Financial Markets and Firm Dynamics

Abstract

Recent studies of the relationship between firm size and growth have overturned the conclusion of Gilbert's Law that firm size and growth are independent. In this paper we analyze whether financial factors are important in generating a negative relationship between firm size and growth. We develop a general equilibrium model with firms that are heterogeneous in the amount of equity. The financing decisions of firms depends on the amount of equity they have. The model generates firm dynamics in which the production and investment behavior of small and large firms differs substantially, and the model replicates many of the key features of industry evolution: smaller and younger firms experience faster growth, lower survival rates and greater volatility of growth.

JEL Classification: G31, G32