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ARTICLE IN PRESSJournal of Financial Economics 89 (2008) 83– 108Volume 88, Issue 1, April 2008ISSN 0304-405XContents lists available at ScienceDirectManaging Editor:G. WILLIAM SCHWERTFounding Editor:MICHAEL C. JENSENAdvisory Editors:EUGENE F. FAMAKENNETH FRENCHWAYNE MIKKELSONJAY SHANKENANDREI SHLEIFERCLIFFORD W. SMITH, JR.RENÉ M. STULZJournal of Financial Economicsjournal homepage: www.elsevier.com/locate/jfecJOURNAL OFFinancialECONOMICSAssociate Editors:HENDRIK BESSEMBINDERJOHN CAMPBELLHARRY DeANGELODARRELL DUFFIEBENJAMIN ESTYRICHARD GREENJARRAD HARFORDPAUL HEALYCHRISTOPHER JAMESSIMON JOHNSONSTEVEN KAPLANTIM LOUGHRANMICHELLE LOWRYKEVIN MURPHYMICAH OFFICERLUBOS PASTORNEIL PEARSONJAY RITTERRICHARD GREENRICHARD SLOANJEREMY C. STEINJERRY WARNERMICHAEL WEISBACHKAREN WRUCKPublished by ELSEVIERin collaboration with theWILLIAM E. SIMON GRADUATE SCHOOLOF BUSINESS ADMINISTRATION,UNIVERSITY OF ROCHESTERAvailable online at www.sciencedirect.comBig business stability and economic growth: Is what’s good forGeneral Motors good for America? Kathy Fogel a, Randall Morck b,c, , Bernard Yeung daSam M. Walton College of Business, University of Arkansas, Fayetteville, AR 72701, USASchool of Business, University of Alberta, Edmonton, Alberta, Canada T6G 2R6National Bureau of Economic Research, 1050 Massachusetts Avenue, Cambridge, MA 02138, USAdStern School of Business, New York University, New York, NY 10012, USAbca r t i c l e in foabstractArticle history:Received 11 July 2006Received in revised form8 June 2007Accepted 15 June 2007Available online 15 March 2008What is good for a country may not be good for its big businesses, at least recently. Moreturnover in top businesses correlates with faster per capita gross domestic product,productivity, and capital growth; supporting Schumpeter’s [1942. Capitalism, Socialismand Democracy, third ed., Harper & Bros., New York, NY] theory of ‘‘creativedestruction’’—innovative firms blooming as stagnant ones wither. These correlationsare greater in more developed economies, supporting Aghion and Howitt’s [1992. Amodel of growth through creative destruction. Econometrica 60, 323–351] thesis thatcreative destruction matters more to economies nearer the technological frontier. Morebig business turnover also correlates with smaller government, common law, less bankdependence, stronger shareholder rights, and greater openness.& 2008 Elsevier B.V. All rights reserved.JEL classifications:O16F30G38Keywords:Business stabilityCreative destructionEconomic growth We are grateful for insightful comments and suggestions by Philippe Aghion, Melsa Ararat, Africa Ariño, Daron Acemoglu, Edgar Cabral, ParthaChatterjee, Pushan Dutt, Petra Christmann, Mara Faccio, Joseph Fan, Ray Fisman, Pankaj Ghemawat, Klaus Gugler, Campbell Harvey, Peter Holgfelt, SimonJohnson, Boyan Jovanovic, Andrew Karolyi, Tarun Khanna, E. Han Kim, Jung-Wook Kim, Bent Kromand, Larry Lang, Don Lessard, Ross Levine, VikasMehrotra, Joel Mokyr, Emi Nakamura, Andris Nobl, Hakan Orbay, Federica Pazzaglia, Enrico Perotti, Raghuram Rajan, Eric Rasmusen, Rahul Ravi, Joan EnricRicart, Tom Scott, Andrei Shleifer, Jeremy Stein, Jan Svejnar, Steen Thomsen, Daniel Trefler, Saif Warraich, Marina Whitman, Clas Wihlborg, and LuigiZingales. We also thank conference participants at the Academy of Management, American Finance Association, Canadian Economics Association,Canadian Institute for Advanced Research, Financial Management Association Doctoral Student Seminar, Instituto de Estudios Superiores de la Empresa,University of Navarra—Harvard Business School First International Workshop on Creating Value through Global Strategy, Asian Institute for CorporateGovernance Conference, Multinational Finance Association, National Bureau of Economic Research (NBER) Summer Institute in Corporate Finance, NBEREast Asian Seminar on Economics, Swedish Institute of Economic Research, and Turkish Corporate Governance Forum as well as seminar participants atthe University of Alberta, University of Amsterdam, University of California at Berkeley, Baruch University, Copenhagen Business School, ConcordiaUniversity, Duke University, Korea University. Harvard Business School, University of Illinois, University of Maryland, New York University, University ofToronto, Washington University at St. Louis, World Bank Global Corporate Governance Forum, and Yale University’s International Institute of CorporateGovernance. Kathy Fogel gratefully acknowledges an International Research Grant from the Western Center of Economic Research at the University ofAlberta. Randall Morck gratefully acknowledges financial support from the Social Sciences & Humanities Research Council of Canada. Bernard Yeunggratefully acknowledges financial support from the Berkeley Center for Entrepreneurial Studies at New York University, Stern School of Business. Corresponding author at: School of Business, University of Alberta, Edmonton, Alberta, Canada T6G 2R6. Tel.: 1780 492 5683; fax: 1780 492 3325.E-mail address: randall.morck@ualberta.ca (R. Morck).0304-405X/ - see front matter & 2008 Elsevier B.V. All rights reserved.doi:10.1016/j.jfineco.2007.06.004

