Flexible Production and Entry: Institutional, Technological, and Organizational Determinants

Academics, the media, and policymakers have all raised concerns about the implications of human workers being replaced by machines or software. Few have discussed the implications of the reverse: firms’ ability to replace capital with workers. We show that this flexibility can help new firms overcome uncertainty and increase entrepreneurial entry. We develop a simple real options model where permissive labor regulations allow firms to take advantage of capital-labor substitutability by replacing ‘rigid’ capital with ‘flexible’ labor. The model highlights institutional, technological, and organizational preconditions to using this flexibility. Using a large and comprehensive dataset on entry by standalone firms and group affiliates, we provide evidence in support of the model.