Dimensions of Firm Growth and Governance

Sep 2019

Natarajan Balasubramanian Syracuse University

Ravi Dharwadkar Syracuse University

Jagadeesh Sivadasan University of Michigan

Abstract

We develop a novel decomposition of firm employment growth based on a finer-grained conceptualization of firm growth than has previously been adopted. Using this, we examine the association between the dimensions of firm growth and governance. We find that poorly governed firms have lower organic growth in existing establishments and new establishments, and significantly greater establishment closures and sales. We do not find significant differences between poorly governed and well-governed firms in growth from acquisitions. Thus, our results do not fully align with the empire building or quiet-life views of governance, both of which would suggest lower levels of contractionary activities by poorly governed firms. Rather, poorly governed firms seem unable to manage growth, which forces them to close or sell their establishments.

Keywords: Firm growth, components of growth, market for corporate control, empire building, quiet life, Census microdata.

Balasubramanian: Associate Professor, Whitman School of Management, Syracuse University, 721 University Ave, Syracuse, NY 13244. nabalasu@syr.edu, tel. (315) 443-3571, fax (315) 442-1449. Dharwadkar: Professor, Whitman School of Management, Syracuse University, 721 University Ave, Syracuse, NY 13244. rdharwad@syr.edu, tel. (315) 443-3386, fax (315) 442-1449. Sivadasan: Professor, Ross School of Business, University of Michigan, 701 Tappan Street, Ann Arbor, MI 48109, jagadees@umich.edu, tel. (734) 763-2373, fax (734) 764-2557

Any opinions and conclusions expressed herein are those of the authors and do not necessarily represent the views of the U.S. Census Bureau. All results have been reviewed to ensure that no confidential information is disclosed. We thank seminar participants at the Whitman School of Management, Molson School of Business, Lally School of Management, and the annual meeting of the Academy of Management for their helpful comments. We gratefully acknowledge the financial support of the Whitman School of Management, Syracuse University.

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Introduction

Firm growth and corporate governance are important determinants of firm valuation for public

companies. While firm growth is important for enhancing market valuation and decreasing the

cost of capital, effective corporate governance ensures that firm growth is associated with

enhanced firm value. Not surprisingly, many studies have examined the association between

elements of corporate governance (e.g., board and ownership characteristics, market for

corporate control, and debt) and aspects of firm growth. Overall, research finds that poor

governance results in misallocation of resources, and therefore that it is associated with either (1)

lower overall firm growth, (2) a greater level of expansionary activities such as mergers and

acquisitions, or (3) a lower level of contractionary activities like divestitures (e.g., Amihud &

Lev, 1981; Bergh & Sharp, 2015; Betrand & Mullainathan, 2003; Brush, Bromiley, &

Hendrickx, 2000; Hoskisson, Johnson, & Moesel, 1994; O’Brien and David, 2010; Trautwein,

1990).

However, most of this research considers only overall firm growth or specific dimensions

of growth in isolation such as acquisitions or divestitures. This misses a critical aspect of firm

growth: managers often simultaneously expand and contract their firms’ boundaries through

organic growth of existing units, acquiring or starting new units, selling units, and closing units.

Hence, focusing on overall firm growth or examining one of these specific dimensions obscures

the multifaceted nature of firm growth and its associated resource allocation decisions. For

instance, the strategic implications of poor governance lowering firm growth by decreasing

expansionary activities would be different from those of poor governance lowering firm growth

by increasing contractionary activities.

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This paper takes a step towards addressing this gap by using a comprehensive and

granular conceptualization of firm growth that overcomes some of the limitations of previous

studies. We conceptualize managers as simultaneously allocating resources to grow firms by: (1)

expanding existing establishments, (2) starting new establishments, (3) acquiring establishments,

(4) selling old establishments, and (5) closing old establishments.1 Thus, in our

conceptualization, two firms with identical overall growth rates could differ considerably in

terms of resources across these different growth components. Empirically, we focus on firm

employment growth (e.g., Baum & Bird, 2010; Beckman, 2006; Rodriguez & Nieto, 2015). We

use establishment-level data to develop a new decomposition of firm growth, which allows us to

measure the distinct expansionary and contractionary processes underlying aggregate firm

growth. We then use this decomposition to examine the association between governance and the

various underlying dimensions of growth to better understand how poor governance might be

associated with inefficient resource allocation across the different growth components.

In so doing, the paper makes two contributions to the related literatures. First, our finer

conceptualization and the associated empirical decomposition better distinguish among the

multiple growth processes underlying overall firm growth, including organic growth from

existing establishments versus starting new establishments, and contractions from selling versus

closing establishments. This addresses three limitations in the literature.

One, as alluded to, most growth studies in general (e.g., Greve, 2008; He & Wong, 2004;

Sharma & Kesner, 1996) and governance studies in particular (Brush, Bromiley, and Hendrickx,

2000; Gompers et al., 2003; O’Brien & David, 2010; Paul, 2007) have focused on aggregate

1 Throughout the paper, we follow the U.S. Census Bureau’s definition of “establishment” as “a single physical location where business is conducted or where services or industrial operations are performed” (https://www.census.gov/ces/dataproducts/bds/definitions.html).

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growth (e.g., year-on-year change in sales, OLS β of sales over time) or treat expansionary and

contractionary processes in isolation (e.g., Hoskisson et al., 1994; Paul, 2007). For instance,

Gompers et al. (2003) find that ineffective governance, as measured by the extent of protection

from takeovers, is associated with lower sales growth, while O’Brien and David (2010) find that

transactional and relational types of debt governance are differently associated with aggregate

firm growth. Moving on to expansionary processes, Paul (2007) finds that certain board

characteristics result in corrective action in the context of poor acquisition bids, thereby

constraining (possibly destroying the value of) firm growth. Focusing on contractionary

processes, Hoskisson et al. (1994) note that the presence of blockholders is indirectly associated

with divestitures (as measured by divestiture intensity). Thus, these studies, while insightful

about the relation between overall firm growth and governance, do not shed light on the

association between governance and the underlying components of growth. This is important

because governance may influence different components of growth differently.

Two, studies often decompose overall growth into organic growth and acquisitive

growth, and compute organic growth by subtracting acquisitive growth from overall growth (e.g.,

Chakrabarti, 2014; Kim et al., 2011; Moatti et al., 2014; Lockett et al., 2009; Zhu and Chen,

2014). However, such a method does not consider whether the organic growth is due to the

growth of existing establishments or the addition of new establishments. More importantly, this

method subsumes all divestments associated with sales and closures of establishments under

organic growth, and thus could significantly understate organic growth and overstate the

importance of acquisitive growth.

Three, some studies use categorical variables to assess if a firm was involved in an

acquisition or not, or the number of acquisitions or patterns of acquisitions made by the firm

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(Rehm, Uhlaner, and West, 2012; Villalonga and McGahan, 2005). Similar approaches are also

taken in the realm of contractionary activities (Kolev, 2016). Divestiture research typically

considers if firms pursue divestitures as a dummy variable (Bergh, 1997), the number of

divestitures (Berry, 2010), and divestiture intensity in terms of the ratio of divested assets to total

assets at the firm level (Hoskisson et al., 1994). Such studies by design do not focus on the

precise magnitudes of the various components of the underlying growth processes, and thus do

not provide a granular picture of the phenomenon.

Our approach addresses these limitations by conceptualizing and measuring the

underlying components of growth more precisely, and by explicitly quantifying the simultaneous

expansions and contractions of firm boundaries observed in firms. Furthermore, because our

approach builds up from individual components that exactly add up to total firm growth, it is

more precise than residual-based approaches that back into growth components (e.g., subtracting

acquisitions from total firm growth to compute organic growth). Consequently, it is able to

incorporate the somewhat-ignored contractionary aspects of growth processes—namely,

establishment closures, which are clearly an important element of growth but rarely considered

in research. Indeed, we find that the contribution of establishment closures to overall firm growth

is similar to that associated with the sale of establishments. In contrast, prior studies have

generally equated contractionary activities only with divestitures, that too captured at a very high

level (e.g., as the ratio of divested assets to total assets in Hoskisson, Johnson, and Moesel,

1994).

Second, we contribute to two interrelated but competing theoretical and empirical

research steams in governance research. Related to the first stream, focused on the private

benefits of investments to managers, we reexamine the dominant view that poorly governed

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managers are associated with “empire building” (Baumol, 1959; Williamson, 1964; Trautwein,

1990) and choose to increase firm size (often through mergers and acquisitions) at the expense of

their shareholders. Jensen (1986) argues that empire-building managers pursue firm growth

through acquisitions rather than paying back their shareholders. Rehm et al. (2012) similarly

note that the larger firms get, the more they rely on mergers and acquisitions to grow despite the

significantly negative market reactions to acquisitions (Sundaram, 2004). Interestingly, some

studies implicitly rely on empire-building arguments or indirectly allude to them, but also

assume that poorly governed managers are negatively associated with firm growth (e.g.,

Gompers et al., 2003).

