The Impact of Prior Performance on Strategic Choice: An Emotion-Based Argument

Abstract

This paper explores the impact of the prior performance of a firm on the distance of its strategic search and choices. Specifically, it focuses on the emotional impact of prior performance and how it influences the strategic decision making process. It identifies a few robust mechanisms from cognitive psychology, cognitive neuroscience and behavioral economics relating to the impact of emotions on cognitive functioning, and then integrates and applies them to the question of how prior performance impacts the distance of strategic search and choice. Through this, two hypotheses are generated that are different from some of the received wisdom on the question. Larger increases in prior performance are predicted to lead to more distant search and choices (and vice versa for decreases) while higher levels of volatility in the prior performance are predicted to lead to less distant (i.e. local) search and choices (and vice versa). The hypotheses are tested empirically in a very specific strategic context, namely the decision of firms to undertake M&As. A large panel dataset that tracks the top 10,000 firms worldwide over 44 quarters from 2001 to 2011 is created for the tests. Strong support is found for the predictions in the data. A more ``direct'' test of the emotion-based mechanism is also attempted by using measures of investor sentiment, and these tests also support the predictions.