When Competencies Are Not Core: Self-Confirming Theories and the Destruction of Firm Value

Abstract:     
In this paper, I identify and examine a class of normative theories that may cause rational managers to inadvertently destroy firm value in equilibrium. The problem occurs when firms take prescribed actions that result in the outcomes predicted by the theory, even though the theory rests upon premises that are, in general, false. Such theories are called "self-confirming." More specifically, I develop a differentiated-products model and prove, by way of motivating example, that the "resource-based view"--a prescriptive theory of horizontal differentiation that is widely respected by both business practitioners and academic researchers in the field of strategy--has this self-confirming property. The existence of self-confirming theories is cause for careful consideration: an industry in which the adoption of such theories is widespread will operate well away from its efficient frontier. By their very nature, inefficiencies resulting from self-confirming behavior are resistant to empirical identification.

Number of Pages in PDF File: 54

JEL Classification: C7, D2, D8, L1, L2

working papers series