ABSTRACT
INTRODUCTION
THEORY DEVELOPMENT AND HYPOTHESES
DATA AND METHODS
RESULTS
DISCUSSION
LIMITATIONS
DIRECTIONS FOR FURTHER RESEARCH
CONTACT
REFERENCES
TABLE 1
TABLE 2

This study examines the economic impact of entrepreneurship by measuring and comparing the wealth created by small, medium, large, and very large U.S. publicly traded firms. Market Value Added (MVA) is used to operationalize wealth creation. From a population of approximately 8,000 U.S. publicly traded firms, two random stratified samples of 240 are selected: one for 1989 and one for 1999. Results indicate that (1) larger firms possess more absolute wealth, (2) smaller firms have larger annual percentage increases in wealth, and (3) that the relative economic impact of smaller ventures appears to be increasing.

Although smaller firms have been shown to create the majority of new jobs in America (Birch, 1979; Storey and Johnson, 1987), little research has been undertaken to identify whether or not a similar wealth creation relationship exists. This study is an exploratory first pass at the examination of how entrepreneurship and smaller firms economically impact society. Specifically, we attempt to answer: (1) Where does wealth reside among U.S. firms?, (2) Do smaller firms create significant wealth in the U.S. economy?, and (3) How is the economic impact of smaller firms changing over time? We compare the wealth creating impact of smaller ventures with that of larger firms, and do so with 1989 and 1999 data to examine change over time.

The essence of entrepreneurship is creation (Meeks and Meyer, 2001). Venkataraman (1997), and later Shane and Venkataraman (1999) argue that entrepreneurship research is not only interested with how and by whom products are discovered, created, and exploited; but also with the “consequences” of such creation. These consequences may include organization-, job-, and/or wealth-creation. The primary motive behind entrepreneurial activity is self-interested wealth creation (Smith, 1776; Schumpeter, 1934; Say, 1816) primarily enacted through the creation of organizations (Gartner, 1985). Regardless of whether entrepreneurial wealth creation is motivated through the lure of high profit potential (Schumpeter, 1976; Kirzner, 1973) or low opportunity costs (Amit, et al., 1995; Reynolds, 1992); or whether entrepreneurs act as gap creators (Schumpeter, 1934) or gap exploiters (Kirzner, 1973; Say, 1816); the societal significance of the entrepreneurial process is the creation of job- and wealth-creating organizations.

The creation of business organizations is a direct consequence of the entrepreneurial process, and business organizations are the mechanisms through which members of developed societies create new economic wealth. Prior to 1979, labor economists and policy makers believed, based on published and well-documented labor statistics, that most new jobs in America were created by very large established firms. Birch (1979) changed that paradigm with his study demonstrating that most new jobs were, in fact, created by small businesses. We now know that small businesses (1) play an important role in technological change, (2) generate market turbulence that provides additional competition, (3) promote international competitiveness, and (4) create new jobs (Acs & Audretsch, 1993; Birch, 1979; Birley, 1986; Kirchhoff & Phillips, 1988; Kirchhoff, 1994). Could small firms also represent a substantial wealth creation engine for America?

This study tests the general equilibrium theory—the dominant macro-economic paradigm in the U.S. for most of the 20th Century—on wealth creation by examining the effect of firm size (small vs medium vs large vs very large business) on firm-level wealth creation. Specifically, this study tests Industrial Organizational Economics performance theory on the economic performance of U.S. publicly traded firms by comparing the wealth created by (1) small firms with fewer than 500 employees, (2) small to medium sized enterprises (SMEs) with 500–5,000 employees, (3) large firms with 5,000–100,000 employees, and (4) very large businesses with more than 100,000 employees. Wealth creation herein refers to the change in organizational wealth over time; wealth being an economic measure of a firm’s long-term survivability (Smith, 1776; Drucker 1954).