Related to the second stream, based on the private costs of investments to managers, we

examine a competing minority view (e.g., Bertrand & Mullainathan, 2003; Tirole, 2017) that

poorly governed managers prefer the “quiet life” and would rather not expend effort to manage

firm size through either expansionary (e.g., starting new establishments) or contractionary

activities (e.g., closing old establishments). In contrast to the first view, fewer studies (e.g.,

Aggarwal & Samwick, 2006; Bertrand & Mullainathan, 2003) have examined the implications of

the quiet-life perspective, likely due to the unavailability of data on contractionary activities.

Furthermore, empirical research has typically tested the empire-building perspective

largely at the firm level (e.g., Morck, Shleifer, & Vishny, 1990), while the quiet-life perspective

has been primarily evaluated in the domain of plant-level activities, such as plant closures (e.g.,

Bertrand & Mullainathan, 2003). Our bottom-up approach assembles firm growth by dovetailing

expansionary and contractionary activities using establishment-level data. This enables us to test

these competing perspectives in a unified setting. When we do so, we find that in line with prior

studies (e.g., Gompers et. al., 2003), better-governed firms have higher growth. However, only a

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very small part of this difference is attributable to growth through acquisitions, which appears to

be incompatible with empire-building arguments. Most of the difference seems to arise from the

lower growth of existing establishments in poorly governed firms and higher levels of

establishment sales and closures among such firms. Of these results, the former is consistent with

the quiet-life view but the latter is inconsistent with both empire-building and quiet life

perspectives. Thus, our results suggest the potential for a new perspective to describe managerial

resource allocation decisions related to firm growth.

Theory and Hypotheses

We develop our theory and hypotheses in two steps. First, we develop our fine-grained

conceptualization of firm growth. Having provided a clear explanation of the various dimensions

of growth being considered, we draw on empire-building and quiet-life arguments to develop our

hypotheses relating governance to elements of firm growth.

A finer-grained conceptualization of firm growth

We conceptualize growth as the composite outcome of underlying expansionary and

contractionary activities that managers can undertake. A schematic of our conceptualization is

presented in Figure 1. Firms can expand organically by growing existing establishments (1) and

setting up new establishments (2). They can also expand by acquiring establishments from other

firms (3). Finally, firms can contract by selling establishments to other firms (4) and closing

establishments (5).

An advantage of this conceptualization is that it not only provides a more precise

estimation of organic growth but also allows us to distinguish between growth in existing

establishments and growth at new establishments. Furthermore, it reflects the simultaneous

expansions and contractions of firm boundaries, or “churn,” found in prior research on firm

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boundary management that uses establishment-level data (e.g., Maksimovic & Phillips, 2001,

Maksimovic, Phillips & Prabhala, 2008). Importantly, by viewing aggregate firm growth as

arising from the underlying activities, our conceptualization incorporates this churn under the

traditional high-level view of firm growth (e.g., Evans, 1987; Eisenhardt & Schoonhoven, 1990).

Focusing on the first component above, the growth in existing establishments, studies

suggest variations in how managers allocate resources and effort among such units. For instance,

prior research (e.g., Karim, 2006; McGuckin and Nguyen, 1995) finds that managers treat acquired

businesses differently from internally grown ones. Similarly, Schoar (2002) observes that newly

acquired plants display productivity improvements, while existing plants experience productivity

losses. Hence, we further decompose growth in existing establishments into (1) growth in older

establishments, (2) growth in establishments that were founded recently, and (3) growth in

establishments that were acquired recently. This finer conceptualization allows us not only to

shed more light on organic growth, but also to assess if poorly governed managers are inclined to

buy fast-growing establishments or pay more attention to recently started establishments and

grow them at the expense of their older establishments that offer fewer growth opportunities.

In sum, we view aggregate firm growth as arising from underlying resource allocation

decisions, some of which relate to expansions and others to contractions. Later in the paper, we

describe the empirical decomposition of growth that maps onto this conceptualization.

Governance and growth

Having highlighted the individual elements of growth, we now theoretically link governance to

these elements. We do so by examining the potential implications of governance for managerial

resource and effort allocation decisions, which in turn affect the various components of growth.

Based on the literature, we build on two broad points of view on how poor governance may

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influence managerial resource and effort allocation—whether it induces managers to become

empire builders and thus favor resource and effort allocation toward expansionary activities and

away from contractionary ones, or whether it allows managers to lead a quiet life and thus reduce

resource and effort allocation activities in general.

We develop our theoretical arguments at two levels. We first examine the individual

growth components discussed in our conceptualization earlier (e.g., growth from acquisitions).

To shed light on how the quality of governance may be influencing firm growth, we delve deeper

and examine individual establishments recently acquired or established by the firm. Such

establishments can be viewed as investments made by managers to grow the firm, and thus allow

us to explore how governance is associated with the performance of such investments.

Poorly governed managers as “empire builders” in governance research

The majority of research on weak governance and growth examines private benefits that accrue

to managers such as by empire building through acquisitions, bridge-building through assigning

resources to powerful divisional managers, reducing risk through diversification, excessive

compensation, perquisite consumption, and overpayment in mergers (e.g., Amihud & Lev, 1981;

Lane, Canella, & Lubatkin, 1998; Moeller, Schlingemann, & Stulz, 2005; Trautwein, 1990;

Xuan, 2009; Yermack, 2006). One of the dominant findings in this line of studies is that poorly

governed managers, such as those in firms with ineffective boards, dispersed owners, and weak

corporate control mechanisms, are associated with increasing the firm size through mergers and

acquisitions. This view of poorly governed managers being engaged in active empire building

has garnered significant support over the past seven decades (Baumol, 1959; Williamson, 1964;

Trautwein, 1990), for both internal and external governance mechanisms.

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Within the context of internal governance for instance, Paul (2007) finds that certain

board characteristics result in corrective action in the context of bad acquisition bids. Similarly,

Gaspar, Massa, & Matos (2005) find that short-term institutional owners are associated with not

only worse abnormal returns, but also worse long-term performance of the mergers. In essence,

effective internal governance appears to limit empire building, whereas poor internal governance

seems to encourage it.

Similar findings are prevalent when the external governance context is considered. In this

context, most governance research finds that poorly governed managers (e.g., those insulated

from the corporate control market) indulge in empire building by pursuing mergers and

acquisitions (e.g., Hitt, Ireland, & Hoskisson, 2001; Moeller, Schlingemann, & Stulz, 2005;

Morck, Shleifer, & Vishny, 1990). Going back to Trautwein (1990), research evidence suggests

that poorly governed managers are interested in empire building, and consequently allocate

disproportionately more effort and resources to expansionary growth activities that enhance the

size of the firm. More recently, Gompers et al. (2003) find that ineffective governance, as

measured by the extent of protection from takeovers, is associated with increased M&A activity.

Thus, arguments and prior findings from this line of literature suggest that poorly governed

managers should be more involved in expansionary activities as they engage in empire building.

Extending this logic further, poorly governed managers would also be less likely to

reduce growth by engaging in contractionary activities such as selling and closing old

establishments, as this would reduce the size of their empires. Reducing firm size is associated

with reductions in private benefits in terms of enhanced risk or lower compensation (Tosi et al.,

2000). In summary, poorly governed managers will be associated with more expansionary

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activities, such as acquisitions and starting new establishments, but a lower level of

contractionary activities associated with selling and closing establishments.

Hypothesis 1a: Poorly governed managers will be associated with greater firm growth from

expansionary activities.

Hypothesis 1b: Poorly governed managers will be associated with a smaller reduction in firm

growth from contractionary activities.

Extending empire-building arguments to the individual establishment level suggests that

managers searching for quick growth are likely to undertake investments that increase firm size,

especially when managers are desperate to grow the firm (Kim et al., 2011). Thus, poorly

governed managers may be more inclined to buy establishments that are growing fast in order to

grow out of trouble and offset the low growth rates of their older establishments, and thus stave

off “empire collapse” (e.g., Kim et al., 2011; Gompers et al., 2003; Gormley & Matsa, 2011).

