Firm-Specific Learning and the Investment Behaviors of Large and Small Firms

Previous research indicates that the differences between large and small firms should be more pronounced during economic down turns. However, although many studies have emphasized equilibrium models with heterogeneous firms and financial frictions, little research has focused on the separate effects of firm heterogeneity and financial frictions. In this paper, a modified version of Jovanovic's (1982) learning model is examined in order to demonstrate the model's ability to generate volatility differences between large and small firms that are similar to those attributed to financial frictions. Findings show that younger, smaller firms, which are usually more uncertain about productivity, are more likely to overreact to aggregate shocks than older, larger firms. These distinctions in firm size and age are often attributed to financial frictions which often affect small and large firms differently. Any future collective significance assessments of financial frictions must go beyond a non-financial theory of firm growth and size distribution.(SFL)