Foundations of Management 2 (MG 459)

Lecture 1: MG459 Course Overview

and Foundational Concepts in Finance

Dr. Yally Avrahampour

Associate Professor (Education)

15th January 2024

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 Today’s lecture
1. Introduction
- Overview of Foundations of Management 2 (MG459)
- Objectives, Content, Times of Lectures and Seminars, Office Hours,
Assessments
2. Accounting, finance and theory of the firm
- Economics: Property Rights and Agency theory
- Psychology / Behaviouralism
- Sociology
3. Evaluating the merits of an investment (Capital Budgeting)
- a) Investment decision rules
- Payback Period
- Net Present Value
- Internal Rate of Return
- b) Determining the opportunity cost of capital (Capital Asset Pricing Model)
- c) Cost of capital in commercial and social finance
4. Summary
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 Aims of Foundations of Management 2
(MG459)
• The aims of Foundations of Management 2 are to provide a
basic grounding in the management literatures covering
disciplines relating to financial control and management
science, and of the literatures on the evolving managerial,
organisational and professional contexts within which these
disciplines are practiced.
• Students will be provided with an overview of each discipline
with the aim that they acquire a basic working knowledge of
each.
• The course will cover origins and disciplinary boundaries, the
foundations of these disciplines in the social sciences, core
concepts, practical applications and current state of play and
debate.
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 Three Levels of Learning on
Foundations of Management 2
1) Technical: To provide an introduction to key techniques used in
accounting, operations management and corporate governance.
As well as facilitating use of these techniques in the workplace,
to inform students’ understanding of these alternatives and
inform decisions relating to course options.

2) Theoretical: To deepen course participants’ understanding of

the debates relating to the techniques introduced in the course
by considering how the disciplines of economics, psychology
and sociology contribute to different solutions relating to the use
of these techniques.

3) Historical: To place techniques and the debates regarding the

use of these techniques in a historical context, relating the
evolution of techniques and theories to their organizational
setting.
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 Organization of the Sessions
Week 1: Making Business Decisions that Commit Capital
Reporting
Week 2: Representing a Firm’s Financial Condition: 1 To users of
Accounts
Week 3: Representing a Firm’s Financial Condition: 2

Week 4: Origins of Management Science Measuring

and
Managing
Week 5: Valuing and Managing Costs
Costs

Week 7: Financial Ratios and Social Return on Investment

Measuring
Performance
Week 8: Balanced Scorecard and Economic Value Added

Week 9: Occupations, Professions and Expertise Management

and the
setting of
Week 10: Individual and Institutional Investors In a Historical Context
standards
relating to
Week 11: Organization and Management Theory governance.
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 Lecture and Seminar Times
and Office Hours
Time: Lecture: Mondays 14:00-16:00, in MAR 1.10
Case Discussion 1: Tuesdays 14:30 - 17:30, in MAR 2.05
Case Discussion 2: Wednesdays 14:00 – 17:00, in FAW 2.04

My office hours: Mondays 16:00 - 18:00, Wednesdays 17.00-19.00

and by appointment.
During office hours I am available in person at my office: MAR 5.24. Please
either book online through student hub, email me or simply turn up without an
appointment.

Alternatively, we can arrange to meet in person or over zoom at a mutually

convenient time. Please email me to arrange a time.

I look forward very much to meeting and speaking with you.

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 Assessment Dates and Review Sessions
Group formative case summaries: In weeks 2 - 10, two study groups will provide a
formative group analysis of the case, no longer than 500-words (excluding appendices
and references). Further, two study groups will provide constructive feedback on the
two case commentaries provided by the first two student groups.

Individual formative essay maximum 1,500 words, excluding appendices and

references. Distributed on Thursday 1st February (week 3 of Winter Term) and due on
Thursday 22nd February (week 6 of Winter Term).

Review session: Wednesday 20 March 14:00-16:00 (WT week 10)

Individual summative essay 1 maximum 1,500 words, excluding appendices and

references and worth 50% of the marks for the course. Distributed on Thursday 21st
March (week 10 of Winter Term) and due Thursday 11th April (week after Easter break).

