How is the Selection Mechanism of Companies Working?

ABSTRACT

When nonproductive and inefficient firms exit and productive firms survive, the productivity of the aggregate level of the overall economy improves. Existing research has noted that this kind of selection mechanism (natural selection function) deteriorated in the late 1990s. This paper confirms the current state of the natural selection function, and analyzes differences resulting from company size, age, and inter-firm relationship. The main findings are as follows.

1. The natural selection function is working normally from the perspective of profitability, growth, and financial standing.

2. Total exits (bankruptcies, dissolutions, business closures, suspensions, and mergers) are high among both large and small firms, but low among mid-sized firms. The natural selection function is strong from the perspective of profitability at large firms and from the perspective of growth at small firms. Mergers at large firms and business closures at small firms result in many exits, while many bankruptcy exits at mid-sized firms are “late”.

3. The total number of exits among young firms is high. Many firms 40-49 years old exit from business closures, and the natural selection function is strong from the perspective of growth.

4. Inter-firm relationships weaken the natural selection function from early exits (dissolutions, business closures, and suspensions), while exits from bankruptcies increase.

(1) This research is based on the research results of the “Finance and Industry Network Research Group” of the Research Institute of Economy, Trade, and Industry (RIETI).