The effect of firm formation and growth on job creation in the United States

This paper demonstrates the importance of new firm formation to economic growth. It begins by providing data that describe the United States as having had greater employment growth than most developed nations of the world over the last 25 years, and focuses upon why job growth in the United States has exceeded that of other nations.Job Creation by Firm Size. We first examine the data on the relative contribution of small and large firms to U.S. job growth. By summarizing research that is uniformly expressed in two-year periods and defines small firms as those with less than 100 employees, conclusive evidence emerges that small firms are the major sources of net new creation.Firm Entry/Exit Rates and Economic Growth. Further understanding of small firm job creation is obtained when we examine firm entry and exit data. Here we find that firm entry rates vary considerably from period to period (range: 10.4%–12.5%), whereas exit rates remain relatively stable from period to period (range: 9.6%–10.4%). Thus, variation in entrepreneurial activity—the formation of new firms—is the major cause of net increases in the number firms. In both the United States and the United Kingdom, net firm increases are positively related to overall economic activity.Firm Entry/Exit and Job Creation. Further exploration of this correlation can be conducted by examining job creation and loss defined by source: entries, expansions, exits, and contractions. The data for 1976 through 1984 shown here demonstrate that new entries account for 74.0% of the 50.8 million new jobs created. Expansions of existing firms accounted for 26.0%. Small firms (less than 500 employees) produced 54.6% of the entry jobs and 56.8% of the expansion jobs.On the other hand, job losses totaled 33.8 million, 79.0% due to exits and 21.0% to contractions. Small firms account for 53.6% of the jobs lost from exits and 47.8% of those lost from contractions. Overall, small firms account for 60.5% of the 17.0 million net new jobs.Given the data that show correlation between net firm formation rates and economic growth, the finding that entry rates vary more than exit rates, and the finding that new entries create most of the new jobs, it can be concluded that firm formation—especially small firm formation—is a significant factor in economic growth. Increases in small firm formation rates have a significant effect on net job creation.Schumpeter's Model and Observed Market Turbulance. Another finding from this data on job creation by entry, expansion, exit, and contraction is the large amount of job creation and destruction activity taking place. For the period studied, three jobs were created and two jobs destroyed for each net new job created. This describes a turbulent job market with many workers moving from job to job. The labor markets are much less stable that normally envisioned.This observed phenomenon fits well with Schumpeter's theory of capitalism; he proposes that capitalistic growth occurs because entrepreneurs use innovations to form new firms which enter existing markets. When successful, these growing new firms destroy existing market structures, causing decline of established firms while creating increased demand and producing overall economic growth. If Schumpeter is correct, one would expect to find high rates of firm formation and failure, and large numbers of jobs created by new firms, while many jobs are lost by exits and contractions of established firms. The findings reported here show this.Government Policy Affects on Entry/Exit. Our results also show that formation of small, new firms is a necessary requirement for economic growth. Historically, however, Government policy has not considered small firm entry as a central issue. Thus, government policies can and have had a negative effect on entry rates and therefore upon economic growth rates.Furthermore, high rates of new firm formation cause a great deal of turbulence in labor markets, with three jobs created and two lost for every one net new job. Such labor turbulence may be seen by policy makers as undesirable as it entails considerable worker movement from job to job. As such, policy makers have recently proposed policies to protect workers from job loss due to contractions and exits. However, such protection policies, as demonstrated in recent European experience, will also construct barriers to entrepreneurial entry. The result may be a decline in small firm entry and a decline in economic growth.Instead of protecting specific jobs, appropriate policies are those that facilitate movement of workers from job to job. Adequate unemployment compensation for short term unemployment, fully vested and portable pension plans, and retraining programs are examples of policies that allow the labor market to remain flexible while reducing the negative effect on those who lose jobs.     

The Extent of Overestimation of Small Firm Job Creation – An Empirical Examination of the Regression Bias

Davis, Haltiwanger and Schuh (1993; 1996a; 1996b) suggested that the belief that small firms are major contributors of new jobs is largely based on methodological flaws. In particular, their reasoning about the "regression fallacy", i.e., that temporary fluctuations in size systematically biases estimates in favor of small firm job creation, has caught on interest among researchers and concern among policy makers. In this article we attempt to estimate empirically the extent of overestimation of small firm job creation due to the "regression fallacy". It is concluded that the effect is very small and that correcting for it does not lead to qualitative change of the results. There may be good reasons to question to what extent small firms can lead economic development, and whether it is good or bad if they do create most new jobs, but concern for the "regression fallacy" does not seem to be an important issue in this context.     

