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Small is Beautiful but Size Matters: The Asymmetric Impact of Uncertainty and Sunk Costs on Small and Large Businesses

Vivek Ghosal ()

MPRA Paper from University Library of Munich, Germany

Abstract: Against the backdrop of the theories developed in the real options and financing constraints literatures, this paper examines the impact of profit uncertainty and sunk costs on firms’ entry and exit decisions. For our empirical analysis, we compile an extensive dataset containing information on 267 U.S. manufacturing industries over a 30-year period containing industry-specific information on the number of firms and establishments, the size distribution of establishments, measures of sunk capital costs and profit uncertainty, among others. Our dynamic panel data estimates show that greater uncertainty about profits, especially in conjunction with higher sunk costs, results in (1) a marked decrease in the number of small firms and establishments; (2) a less skewed size distribution of firms and establishments; and (3) a marginal increase in industry output concentration. In sharp contrast, large establishments seem virtually unaffected. The results point to uncertainty in conjunction with sunk costs fundamentally affecting firms’ decision-making and altering the structure of industries by putting smaller businesses at a disadvantage.

Keywords: Uncertainty; sunk costs; real options; financing constraints; decision-making; small businesses (search for similar items in EconPapers)
JEL-codes: D80 G10 L11 L40 O30 (search for similar items in EconPapers)
Date: 2007-07
New Economics Papers: this item is included in nep-bec, nep-cfn, nep-ent, nep-mic and nep-tid
References: View references in EconPapers View complete reference list from CitEc
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