Abstract:
We document that aggregate or sectoral demand shocks have disproportionately bigger effects on larger firms. Changes in scope, the number of products/locations, plays a significant role in this heterogeneity. Motivated by these facts, we present a theory of firm size, where both scope and expertise (which determines revenues and profits) are chosen endogenously. The extent to which expertise is scalable (applicable to multiple products), as opposed to local (specific to a particular product), is also chosen by the firm. The model predicts rich heterogeneity in responses to a sector-wide demand shock: firms with higher revenue per product (conditional on scope) adjust their scope by less, while those with higher scope (conditional on revenue per peroduct) adjust by more. Using data on multi-product and multi-establishment firms, we provide empirical evidence in support of these predictions. We also construct a proxy for the scalability of the firm’s expertise and show that the predictions of the model with respect to the scalability of firm-level expertise, both in the cross-section and in response to shocks, are also consistent with the patterns observed in the data.

* To join the seminar, please contact at econ.events@umich.edu