The Cyclical Composition of Startups

This paper proposes a new theory of business cycles based on the idea that financial uncertainty shocks change the nature of innovation. When investors become more risk tolerant, they fund riskier startups with greater growth potential. As these ambitious startups grow, the initial shock propagates and generates a boom in output and employment. I develop a heterogeneous firm industry model of the US business sector with countercyclical risk premia and innovation by startups and existing firms. The quantitative implementation of the model jointly matches time series properties of stock returns and macroeconomic aggregates, as well as micro evidence on firm cohort growth over the cycle. ∗Department of Economics, Stanford University, 579 Serra Mall, Stanford, CA 94305 (email: [email protected]). I am deeply indebted to Monika Piazzesi, Martin Schneider and Christopher Tonetti for invaluable guidance and support. I also thank Adrien Auclert, Jose Barrero, Nick Bloom, Emanuele Colonnelli, Patrick Kehoe, Pete Klenow, Pablo Kurlat, Moritz Lenel, Davide Malacrino, Sean Myers, Alessandra Peter, Cian Ruane, Itay Saporta-Ecksten, Alonso Villacorta, David Yang and seminar participants at Stanford University for helpful comments. Financial support from Stanford Institute for Economic Policy Research and Weiland Research Fellowship is gratefully acknowledged.