Job Creation by Company Size Class: The Magnitude,Concentration and Persistence of Job Gains and Losses in Canada

The statistical observation that small firms have created the majority of new jobs during the 1980s has had a tremendous influence on public policy. Governments have looked to the small firm sector for employment growth, and have promoted policies to augment this expansion. However, recent research in the U.S. suggests that net job creation in the manufacturing small firm sector may have been overestimated, relative to that in large firms.The first part of this paper addresses various measurement issues raised in the recent research, reassess the issue of job creation by firm size, and pushes this work beyond the manufacturing sector by employing longitudinal data covering all companies in the Canadian economy. We conclude that over the 1978–92 period, as a group small firms did account for a disproportionate share of both gross job gains and losses, and net employment increases, no matter which method of sizing firms is used. Measurement does matter, however, as the magnitude of the difference in the growth rates between small and large firms is very sensitive to the measurement approaches used. Part one of the paper also produces results for various industrial sectors, and examines employment growth in existing small and large firms (i.e., excluding births). It is found that employment growth in the population of existing small and large firms is very similar. Attempts are made to introduce a job quality aspect to the analysis by using payroll rather than employment data. Payroll data allow any relative change in hours worked or wages paid in small (relative to large) companies to be incorporated in the findings. This did not significantly alter the conclusions reached using employment data only.The second part of the paper looks at concentration and persistence of employment creation and destruction within size classes. If growth is highly concentrated, knowing that a firm is small will provide little information about its prospects for growth. Most small firms would grow relatively little, or decline, while a few expanded a lot. It is found that both job creation and destruction is highly concentrated among relatively few firms in all size groups. There are fast growing firms in all size classes, and although most job creation is found in the small firm sector, the fastest growing large firms out-perform the majority of small firms in any given period. Finally, the employment creation performance of businesses are compared over two three-year periods. It is found that knowing that a firm is a high performer (in terms of jobs created) over one period is of only limited value in determining growth in the second period. This is particularly true among small firms. These results suggest that firms which expand rapidly during one period are replaced to some considerable degree by others in the subsequent period.     

Employment Creation in Small Technological and Design Innovators in the U.K. during the 1980s

This paper provides rare empirical evidence on employment creation by innovative small firms in the U.K. over the eleven years between 1980 and 1991. Drawing on a database of firms which were recognised as having introduced important innovations, the paper examines the extent of employment growth in these companies and compares their growth with that discovered by other studies of small firms in the U.K. This shows that the innovative firms have grown at a significantly faster average rate than small firms generally. Some of the factors associated with employment change in small firms are assessed. This shows that the initial size, age, sector of activity and type of innovation introduced by the firms were all associated with differences in their average rate of growth. The employment created was, however, highly concentrated in a few firms, but even the fastest growing of these companies (directly) created hundreds rather than thousands of new jobs over the period of analysis.     

The Evaluation of Innovation Capabilities in Small Software Firms: A Methodological Approach

This paper presents a methodological approach for the evaluation of innovation capabilities in small software firms. The methodology is based on the assumption of a relationship between specific resources managed by small software firms and their innovation capabilities. Within the proposed methodological approach, a model for the quantitative analysis of innovation capabilities is presented. In order to show how the methodology can be applied to concrete situations, three case studies of small firms operating in the software sector and information services are presented and discussed.     

Job Creation and Job Destruction by Small Firms: An Empirical Investigation for the Dutch Manufacturing Sector

This paper studies the differences in behaviour of small and large firms, concerning job creation and job destruction, in the Dutch manufacturing sector over the period 1978–1991. We find that both job creation and job destruction rates are higher in small firms than in large ones. In addition, we found that the persistence of jobs created in slumps are much higher for small firms than for large firms. Persistence rates of job destruction are, however, less connected to the state of the business cycle and increase with firm size. More importantly, small firms seem to reallocate their jobs in a continuous way, as job turnover moves independent of the business cycle. Large firms, on the other hand, reallocate counter-cyclically. An obvious explanation for this phenomenon is that small firms are better equipped to adjust to shifts in economic circumstances. Large firms adjust only slowly and for them reallocating jobs in a recession is more advantageous than in a boom.     