Revision session: Friday 3 May 14:00-17:00 (ST week 1)

Individual summative essay 2 maximum 1,500 words, excluding appendices and

references and worth 50% of the marks for the course. Distributed on 7th May (week 2 of
Spring Term) and due Tuesday 28 May (ST week 5)
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 Textbooks
For each lecture in MG459, we identify around three ‘core readings’ which
should be given a high priority. We also identify a number of additional,
‘further’, readings which enable you to go deeper into the subject. We do not
use a single textbook throughout the course, but draw upon chapters from
several textbooks. These textbooks also provide broad overviews of the
subjects with which we will engage:

Finance: Berk, J. & DeMarzo, P. (2023) Corporate Finance, 6th edition

Financial accounting: Weetman. P. (2019) Financial Accounting: An

Introduction, 8th edition

Financial accounting theory: Scott, W. & O’Brien, P. (2020) Financial

Accounting Theory 8th edition

Management accounting: Kaplan, R. & Atkinson, A. (2014) Advanced

Management Accounting, Pearson New International Edition, 3rd edition
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Part 2: Three traditions on the theory
of the firm and governance

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 Economics

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Property Rights: Separation of Ownership & Control
- The firm is a nexus of contracts. There is no authority relationship. The
distinguishing factor of the firm is team production.

- The core problem is rewarding each team member in accordance with that
member’s contribution.

- If monitoring (accounting) was costless, none of the members of the team

would shirk, because each would pay the full cost of their shirking.

- However, since the member owns only part of the firm but enjoys the full
benefits of shirking, where monitoring is costly, each member of the team shirks,
because the member can impose the cost of his shirking on others in the team.

- For example, a firm has a single owner. The owner can shirk at a personal
benefit equivalent to £75. The cost of shirking entails a loss of production
equivalent to £100. There is no shirking.

-But if there are two equal owners of the firm: each owns 50% of the shares.
The cost to each owner of shirking is only £50 (£100 cost x 50%). There is an
incentive to shirk and transfer the cost of shirking of £25 to other owner.
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 The Monitor as ‘Residual Claimant’
- Solution: someone should specialize to monitor the individual performance
of the team members.

- But what incentive would the monitor have not to shirk?

- The monitor receives all revenues received over and above the wages paid
to those employed by the firm. The monitor earns his residual income by
reducing the amount of shirking that takes place.

-The classic firm with separation of ownership and control is a consequence

of the need to resolve agency problems and monitoring inherent in team
production.

- The aim of accounting is to align the contribution to the firm and rewards. To
the extent that contribution and reward are aligned, the value of the firm is
increased.

See Alchian, A. & Demsetz, H. (1972) ‘Production, Information Costs and Economic Organization’ The
American Economic Review Vol. 62 No. 5:777-795.
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 Psychology / Behaviouralism

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 ‘The Equilibrium of the Corporation’
There are three members of an organization; the entrepreneur, the customer
and employee.

Each organizational member has inducements to participate in the

organization and makes contributions to that organization.

Inducement Contribution
Entrepreneur Revenue Costs
Employee Wages Labour
Customer Product Purchase price

Entrepreneur Customer

Employee
See Chapter 6 of Simon, H. (1947) ‘Administrative Behaviour’, in further reading list for Foundations.
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 Decision Making and Bounded Rationality
Simon (1947) defines bounded rationality as follows: Individuals are “intendedly
rational, but only limitedly so.”

Individuals have limited ability to process information and limited insight into
their own preferences.

Individuals satisfice (rather than maximize), because they rely on habitual rules
to make heuristic judgments about the world.

Individuals need to rely on on-going patterns of interaction to make decisions

entails that they form organizations.

Organizations are the consequence of the reliance by participants upon the

heuristic rules provided by the organization.

Each individual participates in the firm as long as the satisfaction received from
the net balance of inducements over contributions exceeds the satisfaction
obtained by not participating in the firm.

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 Sociology
(Institutional, cultural, political perspectives)

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 Sociological Perspectives on Accounting
This literature pays attention to the organizational and social contexts in
which accounting (and finance) operate.

‘Accounting is a craft without an essence.’ That is, accounting and financial

techniques are determined by a social context and do not exist separately
from that context.

Accounting techniques do not merely describe pre-existing economic reality.

They play a constitutive role in the social construction of economic reality.

A technical activity becomes ‘institutionalized’ when it acquires a taken-for-

granted quality that entails it is perceived as being correct.

Political economic accounts: Accounting is not technically neutral, but rather

reflects sets of interests.

Ethnographies of accounting: Accounting and financial practices in the lived

experience of prepares and users of accounts.

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 Donald Mackenzie (2011) ‘The Credit Crisis’
Question: how could investment banks misjudge the risks associated with Asset
Backed Security (ABS) Collateralized Debt Obligations (CDOs) so badly as to
contribute to the global financial crisis?