ARTICLE IN PRESS84K. Fogel et al. / Journal of Financial Economics 89 (2008) 83–1081. IntroductionNational economies have landmark corporations.Maersk shipping symbolizes Denmark’s maritime history,as Nokia marks Finland’s new economy. Many, often theprincipals of such great businesses, link an economy’sfortunes to those of its landmark firms. Most famously,Charles Wilson, then chairman of the now financiallyshaky General Motors (GM), testified at his 1953 SenateArmed Services Committee confirmation hearing tobecome US defense secretary that keeping his existingjob would entail no conflict of interest since ‘‘what is goodfor the country is good for General Motors, and viceversa.’’Plausible arguments imply the opposite. Schumpeter(1912) attributes economic growth to upstart innovativefirms arising and ruining doddering behemoths, a processSchumpeter (1942) dubs creative destruction. A feedbackensues, for today’s upstarts not only become tomorrow’sbehemoths, but also inspire a new generation of upstartsthat eventually repeat the cycle. Aghion and Howitt (1992,1998), Aghion, Angeletos, Banerjee, and Manova (2005),and others model this process formally. Nelson andWinter (1982) explain creative destruction by visualizingfirms as collections of ‘‘routines’’ that develop slowly andresist change. Routines let firms prosper if they fit currenteconomic conditions: institutional constraints, consumerpreferences, production technologies, and the like. But asconditions change, an economy needs upstarts with newroutines to displace past winners, which intrinsically havedifficulties changing their ways. All these argumentsimply that Wilson is wrong, and that a negative correlation should be observed between the continuous dominance of large businesses and economic growth.But Wilson’s thesis has champions. A positive linkmight reflect large corporations prospering because theyare well managed, and the wealth they create spilling overthe economy (Chandler, 1977). Schumpeter (1942)amends his vision of creative destruction, arguing thatlarge, quasi-monopolistic businesses can best financeongoing innovation, which sustains both their dominanceand their economy’s growth. Schumpeter (1942) adds thatsuch stability provides job security, which Holmstrom(1989) argues permits high risk—high return undertakings, including investments in firm-specific human capitalthat would pose unacceptable career risks to managersand employees in smaller firms. Galbraith (1967) addsthat larger firms can better absorb advertising investments that shape demand for their products. Romer(1986) formalizes Schumpeter (1942), positing thatinvestment in innovation is worth more to a larger firmbecause its innovation can enhance productivity on alarger scale of operations. Chandler (1990) likewise positsrising economies of scope and scale in ever largercorporations as the motive force beneath economicgrowth in industrial economies. In the managementliterature, D’Cruz and Rugman (2000) and others suggestlarge business enterprises create and capture variouseconomies of scale and scope. In each of these views, apositive feedback ensues, with the dominance of largebusinesses enhancing their economic fortunes, whichfurther heightens their dominance. This feedback, in turn,fuels overall economy growth. All of these perspectivessuggest a positive correlation between and economy’sprosperity and that of its large corporations.Signing the relationship between economic growthand big business stability lets us hone away one or theother class of theories. Establishing a predominantdirection of causality, though of interest per se, is thusnot critical for this exercise. Schumpeter (2002), in theinitially omitted Chapter 7 of Schumpeter (1912), reflectson the slippery epistemology of causation in economicgrowth. Recognizing that ‘‘[t]he distinction between bothforces and their repercussions is of great analytical valuein this as in any particular case,’’ he nonetheless concludesthat economists must learn to deal with a dynamicgrowth process, ‘‘not with a causal chain of explanation.’’We sidestep all this because our objective here isdistinguishing one class of dynamic processes from theother, as a first pass at least, by signing the correlation inquestion.We regress real per capita gross domestic product(GDP) growth, capital accumulation, and total factorproductivity (TFP) growth from 1990 to 2000 for 44countries on the stability of their top ten firms from 1975to 1996, with controls for initial per capita GDP, level ofeducation, and capital stock.1 We say a leading 1975business is stable if it survives to 1996 (it needs notremain in the top ten) and we explore different definitionsof survival. The 1975–1996 window includes the first andlast years for which we had comparable lists of leadingbusinesses when we began this project. We measuregrowth in a ten-year window around the endpoint of thestability window, which smoothes business cycle andtransient crisis effects.We find faster growth in countries where big businessis less stable, and the finding survives numerous robustness tests. This supports Schumpeter (1912), Nelson andWinter (1982), Aghion and Howitt (1992, 1998), Aghion,Angeletos, Banerjee, and Manova (2005), and other liketheories; but suggests more limited traction for theories ofChandler (1977, 1990), Schumpeter (1942), Galbraith(1967), Romer (1986), and D’Cruz and Rugman (2000), atleast in the late 20th century. The latter class couldpredominate in other periods or in certain industries. Werelegate these issues to future research.Establishing a predominant direction of causality isstill ‘‘of great analytic value.’’ Granger causality tests areunviable because the processes we study work over whatSchumpeter (1912) calls the ‘‘very long run,’’ time ingenerations, not years. A useful panel would require pastdata at generational intervals, not filling in higherfrequency data. We relate big business turnover to endof-period growth because the latter is an overarchingpolicy objective. Curiously, growth measured around thebeginning of our window is uncorrelated with our big1The question of large firm stability is distinct from that of optimalfirm size. Acs, Morck, and Yeung (1999) find that US industriescontaining larger firms post faster productivity growth. Rapid turnoverof large firms need not imply a steady state characterized by apreponderance of small firms.

ARTICLE IN PRESSK. Fogel et al. / Journal of Financial Economics 89 (2008) 83–108business stability measures. This is far from conclusivebut loosely suggests big business stability causing slowgrowth. We attempt more rigorous identification withinstruments commonly used in the literature, but all failstandard weak instruments tests, implying that instrumental variables regressions using any or all of thesevariables provide no more information about causalitythan ordinary least squares (OLS) (Staiger and Stock,1997). Despite failing to identify a predominant directionof causality, this exercise elucidates the economics underlying our finding.First, enumerating alternative stories consistent with anegative correlation underscores the relative plausibilityof the Schumpeter (1912) theory of economic development. This is because we link faster growth to a higherdeath rate of old leading firms, not just to their displacement from the top ten list by new bigger firms. We definedeath as having less than one tenth the 1975 workforce in1996. A range of reverse causality stories might linkgrowth to the rise of new leading firms that eclipse stillprosperous old firms. However, the only reverse causalitystory plausibly linking growth to the destruction of oldleading firms is creative destruction itself, for Schumpeter(1912) explicitly envisions corporate turnover causinggrowth and growth causing corporate turnover.Second, although they fail as instruments, a cadre ofinstitutional variables can be usefully recast as potentiallatent factors (things that enhance both corporate turnover and economic growth) associated with the mostplausible alternative stories. We propose that the size andquality of government, the development of the financialsystem, and the degree of economic openness allencapsulate such alternative stories. We therefore identifythe proxies for these most correlated with big businessstability, and rerun our regressions of growth on stabilityincluding them as additional controls. Because thesefactors are also all potentially related to the intensity ofcreative destruction itself, this procedure works againstus. That is, controlling for these factors arguably alsodrains our analysis of much variation driven by creativedestruction. Nonetheless, our results persist: Big businessstability retains a negative sign, consistent with theSchumpeter (1912) view of upstart firms underminingstagnant behemoths. Unfortunately, because no list ofpotential latent variables can be exhaustive; this, too, canprovide only circumstantial evidence consistent withcreative destruction.A final set of clues lies in subsample regressions. Aghionand Howitt (1998) argue that growth in high-incomecountries, already on or near the production possibilitiesfrontier, requires creative destruction to push that frontieroutward; but that rapid growth in low-income countriescan arise from improved factor allocation (outward movement from deep beneath the frontier) in applying offthe-shelf technologies. Consistent with this, we find astronger relation between big business stability and slowgrowth in a subsample of high-income countries.Intriguingly, high-income countries’ growth correlatesmost strongly with large private sector firm turnover,while low income countries’ growth correlates mainlywith sometime state-controlled enterprise (SCE) turnover.85Because we disregard nationalizations and privatizationsin calculating turnover, the destruction of SCEs, not theirprivatizations, correlates with growth. Moreover, theinstitutional variables discussed above are less importantfor low-income countries, suggesting a more direct link.We speculate that sometime SCEs in low-income countries might retain political influence