CRIEFF Discussion Paper Number 0002

CRIEFF Discussion Paper Number 0502

Models of Firm Dynamics and the Hazard Rate of Exits: Reconciling Theory and Evidence using Hazard Regression Models

Arnab Bhattacharjee

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Abstract
This Paper considers empirical work relating to models of firm dynamics. It is shown that a hazard regression model for firm exits, with a modification to accommodate age-varying covariate effects, provides an adequate framework accommodating many of the features of interest in empirical studies on firm dynamics. Modelling implications of some of the popular theoretical models are considered and a set of empirical procedures for verifying theoretical implications of the models are proposed.The proposed hazard regression models can accommodate negative effects of initial size that increase to zero with age (active learning model), negative initial size effects that may increase with age, but stay permanently negative (passive learning model), conditional and unconditional hazard rates that decrease with age at higher ages, and adverse effects of macroeconomic shocks that decrease with age of the firm.The methods are illustrated using data on quoted UK firms. Consistent with the active learning model, the effect of initial size is significantly negative for a young firm and falls to zero with age.The hazard function conditional on size, other firm and industry-level characteristics, and macroeconomic conditions decreases with age only at higher ages, but shows the weaker property of Increasing Mean Residual Life over its entire life-duration. Instability in exchange rates affects survival of very young firms strongly, and the effect decreases to insignificant levels for older firms.

JEL Classifications
C14, C34, C41, C52, D83, L16, L25
Keywords
Firm exit, Learning, Firm Dynamics, Non-proportional hazards, Hazard regression models

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