The firm size-leverage relationship and its implications for firm entry and concentration
Work document
March 2022
WP 22-07 – Larger companies (by sales or employment) have higher leverage. This pattern is explained using a model in which firms produce multiple varieties, acquire new varieties from their inventors, and borrow against future cash flows of the firm with the option to default.
Replaces Working Paper 20-29/R – The Relationship Between Firm Size and Leverage and Its Implications for Firm Entry and Concentration
A variety can die with constant probability, implying that firms with more varieties (larger firms) have lower sales growth variance and, at equilibrium, higher leverage. In this configuration, a drop in the risk-free rate further increases the value of an acquisition for large companies due to their higher leverage: they can borrow (and do borrow) a larger fraction of their future cash flows. The decline drives existing businesses to buy more of the new varieties that are coming into the economy, leading to a lower start-up rate and greater sales concentration.
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