The distributional effects of selection and capital accumulation on firm productivity under imperfect capital markets

In this evolutionary model, random shocks create differences in the rate of return on capital, while individual saving and investment behavior can reduce these differences over time. Firms with either low total factor productivity (TFP) or a low average return on capital are selected for exit, and new firms enter to take their place. As would be expected, a higher turnover rate improves TFP and reduces its variation. While we show that a higher turnover rate would result in a more positively skewed TFP distribution if exit selection is based directly upon TFP, we find that when we select firms for exit based on their average product of capital, the marginal impact of a higher turnover rate is to more negatively skew the TFP distribution. Overall, our simulations highlight the importance of considering the role selection may play in shaping the distribution of productivity when econometricians seek estimates of firm inefficiency.