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

See all articles by Peter Iliev

Peter Iliev

Pennsylvania State University - Department of Finance

Ivo Welch

University of California, Los Angeles (UCLA); National Bureau of Economic Research (NBER)

Date Written: October 31, 2008

Abstract

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

Iliev, Peter and Welch, Ivo, A Model of Operational Slack: The Short-Run, Medium-Run, and Long-Run Consequences of Limited Attention (October 31, 2008). AFA 2010 Atlanta Meetings Paper. Available at SSRN: https://ssrn.com/abstract=954150 or http://dx.doi.org/10.2139/ssrn.954150

Peter Iliev (Contact Author)

Pennsylvania State University - Department of Finance ( email )

348 Business Building
University Park, PA 16802
United States

Ivo Welch

University of California, Los Angeles (UCLA) ( email )

110 Westwood Plaza
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Los Angeles, CA 90095-1481
United States
310-825-2508 (Phone)

HOME PAGE: http://www.ivo-welch.info

National Bureau of Economic Research (NBER)

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