Technological opportunity and the growth process of firms

Journal of the Academy of Business and Economics, Jan, 2004 by Arun K. Mukhopadhyay, Sal AmirKhalkhali

ABSTRACT

The question of whether the growth process of firms is best explained by identifiable systematic influences, or by an essentially random process, is an important one in the literature on market structure. Within this context, the issue of whether firm size has a systematic influence on the growth rate of a firm has been the subject of extensive empirical studies. This paper attempts to re-examine the firm's size-growth relationship using data on large firms in the USA over the 1994-2000 period. The overall empirical results emanating from this study point to a tendency for the smaller firms to grow faster, and this tendency is stronger for industries facing greater technological opportunity.

1. INTRODUCTION

Is the growth process of firms best explained by identifiable systematic influences, or is it essentially a random process? Numerous studies have dealt with this empirical issue which was first addressed by Gibrat. Robert Gibrat demonstrated in his 1931 book that the skewed distributions of enterprise and plant sizes in the French manufacturing establishments can be explained very well by a random growth process. This assumption of random growth has been subsequently christened the "Gibrat's law"; see Sutton (1997) and Caves (1998) for discussions on the theory and empirical studies.

Gibrat's law implies that with a random growth process, the expected growth rate is independent of a firm's size and other identifiable firm and industry characteristics. The issue of whether firm size has a systematic influence on the growth rate of a firm has been the subject of extensive investigation in empirical studies because this size-growth relation is most directly involved in explaining the size-distribution of firms. Following Simon (1955), several studies have used the Gibrat's law to explain the size-distribution of the large firms in the United States. See, for instance, Iriji and Simon (1974) and Vining (1976). In an empirical study, AmirKhalkhali and Mukhopadhyay (1993)investigated the validity of Gibrat's law, examining both the growth rates and the size-distributions of firms, for the large firms in the USA during the 1965-1987 period. The focus in that study was whether research and development (RD) activities and the resulting technological competition imply a qualification of Gibrat's law, that is, whether the size-growth relationship and the consequent size-distribution of firms depend on whether or not the firms are operating in RD- intensive industries. The overall conclusion of the study was that smaller firms tend to have an advantage in the growth process and that this advantage is more pronounced in the industries offering greater technological opportunities. This paper extends the investigation of the size-growth relationship to the 1994-2000 period.

2. TECHNOLOGICAL OPPORTUNITY AND THE SIZE-GROWTH RELATIONSHIP

The basic stylized fact resulting from the various empirical studies on Gibrat's law is that the law does not exactly hold: large firms have a tendency to grow slower while they have a greater propensity to survive, although there is support for Gibrat's law in some studies. As examples, Evans (1987) reported a negative relation between size and growth rate for a large sample of U.S. firms, while Hall (1987), also studying U.S. firms, found that Gibrat's law held for the larger firms, but size had a weak positive effect on growth for the smaller firms. This lack of robustness in empirical results on the size-growth relationship is also evident from the U.K. data: Kumar (1985) found a weak negative effect of size on growth, and the study by Singh and Whittington showed a mildly positive relationship. Studies involving the large international firms (Droucopoulos (1982, 1983), Buckley, Dunning, and Pearce (1984)) similarly reveal conflicting results on the size-growth relationship. In a more recent study, Hart and Oulton (1996) found from a large data base for the U.K. during 1989-93, that among the surviving companies during this period, only the very small companies (those with no more than 8 employees) grew faster; among the remaining companies there was little tendency for the proportionate growth of the firm to vary with its size.

While the studies on Gibrat's law have essentially focussed on whether or not firm size has a systematic effect on firm growth, the central issue of our inquiry is to find out whether the size-growth relationship is influenced by the process of RD in the technologically competitive industries. The basis of suspecting such an influence is rooted in the well-known Schumpeterian hypothesis. This hypothesis suggests that bigger firms have an advantage in the RD process in that these firms enjoy an economy of scale in the RD effort and also have a superior ability to exploit the results of research (Schumpeter(1950); Kamien and Schwartz(1982)). It is reasonable to expect that this Schumpeterian research advantage would lead to a faster growth for the bigger firms, and that this phenomenon would be evident in the technologically progressive (RD-intensive) industries, whereas the non-RD-intensive industries will be largely unaffected by this size--advantage of research and development. Thus, the size--growth relationship would be different between these two groups of industries. The simulation models formulated by Nelson and Winter (1978, 1982a, 1982b) are examples of this expected outcome, where the larger firms have a higher expected growth rate that is attributable to their research advantage in technological competition. In the present paper, we test for this group-specific difference in the size-growth relationship arising out of the Schumpeterian hypothesis.