Skip to Main Content
HBS Home
  • About
  • Academic Programs
  • Alumni
  • Faculty & Research
  • Baker Library
  • Giving
  • Harvard Business Review
  • Initiatives
  • News
  • Recruit
  • Map / Directions
Working Knowledge
Business Research for Business Leaders
  • Browse All Articles
  • Popular Articles
  • Cold Call Podcast
  • Managing the Future of Work Podcast
  • About Us
  • Book
  • Leadership
  • Marketing
  • Finance
  • Management
  • Entrepreneurship
  • All Topics...
  • Topics
    • COVID-19
    • Entrepreneurship
    • Finance
    • Gender
    • Globalization
    • Leadership
    • Management
    • Negotiation
    • Social Enterprise
    • Strategy
  • Sections
    • Book
    • Podcasts
    • HBS Case
    • In Practice
    • Lessons from the Classroom
    • Op-Ed
    • Research & Ideas
    • Research Event
    • Sharpening Your Skills
    • What Do You Think?
    • Working Paper Summaries
  • Browse All
    Decision Making Under Information Asymmetry: Experimental Evidence on Belief Refinements
    11 Aug 2014Working Paper Summaries

    Decision Making Under Information Asymmetry: Experimental Evidence on Belief Refinements

    by William Schmidt and Ryan W. Buell
    Managers often have to make decisions in settings where they (1) know more about the prospects of their firm than other parties and (2) care about how the less-informed party responds to their decisions. For instance, a manager may care about how the stock market responds to the firm's expansion plans. In such situations, the manager's decision may signal the firm's prospects to the less-informed party. This phenomenon has been researched in a variety of situations, including new product and service introductions, competitive entry, supplier contracts, and capacity investments. A common assumption in researching such issues is that managers will make decisions that perfectly reveal the firm's prospects to the less-informed party, even if it is costly to do so. For example, a firm facing a big market opportunity will open more stores than is optimal in order to signal its favorable prospects. The number of stores the firm opens must be so high that a firm facing a small opportunity will find it too expensive to mimic the number of store openings. While such predicted outcomes underpin much of the operations theory developed in these settings, they have not been reconciled against the decisions made by actual decision makers. In a laboratory experiment involving more than 200 participants, the researchers conduct such an analysis. Their findings offer the first evidence that decision makers choose not to make decisions that reveal the firm's market opportunity and instead make the same decision regardless of the firm's prospects. The researchers go on to demonstrate that the discrepant predictions change the theoretical implications of prior research. Key concepts include:
    • Pooling behavior, in which firms make the same choice regardless of their market prospects, was widespread among experimental participants, relative to separating behavior, in which firms make the distinct choices based on their market prospects. Participants were more than three times more likely to pool than to separate.
    • Pooling behaviors were especially common among participants who reported a high level of understanding of the experimental setting, and the degree of pooling increased in later rounds of the experiment.
    • Participants who made pooling decisions were rewarded by participants playing the role of an external investor and earned significantly more in the experimental market than participants who made separating decisions.
    • Leveraging the behavioral insight that real decision makers will pool under certain circumstances can materially affect the implications of existing operations theory.
    LinkedIn
    Email

    Author Abstract

    We explore how individuals make decisions in an operations management setting when there is information asymmetry between the firm and an outside investor. A common assumption in the signaling game literature is that beliefs among the participants in the game are refined using the Intuitive Criterion refinement. Our experimental results provide evidence that the predictive power of this refinement is quite low, and that the Undefeated refinement better captures actual choice behavior. This is surprising because the Intuitive Criterion refinement is the most commonly utilized belief refinement in the literature while the Undefeated refinement is rarely employed. Our results have material implications for both research and practice because the Undefeated and Intuitive Criterion refinements often produce divergent predictions. Our results demonstrate that conformance to the Undefeated and Intuitive Criterion refinements is influenced by changes in the underlying newsvendor model parameters. We also show that adherence to the Undefeated refinement is especially pronounced among subjects who report a high level of understanding of the game and that subjects whose choices conformed with the predictions of the Undefeated refinement were rewarded by investors with higher payoffs in the game. Finally, we demonstrate, through a reexamination of Cachon and Lariviere (2001), how the application of the Undefeated refinement can substantively extend the implications of extant signaling game theory in the operations management literature.

    Paper Information

    • Full Working Paper Text
    • Working Paper Publication Date: July 2014
    • HBS Working Paper Number: 15-001
    • Faculty Unit(s): Technology and Operations Management
      Trending
        • 13 Dec 2021
        • Research & Ideas

        The Unlikely Upside of Mergers: More Diverse Management Teams

        • 14 Mar 2023
        • In Practice

        What Does the Failure of Silicon Valley Bank Say About the State of Finance?

        • 16 Mar 2023
        • Research & Ideas

        Why Business Travel Still Matters in a Zoom World

        • 14 Dec 2021
        • Op-Ed

        To Change Your Company's Culture, Don't Start by Trying to Change the Culture

        • 25 Feb 2019
        • Research & Ideas

        How Gender Stereotypes Kill a Woman’s Self-Confidence

    Ryan W. Buell
    Ryan W. Buell
    C. D. Spangler Professor of Business Administration
    Contact
    Send an email
    → More Articles
    Find Related Articles
    • Decision Making
    • Problems and Challenges

    Sign up for our weekly newsletter

    Interested in improving your business? Learn about fresh research and ideas from Harvard Business School faculty.
    This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.
    ǁ
    Campus Map
    Harvard Business School Working Knowledge
    Baker Library | Bloomberg Center
    Soldiers Field
    Boston, MA 02163
    Email: Editor-in-Chief
    →Map & Directions
    →More Contact Information
    • Make a Gift
    • Site Map
    • Jobs
    • Harvard University
    • Trademarks
    • Policies
    • Accessibility
    • Digital Accessibility
    Copyright © President & Fellows of Harvard College