Transitory Shocks, Limited Attention, and a Firm’s Decision to Exit*

This paper investigates the incidence of limited attention in a high-stakes business setting: a restaurant owner may be unable to purge transitory shocks from noisy profit signals when deciding whether to exit. Combining a 20-year quarterly panel on the alcohol revenues from every restaurant in Texas with weather data, we find that owners with pre-existing experience act as if they are able to account for past transitory shocks in the right direction: Given the same revenue record, restaurants with experienced owners are more likely to exit after unusually good weather (and stay in business after unusually bad weather). Driven by this evidence, we formulate and estimate a structural model in which owners have heterogeneous costs of paying attention to transitory shocks, thus misinterpreting revenue signals. Our results show that the owners’ pre-existing experience substantially reduces the costs of paying attention to transitory shocks. For the 25,283 restaurants in our data, a median restaurant with three years’ owner experience has the cost of paying attention lowered by roughly $900 per quarter. Because exit decisions are permanent, experience is especially useful in reducing welfare loss due to premature exit decisions when the restaurant is hit with negative shocks.