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Small is Beautiful but Size Matters: The Asymmetric Impact of Uncertainty and Sunk Costs on Small and Large Businesses

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Ghosal, Vivek

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Abstract

Against the backdrop of the theories developed in the real options and financing constraints literatures, this paper examines the impact of profit uncertainty and sunk costs on firms’ entry and exit decisions. For our empirical analysis, we compile an extensive dataset containing information on 267 U.S. manufacturing industries over a 30-year period containing industry-specific information on the number of firms and establishments, the size distribution of establishments, measures of sunk capital costs and profit uncertainty, among others. Our dynamic panel data estimates show that greater uncertainty about profits, especially in conjunction with higher sunk costs, results in (1) a marked decrease in the number of small firms and establishments; (2) a less skewed size distribution of firms and establishments; and (3) a marginal increase in industry output concentration. In sharp contrast, large establishments seem virtually unaffected. The results point to uncertainty in conjunction with sunk costs fundamentally affecting firms’ decision-making and altering the structure of industries by putting smaller businesses at a disadvantage.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 5461.

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Date of creation: Jul 2007
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Handle: RePEc:pra:mprapa:5461

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Keywords: Uncertainty sunk costs real options financing constraints decision-making small businesses.

Find related papers by JEL classification:
L40 - Industrial Organization - - Antitrust Issues and Policies - - - General
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
O30 - Economic Development, Technological Change, and Growth - - Technological Change - - - General
L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General

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