Risk and Prior Outcome Effects on Managerial Decision Making

Abstract The article uses an experiment to address two issues. The first issue is the impact of a strategy's past outcomes on managers' willingness to change it, when these outcomes are irrelevant. The literature suggests that bad outcomes that result from abnormal actions cause more regret than similar outcomes that follow normal actions. In addition, a prior bad outcome makes changes more normal whereas a prior good outcome makes changes less normal. This leads to the hypothesis that following past success of a strategy, the manager will be more inclined to retain it. Surprisingly, this hypothesis is not supported by the data: information about the strategy's past outcome does not affect how likely it is to be continued. The second issue addressed is how managerial strategic decisions are affected by risk. While risk aversion is often assumed for individuals, the usual assumption is that firms (and therefore their managers) maximize expected profits, which imply risk neutrality. The experiment, however, found managerial tendency towards safer strategies – strategies with less variability in outcomes. Thus, the results are inconsistent with the common assumption in economics and management, which suggests that managers (as agents for the firm) are risk neutral.