Effects of Concentrated Ownership and Owner Management on Small Business Debt Financing*

Using unique data and a new powerful Monte Carlo-based statistical tool, we examine the effects of concentrated ownership and owner–management (CO-OM) on the creditor–shareholder agency conflicts in small firms. A significant CO-OM effect from the small business owner's view, but insignificant from the commercial lenders' perspective, is found. Special features of informational asymmetry problems in small firms with CO-OM are also highlighted. Theoretical and empirical contributions are made to the small business management and corporate governance literature. Findings obtained from this research have important implications for small business practitioners as well as researchers, and this study can serve as a reference for policymakers and institutional lenders to assist small firms in successfully raising money through debt financing. In addition, a new powerful methodology is introduced to deal with various potential statistical biases and can be further applied to this line of research.     

Gazelles as job creators: a survey and interpretation of the evidence

It is often claimed that small and young firms account for a disproportionately large share of net employment growth. We conduct a meta-analysis of the empirical evidence regarding whether net employment growth rather is generated by a few rapidly growing firms—so-called Gazelles—that are not necessarily small and young. Gazelles are found to be outstanding job creators. They create all or a large share of new net jobs. On average, Gazelles are younger and smaller than other firms, but it is young age more than small size that is associated with rapid growth. Gazelles exist in all industries. They seem not to be overrepresented in high-technology industries, but there is some evidence that they are overrepresented in services.     

Change in the size distribution of UK firms

This paper examines the extent of change and stability in the population of UK firms through time in terms of its size distribution, as defined by number of employees. It was empirically found that the distribution of employment by firm size remained surprisingly constant over the 1987–1989 period. A major implication of this finding is that in times of very high net job creation (involving high gross job creation and loss), factors are at work in the economy to keep the population distribution of firms (in terms of employment concentrations) more or less stable. It is hypothesised that a natural concentration exists for each different size band, and that as change takes place, the proportion of total employment based in the size band will tend towards this natural level.The rise in the proportion of employment in small firms, and the comparatively high job creation ability of small firms in recent times has come about in part because of negative rather than positive macro-economic influences. In recession, small firms in aggregate in spite of their individual volatility, are the most resilient. In prosperous times they do not increase their proportion of employment share, while in times of recession they do. Our results imply that large firms have a very significant, if not the most significant, bearing upon aggregate employment trends. On the other hand, small firms inherently have more potential to create jobs than large firms.The majority of public expenditure and legislative support for UK business is directed at large firms, as a result of culture and tradition. Even with the benefit of this support, large firms in recent decades have still performed badly, in job generation terms. In contrast, small firms have shown an inherent advantage in their ability to create jobs. A shift of government expenditure and legislative support from large to small firms would further enhance and realise the potential of small firms to benefit the economy and create jobs.     

Financial Policy and Capital Structure Choice in U.K. SMEs: Empirical Evidence from Company Panel Data

This article utilises up-to-date financial panel data, and investigates the capital structure of small and medium sized enterprises (SMEs) in the U.K. Different capital structure theories are reviewed in order to formulate testable propositions concerning the levels of debt in small businesses, and a number of regression models are developed to test the hypotheses.The results suggest that most of the determinants of capital structure presented by the theory of finance appear indeed to be relevant for the U.K. small business sector. Size, age, profitability, growth and future growth opportunities, operating risk, asset structure, stock turnover and net debtors all seem to have an effect on the level of both the short and long term debt in small firms. Furthermore, the paper provides evidence which suggest that the capital structure of small firms is time and industry dependent. The results indicate that time and industry specific effects influence the maturity structure of debt raised by SMEs. In general terms, average short term debt ratios in SMEs appear to be increasing during periods of economic recession and decrease as the economic conditions in the marketplace improve. On the other hand, average long term debt ratios exhibit a positive relationship with changes in economic growth.     

