Decision-making: Impact from Risk and Uncertainty

Long term strategic planning and decision-making is crucial in any organization. However, we are not living in a world with crystal ball that we have perfect information for future. Risk and uncertainty play an important role in the planning and decision-making process.

In ACCA Advanced Performance Management, you need to understand the impact of risk and uncertainty in strategic planning and decision-making. It is quite often to see questions in exam asking students to explain decision-making under different conditions. In this article, you will be firstly told about decision theory, then followed by decision-making under different states in details.

Introduction to Decision-Making

Business managers make organizational decisions in several conditions and scenarios. Decision-making fundamentals rest on information available, choices, and outcomes of the decision. The decision-making process begins with evaluating choices and preferences, analyzing the probable outcomes under a specific condition.

Broadly, the decision-making process will involve decision-making conditions related to information, preferences, and alternatives. The decision-making process can be rational or irrational. It can also be classified under several types depending on the underlying approach of the decision-maker. The decision-making will depend broadly on factors like:

  • The explicit knowledge or information available for the decision-maker

  • Decision-maker’s cognitive behavior

  • The conditions under which the decision is being made, the amount of certainty and risks attached to the decision

  • The decision-making approach of the decision-maker

The decision-making is an approach towards problem solving. Numerous decision-making studies and approaches define the effects and results of the decision choices.

Decision Theory

Business managers (the Decision-makers) often face uncertain conditions when evaluating options and alternatives. The process of decision-making under uncertainty by evaluating different choices is the simplest definition of the decision theory.

The psychological study of decision-making also includes the preferences and options perspective. The decision-maker’s preference can be rational or irrational; the options can be made under perfect and imperfect information. The decision theory focuses on the argument that impacts of uncertainty can be reduced with repetitive experiments or the so-called use of probability.

The decision theory evaluating decision process can be classified under three conditions:

  1. Decisions with Certainty: When the decision-maker can evaluate different options with certain outcomes. The information to make decisions is available. These decisions often lead to rational, measurable, and accurate decision-making process.

  2. Decisions with Un-certainty: When the decision-maker doesn’t have access to accurate and measureable information to make the decision. The outcomes of different options are unclear or uncertain. The decision-maker uses the expected value or probability methods to evaluate the best options.

  3. Decision-making with Risks: A situation where the decision-maker analyzes the potential outcomes of different choices under certain or uncertain conditions. The situation often occurs due to a lack of perfect or measurable information.

The decision theory describes the decision-making framework under two models of decision-making.

The Normative Decision-making

This decision-making model describes the perfect set of rules for the decision-maker. The decision should be based on rational and fully informative preferences. The theoretical approach aims to find a perfect decision-making method by evaluating certain and perfect decision options with known outcomes.

The Descriptive Decision-making

This model describes the decision-making under certain rules and factors that affect the decision-maker. In a practical world, many outside factors affect the decision-making process. This model states that not all factors affecting decision-making can be internal and controlled. It links to the probability of events occurring in real terms than in a theoretical framework.