Profitability and the Lifecycle of Firms

Using data on listed and unlisted firms in the U.K., this study documents systematic changes of profitability with age. In their early years, firms realize substantial profitability increases, on average, while mature firms face slow declines in profitability. A model of endogenous profitability changes arising from product development captures this pattern. Investment in product development generates profitability increases for young firms while competitive pressures from new entrants lead to profitability declines for mature firms. In addition, the model predicts that young firms realize profitability jumps more frequently and that the effect of age on firms’ policies would be stronger for young firms. Empirical tests support these predictions. In particular, the last finding suggests that estimates from data sets with mostly mature public firms likely understate true firm lifecycle effects.