How Do Firms Choose Between Growth and Efficiency?

Abstract

This paper explores the relation between firms’ growth and efficiency. To measure it, our approach treats productive efficiency as a deliberate choice made by firms, as opposed to taken as given by the firm and estimated as a residual. In our model, firms choose capital and labor jointly with effort to make these inputs more productive. Fitting the model to the data, we obtain granular estimates of firms’ unobservable efficiency and find that young firms prioritize growth, while older firms focus more on efficiency. Over time, firms tend to shift their emphasis towards efficiency. Among young firms, those that pursue high growth tend to achieve higher markups, but also face a greater risk of failure. Our analysis sheds light on the factors that influence firms’ growth and efficiency strategies and their implications.

Keywords: Efficiency, growth, short-term effort, investment, estimation

JEL Classification: D25, G31, O40