Furthermore, once establishments are acquired, managers involved in empire building

will likely devote more effort and resources to grow those establishments. This is similar to the

“new toy” effect expounded by Schoar (2002) whereby managers prioritize new segments of

their organization over their incumbent segments, possibly due to their lower growth rates (Kim

et al., 2011). Akin to this “new toy” effect, poorly governed managers may therefore prioritize

their new establishments and grow newly set-up establishments.

Alternatively, managerial effort in new establishments could be influenced by the fact

that such investments are manager-specific investments—that is, only incumbent managers can

manage growth effectively in these new establishments. To the extent that managers can allocate

resources to growing these new investments, they can give the appearance that these investments

are more valuable under their oversight, thus making them less dispensable to shareholders. In

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other words, by growing their newest investments, poorly governed managers can enhance their

relationship-specific assets and entrench themselves (Shleifer and Vishny, 1989). The same

arguments imply that poorly governed managers will be reluctant to sell or close their recently

acquired or started establishments, as this would not only reduce firm size but also reduce their

manager-specific investments that enhance managerial entrenchment. Therefore,

Hypothesis 2a: Poorly governed managers will be associated with a higher average pre-

acquisition growth rate of establishments.

Hypothesis 2b: Poorly governed managers will be positively associated with the growth of

recently founded and recently acquired establishments.

Hypothesis 2c: Poorly governed managers will be associated with a lower probability of selling

and closing recently acquired and recently started establishments.

Poorly governed managers and “quiet life” in governance research

In contrast to the vast stream of research on the dominant empire-building view developed over

the years (Baumol, 1959; Williamson, 1964), a smaller subset of research views managers as

being effort-averse (Tirole, 2017). Thus, they may trade off their private costs vis-à-vis their

private benefits, and avoid activities associated with firm growth, as those require effort. Work

by Bertrand and Mullainathan (2003) finds that increases in anti-takeover protections provide

managers with an opportunity to enjoy the “quiet life” originally propounded by Hicks (1935).

Specifically, using plant-level data in manufacturing, they find that increases in anti-takeover

protections reduce managerial propensities to sell and close their existing plants, thus providing

the managers with an opportunity to lead a quiet life. Consistent with this view, they find

associated increases in worker wages (plausibly to attract high-quality employees or lower

turnover or buy “peace”) and reductions in productivity and profitability. Thus, in contrast to the

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empire-building view, the quiet-life view suggests that poorly governed managers focus on

lowering private costs rather than pursuing private benefits through empire building. Aggarwal

and Samwick (2006), one of the few studies of the quiet-life hypothesis, test the trade-offs

between private benefits and private costs implicitly associated with activities such as empire

building, and find supportive evidence for the private costs model in their data.

Based on this perspective that highlights effort avoidance by poorly governed managers,

it follows that such managers would be less involved in both expansionary and contractionary

activities, as they require substantial time and effort on part of the managers. More specifically,

the conclusions of previous research in this stream of literature would suggest that poorly

governed managers will be negatively associated with growth, from both acquisitions as well as

setting up new establishments. Similarly, poorly governed managers would also be less likely to

expend effort on selling and closing old establishments in their pursuit of a quiet life (Bertrand

and Mullainathan, 2003). Thus,

Hypothesis 3a: Poorly governed managers will be associated with lower firm growth from

expansionary activities.

Hypothesis 3b: Poorly governed managers will be associated with a smaller reduction in firm

growth from contractionary activities.

At the individual establishment level, poorly governed managers preferring the quiet life

should be associated with lower growth in their acquired or new establishments. At the same

time, they should have a lower propensity to sell and close their recently acquired and recently

started establishments. In both cases, the quiet-life view suggests that managers would be

reluctant to incur the associated private costs, such as the costs of finding buyers or sellers and

dealing with disgruntled employees. Thus,

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Hypothesis 4a: Poorly governed managers will be associated with a lower growth of recently

acquired and recently set-up establishments.

Hypothesis 4b: Poorly governed managers will be negatively associated with a lower probability

of selling and closing recently acquired and recently started establishments.

In summary, the empire-building and quiet-life perspectives yield diametrically opposite

predictions on growth from expansionary activities. However, both views predict that the level of

contractionary activities would be lower for poorly governed managers, albeit for different

reasons (decreasing size of the firm versus effort aversion).

Data and Empirics

Data

The main source of data for this study is the Longitudinal Business Database (LBD) from 1990

to 2005, linked to Compustat and CRSP data. The LBD, developed and maintained by the U.S.

Census Bureau, contains employment and payroll information on all non-agricultural

establishments in the United States that have at least one employee. It also contains information

on corporate ownership, industry, and geography. No information on sales or assets is included.

A concordance file is used to link these data to Compustat and CRSP, which provide other

firm-level information, such as profitability and leverage. We collect governance data from the

RiskMetrics (formerly IRRC) database for firms. The RiskMetrics governance data are not

available for all years. We therefore follow Bebchuk and Cohen (2005) to fill in the missing

years. In addition, following Bebchuk and Cohen (2005), we eliminate firms with a dual-class

structure. Following Zhao and Chen (2008), we also eliminate observations in the financial

services and insurance services (SIC codes 6000–6999). These procedures result in a sample of

16,966 firm-year observations, corresponding to a total of 2,065,032 establishment-year

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observations. Descriptive statistics for the firm-level and establishment-level samples are

provided in Table 1.

Decomposing firm growth

To develop our measures of the various elements of firm growth, we define the employment of a

firm as the sum of the employment at its establishments. This implies that the change in firm

employment in a given year over the previous year is the sum of three components: (i) change in

employment among existing establishments that continued from the previous year to the current

year, (ii) increase in employment due to new establishments that were set up or acquired in the

current year, and (iii) decrease in employment due to the closure or sales of establishments that

operated in the previous year but not in the current year. Thus, the first and second components

relate to expansionary activities in existing establishments and new (to the firm) establishments,

respectively. The last component relates to contractionary activities.

We then decompose these three components further in line with the conceptualization

presented in Figure 1. In particular, the first component, net internal growth from continuing

establishments, is decomposed into: (1) growth of establishments that were at least two years old

(old establishment growth); (2) employment growth in establishments that were founded one

year ago (recently founded establishment growth); and (3) employment growth in establishments

that were acquired one year ago (recently acquired establishment growth), with respect to the

current time period. This allows us to separate out the effect of governance on new and older

establishments. The second component, net growth from new and acquired establishments, is

decomposed into growth from establishments: (1) acquired in the current year (growth from

acquisitions) and (2) founded in the current year (growth from new establishments). Finally, the

last component, relating to contractionary activities, is decomposed into decline in growth due to

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establishments (1) sold in the past year (decline in growth from sale of establishments) and (2)

closed in the past year (decline in growth from closure of establishments). By construction, the

last two components are negative.

Mathematically, our decomposition formula for employment change is then:

∆𝑌𝑌𝑡𝑡 = ∑ (𝑦𝑦𝑖𝑖𝑡𝑡𝑖𝑖∈𝑆𝑆𝑜𝑜𝑜𝑜𝑜𝑜𝑡𝑡 − 𝑦𝑦𝑖𝑖𝑡𝑡−1) + ∑ (𝑦𝑦𝑖𝑖𝑡𝑡𝑖𝑖∈𝑆𝑆𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑡𝑡𝑟𝑟𝑟𝑟𝑟𝑟

𝑡𝑡 − 𝑦𝑦𝑖𝑖𝑡𝑡−1) + ∑ (𝑦𝑦𝑖𝑖𝑡𝑡𝑖𝑖∈𝑆𝑆𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑡𝑡𝑟𝑟𝑟𝑟𝑟𝑟𝑡𝑡 − 𝑦𝑦𝑖𝑖𝑡𝑡−1) +

∑ 𝑦𝑦𝑖𝑖𝑡𝑡𝑖𝑖∈𝑆𝑆𝑟𝑟𝑟𝑟𝑟𝑟𝑡𝑡 + ∑ 𝑦𝑦𝑖𝑖𝑡𝑡𝑖𝑖∈𝑆𝑆𝑟𝑟𝑟𝑟𝑟𝑟𝑡𝑡 − ∑ 𝑦𝑦𝑖𝑖𝑡𝑡−1𝑖𝑖∈𝑆𝑆𝑟𝑟𝑜𝑜𝑜𝑜𝑐𝑐𝑟𝑟𝑜𝑜𝑡𝑡 − ∑ 𝑦𝑦𝑖𝑖𝑡𝑡−1𝑖𝑖∈𝑆𝑆𝑐𝑐𝑜𝑜𝑜𝑜𝑜𝑜

𝑡𝑡 (1)

where ∆𝑌𝑌𝑡𝑡 is the change in firm employment from the previous year and yit refers to employment

in establishment i in the firm in year t, S refers to the set of establishments, and the subscripts

old, recentnew, etc. denote the various components discussed earlier. Thus, 𝑆𝑆𝑎𝑎𝑎𝑎𝑎𝑎𝑡𝑡 refers to the set

of all establishments acquired in year t. To get growth rates, we divide throughout by total firm

employment in the prior year—that is, in year t-1. For instance, firm growth from acquisitions in

year t is computed as the number of employees at establishments acquired in year t divided by

total number of employees at the firm in year t-1. Thus, this would measure the growth in the

firm arising solely from acquisitions (that is, firm growth if the firm did not grow or contract on

any other dimension). The other six components are computed similarly.

