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A structural empirical model of firm growth, learning, and survival

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  • Jaap H. Abbring
  • Jeffrey R. Campbell

Abstract

In this paper we develop an empirical model of entrepreneurs' business continuation decisions, and we estimate its parameters using a new panel of monthly alcohol tax returns from bars in the state of Texas. In our data, entrepreneurial failure is frequent and predictable. In the first year of life, 20% of our sample's bars exit, and these tend to be smaller than average. In the model, an entrepreneur bases her business continuation decision on potentially noisy signals of her bar's future profits. The presence of noise implies that she should make her decision based on both current and past realizations of the signal. We observe for each bar its sales, which we assume, equals a noisy version of the entrepreneur's signal. That is, the entrepreneur's information about her bar is private. ; The entrepreneur's private information makes the estimation of our model challenging, because we cannot observe the inputs into her decision process. Nevertheless, we are able to recover from our observations the parameters characterizing the entrepreneur's learning process and the noise contaminating publicly available sales observations. The key to our analysis is to note that our ability to forecast the entrepreneur's decisions reveals the amount of noise contaminating publicly available sales observations. We infer that public and private information differ little if we can forecast entrepreneurs' business continuation decisions well. With this information, we can then determine whether the usefulness of past sales observations for forecasting future sales arises only from the noise contaminating public observations or if the observations imply the presence of additional noise contaminating entrepreneurs' observations. ; We estimate our model using observations from the first twelve months of life for approximately 300 Texas bars. We find that entrepreneurs observe the persistent component of profit without error. In this sense, their information is substantially superior to the public's.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Chicago in its series Working Paper Series with number WP-03-11.

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Date of creation: 2003
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Handle: RePEc:fip:fedhwp:wp-03-11

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Keywords: Business enterprises ; Corporations;

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References

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  1. Jeffrey R. Campbell & Hugo A. Hopenhayn, 2002. "Market Size Matters," NBER Working Papers 9113, National Bureau of Economic Research, Inc.
  2. Taber, Christopher R., 2000. "Semiparametric identification and heterogeneity in discrete choice dynamic programming models," Journal of Econometrics, Elsevier, vol. 96(2), pages 201-229, June.
  3. Fishman, Arthur & Rob, Rafael, 2003. "Consumer inertia, firm growth and industry dynamics," Journal of Economic Theory, Elsevier, vol. 109(1), pages 24-38, March.
  4. Rust, John, 1987. "Optimal Replacement of GMC Bus Engines: An Empirical Model of Harold Zurcher," Econometrica, Econometric Society, vol. 55(5), pages 999-1033, September.
  5. Thomas J. Holmes & James A. Schmitz, Jr., 1995. "On the turnover of business firms and business managers," Working Papers 545, Federal Reserve Bank of Minneapolis.
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Cited by:
  1. Jaap H. Abbring & Jeffrey R. Campbell, 2004. "Creative destruction in local markets," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q II, pages 50-60.
  2. Costas Arkolakis, 2011. "A Unified Theory of Firm Selection and Growth," NBER Working Papers 17553, National Bureau of Economic Research, Inc.
  3. Prantl, Susanne, 2003. "Bankruptcy and Voluntary Liquidation: Evidence for New Firms in East and West Germany after Unification," ZEW Discussion Papers 03-72, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.

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