contract”, Econometrica 19: 293–305.
Simon, H.A.: 1976, “From ‘Bounded’ to ‘Procedural’ Rationality”, in Spiro Latsis (ed.), Method and
Appraisal in Economics (Cambridge: Cambridge University Press).
Simon, H.A.: 1978, “Rationality as Process and a Product of Thought”, American Economic Review
68: 1–14.
Simon, H.A.: 1979, “Rational Decision Making in Business Organization”, American Economic
Review 69: 493–513.
Simon, H.A.: 1991, “Organizations and Markets”, Journal of Economic Perspectives 5: 25–44.
Tirole, J.: 1999, “Implicit Contracts: Where Do We Stand?”, Econometrica 67: 741–781.
Williamson, O.E.: 1975, Markets and Hierarchies (New York: Free Press).
Williamson, O.E.: 1998, “Human Actors and Economic Organization”, paper for the 1998 Paris
ISNIE Conference.

Conflict of Interest in Theories of Organization:

Herbert A. Simon and Oliver E. Williamson
MIE AUGIER1 and JAMES G. MARCH2
1 Stanford University, 70 Cubberley, Stanford University, Stanford, CA 94305-3096, U.S.A.
(E-mail: augier@stanford.edu); 2 Stanford University, 71 Cubberley, Stanford University, Stanford,
CA 94305-3096, U.S.A. (E-mail: march@stanford.edu)

In a burst of writing during the 1950s and 1960s, scholars at the Carnegie Institute
of Technology criticized conventional economic theories of the firm for being
inattentive to what was known about the empirical realities of organizational
behavior. Much of that critique was organized around ideas of bounded rationality
and satisficing. Individuals and firms were pictured as limited by cognitive and
organizational restrictions on perfect rationality; they do not have complete and
accurate knowledge about alternatives and their likely consequences; they have to
search for information; and they search until they find alternatives that are good
enough rather than until the marginal expected cost of search equals the marginal
expected return.
Herbert A. Simon laid down the essential elements of these ideas in Admin-
istrative Behavior (1947) and in two papers published in the 1950s, one in a
major economics journal, the other in a major psychology journal (Simon, 1955,
1956). Simon and his colleagues at Carnegie Tech (later Carnegie Mellon Univer-
sity) published two major books around 1960 (March and Simon, 1958; Cyert
and March, 1963) that elaborated the idea of bounded rationality as an important
element in actual organizational behavior and added several other key ideas, partic-
224 ROUNDTABLE ‘COGNITION, RATIONALITY AND GOVERNANCE’

ularly conceptions of the importance of rule-based behavior, the encoding of

history into rules, the endogenous nature of preferences, and the political (conflict
of interest) nature of organizations.
It was a good harvest; and although it would be quite misleading to attribute the
subsequent prevalence of such ideas exclusively to the influence of the Carnegie
group, they were at least to some degree prescient. Within economics, they antici-
pated later developments in transaction cost economics, team theory, the economics
of information, evolutionary theories of economic behavior, agency theory, and
game theory. In psychology, they anticipated later developments in theories of
framing, prospect theory, problem solving, and risk taking. In studies of polit-
ical and social organization, they anticipated later developments in the analysis
of institutions, complexity, coalition formation, implementation, and bureaucratic
politics.
Simon saw all of the ideas that came out of Carnegie as elements of bounded
rationality, thus as subsumed under that rubric; but his own instincts and the kind
of research that he chose to do led him to emphasize some aspects of the Carnegie
critique more than others. As a result, his work, particularly as it emerged after
1960, is different in interesting ways from the work of others who have drawn
from the same gene pool of ideas. One critical difference lies in the extent to
which Simon emphasized a portrayal of decision making as arising in cooper-
ative, well-coordinated systems (as in team theory and studies of problem solving),
whereas others put more emphasis on conflict of interest and strategic behavior
(as in non-cooperative game theory, theories of politics, and contractual theories
of the firm) and on the confusions of poorly coordinated systems. Simon was
aware of both aspects of decision systems but devoted most of his career to under-
standing and improving decision making by boundedly rational actors engaged
in cooperative, coordinated enterprises. Unlike the work of Cyert, March, and
Williamson, Simon’s research was relatively unconcerned with the implications of
seeing organizations as coalitions of diverse interests. He was also relatively uncon-
cerned with the problems associated with ambiguous, endogenous and emerging
preferences.
Such differences can be illustrated by looking at exchanges between Simon
and Oliver E. Williamson during the 1990s. These exchanges, some of them
published and some of them in private correspondence, focused on transaction cost
economics and its relation to behavioral economics in general, and the Carnegie
tradition in particular (Simon, 1991a, 1997; Williamson, 1996, 2001). Almost forty
years earlier, Williamson had been a student of Simon (as well as Cyert and March)
at the Carnegie Institute of Technology. He saw his work as a natural extension
and elaboration of the Carnegie ideas, providing both more precision and more
testability to those ideas (Williamson, 1996). He, his students, and his colleagues
forumulated an economic theory of the firm that emphasized transaction costs
and contracts, and stimulated an extensive program of empirical studies, thereby
ROUNDTABLE ‘COGNITION, RATIONALITY AND GOVERNANCE’ 225

