NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Changing Business Volatility

"Although the level of business volatility is relatively high at privately held firms, it has trended downward. In contrast, the level of business volatility is relatively low at publicly traded firms, but it has trended upward. This pattern of 'volatility convergence' holds in every major industry."

In the past quarter century, the ups and downs of the American economy - that is, its business cycle volatility - have decreased. That's a good thing: it means less severe recessions, milder swings in the unemployment rate, and possibly fewer business failures. Over the same time period, though, the volatility of employment growth rates and sales growth rates at some 10,000 companies whose securities are traded on various stock markets have risen, on average.

In Volatility and Dispersion in Business Growth Rates: Publicly Traded versus Privately Held Firms (NBER Working Paper No. 12354), co-authors Steven J. Davis, John Haltiwanger, Ron Jarmin, and Javier Miranda seek to explain these apparently contradictory trends. For their study, they use the recently developed Longitudinal Business Database (LBD), which contains annual observations on employment and payroll for some 6 million U.S. businesses. This is a dramatically larger and more comprehensive database than the COMPUSTAT data on publicly traded companies used in previous studies. Publicly traded companies constitute less than 1 percent of all U.S. firms and about one-third of U.S. employment in the non-farm business sector.

The authors' main finding is that the employment-weighted mean volatility of firm growth rates for all U.S. businesses has declined by more than 40 percent since 1982. LBD data confirm that volatility rose among publicly traded firms. However, this trend is overwhelmed by declining volatility among privately held firms, some large, but many as small as mom-and-pop shops. Although the level of business volatility is relatively high at privately held firms, it has trended downward. In contrast, the level of business volatility is relatively low at publicly traded firms, but it has trended upward. This pattern of "volatility convergence" holds in every major industry.

Several developments underlie the volatility convergence phenomenon. First, activity has shifted to older employers among privately held businesses, and older businesses tend to be much more stable than new businesses. The employment-weighted rate of business entry and exit has also declined. The authors estimate that the shift of employment toward older businesses accounts for 27 percent of the volatility decline among privately held firms.

Second, large publicly traded companies have gradually displaced smaller businesses in some industries. In retailing and restaurants, for example, Wal-Mart, Target, McDonald's, Applebee's, Starbucks, and other chains have grown relative to smaller stores and restaurants. Larger businesses firms and establishments are less volatile than their smaller counterparts. So the increased market share of large publicly traded companies in certain industries also contributed to a decline in overall business volatility.

As for the extra volatility of publicly traded firms, especially visible in the 1990s, this trend reflects the rise in new business models and high-tech firms, including dotcoms and biotech, which -- with increased venture capital - were able to go public with stock offerings earlier in the life cycle than in previous decades. As a result, newly and recently listed firms became riskier compared to newly and recently listed firms in earlier decades. The number and market share of recently listed firms also rose rapidly starting in the early 1980s. The influx of large numbers of increasingly risky firms accounts for most of the rise in volatility among publicly traded firms.

The decline in firm-level volatility in the United States has contributed to a decline in what economists call "frictional unemployment." Fewer workers become unemployed because of layoffs when employer volatility drops. The authors conjecture that long term declines in business volatility and unemployment flows may stem in part from greater wage-and-earnings flexibility. Reasons for greater flexibility of wages and earnings include declines in the real minimum wage, a diminished role for private sector unions, intensified competitive pressures that undermine rigid compensation structures, and the growth of employee leasing and temporary workers.

Interestingly, the decline in business volatility coincides with a period of impressive productivity growth in the nation. This does not fully square with the creative-destruction view of economist Joseph Schumpeter - the notion that productivity growth relies mostly on the displacement of less productive firms by more productive rivals. Perhaps, the authors speculate, there has been a large increase in the pace of restructuring, experimentation, and adjustment activities within publicly traded firms that boosted productivity throughout the economy

-- David R. Francis

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