Information and Bias Effects in Discretionary Pricing: Evidence from an OTC Drug Pricing Quasi-Experiment

Abstract

In theory, discretionary pricing improves the company's performance by allowing managers to incorporate local information into their pricing decisions. However, in practice, managers are vulnerable to behavioral biases that can lead to inaccurate estimation of the customer's willingness to pay and price sensitivity, and precipitate poor decisions. This paper investigates the effectiveness of discretionary pricing and examines how information advantage and behavioral bias influence managers' pricing decisions. Collaborating with a pharmacy retailer, we analyze a quasi-field experiment that delegates pricing power to local pharmacy managers. Our analysis reveals that under discretionary pricing, managers incorporate local information into their pricing decisions. However, they are also subject to behavioral biases, which leads to aggressive, sub-optimal price adjustments. We find that managers increase prices of high-priced drugs by 8.6\%, resulting in significant sales and revenue losses. The effect is particularly prominent in stores located in low-competition areas. Moreover, we find that manager experience can alleviate such behavioral biases---more experienced managers from larger stores are not subject to these biases. Our findings highlight the importance of recognizing managers' behavioral biases in business decisions. We provide implications for pricing practices and offer solutions that allow companies to leverage local information while reducing the impact of human biases.