contributing to Simon’s call for an empirically based microeconomics (Simon,

1997).
The exchanges between Simon and Williamson are particularly interesting
because of the delicate intertwining of three rather different complaints that Simon
lodged against the Williamson program. First, and most poignantly, he accused
Williamson of selling out to the enemy (Simon, 1991a, 1997). In a 1993 letter,
Simon described Williamson as basing his approach to organizations on assump-
tions that people act by first “thinking problems through” in a comprehensive way
(letter to Williamson, September 29, 1993). This collided with Simon’s views on
bounded rationality. Specifically, Simon argued that transaction cost theory simpli-
fied things too much by inventing mechanisms that people might be imagined to use
to enlarge their rationality. Although Simon acknowledged the empirical evidence
for some elements of the transactional point of view, he wondered how much of that
evidence was evidence “that under certain circumstances and on certain occasions,
people use certain ingenious kinds of contracts? . . . how do we use such findings
to draw the boundaries of rationality in everyday transactions?” (Ibid.).
From Simon’s perspective, Williamson’s efforts could be seen as one more
attempt to make bounded rationality palatable to economists by rationalizing
behavior that might appear, at first blush, as irrational. The strategy is familiar
and, in this case, certainly dates back to Williamson’s thesis, the main arguments
of which were published as a chapter in the first edition of a behavioral theory
of the firm (Cyert and March, 1963; Williamson, 1963a) and as an article in the
American Economic Review (Williamson, 1963b). The 1963 Williamson model of
managerial behavior was “behavioral” in the sense that it assumed managers did
not maximize corporate profits but rather pursued other elements of managerial
self-interest. However, the model adopted the general rationality assumptions of
mainstream economics (1963a, 1963b).
Like other economists who worked to convert ideas of bounded rationality into a
respectable economic theory (Radner, 1975a, 1975b), Williamson folded organiza-
tional considerations into a theory that assumed rational individual actors. To
Simon this was an apostasy. He consistently saw efforts to rationalize behavior as
permicious attempts to preserve a corrupt theory. He saw Williamson as “disguising
the wolf of classical theory as a satisficing sheep – or if that is too weird a metaphor,
of pouring the new bounded rationality wine into the old maximizing bottles”. All
in all, Simon regarded Williamson’s position as being closer to the ‘neoclassical
wing’ than his own, a point to which Williamson responded that “[m]uch of the
Chicago School . . . has been reluctant to buy into my stuff.”1
Ultimately, in the tradition of fathers, Simon forgave Williamson his sins,
accepting that despite what he saw as the trappings of rationality, the Williamson
theories might properly be considered part of the bounded rationality tradition.
After a re-reading of The Economic Institutions of Capitalism, he concluded
that Williamson had adopted a bounded rationality position and had adequately
renounced optimization. In fact, at the end of his last note to Williamson, Simon
226 ROUNDTABLE ‘COGNITION, RATIONALITY AND GOVERNANCE’