Therefore, this decomposition not only allows us to simultaneously examine both

expansionary and contractionary activities, but also has the highly desirable mathematical

property of the individual components of growth exactly adding up to total firm growth. In a

separate study, we extend this approach and show that this also allows for a similar

decomposition of economy-wide employment changes.

Empirics

The first part of our analysis is at the firm level, and examines whether the quality of

governance is associated with differences in the composition of firm growth (Hypotheses 1 and

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3). The second part of the analysis focuses on the performance of acquired and newly founded

establishments and its relationship to the quality of governance (Hypotheses 2 and 4).

Firm-level analysis. We estimate the following specification, which broadly follows Bebchuk et

al. (2009):

𝑔𝑔𝑔𝑔𝑗𝑗𝑡𝑡𝑖𝑖 = 𝛼𝛼1𝐺𝐺𝑗𝑗𝑡𝑡 + �𝛼𝛼2𝑂𝑂𝑗𝑗𝑡𝑡� + 𝛼𝛼3𝑦𝑦𝑗𝑗𝑡𝑡−1 + 𝑍𝑍𝑗𝑗𝑡𝑡 + 𝜔𝜔𝑚𝑚𝑡𝑡 + 𝜖𝜖𝑗𝑗𝑡𝑡 (1)

The dependent variable is either overall firm growth or a specific component of firm growth for

firm j in year t. These are measured as discussed in the previous subsection. To eliminate the

influence of outliers, we winsorize the growth variables at 1% on both tails.

G in Equation (1) is a measure of governance. The U.S. governance context is often

considered to be more market driven (e.g., pressures from the corporate control market, labor

markets, etc.) in relation to its emphasis on internal governance (e.g., effective monitoring by

boards or large owners). Among external governance mechanisms, scholars suggest that the

predominant mechanism is the market for corporate control (e.g., Bhide, 1994; Bebchuk et al,

2009; Gompers et al., 2003; Sundaram, 2004). We therefore use reduced effectiveness of the

corporate control market mechanisms as our proxy for poor governance. This approach has

been taken in studies such as Bebchuk et. al. (2009), Connelly, Shi and Zyung (2017), Gompers

et al. (2003), and Shi, Connelly, and Hoskisson (2017).

In particular, we use G-index and E-index, in separate specifications. G-index is defined

as the governance index used in Gompers et al. (2003), which is based on the presence or

absence of 24 corporate governance provisions (categorized as delay, protection, voting, and

other). Higher values of this index represent greater protection from the corporate control

market. The second measure of governance is the E-index, a strict subset of the G-index, and a

narrower measure of protection. E-index is defined as the entrenchment index proposed by

17

Bebchuk et al. (2009), which is based on the presence or absence of six provisions: staggered

boards, limits to shareholder bylaw amendments, poison pills, golden parachutes, supermajority

requirements for mergers, and charter amendments. As with the G-index, the higher the E-

index, the greater is the degree of protection afforded to managers due to ineffective

governance. In line with Bebchuk et al. (2009), when using the E-index in regressions, we

include a variable called other provisions index, denoted as Ojt in Equation (1) and defined as

the difference between the G-index and the E-index.

Turning to the other variables in Equation (1), yjt−1 is log lagged employment; Zjt are

firm-year controls, described below; and 𝜔𝜔𝑚𝑚𝑡𝑡 are joint SIC three digit-year fixed effects, a

considerably more conservative approach than that of Bebchuk et al. (2009). Zjt, following

Bebchuk et al. (2009), includes log company age (from CRSP), a dummy for Delaware

incorporation, return on assets (ROA), leverage, capital expenditures (capex) to sales, and R&D

to sales.

Establishment-level analysis. To examine empire-building and quiet-life arguments at the

investment level, we use the following specification, which is analogous to Equation (1):

𝑔𝑔𝑔𝑔𝑒𝑒𝑗𝑗𝑘𝑘 (𝑜𝑜𝑔𝑔 𝐷𝐷𝑒𝑒𝑗𝑗𝑘𝑘 ) = 𝛼𝛼1𝐺𝐺𝑗𝑗𝑡𝑡0 + �𝛼𝛼2𝑂𝑂𝑗𝑗𝑡𝑡0� + 𝛼𝛼3𝑦𝑦𝑗𝑗𝑡𝑡0−1 + 𝑍𝑍𝑗𝑗𝑡𝑡0 + 𝜗𝜗𝑠𝑠𝑚𝑚𝑡𝑡0 + 𝜖𝜖𝑗𝑗𝑡𝑡0 (2)

The dependent variable is growth in the one, three, or five years (k years) before acquisition,

when testing whether poorly governed managers buy fast-growing establishments (Hypothesis

2a). For testing the association between governance and growth of recently acquired or founded

establishments (Hypotheses 2b and 4a), the left-hand side is growth k years after founding or

acquisition. To test whether poorly governed managers are more or less likely to close recently

acquired or founded establishments, we use a dummy variable equal to 1 if establishment was

sold or closed within the first k years of founding or acquisition and 0 otherwise.

18

In all establishment-level analyses, the sample consists of one observation per

establishment, with all control variables pertaining to the year of acquisition or founding. Since

the establishment-level sample is considerably larger than the firm-level sample, we adopt an

even more conservative approach than in Equation (1) and include joint state-SIC three digit-

year fixed effects (𝜗𝜗𝑠𝑠𝑚𝑚𝑡𝑡0) to rule out potential unobserved differences on these dimensions.

Results-

Overall firm growth

Table 2 presents a decomposition of the mean one-year growth in firm employment into the

seven components discussed earlier. In this sample of firms, the average net firm growth is

5.42%. However, consistent with Maksimovic et al. (2008), this aggregate growth hides

significant churning within the firm—specifically, large contributions from both expansionary

and contractionary activities. Growth from founding of new establishments (3.25%) and growth

from acquisitions (4.89%) add up to about 8.14%. There are comparably large (negative)

contributions from contractionary activities, of about 4.88% from closure (–2.22%) and sales (–

2.66%) of establishments. Organic growth—namely, the sum of growth of existing

establishments (old establishment growth and recently founded establishment growth) and

growth from new establishments—is about 4.65%, with growth from new establishments being

the dominant component (3.25% vs. 1.40%). Hence, managers appear to generate similar

magnitudes of organic expansion (4.65%), acquisitive expansion (4.89%), and contractions

(4.88%).

Firm growth and governance

Table 3 provides a breakdown of the growth components by the quality of governance.

Focusing on net firm growth (bottom row), poorly governed firms exhibit a growth of 2.69%,

19

compared to a growth of 7.91% for well-governed firms. This difference is consistent with

Gompers et al. (2003), who find that firms with poor governance have lower growth rates.

However, as before, the broad pattern conceals interesting and important underlying variation.

First, well-governed firms have a more balanced growth portfolio. In particular, growth

from continuing establishments (components (1)–(3) in Table 3) is almost negligible for poorly

governed firms (about 0.39%), accounting for less than a sixth of the mean total growth of

2.69%. In contrast, among well-governed firms, these components sum up to 2.63%, which is

nearly a third of their mean growth of 7.91%. In other words, compared with well-governed

firms, poorly governed firms seem unable to grow their existing establishments and rely almost

entirely on adding or acquiring new establishments for their growth. Second, both poorly

governed firms and well-governed firms have similar levels of gross additions (components (4)

and (5)). The contribution from acquired establishments is virtually identical for both these

types of firms (4.90% and 4.95%), while the contribution from new establishments is only

about 0.5 percentage points lower for poorly governed firms. Finally, another stark difference

between poorly governed and well-governed firms lies in the negative contribution to growth

from sales and closure, which is almost 1.65 percentage points higher for poorly governed firms

(–5.74% vs. –4.09%).

Thus, these results indicate that poorly governed firms have a lower growth rate because

of the lower growth rates of their existing establishments (components (1)–(3) in Table 3) and

their higher levels of contractionary activities (components (6) and (7) in Table 3). In contrast,

they do not appear to have higher growth from acquisitions. We test these formally below.

