With Jeff Campbell, I am studying firm growth, learning, and survival.
Abbring, Jaap H., and Jeffrey R. Campbell (2005), “A firm's first year”, Discussion Paper 2005-046/3, Tinbergen Institute, Amsterdam. This paper is currently under major revision.
We aim to characterize the accumulation of information to entrepreneurs about their firms’ profitability and to assess the entrepreneurs’ effectiveness in selecting profitable firms for survival. To this end, we develop an econometric model that distinguishes processes at three information levels. Nature draws a profit-relevant parameter from a first-order autoregressive process. The agent (entrepreneur) only observes a noisy measure of this time-varying parameter and, when deciding on firm survival, uses Bayes’ rule to assess its value and predict his future profits (as in Jovanovic’s, 1982, model of industry evolution). The econometrician only observes the agent’s survival decisions and part of the state vector on which these are based. Thus, this model distinguishes between the agent’s and the econometrician’s ignorance about the state of nature. We provide identification results that show that the two can be empirically separated and empirical and computational methods that facilitate the model's application.
We apply this framework to the entry, growth, and survival of Texas bars, using monthly sales data on all mixed beverage licence holders from Texas Alcoholic Beverage Commission. We find that heterogeneity in firms’ pre-entry scale decisions accounts for about 40% of their sales’ variance; persistent post-entry shocks account for most of the remainder. We find no evidence of entrepreneurial learning. Variation of the firms’ fixed costs consistent with an annual lease cycle explains their exit rates. We use the estimated model to price a new bar’s option to exit, which accounts for 124% of its value.