High-employment-growth firms: defining and counting them
Related to the issue of short-run transitory growth is whether high-growth firms should be defined on the basis of sustained growth—that is, growth each year—over the 3-year period. It is reasonable to state that a firm which grows by, say, 20 percent a year for 3 consecutive years is a high-growth firm during this 3-year period. This firm has grown by 72.8 percent growth over 3 years (1.2 × 1.2 × 1.2 = 1.728). But should a firm that grows by 72.8 percent in 1 year, with no growth in the other 2 years, be considered a high-growth firm? We believe yes. The primary reason, continuing with the example, is that firms which have grown by 72.8 percent in 1 year with no growth in the other 2 years have created the same number of jobs in a 3-year timeframe as firms which have grown by 20 percent in 3 consecutive years. When defining high-growth firms by the number of jobs created during a 3-year period, the year-by-year pattern of how those jobs were created should not matter.
Some of the first estimates of high-growth firms in the literature did not use the OECD definition or another definition that incorporates a threshold; instead, these estimates focused on the top 1 percent of growing firms. The problem with this top-1-percent approach is that it is difficult to create a consistent time series of high-growth firms because the threshold that defines the top 1 percent of firms is higher during the expansion phase of the business cycle than during the contraction phase.
The OECD threshold (average annualized growth of 20 percent per year over a 3-year period) is measured as a percentage rather than as a level. Measuring high-growth firms as those which grow by a certain percentage will lead to small firms being more likely to be classified as high-growth firms, as it’s easier for a small firm than a large firm to grow by 20 percent—for example, a five-employee firm needs to add just one employee. On the other hand, measuring high-growth firms as those which grow by a certain level will lead to large firms being more likely to be classified as high-growth firms, as it’s easier for a large firm than a small firm to grow by 20 employees. To avoid classifying small firms with a small amount of growth as high-growth firms, the OECD definition requires high-growth firms to have 10 or more employees.
The estimates presented in this article differ from the OECD definition on this point. In the U.S. private sector, more than 75 percent of firms have fewer than 10 employees.7 This means that the OECD definition excludes the approximately 3.8 million firms (of the 5 million total private-sector firms) with fewer than 10 employees from being classified as high-growth firms. The modified OECD definition used in this paper incorporates a threshold in both levels and percentages.
This paper uses a “kink point” approach for defining a threshold in both levels and percentages. Under the OECD definition, as previously noted, firms with 10 or more employees are classified as high-growth firms if they grow by more than 72.8 percent over a 3-year period (this is equivalent to average annualized growth of greater than 20 percent per year over a 3-year period). Thus the threshold for a firm with 10 employees is growth of 7.28 employees or more over 3 years. Expressing this in integers—because the BED does not measure fractions of a job—a firm with 10 employees needs to grow by 8 or more employees over a 3-year period to be classified as a high-growth firm. The “kink point” approach says that any firm with fewer than 10 employees that grows by 8 or more employees over a 3-year period will be classified as a high-growth firm. Combining this 8-employee-or-more threshold with the OECD threshold of 72.8 percent or more includes both small firms and large firms in the analysis. The threshold in levels—8 or more employees—will be the relevant threshold for defining small firms as high-growth firms, and the threshold in percentages—72.8 percent or more—will be the relevant threshold for defining large firms as high-growth firms.