Essays on firm dynamics

• Autores: Beatriz González López
• Directores de la Tesis: Andrés Erosa Etchebehere (dir. tes.)
• Lectura: En la Universidad Carlos III de Madrid ( España ) en 2019
• Idioma: español
• Tribunal Calificador de la Tesis: Andrea Caggese (presid.), Emircan Yurdagul (secret.), Josep Pijoan-Mas (voc.)
• Programa de doctorado: Programa de Doctorado en Economía por la Universidad Carlos III de Madrid
• Materias:
  • Ciencias económicas
    • Economía general
• Enlaces
  • Tesis en acceso abierto en: e-Archivo
• Resumen

  • There is a growing interest among macroeconomist in incorporating explicit heterogeneity into macroeconomic models, allowing to bring in micro data to discipline them. In this way, we can understand how shocks or policies impact differently these heterogeneous agents and their macroeconomic implications, which sometimes might differ from those obtained using a representative agent model. My dissertation consists of two main chapters that attempt to understand the impact of changes in the economic environment, with a special focus on taxes, on heterogeneous firms' investment and growth decision, the firm size distribution of firms, and ultimately their impact on macroeconomic aggregates.

    In the first chapter, `Taxation and the Life Cycle of Firms', we extend the Hopenhayn and Rogerson (1993) framework of firm dynamics to understand how different forms of taxing corporate income affect the life cycle of firms. We stress that the various ways capital income can be taxed (whether corporate income, dividend, or capital gains taxation) have quite different effects on investment and payout policies over the life cycle of firms, and hence on their life cycle growth. They also have different and asymmetric effects on the market valuation of new versus incumbent firms, and thereby on firm entry.

    We start by analysing a simple version of the model with a deterministic fixed level of productivity determined upon entry. Companies need to raise equity to set the firm up, starting their life in the `traditional view' regime (equity issuance phase). They grow by accumulating profits (growing phase), until they reach their optimal size and start distributing dividends (maturity phase). Consistent with the `new view', dividend taxation does not distort investment decisions and dividends paid by mature firms. However, dividend taxation diminishes the optimal amount of initial equity issued by firms. Intuitively, firms can diminish the taxes paid by financing a larger portion of investments with retained earnings. Hence, dividend taxation reduces the initial size of firms, retarding the age at which they reach maturity, and diminishes entry. The taxation of capital gains has the opposite effects of dividend taxation. First, the taxation of capital gains encourages firms to issue more equity at entry in order to avoid paying the taxes that would accrue with the accumulation of internal funds. Second, it distorts the optimal scale of the firm at maturity. Corporate income taxation impacts on capital accumulation through several channels. First, corporate income taxation distorts the optimal size and dividends paid by mature firms by decreasing the return on capital. Second, crucial to our analysis and results, the corporate income tax decreases after-tax earnings, making it harder for firms to finance investment with retained earnings and causing firms to grow at a slower pace over their life cycle. As a result, the market value of the firm decreases, leading to two additional effects of corporate income taxation on capital accumulation: firms raise less equity at entry, and the equilibrium mass of entry becomes smaller. While these effects are also present under dividend taxation, they are stronger under corporate income taxation.

    The baseline economy with firm dynamics (due to idiosyncratic productivity shocks at the firm level) is calibrated to moments on the micro data on firms' investment and financing decisions. We use the calibrated model economy to quantitatively assess the effects of a reform that eliminates the taxation of corporate income while keeping constant the tax revenue collected on capital. This is done by finding the common tax rate on all forms of capital income (dividends , interest income, and capital gains) that collects the same tax revenue as in the baseline economy. The purpose of the proposed policy reform is twofold. Firstly, all sources of capital income are treated symmetrically from the household perspective. Secondly, by eliminating the corporate income tax, financially constrained firms are able to accumulate profits and to reach maturity (the dividend distribution stage) faster. The elimination of the corporate income tax in the baseline economy (which was previously 0.34) should be accompanied by an increase in the other capital income tax rates to 0.41 in order to keep government revenue constant (the dividend and capital gains tax in the baseline economy were set to 0.15 and the interest income tax was set to 0.25). In equilibrium, this leads to an increase in the initial size at entry, a decrease in the optimal size at maturity, and a decrease in the time to reach maturity. This benefits mostly young firms, thereby increasing entry by 35%. Aggregate output increases 12%, accompanied by a large increase in the aggregate capital stock (32%). Hence, the large response of firm entry is important for understanding the macroeconomic effects of the tax reform. When entry is kept fixed, the increase in output is a third and the rise in capital is half of those in the economy with endogenous entry.

