Profitability and the Lifecycle of Firms

Abstract

Using data on private and public firms, this study documents that profitability follows a hump shape over the lifecycle of a firm. Profitability rises with age for young firms, remains elevated, and then declines slowly for mature firms. A dynamic lifecycle model captures the observed age profile of profitability. Investment in product development generates profitability increases for young firms while wage pressures from more productive entrants lead to profitability declines for mature firms. The model generates the lifecycle behavior of financing and growth documented in the literature, even though it contains no financial frictions. It also implies greater sensitivity of financing and growth to age for young firms, a prediction supported by empirical tests. Taken together, these findings indicate that profitability dynamics influence the financing and growth of firms over the lifecycle.

Keywords: Firm lifecycles, Profitability, Quality ladder, Financial frictions

JEL Classification: D92, G31, E22, L20