Adaptive Rationality in Strategic Interaction: Do Emotions Regulate Thinking about Others?

Forming beliefs or expectations about others' behavior is fundamental to strategy, as it co-determines the outcomes of interactions in and across organizations. In the game theoretic conception of rationality, agents reason iteratively about each other to form expectations about behavior. According to prior scholarship, actual strategists fall short of this ideal, and attempts to understand the underlying cognitive processes of forming expectations about others are in their infancy. We propose that emotions help regulate iterative reasoning, that is, their tendency to not only reflect on what others think, but also on what others think about their thinking. Drawing on a controlled experiment, we find that a negative emotion (fear) deepens the tendency to engage in iterative reasoning, compared to a positive emotion (amusement). Moreover, neutral emotions yield even deeper levels of iterative reasoning. We tentatively interpret these early findings and speculate about the broader link of emotions and expectations in the context of strategic management. Extending the view of emotional regulation as a capability, emotions may be building blocks of rational heuristics for strategic interaction and enable interactive decision-making when strategists have little experience with the environment.