    At the heart of our results is the fact that the tax reform increases the expected value at entry more than the value of incumbent firms, leading to a reallocation of resources from mature to younger firms, which operates through an increase in entry and in the equilibrium wage rate. The elimination of corporate income taxation allows financially constrained firms to retain a larger fraction of their earnings and increase their investments. The ability to retain earnings is particularly relevant for young firms, which are more likely to be constrained than the average incumbent firm in the economy. Since the value at entry is determined by the average value of age-0 firms, the value of the average firm entering the economy increases more than that of incumbent firms when corporate income taxation is eliminated. In general equilibrium, the increase in the value of entry requires the wage rate to rise, which reduces labor demand by incumbent firms. Labor market clearing requires a larger mass of firm entry, which rises by about 35%. Larger firm entry, together with a reallocation of resources to financially constrained firms, lead to an increase in aggregate TFP of 4.6%.

    In the second chapter of this thesis, `Macroeconomics, Firm Dynamics and IPOs', I argue that changes in the economic environment can impact differently privately held and publicly traded firms. There have been several important changes in the US economic environment since the 1970s: a large decrease in corporate and dividend taxes (McGrattan and Prescott (2005)), an increase in financial development(Kim et al. (2008), Jayaratne and Strahan (1996)), and changes in idiosyncratic uncertainty (Bloom (2009), Gilchrist et al. (2014)). These changes might asymmetrically impact publicly traded and privately held firms since these firms are facing different financial frictions, hence they might react differently to changes in the economic environment. Acknowledging the difference between privately held and publicly traded firms, not only we can better understand how firms react to changes in the economic environment, but also the implications for selection (i.e. privately held firms deciding to do an IPO), and ultimately their impact on macroeconomic aggregates. This is especially interesting since in the last decades the selection into public and characteristics of public firms have suffered major changes, but the reasons behind these changes are not yet well understood. From the 1970s until the 1990s, the number of public firms nearly doubled, and the market capitalization of domestic public companies went from nearly 54% of GDP in 1970 to almost 160% of GDP in 2000. After the beginning of the new century, the number of public firms decreased, but surprisingly the market capitalization to GDP was still high. A theory that connects private and public firms in a general equilibrium setting helps explaining how changes in the economic environment contribute to the observed trends and map out subsequent macroeconomic consequences. Most papers studying heterogeneous firms focus on publicly traded firms (Cooley and Quadrini (2001), Gourio and Miao (2010)),, i.e. firms with readily access to equity financing. Although publicly traded firms are important (they employ around one third of the population, and make up 40% of GDP), most firms are privately held and rarely use equity financing. Other papers study the behaviour of small operating units, or entrepreneurs (Buera et al. (2011)), who self-finance the firms, but do not take into account these large publicly traded firms. Some papers introduce in this setting a corporate sector, usually as a representative firm, but corporate and non-corporate firms only interact via general equilibrium (Quadrini (2000)). My contribution is departing from the standard firm dynamics framework by introducing an explicit IPO decision in a general equilibrium model with heterogeneous private and public firms. The focus of this paper is threefold: 1) understanding the differential effect economic changes might have on privately held C-corporations, and publicly traded firms; 2) how these changes affect the endogenous IPO decision, and hence selection into publicly traded firms; and 3) their impact on macroeconomic aggregates.

    In the model there is a fixed mass of firms that are heterogeneous in assets and productivity. They begin their lives as privately held. Production technology features decreasing returns to scale, and firms feature a life-cycle: they are created small due to financial frictions, grow, and eventually exit. They can finance operations either with debt subject to a collateral constraint, or with retained earnings. Each period, they can decide whether to do an IPO or not. At this decision point, they face a trade-off, as access to (costly) equity markets comes at the expense of a one-off fixed cost of IPO and a higher on-going cost of operation. This higher cost of operation captures the costs of being public, such as higher auditing cost, corporate governance regulations or principal-agent problems, that this paper abstracts from modelling. Firms deciding to do an IPO are those that are constrained since they can benefit from the extra financing they obtain when they are public. When firms have accumulated enough assets, the costs of going public outweight the benefits, and firms remain private. Thus, as in the real world, the rich dynamics of the model give rise to the existence of large privately held firms (such as Cargill). The publicly traded status is therefore history-dependent, since it depends on the stream of shocks the firm received during its life cycle. I calibrate the model to match key moments of the distribution of public and private firms between 1970-1980, aimed at capturing the skewness of the firm distribution. The model macthes reasonably well some non-targeted moments, and it replicates the dynamics of TFP around the IPO date found in the data by Chemmanur et al. (2009).

