How did small business respond to unexpected shocks? Evidence from a natural experiment in China

We analyze how managerial beliefs about firm growth and business conditions change during unexpected shocks. Using the outbreak of the COVID-19 pandemic in China as a natural experiment, we conduct an at-scale quarterly tracking survey with the People’s Bank of China on small business managers about subjective responses and objective information about their firms’ conditions. We find that managerial beliefs are consistent with firms’ performance before the pandemic; managers tend to be optimistic and underreact during the peak while becoming pessimistic and overreacting after the peak. We show that the existence of moderates and anchoring effects may explain such alternations in managerial beliefs, and government policy support could effectively mitigate the negative shifts in these beliefs. Further, managerial biases formed during the pandemic might affect firms’ decision-making in the future, leading to unintended aggregate inefficiency.