Effect of Size on Wealth Creation

General equilibrium theory—built on the neo-classical model of capitalism developed in the late 19th century—contends that any disequilibria in the market will move toward its natural state of equilibrium, and will do so in a manner such that static models provide both explanatory and predictive use. General equilibrium theory and Industrial Organizational Economics holds that market share, economies of scale, and proven routines are necessary for long-tern sustainable competitive advantage (Bain, 1956; Caves, 1964; Porter, 1980, 1985). The resources necessary to increase market share, capitalize on economies of scale, and develop proven routines are disproportionately available to larger firms (Cooper & Dunkelberg, 1986). Penrose (1959) suggests that as firms reorganize their resources as they grow in size, and these new combinations often necessitate different management practices to sustain economic performance (Miller & Freisen, 1984). Freeman (1989), using ‘number of employees’ as an indicator of size, found that among U.S. semiconductor firms between 1946 and 1984, larger firms significantly outperformed smaller firms. Barnett & Carroll (1987) found the same liability of smallness among telephone companies; as did Freeman & Hannan (1983) regarding California restaurants. In addition, Delacroix et al (1989) found that among California wineries between 1940 and 1985, the larger wineries significantly outperformed their smaller competitors.

Liabilities of smallness include difficulty of raising capital, tax laws, governmental bureaucratic reporting burden, and labor acquisition limitations due to inability to provide workers with perceived stability (Aldrich & Auster, 1986). A firm’s size can limit its access to strategic resources, and thus impede its performance (Cooper & Dunkelberg, 1986). The liability of size is frequently used to explain inferior performance among smaller firms (Stinchcombe, 1965; Hannan & Freeman, 1977; Aldrich & Auster, 1986; Venkataraman & Low, 1994). Noori (1987) suggests that smaller firms, because of their lack of information, financial, and human resources, are more vulnerable. Therefore we postulate that:

Hypothesis 1a: Larger firms create more annual wealth than do smaller firms.

Hypothesis 1b: Larger firms have a larger annual percentage wealth increase than do smaller firms.

If Industrial Organization Economics theory holds true, then larger firms should outperform smaller firms. As wealth is accumulated over time as a result of superior performance, it would follow that:

Hypothesis 2: Larger firms possess more wealth than do smaller firms.

Punctuated equilibrium theory challenges the general equilibrium model positing firms exist in a static environment interrupted by brief periods of cataclysmic adjustment (Miller & Friesen, 1984; Tushman & Romanelli, 1985; Schumpeter, 1934). The entrepreneurial process of creative destruction (Schumpeter, 1934) requires change, and this change is often viewed as disruptive and to be avoided (Hannan & Freeman, 1984; Romanelli & Tushman, 1994). Both general equilibrium theory and punctuated equilibrium theory rely strongly on the assumption that equilibrium is a natural state, and that markets tend toward this state. However, in today’s increasingly hyper-competitive, global, and dynamic environment, continuous change is becoming unavoidable (D’Aveni, 1994; Brown & Eisenhardt, 1997). In today’s business environment, firms must be flexible, adaptable, and responsive if they are to achieve above market rents (Hitt & Ireland, 2000). It may be that in a dynamic environment, the liabilities of smallness may be somewhat offset by the ability to quickly adapt to environmental changes.

Advances in technology have, in many ways, leveled the playing field with regard to size. McKenna (1997) argues that where once size lead to competitive advantage via economies of scale; in today’s business environment; smaller nimble firms have an advantage. As responsiveness becomes more critical, time-compressed decision processes are necessary to meet the needs of customers, adapt to the environment, and compete in a continuously changing competitive landscape (Bettis & Hitt, 1995; Brown & Eisenhardt, 1998). The tide of “liabilities of size” may be shifting.

In their efforts to link organizational ecology and business strategy perspectives, Aldrich and Auster (1986) argue, “Large, aging organizations face a number of constraints which severely limit their possibilities of metamorphosing and adapting to changing conditions.” Such liabilities include developmental processes, internal inertia, and external dependencies. Given these liabilities of largeness, and if D’Aveni (1994), Brown & Eisnehardt (1997), and Hitt & Ireland (2000) are correct in their assessment of the new competitive landscape, then we would expect:

Hypothesis 3a: Over recent time, the share of total wealth held by small businesses to increase more than that of larger firms.

Hypothesis 3b: Over recent time, the percentage increase in firm wealth to increase more for small businesses than it does for large firms.

