DP17664 Theory-Driven Strategic Management Decisions
This paper studies managerial decisions under uncertainty for which past data are not available. It shows that choosing a good theory and state space might make a larger difference in performance than solving optimally the ``wrong'' decision problem. Therefore, developing and testing alternative theories can be a key source of competitive advantage. The paper also shows that decision makers should experiment with more uncertain theories, because testing the "boundary" models of these theories elicit more informative signals that generates larger belief updating. The paper provides microfoundations to the theory-based view of the firm and explains why performance heterogeneity and competitive advantage is created by exploring theories with higher variance.