Idea Rents and Firm Growth

Abstract

Which firms drive aggregate growth? Price-earnings ratios differ markedly and persistently across publicly-listed firms. Large differences remain after netting out the impact of proxies for firm-specific discount factors, and are highly correlated with analyst forecasts of future earnings growth. The implication is that listed firms deviate from Gibrat’s Law, under which expected growth rates are purported to be the same across firms. We find further that fast-growing firms are expected to see increases in their earnings relative to sales, which we interpret as rents from ideas. We construct an endogenous growth model with persistent shocks to firm innovation step-sizes and calibrate it to match patterns in the data. The model implies that the fastest-growing firms are responsible for a much bigger share of aggregate growth than predicted under Gibrat’s Law.