The Rise in Profits and Fall in Firm Entry: A Tale of the Life Cycle of Profits

Abstract

It is crucial to consider how profits vary over the life cycle of the firm in order to understand why the aggregate profit share has been increasing while firm entry has been declining. All else equal, the more back-loaded profits are, the lower is the value of the firm due to discounting. Therefore, fewer entrepreneurs choose to enter the market, leading to an increase in average profits per firm as market shares are increasing. Under some conditions, this fall in entry also leads to an increase in the aggregate profit share. Empirically, profits have become more back-loaded. Using a quantitative life cycle model of the firm with varying markups I find that this increase in back-loadedness explains between half and all of the rise in profits, and more than fully explains the fall in firm entry.