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The Economic Contribution of a Cohort of New Firms Over Time

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Abstract

What is the economic contribution of a cohort of new entrants? Previous research has investigated this topic but only in passing, and found conflicting results. We analyze a cohort of 6578 firms that entered in 2004, and track them for 10 years with an emphasis on size, which is measured using (deflated) sales data from the entrepreneurs’ bank account records. The overall economic contribution of the cohort decreases in the years after entry. Post-entry growth is not sufficient to offset the economic loss from high exit rates. Broadly similar results are found when disaggregating by firm size and industry.

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Notes

  1. See however Calvino et al. (2015, 2018), who introduce a decomposition of the economic contribution of a cohort of new firms into four elements: the start-up ratio (for the relative weight of new firms in the economy); the survival rates of new firms; the average size of firms at entry; and the average post-entry growth rate of survivors.

  2. Value added could be a better indicator than sales, but this must be left for future research because unfortunately value added does not appear in our dataset.

  3. The UK, unlike many countries in continental Europe, is not characterized by multiple banking relationships (Ongena and Smith 2000). Furthermore, multiple banking relationships are unusual among firms that are young and small (Ongena and Smith 2000), such as those in our sample. The business account at a single bank is therefore likely to capture the full trading activities of the firm.

  4. Note that it is not possible to verify the origins of possible payments by the entrepreneur into the business account in the form of cash or cheque deposits. However, we consider that there is very limited scope for non-sales income to distort significantly the measures that we have selected in a sample of more than 6000 firms.

  5. The adjustment for inflation is undertaken using World Bank data for the consumer price index for the United Kingdom (GBR), as in Lundmark et al. (2020): see https://data.worldbank.org/indicator/FP.CPI.TOTL?locations=GB (last accessed 23rd June 2019).

  6. This could be an understatement of the true number if there were imperfections in the reporting process such that some switchers were not recorded. However, our rates are broadly in line with Fraser (2005, p. 90) for all types of UK (SME) businesses.

  7. It is possible that some of these firms may have switched activity to a rival bank, rather than closed.

  8. Some Barclays customers show little or no activity for several months before their turnover returns to non-negligible levels. This reflects the heterogeneous and idiosyncratic nature of many ‘micro’ businesses.

  9. For example, in the UK, the threshold for Value-Added Tax (VAT) registration was set at a turnover of £58,000 for the 12 months from 1 April 2004. From 1 April 2011 it has been £73,000 per annum. Our Table 2 shows that the median firm in our dataset is below the VAT threshold in year 1.

  10. Future work could include exit via mergers and acquisitions (M&A) in Eq. (2), in addition to the exit term (the second term on the right-hand-side). This is not done in the present paper, because our data do not allow us to cleanly identify M&A events. Note however that there is no need to distinguish between bankruptcy and voluntary liquidation for the purposes of Eq. (2).

  11. This is in keeping with the previous literature that investigates (in passing) the economic contribution of a cohort: e.g., Boeri and Cramer (1992), Mata et al. (1995), and Strotmann (2007). See also Decker et al. (2016) for an example of industrial organization research that presents its main results using line charts. Future work could potentially apply more advanced techniques such as regressions and Blinder-Oaxaca decompositions.

  12. Note that while firm growth is overall positively related to survival, nevertheless some growing firms will exit in each year, and fast-growth firms have higher death rates than do moderate-growth firms.

  13. One possible explanation for this could be that their market share is under attack from an even younger cohort of entrants.

  14. Number of observations in each sector in year 1: Agriculture: 67 obs; Manufacturing: 320 obs; Construction: 967 obs; Retail: 1169 obs; Transport: 176 obs; Accommodation: 619 obs; Information: 393 obs; Real Estate: 227 obs; Professional: 473 obs; Administrative: 985 obs, Education: 54 obs; Health: 104 obs; Arts: 225 obs; Other: 800 obs.

  15. To be precise, the cut-off point, which corresponds to the median sales in the first year, is ₤38’712.

  16. Other types of entrants can also be envisaged, for example innovators who develop significant cost-cutting process innovations. These entrants do not easily fit into the categories of imitators or Schumpeterian market creators. We are grateful to the Editor for this suggestion.

  17. “Fine Young Cannibals” is the name of a British rock music band formed in Birmingham, England, in 1984, who took their name from a 1960 film “All the Fine Young Cannibals” that starred Robert Wagner and Natalie Wood.

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Acknowledgements

We are grateful to David Storey for many helpful suggestions and for suggesting the opening quote. We are also grateful to Masatoshi Kato, Yuji Honjo, and workshop participants at Kwansei Gakuin University (Tokyo), as well as an anonymous referee, and the Editor (Lawrence J. White) for many helpful comments. Julian Frankish writes in a personal capacity, and the views expressed do not necessarily represent those of Barclays Bank UK plc. The usual caveat applies.

Funding

This work was supported by the National Research Foundation of Korea, funded by the Korean Government (Grant NRF-2018S1A3A2075175).

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Correspondence to Alex Coad.

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Appendix 1: Controlling for M&A in Our Data

Appendix 1: Controlling for M&A in Our Data

Merger and acquisition (M&A) events are rare in our data, which focuses on firms that are small and young and not specifically from high-tech sectors. While much of the entrepreneurship literature is biased towards focusing on high-potential high-tech startups—where acquisitions are glorified (e.g., Nightingale and Coad 2014)—nevertheless our data are a representative sample of micro/small firms in all sectors of the economy, where M&A events are overall very rare.

While we do not specifically observe M&A events, we do observe if new ventures switch from one bank to another. The following diagram explains what switching corresponds to, and what M&A corresponds to.

Figure 5 above shows how the exit routes (survival, M&A, voluntary liquidation, and failure) correspond to the bank account activity that we observe in our dataset. In particular:

Fig. 5
figure 5

Exit routes and outcomes observed in our data

  1. 1

    Surviving firms can either continue with the same bank account, or switch banks;

  2. 2

    M&A firms can either continue with the same bank account, or else switch banks (presumably to the bank account of the acquiring firm); and

  3. 3

    Failures or voluntary exits correspond to the closure of the bank account.

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Coad, A., Frankish, J.S. & Link, A.N. The Economic Contribution of a Cohort of New Firms Over Time. Rev Ind Organ 57, 519–536 (2020). https://doi.org/10.1007/s11151-020-09777-9

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