Managerial cognition, sunk costs, and the evolution of industry structure

A significant body of research investigates whether intraindustry competitors hold a common pattern of beliefs (or schema). Some work suggests that socially constructed shared beliefs, not technology-based economic factors, determine industry structure. While research on managerial cognition is important because it helps strategy researchers incorporate bounded rationality into otherwise hyper-rational theories, we take issue with the notion that the social construction works independently of economic factors. Empirical studies looking for shared beliefs find conflicting results. Some work suggests that managers in an industry share a common set of beliefs; other work finds the opposite (managers do not share common beliefs). Understanding, if and to what extent, managerial cognition influences industry structure and competitive heterogeneity would greatly expand our understanding of strategy and firm performance. We model bounded rationality, cognition (belief formation), competition (economic restraints), and industry structure (competitive heterogeneity). We find that competitive pressure and bounded rationality induce agents (firms or managers) to focus their attention on nearby competitors. Thus, firms develop biased estimates of their competitive environment. These estimates correlate with the estimates of nearby firms. Thus, clusters of firms will have similar beliefs resulting in stable strategic and performance heterogeneity within an industry. However, as competitive pressures and the costs of strategic change decrease, managerial beliefs tend to converge, and the pattern of strategies that emerges is consistent with those predicted by economic theory, even under conditions of bounded rationality.