Regression results for firm growth and sub-components of firm growth

The regression results from estimating Equation (1) for overall firm growth and its components

20

are presented in Tables 4 and 5. Recall that all these regressions include SIC three-year fixed

effects, thus eliminating any confounding effects of time-varying changes at the industry level.

Our baseline results in Table 4 confirm the findings in Gompers et al. (2003) and indicate that

poor governance is negatively associated with firm growth. The coefficients on G-index and E-

index are negative and significant throughout. (Recall that higher values of G-index and E-

index imply poorer governance.) Based on column 3, a one-standard-deviation increase in the

G-index (2.77, from Table 1) is associated with a 0.68 percentage point reduction in firm

growth. Similarly, a one-standard-deviation increase in E-index is associated with a 1.48

percentage point reduction in firm growth (column 4). The coefficients on the control variables

are generally in the expected direction. Profitability, leverage, and capital expenditure are

positively associated with growth, while prior size and firm age are negatively related to

growth. Hence, our findings at the overall firm growth level are consistent with prior research

(e.g., Gompers et al., 2003).

Table 5 presents regressions of the components of growth and their associations with

governance. Focusing on the expansionary activities represented by the first five components

(Hypotheses 1a and 3a), we find that the coefficients on all but two of them (growth from

recently acquired establishments and growth from acquisitions) are consistently negative across

all specifications. In general, E-index appears to have a stronger negative association than G-

index. A one-standard-deviation increase in E-index is associated with a sizable 0.36 percentage

point decrease in old establishment growth. Growth from new establishments and recently

founded establishment growth also have significant coefficients, with a one-standard-deviation

increase in E-index associated with a 0.20 and 0.08 percentage point decrease, respectively, in

the two components. The coefficient on recently acquired establishments growth is virtually

21

zero, while those on growth from acquisitions are inconsistent and statistically insignificant. In

sum, the overall evidence suggests that poorly governed firms tend to have a lower level of

expansionary activities, particularly from organic growth, than well-governed ones. This

strongly supports Hypothesis 3a, based on the quiet-life view. There is little direct support, if

any, for Hypothesis 1a, based on empire-building arguments.

Focusing on contractionary activities (Hypotheses 1b and 3b), poorly governed firms

appear to have a higher negative contribution to growth from sale and closure of establishments

(last two components in Table 5). In particular, the coefficients on decline in growth from sale of

establishments and decline in growth from closure of establishments are negative and statistically

significant throughout. Thus, the evidence strongly suggests that poor governance is associated

with greater levels of contractionary activities, and does not support either Hypothesis 1b (based

on the empire-building perspective) or Hypothesis 3b (based on the quiet-life perspective). This

is in contrast to the evidence for expansionary activities that seem to support the quiet-life

arguments.

Together, the results in Tables 4–5 support the thesis that poor governance is negatively

related to firm growth. However, they also provide a more nuanced understanding of growth

patterns associated with the different governance regimes. The data reveal that governance is

associated differently with different subcomponents of growth. Better-governed firms appear to

be more capable of managing growth more effectively, as seen by their higher contribution

from growth from existing establishments and lower sales and closures. In contrast, growth

from acquisitions does not appear to vary significantly with governance.

Regression results for investment performance

We now focus on new and acquired establishments and assess the impact of governance at the

22

establishment level in order to test Hypotheses 2a–2c and 4a–4b. Table 6 presents the results of

estimating Equation (2).

Panel A presents the results from establishment-level regressions of an establishment’s

past growth rate on the measures of governance. All the coefficients on both governance

measures are very close to zero and statistically insignificant. Thus, Hypothesis 2a does not

seem to have much support.2 This suggests that poorly governed firms are not acquiring fast-

growing establishments, as empire-building arguments would suggest. Combining this with

earlier firm-level regressions, which suggest that poorly governed firms have slower growth, it

indicates that the problem with poor governance likely lies in the process of managing growth.

Focusing on Panel B, and consistent with the firm-level results, new and acquired

establishments of poorly governed firms have a slower growth rate than do well-governed

firms. The one-year growth is lower by 1.2–1.6 percentage points for a unit increase in the

governance measures, while the three-year growth rate is lower by 1.4–2.9 percentage points.

The five-year growth regressions also exhibit negative but statistically weaker coefficients.

Thus, this evidence supports Hypothesis 4a (quiet life) but not Hypothesis 2b (empire building).

Turning to closure and sale of establishments, Panel C shows that establishments of

poorly governed firms are significantly more likely to be closed or sold shortly after being

acquired or set up. The probability that such firms will exit within three years after they are

established or acquired is higher by 1.5–2.1 percentage points for every unit increase in the

governance measures; the corresponding figure for the five-year exit rate is 1.1–2.1 percentage

2 We also examined whether new establishments were started at a larger scale by poorly governed firms. This addresses the possibility that establishments of poorly governed firms may exhibit lower growth since they have a smaller gap between their initial and final size. The regression coefficients (not presented) were all small and insignificant.

23

points. Interestingly, this evidence supports neither Hypothesis 2c (empire building) nor

Hypothesis 4b (quiet life). Together, though, the results in Table 5 strongly indicate that

compared with poorly governed firms, well-governed firms are better at managing their

investments, as evidenced by their higher growth rates and lower exit rates.

Robustness to Alternative Growth Measures

We repeat the analyses in Tables 2–5 with three-year and five-year firm growth and find

results similar to those with one-year growth (results presented in the Online Appendix).

Specifically, growth from acquisitions and new establishments continues to be the dominant

way of growing a firm compared with the growth of existing establishments. Growth from

acquisitions is 16.44% and 28.31%, respectively, over three years and five years. The

corresponding figures from growth from new establishments are 15.94% and 38.16%. Thus,

over the longer growth horizons, growth due to new establishments seems to be even more

important than growth from acquisitions—an insight that needs further exploration. Firms also

exhibit significant churning of establishments (negative contributions of 14.05% and 21.16%

from sales and closures to three- and five-year growth rates, respectively).

As with the annual growth results, the average growth rates are significantly higher for

firms in the lowest quartile of the G-index than for firms in the highest quartile (three-year

growth rate: 45.57% vs. 13.62%; five-year growth rate: 112.12% vs. 29.41%). As before,

better-governed firms have more balanced growth than their poorly governed counterparts do.

Focusing on the three-year growth rates, growth from acquisitions is 18.97% for well-governed

firms, which is lower than their growth from their new establishments, 19.78%. Moreover, the

other component of organic growth, growth from existing establishments, is about 12%,

comparable in magnitude to growth from acquisitions. In contrast, for poorly governed firms,

24

growth from acquisitions is 14.24%, which is higher than growth from new establishments

(12.26%) and much higher than growth from existing establishments (1.62%). The same

patterns persist in the five-year growth rates; indeed, the role of acquisitions becomes even

smaller for well-governed firms over this longer horizon. Similar to the baseline results, well-

governed firms show significantly fewer closures and sales (–11.48% and –16.47%,

respectively, for three-year growth rates and –17.72% and –24.05%, respectively, for five-year

growth rates). Taken together, these results are in line with our baseline results: well-governed

firms are better able to grow their existing establishments and have a smaller (negative)

contribution from establishment sales and closures.

Discussion and Conclusion

Our study uses a novel growth decomposition and assesses how governance is associated with

the underlying additive components of growth. In so doing, it confirms that poor governance is

negatively associated with firm growth. It then goes beyond existing literature to make two

broad contributions. The first is to yield new insights about firm growth, while the second is to

shed new light on the link between governance and growth. We discuss these insights below.

Insights on firm growth

The first set of contributions from our study relates to the novel growth decomposition. At the

outset, our results clearly highlight that it is important to understand aggregate firm growth as a

composite process resulting from several underlying processes. This is in contrast to most of the

literature, which considers firm growth broadly at the firm level or only as having organic

versus market components or in terms of mergers and acquisitions or divestitures that result in

firm growth. Further, our approach allows us not only to highlight many aspects of growth that

have been largely ignored but also to be more precise about the magnitudes of the underlying

25

growth components. For example, based on Table 2, organic growth as the residual of total firm

growth less growth from acquisitions, as done in prior studies (e.g., Moatti et al., 2014; Kim et

al., 2011), would indicate that on average, firms grew 5.42%, of which 4.89% was through

acquisitions and 0.53% through organic growth. However, this would understate the importance

of organic growth, which is about 4.65% (the sum of the first four elements in Table 1) and

comparable to growth from acquisitions (4.89%, Table 1). Indeed, in the five-year results

presented in the Online Appendix, organic growth completely dominates growth from

acquisitions (approximately 51% to 28%). Thus, our results highlight the importance of organic

growth in comparison to acquisitive growth, an insight not evident in previous research. In

addition, our approach is also able to provide a finer picture of organic growth. Specifically, it

not only distinguishes between growth from adding new establishments and growth in existing

establishments, but also categorizes the latter into three finer classes, including growth from old

establishments. As explained later, these distinctions appear to be important in explaining the

growth-governance relationship. We speculate that there may be other contexts where this

distinction matters.

