Testing the Principle of "Growth of the Fitter": The Relationship between Profits and Firm Growth

In this study, we test the evolutionary principle of "growth of the fitter." Previous studies suggest that growth does not discriminate between firms according to their fitness when this latter is proxied by productivity. We use profits as a proxy for fitness and explore its influence on subsequent growth rates by tracking 9721 French manufacturing firms over the period 1996-2002. We overcome problems of unobserved firm-specific effects, persistence, and endogeneity by using the 'system GMM' estimator developed by Blundell and Bond (1998). Past profits have a positive effect on employment and sales growth, but a negative effect on Value-Added growth. Growth, on the other hand, has a strong effect on profits, which suggests that dynamic increasing returns to firm growth dominate potential "Penrose effects."