Modelling the Growth of Corporations

Consistent growth of income and of living standards is a feature of modern industrial economies. One of the ’stylised facts’ concerning growth, first discussed by Kaldor in 19611 but equally pertinent today, is that output per worker has continually risen `at a steady trend rate’ over a long period of time and has shown no tendency to decline. This book is concerned with understanding and modelling economic growth. However, unlike much of the economic literature we concentrate on analysing the growth of productivity of the corporation. Just as the productivity of nations has grown consistently, so too has the output per person employed in the typical modern large corporation. But, as at the national level, it is clear that different corporations grow at different rates over fairly long periods of time. This book develops an approach for understanding and modelling the productivity growth of individual corporations.

Traditional economics has concentrated upon analysing economic growth at the aggregate or national level. The principal objective has been to explain the sustained growth of living standards in industrial countries and why the long-run rate of growth has varied across countries, particularly when the standard theory predicts that countries will tend to converge to the same long-run trend rate of growth.

In this chapter we present our model of corporate growth which is based upon strong theoretical reasoning but is also designed to be applicable empirically and in particular to be of use in explaining the different growth performance of various corporations. Here we provide the underlying basis of the model in an intuitive manner without the use of technical and particularly mathematical terms. A technical specification of the model is provided in Appendix 3.1 (p.39), while a discussion of how the model can be calibrated to available data for specific corporations is provided in Appendix 3.2 (p.46). The basic objective of the model is to explain why corporations tend to exhibit persistent growth of labour productivity over time and why growth rates differ between corporations competing in similar markets. There are two key elements to the model which are first discussed in the chapter: first, the nature of the firm and then, secondly, technological progress and learning processes. In the final part of the chapter we bring these concepts together to provide a full discussion of the model of the growth of productivity within modern corporations.

In this chapter we proceed to apply the model and ideas presented in Chapter 3 to data for actual companies. We consider a range of companies in the following major sectors; chemicals, pharmaceuticals and electronics. All of the data are derived from annual company accounts and come from publicly accessible internet sites.1 We present a simple application of the model, the details of the calibration of the model are described in Appendices 3.1 and 3.2 (pp. 39-50).

In addition to internal growth processes firms also have the opportunity to increase their size through mergers. Indeed, during certain periods this has been a very popular means of expansion leading to an increasing concentration of activity amongst a declining number of firms. However, previous studies suggest that the impact of mergers on firm performance is not generally clear. There is still much debate as to what are the conditions that are necessary for a merger to be successful in the long run.

In Chapter 4 we provided an analysis of firm performance from an internal point of view and discussed the application of the approach to modelling corporate productivity growth as a tool for management. Here we discuss how the ideas concerning the nature of the firm and the way that it evolves and the model which reflects these can be used as an analytical tool from an external point of view, and specifically in terms of informing long-term portfolio investment choices. Our focus is entirely upon long-run investment decisions. This follows from the view of the firm as a complex self-organising institution which, because of increasing returns and positive feedback effects from learning and experience, tends to exhibit a sustained and constant process of growth. Deviations around this trend rate of growth tend to be associated with the business cycle. As we have argued earlier, in the medium term, firms are generally bound by their trend rate of growth of productivity.