Moreover, previous conceptions of growth have either underemphasized or completely

ignored the large role of contractionary activities (e.g., Moatti et al., 2014; Kim et al., 2011).

Furthermore, though research has studied contractionary activities such as divestitures

(Hoskisson et al., 1994; Villalonga & McGahan, 2005), it has disregarded one important

resource redeployment aspect of growth: that of closing establishments. Though some prior

research by strategy scholars has examined this from other perspectives (e.g., Lieberman, 1990),

we still do not know the overall contribution of such closures to firm growth. Our results suggest

that the contraction from closing establishments (–2.66%), is comparable to the decline in

26

growth from selling establishments (–2.22%). Thus, distinguishing between the alternate

contractionary modes highlights not only their relative importance, but also adds to our

understanding of two very different types of establishment exit decisions.

Insights into the growth-governance relationship

Turning to the second set of contributions, in line with prior studies such as Gompers et al.

(2003), we find that well-governed firms have higher growth rates. Our growth decomposition

allows us to go significantly beyond and compare the magnitudes of the various growth

components under different governance regimes. This reveals two important differences

between poorly governed and well-governed firms. First, well-governed firms appear to be

much better at achieving organic growth, especially by growing their old establishments. Using

the numbers from Table 3, under regimes of good governance, managers have a relatively well-

balanced growth portfolio with significant emphasis on organic growth (6.12%, the sum of the

first four elements) compared with acquisitive growth (4.95%). In contrast, poorly governed

managers are less able to grow their firms organically (3.39%) compared with their acquisitive

growth (4.90%). This large difference in organic growth (of 2.73%) appears to be in large part

due to the inability of poorly governed firms to grow their old establishments (–0.36% vs.

1.44% or a difference of 1.80%).

The second important insight from this exercise is that poorly governed managers are

involved in a higher level of contractionary activities (–5.74%, the sum of lines 6 and 7 in Table

3) compared with their well-governed counterparts (–4.09%). Within these activities, selling of

establishments (–2.79% vs. –1.65%) appears to account for a bigger share of the difference than

closures of establishments (–2.95% vs –2.44%). This suggests that poorly governed managers

are engaged in a much higher level of selling than their well-governed counterparts. Though we

27

have used numbers from Table 3 in our discussion here, these patterns are similar in the

regressions that include controls.

Taken together, the two main differences in growth patterns between well-governed and

poorly governed managers are the emphasis on organic growth and lower levels of divestments,

with little to no difference in their acquisitive growth. Turning to possible mechanisms driving

these differences, our analysis of recently set up and acquired establishments suggests that the

quality of growth-related investments made by managers may be a possible route that links

governance to firm growth. Compared with recent investments made by well-governed firms,

investments made by poorly governed firms appear to perform poorly; they grow at a slower

rate and are more likely to be closed or sold shortly after being acquired or set up.

Empire building versus the quiet life

As another important contribution, our paper allows us to compare the predictions from the

empire-building view with those from the quiet-life perspective. This is relevant because

though a vast stream of research has focused on private benefits to managers accruing from

empire building, some recent research suggests the alternate possibility that poorly governed

managers may focus on their private costs and would rather not indulge in activities associated

with empire building—that is, they may prefer the quiet life.

When the growth-composition data are partitioned across governance quartiles (Table

3), it appears that the differences among these groups are not driven by the two growth

components related to acquisitions: growth in recently acquired establishments and growth

from acquiring establishments, as suggested by empire-building arguments. Compared with

other components, the differences among firms with poor, medium, and good governance on

these two components are minimal. The same inferences emerge from the regression analyses.

28

Thus, our results do not support the empire-building arguments. This is an interesting finding,

as a large literature suggests that managers who indulge in empire building under poor

governance regimes would be associated with greater growth on these components. In fact, with

longer periods, we find that well-governed firms have greater growth from these two

components, which is inconsistent with “pure” empire-building arguments. Gompers et al.

(2003) hint to this inconsistency; they note that empire-building arguments conflict with their

negative findings between governance and sales growth, and suggest that managers may be

attempting to stave off “empire collapse” with high expenditure and acquisition activity.

Nonetheless, because organic growth is smaller for poorly governed firms, growth from

acquisitions plays a bigger role in driving overall growth than it does for well-governed firms.

To that extent, our results are not inconsistent with the broad argument that poorly governed

managers tend to overly rely on acquisitions for growth.

While we do not find strong support for the empire-building arguments, we also find that

poorly governed firms have much higher levels of growth reductions from closing and selling

establishments. This is inconsistent with the predictions of the quiet-life model that emphasizes

managerial effort aversion. Further, though our findings in the expansionary domain may favor a

quiet life interpretation, in the contractionary domain, we find that poorly governed managers are

associated with higher levels of contractionary activities (albeit for different reasons). This is

inconsistent with both the empire-building and quiet-life hypotheses.

Taken together, our results suggest that the lower growth associated with poorly

governed managers is conceivably not because of their attempts at empire building or because of

the lack of effort. Rather, the results appear to be consistent with managers trying to deal with

the consequences of making poor investments, especially those related to organic growth. Our

29

establishment-level analyses are particularly helpful in this regard, shedding light on this

argument. They show that poorly governed firms are not selectively acquiring faster-growing

establishments, but their recently founded and acquired establishments grow more slowly and are

more likely to be closed or sold a few years after founding or acquisition. The consequences of

this can also be seen in the growth decomposition where growth from new establishments,

growth from recently founded establishments, and growth from old establishments are all

negatively related to governance. Thus, poorly governed managers appear to be “running to

stand still,” actively engaged in acquiring and founding new establishments, but also actively

engaged in closing and selling them because they are unable to grow them. Extending these

findings, our results suggest that the inability to manage organic growth effectively may lie at the

heart of why poor governance may reduce market value.

Our results are more in line with Maksimovic et al. (2008), who find that acquiring firms

sell 27% and close 19% of the plants of target firms within three years—an outcome they suggest

is not consistent with pure empire building. They suggest that the outcome is more consistent

with a comparative advantage perspective in which the skill of the acquirer determines post-

merger restructuring. We offer a complementary explanation. Our results suggest that the skills

of well-governed managers may be an important determinant of firm growth. Well-governed

managers appear to be able to manage a balanced growth portfolio by better managing organic

growth and achieving lower levels of contractionary activities.

Limitations and implications for future research

Notwithstanding the controls, fixed effects, and robustness checks, given the absence of

exogenous variation, it is important to be cautious in interpreting our results as the causal

effects of good or bad governance. Nonetheless, our analysis of the pre-acquisition growth of

30

acquired establishments (Hypothesis 2a) provides some confidence in the direction of causality.

In particular, it does not appear that poorly governed firms buy slower-growing establishments.

Thus, this analysis strongly suggests that the decline in the performance of establishments

acquired by poorly governed firms occurs after the acquisition.

Another limitation is that since we do not have data on profitability, assets, or revenues of

individual establishments, we use employment growth. Even though employment growth is

correlated with firm value and growth in other variables such as profits, revenues, and assets

(e.g., in many theoretical models of firm value such as Jovanovic 1982, profitability is a direct

function of firm employment or size), there could be inter-firm differences in the choice of

capital-labor ratios that add noise to these correlations. If these differences are systematically

correlated with governance, then our results on the employment growth–governance association

cannot be extended to the profit growth–governance relationship. Second, our data do not

include any data on global operations of these firms. Thus, there could be differences in the mix

of foreign and domestic growth that are not examined in our study.

These limitations also suggest potential extensions. Two obvious extensions would be

assessing how these individual components of growth vary over the firm’s industry segments or

time (e.g., firm age or managerial tenure) and how they might be associated with other measures

of governance (such as boards and ownership characteristics) and managerial incentive

mechanisms (such as stock options and restricted stock). More detailed studies could disentangle

the underlying motivations for mergers and acquisitions to see when they result in success or can

be attributed to empire building (Andrade, Mitchell, & Stafford, 2001). Studies could also

decompose additional acquisition components (e.g., establishments owned by publicly listed

firms versus private firms) and assess if there are differential outcomes. On the flip side, more

31

attention should be paid to why and when managers divest and close establishments; there is

rather limited work on understanding contractionary activities, likely due to the lack of precise

measures. Putting all these together, individual components of growth identified in our

decomposition can be a starting point for understanding the motivations for managerial resource

allocations on the various growth dimensions. Overall, our results make a strong case for

considering the various growth components in addition to overall firm growth in future research.

