Benefits of Game Theory in Decision Making

Game theory models can be usefully applied in negotiation situations between business partners where the intention of the negotiating partner is only partially transparent and their options for action are only partially known. The same applies to cooperative relationships. Relationships between managers and employees are just as much part of cooperative relationships as relationships between manufacturers and sales representatives and relationships between project partners. For example, employee appraisals can gain in quality through game theory models.

All cooperation partners want to derive the maximum benefit from a cooperation, but for this very reason they do not necessarily bring maximum performance to the cooperation. As a result, cooperation results can suffer to such an extent that the purpose of the cooperation can be called into question. Also, the decision for strategies is usually made with incomplete information. In such cases, scenarios are systematically thought through in order to optimize one’s own position through strategic decisions.

The fact that trust and good communication have a decisive influence on cooperation does not really need to be mentioned. But which indicators justify how much trust? What is really meant by good communication? These questions are not trivial. Do we achieve good communication when every individual behaves rationally? Using the example of the much-cited prisoner’s dilemma, we see that rational behavior at the individual level can lead to collective self-harm, experienced as a collective good problem (CO2 emissions, water pollution) or social dilemma (social redistribution, health insurance systems). The basic structure of collective good problems and social dilemmas is that several or many actors, who are mutually interdependent but cannot directly coordinate with each other, each have different alternative courses of action; symmetrical payoffs exist and can lead to sustainable operations. The limits of growth can be identified and the consequences of economic growth can be estimated.

In “Rational Man and Irrational Society”, Brian M. Barry and Russel Hardin drew attention to the fact that irrational, non-optimal societal conditions may well arise as a consequence of strictly rational actions by individual actors. Obviously, individual and collective rationality often fall apart. As a result, outcomes remain inefficient. Possible solutions are either not recognized or cannot be achieved. Remedies can be found by applying the Balanced-Scorecard concept, by definiing the Corporate Social Responsibility, by gathering awareness of the effects of Employer Branding and  by developing the ability to cooperate.

The American mathematician and founder of cybernetics Norbert Wiener expressed in 1966 in his influential work “Man and Man-Machine” “[…,] that society can only be understood through the study of messages and the associated means of communication”. Indeed, a good understanding of communication is the key to stability and to greater efficiency. Communication results from the sending, receiving, and interpreting of signals. The range of possibilities inherent in these activities should not be underestimated. Information is often distributed asymmetrically, signals can be honest or (deliberately) false (threats, bluff).

There may be incomplete information or rationality gaps that lead to wrong decisions; strategic and tactical interdependencies between participants may also generate infinite recourses that seem intractable.

Game theory approaches that address decisions in situations of strategic interdependence can help understand interaction structures, better assess possibilities, and identify good solution paths. Game theory is a mathematical discipline. Using mathematics, methods and formal models can be provided to describe social interactions formally and precisely. However, it is not necessary to delve into the depths of mathematics for a basic understanding of game theory approaches. This is good news, because good solutions can be enforced more effectively the more participants in a decision-making process have an insight into the principles of game theory.

Game theory points to important means, such as institutions, social norms, social sanctions, reciprocity, and the self-organization of cooperation in repeated “games,” by which collective good problems and social dilemmas can be solved.

In the following, I compile selected aspects of game theory that can provide insights for a better understanding of cause-effect relationships.

Basically, two types of games need to be distinguished, namely games (i) in situations that require simultaneous decisions by different participants that have mutual effects and cannot be coordinated with each other (representable in the normal form), and (ii) in situations where decisions are made sequentially (representable in the extensive form). In sequential decision situations, in addition to the reasons for bad decisions outlined above, there may be misunderstandings, deceptions, or misinterpretations that should be considered as possibilities for arriving at good decisions.

Regarding the alignment of interests of all parties involved, there is basically a wide range between the extremes of (i) coinciding and (ii) opposing interests.

In order to achieve a stable and efficient outcome in mutual decision-making situations with coinciding interests, a coordination problem has to be overcome. Either open and relevant communication, social norms, or both can contribute to the solution. Successful coordination allows all parties to be in a better position than they were before the match. If this is successful, value is created jointly.

If the interests of the stakeholders are opposed, a decision will amount to a zero-sum game at best. This means that, on balance, no value is created, even if individual parties may be better off as a result of the game. In the distribution, the respective expression of the two motives, (i) not to be exploited oneself (defensive motive) and (ii) to exploit the others as much as possible (aggressive motive), plays a central role.

Most real-world decision situations are played out somewhere between these extremes. There will be both aligned and conflicting interests. This intermingled set of interests increases the complexity of decision situations. Possible solutions lie in a sensible combination of cooperation and conflict limitation. However, the development possibilities cannot be captured so easily because of the higher complexity.

Important models for decision-making situations in companies are the Nash equilibrium and Pareto Optimality.


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