The variance composition of firm growth rates.
| Autor | Brito, Luiz Artur Ledur |
| Cargo | Report |
Introduction
Some firms grow at impressive rates while others, sometimes rather similar ones, stagger or even shrink in size and end up disappearing from the business context by being acquired by the successful ones or simply ceasing to continue their activities. This wide variance in individual growth rates is just another aspect of the fact the firms differ in several dimensions (Carroll, 1993; Nelson, 1991).
What reasons lie behind this heterogeneity in firm growth rates? Is firm growth closely related to industry structure or to industry evolution, as Keppler and his associates imply (Keppler, 1996; Keppler & Grady, 1990; Keppler & Simons, 2000)? Or, maybe, firm growth is heavily influenced by country, or institutional context (North, 1992; Porter, 1990). Finally, firm growth may be firm specific. Some firms, with superior resources, grow faster while others, due to the inadequacy of their resources, do not succeed. This is basically the approach of the original work of Penrose (1959) and an extension of the development of the resource-based view of strategy, applied to growth. How can we balance out all these sources of variability and assess their relative influence? This paper makes a contribution to help understand these specific questions.
A well-known, and currently active, line of research in strategy has dealt with a similar question when analyzing the variance components of firm financial performance, using profitability measures. This line of research was introduced by the seminal papers of Schmalensee (1985) and Rumelt (1991) and further developed by several other authors uncovering many of the factors underlying the observed heterogeneity in firm performance (Bowman & Helfat, 2001; Brush & Bromiley, 1997; Brush, Bromiley, & Hendrickx, 1999; Hawawini, Subramanian, & Verdin, 2003; Makino, Isobe, & Chan, 2004; McGahan & Porter, 1997, 2003; McNamara, Vaaler, & Devers, 2003; Misangyi, Elms, Greckhamer, & Lepine, 2006; Roquebert, Phillips, & Westfall, 1996). It is now well established that firm effects are the most relevant source of variation in financial performance. Firm effects are associated with idiosyncratic firm characteristics and are not shared by other firms. Corporate effects also seem to be particularly relevant in more recent times (Bowman & Helfat, 2001; McNamara et al., 2003). Industry effects are a secondary source of variability but McGahan and Porter (1997) argued that in some economic sectors, other than manufacturing, its relevance is greater and they also show stronger persistence than firm effects (McGahan & Porter, 2003). Year effects, associated to factors that affect all firms in certain years, are usually small or nonexistent. Finally, recent work has explored the variability of performance outside the United States introducing other sources of variability such as belonging to business groups in emerging economies (Khanna & Rivkin, 2001) or the effect of the country of operation (Makino et al. , 2004). This line of research has also drawn the attention of Brazilian academics (Bandeira-de-Mello & Marcon, 2005; Brito & Vasconcelos, 2004; Goncalves & Quintella, 2006). These also focused on profitability as the relevant dependent variable and found the pattern of variability of Brazilian companies is similar to the samples studied in the international literature.
This research question has great relevance for strategic management. Strategy, unlike economics, concerns itself with individual firms rather than industries. The economist sees the firm as a player in a game. The game, not the player, however is the object of interest (Nelson, 1991). The fact that most of the observed variability in financial performance is firm or corporation specific lends empirical support and relevance to strategy itself as a field of inquiry and to the resource-based view when compared with other approaches like industry analysis or environmental scanning.
Although different forms of operationalization of financial performance have been explored, leading to similar results (Hawawini et al., 2003; McGahan, 1999; Powell, 1996), it has been restricted to profitability measures and growth has never been considered as an alternative outcome. In fact, most of the empirical research on firm growth has been of an econometric nature, building on the original work of Gibrat (1931). Sutton (1997) recently provided a comprehensive review. Most of these works develop a model with different assumptions of firm growth mechanism, but the real interest is the industry structure as an outcome. These results show the existence of firm (Evans, 1987b); Hall, 1987), industry (Dunne, Roberts, & Samuelson, 1989; Hall, 1987; Singh & Whittington, 1975), and year effects (Dunne et al. , 1989; Hall, 1987), but are not able to give the relative importance and magnitude of each. The approach taken in this paper bridges this gap.
