Expanding the Concept of Bounded Rationality in Tce: Incorporating Interpretive Uncertainty in Governance Choice

Abstract: Bounded rationality (BR) is a fundamental behavioral assumption in most major strategy theories, including transaction cost economics (TCE), the resource-based view and positivist agency theory. Critics suggest, however, that the application of BR in these theories is incomplete, remaining largely compatible with the strict rationality assumption employed in neo-classical economics. In response to the criticisms, we expand the notion of bounded rationality to address both interpretative limitations on rationality, as well as processing limitations, which have been traditionally embraced in economic-based strategy theories. Using TCE as an example, we show how a more comprehensive bounded rationality assumption allows us to refine theoretical concepts (uncertainty), identify significant impacts of processing limitations on intra- and inter-firm activity (novel transaction costs), expand the theory’s predictions (hybrid governance under uncertainty), and address new applications (relational governance and the make-or-buy decision under hierarchy).