Firm Age, Investment Opportunities, and Job Creation

• Author: DAVID ROBINSON,SONG MA,MANUEL ADELINO
• Published date: 01 June 2017
• DOI: http://doi.org/10.1111/jofi.12495
• Date: 01 June 2017

THE JOURNAL OF FINANCE •VOL. LXXII, NO. 3 •JUNE 2017

Firm Age, Investment Opportunities,

and Job Creation

MANUEL ADELINO, SONG MA, and DAVID ROBINSON∗

ABSTRACT

New firms are an important source of job creation, but the underlying economic

mechanisms for why this is so are not well understood. Using an identification strategy

that links shocks to local income to job creation in the nontradable sector, we ask

whether job creation arises more through new firm creation or through the expansion

of existing firms. We find that new firms account for the bulk of net employment

creation in response to local investment opportunities. We also find significant gross

job creation and destruction by existing firms, suggesting that positive local shocks

accelerate churn.

STARTUPS CREATE THE MAJORITY of new jobs in the American economy

(Haltiwanger, Jarmin, and Miranda (2013)), and job creation at young firms

exhibits strong comovement with business cycles.1However, the precise eco-

nomic mechanisms underlying the central role that startups play in the job

creation process are not well understood. Identifying and understanding these

mechanisms is important, especially in light of recent evidence on the struc-

tural shifts in employment from young to mature firms and the reduction in

the dynamism of the U.S. economy.2

To better understand the mechanisms that connect startups to aggregate

job creation, and to understand how the economy creates jobs in response to

shocks, it is first important to look past the firm size distribution and instead

focus on comparisons based on firm age. Although most new firms are small,

the vast majority of small businesses are old firms. Indeed, Hurst and Pugsley

∗Adelino is with Duke University’s Fuqua School of Business; Ma is with Yale School of Man-

agement; and Robinson is with Duke University’s Fuqua School of Business and NBER. We thank

Ken Singleton (Editor), an anonymous Associate Editor, and two anonymous referees. We are

also grateful to Andrew Abel; Hengjie Ai; Simon Gervais; John Haltiwanger; Javier Miranda;

Ben Pugsley; Manju Puri; Michael Roberts; Martin Schmalz; Vish Viswanathan; and seminar par-

ticipants at Chicago Booth, Darden, Duke, Econometric Society Meetings 2016, Emory, Harvard

Business School, HEC Paris, Minnesota Corporate Finance Conference, NBER Productivity,NBER

Entrepreneurship, Nova SBE, Red Rock Conference, Stanford, UCLA, UNC Charlotte, University

of Miami, UT Austin, Wharton, and Yalefor providing helpful feedback. We have read the Journal

of Finance’s disclosure policy and have no conflicts of interest to disclose. The usual disclaimer

applies.

1See Fort et al. (2013), Pugsley and Sahin (2015), and Sedl´

acek and Sterk (2014).

2Decker et al. (2014) and Pugsley and Sahin (2015) provide evidence on the structural shifts in

employment across the firm age distribution.

DOI: 10.1111/jofi.12495

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(2011) show that most small business owners have no desire to grow, create

jobs, or do anything other than provide a lifestyle for the founder.

Another reason why the specific mechanisms are not well understood is be-

cause the connections between new firms, employment, and economic growth

are determined in general equilibrium and thus are difficult to isolate. Our aim

in this paper is to identify one specific channel linking startups to employment

and growth. We develop an empirical strategy in which cross-sectional varia-

tion in local demand shocks gives rise to variation in sector-specific investment

opportunities, which in turn induces firms to respond by increasing employ-

ment. By comparing the amount of job creation through new firm formation to

that created by the expansion of existing firms, we identify a channel through

which firms of different ages create employment.

Specifically, this paper focuses on a region’s nontradable sector and consid-

ers how firm entry and expansion respond to changes in local income. Follow-

ing Bartik (1991), Blanchard and Katz (1992), and Autor, Dorn, and Hanson

(2013), we identify exogenous shocks to local income by interacting the preex-

isting composition of a region’s manufacturing sector with the national growth

in employment in that sector. The idea is that when a national shock hits a spe-

cific manufacturing industry, some regions are hit harder than others because

their preexisting economic structure leaves them more exposed to the under-

lying shock. Regional variation in income gives rise to variation in investment

opportunities for firms that are especially dependent on local demand. Impor-

tantly, this variation is exogenous to any opportunities created by the firms in

this sector, which resolves the reverse causality problem in analyzing the link

between firm creation and economic growth.