to soften their budgetconstraints, distorting resource allocation and slowinggrowth (Kornai, 1986). Also, Marshall (1956, p. 339) writesthat ‘‘a government could print a good edition ofShakespeare’s works, but it could not get them written.’’Shleifer and Vishny (1994a, b) and Shleifer (1996) formalize this to explain the museum pieces prominent in1989 transition economy factories. If distrust of innovation persists in sometime SCEs, this too might directlyretard growth. Thus, though privatization raises firm-levelperformance (Megginson, Nash, and van Randenborgh,1994; La Porta and Lopez-de-Silanes, 1997; and WorldBank, 1995), a drag on economy-level growth could lingerif sometime SCEs continue to dominate.These tests do not conclusively confirm our thesis, butthey coalesce into strong circumstantial evidence that theSchumpeter (1912) process of economic developmentunderlies economic growth in the late twentieth century.The paper is organized as follows. Section 2 reviewsthe construction of our key variables, and Section 3presents our main results. Section 4 discusses causality,identification, and latent variables. Section 5 describessubsample regressions, and Section 6 concludes.2. Data and variablesThis section describes the raw data used to constructour big business stability indexes. It then explains theindexes themselves, the growth measures, and the othervariables central to our empirical tests.2.1. Big business sector dataOur data are hand-collected from the 1978 and 1998/99editions of Dun & Bradstreet’s Principals of InternationalBusiness. We use this source because it includes a widespectrum of businesses: privately held companies, publiclyheld companies, cooperatives, and state-controlled enterprises.2 This circumvents sample selection problems stemming from stock exchanges, and hence listed firms, being lessimportant in some countries than others. Comparisons withannual reports show the 1978 volume to contain mainly1975 figures, so we call this 1975 data. The 1998/99 volumegenerally contains 1996 figures, so we call it 1996 data.Our final sample of 44 countries, listed in Table 1,meets the following criteria:1. The country must appear in both the 1978 and 1998/99editions of Principals of International Business. Thiseliminates transition economies.2We use the term state-controlled enterprise (SCE) instead of stateowned enterprise (SOE) because the state could hold a control blockwithout owning the firm outright.

ARTICLE IN PRESS86K. Fogel et al. / Journal of Financial Economics 89 (2008) 83–1082. We delete small economies whose tenth largestcompany has fewer than 500 employees or whichhave less than ten companies whose labor forces arelisted in both editions. This removes microstateeconomies, which could differ fundamentally fromlarger countries.3. We drop countries involved in major wars, includingcivil wars, between 1975 and 1996.4. We require data on education and capital assetsbecause these initial conditions are known to affecteconomic growth and are needed as controls in ourregressions.5. We require comparable national income accounts datato construct comparable economic growth measures.This limits us to countries included in the Penn WorldTables.2.2. Measuring the stability of leading businessesWe first need a list of each country’s top businesses in1975 and 1996. La Porta, Lopez-de-Silanes, and Shleifer(1999), Claessens, Djankov, and Lang (2000), Faccioand Lang (2002), and others show that large businessesin many countries, the US and UK being notable exceptions, are not single firms but business groups, that is,constellations of listed corporations tied together byequity control blocks and usually all ultimately controlled by a single wealthy individual or family. Wetherefore define a country’s largest businesses as theunion of its largest freestanding firms and businessgroups.We start with the list of firms in Dun and Bradstreetand determine the ultimate controlling shareholder ofeach. To do this, we search Google, online databases suchas Hoover’s online, corporate websites, Worldscope,Securities Data Company (SDC) datasets, Forbes’ annuallists of billionaires, newspaper archives, case studies, andacademic research papers. We define a firm as controlledif it is so defined in any of these sources or if 20% or moreof its stock is voted by a firm, wealthy family, government,trust, or bank.3 We then consolidate affiliated firms intobusiness groups accordingly.We define a business’ size as the number of people itemploys. For business groups, this is the total employeesin all the group’s component firms. Employee tallies forbusiness groups are cross-checked whenever possibleacross the various sources mentioned earlier.4 We meas

University, Duke University, Korea University. Harvard Business School, University of Illinois, University of Maryland, New York University, University of Toronto, Washington University at St. Louis, World Bank Global Corporate Governance Forum, and Yale University’s International Institute of Corporate . Granger causality tests are .

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