The Relationship Between Firm Size and Firm Growth in the US Manufacturing Sector

Abstract

This paper investigates the dynamics of firm growth in the U. S.manufacturing sector in the recent past. I use panel data on thepublicly traded firms in the U. S. manufacturing sector: from auniverse of approximately 1800 firms in 1976, I am able to follow mostof them for at least three years, and over half of them from 1972 until1983. I consider several problems, both econometric and substantive,which exist in analyzing this kind of data: the choice of size measure,the role of measurement error, and the effect of selection (attrition)on estimates obtained from this sample.Using time series methods, suitably modified for panel data (wherethe number of time periods per observational unit is small), I analyzethe behavior of employment over time and find that most of the change inemployment in any given year is permanent in the sense that there is notendency to return to the previous level. Year-to-year growth rates arelargely uncorrelated and there is almost no role for measurement error.I find that Gibrat's Law is weakly rejected for the smaller firms in mysample and accepted for the larger firms; Other measures of sizeproduce essentially the same results.Correction for attrition from the sample changes the resultssomewhat: I use a simple model in which firms leave the sample becausethey are small and/or undervalued (since many exits are acquisitions)and find that Tobin's Q, the raio of market valuation to the value ofthe underlying assets of the firm, is a much better predictor of exitprobability than size alone (firms with low Q are more likely to exitthe sample). When I use this estimate of the probability of exit tocontrol for selection bias, Gibrat's Law is weakly rejected for firms ofall sizes and there are significant positive effects on firm growth fromboth investment in physical capital and R&D expenditures, with R&Dhaving a somewhat higher net effect.