Sample and Data Collection

The data for this study were drawn from a sampling frame of all U.S. publicly traded firms as of January 1, 1989 and a similar sampling frame as of January 1, 1999. For firms to qualify, they must be incorporated and based primarily in the United States, and they must be traded on a U.S. stock exchange. The sampling frame was built from COMPUSTAT, CRSP, Gale, Moodys, and EDGAR data sources; representing the New York, American, Boston, Chicago, Over-the-Counter, NASDAQ-NM, NASDAQ-SC, Pacific, Midwest, and Philadelphia stock exchanges. COMPUSTAT reports there to be 10,422 such firms as of January 1st 1989, and 9,383 such firms on January 1st 1999. Because COMPUSTAT reports firms that are no longer active, we were forced to remove inactive firms from the sampling frame, most of which had been acquired or were no longer in business. We also eliminated foreign firms that trade on U.S. stock exchanges. After eliminating foreign firms and firms that are no longer active, and correcting for duplicate entries, the 1989 sampling frame consisted of 7,838 firms, and 1999 frame included 8,183 firms. The resulting sampling frames were then stratified by size, size being determined by number of employees. The final data set, obtained by stratified random sampling, contained 480 companies; 240 for the 1989 group, and 240 for the 1999 group.

We collected data for the dependent variables on the first and last trading days of 1989 and 1999. We collected data on size as of the first trading day of the year in question. The data were collected from a minimum of two of the following data sources: COMPUSTAT, CRSP, Wharton Research Data Services (WRDS), Gale, Moodys, EDGAR, quicken.com, stockquotes.com, and stocktools.com. Surprisingly, over 32% of our sample contained errors that we corrected, most of which appeared to be data entry errors (e.g one firm was listed as having 500,000 employees, but upon further investigation and review of their SEC 10-K filing, it was determined that the firm only had 30 employees. It did, however, have 500,000 outstanding shares—an apparent data entry error).

All firms in the sampling frame were placed into nine strata, based on size as determined by number of employees. Strata were then grouped into four categories: small firms (0–500 employees), medium firms (501–5,000 employees), large firms (5,001–100,000 employees), and very large firms (100,000+ employees). A random stratified sample was selected for each of the four groups.

Dependent Variables: Wealth and Wealth Creation

Economic performance and social wealth creation are relevant benchmarks of entrepreneurial pursuit. Traditional measures of performance—profit, margin, market share, and financial ratios ad nauseam—are plagued with problems such as relying on unrealistic historically-based accounting measures, resources charged off as expenses, tax manipulation strategies, no allocation for organizational learning, short-term versus long-term goal orientation, and lack cost of capital consideration (including opportunity costs) (Hubbard & Bromiley, 1995; Ebhar, 1998). Because stock prices are set, within a market economy, by members with disbursed knowledge (Hayek, 1945) and the ability to trade property rights (Coase, 1937); the pricing mechanism, the invisible hand of the market system (Smith, 1776; von Mises, 1944; Hayek, 1945; Coase, 1937), provides an effective and efficient measure of economic performance for public organizations (Ebhar, 1998; 1999). Therefore, we use market capitalization—the product of stock price and number of outstanding shares of stock—as a best available measure of wealth.

Economic Value Added (EVA) charges the cost of all firm employed capital against profit (Ehrbar, 1998, 1999; Grant, 1997; Drucker, 1995), and MVA (Market Value Added measures wealth creation as the difference between the total capital tied up in an organization over its life (i.e. reinvested profits and funds from stockholders and lenders), and the market value of the firm’s equity and debt (Ehrbar, 1999). Although EVA is an improved measure of economic performance, Market Value (MV) and Market Value Added (MVA) provide parsimonious measures of wealth and wealth creation respectively. We computed MV and MVA for each firm in the sample, using the 30-day average closing stock price. We included stock options data in the calculation.

Independent Variable: Size and Time

Differentiating between small and large businesses is a difficult task. White et al (1982, p3) reported, “A Congressional committee in the USA was presented with 700 definitions of a small business.” For this study, we will measure firm size by number of employees at the beginning of the calendar years of interest, adopting the Small Business Administration definition of small business: firms with fewer than 500 employees. For categorization purposes, firms were divided between small business (SB), small to medium enterprises (SME), large business (LB), and very large business (VLB). Small businesses are those firms with fewer than 500 employees; small to medium sized enterprises are those firms with 501 to 5,000 employees; large firms are those with 5,001 to 100,000 employees, and very large firms are those firms with more than 100,000 employees.

