Karthik Sastry, Professor, Harvard University
Abstract: We document that, in aggregate downturns, US public firms’ attention to macroeconomic conditions rises and the size of their input-choice mistakes falls. We explain these phenomena with a business-cycle model in which firms face a cognitive cost of making precise decisions. Because firms are owned by risk-averse households, there are greater incentives to deliver profits by making smaller input-choice mistakes when aggregate consumption is low. In the data, consistent with our model, financial markets punish mistakes more in downturns and macroeconomically attentive firms make smaller mistakes. Quantitatively, attention cycles generate asymmetric, state-dependent shock propagation and stochastic volatility of output growth.