Instead of focusing on information (a common focus of the economic and

psychological literatures) Mackenzie focuses on practices of evaluation.

Mackenzie argues that evaluation practices are similar to sub-cultures. Local

cultures adopt a subjective view of which evaluation practice is appropriate.

The valuation of ABS CDOs was conducted within two parts of investment
banks. ABS were valued in one part. CDOs were valued in another.

When it came to valuing ABS CDOs the different parts of the investment banks
did not compare practices and consequently failed to correctly price these
securities. Knowledge is tied up with social structure and organization.

Please see: Mackenzie, D. (2011) ‘The Credit Crisis as a Problem in the Sociology of Knowledge’ American
Journal of Sociology Vol.116 No.6:1778-1841, available in further readings on Moodle.
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 Part 3a: Investment Decision Rules

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 How To Distinguish Good from Bad Investments?
In order to know whether it is worthwhile investing in a particular project we
need to take two steps:

First, we need a methodology for comparing the project’s costs and benefits.

Second, we need to know the opportunity cost of the capital invested in the
project.

That is, we need to compare the return on the project that is considered for
investment with the return that would be earned on projects with equivalent
Risk, which are foregone.

We will investigate these two steps in this lecture, in two parts. In the
case study discussions we will focus on the first part through the Lockheed Tri
Star case.
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 1) Payback Period
The payback period investment rule asks how long it takes for the cash flows
received from the investment to exceed the investment amount.

It then compares this with a pre-specified period of time. If the amount

received is expected to recoup the investment within a given time, the
investment is made.

Please note that this rule:

1) ignores cash flows occurring after the payback period.

2) introduces an arbitrary criterion in the decision to proceed: the amount of

time within which we aim to recoup the investment. There is no rigorous basis
for determining what the time frame should be.

3) ignores the ‘time value of money’.

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 The Time Value of Money
A dollar today and a dollar in one year are not equivalent. One can invest
today’s dollar and earn a year’s interest on it.

If the interest rate is 10%, then in a year $1 is worth $1.10 (= $1 x 1.1) and in
2
two years $1 would be worth $1.21 (= $1 x 1.1 x 1.1 = $1 x 1.1 )

n
Future value of a cash flow = C x (1+r) , where: C = cash flow, r = interest rate
(cost of capital), n = number of years.

The value today of cash received in the future is called its present value. The
n
present value of a future cash flow = PV = C / (1+r)

By comparing values at the same point in time, the present typically, we make
these values commensurable; that is, we are ‘comparing like with like’.

Please see Franks et al (1985) ‘Corporate Finance: Concepts and Applications’ Chapter 3, reading on Moodle.
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 Perpetuities and Annuities
A perpetuity is a series of cash flows that are received forever.

The present value of a perpetuity = C / r.

The present value of a perpetuity where the cash flows increase at a constant
rate = C / (r – g), where g = growth rate.

An annuity is a series of cash flows that are received for a finite period.

Present value of an annuity = C x 1/r x (1- 1/(1+r) N), where N = no. of payments
and r = interest rate.

N
Present value of a growing annuity = C x 1/(r-g) x (1- ((1+g)/(1+r)) ), where
N = no. of payments, r = interest rate and g = growth rate.

Please see Berk & DeMarzo (2023) ‘Corporate Finance’, chapter 4.

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 2) Net Present Value
The net present value rule places all the cash flows in a project on the same
basis to determine whether to proceed with a project.

Net Present Value = Present Value of Benefits - Present Value of Costs

1 N
3
NPV = C + C /(1+r) + C /(1+r) + C /(1+r) + … = ∑ C /(1+r)n
2
0 1 2 3 n
n=0

Note that the cash flows may differ along many dimensions: near versus
distant, positive versus negative and certain versus risky.

Example: Project C0 C1 C2 C3 NPV

r = 10% A -2,000 500 500 5,000 2,624
B -2,000 500 1,800 0 -58
C -2,000 1,800 500 0 50

NPV project A = -2,000 + 500 / 1.1 + 500 / 1.12 + 5,000 / 1.13 = 2,624
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 3) Internal Rate of Return
As the cost of capital for the project rises, it becomes increasingly difficult to
justify investing in the project.

The internal rate of return (IRR) is the interest rate at which the net present
value of the project is zero.

This rate of return tells us at the rate of return that the project must exceed if it
is to be worthwhile.

