Systematic Differences and Random Rates: Reconciling Gibrat's Law with Firm Differences

Forthcoming, Strategy Science

31 Pages Posted: 15 May 2017

See all articles by Thorbjorn Knudsen

Thorbjorn Knudsen

University of Southern Denmark - Department of Marketing & Management - Strategic Organization Design Unit (SOD)

Daniel Levinthal

University of Pennsylvania - Management Department

Sidney G. Winter

University of Pennsylvania - Management Department

Date Written: March 2017

Abstract

A fundamental premise of the strategy field is the existence of persistent firm level differences in resources and capabilities. This property of heterogeneity should express itself in a variety of empirical “signatures”, such as firm performance and arguably systematic and persistent differences in firm level growth rates, with low cost firms outpacing high cost firms. While this former property of performance differences is a robust regularity, the empirical evidence on firm growth and Gibrat’s Law does not support this later conjecture. Gibrat’s Law, or the “law of proportionate effect,” states that, across a population of firms and over time, firm growth at any point is, on average, proportionate to firms’ size. We develop a theoretical reconciliation of evidence that suggests firm growth may in early stages of an industry history have a systematic component but for much of an industry’s and firm’s history should have a random pattern consistent with the Gibrat property. The intuition is as follows. In a Cournot equilibrium, firms of better “type” (i.e., lower cost) realize a larger market share, but act with some restraint on their choice of quantity in the face of a downward sloping demand curve and recognition of their impact on the market price. If firms are subject to random firm-specific shocks, then in this equilibrium setting a population of such firms would generate a pattern of growth consistent with Gibrat’s Law. However, if a broader evolutionary dynamics of firm entry, and the subsequent consolidation of market share and industry shake-out is considered, then during early epochs of industry evolution, one would tend to observe systematic differences in growth rates associated with firm’s competitive fitness. Thus, it is only in these settings far from industry equilibrium that we should see systematic deviations from Gibrat’s Law.

Keywords: Industry Evolution, Evolutionary Economics

JEL Classification: L10, L22

Suggested Citation

Knudsen, Thorbjorn and Levinthal, Daniel A. and Winter, Sidney G., Systematic Differences and Random Rates: Reconciling Gibrat's Law with Firm Differences (March 2017). Forthcoming, Strategy Science. Available at SSRN: https://ssrn.com/abstract=2967815

Thorbjorn Knudsen

University of Southern Denmark - Department of Marketing & Management - Strategic Organization Design Unit (SOD) ( email )

Faculty of Social Sciences
Campusvej 55
DK-5230 Odense
Denmark

HOME PAGE: http://www.sdu.dk/sod

Daniel A. Levinthal (Contact Author)

University of Pennsylvania - Management Department ( email )

The Wharton School
Philadelphia, PA 19104-6370
United States
215-898-6826 (Phone)
215-898-0401 (Fax)

Sidney G. Winter

University of Pennsylvania - Management Department ( email )

The Wharton School
Philadelphia, PA 19104-6370
United States

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