Firm productivity, heterogeneity, sunk costs and market selection

The main objective of this paper is to explore whether or not patterns of entry and exit are systematically related to productivity differences at the firm level, as suggested by models of industry dynamics Hopenhayn (1992) [Hopenhayn, Hugo, 1992. Entry, exit, and firm dynamics in long run equilibrium. Econometrica, 60, 1127-1150 (September)]. The comparisons of productivity distributions for entering, exiting and continuing firms are performed by non-parametric procedures and for a large scale firm-level panel data set of Spanish manufacturing firms. The main empirical findings can be summarized as follows. First, heterogeneity in productivity levels across firms is persistent through time. Second, entry and exit decisions are systematically related to differences in firm productivity. In particular, the productivity distribution of continuing firms stochastically dominates the distributions of entering and exiting firms. Third, at the moment of entry, the group of failing members of any entry cohort has lower productivity than the group of surviving members of the same entry cohort. Fourth, the post-entry productivity level of entering firms grows more rapidly than the productivity of incumbent firms, although this pattern is not always highly significant. Finally, we find that sunk costs are an important source of heterogeneity across firm productivity. The evidence we find is consistent with models of industry dynamics predicting lower productivity for firms operating in markets with a higher level of sunk entry costs.