The IRR’s for the projects A to C were 51%, 8% and 12%, respectively.
Remember that the cost of capital was 10%.

Consequently, IRR generated the same recommendations as NPV. We will

cover exceptions in the seminar.

Please see Franks et al (1985) ‘Corporate Finance: Concepts and Applications’ Chapter 4 reading on Moodle.
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 Part 3b: Determining the discount
rate

(A brief introduction to the ‘Capital

Asset Pricing Model’.)

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 The Discount Rate as the
Opportunity Cost of Capital
The question now arises: How do we derive the discount rate?

In the NPV calculation, the discount rate is the rate of return on projects of
equal risk to the risk of the project being considered for investment.

That is, we are assessing whether the cost / benefit trade-off of the cash flows
associated with the project have a positive net present value using a discount
rate that reflects the rate of return on equally risky projects.

The rationale is that the return earned on investments with the same risk is the
opportunity cost of capital. By using this discount rate one is ascertaining that,
given the returns that could be earned elsewhere, the project has a positive net
present value.

But how can we relate risk and return to know what should be the expected
return of a project with a given level of risk?
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 Review: Debt and Equity Investments
There are two primary ways to raise debt financing: borrowing from banks or
issuing a bond in the capital markets.

The lender expects the borrower, such as a government, municipality,

corporation or individual to repay the principal amount with interest.

An investor in equity securities issued by a corporation becomes an owner in

whole or part of the firm. The investor receives dividends paid by the firm out of
profits, but has no guaranteed return.

Corporations pay interest to lenders prior to paying dividends to shareholders.

Additionally, in principle, in the event of bankruptcy and liquidation of the firm,

debt investors are paid back before equity investors.

Please see Bodie, Z., Kane, A. & Marcus, A. (1996) ‘Investments’, chapter 2: ‘Asset Classes and Financial
Instruments’, for further and fuller background.

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 Deriving the Opportunity Cost of Capital
To know the opportunity cost of the capital invested in a project we need to
know the return investors expect to earn on investments with equivalent risk.

We look at securities’ past returns for an indication of investors’ past expected

returns.

We assume that the probability distribution of returns remains unchanged, so

that this also provides an indication of the returns investors expect in the
future.

That is, the same underlying processes generating the returns associated
with a particular type of investment or ‘asset class’ would continue to
generate return outcomes in the future.

However, since we do not know asset returns for all past years, we are
estimating the returns of an underlying population from a sample of years.

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 Expected Return
The expected return is the average return we would expect to earn if we
repeated the investment many times with the return therefore drawn from the
same distribution on each occasion.

The outcomes differ each year with given probabilities of occurrence.

Current Stock price Return Probability

stock price after 1 year (R) (Pr)
100 140 40% 25%
100 110 10% 50%
100 80 -20% 25%

Expected Return = E(R) = (Probabilities x Returns)

= 25% x 40% + 50% x 10% + 25% x -20% = 10%

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 Risk
In finance a common definition of risk is volatility of returns. The higher
the volatility, the greater the risk.

The returns of company Red are more volatile and therefore, under
this definition, riskier than those of company Blue.

Return

Time
What measures can we use to assess volatility of returns and therefore risk?

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 Variance and Standard Deviation as
Measures of Risk
The volatility of the returns of a security or asset class is a measure of its risk

Volatility can be measured as the standard deviation of the returns of a security

or an asset class.

Variance is the expected squared deviation of returns from the mean return.

2
Variance (R) = (1 / n -1) x ((Actual Return – Mean Return) )

Standard Deviation (R) = √ Variance (R)

We can expect that the annual return of an security or asset class to be within
2 x the standard deviation of the returns approximately 95% of the time.

See Berk & Demarzo (2019) Corporate Finance, Chapter 10, page 364, available on Moodle.
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 Debt and Equity Risks and Returns (1926 – 2021)
The returns and risk of different assets classes in the United States, in the 96
years spanning 1926 and 2021, were as follows:

Asset Class Mean Return Standard deviation (risk)

US Treasury Bills 3.3% 3.1%
Corporate Bonds 6.2% 6.3%
S&P 500 Equities 12.2% 19.7%
Small Capitalization Equities 18.6% 38.6%

Recall that we are trying to infer the expected rates of return that investors had
with respect to each of these asset classes.

These returns and risks were derived from a sample of 96 years. However,
these asset classes have existed for much longer.

