Institutional Memory, Inertia and Impulsiveness

Ivo Welch and David Hirshleifer

No 2-94., Finance from University of California at Los Angeles

Abstract: This paper examines how imperfect institutional memory affects organizational decisions. In our model, a manager knows his firm's previous actions but (owing, e.g., to turnover) not the rationale for these actions. If the environment is stable, we find that a firm that has followed an old policy long enough and then loses memory generally should optimally exhibit excess inertia, defined as a higher probability of following old policies than a full-recall firm. On the other hand, if the environment is volatile or if firm has followed its prior policy only briefly, previous decisions are not very informative, and the firm can exhibit excess impulsiveness (i.e., be more prone to follow new information signals). This suggests that organizational routines and cultural norms should be more extensive and effective in stable environments than in volatile ones. The model implies relationships among observable variables such as the frequency of policy changes, managerial turnover, the quality of record-keeping, the history of project choices, and the volatility of the external environment.

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