Working Paper

The Firm Size-Leverage Relationship and Its Implications for Entry and Business Concentration

Abstract: Larger firms (by sales or employment) have higher leverage. This pattern is explained using a model in which firms produce multiple varieties, acquire new varieties from their inventors, and borrow against the future cash flow of the firm with the option to default. A variety can die with a constant probability, implying that firms with more varieties (bigger firms) have a lower variance of sales growth and, in equilibrium, higher leverage. In this setup, a drop in the risk-free rate increases the value of an acquisition more for bigger firms because of their higher leverage: They can (and do) borrow a larger fraction of their future cash flow. The drop causes existing firms to buy more of the new varieties arriving into the economy, resulting in a lower startup rate and greater concentration of sales.

Keywords: Startup rates; concentration; leverage; firm dynamics;

JEL Classification: E22; E43; E44; G32; G33; G34;

https://doi.org/10.21799/frbp.wp.2022.07

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2022-03-17

Number: 22-07