expressed his “contrition at not having understood you as well as I should and
at not having appreciated the amount of aid and comfort that your work gives to
the cause of bounded rationality and, more important, of returning economics to
reality”.2 The father and son reunited.
This reconciliation reflected a recognition by Simon of Williamson’s important
role in organizational economics, especially his contribution to bringing empir-
ical studies to a field dominated by armchair theorizing. That reconciliation,
however, should not conceal two other disagreements that were lodged less in
sentiments of intellectual betrayal than in fundamental judgments about the nature
of employment contracts and the place and nature of conflict in organizations.
Simon’s conception of conflict and the contractual resolution of it was substan-
tially more benign than that of Williamson and non-cooperative game theory. It
was closer to more recent interest in the role of trust in organizations (Kramer
and Tyler, 1996). Rather early in his career, Simon had written about the employ-
ment contract, the agreement between employer and employee as to how they
will manage their subsequent relations (Simon, 1951). The idea of an employment
contract can be viewed as a simple solution to the disparity between a conception
of an orgaization as a coherent problem solver and a conception of an organization
as a collection of inconsistent interests. The basic analytic strategy is to divide
decision making into two stages. In the first stage (the negotiation of the contract),
the process involves bargaining, threats, resource mobilization, and compromise
until the parties reach an agreement. During the second stage, the organization acts
as if it had a consistent preference function (thus converting the organization to a
coherent actor). The strategy is celebrated throughout studies of collective actors
as diverse as business firms, public bureaucracies, and nation states.
Simon had no profound objection to a view of organizations as built, at least
in part, on bilateral contractual exchange relations. He portrayed the employment
relation as being grounded in an exchange of “inducements” for “contributions”
and the acceptance of authority through ’acceptance zones’, where employers defer
to organizational authority. This conception of the exchange of mutual incentives
came as much from Chester Barnard (1938; see also Williamson, 1990) as from
economics, but it was generally consistent with an economic perspective and with
subsequent efforts to provide an economic interpretation to trust (Kreps, 1990).
Although he recognized (particularly in the 1951 article) the hazards of employ-
ment contracting, Simon thought that Williamson (along with other economists)
erred in imputing unbounded rationality to contractual relations. In effect, he
saw the contracts involved in organizations as being “soft” ones, relatively far
removed from an “efficient” frontier (Simon, 1991a, 1992, 1997). He believed
that, in this domain as in others, Williamson had inappropriately abandoned satis-
ficing as a concept. Contracts between satisficing parties would persistently have
slack in them, providing possibilities for unilateral adjustments that would not
disturb continued cooperation. As a result, issues of monitoring and strategic action
receded into the background. The incomplete contracts that were central prob-
ROUNDTABLE ‘COGNITION, RATIONALITY AND GOVERNANCE’ 227

lems to be solved for Williamson, raising complex issues of clarification, shirking,

and enforcement, were for Simon a source of slack that absorbed, rather than
accentuated, conflict.
Williamson made no use of the idea of satisficing, finding it intractable as an
empirical concept, and – in Simon’s view – saw contractual relations as overly
rational. For Williamson, the central implication of bounded rationality was that
all complex contracts are unavoidably incomplete (Williamson, 2001). Simon
believed that, by ignoring satisficing and other elements of bounded rationality,
Williamson misrepresented the ways in which organizations dealt with conflict.
Even more, however, Simon believed that Williamson (and by implication also his
old colleagues Cyert and March, not to mention modern game theory) systemati-
cally exaggerated the level and importance of conflict in modern organizations.
Williamson’s emphasis on opportunism and conflict of interest was in fundamental
agreement with A Behavioral Theory of the Firm (Cyert and March, 1993). Cyert
and March (who were also Williamson’s teachers) emphasized that economic
organizations involved multiple actors with persistently conflicting interests that
cannot be resolved by a formal employment contract or by any prior agree-
ment. Their view left plenty of room for opportunism, creeping renegotiation, and
implementation problems.
Simon felt that Williamson’s focus on opportunism was overdone, that it
exaggerated the amount of lying, cheating, shirking, and stealing in organizations.
Simon juxtaposed ideas of altruism and organizational identification to William-
son’s emphasis on opportunism and contractual negotiation and enforcement
(Simon, 1991a, 1992, 1993, 1997) According to Simon, organizational identifi-
cation tempers some of the effects of self-interest because people become attached
to an organization through adopting (to some extent) its goals. By linking indi-
vidual actors to each other, organizational identification makes the organization
more coherent. Simon felt that, by relegating this part of the Barnard formulation
to a minor role, Williamson joined other economists in overlooking the substantial
elements of organizational life that are driven less by self-interest and guile than by
good-spirited cooperation. In a letter to Williamson in 1993, he noted that “[m]y
experience of organizations . . . leads me to place a heavier weight on identification
than I interpret you as doing” (Letter to Williamson, September 29, 1993).
For Williamson, there was no contradiction in the juxtaposition of bounded
rationality and opportunism, but the rationality of his actors tended to become
somewhat less bounded when they acted opportunistically. At times, Simon seemed
to view organizational identification as an aspect of bounded rationality but
primarily when he used “bounded rationality” as a label for the entire Simon
canon. He generally treated identification not as a cognitive simplification but as
an elementary property of actual human behavior. His objection to opportunism as
a central concept was empirical.
Lurking behind the empirical complaint, however, was perhaps a moral
complaint and a personal one. Neither Simon’s beliefs, nor his experience, nor
228 ROUNDTABLE ‘COGNITION, RATIONALITY AND GOVERNANCE’

