Entry, Exit, Firm Dynamics, and Aggregate Fluctuations

How important are firm entry and exit in shaping aggregate dynamics? We address this question by characterizing the equilibrium allocation in Hopenhayn (1992)’s model of equilibrium industry dynamics, amended to allow for investment in physical capital and aggregate fluctuations. We find that entry and exit propagate the effects of aggregate shocks. In turn, this results in greater persistence and unconditional variation of aggregate time-series. In the aftermath of a positive productivity shock, the number of entrants increases. The new firms are smaller and less productive than the incumbents, as in the data. As the common productivity component reverts to its unconditional mean, the new entrants that survive become progressively more productive, keeping aggregate efficiency higher than in a scenario without entry or exit. We also find that both the mean and variance of the cross-sectional distribution of firm–level productivity are counter–cyclical, in spite of the assumption that innovations to firm–level productivity are i.i.d. and orthogonal to aggregate shocks. This happens because of selection: the idiosyncratic productivity of the marginal entrant is lower in expansion than during recessions. Since idiosyncratic productivity is mean–reverting, mean and variance of the distribution of productivity growth are pro–cyclical.Selection, Propagation, Persistence, Survival, Reallocation

Executive Compensation: Facts

In this paper we describe the important features of executive compensation in the US from 1993 to 2006. Some confirm what has been found for earlier periods and some are novel. Notable facts are that: the compensation distribution is highly skewed; each year, a sizeable fraction of chief executives lose money; the use of security grants has increased over time; the income accruing to CEOs from the sale of stock increased; regardless of the measure we adopt, compensation responds strongly to innovations in shareholder wealth; measured as dollar changes in compensation, incentives have strengthened over time, measured as percentage changes in wealth, they have not changed in any appreciable way.CEO, Pay–Performance Sensitivity, Stock, Options

A Theory of Financing Constraints and Firm Dynamics

There is widespread evidence supporting the conjecture that borrowing constraints have important implications for firm growth and survival. In this paper we model a multi-period borrowing/lending relationship with asymmetric information. We show that borrowing constraints emerge as a feature of the optimal long-term lending contract, and that such constraints relax as the value of the borrower's claim to future cash-flows increases. We also show that the optimal contract has interesting implications for firm dynamics. In agreement with the empirical evidence, as age and size increase, mean and variance of growth decrease, firm survival increases, and the sensitivity of investment to cash-flows declines.Optimal Contract, Borrowing Constraints, Moral Hazard, Survival.

Executive Compensation: Facts

In this paper we describe the important features of executive compensation in the US from 1993 to 2006. Some confirm what has been found for earlier periods and some are novel. Notable facts are that: the compensation distribution is highly skewed; each year, a sizeable fraction of chief executives lose money; the use of security grants has increased over time; the income accruing to CEOs from the sale of stock increased; regardless of the measure we adopt, compensation responds strongly to innovations in shareholder wealth; measured as dollar changes in compensation, incentives have strengthened over time, measured as percentage changes in wealth, they have not changed in any appreciable way.CEO, Pay–Performance Sensitivity, Stock, Options

Cross–Sectoral Variation in Firm–Level Idiosyncratic Risk

We estimate firm–level idiosyncratic risk in the U.S. manufacturing sector. Our proxy for risk is the volatility of the portion of growth in sales or TFP which is not explained by either industry– or economy–wide factors, or firm characteristics systematically associated with growth itself. We find that idiosyncratic risk accounts for about 90% of the overall uncertainty faced by firms. The extent of cross–sectoral variation in idiosyncratic risk is remarkable. Firms in the most volatile sector are subject to at least three times as much uncertainty as firms in the least volatile. Our evidence indicates that idiosyncratic risk is higher in industries where the extent of creative destruction is likely to be greater.Schumpeterian Competition, Creative Destruction, Product Turnover, R&D Intensity, Investment–Specific Technological Change

Cross-Sectoral Variation in The Volatility of Plant-Level Idiosyncratic Shocks

We estimate the volatility of plant–level idiosyncratic shocks in the U.S. manufacturing sector. Our measure of volatility is the variation in Revenue Total Factor Productivity which is not explained by either industry– or economy–wide factors, or by establishments’ characteristics. Consistent with previous studies, we find that idiosyncratic shocks are much larger than aggregate random disturbances, accounting for about 80% of the overall uncertainty faced by plants. The extent of cross–sectoral variation in the volatility of shocks is remarkable. Plants in the most volatile sector are subject to about six times as much idiosyncratic uncertainty as plants in the least volatile. We provide evidence suggesting that idiosyncratic risk is higher in industries where the extent of creative destruction is likely to be greater.

Asset Pricing in a General Equilibrium Production Economy with Chew-Dekel Risk Preferences

In this paper we provide a thorough characterization of the asset returns implied by a simple general equilibrium production economy with convex investment adjustment costs. When households have Epstein-Zin preferences, there exist plausible parametervalues such that the model generates unconditional mean risk--free rate and equity return, and volatility of consumption growth, which are in line with historical averages for the US economy. Consistently with the data, the model's implied price--dividendratio is pro-cyclical and stock returns are predictable (and increasingly so as the time horizon increases), while dividend growth is not. The model also implies realistic values for (i) the correlation of the risk--free rate with output growth and consumption growth and (ii) the correlation pattern between risk--free rate, equity return, and equity premium. The risk implied by the model is rather low. At the modal state of nature, an individual that expects to consume for 100,000 dollars a year faces a lottery over future consumption with a standard deviation of 55 dollars (per quarter). Her risk aversion is such that she's willing to pay 1 dollar (per quarter) in order to avoid that lottery. Very similar results can be obtained assuming that agents are disappointment averse in the sense of Gul (1991). With such risk preferences, the universality requirement is not a problem to the extent that it is in the case of expected utility. In fact, faced with a lottery that has a coefficient of variation 100 times as large as that implied by our model, a disappointment averse agent displays the same relative risk aversion as an expected utility agent with logarithmic utility!Equity Premium, Business Cycle, Predictability, Disappointment Aversion.