Time is used to (1) differentiate between organizational wealth at the beginning and end of a one-year period, and (2) to differentiate between the dependent variables (i.e. MV and MVA) at the beginning and end of the 1990s decade.

Analysis

To address our research questions, six separate analyses were performed on the data in this study, using analysis of variance to test for significance between group means. The first analysis examined absolute wealth as measured by total market value of the firm at the end of each year (i.e. 1989 and 1999). The second analysis examined the amount of wealth created during the years in question as measured by the increase in firm market value (MVA). The third analysis examined the percentage increase in firm wealth as measured by percentage of market value added (PMVA). In each of these analyses a two-way ANOVA provided comparisons between different size firms and differences between the 1989 and 1999 data (see Table 2).

Hypothesis 1a (larger firms create more annual wealth than do smaller firms) was supported for the 1989 data at the 0.05 level, however, due to exceedingly large variation among 1999 firms market value added, the 1999 results were not statistically significant. Nonetheless, of the $296 billion wealth created in 1989, large and very large firms created 66.5%. Results from the 1999 data indicate just the opposite: that small businesses created 5.6% of the $1.16 trillion generated by U.S. publicly traded firms that year and SMEs created 54.7%, whereas the large and very large firms only generated 23.1% and 16.7% respectively.

Hypothesis 1b (larger firms have a larger annual percentage wealth increase than do smaller firms) was not supported. In fact, the opposite was found to be true. Very large firms in 1989 and 1999 actually lost 1.1% and 2.4% of their accumulated wealth respectively and large firms increased their wealth a mere 2.1% and 1.2%. In contrast, SMEs during the same periods increased wealth by 16.9% and 18.8%, and small businesses increased by 92% and 74%. These results are supported at a .002 level of statistical significance.

Hypothesis 2 posited that larger firms possess more total accumulated wealth than do smaller firms. Results indicate Very Large firms do indeed enjoy significantly higher levels of accumulated wealth. In 1989, small businesses accounted for a mere 5.9% of the total market value of all U.S. publicly traded firms, SMEs 12.1%, and Large and Very Large firms 62% and 20% respectively. Firms with more than 5,000 employees, although they represent only 12.2% of the U.S. publicly traded firms in 1989, account for 82% of accumulated wealth. Data for 1999 support similar findings: firms with more than 5,000 employees enjoy 87.3% of the accumulated wealth, while representing only 15.5% of our population.

Time appears to have a significant impact on wealth creation. Hypothesis 3a (over time, the share of total wealth held by small businesses increases relative to that of larger firms) was supported at the 0.05 level. The share of wealth held by small businesses and SMEs increases from 5.9% in 1989 to 9.2% in 1999, and from 12.1% in 1989 to 18.3% in 1999 respectively. Large firms, however, also increased their share of accumulated wealth from 62% to 67.7%. Very large firms had a significant loss in share of total wealth, dropping from 20% to 4.8%. Hypothesis 3b (over time, the percentage growth in firm wealth increases more for small businesses than it does for large firms) was also supported at the 0.05 level, although mixed in effect, as large firms and very large firms experienced a decrease in their percentage growth of wealth from 2.1% to 1.2% and from -1.1% to -2.4%, while small businesses also experienced a decrease from 92% to 74% PMVA. SMEs, however, increased PMVA from 16.9% to 18.8%.

A central thrust of this research was an exploratory effort toward investigating a possible relationship between small business and wealth creation, similar to the “small business to job creation” relationship revealed by Birch (1979). We addressed three research questions: (1) Where does wealth reside among U.S. publicly traded firms?, (2) Do smaller firms create significant wealth in the U.S. economy?, and (3) How is the economic impact of smaller firms changing over time? We believe that the answers to these three questions are clearer as a result of this study. Wealth appears to reside primarily in larger U.S. firms and the results herein suggest that this is changing. Smaller firms do create significant wealth and, more importantly, the percentage of wealth increase is significantly larger among small firms. Although further research is needed, it may be, based on the results of our study, that the very large corporate behemoths are wealth destroyers rather than wealth creators. It also appears that the economic impact of smaller firms is significantly increasing over time.