This approach rests on two key features of the nontradable sector. First, con-

ditions in this sector depend primarily on local demand (Mian and Sufi (2012),

Basker and Miranda (2014), Stroebel and Vavra (2014)), easing concerns that

the net job creation we measure could be confounded by unmeasured changes in

fundamentals affecting both national income and the demand for jobs. Second,

in this sector startups do not have an inherent innovation advantage relative

to older firms that would make them especially well-suited to generate growth

opportunities. This is not to say that innovation is unimportant in the non-

tradable sector; rather, in the nontradable sector existing large firms are also

important innovators, thus there is no clear disadvantage ex ante for existing

firms relative to new ones.3

We find that firm entry is responsible for the majority of net job creation in

response to local demand shocks. Moving from the 25th to the 75th percentile

of two-year income growth raises a region’s job creation in nontradable in-

dustries by about 1.5% of the 2000 employment level. Startups account for

approximately 90% of a region’s total net employment creation in the nontrad-

able sector as a result of income shocks. Firms six or more years old account

3Wal-Mart is perhaps the most prominent recent example of innovation in retail, which, in

turn, caused dramatic displacement of smaller, less competitive, firms (Basker (2005), Foster,

Haltiwanger, and Krizan (2006), Neumark, Zhang, and Ciccarella (2008)).

Firm Age, Investment Opportunities, and Job Creation 1001

for the remaining net employment response (firms between two and five years

of age generally show small and insignificant net changes in employment). The

magnitude of the net employment response by new firms is especially strik-

ing given the patterns of overall employment across the firm age distribution.

Firms more than five years old account for more than 84% of total employment

on average in nontradables, while employment in startup firms accounts for

only 6% of total employment.

Indeed, the differences in employment shares by firm age are important for

understanding the elasticity of employment to income shocks among estab-

lished businesses. When we compare existing firms under five years of age (in

the 1-2 and 3-4 year-old groups) to those that are six years or older, the differ-

ences in “responsiveness” described above are driven by differences in the share

of total employment by established businesses of different ages. In fact, with

the exception of the startup group, we do not find statistically significant dif-

ferences in the elasticity to income shocks across age groups. This means that,

in the nontradable and construction sectors, and using a Bartik-type approach

to identify shocks, existing younger and older firms do not show differential

responsiveness. New firm starts, rather than the expansion of existing young

firms, are responsible for the net employment response we find.

When we move from net job flows to gross flows, we find that the low net

job creation in the old-firm sector masks substantial heterogeneity in gross job

creation and gross job destruction. Although these large changes in job gains

and losses effectively cancel each other out, the net job creation figures reflect

the fact that when positive shocks occur in a region, some old firms respond

by shrinking or exiting, while others respond by adding jobs, highlighting the

importance of churn for the job creation process. Nevertheless, because startups

are such a small portion of the overall share of employment in the economy,

the gross job creation that we witness among startups still amounts to a much

larger proportional response than what we see from older firms.

To demonstrate that differences in net employment creation are a feature of

firm age rather than firm size, we explore the joint distribution of firm size and

age using data from the U.S. Census Business Dynamics Statistics (BDS). We

find that net employment creation by older firms is heavily concentrated among

large older firms: older small firms shed jobs on net as a result of these shocks.

This result indicates that the channel we identify operates through new firms,

not small ones. It also speaks against the idea that increased bureaucratic con-

straints in older firms prevent them from seizing the opportunities presented

by economic shocks: larger firms presumably have more complex bureaucra-

cies than small businesses, and yet among older businesses it is the large, more

organizationally complex firms that contribute to net employment growth as a

result of economic shocks. Clearly, the balance of net job creation in response

to economic shocks comes from small, new firms and large, old ones.

These results are robust to a number of concerns. One is that organizational

arrangements specific to the nontradable sector (such as franchising) drive our

results. Our findings are similar when we look at the construction sector’s re-

sponse to the same shocks—like the restaurant and retail sectors, construction