On the Mechanics of Firm Growth
Federal Reserve Bank of Minneapolis Staff Report No. 440
Posted: 30 Mar 2010 Last revised: 2 Apr 2010
There are 2 versions of this paper
On the Mechanics of Firm Growth
Date Written: March 2, 2010
Abstract
The Pareto-like tail of the size distribution of firms can arise from random growth of productivity or stochastic accumulation of capital. If the shocks that give rise to firm growth are perfectly correlated within a firm, then the growth rates of small and large firms are equally volatile, contrary to what is found in the data. If firm growth is the result of many independent shocks within a firm, it can take hundreds of years for a few large firms to emerge. This paper describes an economy with both types of shocks that can account for the thick-tailed firm size distribution, high entry and exit rates, and the relatively young age of large firms. The economy is one in which aggregate growth is driven by the creation of new products by both new and incumbent firms. Some new firms have better ideas than others and choose to implement those ideas at a more rapid pace. Eventually, such firms slow down when the quality of their ideas reverts to the mean. As in the data, average growth rates in a cross section of firms will appear to be independent of firm size, for all but the smallest firms.
Keywords: Aggregate Growth, Firm Size Distribution, Gibrat's Law
JEL Classification: L1, O4
Suggested Citation: Suggested Citation