Manufacturing entrepreneurs: An empirical study of the correlates of employment growth in the Tulsa MSA and rural East Texas

Manufacturing firms and firms totally dependent on manufacturing provide more than 50% of the jobs in the United States and other industrialized nations. In spite of the belief that the United States has become an “information economy,” it has recently been recognized by researchers, politicians and industry experts that the loss of America's leadership position in manufacturing threatens the American industrial position. In addition, small firms provided most of the job growth in the decade of the 80s and the most innovation and new products.The impact of these factors indicates the importance of determining what it takes to be successful as a manufacturing entrepreneur. Beyond the importance to the national economy of understanding the success-related factors in manufacturing entrepreneurship, several stakeholder categories have a vested interest in this information as well. Job creation, job growth and economic development become major agenda items in the 1992 presidential campaign. Also, investors would like to have a model of small firm growth on which to base their investments in start-up firms. Finally, political units are looking for mechanisms to create much-needed new jobs to provide tax revenue.The purpose of this study was to: (1) determine the relationship between eight literature-based predictor variables and employment growth in entrepreneurial manufacturing firms and (2) attempt to develop a meaningful linear model, incorporating as many significant variables as possible from the original eight that would explain variance in firm performance.The focus of this study was 327 manufacturing entrepreneurs located in the Tulsa Metropolitan Statistical Area and 13 contiguous counties in East Texas. Manufacturing entrepreneurs were defined as the founders of their firms. The firms included in the study were all less than ten years old, independent (not a division of some other firm) and had primary SIC codes between 2000 and 3999. Usable responses to a mail survey were 103, a 31.5% response rate.Results of this study suggest that age (of the entrepreneur) at founding, entrepreneurial management experience, industry experience and environmental scanning practices are significantly correlated with firm performance as measured by employment growth.     

Entrepreneurial characteristics and the size of the new firm: A model and an econometric test

This paper examines entrepreneurial influences on the size of the new firm. Theory and previous empirical research indicate that the entrepreneurial attributes most likely to influence the characteristics and performance of new firms are motivation, workskills and information. The results of a regression analysis confirm these hypotheses when turnover and total assets are the dependent variables but are less conclusive when employment is the dependent variable. Possibly the most interesting finding is that the entrepreneurs who create the most jobs are those who are highly motivated, have managerial skills and whose firms are in the manufacturing sector.     

Towards an Interdisciplinary Theory of Entrepreneurship

Entrepreneurship is one of the least understood topics in economics. The rising significance of small companies and especially of start-ups for the creation of new jobs has been an intensively discussed subject for nearly one decade. But there is still no theory of entrepreneurship.First this paper reviews the role of the entrepreneur in the history of economic thought and concludes that there is no agreed upon definition of what an entrepreneur does or is. The unsolved problem is the non-rational human behavior. Schumpeter and Kirzner have developed economic models of the role of the non-maximizing entrepreneur in the price-mechanism. But they did not develop a theory of entrepreneurship.In the second part of the paper entrepreneurship is understood as the pursuit of opportunites without regard to resources currently controlled (Stevenson, Roberts, and Grousbeck). Based on that definition the contributions of economic decision theory, sociological system theory, psychoanalytical research and behavioral studies are reviewed and an interdisciplinary approach to the development of an entrepreneurship theory is proposed.     

Jobs mismatch and productivity impact of information technology

This paper studies the link between jobs mismatch and the impact of information technologies (ITs) on the efficiency of small service firms. From the perspective of job matching theory, the paper explores how small service firms that use ITs obtain an optimal matching between new skill requirements and workforce skills. The hypotheses suggest that optimal equilibrium will be obtained by matching IT intensity to ITs training and the proportion of workers with high educational levels. The study tests the hypotheses on a large sample of small services firms in Spain. The results confirm that matching the educational levels of the workforce with the IT intensity of the firm increases the efficiency of small service firms, while mismatch will decrease it. The contribution of IT training to firms' efficiency depends on training intensity but not on IT intensity.     

Leveraging Research and Development: Assessing the Impact of the U.S. Advanced Technology Program

This paper examines the factors that affect a firm's chances of winning an award from the Advanced Technology Program (ATP) and the subsequent impact of the award on a firm's success in raising additional funds for its research and development (R&D) activities. Analysis of data from a survey of 1998 ATP applicants shows that proposals with higher ratings by technical and business/economic experts have a greater chance of winning an award. Further, the projects and firms selected by ATP are more willing to share their research findings with other firms, and tend to be those that open up new pathways for innovation through combining technical areas or by forming new R&D partnerships. Most of the non-winners have not proceeded with any aspect of the R&D project proposed to ATP and, of those that have, most did so at a smaller scale. Furthermore, the ATP award has prestige value for the winning firms; the halo effect from the award increases the success of these firms in attracting additional funding from other sources. Our conclusion is that the ATP is leveraging activities that have a strong potential for broad-based economic benefit.     

