A Model of Operational Slack: The Short-Run, Medium-Run, and Long-Run Consequences of Limited Attention
48 Pages Posted: 2 Jan 2007 Last revised: 9 Dec 2016
Date Written: October 31, 2008
This paper studies institutions, such as firms, in which multiple projects can require attention at unpredictable times. Firms respond optimally by limiting the number of projects they simultaneously undertake (medium-term) and by acquiring attention capacity (long-term). The most interesting implications relate to a variable that would otherwise be interpreted as the sign of an agency conflict: idleness (operational slack). In our full-information model, it is optimal for the institution to be idle some of the time. In the medium-term and long-term, when firms respond optimally, they tend to idle *more* when projects require "more" attention and when they have "less" attention capacity. Moreover, natural model extensions suggest that managers who want to signal higher quality or who are overly optimistic take on too many projects. This can explain overinvestment and the diversification discount even when managers are not agency-conflicted.
Keywords: Attention, Project Choice, Slack, Overinvestment, Diversification Discount
JEL Classification: L2, G2, G31
Suggested Citation: Suggested Citation