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Microfoundations of Low-Frequency High-Impact Decisions

Author

Listed:
  • Gambardella, Alfonso
  • Camuffo, Arnaldo
  • Maccheroni, Fabio
  • Marinacci, Massimo
  • Pignataro, Andrea

Abstract

We show that grounding low-frequency high-impact strategic decisions under uncertainty on the development and test of theories is a foundational strategic choice of firms, and an important determinant of performance. Our normative Bayesian model shows that decision-makers benefit from comparing alternative theories and when theories are reliable (less uncertain) they should not experiment and they should focus on their most plausible theory (highest prior). Otherwise, they ought to experiment with their less reliable theories because they learn more. We also show that the variability of the optimal experiment matches the variability of the prior. In particular, large scale experiments may be overprecise and penalize radical new theories with more variable priors. Overall, our framework explains how structured exploration improves strategic decisions by reducing model mis-specification and why performance heterogeneity and competitive advantage is created by exploring theories with higher variance

Suggested Citation

  • Gambardella, Alfonso & Camuffo, Arnaldo & Maccheroni, Fabio & Marinacci, Massimo & Pignataro, Andrea, 2022. "Microfoundations of Low-Frequency High-Impact Decisions," CEPR Discussion Papers 17392, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:17392
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    More about this item

    Keywords

    Decision problem; Experiments; Exploration; Framing; Strategy; Theory; Uncertainty;
    All these keywords.

    JEL classification:

    • L21 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Business Objectives of the Firm
    • L26 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Entrepreneurship
    • M13 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - New Firms; Startups
    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics

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