CPB Hybrideseminar – The rise in profits and fall in firm entry: A tale of thelife cycle of profits

It is crucial to consider how profits vary over the life cycle of the firm in order to understand why the aggregate profit share has been increasing while firm entry has been declining. All else equal, the more back-loaded profits are, the lower is the value of the firm due to discounting. Therefore, fewer entrepreneurs choose to enter the market, leading to an increase in average profits per firm as market shares are increasing. This makes that profits in the cross-section have increased while the discounted value of profits at entry might not have increased. Empirically, profits have become more back-loaded. Using a quantitative life cycle model of the firm I find that this increase in back-loadedness explains between a third and a half of the rise in profits, and explains 70% of the fall in firm entry.