Small and large firms behave differently over the business cycle

The business cycle affects firms differently based on size. Large firms as measured by the top 1% in size are less sensitive to the business cycle than small firms. However, since these larger firms have high and rising concentration, the impact of small firms is less on the aggregate economy. Small firms may disappear and will not be missed by the economy as a whole as industries become more concentrated. Yet, the impact of small firm failure and growing concentration is not to be dismissed. The impact of economic shocks on firms of different sizes is an important area of research and understanding this affect will be important for those investing in small firms.

Unfortunately, the standard financial accelerator argument that the cyclicality of firms by size is based on financing constraints and frictions does not seem to be as clear-cut as measured by a recent study in the American Economic Review, (November 2020) "Small and Large Firms Over the Business Cycle". While financial constraints may have an impact on firms of different sizes, the relationship between size and financing may be less clear. This is important because current monetary policy is supposed to be geared to helping small firms, yet the premise that credit is the main problem is not substantiated in a close examination of the data. The authors are careful with their analysis. Financial constraints and credit channels may be important but the differential between small and large firm effects is more complex than described by financial accelerator models. 

The negative impact of a recession on sales based on size is significant, but the authors find that the difference in cyclicality of these firms is not based traditional proxies for financial strength. Policies that try and target financing for small business may not be as effective as thought from earlier research which focuses on the financial constraint channel. What seems to be important factors on the size effect are economies of scope and customer capital. Small firms, by being more focused, are more vulnerable to an economic downturn. More concentrated firms by region and product are more susceptible to economic shocks regardless of their financial situation.