Understanding the regularities underneath the variability of firm growth rates has significant relevance for strategy in several dimensions. From the practitioner of consultant point of view, profitability and growth can be competing or complementary objectives and understanding the nature of the variability in both can support better decisions. Geroski, Machin and Waters (1997) have argued that growth is more erratic and less predictable than profitability and for this reason, the preferred choice, if any, should favor the former rather than the latter. The findings of this research challenge such a conclusion. For those responsible for deciding on public policy issues, understanding this variability is crucial. If industry effects are of lesser importance, as the findings of this research suggest, traditional policies targeted at specific industries may not be the most effective action. Finally, from the perspective of the theorist, if firm growth is fundamentally specific to the individual firm, as the results of this research suggest, growth can be seen as an outcome of superior resources and as an additional dimension of the outcome of competitive advantage. The competitive advantage construct has been linked to rents in most of the theoretical development of the RBV. Why not see growth as evidence of a competitive advantage?
The first texts covering the notion of competitive advantage presented the evidence of success, normally as increased market share and dominance, in other words, growth (Ansoff, 1965; Gluck, Kaufman, & Walleck, 1980; Ohmae, 1978; South, 1981). Growth is also at the foundations of the resource-based view of strategy through the fundamental work of Penrose (1959), acknowledged by most authors as one of the founders of the RBV (Barney, 1991; Cooner, 1991; Grant, 1991; Mahoney & Pandian, 1992; Peteraf, 1993; Wernerfelt, 1984; Williams, 1994). Some voices, however, have been heard contesting this and pointing to the forgotten dimension of growth in the current literature of RBV so centered on rents. Foss (2002) argues that the influence of Penrose (1959) in the RBV, as it developed, is small. Penrose (1959) concerns herself with the phenomenon of disequilibrium and growth while the RBV attempts to explain rents above norm in an equilibrium state. A similar argument is used by Rugman and Verbeke (2002). Maybe the approach used by the RBV so far is limited and it should go back to its roots and look more deeply into the growth and disequilibrium too. This paper can also be seen as a contribution in this direction.
The next section reviews some of the relevant literature on previous studies using variance components analysis of financial performance, the resource-based view and its link to the phenomenon of growth, and the previous econometric studies on growth rates. The data and method are then presented. The results and their discussion form the main part of the paper and a conclusions section summarizes them and explores limitations and future studies.
Literature Review
Previous Studies on Variance Components of Performance
This line of research in strategy started with the paper of Rumelt (1991). His source of data was the FTC [Federal Trade Commission] database covering the return on assets of 1174 business units during the years of 1974 to 1977. He expanded the previous analysis of Schmalensee (1985) and identified the so called firm effects. These accounted for 46.4% of total variance, being the most important source of variation. Industry effect alone was responsible for 8.3% of total variance and the industry--year interaction for another 7.4%. A small corporate effect of 0.8% and no year effect made up for the rest of the explained variance that reached 63.3% of total variance. These results were used to support the then-emerging resource-based view of strategy in opposition to the positioning school derived from the industry analysis and led by Porter (1985).
Roquebert et al. (1996) published a similar study using a much larger database (Compustat) and covering the period ranging from 1985 to 1991. Their model explained 68.0% of total variance, and the most important effect was again firm effect, with 37.1%. Contrary to Rumelt (1991) they found an important corporate effect, with 17.9%. Industry accounted for 10.2% and industry-year interaction for 2.3%. A long debate established itself around the issue of corporate effects (Bowman & Helfat, 2001; Brush & Bromiley, 1997; Brush et al., 1999; Chang & Singh, 2000; McNamara et al., 2003). It is now clear the results of Rumelt were very sensitive to sample, that corporate effect is relevant, and its importance seems to have increased during the eighties and nineties (McNamara et al., 2003). McGahan and Porter (1997) published research also using the Compustat database, but using a much larger dataset with 72,742 observations covering business units' results from 1981 to 1994. They found the variance structure was substantially different when the different economic sectors (or SIC divisions as defined in this...
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