We are estimating the average of a population (the many decades that these
asset classes have existed) using a sample (96 years).
See Berk & Demarzo (2023) Corporate Finance, Chapter 10, available through the LSE library.
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Using the Standard Error to Infer Expected Return
The sample mean may differ from the mean of the underlying population.

How much do the two estimates of the average differ from each other?

The average return that we measure is just an estimate of the true return
because it is the sample mean. The estimation error may be very large.

The standard error measures the standard deviation of the sample mean
around the population mean.

Assumption: the probability distribution of the returns remains unchanged,

and each year’s return is independent of prior years’ returns.

The standard error enables us to expect that the average return will be within
two standards deviations of the true expected mean 95% of the time.

Standard error = standard deviation (sample) / √no. of observations.

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 Can We Estimate Investors Expected Return
Using This Data?
Standard error of the expected return on S&P 500 = 19.7%/√96 =
2.0%.

The 95% confidence interval of the expected return = 12.2% + / - (2 x

2.0%) = 12.2% + / - 4.0% = 8.2% and 16.2%.

Therefore, even with 96 years of data we can’t accurately estimate

investors’ expected return from investing in the S&P 500 stock index.

Further, while a systematic relationship between volatility and return

holds for asset classes, it does not hold for individual securities.

We therefore need another measure of risk to understand the

relationship between risk and return of an individual security.
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 Market Risk versus Firm Risk
Market (or systematic) risk reflects risk factors that are common across
all firms. For example, the strength of the economy.

Firm (or idiosyncratic) risk reflects risks that are specific to that firm. For
example, key-person risk: the CEO resigning.

Consider two securities: Type S stocks are affected only by systematic

risk. If the economy is strong (50% probability) the return on these
stocks is 40%. If it is weak (50% probability), the return is -20%.

In contrast, type I stocks are affected solely by idiosyncratic risks. Their

return is either 35% (50% probability) or -25% (50% probability)
depending on firm specific factors.

See Berk & Demarzo (2019) Corporate Finance, Chapter 11, core reading available on Moodle.
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 Risk & Return of Stock S
Stock S: All the stocks in the portfolio behave identically.

The expected return is: 05. x 0.4 + 0.5 x (-.2) = 0.1 = 10%

The risk of a portfolio of ten shares type S is:

2
SD (Return of Stock S) = √[0.5 x (0.4-0.1) + 0.5 x (-0.2-0.1) 2 ] = 30%

Since all of the stocks rise and decline together, their risks are not independent.
Consequently, the standard error does not reduce when one increases sample
size. That is, increasing the number of stocks does not increase certainty about
portfolio return in any given year.

Over the long term the average annual return will be 10%, but in any year the
portfolio return will be either 40% or -20%, no matter how many stocks in it.

Implication: systematic risk cannot be diversified away.

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 Risk & Return of Stock I
Stock I: The return on each stock depends on firm specific factors.

The expected return is: 0.5 x 0.35 + 0.5 x (-0.25) = 0.05 =5%.

2 2
Standard deviation of I’s returns:√[0.5 x (0.35-0.05) + 0.5 x (-0.25-0.05) ] =
30%

Since the returns are independent, the standard deviation of the expected
return from the true return (standard error) reduces as more observations are
added.

If the portfolio has 10 shares of type I: Standard error = 30% / √10 = 9.5%
If the portfolio has 10,000 shares: Standard error = 30% / √10,000 = 0.03%

The more stocks of type I are in the portfolio, the more certain we are that the
sampled mean is an indication of the true mean. That is, the more certain we
are the portfolio return in any given year will equal the expected return.

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Idiosyncratic risk can be diversified away!
 An Aside: The Concept of Arbitrage
The practice of buying and selling equivalent goods or securities in different
markets to take advantage of price differences.

Investors purchase the security in the market where the price is low and sell it
where the price is high.

The prices of the security in the different markets adjust so that we usually
assume that the arbitrage opportunity is temporary.

Law of One Price: if equivalent investment opportunities trade in different

markets then they must trade for the same price in both markets.

An arbitrage opportunity: it is possible to make a profit that is greater than that

earned on the risk free asset without taking risk.

Please see Sharpe et al (1999) ‘Efficient Markets, Investment Value and Market Price’ chapter 4 for further
background.
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 The Risk Premium of a Security Reflects Only
its Systematic Risk
Suppose that the expected return of a large and diversified portfolio of shares of
type I is greater than the risk free rate of return.

One could then borrow money at the risk free rate, invest it in this portfolio and
earn a return exceeding the risk free rate, without taking risk.

