Do Small and Medium-Sized Enterprises Stabilize Employment? Theoretical Considerations and Evidence from Germany

The hypothesis that the behavior of firms in adjusting the number of their employees along a business cycle depends on the size of the firms has often been mentioned in the literature. Several authors argue that small and medium sized enterprises are more hesitant in hiring additional employees in a boom situation but also do not offset workers as fast as big enterprises in a recession. This implies that small and medium-sized enterprises stabilize economy-wide employment. However, up to now there is hardly any theoretical support and only very limited empirical evidence for this view. This paper addresses these shortcomings and presents a theoretical framework for a size-specific behavior of firms in hiring and laying off workers. We argue that the main reason for the difference stems from the existence of sunk costs associated with changes in employment. We also examine the empirical evidence for the industrial sector in Germany. Our findings confirm the view of a smaller employment response of small and medium-sized enterprises to changes in economic activity.