Hervé Crès, Dean of Social Sciences
Hervé Crès, Dean of Social Sciences

Rational, but not too Rational: Hervé Crès on Decision-Making in the Corporation

Economics — the theoretical kind, with lots of advanced mathematics — meets sociology and philosophy, as well as political science, in the work of Hervé Crès, dean of social science at NYU Abu Dhabi and a professor of economics.

"Mainstream economics starts with assuming the rationality of the individual," Crès says. "I've been interested in the aggregation of decisions, asking whether we can talk about the rationality of a group."

Before you start making jokes about politics, note that for Crès the unit of study is the corporation. "My laboratory is the firm," he says. As owners or shareholders decide how their company should allocate resources, can they be said to be rational?

The answer, Crès says, is that collective decisions can never be as rational as individual ones, because any group decision will involve the aggregation of beliefs, preferences, judgments, and other elements that can be so diverse as to be incompatible.

For several years now, he says, "I've been trying to think about situations where the persons who have to take a collective decision have something in common." Stockholders in a company, for example, may well have bought their shares because they have common interests or attitudes. When owners disagree on corporate strategy, "they have to come to terms," Crès says, "and this is a political process. But the voting population is self-selected."

At first glance it may seem that shareholders will always agree on profit maximization, but this happens only if markets work perfectly, which is unlikely in practice, he notes.

So the question Crès is tackling is whether the common interests that lead people into the same investment can also lead to stable internal decision-making. It is, he says, "the interaction between market mechanisms and the democratic principle." You can see why Greek-letter mathematics come in handy for calculations on this frontier of economic theory.

Crès is addressing two questions in his current research. First, does the market mechanism within the firm help the democratic process to select a stable outcome? Second, does any such stable outcome help the firm allocate its resources efficiently?

The answers so far, he adds, are partially positive. First, what he calls the "endogenous homogeneity" of shareholders reduces the amount of disagreement, but in areas of residual disagreement, market failures leave plenty of room for conflict.

And at the center of gravity of any such internal disagreement, Crès finds the average stakeholder, "well-placed in the political geography — at least in a stakeholder democracy" — and it turns out, he argues, that "this guy always pushes for efficiency … there's a kind of gravitation, so that stability and efficiency are compatible."

All this may sound more than a little esoteric, but Crès points up practical implications that are worth pursuing. "I'm trying to understand, for example, why the bankers all concluded that sub-prime mortgage investments were a good idea," he says. "There is economic correctness, just as there is political correctness, but that can't explain the unanimity that we observed in that case."

The standard tools of political science and economics, he says, fail to explain some behavior, and that's where his work comes in. "It's not precise, it's meant to be only descriptive," he says. "It's also normative and philosophical.

"To have a real stakeholder democracy" within a company, he says, "you have to give voting rights not only to the owners but to the workers, and the outside suppliers, and government on behalf of society … it's totally utopian. The democratic principle is not always fully operational in practice, and to organize a real stakeholder democracy would be very challenging.

"But the understanding I get from my model will help me give advice on how to design the governance of firms, and on the regulation by government of the economic system."