Newswise — Firm growth drives job creation and allocation of resources. The importance of particular modes of growth, their inter-relationships, and their relation to future performance is vital for understanding how firms and industries evolve. In a new study, Jagadeesh Sivadasan, professor of business economics and public policy, provides an in-depth analysis of firm growth and offers new insights into the relative importance and impact of organic and transactional modes of growth.
The paper “How do US firms grow? New evidence from a growth decomposition” explores employment growth data from all U.S. companies from 2004 to 2013. In examining the data, Sivadasan and his collaborators found that organic growth strategies, such as opening new plants or expanding existing operations, play a more significant role in growth compared to transactional growth strategies, such as mergers, acquisitions, and selloffs. However, transactional growth modes are more positively correlated with future survival.
The research is particularly impactful as the study covers growth data from the 2008 financial crisis and provides a unique perspective on what growth factors help create a more healthy and stable economy.
Sivadasan shared a few insights into this research in the following Q&A.
How do your findings differ from previous understandings of growth modes?
We examine data for all firms in the U.S. economy in a framework that allows for a comprehensive examination of growth modes to make several novel contributions.
We document that different modes are generally complements, which suggests that the typical growth story involves a firm facing opportunities trying to grow through all available modes, as opposed to a view where a firm focuses on one mode, say acquisitions, at the expense of others, e.g., new establishments.
In response to competition, primarily from the reduction of tariff barriers to Chinese imports, we find that firms reduce size through multiple modes: shrinkage of existing (old) establishments, reduction in acquisitions, greater closures, and greater selloffs. Interestingly, there is no decline in growth from new units, suggesting that firms continued to experiment.
Finally, comparing firms in the same sector and of the same size, we find that the ones that grew more through transactional growth have stronger future growth and survival.
We saw a major financial crisis in 2008. In your data, how did this phenomenon affect growth modes?
While we do not present these results in our paper, our data show several interesting patterns following the Great Recession. Of course, overall employment growth was negative in 2009 and 2010, and recovery was slow. The bulk of the decline in growth came from layoffs in continuing establishments. Interestingly, there was less job loss from closures compared to pre-2008 levels, but there was a significant slowdown in the entry of new businesses. We also find a steep fall in the volume of transactional modes. The results suggest the financial crisis reduced the available pool of buyers for businesses and assets, reducing the benefits from sales and closures.
What new patterns about the growth of firms across size and age categories does your study find?
A surprising finding is that among large firms, young firms show significantly slower growth than old firms. Although contrary to the conventional notion that younger firms grow faster, this aligns with Penrose’s pioneering work, which suggests that the size and growth of the firms are limited by managerial expertise. Thus, after a period of growth, firms can be expected to slow down as they need time to build up additional expertise. Among small firms, we find that older firms grow slower, which is in line with the conventional wisdom that entrants and young small firms are key sources of growth.
Could you elaborate on the significant correlation you found between transactional growth and future firm survival?
We find that transactional growth is significantly positively correlated with future growth and survival, whereas growth from organic modes is slightly negatively correlated with survival. One possible explanation is that more productive and larger firms attempt acquisitions. Another is that certain industries experience a period of consolidation from mergers and then experience growth. Our analysis controls for firm size and past growth, as well as industry-year effects. Thus, our findings suggest a positive causal effect of transactional growth, possibly through learning ideas or gaining capabilities or new resources from the acquired firms. But, it could also be that firms with certain capabilities expand through transactions, and those same capabilities help the firm succeed. We hope future research will help untangle the underlying mechanism for our findings.
How can your findings influence business or public policy leaders to develop overall growth?
A key focus of government policy is on supporting small businesses. In line with other recent work, our results suggest that small young businesses have the greatest scope for positive growth. At the same time, a broad reallocation of resources to younger firms is not advisable, as young firms that have achieved a large size experience significant negative growth on average. For managers, the positive link between transactional growth and future performance suggests that they may want to consider if acquisitions could be beneficial in their context. One caution here is that managing and integrating acquisitions is notoriously challenging, and any gains often go to the shareholders of the target company as acquirers frequently tend to pay too high a price.
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