Beyond “Does it Pay to be Green?” A Meta-Analysis of Moderators of the CEP–CFP Relationship

Review of extant research on the corporate environmental performance (CEP) and corporate financial performance (CFP) link generally demonstrates a positive relationship. However, some arguments and empirical results have demonstrated otherwise. As a result, researchers have called for a contingency approach to this research stream, which moves beyond the basic question “does it pay to be green?” and instead asks “when does it pay to be green?” In answering this call, we provide a meta-analytic review of CEP–CFP literature in which we identify potential moderators to the CEP–CFP relationship including environmental performance type (e.g., reactive vs. proactive performance), firm characteristics (e.g., large vs. small firms), and methodological issues (e.g., self-report measures). By analyzing these contingencies, this study attempts to provide a basis on which to draw conclusions regarding some inconsistencies and debates in the CEP–CFP research. Some of the results of the moderator analysis suggest that small firms benefit from environmental performance as much or more than large firms, US firms seem to benefit more than international counterparts, and environmental performance seems to have the strongest influence on market-measures of financial performance.     

Growth of New Technology-Based Firms: Which Factors Matter?

This paper deals with the explanation of variations in the growth between New Technology-based Firms (NTBFs) and non-innovative firm foundations. Based on theoretical models explaining the growth of firms, hypotheses on potential determinants are derived. The regression results indicate strong correlations between the growth rate on the one hand and firm-specific, founder-specific as well as external factors on the other. These factors influence the growth rates of innovative and non-innovative young firms in different ways. Furthermore, based on the results of multivariate regressions, NTBFs achieve on average higher growth rates than non-innovative firm foundations. Moreover, the net employment effect of those NTBFs founded in 1989/90 is positive. This does not hold for non-innovative young firms, in which the number of jobs destroyed by closures and shrinking firms is larger than the number of new jobs in growing and expanding firms.     

The growth of UK companies and their contribution to job generation, 1985–1987

Theories of firm growth are reviewed and various models examined. The firm growth and job generation process in the UK over the period 1985–87, is examined empirically, by using the very large data files of the Dun and Bradstreet credit rating organisation. In the analysis, four computer processes were carried out; the sorting and matching of files, the cleaning of the data, the validation of the cleaned data, and the scaling up the results. The final adjusted data were grossed-up to provide an overview of the growth and job generation potential of UK firms. This is compared with past results for the periods 1971–81, and 1982–84. Small firms performed well, providing 48% of all new jobs, although consisting of only 21% of all employment in 1985. The 1000+ employee range provided only 13% of all new jobs over the period, although consisting of 37% of all employment in 1985. An overall trend of positive performance in smaller firms, and negative in larger firms was apparent. The 20–49 employee cohort performed unusually poorly in firm and job creation, against the expected pattern. The effect of takeovers, mergers and rationalisations on employment was examined. As expected, there was negligible restructuring of small firms, but over 5% of employees in the largest 1000+ cohort were involved in some form of reorganisation.In this and the two previous studies for 1971–81 and 1982–84, we found a consistent pattern of small firms as net generators of jobs, and large firms as net losers. This overall net behaviour is essential for the overall stability of the population, and can not be seen in good or bad terms. Bolton in 1971 found that the UK had an unduly small and weak small-firm sector. That trend to concentration is being reversed.This research was supported by the Department of Employment, Small Firms Division.     

Information acquisition and export entry decisions in small firms

Consistently low usage of export promotion programs and incentives has been observed among small firms. This has led researchers to argue that these firms operate on a limited information basis and deprive themselves of cheap export market knowledge. This study disputes these conclusions and finds that small firms discriminately use alternative sources to acquire foreign market information and assistance. Furthermore, such information acquisition, irrespective of source, is found to have a substantive and significant association with new export market entry. The implications of these findings for government export policy, small firm decision makers, and export literature are explored.     

Firm size and job creation in Germany

This paper reports new results on the role of firms from various size classes in the job generation process in Germany. It is based on a unique longitudinal data set covering all manufacturing establishments that existed in at least one year between 1978 and 1993 in the German federal state Lower Saxony. We find that gross job creation and destruction rates tend to decline with firm size, while net job creation rates and firm size are not systematically related when firms are classified according to their average number of employees in the base and end year. Small firms create (destroy) quite a large share of all new (lost) jobs.