Understanding the Variations in Gibrat's Law with a Markov-Perfect Dynamic Industry Model

Abstract

Gibrat's Law of proportionate effect, as applied to firms, states that the growth rate of a firm is independent of its size. Empirical work on firm dynamics finds crucial deviations from Gibrat's Law such as smaller firms growing faster than larger firms (Evans, 1987, and Hall, 1987), a negative relationship between the variance of growth rates and size (Dunne and Hughes, 1994), and first-order positive autocorrelation in the growth rates (Kumar, 1995). Moreover, the degree of deviation from Gibrat's Law varies across industries. This paper contributes to our understanding of the forces that make Gibrat's Law a close, but imperfect approximation of firm size distributions and seeks to determine potential sources of cross-industry variation. Here, we employ an extension of the Ericson-Pakes (1995) theoretical framework that allows for firm growth developed by Laincz (2004a). By varying key parameters, the simulations demonstrate potential sources for the various, and sometimes conflicting, results on Gibrat's Law uncovered in the empirical literatureGibrat's Law, Firm Size Distribution, Entry, Exit