Tardy Learning, Cognitive Biases, and SMEs' Decision-Making

This paper examines the cognitive biases in small and medium-sized enterprise (SME) managerial beliefs under exogenous shocks and investigates whether such biases affect firms’ decision-making in the future. We use unique administrative survey data spanning the outbreak of COVID-19 in China and find managers have significant cognitive biases due to a delayed and rigid response to learning new information in the huge unexpected changes. Specifically, before the exogenous shock, overall managers hold consistent beliefs in their enterprises’ performance; while faced with the epidemic, managers tend to be optimistic and underreact during the peak, becoming pessimistic and overreacting during the weakened, as the managers failed to realize the negative impact of pandemic, and the government’s ability to control the pandemic. In addition, such an asymmetric bias in managerial cognition diminished when uncertainty decreases. We show the existence of moderates and an anchoring effect under imperfect information may explain the underreaction and overreaction; further, negative cognitive biases affect firms’ decision-making in the future, while government’s support and financial relief can effectively mitigate the negative cognitive biases