Such excess returns would be traded away through arbitrage. Consequently,

because a large portfolio of Type I firms has zero systematic risk, it must earn
the risk free interest rate.

Investors are not compensated for holding firm specific risks that can be
diversified away. The risk premium of a stock is unaffected by its diversifiable,
firm specific risk.

Rather, the risk premium of a security is determined by its systematic risk.

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 Beta as a Measure of Systematic Risk
The measure of the systematic risk of a stock is its beta.

The beta of a stock is the expected percentage change in its return given a
1% change in the return of the market portfolio.

Beta (stock) = Covariance (stock, market) / Variance (market)

Knowing the beta of a stock enables us to determine its expected return.

Expected return (stock) = Risk Free Return + Beta x (Market Return – Risk
Free Return)

The ‘Capital Asset Pricing Model’ enabling investors to determine the

opportunity cost of capital, that is, the expected return of an investment for a
given level of risk.

Please see Berk, J. & Demarzo, P. (2019) Corporate Finance, readings on Moodle.
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Risk and Return in Conventional Finance
and
Risk, Return & Impact in Social Finance

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Risk and Return in Conventional and Social Finance
• Finance theory suggests that the • A conjecture regarding the
expected rate of return of an investment relationship between risk,
is related to its sensitivity to systematic return and impact in social
risk. finance is that financial
• The higher the systematic risk of the returns are lower because of
investment, the higher the expected return. the trade-off between
financial and social
objectives (impact).

See Nicholls, A. & Tomkinson, E. (2015) “Risk and return in social finance” in Nicholls, A. Paton, R. &
Emerson, J. Handbook of Social Finance: 282-310, further reading on Moodle.
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 Part 4: Summary

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 Summary
In this lecture we began with an introduction to the course.

We then compared three perspectives on the role of accounting in organizations:

1) Economics 2) Behaviouralism / Psychology and 3) Sociology.

We examined how the attractiveness of a project might be assessed in two

parts:

First, we distinguished between three different investment decision rules,

payback period, net present value and internal rate of return.

Second, we how considered how we determine the opportunity cost of capital of

an investment in a project. We compared what we understand by opportunity
cost of capital in commercial enterprises and social enterprises.

In the seminars this week we will review the payback period, net present value
and internal rate of return investment decision rules. Please prepare by reading
the questions in the case document.
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 Appendices

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 Appendix 1: Technical Preview of Weeks 1-8
W1) Valuing Investments: Cost of Capital, Net Present Value,
Internal Rate of Return

W2) Reporting to Investors 1: Historical Cost Accounting

Revenue Recognition, Intangibles

W3) Reporting to Investors 2: Fair Value Accounting

W4) Managing Operations: Inventory management

W5) Assessing Cost: Absorption costing, direct costing,

Activity based costing.

W7) Performance Measurement 1: Ratio analysis, Social Return on

Investment

W8) Performance Measurement 2: Balanced Scorecard, Economic

Value Added
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 Preview of Weeks 9-11: Professions,
Standards, Investors and Managers
In weeks 9-11 of Foundations of Management 2 (MG459), we expand on the
concepts and ideas developed in earlier weeks and locate these to greater
extent in relation to questions arising within the management literature.

Week 9) Professions, professional service firm and the setting of standards.

How do we understand the setting of standards and how professions contribute
to these standards? Is management a profession?

Week 10) What is the history relating to the types of investor that dominated the
capital markets and what were some of the implications for corporate
governance? The historical evolution of standards relating to governance and
more recently the natural environment and sustainability.

Week 11) How can contemporary organization and management theory enable
us to understand the role of managers and management in relation to the topics
outlined in previous weeks?

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 James March (1987) ‘Ambiguity and Accounting’
Focuses (but not exclusively) on the psychological aspects of decision making.

Highlights that consequentiality reasoning focuses on the uncertainty of future

events. Another type of uncertainty which has been ignored is uncertainty in
the preferences of the decision makers.

Processes for conveying information and making decisions in firms often

display disorder.

Not only does this not reflect the precepts of economic theory, but those
precepts imply a decision making process that is imperfect.

Rules develop and have an impact on decision making that improves the
outcome of decisions in such a way that remedies failures arising from self-
interested and individualistic action.

See: March, J. (1987) ‘Ambiguity and Accounting: The Elusive Link Between Information and Decision Making’
Accounting, Organizations & Society Vol.12 No. 2:153-168, available in further readings on Moodle.

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