The Allocation of Limited Entrepreneurial Attention

Imagine a juggler on the “Ed Sullivan Show” who is rewarded according to the number of plates she can spin on the tips of long sticks on a table. The plates are targets of attention and the juggler allocates limited attention between respinning old plates and setting up new plates. Assume that there is an unlimited supply of plates and sticks (and tabletop). As soon as one plate is set spinning, the juggler can set up another one. However, as she continues to set up additional spinning plates, the first one starts to wobble, threatening to fall.

The limits of attention, which must be allocated among a given number of alternative uses, have been recognized by many economists. For example, a manager may want to allocate his or her attention between a number of projects or other sources of information. Or a manager may want to allocate employees’ attention among different tasks. However, in these models of allocating attention, the number of alternative uses to which attention may be allocated is exogenously given. When applied to the problems of innovation and product improvement, limited entrepreneurial attention is allocated between improving the declining profitability of current operations and increasing the number of current operations. The allocation of entrepreneurial attention endogenizes the number of current operations and the opportunity costs of attention. The optimal allocation of entrepreneurial attention thus determines the size of the firm, its rate of growth and the firm’s level of innovative activity.

Although limited attention and the problem of its allocation has been recognized by many economist, attempts to model this problem have assumed a given number of activities among which attention is to be allocated. The model of limited entrepreneurial attention remedies this shortcoming of previous models by modeling the adoption of new activities as one of the targets of attention. This has two primary implications. The number of activities becomes endogenously determined by the optimal allocation. This allows the model to address issues of the optimal number of activities and its dependence on the parameters of the model. In addition, the opportunity cost of attention becomes endogenously determined because the values of alternative targets of attention depend on the allocation of attention.

Limited entrepreneurial attention plays a critical role in the ability of a firm to innovate new products and to maintain the profitability of current product lines. When the entrepreneur is responsible for decisions concerning both the innovation of new products and the maintenance of current products, then one of the costs of innovation is the opportunity cost of the entrepreneur’s time. This opportunity cost is caused by the neglect of current operations and the resulting loss of profits. This loss of profits may be due to the entry of competing products from other firms, changes in consumer tastes or any number of other causes. If the ability of the entrepreneur to improve the profitability of current products is sufficiently high, relative to the ability to innovate new products, then these current operations distract the entrepreneur from innovating new products. If this is the case, then as the number of current operations increase, the entrepreneur has less time to devote to innovating new products. If the profitability of current operations declines slowly when neglected, then the diversion of the entrepreneur’s attention away from innovation is less frequent. This allows the entrepreneur to more innovative.

This chapter addresses the choice of career for entrepreneurs with limited and heterogeneous abilities in both acquiring projects and maintaining them after adoption. Entrepreneurial ability is defined as the ability to recognize a new profit opportunity and to acquire resources, including financing, to begin the exploitation of the opportunity. Managerial ability is defined as the ability to maintain the profitability of current operations, that is, to manage projects after they have been adopted. Without any assumption of risk aversion or liquidity constraints, the endowments of entrepreneurial and managerial abilities determine the career choices of individuals between becoming an innovative entrepreneur who conducts only new product innovation, a managerial entrepreneur who conducts both new product innovation and product improvement, or a salaried employee.

One of the critical roles for the entrepreneur in successfully starting a new firm and introducing new products or services is to mobilize the necessary resources. These activities include hiring employees and lining up suppliers of intermediate goods and services. Both of these activities involve contracting with other parties. Therefore, the issues dealt with in the economics of contracting are of great importance to a theory of entrepreneurship. One of these issues is the implication of incomplete contracts. Although there is a vast literature on this topic, the approach of most of this literature is to assume that the contract already exists and that it is incomplete due to exogenous contracting costs, unforeseen contingencies or indescribable states.

This chapter addresses a critical problem for the entrepreneur: whether to “make or buy”; that is, the question of the internalization of transactions. This topic appears in the economic literature under the various headings of transaction costs, the theory of the firm, organization theory, vertical integration and the theory of contracts.⁴⁰ This chapter offers a new approach to the question of the internalization of transactions which depends the endogenous costs of contracting internally and over markets. However, the issue of internalizing transactions immediately raises the questions of what is a firm and what distinguishes internal transactions from market transactions.⁴¹

This chapter analyzes the venture capitalist’s incentives to maximize the profits of the entrepreneurs of ventures and the limited partners of a venture fund. Venture capital is a professionally managed pool of capital invested in equity-linked private ventures. Venture capitalists are actively involved in the management of the venture to assure its success. Venture capitalists are general partners and outside investors are limited partners. Venture capital contracts have three main characteristics: 1) staging the commitment of capital and preserving the option to abandon, 2) using compensation systems directly linked to value creation 3) preserving ways to force management to distribute investment proceeds.

Independent contractors, such as lawyers, architects, builders and accountants, often have numerous, long-term customers who require a great deal of personal attention. A fundamental problem for independent contractors is balancing the desire to fulfill the needs of current customers while at the same time acquiring new customers. A common complaint among customers of independent contractors is that the customer feels that that he or she is not receiving the desired amount of attention from the independent contractor.

The study of the optimal allocation of entrepreneurial attention is in its infancy. The breadth of its applicability is only hinted at in the previous chapters. In this final chapter I will suggest some additional economic problems to which the model may be applied. Some of these applications are already underway. In addition, I will suggest some extensions of the model that will broaden its applicability and realism.