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<p>\abstract</p><p>Managers constantly make decisions that depend, at least in part,
on what they believe their competitors (or customers, or employees) will do in response.
These judgments are susceptible to error. Indeed, behavioral research suggests a widespread
bias towards underestimating others. To explore the ramifications of such an intuitively
irrational bias, we provide a theoretical model that compares the long-run effects
of consistent underestimation bias with those of consistent overestimation bias across
different competitive contexts relevant to marketing managers. In the first set of
analyses, we derive analytic equations to calculate the relative expected payoffs
associated with conditions of overestimation bias, underestimation bias, and no bias
and discern trends as a function of environmental features including game complexity
and player skill levels. In the second set of analyses, we derive equations for the
relative effort costs associated with each of the three bias conditions as a function
of the relevant game and player parameters. We then combine the results of the expected
payoffs and effort costs to determine the relative net expected payoffs associated
with each bias condition as a function of game and player parameters. In the third
set of analyses, we relax many of the assumptions present in the first analysis and
test the relationships of interest across additional contexts including risk aversion,
power imbalance, and opponent arrogance. The results across all analyses are summarized
by fifteen propositions which show that, when effort is at all costly, underestimation
will provide the best net expected payoff when games are above some critical level
of complexity as well as when opponents have above some critical minimum level of
skill. The range of underestimation's advantage compared to overestimation can be
increased in contexts with high first mover advantage, when payoffs are cumulative
over time, when the player is risk averse, when there is an imbalance in power between
the players, and when the opponent exhibits arrogance. Furthermore, underestimation
can outperform overestimation even when effort is not costly when there is a power
imbalance between the players or when the player exhibits certain risk attitudes.
The results provide theoretical support for the ecological rationality of underestimation
bias by showing it to be advantageous under many conditions, particularly in comparison
to overestimation bias. It also provides managers with prescriptive insights regarding
when any opponent skill estimation error is more vs. less harmful, and when managers
may fare better in the long run if they don't spend too much time trying to think
through the competition's eyes..</p>
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