Do experience and markets eliminate strategic opportunities due to poor dynamic decision making?
Managers regularly deal with dynamic tasks, where decisions impact immediate payoffs as well as long-term capabilities. Prior research has shown that people do poorly in dynamic tasks, but we lack a clear diagnosis of the problem. Does poor performance reflect poor problem solving and sub-optimal learning or could it result from rational learning processes operating in a complex environment? The answer matters for strategic management: if people fail to understand the value of long-term resources, there may be systematic profit opportunities for sophisticated managers. We design a series of lab experiments to better understand why people perform poorly in dynamic tasks and explore what the market consequences are. Our results show that poor performance is due to behavioral difficulties and cannot be explained as the result of rational learning. People do poorly even with complete information about the payoff function, which in theory eliminates any need for learning. It appears that people unsystematically search the space of possible solutions with limited attention to the resulting changes in the underlying states of the system. As a result, they get stuck at local optima in the solution space. We also show that allowing participants to trade in a market surprisingly exacerbates failures and lead to erroneous learning. Introducing a market also lead to higher variation in performance, because sophisticated managers can take advantage of naïve ones who underestimate the value of long-term resources. The results suggest that differences in thinking through a dynamic problem lead to substantial variation in performance, despite the opportunity to learn and even if all other sources of complexity and ambiguity are excluded.