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34

Figure 1: A Finer-Grained View of Firm Growth

Total Firm Growth

Growth from continuing

establishments (1)

Growth from new establishments

(2)

Contraction from closed establishments

(4)

Growth from acquired establishments

(3)

Contraction from sold establishments

(5)

Old establishments

(1A)

Recently founded establishments

(1B)

Recently acquired establishments

(1C)

Organic growth

Expansionary activities

Contractionary activities

35

Table 1: Descriptive Statistics

Variable Mean (Std. Dev.) Firm-Year

Level Sample Establishment Level Sample

One-year growth (%) 5.42 (37.25)

6.97 (74.43)

G-index 9.21 (2.77)

9.16 (2.66)

E-index 2.18 (1.31)

1.96 (1.29)

Other provisions index 7.03 (2.04)

7.20 (1.98)

Lagged log employment 8.11 (1.55)

2.24 (1.53)

Log firm age 2.99 (0.718)

3.11 (0.862)

Delaware incorporation 0.517 (0.500)

0.493 (0.500)

ROA 0.032 (0.085)

0.036 (0.054)

Leverage 0.190 (0.169)

0.205 (0.172)

Capex to sales 0.057 (0.069)

0.049 (0.065)

R&D to sales 0.016 (0.032)

0.005 (0.017)

N 16,966 274,268

36

Table 2: Composition of Annual Overall Firm Growth

Component Mean (%) Sample Std. Dev. (%)

(1A) Old establishment growth 0.42 16.72

(1B) Recently founded establishment growth 0.98 3.65

(1C) Recently acquired establishment growth 0.00 3.81

(2) Growth from new establishments 3.25 9.31

(3) Growth from acquisitions 4.89 17.83

(4) Decline in growth from sale of establishments –2.22 8.57

(5) Decline in growth from closure of establishments

–2.66 5.98

Net Firm Growth 5.42 37.25

Note: The table decomposes the mean one-year growth in firm employment into the various components. N=16,966.

37

Table 3: Composition of Firm Growth and Governance

Poor Governance (%)

Medium Governance

(%)

Good Governance (%)

t-statistic (Poor vs. Good)

(%) (1A) Old establishment growth –0.36 0.34 1.44 5.56

(1B) Recently founded establishment growth 0.85 0.98 1.12 3.89

(1C) Recently acquired establishment growth –0.10 0.00 0.07 2.31

(2) Growth from new establishments 3.00 3.29 3.49 2.70

(3) Growth from acquisitions 4.90 4.85 4.95 0.15

(4) Decline in growth from sale of establishments –2.79 –2.16 –1.65 6.64

(5) Decline in growth from closure of establishments

–2.95 –2.58 –2.44 4.25

Net Firm Growth

2.69 5.91 7.91 7.41

Note: Poor governance refers to firms in the highest quartile of the G-index (N=5,537). Good governance refers to firms in the lowest quartile of the G-index (N=4,773). Medium governance refers to the remaining firms. All t-statistics are significant at the 5% level or lower, except for growth from acquisitions.

38

Table 4: Overall Firm Growth and Governance

(1) (2) (3) (4) G-index$ –0.396

(0.130) –0.244 (0.127)

E-index$

–1.163 (0.263)

–1.127 (0.258)

Prior Employment –0.035

(0.004) –0.036

(0.004) –0.035 (0.004)

–0.036 (0.004)

Other Provisions Index

0.000

(0.001)

0.002

(0.002)

Log (Company Age)

–0.027 (0.006)

–0.029 (0.006)

Delaware Inc.

0.008

(0.007) 0.010

(0.007)

ROA

0.445 (0.049)

0.440 (0.049)

Leverage

0.072

(0.027) 0.073

(0.027)

Capex

0.142 (0.061)

0.142 (0.060)

R&D

–0.048 (0.137)

–0.059 (0.136)

N 16,966 16,966 16,966 16,966 R2 0.28 0.29 0.28 0.29

Note: $: Coefficients and standard errors multiplied by 100. All regressions include fixed effects for each SIC three-year combination. Standard errors clustered by firm presented in parentheses. Coefficients significant at or below the 10% level highlighted in bold.

39

Table 5: Subcomponents of Growth and Governance

G-Index G-Index (with Controls)

E-Index E-Index (with Controls)

(1A) Old establishment growth –0.127 (0.055)

–0.060 (0.053)

–0.341 (0.116)

–0.274 (0.113)

(1B) Recently founded establishment growth

–0.040 (0.014)

–0.025 (0.014)

–0.058 (0.033)

–0.062 (0.032)

(1C) Recently acquired establishment growth

–0.007 (0.010)

–0.007 (0.010)

–0.004 (0.031)

0.002 (0.031)

(2) Growth from new establishments

–0.088 (0.038)

–0.055 (0.038)

–0.144 (0.077)

–0.153 (0.076)

(3) Growth from acquisitions 0.067 (0.072)

0.042 (0.071)

–0.163 (0.148)

–0.242 (0.148)

(4) Decline in growth from sale of establishments

–0.087 (0.031)

–0.083 (0.032)

–0.165 (0.069)

–0.133 (0.069)

(5) Decline in growth from closure of establishments

–0.050 (0.023)

–0.058 (0.023)

–0.090 (0.049)

–0.056 (0.049)

Note: All coefficients and standard errors multiplied by 100. The first and the third columns include only lagged employment as a control. Columns 2 and 4 include the full set of controls from Table 4. All regressions include fixed effects for each SIC three-year combination. Coefficients on these fixed effects and other controls are not presented. Standard errors clustered by firm presented in parentheses. N=16,966 in all regressions. Coefficients significant at or below the 10% level highlighted in bold.

40

Table 6: Establishment-Level Performance and Governance

PANEL A (Past growth before acq.)

G-Index G-Index (with Controls)

E-Index E-Index (with Controls)

One-year past growth 0.001 (0.003)

0.001 (0.003)

0.004 (0.006)

0.003 (0.007)

Three-year past growth 0.000

(0.004) 0.001

(0.003) –0.005 (0.014)

–0.003 (0.010)

Five-year past growth 0.004

(0.006) 0.004

(0.007) 0.012

(0.016) 0.005

(0.015)

PANEL B (Growth after entry or acq.)

G-Index G-Index (with Controls)

E-Index E-Index (with Controls)

One-year growth –0.012 (0.004)

–0.012 (0.004)

–0.020 (0.009)

–0.016 (0.009)

Three-year growth –0.019

(0.006) –0.014 (0.005)

–0.039 (0.013)

–0.029 (0.012)

Five-year growth –0.021

(0.010) –0.013 (0.009)

–0.034 (0.020)

–0.021 (0.016)

PANEL C (Closure after entry or acq.)

G-Index G-Index (with Controls)

E-Index E-Index (with Controls)

Exit within one year 0.002 (0.001)

0.002 (0.001)

0.000 (0.002)

0.000 (0.002)

Exit within three years 0.016 (0.003)

0.019 (0.003)

0.015 (0.007)

0.021 (0.007)

Exit within five years 0.011 (0.003)

0.013 (0.003)

0.013 (0.006)

0.021 (0.007)

Note: The first and the third columns include only establishment employment as a control. Columns 2 and 4 include all the other controls from Table 4. All regressions include fixed effects for each SIC three-state-year combination. Coefficients on these fixed effects and other controls are not presented. N=154,821; 124,956; and 104,281, respectively for one-, three-, and five-year past growth regressions. N=274,268; 163,626; and 98,241, respectively, for one-, three-, and five-year growth (after entry or acquisition). N=2,065,032; 504,134; and 504,134, respectively, for one-, three-, and five-year exit regressions. Standard errors clustered by firm presented in parentheses. Coefficients significant at or below the 10% level highlighted in bold.

1

ONLINE APPENDIX

TABLE A1: COMPOSITION OF THREE-YEAR FIRM GROWTH

Component Mean Sample Std. Dev.