These results are significant to the development of general equilibrium and punctuated equilibrium theories, which suggest that market economies tend toward a steady state of equilibrium. If this were true, the benefits of largeness would manifest in significantly larger wealth creation capacity for firms enjoying such size. But this does not appear to be the case, and the new competitive landscape model of rapid and relentless change does appear appropriate.

This study may aid in the advancement of the resource based view (Barney, 1986; Penrose, 1959; Wernerfelt, 1984) and/or the dynamic capabilities perspective (Teece, et al, 1997; Eisenhardt & Martin, 2000). As resources are reorganized and bundled during organizational growth (Penrose, 1959), the marshalling of resources to create competitive advantage to increase market share and/or capitalize on economies of scale (Miller & Freisen, 1984) may not be as strategically effective as structuring resource sets to create agility, flexibility, and customer responsiveness (Teece, et al, 1997). Considering employees as a critical resource, we calculated the mean MVA per employee and found that for 1999, small businesses generated $195,219 in MVA per employee and SMEs generated $170,142 MVA per employee. However, large and very large firms only generated $25,538 and $15,229 MVA per employee respectively.

We hope that in opening this important line of empirical inquiry, we will motivate policy, strategy, small business, and entrepreneurship researchers to advance our understanding of the impact of entrepreneurship and small business on wealth and wealth creation.

As in most exploratory research, several limitations exist. First, the sample of U.S. publicly traded companies chosen for this study, although representative of U.S. public companies, is not representative of the entire U.S. business economy. In fact, publicly traded firms represent less than 0.05% of all 25-million U.S. businesses and less than 0.1% of all U.S. employers (Dennis, 1998). The size dimension chosen to delineate smaller new ventures from their larger counterparts would probably not be appropriate for private firms. This is because by the time a typical firm goes public, it is of sufficient size and age to be significantly different than firms much younger and smaller. Nonetheless, this study provides empirical evidence that entrepreneurial activity is a significant contributor to economic wealth.

An additional challenge to this type of research is the difficulty associated with assigning wealth data to a particular size category because multi-business firms often merge, are acquired, or simply disappear. If an SME with 4000 employees, and significant wealth, is acquired by a very large firm with insignificant wealth creating capacity, the positive performance of the acquired firm can easily get lost in the data shuffle. Market fluctuations, which can distort results, are a common occurrence, and why we used 30-day average of closing stock price when calculation market valuations.

We did not control for industry, as we were attempting to get a “feel” for the entire U.S. publicly traded market. It may well be that industry effects significantly impact wealth creation and the results of our study. One last limitation was that inflation was not accounted for. Correcting for inflation would most likely enhance the results herein, increasing the negative PMVA values for the very large firms, more clearly identifying these firms, on average, as wealth destroyers.

The same cry made by Aldrich and Auster (1986) still applies today: there is a genuine need to investigate the processes that underlie the effects of age and size.As noted, although previous research has shown the link between entrepreneurial endeavor and job creation (see Birch 1979), very little research effort has been directed at establishing and then exploring a dependent variable for the field entrepreneurship. If, as Venkataraman (1997) suggests, the consequences of entrepreneurial activities are of import, then we believe that further research needs to be done in the area of performance evaluation with respect to entrepreneurial activity.

Studies to better understand how well EVA and MVA evaluate performance, and the correlation of these measures should be undertaken. How valid are these measures of wealth? Are wealth, performance, and effectiveness independent constructs, or different measures of the same construct?

Of primary concern in future research should be bridging the gap between the performance measures of private and public companies. As management scholars we are bound to endeavor to better understand the wealth accumulation and wealth creation capacities of all firms, large and small. As always, this research should be extended internationally. We believe that such international research is a particularly exciting avenue for further exploration.

CONTACT: Michael D. Meeks, University of Colorado, Campus Box 419, Boulder, CO 80309-0419; (T) 303-440-7997; (F) 720-294-0201; mmeeks@colorado.edu

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