his research made him particularly comfortable with conflict; and he appeared
to feel that rationalizing opportunism served to legitimize it. Although he first
encountered organizations in the context of political science, a field dedicated to
the exploration of conflict and its resolution, most of the later development of his
ideas were focused on cooperative problem solving. Simon’s later contributions
to artificial intelligence and cognitive science built upon and extended ideas of
bounded rationality introduced in the context of organizational decision making
(Feigenbaum, 1989; Simon, 1989, 1991b). However, in the arena of individual
problem solving as he elaborated it, preferences and goals were unproblematic
and issues of contractual relations non-existant. The central questions concerned
ways in which individuals and machines with limited cognitive capabilities coped
with difficult problems, and how those coping mechanisms might be mimicked or
improved through the use of high speed electronic computers.
The problem solving focus undoubtedly reflected many things, including
Simon’s friendship with Allen Newell, the movement of Richard Cyert into
academic administration, the emergence of the digital computer as a tool for
research and decision aid, and the departure from Carnegie of his other primary
organizational colleagues; but it also probably reflected to some extent an intel-
lectual discomfort with conflict of interest. Simon was a political scientist, but his
training and experience in political science was fueled more by a desire to solve
political and social problems intelligently than by an enthusiasm for bargaining,
confrontation, negotiation, or coalition formation. In politics, as in other domains,
he advocated rational discourse based on shared premises. He recognized the
reality of conflict and the possibility of strategic rational action, but he felt both
were given undue prominence in economic theories of collection action.
Like other great thinkers, Simon spawned ideas in others. The resulting brood
of concepts and considerations often wandered relatively far from his original
conceptions, sometimes to his surprise, even to his dismay. His exchanges with
Oliver Williamson reveal some of the glories and anguish of that process. Simon
was, as one of us noted earlier, “an unrepentant knight of the enlightenment”
(March, 1978), committed to understanding and improving human intelligence.
Throughout his life, he struggled to have a boundedly rational conception of intel-
ligence accepted as a basis for describing human action and for changing it. He saw
the instincts of economists to interpret any economic behavior as an instance of
unbounded rationality as destructive of a scientific understanding of that behavior.
At the same time, although he saw the accommodation of conflict of interest as
a part of the reality of collective choice, he never moved conflict to a position
of primacy in his own work. These commitments and experiences gave Simon
difficulty as he sought to integrate the contributions of Oliver Williamson into his
view of his own program.
In the end, there was reconciliation; but it was one based more on lifetimes
of mutual respect than on a profound resolution of their differences in these
respects. Williamson’s attention to elements of rational opportunism and guile
ROUNDTABLE ‘COGNITION, RATIONALITY AND GOVERNANCE’ 229

in organizations led persistently to different emphases from those produced by

Simon’s attention to elements of cooperative problem solving under conditions
of bounded rationality. Agreeing with Simon that humans are limited in their
rationality, Williamson nevertheless developed a different perspective, trying to
use the underlying rationality of bounded rationality to explore the consequences
for choosing forms of economic organization. Agreeing with Cyert and March
(though less with Simon) that conflict of interest is a central concern to economic
organization, Williamson applied these insights to the study of contracts rather
than choice, and to the problem of vertical integration. Agreeing with his Carnegie
connections that humans are analytic satisficers, Williamson sometimes used a
short-cut form of analysis, maximization, which he saw as ‘good enough’ to study
some of the effects of bounded rationality on economic organization (Williamson,
2001). Thus, Williamson’s work remain an extension of the ideas from Carnegie,
although Simon occasionally disagreed.
Similar disagreements, in fact, made Simon uncomfortable not only with
economic students of organizations but also with many whose primary disciplinary
ties were with history, political science, or sociology. Modern inclinations to see
organizations as complex, coordinated systems fit the Simon perspective better than
did modern inclinations to see them as systems of conflict and power.
The differences between Simon and Williamson are not differences to be
resolved by decisive observation. Each of the two perspectives is incomplete, a
condition each shares with any perspective that can be made comprehensible to the
bounded capabilities of human minds. They have a great deal in common. Each
is derivative in important ways of a particular era (the 1950s and 1960s) and a
particular place (the Graduate School of Industrial Administration as the Carnegie
Institute of Technology). They differ in the importance they accord to conflict of
interest in organizations; but this difference between them, like the conflict over
which they differed, was embedded in an ethos of a shared heritage and destiny
and should be understood within that context.

Acknowledgements
We are thankful to Nicolai J. Foss, Anna Grandori, and in particular Oliver E.
Williamson for comments on earlier drafts.

Notes
1 Letter from Williamson to Simon, October 19, 1993. Williamson also mentions that “my creden-
tials as a neoclassical economist are more problematic than you imagine them”.
2 E-mail message from Simon to Williamson, March 27, 2000.
230 ROUNDTABLE ‘COGNITION, RATIONALITY AND GOVERNANCE’

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