    In the quantitative analysis, I show how changes in the economic environment impact privately held and publicly traded firms policies, and the selection into publicly traded firms (IPO choice). More precisely, I analyze how much of the changes observed in the data can be explained in the model through exogenous changes in the economic environment, and ultimately what the macroeconomic impact of these changes is.

    %First, I show that only changes in corporate and dividend taxes from the 1970s to the 1990s can explain half of the increase in stock market capitalization to GDP, and goes a long way explaining changes in payout, investment, and savings policy of publicly traded firms. It also helps explaining the changes in selection , i.e. type of firms doing IPO. Second, I show that changes in taxes, although they imply changes in policies that are still in line with the data, produce counterfactual selection into public (IPO choice) patterns in the 2000s. I explore some of the possible changes that might be behind this trend, namely changes in the cost of being public, better access to credit, and changes in the idiosyncratic shock process, and analize their impact in firms' behaviour, selection into IPO, and macroeconomic aggregates.

    In the first part of the quantitative analysis, I show that the observed changes from the 1970s to the 1990s in corporate and distribution taxes incentivize IPOs, increasing the number of public firms and its stock market value (stock market boom). Consistent with the data, more firms go public, the median size at IPO decreases and the dispersion of employment at IPO increases. Changes in taxes correctly predict an increase in the use of external equity, an increase of the equity issued, and a decrease in the fractions of firms making distributions (Fama and French (2001)). The model also correctly predicts an increase in investment and a higher stock of savings of firms (Sánchez and Yurdagul (2013)). Furthermore, it predicts an increase in concentration, consistent with the evidence presented by Autor et al (2017). Introducing private and public firms connected by the IPO decision amplifies the macroeconomic impact of these regulations, and its assymmetric impact in private and public firms makes concentration increase more than it would have if we do not take this distinction into account. The mechanism at work is as follows: a decrease in corporate taxes makes investment in private and publicly traded firms less distorted, and allows a faster accumulation of resources, thereby decreasing the tightness of the financing constraint. Ceteris paribus, this affects private and public firms symmetrically, but it benefits more constrained firms, as they have more after-tax profits to reinvest and they can undo financing constraints faster. While lower corporate tax increases the market value of public firms, it also increases the value of keeping the firm private. Conversely, distribution taxes have an asymmetric effect on public and private firms. After a decrease in distribution taxes, the external equity financing becomes cheaper. The incentives to go public increase for constrained firms, who find it profitable due to the lower cost of external financing. In equilibrium, after the decrease in taxes, selection into public tilts towards immature firms. These firms issue more equity and invest more proportionally than their mature counterparts. The fraction of firms distributing dividends then decreases, consistent with the pattern observed in the data. Changes in taxes also affect public mature firms. When hit by a good productivity shock, they use more equity and invest more. Since there is less misallocation and firms can outgrow constraints faster, output increases 3.2% and TFP increases 0.9%. Without this selection mechanism (i.e. if all firms are publicly traded), the increase in stock market capitalization to GDP would be half. Boosted by the differential impact of the policy in private and public firms, there is an increase in the concentration of employment, with the top largest 1% firms increasing their employment share by 1.6%. Direct costs of issuing equity also decreased in this period. However, I show that changes in taxes have a larger impact in the selection and behaviour trends of publicly traded firms.

    In the second part of the quantitative analysis, I show that changes in taxes alone cannot explain the changes in selection patterns since the 2000s. I explore how the interaction of changes in taxes with other changes in the economic environment, namely the cost of being public, idiosyncratic uncertainty (idiosyncratic shock process) and financial development (access to credit), affect firms' payout and investment policies, the IPO choice, and how these affect macroeconomic aggregates. I show that an increase in the cost of being public, one of the most common explanations behind the decrease in the number of IPOs since the 2000s, is at odds with many changes in the selection patterns (firms doing IPOs), and behaviour of publicly traded firms. Greater access to credit cannot explain either of these changes, nor most of the changes in behaviour of public firms, but have important macroeconomic implications. Finally, changes in the shock process (higher persistence and volatility of the shock) make less productive firms decide against an IPO. This channel can rationalize the decrease in the number of IPOs and the number of public firms, together with an increase in the market capitalization to GDP, and it is consistent with most of the changes in behaviour observed in the data. These changes also have large macroeconomic implications since there are larger and more productive firms in the economy, and it is an important driver for the increase in corporate savings.