'The mortality of companies' by Madeleine Daepp, Marcus Hamilton, Geoffrey West and Luís Bettencourt in (2015) 12(106)
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The firm is a fundamental economic unit of contemporary human societies. Studies on the general quantitative and statistical character of firms have produced mixed results regarding their lifespans and mortality. We examine a comprehensive database of more than 25 000 publicly traded North American companies, from 1950 to 2009, to derive the statistics of firm lifespans. Based on detailed survival analysis, we show that the mortality of publicly traded companies manifests an approximately constant hazard rate over long periods of observation. This regularity indicates that mortality rates are independent of a company's age. We show that the typical half-life of a publicly traded company is about a decade, regardless of business sector. Our results shed new light on the dynamics of births and deaths of publicly traded companies and identify some of the necessary ingredients of a general theory of firms.
The authors state
Publicly traded companies are among the most important economic units of contemporary human societies. As of 2011, the total market capitalization of firms in the New York Stock Exchange was 14.24 trillion dollars, comparable to the entire gross domestic product of the USA. While researchers have devoted considerable attention to the distribution of firm size, the distribution of firm lifespan has been the subject of far fewer studies. Thus, despite the availability of much quantitative information, our understanding of the way public companies live and die remains limited.
At present, there are several arguments addressing the statistics of company lifespans that have led researchers to a range of different conclusions. Some of these considerations hinge on the interpretation of the meaning of the death event for a company. In the framework of this paper, definitions of ‘birth’ and ‘death’ are based on the sales reports available in the Compustat database; details can be found in §4. While liquidation is often responsible for firm deaths, a much more common cause of death relates to the disappearance of companies through mergers and acquisitions. Thus, in our definition, firms may ‘die’ through a variety of processes: they may split, merge or liquidate as economic and technological conditions change. This raises the question of what characteristics of firms may initiate such events. In particular, it has often been suggested that the mortality rates of firms are age-dependent, a proposition that offers significant insight into the forces that determine firm survival. We address this question using a comprehensive database of over 25 000 publicly traded North American companies covering a large spectrum of business sectors over the period 1950–2009. The present analysis provides one of the largest studies of this kind, both in terms of numbers of firms and timespan.
There is a great diversity of perspectives on a theory of the firm, focusing on different aspects of their costs, organization and evolution. In modern economic theory, the existence and boundaries of firms are understood in counterpoint to the dynamics of self-organization in markets. Economists such as Coase and Williamson proposed that firms exist in order to minimize (positive) market transaction costs involved in the production of goods and services. In situations when, for example, there is particular specificity of goods and services exchanged between two economic agents, such transactions may be best organized internally to an organization rather than negotiated in the open market. As such, firms may split, merge or liquidate in response to economic agents evolving new and better ways of dealing with the various costs and revenues of production and exchange. Therefore, at least on the average, the merger of existing companies should be approximately neutral in terms of the balance between costs and benefits. However, this relatively simple picture becomes more complex in the light of behavioural studies of the impact of decision-making and management practices on the growth and viability of actual firms.
A perspective more directly tied to the demography of companies is organizational ecology. In the framework of organizational ecology, organizations that vary in their structure and relationships are modelled as competing for finite resources within a complex ecology of economic interactions. In this approach, which emerged from economic sociology, companies are seen as units of selection in markets and their longevity is the result of their successes of learning and adaptation in these environments. Similar to this approach, we employ mathematical models from theoretical ecology to examine the lifespans and mortality of companies.
Among the most widely replicated results relating to the mortality of firms is Stinchcombe's liability of newness. This is the expectation that young establishments experience higher mortality rates. This scenario is supported by observation of US manufacturing plants, Argentinian and Irish newspaper companies and other types of businesses. Theoretical grounding draws from the adaptive requirements of market entry; it takes time for young companies to gain the competencies and build relationships that will ensure their ability to survive [29,30]. Moreover, new companies are likely to be smaller and less experienced and thus more susceptible to market shocks. Knott and Posen stress the evolutionary character of these arguments by suggesting that liability of newness is evidence for market-based selection.
However, more recent evidence begins to diverge from this hypothesis. In a study of West German business enterprises, Bruderl and Schussler find that companies are, in fact, protected from mortality in the immediate period after founding. This liability of adolescence likely results from the buffer a firm acquires via its capital endowment at birth, which is also a characteristic of firms that have recently entered financial markets. As their initial capital stock is expended, less profitable companies become more vulnerable to environmental changes in market conditions.
A third perspective suggests that mortality rates increase as companies age. This idea is based upon two related concepts: the first is liability of senescence, the idea that as companies age, they accumulate rules and stagnating relationships with consumers and input markets that render them less agile and that re-configuration is increasingly expensive. Arguing instead for a liability of obsolescence, Sorenson and Stuartsuggest that environmental requirements change over time and that, although firms may improve in competence and efficiency with age by becoming more specialized, these specific adaptations also increase the companies’ risk to new kinds of external shocks that will inevitably beset them.
Finally, Coad has argued that these assorted liabilities constitute small deviations, at the tails, from an aggregate lifespan distribution that is generally well approximated by an exponential distribution. This proposition has been confirmed in Italian, Spanish and French firms. As noted by Amaral et al. and Coad, the statistical patterns of firm entry and exit will affect the distribution of firm sizes in any given year and set its form and temporal stability. Thus, a better understanding of the mortality risk of firms is necessary to generate new insights on the empirically observed scaling regularities in firm size frequency distributions.
In this paper, we test these alternative hypotheses of firm lifespan and mortality risk by analysing a large database of North American publicly traded companies between 1950 and 2009. We confirm the hypothesis of an approximately constant mortality rate, finding that the exponential distribution of firm lifespans holds across business sectors and causes of mortality. We apply survival analysis to estimate in a variety of ways that the firms in our dataset have a half-life of approximately 10 years, regardless of age.
