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Age of Firms: Irrelevance Proposition Modern Economy, 2019, 10, 1446-1478 http://www.scirp.org/journal/me ISSN Online: 2152-7261 ISSN Print: 2152-7245 Age of Firms: Irrelevance Proposition Gautam Vora Anderson School of Management, University of New Mexico, Albuquerque, NM, USA How to cite this paper: Vora, G. (2019) Abstract Age of Firms: Irrelevance Proposition. Modern Economy, 10, 1446-1478. Age of firms is used with an alarming regularity in various studies in the fields of https://doi.org/10.4236/me.2019.105097 organizational behavioral, accounting and corporate finance/law/governance, industrial economics and the like. The variable “firm age” is typically called a Received: August 28, 2018 Accepted: May 24, 2019 control variable. Why it is necessary or what it controls is infrequently ex- Published: May 27, 2019 plained. The variable’s statistical significance or insignificance is duly noted; explanation thereof is hardly ever provided. This paper demonstrates that this Copyright © 2019 by author(s) and variable does not provide any sensible information its users would have us Scientific Research Publishing Inc. This work is licensed under the Creative believe. The paper provides numerous examples demonstrating that mana- Commons Attribution International gerial discretion changes the nature and value of the firm, thereby negating License (CC BY 4.0). the value of the variable. We recommend that a conceptual foundation be se- http://creativecommons.org/licenses/by/4.0/ cured before using the variable and it not be wantonly used as a control or Open Access fixed-effect variable. Researchers would do well to report the effect size in- stead of merely statistical significance at some level. Keywords Firm Age, Control Variable, Fixed Effect, Effect Size, Irrelevance Proposition, Strategic Management, Firm Evolution, Theories of the Firm 1. Introduction “Age of firm” (also “firm age”; both phrases are used interchangeably) is used with an alarming regular frequency in various studies in the fields of organiza- tional behavioral, accounting and corporate finance, law and law and economics, corporate governance, industrial economics and the like. Rarely is the variable used as an explanatory one; the variable is typically called a control variable. Why it is necessary or what it controls is infrequently explained. The variable’s statistical significance or insignificance is duly noted; explanation thereof is hardly ever provided.1 1See, for example, Kim, Park and Wier [1]. They include firm age as a variable in the empirical work “to control for the potential effect across different developmental stages of the business”. DOI: 10.4236/me.2019.105097 May 27, 2019 1446 Modern Economy G. Vora In this paper we take on the challenge of demonstrating the irrelevance of the use of the age of firm variable. We demonstrate that this variable does not pro- vide any sensible information its users would have us believe. Scholars who use this variable in studies in management and strategic management often appeal to Cyert and March [2] [3]2 or Penrose [4]. As the works of Penrose have be- come more popular, the use of the variable is attributed to a resource-based view of the theory of the firm. While management scholars have embraced Penrose and created an enormous amount of literature on the resource-based view and its extensions, nowhere does Penrose or her followers imply that firm age is de- terrence to the production of knowledge or growth of the firm. The other two dominant views of the firm, viz., transaction-cost economics or agency theory do not make any prediction about the age and its effect on transaction or agency costs for organization. The vast literature on corporate governance is also nearly silent on the issue of firm age.3 A review of the literature across disciplines lays bare the absence of conceptual, theoretical and empirical studies using firm age as an explanatory variable (or dependent variable!) in organizational behavior studies or strategic management studies, despite its often perfunctory inclusion as a control variable. The areas of finance and accounting have seldom used the variable and typically the use is not well-integrated. The literature does offer a few instances in industrial economics where the variable is justifiably used. A majority of studies claim to use firm age as a control variable. It will not be an exaggeration to say that these studies would not lose any of their potential if the variable of firm age were left out. At the minimum one would not be able to al- lege that they are using it superfluously. We first review the literature where this variable is used. We then explore a more recent debate about the interpretation of variable effect sizes which might be used to argue that age of firm variable actually does explain something mea- ningful. However, we find this argument to be without merit. We provide nu- merous examples showing that managerial discretion changes the nature of the firm, thereby negating the value of the firm age variable. We conclude that these examples demonstrate the lack of relationship between the age of a firm and its ability to adapt to environmental changes. 