Federal Reserve Bank of Minneapolis Working Paper No. 657
46 Pages Posted: 24 Feb 2008
Date Written: February 2008
Given a common technology for replicating blueprints, high-quality blueprints will be replicated more quickly than low-quality blueprints. If quality begets quality, and firms are identified with collections of blueprints derived from the same initial blueprint, then, along a balanced growth path, Gibrat's Law holds for every type of firm. A firm size distribution with the thick right tail observed in the data can then arise only when the number of blueprints in the economy grows over time, or else firms cannot grow at a positive rate on average. But when calibrated to match the observed firm entry rate and the right tail of the size distribution, this model implies that the median age among firms with more than 10,000 employees is about 750 years. The problem is Gibrat's Law. If the relative quality of a firm's blueprints depreciates as the firm ages, then the firm's growth rate slows down over time. By allowing for rapid and noisy initial growth, this version of the model can explain high observed entry rates, a thick-tailed size distribution, and the relatively young age of large U.S. corporations.
Keywords: Gibrat's Law, firm age and size distribution, capital accumulation
JEL Classification: L110, O400
Suggested Citation: Suggested Citation
Luttmer, Erzo G. J., On the Mechanics of Firm Growth (February 2008). Federal Reserve Bank of Minneapolis Working Paper No. 657. Available at SSRN: https://ssrn.com/abstract=1096769 or http://dx.doi.org/10.2139/ssrn.1096769