to Lack of Selection and Limits to Delegation: Firm Dynamics in Developing Countries

Abstract

Firm dynamics in poor countries show striking differences to those of rich countries. While few firms indeed experience growth as they age, most firms are simply stagnant in that they neither exit nor expand. We interpret this fact as a lack of selection, whereby producers with little growth potential survive because innovative entrepreneurs do not expand enough to force them out of the market. To explain these differences, we develop a theory whereby firms require managerial inputs for production and countries differ in their managerial delegation possibilities. If delegation of managerial tasks to outside managers is difficult in poor countries, entrepreneurs are forced to rely on their own time to supply managerial services. Improvements in the efficiency of delegation will raise the returns to growing large, induce innovative firms to expand, and thereby force stagnant entrepreneurs out of the market. We prove the existence and uniqueness of the dynamic equilibrium and show analytically how the degree of selection depends on some of the key structural parameters. To discipline the quantitative importance of this mechanism, we calibrate our model to micro data from the US and India. Differences in the efficiency of managerial delegation can explain an important fraction of the differences in plants' life-cycles.