2. Is Age of Firm Variable Informative? This section provides a review of potential theoretical bases for the use of the age of firm variable. It seems customary to attribute the relevance of age of firms to the first edition, published in 1963 [2], of Cyert and March [3]. They, however, do not address importance of the age of firms at all. Nevertheless, one may be able find an implication about age of firms from their discussion of the firm as 2Their 1963 book almost surely incorporated insights from March and Simon [5]. 3Consider one of most cited survey by Shleifer and Vishny [6] to be representative of this literature. Also, visit A Survey on Corporate Governance at https://corgovinstitute.com/a-survey-on-corporate-governance/. More discussion is provided in a section below. DOI: 10.4236/me.2019.105097 1447 Modern Economy G. Vora an adaptive institution (§5.2, pp. 117-120) and (§5.3, pp. 120-133) because they state, “the firm learns from its experience” (p. 118) and list three basic principles of the standard operating procedures, viz., 1) avoid uncertainty, 2) maintain the rules, and 3) use simple rules (p. 121). These sections may be construed as an approximation of rigidity of the processes of decision-making or ossification of views about changing environment or status-quo mentality of the top manage- ment team, with the implication that these would increase as a firm ages and impair the ability of the firm to change itself in response to changing conditions. Even though March ([7], p. 563) is quite clear when he states, “Organizations are continually changing, routinely, easily, and responsively, but change within them cannot ordinarily be arbitrarily controlled. Organizations rarely do exactly what they are told to do.” Later, on the same page, he adds: What most reports on implementation [of public policy in public organiza- tions] indicate, however, is not that organizations are rigid and inflexible, but that they are impressively imaginative. The ability to frustrate arbitrary intention [of an arbitrary group of public policy-makers], however, should not be confused with rigidity; nor should flexibility be confused with orga- nizational effectiveness. Most organizational failures occur early in life when organizations are small and flexible, not later. Despite this, researchers have continued to allude to ossification or perception thereof.4 After Cyert and March an appeal may be made to Hannan and Freeman [8] through the concept of structural inertia. In their work, however, Hannan and Freeman [8] [9] lend support to the adaptability of firms to volatile environment through the lens of ecological-evolutionary process. They examine inertial pres- sures on organizations, labelling this tendency “structural inertia”, and scrutin- ize how their strength varies with age, size and complexity. The reader, however, should recognize that the claim of strong inertial pressures does not equate to the claim that organizations never change, but that organizations respond dy- namically and deliberately to threats and opportunities in their environments. They state (p. 151) “structures of organizations have high inertia when the speed of reorganization is much lower than the rate at which environmental conditions change.” They develop some testable propositions, viz., 1) Structural inertia in- creases monotonically with age, 2) Organizational death rates decrease with age (the “liability of newness hypothesis” due to Stinchcombe [10]), 3) Attempts at reorganizations increase death rates (depending on size, defined by the number of employees), 4) Complexity (of an organization which is non-hierarchical with multiple interconnected units) increases the risk of death due to reorganization. Brüderl and Schüssler [11] study West German business organizations to intro- duce the concept of a “liability of adolescence” and provide empirical evidence. 4Merton [13] actually anticipates March and his associates extremely well in his study of bureaucra- cy. He credits Mannheim [14], (revised and expanded in [15]) for the development of the concept of “rational organization”. DOI: 10.4236/me.2019.105097 1448 Modern Economy G. Vora Hannan [12] provides three logical formalizations for empirical findings con- cerning the relation between organization age and the hazard of mortality. These formalizations depend on five concepts of endowment, imprinting, inertia, ca- pability and position. Thus it is structural inertia which may hinder organiza- tional choice in decision making, not firm age per se. More commonly, it is the “resource-based view” (RBV) (also known as “re- source-based theory” (RBT)) attributed to Penrose [4] that is often cited for the inclusion of the variable “firm age” in various empirical studies in the fields of organizational studies and strategic management where the Penrosean viewpoint of the firm as a resource-based or knowledge-based or dynamic capabili- ties-based entity is one of the most widely accepted perspectives.
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