Entry, Gibrat's Law, Innovation, and the Growth of Firms

Using econometric results and models, Mansfield contributes toward the understanding of the dynamic aspects of an industry's composition and structure, especially the birth, growth, and death of firms. First, the paper constructs some simple models to estimate the effects that the capital requirements and profitability of an industry have on its entry and exit rates. Then it investigates how well Gibrat's law of proportionate change in firm growth, which has been tested only a few times against data for very large firms, represents the growth of firms. Gibrat's law holds that the probability of a proportionate change in size during a period is the same for all firms in a given industry. Three formulations of the law are tested against data from the steel, petroleum, and rubber tire industries. For all three versions, Gibrat's law holds in fewer than half the cases; there is an inverse relationship between a firm's chance of death and its initial size, and smaller firms have higher and more variable growth rates than larger ones. A previous study found that the effect of successful innovation on growth rate was greater for a small firm than a large one (the average effect being to raise growth rate by 4% to 13%). After estimating the effects of significant innovations on the mobility (change in relative positions in size distribution) and rewards of firms, the paper presents and tests a simple model accounting for successful innovators, to explain which firms change relative position in size distribution of an industry. Available evidence fits the model very well. Overall, the study contributes to a better understanding of the processes of firm formulation, growth, and decline, yielding a richer theory of the dynamic aspects of industrial structure. (TNM)