(1A) Old establishment growth 1.60% 23.12%

(1B) Recently founded establishment growth 2.42% 10.80%

(1C) Recently acquired establishment growth 1.22% 15.39%

(2) Growth from new establishments 15.94% 38.41%

(3) Growth from acquisitions 16.44% 53.22%

(4) Decline in growth from sale of establishments –5.23% 14.69%

(5) Decline in growth from closure of

establishments

–8.82% 12.92%

Net Firm Growth 27.98% 122.14%

Note: The table decomposes the mean three–year growth in firm employment into the various components.

N=16,266. Old establishment growth refers to employment growth in establishments that are at least 4 years old

at year t; Recently founded establishment growth refers to employment growth in establishments that were

founded exactly 3 years ago; Recently acquired establishment growth refers to employment growth in

establishments that were acquired exactly 3 years ago; Growth from new establishments refers to employment

in establishments that were founded between years t and t-3; Growth from acquisitions refers to employment in

establishments that were acquired between years t and t-3; Sale of establishments refers establishments that

were sold to another firm between years t and t-3; Closure of establishments refers to employment in

establishments that were closed between years t and t-3;

2

TABLE A2: COMPOSITION OF FIVE-YEAR FIRM GROWTH

Component Mean Sample Std. Dev.

(1A) Old establishment growth 1.70% 21.39%

(1B) Recently founded establishment growth 5.97% 27.63%

(1C) Recently acquired establishment growth 3.54% 28.31%

(2) Growth from new establishments 38.16% 103.33%

(3) Growth from acquisitions 28.31% 89.86%

(4) Decline in growth from sale of establishments –7.04% 16.22%

(5) Decline in growth from closure of

establishments

–14.12% 17.27%

Net Firm Growth 65.58% 242.06%

Note: The table decomposes the mean three–year growth in firm employment into the various components.

N=16,045. Old establishment growth refers to employment growth in establishments that are at least 6 years old

at year t; Recently founded establishment growth refers to employment growth in establishments that were

founded exactly 5 years ago; Recently acquired establishment growth refers to employment growth in

establishments that were acquired exactly 5 years ago; Growth from new establishments refers to employment

in establishments that were founded between years t and t-5; Growth from acquisitions refers to employment in

establishments that were acquired between years t and t-5; Sale of establishments refers establishments that

were sold to another firm between years t and t-5; Closure of establishments refers to employment in

establishments that were closed between years t and t-5;

3

TABLE A3: COMPOSITION OF 3-YEAR FIRM GROWTH AND GOVERNANCE

Poor Governance Medium

Governance

Good

Governance

t–statistic

(Poor v. Good)

(1A) Old establishment growth 0.14 1.26 3.76 7.78

(1B) Recently founded establishment growth 1.46 2.61 3.26 8.45

(1C) Recently acquired establishment growth –0.00 0.98 3.00 9.60

(2) Growth from new establishments 12.26 16.26 19.78 9.65

(3) Growth from acquisitions 14.24 16.46 18.97 4.39

(4) Decline in growth from sale of establishments –6.96 –4.99 –3.55 11.21

(5) Decline in growth from closure of

establishments

–9.51 –8.89 –7.93 6.15

Net Firm Growth

13.62 27.27 45.57 12.61

Note: Poor governance refers to firms in the highest quartile of G–index (N=5,325). Good governance refers to firms in the lowest quartile of G–

index (N=4,602). Medium governance refers to the remaining firms. All t–statistics are significant at the 5% level or lower.

4

TABLE A4: COMPOSITION OF 5-YEAR FIRM GROWTH AND GOVERNANCE

Poor Governance Medium

Governance

Good

Governance

t–statistic

(Poor v. Good)

(1A) Old establishment growth 0.83 1.34 3.22 5.54

(1B) Recently founded establishment growth 2.54 5.96 10.03 13.17

(1C) Recently acquired establishment growth 0.49 2.85 8.08 13.04

(2) Growth from new establishments 23.72 38.66 54.52 14.50

(3) Growth from acquisitions 22.62 28.06 35.40 6.91

(4) Decline in growth from sale of establishments –9.39 –6.65 –4.81 13.55

(5) Decline in growth from closure of

establishments

–14.66 –14.53 –12.91 5.13

Net Firm Growth

29.41 62.83 112.12 16.33

Note: Poor governance refers to firms in the highest quartile of G–index (N=5,322). Good governance refers to firms in the lowest quartile of G–

index (N=4,504). Medium governance refers to the remaining firms. All t–statistics are significant at the 5% level or lower.

5

TABLE A5: OVERALL 3-YEAR AND 5-YEAR GROWTH AND GOVERNANCE

3–Year Growth (1) (2) (3) (4)

G–index$ –0.010

(0.006)

–0.003

(0.006)

E–index$

–0.042

(0.011)

–0.045

(0.011)

Other Provisions Index

0.007

(0.008)

0.020

(0.008)

N 16,266 16,266 16,266 16,266

R2 0.39 0.39 0.39 0.40

5–Year Growth (1) (2) (3) (4)

G–index$ –0.015

(0.012)

–0.003

(0.012)

E–index$

–0.069

(0.026)

–0.075

(0.026)

Other Provisions Index

0.015

(0.017)

0.038

(0.016)

N 16,045 16,045 16,045 16,045

R2 0.42 0.42 0.43 0.43

Note: $: Coefficients and standard errors multiplied by 100. All models include prior employment as a control.

In addition, Models 3 and 4 include all controls from Table 4 in the main text. Coefficients on controls not

presented. All regressions include fixed effects for each SIC3–year combination. Standard errors clustered by

firm presented in parentheses. Coefficients significant at or below the 10% level highlighted in bold.

6

TABLE A6: SUBCOMPONENTS OF 3-YEAR GROWTH AND GOVERNANCE

G–index G–index

(with Controls)

E–index E–index

(with Controls)

(1A) Old establishment growth –0.124

(0.110) –0.027

(0.109) –0.509

(0.238) –0.430

(0.233)

(1B) Recently founded

establishment growth

–0.157

(0.441)

–0.092

(0.043)

–0.297

(0.103)

–0.301

(0.101)

(1C) Recently acquired

establishment growth

–0.147

(0.063) –0.039

(0.062) –0.384

(0.139) –0.389

(0.137)

(2) Growth from new

establishments

–0.429

(0.194) –0.186

(0.194) –0.892

(0.398) –1.104

(0.386)s

(3) Growth from acquisitions –0.064

(0.288)

0.100

(0.209)

–0.862

(0.545) –0.114

(0.054)

(4) Decline in growth from sale

of establishments

–0.229

(0.073) –0.216

(0.075) –0.454

(0.169) –0.400

(0.168)

(5) Decline in growth from

closure of establishments

–0.192

(0.071) –0.215

(0.070) –0.285

(0.160) –0.182

(0.156)

Note: All coefficients and standard errors multiplied by 100. The first and the third columns include only lagged

employment as a control. Columns 2 and 4 include the full set of controls from Table 4. All regressions include

fixed effects for each SIC3–year combination. Coefficients on these fixed effects and other controls are not

presented. Standard errors clustered by firm presented in parentheses. N=16,266 in all regressions. Coefficients

significant at or below the 10% level highlighted in bold.

7

TABLE A7: SUBCOMPONENTS OF 5-YEAR GROWTH AND GOVERNANCE

G–index G–index

(with Controls)

E–index E–index

(with Controls)

(1A) Old establishment growth 0.111

(0.126)

0.110

(0.126)

–0.369

(0.238)

–0.290

(0.237)

(1B) Recently founded

establishment growth

–0.259

(0.117)

–0.097

(0.116)

–0.666

(0.257)

–0.669

(0.252)

(1C) Recently acquired

establishment growth

–0.311

(0.149)

–0.115

(0.143)

–0.642

(0.314)

–0.634

(0.310)

(2) Growth from new

establishments

–1.01

(0.518)

–0.469

(0.505)

–3.23

(1.16)

–3.47

(1.13)

(3) Growth from acquisitions –0.255

(0.549)

–0.310

(0.543)

–1.20

(1.06)

1.63

(1.06)

(4) Decline in growth from sale

of establishments

–0.304

(0.102)

–0.293

(0.103)

–0.640

(0.214)

–0.550

(0.214)

(5) Decline in growth from

closure of establishments

–0.186

(0.110)

–0.224

(0.108)

–0.158

(0.248)

–0.059

(0.243)

Note: All coefficients and standard errors multiplied by 100. The first and the third columns include only lagged

employment as a control. Columns 2 and 4 include the full set of controls from Table 4. All regressions include

fixed effects for each SIC3–year combination. Coefficients on these fixed effects and other controls are not

presented. Standard errors clustered by firm presented in parentheses. N=16,045 in all regressions. Coefficients

significant at or below the 10% level highlighted in bold.