Economies of cognition: a cognitive theory of the firm

Abstract What is the fundamental economic function of the firm under radical uncertainty? This paper advances a theory of the firm centered on economies of cognition: the systematic reduction in the costs of perception, interpretation, and reasoning while maintaining representational quality. Firms are conceived as cognitive systems whose primary function is constructing and updating internal models that guide coordinated action. Intelligence is defined as the capacity to achieve goals across a diversity of environments (Legg and Hutter 2007); it becomes strategic when it enables the firm to persist over extended periods despite irreducible uncertainty. Building on the behavioral tradition (Cyert and March 1963; Simon 1955) and organizational cognition research (Weick 1995; Gavetti 2012; Ocasio 1997; Csaszar and Laureiro-Martínez 2018), the paper formalizes strategic intelligence as a workflow based on a triadic architecture of Sensing, Reasoning, and Acting coordinated by a Validation meta-function. Each function incurs cognitive costs. Three mechanisms reduce these costs without degrading representational quality: procedural recursion, informational compression, and staged epistemic action. The critical boundary condition is stock-for-function substitution, where firms reduce costs by ceasing updating altogether, producing compounding representational decay. Using the contrasting cases of Kodak and Fujifilm, and testing the framework against artificial intelligence—which the theory predicts will redistribute cognitive costs toward validation, generating Validation Debt—the paper demonstrates that durable advantage stems from the organized capacity to perceive and adapt faster than environmental change can erode strategic logic.