Locus of Control and Business Formation

Abstract

This paper brings the insights from management to firm dynamics literature and introduces the notion of locus of control, according to which entrepreneurs can direct their startup efforts toward projects with different target sizes. Firm-level data from the U.S. reveal that businesses which eventually become large tend not to be started in recessions, and that financial conditions at birth are critical for the formation of such enterprises. A version of a standard firm dynamics model with financial frictions and the ability of potential entrepreneurs to choose their target size can account for the data. In the estimated model, financial frictions slow the rate at which growth-oriented businesses expand disproportionately; this discourages entrepreneurs from pursuing such ideas in recessions. From the policy perspective, I highlight the importance of improving the quality of startups rather than increasing their quantity.

Keywords: Business cycles, firm dynamics, financial frictions

JEL Classification: E22, E32, H25